Founder Mode, the Damodaran Bot, and “Not-So-Smart Money”

The most recent essay published on the site was “Finding the Right Speed,” which dealt with a problem that doesn’t get much attention.  At what pace should an investment decision get made?  The answer could vary from nanoseconds to years depending on the type of decision; the key is to design an approach that fits best with the circumstances, but it is easy to be pushed into being too fast or too slow.

Speaking of decisions, taking the time to include The Investment Ecosystem in your content diet is much appreciated.

Founders and managers

Paul Graham triggered a lot of online activity with his essay on “Founder Mode.”  He wrote that “there are two different ways to run a company:  founder mode and manager mode.”  As most startup companies scale, they shift from founder to manager mode:

The way managers are taught to run companies seems to be like modular design in the sense that you treat subtrees of the org chart as black boxes.  You tell your direct reports what to do, and it’s up to them to figure out how.  But you don’t get involved in the details of what they do.  That would be micromanaging them, which is bad.

To hear Brian Chesky (the CEO of Airbnb, whose talk spawned Graham’s posting), Graham, and many other commentators tell it, the shift to manager mode is normally the start of a decline of a company.  But that assumes that the founder is motivated more by the continuing process of creation than the money that is flowing their way — and can effectively adapt their process and style to meet the challenges of a larger firm.  Not every founder can do so; it sounds like staying in founder mode must be the very best thing, but in some cases not making the switch can be as dangerous as making it.

The same considerations apply to investment organizations.  Often the founder(s) stick to what got them there — leading to stagnant organizations, declining performance, and irrelevance.

The Damodaran Bot

Aswath Damodaran, the prolific professor of finance and valuation expert, wrote about “the Damodaran Bot”:

This is an AI creation, which had read everything that I had ever written, watched every webcast that I had ever posted and reviewed every valuation that I had made public.

For him, waiting to see the output from the bot and have it compared to his own work and that of others:

I am not sure what results I would like to see.  If AI values companies as well, or better, than I do, that is a strong signal that I am facing obsolescence.  If it does so badly, that would be a reflection that I have failed as a teacher.

Increasingly, we will be asking questions about our own performance — and our worth in a new world.  Damodaran includes some thoughts about the kind of jobs that may be outsourced to machines.

Harvard

A Bloomberg story by Janet Lorin is titled “Harvard’s Not-So-Smart Money: Two Decades of Poor Returns and Rich Pay,” and carries a subtitle that says “Its money managers underperformed after changing personnel and strategies at the worst times.”  That pretty much sums up the last couple of decades of the largest endowment fund; the details are here.

Excess return profiles

This graphic appears in a paper from Jo Drienko, et al., “Excess Return Profiles for Stocks Purchased by Active Equity Managers.”  It shows the average magnitude and time horizon of excess returns for new positions taken by equity mutual fund managers.  Upper left is the profile for all funds and to its right is a breakdown between large, mid, and small stocks.  In the lower row are the profiles in each of the nine categories of the Morningstar style box and growth, blend, and value funds.

There are similar graphs based upon quintiles of fund turnover, expense ratio, tracking error, fund size, and other measures.  Plus an exhibit that shows the overall performance of funds rather than just that of the individual new holdings.

The profiles provide insight into the differences in how excess returns rise and fall across different kinds of funds.  In the abstract, the authors summarize their main findings:

Purchases by small-cap funds and value funds deliver outperformance relative to style indices that accrue over long horizons, while purchases by growth funds and high turnover funds outperform over short horizons.

This type of analysis should be a part of how asset managers identify patterns in the performance of their stock picks.  Some have in-house evaluations of the type and others use outside services that specialize in those calculations, but many don’t track them at all.  (Those who allocate assets to asset managers should be asking about whether they can see the results.)  This paper provides some overall tendencies to consider when doing due diligence and constructing portfolios.

OCIO pushback

Institutional Investor published an opinion piece from Dennis Simmons of the Committee on Investment of Employee Benefit Assets that includes the text of its report, “Challenging the OCIO Hype: Debunking the Myths.”  The piece says that promised OCIO benefits “rarely materialize,” and emphasizes that despite hiring an OCIO to shoulder the load, “employers are always ultimately responsible for the prudent management and administration of their benefit plans.”  Simmons also references expected cost reductions not being realized and potential conflicts of interest.

