The Relevance of Emotional Intelligence in Hedge Fund Leadership

An Exploratory Study

LOREN J REMETTA

Beginning a dialogue on the relationship between hedge fund (HF) leadership and emotional intelligence (EQ) is the objective of this research paper. By composing an exploratory study determining the relevance of EQ in HF leadership, the researcher aims to lay a foundation for future discussion and debate. To our knowledge, this is the first study of its kind in the field.

The study utilised Goleman’s (1998) EQ framework to examine the growth impact of a HF leader’s EQ. More specifically, how determinant is a HF leader’s self-awareness (SA), self-regulation (SR), motivation, empathy and social skill in his success?  Goleman’s model was chosen due to its applicability to both portfolio management and organisational leadership – a HF leader’s primary responsibilities.

The empirical evidence suggests not only is a high level of EQ beneficial to successful HF leadership – it was deemed vital in specific instances. If the fund’s leadership possessed a high level of EQ, the benefits reached beyond performance and AUM growth. Founders with a high EQ positively impacted the culture and climate, and a leader with a lower EQ had converse effects. The leadership of failing funds often had low EQ levels.

What is emotional intelligence?
Dulewicz and Higgs (2000, p.343) contest the roots of this “nebulous” construct of EQ appear to “lie in the apparent inability of traditional measures of rational thinking such as IQ tests or grades to predict who will succeed in life.”

While the definitions of EQ are often varied for different researchers according to Ciarrochi et al (2000), they tend to be complimentary rather than contradictory and cover more or less four distinct areas: emotional perception, regulation, understanding, and utilisation. Rosete and Ciarrochi (2005) classify EQ approaches in two broad categories: ability models (Mayer and Salovey, 1997) and mixed models.

Goleman’s (1998) mixed model was chosen due to its applicability to both aspects of HF leadership, money management and organisational leadership. What piqued the researcher’s interest in Goleman’s (1998) model was the apparent relevance to HFs, yet EQ is rarely acknowledged in the industry.

“In HFs, most have an analytical mind-set and underdeveloped EQ relative to the average population. Also, EQ is not really encouraged or rewarded” (Interviewee D).

Fig.1 highlights Goleman’s (1998) five components of EQ used for the study.

An anonymous electronic survey addressing the topic was completed by thirty-one HF founders, investors, advisors, and employees. Further data was collected on EQ and HF leadership via eleven in-person interviews with the majority of the group being HF employees.

The survey of thirty-one industry members produced a strong consensus on the relevance of EQ in HF leadership. The strength of the survey’s consensus formed two hypotheses on EQ which were tested by the interview process.

The interviews with HF employees resulted in short case studies on each fund where they were employed. The cases formed a model assessing a leader’s level of EQ combined with the fund’s returns indicating a likelihood of failure and success.

Hedge fund leadership – the founder as the leader
“Minerva, the Roman goddess of wisdom, is said to have sprung full-blown from the forehead of Zeus. Similarly, an organisation’s culture begins life in the head of its founder – springing from the founder’s ideas about truth, reality and the way the world works” (Schein, 1983, p.13). The founder’s effect penetrates nearly every aspect of a fund’s climate and culture.

“The leadership was a one man show. The founder owned the majority of the firm where it was very much a culture of personality. His name was on the door with 18 years of successful track record” (Interviewee D).

“The founder effect can have a profound impact. The firm was named after him, and that should tell you it was his firm. He was involved in every day to day aspect. He was influential and did not want anyone building relationships that could threaten him” (Interviewee E).

Even in situations where a CEO or COO is present and there is a separation of responsibility, “it is usually the leader that runs the money, and the public figure is the head of investment,” said Interviewee B. “This places a significant amount of pressure on the founder when it comes to managing the emotions of investing and isolating those from impacting business development decisions” (Interviewee K).

Is EQ developable?
Dulewicz and Higgs (2004) concluded that there is evidence to support the belief that EQ is capable of being developed. They categorised intra-personal enabling traits such as SA as developable along with interpersonal sensitivity and influence and other traits such as motivation, emotional resilience, and intuitiveness as static (ibid, 2004).

