The Characteristics of Successful Investment Firms - Dr. Charles D. Ellis, CFA

Great to remember what makes people-based businesses thrive.

The Characteristics of Successful Investment Firms - Dr. Charles D. Ellis, CFA

Ray Dalio: Company Culture and the Power of Thoughtful Disagreement

This video probably summarizes what I have learned this year not only as an investor, but also as a human being. Do you want your company to make a difference? Create and nurture an outstanding culture. It might sound odd to most people, even from people within, but you have to put your beliefs in practice. That's how others companies also work. As Dalio puts its, the real difference is either on people or culture.

In his company's case, the ruthlessly transparent internal environment (forcefully) creates a trustful atmosphere, in which thoughtful disagreement foments knowledge creation. The possible issue: as people are smart in so many different ways, they must appreciate each other and make a team of them - the possible solution: the culture itself. It takes a genius to make it simple, and Dalio indeed did it by building an environment built on truth and thus, trust.

Culture is self-reinforcing.

 
"My biggest advantage is that I know what I don't know."

The Culture of Learning as The Ultimate Competitive Advantage

'The end of work' has been quite of a debated theme, including by Brynjolfsson, McAfee, Drucker, Keynes, Andreessen, among others. As Nobel Prize winner Wassily Leontief has put it,

The role of humans as the most important factor of production is bound to diminish in the same way that the role of horses in agricultural production was first diminished and then eliminated by the end of introduction of tractors.

Fast forward, (robotic) engineering and automation in general have played quite a role in the last decade. As Mr. Gave put it in his book titled "Too Different for Comfort",

Thanks to functionality, and lower prices, the global 'labor-cost arbitrage' trend, which was the predominant macroeconomic feature of the past decade, may now be coming to an end.

Automobile manufacturers were the main beneficiaries of robotization wave #1, followed by electronic devices industry. More recently, we have seen other industries also benefit from the same trend.

The most staggering fact though is that we may be entering into a new revolution within this decade - a Robolution - as lower robots costs and inflationary labor costs converge, favoring robots adoption by industry participants.

But what types of jobs are at risk? Again recurring to Gave's book "Too different for comfort", he categorizes 4 kinds of jobs, being:

That said, categories 3 and 4 certainly fall at risk, while we (equity investors & research analysts) certainly follow under category 2 - non repetitive and complex tasks - and are likely shielded from robots. Thus, if we are indeed safe from robots, how could we lever our skills to better perform our jobs at the individual level, but more importantly, at the company level? Here kicks in Edward Hess and his recently published book "Learn or die: Using science to build a leading-edge learning organization".

Hess' motivation to write the book likely emanated from the conclusion that continually learning better and faster than the competition may be the only sustainable competitive advantage individually and organizationally. Take McGrath's thought-provoking book "The end of competitive advantage: how to keep your strategy moving as fast as your business" as the basis of this. If this assertion is correct, then to perform at a high level on job category 2 we must lever critical thinking, innovative thinking, emotional and social high engagement and other humans. As Hess put it,

the way to unify operational excellence and innovation in an organization is to have a learning culture, because learning underlies operational excellence and it underlies innovation.

In a recent interview with Hess conducted by Shane Parrish from Farnam Street blog, Hess lied a couple tenets of a learning culture, such as de-emphasized hierarchy, intellectual and leadership humility, curiosity, questioning, the right to debate freely, clarity, preparation, a praise for vulnerability, strong processes, accountability, empathy, compassion, humane relationships, no complacency, and so on.

At the end of the day, what we are talking about here is a CULTURE OF LEARNING. At Bridgewater, for instance, the culture is so strong we might call it a doctrine or a religion - if haven't read Ray Dalio's principles yet, please do! As companies with such a peculiar culture say it, "we are not for everyone!"

As I don't to spoil Hess' amazing book, I will finish this post with a couple quotes I got from his previous mentioned interview.

