Alternatives, Asset Allocation, Asset Managers, Defined Benefit, Institutional Investors, Pension Funds, Performance Measurement, Private Equity, Public Funds

What Would Freud Say? Texas Muni Puts Managers to the (Psyche) Test

Chris Schelling, director, private equity, at Texas Municipal Retirement System (TMRS), has long had an interest in psychology. He majored in psychology at the University of Illinois at Urbana-Champaign before going on to receive his MBA from the University of Illinois at Chicago and an MS in financial markets from the Illinois Institute of Technology.  So, it’s not a great surprise that Schelling brings certain aspects of psychology to bear in his efforts to invest the retirement system’s private equity effectively.

While many portfolio managers mire themselves in spread sheets and research reports seeking the best PE investment partners, Schelling takes another approach: He administers a psychological test to potential managers. He believes the test delivers insight into a manager’s energy level and drive, among other attributes. Schelling took some time, recently, to speak with Institutional Allocator about why he uses such a test as part of the investment process and how successful the results have been.


Chris Schelling, director, private equity, Texas Municipal Retirement System

IA: How did you first get interested in psychological testing?

Schelling: The genesis of this goes back to when I joined TMRS in 2015. I joined TMRS from the Kentucky Retirement Systems and had conducted due diligence prior to that, at Mercer Investment Consulting. I had an institutional due diligence process in place from Mercer, which I began to modify and adapt a bit and had been thinking about how to study the epistemology of due diligence–I took bits of what were good from Mercer, and tried to learn how to do it better. In private equity, to me it became clear that [as an investor] you are tied to these individuals [general partners] for ten years—it’s a lock up. Also, the dispersion of return in private equity is the widest of any asset class. The difference between the top and the bottom managers is huge. So, the upside to and risk to manager selection is great, which means you need to do a good job [when choosing a partner], so I started thinking: “Is there a way to assess the people we are hiring more empirically?”

At TMRS, we have a philosophy here that we use for manager selection: people, philosophy, process, portfolio, performance. People is something we always asses when choosing a manager—it is always more subjective than performance analytics. It’s a very subjective part of the process. For example, “What is the experience of the team? What is its background?”  We walk through how they think, and we walk out of the meeting thinking, “those guys are smart or not smart;” it’s very subjective.

I had seen some tests before, in process, as an applicant for a job at a fund-of-funds and at a big investment bank. So, I thought: “Why can’t we implement the same thing here.” We did some research on it, found some academic research on the use of personality profiles in hedge fund managers and CEOs, and realized that it’s the same thing, “so let’s try to find a vendor.”

In private equity, to me it became clear that [as an investor] you are tied to these individuals [general partners] for ten years—it’s a lock up.

IA: How did you get started?

Schelling: We had to run a process, similar to hiring a manager. We spent a month or two where we looked at various service providers and stacked them all up as competitors for our business.  We were looking at their products, getting sample reviews, determining if it would be appropriate, and settled on Profiles International [a solution provider] and their product, Profiles PXT, for a couple of reasons. One, was that it’s relatively simple and easy to use. While we thought we could ask for managers to do it [take the test], we did not want it to be a two-hour intrusive process. So, this is a 45-minute online test. You just log in; it’s a piece of cake. The cost is reasonable and well within our due diligence budget, and the results were very accurate. 

We did the test on a number of individuals on our team, and it came back not just accurate, on a personal level—(it described the members on our team, me included, very accurately, warts and all!)—but easily translatable to limited partner [LP]  and general partner [GP relationships, which is important; we are not hiring people, we are hiring managers, so they have all the discretion, but it’s not like an employer-employee relationship.

We may be hiring them, but they have discretion. That is, we are not the boss. So, the employer screening candidates to hire is not exact, (i.e., when someone scores low on manageability, you take them aside and discuss why you are the boss, etc.)

We were trying to measure three kinds of key characteristics or axes of personality.  I call them the three I’s:  intensity integrity and intelligence.  And so, this test covered it, it has things that address all of those. So, we are getting quantified metrics based on this, rather than leaving an interview with just general impressions.

IA: Do you then also evaluate the performance of the manager?

