Super LP

All Politics Is Local . . . Maybe Investing Should be Too?

[Ok, ok . . . I've been slow on my long-promised post about out-years risk, but I started writing it last night and the post got unruly.  Back to the drawing board on that one . . .]

In the meantime, I've got another quick thought about this whole Madoff mess: I'm amazed - but unsurprised - by how international the roster of victims has been.  (Harry Markopolis, the man who tried to alert the SEC, suspected that half to three quarters of Madoff's capital came from overseas).  As you read through the list, you can almost imagine Ricardo Montalban or Catherine Deneuve reading off the foreign names with crisp and precise diction (while heavily accenting the American ones: Ferh-feeeld Ghreenesh Ehdvisors . . . Tree-Mon Groope . . .)  It's a far-flung group that now shares a common shame.

And that got me thinking about how we, as investors, do diligence.  I mean, information is the raw material of investing, right?  I'm not talking a Gordon Gekko/Bud Fox sort of information ("Blue Horseshoe loves Anacot Steel.")  What I'm talking about is knowledge.  Do you have a view?  Is your opinion the product of a dialectic?  How was the tension in your thinking resolved?  What data tipped the scales in favor of one route, but not another?  After all, we're just intelligent switches and network nodes, gathering and processing information. 

And if information is our sustenance, how often do we outrun our supply lines?  I've been thinking a lot about the epistemology of investing lately: how do we know what we know?  Is it harder to triangulate information when investing across the country?  Across the world?  How frequently do we not speak the same language (literally or metaphorically) as the people with the insights?  How frequently do we not even know who those people might be? 

And fund of funds have it even worse.  At least the primary investors are buying assets with (hopefully) some intrinsic value or growth potential.  FOFs make investments in the people who buy those assets, placing at center stage the most pernicious irritant in all of finance: the Principal-Agent Problem.  Don't get me wrong: I'm not kicking any of the cats who lost money.  I'm sure they're all smart, well-intentioned people who somehow wandered beyond the frontiers of their expertise or suspended their disbelief.  It reminds me of the exchange in Leo DiCaprio's Magnum Opus Catch Me If You Can:

Frank Abagnale, Sr.: You know why the Yankees always win, Frank?

Frank Abagnale, Jr.: 'Cause they have Mickey Mantle? 

Frank Abagnale, Sr.: No, it's 'cause the other teams can't stop staring at those damn pinstripes. 

Now I don't want to sound provincial.  Investing is a global discipline and we need to seek out the best risk-adjusted returns wherever they might be.  My fear is that we've systemically underestimated the amount of risk in going increasingly far afield. 

In people businesses, it's actually really valuable to see people firsthand, to look them in the eye, to know where and how they live, to bump into them at the grocery store, to interact with them closely in hopes of building a sense of mutual obligation.  That's the genesis of trust.  And in finance - just as in a democracy - someone must be trusted.  And, indeed, trust is always at a premium, it's just that today trust is also in extremely short supply.

Crime and Punishment

In high school, I tried to get a summer job across the river in Manhattan.  A bull market raged in the summer of 1987 and Duran Duran was on the soundtrack.  I’ll never forget the morning of my interview, walking down McDonald Avenue toward the F train wearing a fresh-pressed suit and spiffy-shined shoes.  It was still early yet and Mrs. Pulaski was sweeping off her stoop, as she did each summer morning, with an ancient straw broom that looked like she’d brought it over from the Old Country.  Seeing me coming, she offered me a banana and some advice: “little Chris, always remember: the gangsters and thugs may live in Brooklyn, but the real crooks work in the City.”

Of course, Brooklyn’s convicted get all-expense paid stays in places with foreboding names like Attica, Dannemora, Rikers, and The Tombs.  The City’s crooks, on the other hand, get to wear that fashion accessory of the once-rich and now infamous: the ankle bracelet. 

And boy, do they get to wear those bracelets in some fancy places.  Look at this (do I need to say, “alleged?”) scoundrel, Madoff.  Where’s he serving his house arrest?  The Upper East Side?  Maybe Montauk?  But hey, those December winds howl on Eastern Long Island.  I mean, that place may be fancy in-season, but in the winter it’s positively hard time.  Just dreadful, Lovey!

Anyhow, I got to thinking about a lecture I’d heard in college about the transformation of punishment in America .  Since the earliest colonists focused on community above all else, crimes and deviations from norms were seen affronts to society and punishment took the form of publicly-assigned shame.  Think pillories, stocks, scarlet letters.

During the industrial revolution, society became more mobile, more dynamic  Family supplanted the community and the primary unit of organization.  Punishment became more guilt-oriented, more inwardly-focused; guilt, after all, is a matter of conscience while shame is a matter of reputation.  Guilt seeks forgiveness while shame seeks concealment from view.  As we became more guilt-focused as a society, shame lost it sting.  We’ve literally and figuratively become shameless (Exhibit A: Hilton, Paris.)

So what does this have to do with PE?  I’ve often said that managers who are intrinsically motivated to build portfolio companies are the ones I want to hire; ones for whom the pride of building something greater trumps it all.  If they fail, it'll hopefully be because of poor execution or bad luck, not because of mislaigned interest.  Of course, it’s very tough to test for that mindset, but that’s the essence of the voodoo I try to do.

As for Madoff, let’s find some suitable public punishment once he’s found “guilty” in a court of law.  In the markets, as in a democracy, there must be trust.  And Madoff’s (ahem, alleged) fraud makes him the poster child for this era’s breakdown in trust.  Since punishments should fit crimes, maybe he should also become the poster child for a return to shaming?  Let’s set up some pillories in Times Square and have the people come with buckets of slop, entrails and dung to hurl his way.  Sure, I’ll line up to huck a tomato or two, but I’m guessing I’d be near the end of a very long line. 

And I think the whole thing could be cathartic, a sloppy capstone to an era whose closing headlines were all provided by grifters and slicksters.  And who knows?  If people started again worrying about being shamed, worrying about the effect of their actions on the community, maybe the next scalawag might think twice before messing with our trust.