That’s not a framework…
At Martialis, we routinely advise in situations where an absence or the presence of adequate frameworks has led to problems that client firms might otherwise have avoided; which explains our somewhat obsessional interest in promoting frameworks.
Obsessions aside, we do not suggest every minor firm issue needs a framework -far from it. But those that feature prominently in firm outcomes, particularly where issues may undermine the outcomes for firm shareholders, should be considered (if nothing else).
In this blog I venture into listing the attributes of what we believe constitute healthy frameworks, sharing the collected Martialis house view. It’s not the work of academia or a collection of on-line material, rather it is our experience of how solid framework brings positive results.
I start with an example of a framework which has stood the test of time.
An example of solid frameworks - Ray Dalio
Connecticut based, Bridgewater Associates is one of the world’s largest and most successful hedge fund managers. With circa U$150 billion under management, in certain size categories it would be considered the world’s largest, just as in certain return-series the firm’s returns have been simply Buffet-like, astounding.
Founded in a Manhattan apartment in 1975, Bridgewater has been a success at almost everything it has touched; from consulting, to research, and through to money management (particularly), and many readers will associate the firm with its founder and inspirational leader, Ray Dalio.
Aside from the many successes of Bridgewater, one of the things that singles the firm out as unique is Dalio’s preparedness to spread his view of how to build a great business (or great anything really).
He does this by promoting access to the firms Principles: Life and Work, which has been variously turned into:
Having read the earliest versions of Dalio’s work (in its initial e-book stage), like so many of my peers in financial markets I wanted to get a feel for how the Bridgewater founder thought; what was his firm’s recipe for success? At a mind-numbing list of actual principles (I haven’t counted them, but the condensed version lists 157), I love so many aspects of the list, but I’m not sure they can easily be lived by, and Dalio himself doesn’t suggest one actually try.
In making a point about Ray Dalio in a work exploring the importance of frameworks, readers should note that Principles mentions ‘framework(s)’ literally only three times. This might present as strange, but the reason for this is simple: Ray Dalio actually considers his work a framework in its own right, noting eventually (see page 315) that Principles is: “a framework you can modify to suit your needs (Principles: Life and Work, Ray Dalio, Simon & Schuster, New York, Page 315).
Which is my point.
Bridgewater’s success is well known to be the result of the firm’s leadership embracing Dalio’s Principles as their overarching framework. A framework that guides how people operate within the firm, not necessarily as we might infer, some codified system of rules and/or controls that manage specific matters.
The key is that Bridgewater has an amazing high-level framework that guides staff when they make decisions; witness the quite staggering compound benefits.
Principles or Frameworks?
One could easily argue all day about what constitutes a principle and what constitutes a framework. The two concepts are obviously related, though subtly different, but we believe they play important and somewhat different roles at different points in the hierarchy of firm management and control.
And the difference, subtle or otherwise, should not be dismissed.
Taking the Oxford Dictionary definitions in turn:
Principle: a moral rule or a strong belief that influences your actions
Framework: a set of beliefs, ideas or rules that is used as the basis for making judgements, decisions, etc.
Perhaps the best way to explain the difference is by resorting to the example of the founding of the United States as an independent nation.
The framers of the US constitution settled on a set of five guiding principles for the system of government they wanted to establish; which included: federalism, limited government, popular sovereignty, republicanism, with checks and balances.
These were enshrined throughout the Constitution that was eventually crafted, and it – The Constitution for the United States - became the crucial written framework for how the US form of government would work.
At Martialis, we believe that in a firm-management context it is this latter distinct and crucial difference between principles and frameworks that matters when it comes to how best to order firm workings:
Principles provide high-level guidance with respect firm directions and values
Frameworks establish rules-based structures in particular areas, circumstances, and where enterprise risks are present
Which brings us to the question of what constitutes a healthy framework?
Principles of Healthy Frameworks
In formulating the following, we naturally lean towards our experience within financial markets. However, we believe in most cases these could be applied to firms in almost any industry setting.
There are seven Martialis principles for healthy frameworks, in what is still for us a work in progress:
Principle 1 - Tailored for Task
Individual frameworks should be tailored for the specific circumstance, task, objective, or risk the firm wishes to manage or control; no more, no less.
The degree of tailoring is theoretically limitless, but we believe should be calibrated based on relevant elements such as:
Degree of subject-matter complexity
Degree of prescriptiveness desired
Formality, for example: guidance versus policy
In financial-market risk, macro-economic factors and correlations should also be considered and/or formally assessed when tailoring.
In assisting clients in a range of subject-matter, we are often tasked with cross-reference reviews into firm frameworks. In this we often note that elements of quite workable frameworks sit in disparate fragments, while others can be beautifully crafted and perfectly concise, while sitting hidden in tome-like volumes. We therefore recommend that any individual framework be tailored in ways that avoid fragmentation or the risk of the work becoming submerged (out of sight, out of mind).
Principle 2 - Designed to avoid reactive decision-making
Reactive decision-making can be argued to invite randomness into firm outcomes, particularly in financial-market risk settings. Ensuring a framework minimises reactive decision-making is crucial.
It’s important to note that for Martialis, we believe this should apply on both sides of firm outcomes, avoiding reactivity across different states, such as:
When markets deliver unfavourable conditions,
When market conditions are favourable,
When market conditions are stable/unremarkable
I note that very few of the frameworks we have encountered have any definition of what might be done when market conditions present opportunities.
In my most recent blog I recounted the story of a firm that had a ‘do-nothing’ framework based on a buffer-rate, while maintaining a significant (actually existential) firm sensitivity to an exchange rate. This unfortunately ensured that when currency market conditions favourable to the setting of longer-term risk hedges were reached the firm continued to do nothing.