Number one, underlying innovation and operational excellence, go back to root cause analysis, or the five why's. Unpacking assumptions, good digging, the why, why, why, is underlying both processes.

Hierarchy as an elitism is de-emphasized, and there is a real push for highly engaging employees and leadership humility, and intellectual humility. (...) Does the CEO own the learning culture and walk the talk? (...) Has the organization put in place culture, structured leadership behaviors, HR policies, measurement and rewards to enable and promote learning behaviors? (...) You've got to start small and figure out and prioritize what you are really going to start working on.

Arrogance is a huge inhibitor to learning. Arrogance comes also from success in positional authority.

Where can I improve? What happened today? What would I do differently in how I think? What would I do differently in that conversation as to how I relate?

A leadership model that is very, very humanistic and people-oriented.

 The purpose of the whole system at Bridgewater is to overcome our humanness in a humane way. (...) The first thing they want to talk about is their vulnerability.

You don't put things off. You deal with them directly, honestly, openly. (...) everything about everybody is public record. 

Indeed, we are all work-in-progress until the last day of our lives. Thinking about how we are thinking is a never ending loop. We can't ever truly get comfortable. As this topic may look too 'soft' for for-profit companies, actually, it's not according to Hess:

There's this whole concept in the business world that if you're humanistic and engaging with people, you'll come across as soft. People will take advantage of you. (...) It's not the case. You can be humanistic and have high standards and high accountability. The companies I write about, every one of them are outstanding performers because they have the highest of standards that they hold themselves to. There is no softness in standards. There's a human element.

Berkshire Beyond Buffet: Excerpt from Chapter 8

Lawrence Cunningham's new book Berkshire Beyond Buffet is scheduled to be released on Oct 21st, though you can find here the chapter 8 from the book. Below, notice Berkshire's tenets for its subsidiaries' CEOs praising independence, trust and an owner's mindset:

"Berkshire corporate policy strikes a balance between autonomy and authority. Buffett issues written instructions every two years that reflect this balance. The missive states the mandates Berkshire places on subsidiary CEOs: (1) guard Berkshire’s reputation; (2) report bad news early; (3) confer about post-retirement benefit changes and large capital expenditures (including acquisitions, which are encouraged); (4) adopt a fifty-year time horizon; (5) refer any opportunities for a Berkshire acquisition to Omaha; and (6) submit written successor recommendations. Otherwise, Berkshire stresses that managers are chosen because of their excellence and are urged to act on that excellence."

Simon Sinek: Great Leaders Eat Last

As the old saying goes leaders are chosen by the people. In a highly competitive environment, employees tend to be egoistic and afraid. Why not create a great and complementary team based on trust and cooperation? It's not a coincidence that Patagonia's owner Yvon Chouinard hired friends and friends of friends to his company in its early innings. It's all about creating a great environment so people feel comfortable to give their best efforts for the company and his co-workers.


If you have the time, watch the complete speech.



If you are still interested, check his most recent book Great Leaders Eat Last.

Governance & Culture: Munger, Peter Thiel & Netflix Combined

Combining Munger takes on Governance, Peter Thiel's insights and Netflix HR presentation was fun to delve into intelligent governance frameworks sourced from an equity investor, a venture capitalist and a company. So, what are them?

• The fundamental principle: good character - when in doubt, there's no doubt. Do not hire;

• Strive for a trust-based environment;

• Provide context to people (why, why, why?), over-communicate - candor & clarity are musts;

• Inspire responsible behavior through freedom and independence, though reinforce accountability;

• Less formal processes, DOs and DON'Ts: "Act in Netflix's best interest". Yes, that's it. It's a principle-based approach that works with minimal good sense and intelligence; 

• Offer modest fixed salary, roughly equal to fixed costs. Align with equity ownership;

• Control is for beginners: “When we don’t give our people the space to take calculated risks, learn, apply, and iterate, we are really risking our future. While there is a risk to improvising and spontaneity, control brings its own insidious dangers. In our push for perfection, we over-engineer. We add so many bells and whistles that it takes a Ph.D. to use the product. Just because we can doesn’t mean we should. Just because we can practice to perfection doesn’t mean that’s best.” - HBS Article

Stanford - Munger on Corporate Governance.pdf by Igor Chalhub

Culture from Reed Hastings

Quality Investing

What if we make the link that people drive good business and then we got the (in)famous bottom line "E" so we finally have our estimated multiple? Then, value investing is all about people and corporate culture after all! Have you thought of that?

