Greetings! It has been a very long time since our last PM Jar article. In 2015-2016, a variety of opportunities emerged in the marketplace, and I was busy actively investing and implementing PM Jar concepts at Marram Investment Management. If you are curious about this implementation process and its outcome, here’s a link to Marram’s historical investor letters.
In recent days, with markets complacent and opportunities increasingly scarce, I am looking forward to continuing to build the PM Jar knowledge repository. To kick things off, below are some especially insightful excerpts (Part 1 of 2) from an interview with Kingstown Capital Management (Michael Blitzer and Guy Shanon) conducted by the Columbia Business School Graham & Doddsville newsletter publication.
Psychology, Portfolio Management, Mistakes, Process Over Outcome
“Over the years, a lot of our former students have asked us about starting funds and how we would evaluate somebody who is starting a new fund. I think there are three parts. There’s being a good analyst, and then there’s being a good portfolio manager, which is actually a pretty different skill set. Then there’s the third part, which is temperament. The big intangible. There are a lot of people who have one of the three or two of the three, but it’s very hard to have three of the three because it’s a mixture of a bunch of personality traits that are not often on the same gene. But you need all three.
Part of temperament is being able to be self-critical. Many people in this industry have been very successful all their lives. They have always been at the top 10% of everything they have done. All of a sudden, a position is going against you and you have to really break it down and be honest with yourself. Or you have to take a view that is vastly different from what the ‘smart’ people are saying, what your smart friends who are making money this year are saying. A lot of people have never done that before. You have to be very critical and skeptical all the time, but also know when not to be. And how you go about that has a big impact on performance over time.
You have to put up walls and blinders to eliminate behavioral biases when these things happen. Of course, when something goes against you in a meaningful way, the market is usually not that wrong. At the very least, it’s down for a reason. Stepping back and understanding what that reason is. I think the only way to do that is through a constant re-underwriting process and a diligent research process.”
“…being very patient and permanent impairment often become the same thing eventually…we are re-underwriting every single position every single day. If the facts change, we have to be intellectually honest and reevaluate that, otherwise you are just hoping. It’s a combination of research and portfolio management.
It’s easier said than done, but when something is going against you, you have to fight off the urge to ignore bad news…be brutally honest with yourself whether or not what you thought was going to happen actually did happen or is happening.”
“The closest thing we have to a formalized process is our emphasis on written memos. For any position of a decent size, we write very detailed memos. We date them and we update them, so that six months or eighteen months later we can go back and see what we thought was going to happen. From a psychological standpoint, you can play all kinds of games if your investment ideas are all in your head, which is bad for performance. It also makes you refine your thinking. By writing something down you are forced to focus your thoughts in a way that verbally you cannot…many times I have had this experience: I decide I like something, then I write down the bull and bear cases for it, go back to it a few times over several days, adding things, and then I think, you know what, I don’t like this so much anymore. Writing things down brings more precision to your thinking and helps in the process of weighting factors.
Often we all have very similar information, but the rub is, how do you weight it differently in a decision to get better outcomes…You should get better at that every year and as you live through more things. But then again, you don’t want to be over-influenced by an unusually good or bad experience, because outcomes are more like the mean than the exception…”
“…a lot of people have come into this industry because it’s the next logical step or the way to become wealthy. It’s what Investment Banking was before that. So it has attracted very high performing individuals many of whom have never experienced a setback or disappointment. But, this business humbles people very quickly and how you deal with these initial setbacks will determine success or failure…The setbacks and how they have learned to think about risk and reward and their lives in general are what differentiate people in our experience.”
“Thinking, Fast and Slow is a great book. We’ve both read it. I read it over and over and I’m still learning, it’s not exactly beach reading…We’re very aware of the behavioral stuff, it’s important. It is possible that managing our own behavior effectively is the single most important thing we do as investors in public markets at the end of the day.”
100% agree that Amazon: Thinking, Fast and Slow by Daniel Kahneman is a fascinating read, especially for investors seeking to become more self-aware.
Team Management, Psychology
“Mike and I work on the names with the analysts. The two of us are intimately familiar with everything in the portfolio. I think that’s important because at a lot of funds, if a name goes against the portfolio manager and he or she is reminded they just don’t know much about it. Then they look to the analyst and ask, ‘Is the analyst good?’ Then they start thinking about the idea in the context of the analyst. ‘How has the analyst done recently?’ This actually reduces to a kind of momentum that analysts get inside funds, which influences investment decisions and is kind of crazy when you step back and think about it. We are trying to reduce the behavioral stuff between us and the idea, and want to be right there on the front line. We want to be fully informed and decisive. We don’t have to wait for a committee meeting or consider the internal politics of an investment decision, because we have neither of those.”
Capital Preservation, Risk
“Before we figure out how much we can make in an idea, we have to discuss what all the possible risks are that may or may not happen. I am not sure if I would call that a ‘pre-mortem’…We see that term a lot, it’s part of a checklist that people interviewing for jobs have decided they need to have in anything they write, it has become part of hedge fund analyst culture, like it’s some kind of innovation. But really it’s common sense—if you are going to put a substantial amount of your net worth at risk, wouldn’t you think through how it could go terribly wrong, and what the first signs of that would be? The answer is yes, and it’s probably a good idea to write it down.”
“When most people have lost money, us included, it is often not from any of the twenty possible risks you listed in advance. When the bad outcome happens, you’d be shocked how often it was related to something that wasn’t on your original list. For us, this is why it all comes back to valuation. Being a good investor requires you not only to be wrong in ways you didn’t anticipate and still not lose a lot of money. I think the only way to do that is to buy things very, very cheaply. For most investments that haven’t worked, we have been very wrong on a number of things and still not taken a large impairment.”