Sunday , November 18 2018
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Kings Unwilling

Summary:
“Thus came Aragorn son of Arathorn, Elessar, Isildur’s heir, out of the Paths of the Dead, borne upon a wind from the sea to the kingdom of Gondor.” The Lord of the Rings, by J.R.R. Tolkien “Toss me.” The Two Towers, loosely adapted by Peter Jackson from a text by J.R.R. Tolkien If you’ve read Epsilon Theory long enough, you’ll know that I am a huge Tolkien fan. I quote it entirely too much, but as long as Ben stays a few Godfather quotes ahead of me, I will willingly fall prey to moral hazard. Being a Tolkien fan means being a Lord of the Rings fan. I adore the books. And like any obsessive fan of a book, I very predictably loathe the movies. You didn’t come here for a fanboy rant, but let me at least tell you what makes me the most furious about the films: the character

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Kings Unwilling

“Thus came Aragorn son of Arathorn, Elessar, Isildur’s heir, out of the Paths of the Dead, borne upon a wind from the sea to the kingdom of Gondor.”

The Lord of the Rings, by J.R.R. Tolkien

“Toss me.”

The Two Towers, loosely adapted by Peter Jackson from a text by J.R.R. Tolkien

If you’ve read Epsilon Theory long enough, you’ll know that I am a huge Tolkien fan. I quote it entirely too much, but as long as Ben stays a few Godfather quotes ahead of me, I will willingly fall prey to moral hazard. Being a Tolkien fan means being a Lord of the Rings fan. I adore the books. And like any obsessive fan of a book, I very predictably loathe the movies.

You didn’t come here for a fanboy rant, but let me at least tell you what makes me the most furious about the films: the character Aragorn. Believing his audience to be too stupid to understand a world already in place, with characters, cultures and motives long-established, Peter Jackson undertakes to remake the character Aragorn into a whining, mewling, reluctant heir, who only takes on his kingly airs once he is forced to do so by evil circumstance. It’s a story of growth, you see! Jackson’s commitment to this conceit is so complete, so dumbfoundingly moronic, that he would utterly ruin the climax of the third film by positioning the “Army of the Dead” as deus ex machina, thoroughly invalidating every act of courage during the battle by literally every major character, rather than acknowledge that it was the greatness of Aragorn, his overthrow of the Corsairs of Umbar, leading the soldiers of Lebennin and Lamedon into the fray…I…I’m sorry, this has turned into a fanboy rant, hasn’t it?

The point, however, is that our modern sensibilities really, really dislike the trappings of pride. We find the idea of a king-in-all-his-state distasteful. We only accept the king unwilling.

These sensibilities make their way into our investment thinking as well.

Every once in a while, an investment publication or consultancy has waited the requisite period before posting a rehashed ‘investment manager due diligence tips’ blog post with justified text and columns. You know. A white paper. It will be a list of ten things due diligence professionals or asset allocators ought to do. By some unspoken rule, between 6 and 8 of those must be serviceable and real, if perfunctory sorts of key checklist items. Nothing wrong with that. Seriously.

Likewise, between two and four of the items are intended to be provocative, to get you to think about some other dimension you may not have thought about before. These are usually heuristics – rules of thumb from years of experience – and they usually have to do with the people running the money.

“Invest with someone who drives a Hyundai, not a flashy car.”

“Truly smart people don’t talk about how smart they are.”

“Really educated people don’t talk about their credentials.”

“Beware the PM who is also a good presenter!”

I’ve read and heard every single one of these things. I’ve…probably said a few of them. Sadly, for the most part, they are all nonsense.

Now, I say ‘for the most part’ because there are related concepts with some merit. For one, there is some evidence that PMs who buy sports cars tend to underperform those who buy something more practical, like a minivan. In most treatments, however, this effect appears to be related more to the risk-taking implications of buying a fast car. Likewise, there are good and proper reasons to favor humility. We talk about humility a lot here, because we think it’s one of the most important traits in an investor.

But humility is different from humility! The former is a practiced willingness to test and retest our conclusions, our instincts, our intuition and our priors. The latter is an obsession with the trappings and appearance of being humble. I believe the former is extremely predictive. I believe the latter isn’t worth a bucket of warm spit.

The best-performing manager I ever hired did ALL the things you’re not supposed to do. Wordy 100-page presentations listing every accolade, every qualification and credential of the staff, every research piece they penned. Brags about the traits of their computing clusters. Highly visible poker and chess competitions. Math Olympiads. They annihilated the performance of their peers.

One of my favorite PMs – and yours – is charming, funny and kind. One time a colleague came back to the office in a Ferrari. This PM looked through the brochure, and left to buy one for himself. He has wonderful returns and an enviable business.

In my early days of building a small cap activist portfolio, I was deciding between two funds. On the one hand, the PM team for one was new and hungry. They were also collaborative and humble, pitching the idea of being a valued participant in the board room. I even did a call with the CEO of a portfolio company – a brilliant guy, actually, running a damn good company that makes a healthy portion of the equipment you’ll see making unhealthy food in the average fast food joint. They loved this activist team. My other choice was a slick firm with slick operators in slick suits, run by a blindingly smart guy who was a dead ringer for Aaron Eckhart’s character in Thank You for Smoking. Every time we met with them, the team’s notes were consistent: smart, arrogant, overconfident?

You can probably guess what choice we made. No, the choice I made. It was the wrong one. Not by a little. By a lot. By a TON. What’s more, the main reason why the returns were so different was the friendly manager’s unwillingness to move on from a management team that was giving them a slow maybe, or from stocks for which their operational improvement thesis proved unrealistic. In other words, I lost because I picked the humble! manager who didn’t demonstrate true humility in their decision-making.

There are times as investors and allocators where we do need to listen to our intuition, especially if we are suspicious that there may be something unethical, misleading or fraudulent going on with one of our would-be partners. Likewise, a manager living very large is a manager who needs your management fee. That’s bad. There are very real logistical considerations that go into these decisions.

And yet, if you would insist upon hiring kings unwilling, in my experience you’ll too often end up with a portfolio of managers who have practiced the game of appearing humble!

So what do we do? We design our diligence process and our questioning around identifying traits of true humility.

Rusty Guinn
Executive Vice President of Asset Management, Salient. Rusty Guinn is the executive vice president of asset management at Salient. He oversees Salient’s retail and institutional asset management business, including investment teams, products, and strategy. Rusty shares his perspective and experience as an investor on the Epsilon Theory website.

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