Super LP

DC-8s and Tigers and GPs! Oh my!

A few weeks ago, a local TV station aired a news story about a mostly-forgotten plane crash, the May, 1968 unintentional ditching of JAL Flight 2 in San Francisco Bay.  After an uneventful flight from Tokyo, the nearly-new DC-8, nicknamed "Shiga," was on final approach to an overcast SFO.  Captain Kohei Asoh, a veteran pilot, guided Shiga's descent through the low-hanging clouds.  But planning errors, equipment unfamiliarity, and miscalculations conspired against the crew.  Dropping out of the fog, Shiga was lower than expected and about to crash into the foam-flecked bay just below.  By the time the First Officer cried out, "pull up!" and Captain Asoh applied throttle, it was too late.  The landing gear had struck the brackish water and the plane lurched to a halt, the wheels coming to rest in the muck seven feet below -- two and a half miles short of the threshold of Runway 28 left.

Remarkably, no one was hurt and some passengers had no idea that they had landed in the water until the evacuation began.  And even then, the de-planing was so uneventful that most folks didn't even get their feet wet.  But for me, the best part of the story was popularized by management guru, Jerry Harvey (author of the Abilene Paradox): when Captain Asoh was called before the Transportation Safety Board, the inquisitors opened by asking how an experienced pilot flying a sound airplane on a straight line to an unobstructed runway in generally benign conditions could land in the water miles short of the field?  Offering an answer that resounds across the ages in its clarity and honesty, the Captain replied, "as you Americans say, 'Asoh f@#%ed up.' "

Fast forward 40 years and compare Captain Asoh to the bellyaching finger-pointers that were in the cockpit of the Northwest flight that overflew Minneapolis.  And the public nature of Captain Asoh's taking of responsibility stands in stark contrast to the recent (ahem) screw-ups of Tiger Woods.  Look, I'm not a moralizer or a scold -- I grew up in the anti-role model era heralded by Charles Barkley and Ice Cube -- but Tiger, dude, you make your living by having people look at you; you get paid because people watch what you do.  I'm not sure you get to flick that switch off by pleading for privacy.  Even if you ask, "pretty please."

And what does this have to do with investing?  Recently, I was talking to a buddy who's a GP at an LBO shop (this conversation was explicitly cleared for the blog on the condition of vagueness -- I should note that it's not a group in which I'm an investor).  This GP bemoaned the fact that his LPs had seemingly thrown in the towel on his troubled fund; turnout had been sparse at this year's annual meeting and some investors had stopped returning phone calls.  He insisted that they had Great Stories of Progress to tell for each of their troubled portfolio companies and that if they could just convey these stories to LPs, all would be well.  How, he asked, could he communicate the exciting stuff afoot? 

So I asked him to test drive some of the rap on me.  After a few tales larded with lament over difficult (but improving!) end markets, missteps by (recently replaced!) management teams, and (impossible to please!) crabby lenders, I asked him how many times they'd screwed up in the fund?  Now I don't mean to be harsh, but here's what I heard for the next 90 seconds: "excuse excuse excuse blah blah blah excuse excuse excuse blah blah blah."  No wonder his LPs have tuned out his firm's fund, I told him; I'd just been handed a bagful of excuses devoid of any corresponding accountability or responsibility.  It was the first time I'd heard the fund's story and I was already tired of it.

Look, LPs understand that business has been tough and even the tightest investment theses have been severely tested over the last 18 months.  We get that.  And we also know that investors are fallible.  It's OK to make mistakes sometimes.  Really it is.  Sometimes even good decisions have bad outcomes and vice-versa (more on that next week).  Sometimes people are just unlucky or in the right place at the wrong time.  But when things head south, please be honest and straightforward.  (There's no need to take things to an extreme and self-flagellate, like some GPs do.  There's no joy in that for anyone.)  As GPs and LPs, we're in a long term relationship -- one that's longer than many marriages.  An open, honest, transparent dialogue pays dividends in the long term. 

So my GP buddy asked me for some advice once I climbed down off of my soap box.  The best I could come up with was, "just remember, it's not the break-in that brings down the presidency, it's the cover up."  Sometimes, like Captain Asoh, you've just gotta say, "I f@#%ed up."