Baupost's Culture/Principles - Seth Klarman Interview (2008)

After years of compounding at a great rate of return, Klarman definitely and deservedly is considered one of the best investors of all times. In spite of Baupost's historical return, the main subject one would need to understand/study before judging a firm's performance, is the company's culture/principles. That's how one may achieve long term success.

Bottom line: do what you love in the first place, not for money, cultivate a strong culture, value long-tenured people you can trust and pay them well, so you hang out with them the longest time possible, be willing to delegate tasks, investing is more of an art than anything so be curious and open since we never know everything. Below, I have highlighted a couple quotes from this interview with him, by TIFF.

On needed skills:

"We want people who want to be part of a team. We also place huge empashis on values and ethics."

"We try to identify people with broad ideational fluency. Just plain common sense is also important."

"I think to take the next step and be a portfolio manager you need both a sense of history and a vivid sense of risk.(...) A broad curiosity blended with some contrarianism and a sense of what makes you money is the right combination of traits. Also, understanding the value of optionality is important." 

On turnover:

"I hate turnover; I really hate value long-tenured people. So I'd rather pay up for the people that I might be able to attract to make their entire careers at our firm rather than try to be cheap about it and hire bargains but ultimately pay the price for that in turnover or other things." 

"I think turnover is terrible not just because you've taken the time to train people and not necessarily gotten a lot of value out of them. It's really bad because there's something about the facility of communication with longstanding partners."

"When that knowledge walks out the door, and even more dangerously, when new knowledge that you're not familiar with walks in the door, it's very hard to think about where the trust is. Trust has to be earned, not just given." 

On investing:

"I would say (it is) art first and foremost, craft second, science third. (...) the nuances I was talking about - the ability to distill two or three major themes out of an investment and get right to the heart of the matter - is truly an art."

"(...)we think more value is added by being generalists and seeing opportunities from  a broader perspective. If you have silos, you're going to own things only within those silos."

On compensation/meritocracy:

"(...)we have evolved to a system where the partners would strive for equality with each other. (...) let's do this together, let's make it work. There are huge advantages to not keeping track of each person's individual contribution in terms of letting capital slosh back and forth so that no one person hogs the capital. (...) The problem is, if over time the contributions aren't equal, equal compensation will adversely select the people who are contributing less."

"What's great about our team is that I think most people feel like the firm is bigger than themselves. (...) Also, I think by bending over backwards to be fair and to not hog the money myself, I think everybody feels pretty good about a system that gives them a lot of compensation, even if it's not exactly the right amount."

On time allocation, an scarce item:

"We don't spend a lot of time in client meetings - I think, historically, that's probably 1% or 2% of our time, at most. That let me focus the great majority of my time on investing. I think that I do a good job of delegating, so that as we've grown, I've been able to bring other people into the loop and to give them serious responsibility." 

On explaining the firm's investment philosophy:

"The truth is, some of our clients don't understand, but we've worked really hard over time to explain it and to educate them to our way of thinking. It isn't the only way of thinking, but it;s how we approach it." 

On the best job ever:

"You know, I've said over and over, I have the best job in the world. I get to do something that is interesting and ever-changing and therefore ever-interesting, working with great people in a great culture. I get to do things like this from time to time. I get to teach from time to time. I get to write a book and communicate frequently to my clients. So I have the best deal possible."