Emotional contagion
Stubbs (2005) completed a study analysing various air force regiments and groups to assess the team leader’s EQ competencies that affect the emergence of emotionally competent group norms (ECGN) in a team. The research showed that a team leader’s EQ effects team performance through the ECGN that are established on the teams they lead and that individual EQ and  group emotional intelligence (GEI) are correlated despite being two distinct concepts (Stubbs, 2005).

Shortcomings of EQ
The concept of EQ certainly has many critics particularly in academia debating if it is true intelligence, a trait or just simply personality.

“Locke (2005) states that the individual does not reason with emotion, he just reasons about it. Locke (2005) dismisses the idea of EQ since he considers the ability to successfully navigate and adapt to certain emotional responses learned behaviours and not a trait. Becker (2008) also criticises the idea of EQ as an individual trait by positing that EQ might just be the presence of high level of personality traits of agreeableness and extraversion” (Locke, 2005; Becker 2008; cited by Ghuman, 2011, p.419). Keeping in mind these criticisms, the purpose of the study is to explore the growth impact of a HF leader’s EQ defined by Goleman (1998).

Survey results
After sending roughly fifty requests via surveymonkey.com, the sample for the survey consisted of thirty-one industry participants (Fig.2) answering eight questions. An email was sent requesting their participation along with Fig.1 highlighting Goleman’s (1998) EQ framework which formed the basis of their replies. Most respondents had at least five years of HF experience and ten years in asset management.

Fig.3 became significant in light of Interviewee F’s comment that “68% of HFs are under $100mm.” This provided comfort that our survey was a reasonably accurate cross-section of the industry with 61% of respondents working at firms with less than twenty-five people.

In Fig.4, a more pointed question was proposed based on their experience whether successful HF managers possessed a high level of EQ. A shocking 83% either agreed or strongly agreed. That 83% is even more significant in the context of question #3, where 55% replied that EQ is rarely discussed in their organisation. Given the strength of the survey results, they will act as a control group to test the following hypotheses during the interview process.

Hypothesis 1: The researcher anticipates that a HF leader’s EQ will play an important role in the fund’s growth.

Hypothesis 2: In an adverse situation (i.e. a large trading loss, investor redemption, or key employee departures) when a HF leaders EQ is low, the likelihood of the fund’s demise increases.

Interview process
The interviews subjectively tested our hypotheses on EQ aiming to establish the founder’s approximate EQ competence in a broad sense (low, moderate, or high) and assess its growth impact. Lastly, were the fund’s returns average or above or below average? This allowed a conclusion to be drawn on the relevance of the founder’s EQ, ultimately testing our hypotheses.Eleven in person interviews (Fig.5) were conducted in 2016. Each person was sent an introductory letter and all interviewees read Goleman’s (1998) HBR article on EQ. The interview approach varied between HF employees and those who were not, lasting twenty-five minutes to an hour with an average of forty minutes.

HF Leadership and EQ
Fig.6 is a consolidated report on the various funds where the interviewees worked. The founder’s EQ level (high, low or moderate) was defined by the interviewee as well as the fund’s overall performance over its life (average or below or above average). It was noted in parenthesises (Fund B and E) where an instance of multiple founders existed under the EQ column. In those cases, a blended average was used. The divergent paths of funds lead by a person with a high EQ is obvious.

Institutionalisation
“Track record as a measure of success is determinant. The EQ traits only begin to shine when the environment is ripe for those to develop. The environment is much more challenging which make EQ more valuable today. Can you build a business around it, raising money that generates profits and continues the cycle” (Interviewee C)?

Prior to the golden era of the late 1990’s, before the industry institutionalised, a successful manager was “simply the best money manager,” said Interviewee C. As the environment changed and became increasingly competitive, ones EQ traits beyond motivation became differentiating.

“The industry shifted to an institutional structure that is management controlled, not trader controlled. This changed the EQ of our organisation where the collective EQ has risen. This has been 80% client driven and in big meetings, the CEO attends where historically it was only the PM and CIO” (Interviewee J).

Self-awareness and empathy
“Even with a high level of SR and motivation, SA or lack thereof can be the critical make or break attribute in fund management. The least important is social-skills unless it is a very large fund. It is contextually based significance” (Interviewee B).

“A higher GEI has led to higher individual EQ. We designed seating to influence and increase SA. Each trader has access to a trading coach – an externally paid psychologist” (Interviewee J).

During the interviews, SA continued to surface as a pivotal determinant of success and failure.