In a piece on the CAIA Association’s site, Brian Schroeder brings up the issue of OCIO search (and review) consultants being too tight with OCIO providers:  “The horse trading potential is limitless.”

The initial wave of OCIO placements has now matured to the point where clients are seeing some of the pitfalls of the structure, while others are very much stuck in performance-shopping mode, just as they were when they hired asset managers directly.

Other reads

“Private Equity Calls in Experts to Fix Firms They Can’t Sell,” Marion Halftermeyer and Layan Odeh, Bloomberg.  The old PE playbook gets a rework.

“Thinning the Herd: ~50% of Unicorns Should No Longer Be Unicorns,” Justine Huang & Wiley Miller, Industry Ventures.

All of the methods we have used to determine Unicorn value have converged at a similar answer, which is that about half of the Unicorn population could be dehorned.

“Who Needs Academic Finance Literature?” William Bernstein, Advisor Perspectives.  Bernstein cites some seminal works of the last fifty years (which came after the initial rush of academic finance frameworks).

“The barbell tolls for fixed income investing,” Huw Van Steenis, Financial Times.

The “barbell effect” long associated with equity investing is now playing out in the bond markets in earnest.  This shift underscores just how much the market structure of finance is changing.

“A Mixed Review for Institutional Private Debt Performance,” Stephen Nesbitt, Cliffwater.  Why have institutional strategies apparently underperformed “SEC-registered private debt vehicles focused on the fast-growing wealth and retail channels”?

“Facing Up to the Growth Curse,” Yves Doz and Keeley Wilson, INSEAD.

Over time, CEOs and senior executives may buckle under investors’ demands for predictable quarterly growth — as these demands become increasingly difficult to meet as a business matures — and be tempted to resort to short-term expedient measures that maintain the appearance of success and growth but prove very detrimental to the longer-term health of their company.

“Living in a Material World: The Surprisingly Gripping Tale of Six Natural Resources,” Laurence Siegel, AJO Vista.  A glowing review of Edmund Conway’s book about the materials that power our world.

“Look for Boring First,” Byrne Hobart, The Diff.

The curse of base rates is partly a blessing:  the historical record has plenty of evidence of bad predictions, and it’s good to keep that in mind when hearing them or making them.

“Tom Brady on the Art of Leading Teammates, Tom Brady and Nitin Nohria, Harvard Business Review.  The soon-to-be Hall of Famer offers some lessons that apply to investment organizations too.

“Wannabe Goldman interns should be hitting the beach,” Robert Morier, Financial Times.  A reminder that jobs far afield from the standard industry path can provide underappreciated development opportunities.

Fear less

“Nothing in life is to be feared, it is only to be understood.  Now is the time to understand more, so that we may fear less.” — Marie Curie.

Flashback: The Power Broker

It has been fifty years since the publication of The Power Broker, Robert Caro’s masterful biography of Robert Moses, which became an unlikely bestseller that is still popular today.

The anniversary has spawned an exhibit at the New York Historical Society, as well as many articles, podcasts, etc.  Among them are a profile in New York and a long series of podcasts from 99% Invisible.

An interview with Caro on the New York Times Book Review podcast is a good introduction.  It offers perspective on power (it always reveals the person who holds it) and how power relationships shift over time.  He also discusses his investigative methods, which are explored in depth in his book Working.

Caro takes years to do his research, so it might seem that his experience offers little applicability for investment professionals, but his tactics and his dogged pursuit of the truth offer inspiration for those charged with uncovering the story behind the narrative.

Postings

Past postings can be found in the archives.

Among them is one on “Communicating in the Virtual World,” part of a series on Talent, a book by Tyler Cowen and Daniel Gross.  A snippet:

In-person meetings often involve a power dynamic; where the most important person sits (and how others array themselves in response) forms a stage — and frames a performance of sorts — that isn’t there online.  Dress, physical presence, and “witty repartee” all diminish in importance.

Thank you for reading.  Many happy total returns.