Twenty years ago, the cover story of last week’s Economist (The Search for Talent Oct. 7-13) may not have attracted a lot of attention from the financial community. HR was a corporate backwater and human capital was given only occasional lip service.
But a careful review of 14-page survey entitled The Battle for Brainpower reveals that the search for talent is analogous to the search for alpha. In fact, we all may be searching for the same thing â€“ an ethereal force that defies standardization.
In attempting to define talent, The Economist says:
Some use it to mean people like Aldous Huxley’s alphas in Brave New World â€“ those at the top [right tail] of the bell curve.
Any market inefficiency that has been identified, documented and exploited disappears. The only way find new inefficiencies is to rely on talent. In other words, it takes talent to identify market inefficiencies.
The Commoditization of Talent
The Economist goes on to describes how McKinsey & Co. has divided American jobs into three categories:
- Transformational: extracting raw materials or converting them into finished goods,
- Transactional: interactions that can easily be scripted or automated, and,
- Tacit: complex interactions requiring a high level of judgment.
Long ago, transformational jobs may have required a lot of judgment. After all, converting copper into bronze tools sounds pretty complex to me. The cave man that figured this out must have been pretty talented.
But new technologies and processes eventually moved the cave men up the learning curve until bronze became a commodity. This cycle of commoditization, where previously complex tasks become commonplace (and inexpensive) reminds us of Pranay Gupta and Jan Straatman’s paper on commoditized and non-commoditized beta (first brought to our attention by our friend Richard Kang at Seeking Alpha). These two ABP executives argue that alpha is just beta that hasn’t been commoditized yet. They might also argue that “tacit” jobs are just “transformational” jobs that haven’t been commoditized yet.
Talent and Alpha aren’t just similar concepts. If talent can also be defined as the ability to successfully perform non-commoditized activities, then the search for alpha is itself the search for talent. (Witness Goldman Sachs’ investments in their recruiting process.)
No matter how skilled an employee becomes, if the job becomes merely transformational, then the employee adds less value. Likewise, no matter how good an investment manager becomes at exploiting a market inefficiency, they will add little value once that trade has been commoditized.
Alpha/Talent Beyond Money Management
The notion that talent is alpha can also be applied beyond the trading desk. The Economist is essentially saying that corporate alpha (i.e. the ability to perform beyond what industry drivers would dictate) is the result of talent. Since talent is “un-commoditizable”, it is therefore becoming the only reliable competitive advantage for today’s companies.
Alpha/Talent in Emerging Markets
As we have discussed here, emerging (and generally less liquid) markets tend to contain greater inefficiencies. These markets represent an opportunity for those investors seeking greater alpha and a threat to those investors content with the (lower alpha-potential and more efficient) S&P500. Similarly, emerging economies such as China and India contain untapped supplies of talent â€“ representing an opportunity for global companies such as Dell and HP and a threat to those companies content with the relatively over-exploited (read: liquid and efficient) US talent market.
As the Economist points out, the talent shortage is really just a pricing problem. As talent prices eventually rise in the developing world, a shortage will occur there too and the balance of power will drift back across the Pacific. But talent will continue to be the key to success since it represents the sum of all non-commoditized skills. New technologies and processes arise and new, not-yet-commoditized skills, arise.
Likewise, as market inefficiencies in the developing world become arbitraged away, new ones will arise to take their place. The continual advancement of financial technology will ensure a continuing supply of market inefficiencies.
But Talent isn’t a Zero-sum Game
One might argue that the similarities between the search for talent and the search for alpha end here. While alpha is a zero-sum game, we can all create and consume more talent, right? Universities and colleges create talent, they say. Invest in education and presto: more talent! If only we could produce alpha this way.
But if talent is the ability to produce relatively more output from the same input, then for all intents and purposes, talent is a relative-value game. Sure, we all have somewhat talented employees. But “just enough” talent doesn’t cut the mustard when companies compete in a zero-sum game for a fixed market size. For every “above average” employee in the labour market, there is a “below average” employee. Add up all these above and below average workers and you get…zero. In other words, while the talent pool can grow over time, a talent advantage is a zero sum game.
Not only does talent beget alpha, but as this survey points out, talent and alpha might actually be the same thing – a point not lost on the leaders of today’s money management firms.
– Alpha Male