In our view firms who seek to manage outcomes need to be mindful of the practical impact of the framework at both ends of the risk continuum, not simply on one side. In favourable circumstances rainy-day hedges can prove highly beneficial. Frameworks should encourage latitude to manage the upside as well as the downside.
Principle 3 - Accountabilities should be clearly defined
Where decision-making accountabilities are involved unambiguous accountabilities as to delegated authority are vital, and ideally formally maintained. This includes decision-making forums, particularly where a quorum is needed before time-sensitive decision making is prevalent.
Who is delegated to make a decision?
Who can make the decision in the event they cannot?
To whom is the decision-maker responsible, and to whom can a decision be escalated?
On what basis can they make their decision? E.g., do they require formal advice?
What is the boundary on the extent of their decision-making delegation?
What decision-making artefacts should be preserved once a decision is taken?
We mentioned in Principle 2, that reactive decision-making invites randomness into firm outcomes. This is often due to the fact that key decisions are often forced upon firms in time-sensitive settings, particularly where financial market risk is concerned. It is also the case that risk-reward asymmetry can play a role (a topic for a future blog, but losses are psychologically different to gains). Healthy frameworks are those devised to minimise decision-making ambiguity in all its guises’.
Put another way: ambiguity invites eventual disaster.
Principle 4 - Thresholds should be thoughtfully calibrated and consequential
Where circumstances demand the imposition of framework thresholds, for example in areas of stopping risk or losses, it’s important that the thresholds themselves be:
Carefully considered (and maintained on an ongoing basis where appropriate)
Respected
Monitored
Policed if necessary
This remains the case regardless of the decision-making latitude afforded to key staff.
Our firm has deep experience in managing teams in various financial markets settings, including settings which afforded key-staff quite generous decision-making latitude. It’s important to note that in these settings robust frameworks were not devised to prevent active management of financial risk, but quite the opposite.
Well thought out thresholds, for example: well thought-out loss tolerances, can promote good decision-making, but only if thresholds set and agreed are meaningfully policed.
Principle 5 - A framework should be formally recorded
Lack of formal recording of frameworks, particularly risk-bearing elements such as delegations and authorities can be as dangerous as the absence of a proper framework. We recommend a reasonable degree of formality be associated with the task, and proper recording is not difficult once a framework has been tailored and agreed upon.
Proper recording has many associated benefits, not limited to:
·Minimising confusion and downstream dispute
Ensuring stakeholder awareness
Facilitating appropriate 2nd/3rd line ex-post review
As a record of decisions-taken,
As mentioned in my last blog, the absence of formal record keeping of firm policies can present as a weakness of governance where firms are targeted in acquisitions.
Here I will simply remind readers of our standard refrain: If it’s not written down, it doesn’t exist.
Principle 6 - Good frameworks are memorable, and readily accessible
Overly complex frameworks and/or frameworks that are inaccessible in normal conditions to reasonably well-informed staff should be avoided.
In Martialis experience, illogical or overly complex frameworks can be self-defeating and open firms to dispute and/or policy non-adherence. Where framework records are poorly kept or buried within excessively large policy manuals similar problems can arise.
Logical, internally consistent, and easily understood policies that can be retrieved from internal firm libraries should be thought of as good practice that promotes framework effectiveness.
It was the highly regarded Austrian-American management consultant and educator, the late Peter Drucker, who coined the phrase: “what gets measured gets managed.” We’re not as certain of Drucker’s claim in the age of big data, but we do agree with the thrust and suggest firms consider what happens when things that can and should be managed are poorly managed.
Our experience suggests that if staff can’t give a reasonable elevator pitch about a particular topic, they either don’t understand it, or they aren’t aware of it. The same is true of frameworks. Well calibrated frameworks with appropriate thresholds that are readily retained by key staff are more likely to be deployed when circumstances demand they be deployed; not left open to the vagaries of chance or random outcomes.
Principle 7 - Good frameworks are memorable, and readily accessible
We believe frameworks should be subject to ongoing review, particularly in situations where market circumstances can change rapidly. Markets and economies are constantly evolving, hence frameworks judiciously formed in one setting can be found wanting, or even inappropriate.
This does not mean that the tempo of review has to be disruptive, nor onerous, but a degree of regularity can be expected to pay dividends.
We note that firms that review policies and procedures keep their frameworks current, and the simple process of review can lead to improvements not recognised at framework inception.
There are few elements of business that couldn’t benefit from a commitment to ongoing review. For firms in financial markets the post-GFC regulatory environment has turbo-charged the extent of necessary policy and compliance standards that firm policy-libraries are now basically overflowing.
But this is not likely to change; which means adaptation is key.
We believe that firms who accept the realities of ongoing review and adapt to the environment stand a better chance of negotiating future risks, and of maintaining the operational poise to gain from future opportunities.
Thus, well laid policies and protocols, modern and judiciously maintained, have an intrinsic value far beyond the costs of production and ongoing maintenance, and a regular tempo of review only adds to that value.
A tedious topic?
The topic is tedious, certainly; but should it be ignored?
We intend to write more on frameworks in coming blogs, which is something of a measure of how much emphasis we believe firms should place on their proper formation: making them and keeping them fit-for-purpose.
In the context of the risk-bounty found in financial markets, I will leave you with a simple quote from Ray Dalio, explaining his personal success in his 2019 CBS 60-Minutes expose.
Ray Dalio: “It’s 100% in those principles, in other words, principles are like, um, when you’re in a situation, what choices should you make? “