Schelling: When you are investing in a private equity fund, the fund that you commit to is a blind pool. There is nothing there today. Their last fund is what they are invested in, so you look to the prior fund or the represented deals for their track record. But you don’t buy those deals, so you are basically buying into a promise—that they will work in a similar way to how they have done in the past. 

We were trying to measure three kinds of key characteristics or axes of personality.  I call them the three I’s:  intensity integrity and intelligence. 

It’s really about what their process is and, again, that is subjective. They can tell you, we will do a similar size company etc., but what we want to know is: “How do you make those decisions?” So, for instance, legal documents will say: “You can’t invest more than 25 percent in energy.”  So, we will say, “Okay, we are good with that, but we still want to know: What motivates you, what drives you, how do work together with your partners, who does what?” And the test does that, it scores broad aptitude, verbal and math skill, energy level: “Do you like working in a fast-paced environment?” Questions like that come up, over and over, about how they make decisions.

Also, you want people who have a certain degree of energy, even though private equity is long term, it’s a transaction-based business. In our experience, firms that can diligence faster than peers, can get up to speed faster than competitors, they can see trends faster than competitors. They can close more quickly, they can implement value creation quickly; generally, they create more value more quickly, which translates into higher time-weighted rates of return. So, we do think it’s all important, you can’t be so frenetic that you aren’t prudent, but you’ve got to be intense. It’s a competitive industry.

IA: What attributes are you looking for in a person?

Schelling: There is a whole host of spectrums, there’s sociability, decision making, independence, judgment, manageability.  So, we are looking for scores on those things—an aptitude higher is better than lower. We want to see how the team works together, if there is someone who is very low on sociability, we want to see what is that individual’s role on the team. That person may be very analytical doing due diligence or building models, but if that is what they are great at, then we want to see if the other partner is more outward facing or is responsible for finding new companies and engaging with brokers and engaging with CEOS to drum up business. That person is going to score higher on sociability. The test lets us see that. Normally, you sit down and talk to two partners and one says: “I am this, and I am that,” and that is all you have, but we can literally now quantify that. 

It’s an iterative process picking managers, the interview process.  We are looking at them for months before making recommendations to invest. Performance is part of it, but it’s not the only thing. We have five key characteristics we are looking for, and as we spend more time and do more research, we get more information. So, you don’t get as deep early on, if you are not convinced it’s worth spending limited man-hours and due diligence resources on.

IA: When in the selection process do you administer the test?

Schelling: We run this step a lot later in the process; it’s the same for hiring a candidate, you don’t have 100 applicants take a test. You ask the last one or two applicants left in the process to do it, after the onsite interviews.

We have also gotten a couple clear wins from it, and it has also helped us to better understand how our managers make decisions.

IA: How have managers reacted to the test?

Schelling: The managers have been pretty receptive to it. We have noted that half of the time the private equity managers will tells us, “We do a similar thing when we are hiring the CEO for a company, if we have to replace them.”  We are investing in them for four to five years, so we want them to have a big responsibility in managing the company.  It [the test] is important, and they kind of get it.

So far, there has been no pushback. Although some people question us about it: “What do you get out of it? How do you use it? Can we see it?” But so far, everyone has participated. We have been doing it for almost three years now.

IA: So, the results of the test have been helpful? 

Schelling: Yes, in one instance, we had the results of one of the profiles come back, and we thought we wanted to change the key man clause as a result of it. It was not the only reason why we did it, but it certainly gave us better ammunition to argue for that.

We have also gotten a couple clear wins from it, and it has also helped us to better understand how our managers make decisions. I think that helps us make better decisions. It’s gotten us better information and made us more efficient. There are other investors, who have gotten the same amount of clarity on the team but have had to spend hours and hours. This allows us to get these questions answered relatively quickly.

IA:  Will continue administering the test going forward?

Schelling: If anything, we will probably expand it across the portfolio.  We are doing it in real assets and real estate and are considering it on hedge funds. It will take a little time before it will start working with some of the hedge funds—to get them comfortable with how we do it, how we use it, and what’s in it for them. We share the results with the general partners, so they get free HR [human resources] organizational, psychological consults.  

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