Fund B
“The best part about Fund B is that it was setup by four partners each having an equal share which is atypical. They understood the culture of each division they ran, and there was no founder effect” (Interviewee I).

“When a large stake in the business was being sold, the partners selected two of the better negotiators to handle the process. They wanted the right people at the table. The highest profile founder took a step back because he could have volatile moments which he did not want to hurt the process” (Interviewee I).

A large stake in the fund was sold during a period of peak HF valuations achieving a multiple of 7-10xs revenue versus 3-5xs presently.

Fund K
“The founder ruled by divide and conquers and lacked a serious amount of EQ. He preferred to make people very upset and insecure. The firm shut down due to the founder’s behaviour. The EQ issue that led to the redemptions was his lack of empathy” (Interviewee E).

Fund M
“This fund was run unilaterally – like a military operation – given the founder was a former General. There was only one vision and no one knew what it was since it was never shared. The fund peaked at $850mm and declined as the closed end funds matured. They never raised new funds even with decent performance. There was a total lack of empathy. The fund ultimately closed” (Interviewee G).

Fund G
Interestingly, Interviewee Gleft Fund M when she was hired by a former co-worker (Fund G founder.) Fund M’s founder’s lack of empathy and SA allowed an attractive business opportunity to slip out the door largely unnoticed.

“I did not know him that well as we only overlapped for 2 months. He is very quick and a very good reader of people. He had a very good contact list and deep relationships with the right people” (Interviewee G).

Fund G was wholly acquired by a large European institution were the founder remained and raised four more funds totalling $2b AUM.

Fund I
“The founder managed by fear and was uncomfortable interacting with people. He was contrarian and didn’t mind hiring those who were different from him and offset his shortcomings. He was not very high on empathy and had little interest in exploring. I always wondered how much better it could have been” (Interviewee D).

Fund I is regarded as top fund in their discipline still operating today with $15bn of AUM.

GEI and Emotional Contagion
Fund E
“We created an institutional framework with five partners where three out of the five have a high EQ, and you can see that coming through the organisation” (Interviewee H).

“The founders believe you need a good life-work balance with an emphasis on the value of creating your own firm and allowing people to know they are still human. One of our largest investor considers himself part of the fund’s family. We continue to listen to investors regardless of our growth and success” (Interviewee H).

Fund E provided the strongest evidence linking a high EQ to growth and success. The elevated level of emotional awareness at the senior level combined with a strong collective intelligence within the organisation resulted in unusual AUM growth in light of the slightly above average performance.

Predicting HF success and EQ
Fig.7 is a HF growth predictability model based on EQ and investment performance derived from the interviews and Fig.6.

By modelling the relationship between EQ and performance, a fairly compelling case for the value of EQ in HF leadership is revealed. It is telling that Funds G and B, (optimal quadrant) were fully and partially acquired by larger institutions. Perhaps it was due to the sample size, but Sub-Optimal (Performance) was empty – no one had a high EQ and below average returns. Other observations from Fig.7 are:   

a.) Only one fund had well below average investment performance – Fund F.
b.) All closing funds had low leadership EQ levels and shut regardless of performance.
c.) Fund I – Interviewee D, “I always wondered how much better it could have been.”

Hypotheses
Hypothesis 1 predicted a HF leader’s EQ will play an important role in the fund’s growth, and it was supported by both the survey and interviews. All five characteristics of Goleman’s (1998) framework were noticeable in various forms in successful HFs. SA stood out as the most impactful trait along with motivation.

Hypothesis 2 predicted in an adverse situation when a HF leader’s EQ is low, the likelihood of the fund’s demise increases. A low EQ level was highlighted in all four failing funds.

Conclusion and contributions
If the fund’s leadership possessed a high level of EQ, the benefits reached beyond performance and AUM growth. Founders with a high EQ positively impacted the culture and climate, and a leader with a lower EQ had converse effects.

The research contributes to HF management by strongly suggesting that a high EQ is a desirable trait in fund managers. It also adds value for fund managers given the high value placed on SA. This was repetitively noted as a key characteristic for success, and fortunately, it is one of the EQ traits that are developable (Dulewicz and Higgs, 2004). Lastly, the research widens the due diligence repertoire of investors raising the industry’s awareness on the relevance of EQ in HF success.