Getting Out of the Doghouse

Hey, finance professionals: we've got a problem.  Really we do.  In case you haven't noticed, the Great Recession of 2008/9 has a Villain (with a capital V) and it's you and me.  I know, I know, we did nothing wrong; we're generally decent, hard working, well-intentioned souls who humbly ply our trade in a peculiar, esoteric, and well-paying corner of the economy.  But we don't actually produce anything tangible, which makes us an easy target when a lot of people who do actually manufacture real "stuff" are out of work.

And, indeed, the demagogues swirl like turkey vultures seeking carrion.  Who is blameworthy for the sad state of affairs in this country?  The cry rises from the frenzied mob: Banks!  Private Equity Firms!  Mortgage brokers!  Investment banks!  Venture Capitalists!  Money Managers!  MBAs!  (Barney Frank busies himself handing out torches and pitchforks while Timmy G and the Treasury crew ready the shackles.)

But even our friends are enemies in this battle: over the summer I helped a cousin work through a mortgage refinancing.  Some Excel whiz-bangery did little to clear up a confusion born of too many options marinated in too many layers of uncertainty.  "Forget the spreadsheet; what's the best choice for me?" asked my cousin.  "It depends," I replied, dusting off an all-purpose answer.  "What do you think the future holds?  How long will you live there?  Are rates going up or down?  What will your tax situation be?" etc., etc.  "It's all so confusing," was the reply.  Then, my cousin's tone changed to bewildered frustration: "you finance people have made this stuff so complicated, and each choice seems like another opportunity for people to get ripped off."

And then it hit me: the average person doesn't want life to be an HBS case.  The Socratic method may work well in air-conditioned, wi-fi enabled classrooms with sage professors guiding a meandering discussion, but people live in the real world where decisions have consequences and costs -- sometimes big ones, sometimes immediate ones.  And all of the optionality increases anxiety, not to mention adding complexity to once-simple account statements.  I know some pretty smart people who just don't understand their cell phone bills.  The dis-utility of complexity has exceeded the utility of choice optimization. 

But we can help, finance people!  And burnish our tarnished communal reputation at the same time!  Here's my modest proposal: what if everyone in finance, insurance, and real estate committed to doing a few hours a month of pro bono work?  Maybe we could participate in "office hours" for half a weekend day once a month?  We could use bank branches; after all, the government owns a lot of 'em now.

Sure, you'd have to pass some good Samaritan protections so that lawsuits wouldn't ensnare the well-meaning, but imagine the good (and goodwill) that would arise from an army of savvy people helping oldsters understand their cable bills, helping young couples think about their mortgage options, helping college graduates set up their 401k plans.  Anything that has to do with money and is even remotely intimidating would be fair game.  (Of course, it would have to be a marketing-free zone.)

You could even make it a continuing education requirement for the first five years after attaining professional licensing or designation like a CPA, CFA charter, Series 7, CLU, or CFP, with subsequent participation encouraged.  I suspect the idea of ongoing participation could elicit some chortles on the 5:26 out to New Canaan, but remember, guys: that cat next to you from Ropes & Gray's New York office could be coming back from a day at the NYC Family Court Legal Service Project.

My old buddy, the Prof, suggested making some threshold of pro bono activity a requirement for FDIC insurance.  He even had the idea of creating the equivalent of "patient advocates" for thornier cases.  Maybe we could establish industry-funded fellowships to support laid-off or on-sabbatical professionals.

You could even imagine some kind of clearinghouse for people that incorporated the best of Web 2.0: feedback ratings, maybe even a "bid system" for appointments or specialists.  Think of it as a mashup of Craigslist, eBay, Google Maps, and us.  You could even throw in Twitter for good measure.  We can fix this, we have the technology.

Now the last thing I want is to create more bureaucracy and regulation.  But we have to realize that the regulation train has left the station and is bearing down on us at full steam.  And indeed, there are a lot of folks in the chattering classes who would portray finance professionals as the looters that smashed the storefronts of the economy, cynically plundering from the earnest masses.  Maybe the best thing we can do for ourselves and the economy is to pick up a broom and start sweeping up the mess.  

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.