|Daruma Capital Management LLC
80 West 40th Street, 9th Floor
New York, NY 10018www.darumanyc.com
Founded in 1995, Daruma Capital Management invests in high-conviction portfolios of no more than 35 stocks.
Daruma manages $1.7 billion for public and corporate pension plans, endowments, foundations and individuals. Our annualized Small-Cap return net of fees since inception is 12.1% vs. 7.6% for the Russell 2000 (7/28/95 to 12/31/12). Our annualized SMid-Cap performance net of fees since inception is 3.6% vs. 9.5% for the Russell 2500 (4/30/10 to 12/31/12).
Notes to Performance
For more information about the work we do, please visit us here
Today we talk about experience. Specifically, why it's overrated and how an understanding of history can help you, as an investor, spot inflection points and exploit misunderstandings on the part of other investors.
We also give a shout out to friend and chef, Eddie Huang, of Baohaus!
(To listen to this month's newsletter, click here
All the best,
Mariko O. Gordon, CFA
Founder, CEO and CIO
Daruma Capital Management LLC
Ducks, Swans, and Old People
Last month we hosted two groups of students in our office:
undergrads from the University of Wisconsin Milwaukee, and graduate students from the Instituto de Empresa in Madrid, Spain. All were stock jockeys, the undergrads having competed to be accepted into the Investment Management Certificate program at the Lubar School of Business, led by Dr. G. Kevin Spellman.
Not only does Dr. Spellman have a Ph.D. in Behavioral Finance, he has also slogged in the investment trenches since 1993. I'm proud to report that my young staff members here at Daruma rocked career day:
- Analyst April Zhu talked about making 125 cold calls to land her first summer job in finance while a student at the Cornell School of Hotel Administration;
- Trader Ron Viener described making the jump from operations to trading while getting his MBA from NYU at night;
And then came my turn, to talk about stocks.
- Controller Rob Motch reminded the students that it takes a village of non-investment pros to keep a money management firm humming like a well-oiled machine. (This last point is important. Putting up numbers is incredibly difficult. Putting up numbers when your house is on fire is impossible.)
Let me tell you, nothing thrills an old fart more than being asked to give advice (solicited, no less!) to fresh blood.
Over the next hour, I lobbed many advice bombs. One in particular, which I share with you today, was this:
If you don't have experience, substitute history. Experience is overrated
Regardless of where you, personally, fall on the investment experience continuum - total rookie to blowhard veteran - this particular trait isn't all that it's cracked up to be.
I can think of at least four reasons why not:
- The older we get, the easier it is to be dismissive and to rely too much on pattern recognition and heuristics as lazy shortcuts.
"If it walks like a duck and quacks like a duck, it must be a duck." Except, of course, when upon closer examination, it turns out not to be duck (Q.E.D. The Ugly Duckling). The world is always changing, and the market always discounts the future. If you aren't open to recognizing in what ways the future will be different from the past, you will miss opportunities.
It's worth poking that duck hard, because most everyone else will be too lazy to do so. By the time they figure out it's a swan, you've made a bundle. Young people, not having built dismissive shortcuts, always poke the duck hard.
- Lots of the same kind of experience doesn't make you any wiser.
It cracks me up when I read firms brag about their collective "200+ years of investment experience." It could be 40 guys with five years, five guys with 40 years, or 200 spider monkeys with one year - no matter. Whatever the calculation, it's hard wired into humans to overweight what happened most recently and fight the last investment war (remember the Maginot line?).
And with all that shared past experience at a given firm, there's probably no differentiated perspective. If people all think alike, does it matter whether it's five, 10 or 20 years' worth of shared experience making them think alike?
- With age comes caution - but often too much.
The adage that "bull markets are for young people and bear markets for old people" does young people a disservice. The point of the truism is that young people won't be scared to ride bull markets all the way up because they haven't learned to fear the ugly and brutal end, whereas old hands will know a bubble when they see one.
But it cuts both ways: We old folks tend to take money off the table way too early (and then complain bitterly about a market that doesn't make sense). And while the young gunslingers may very well bury their investors, the old guys will so wallow in being right to have called the bubble that they are scared to actually deploy all that capital they preserved by being bearish in the first place. Then they miss the next market upswing.
History has much to teach
- Young blood isn't stupid blood.
Early on in Daruma's history we pitched a university endowment, disastrously. I knew we were toast when I got asked "What will you do in a bear market?" in such a way that it was clear that no matter what I said, the answer the questioner (an old guy, natch) would hear would be "Why, panic of course, because I am so INEXPERIENCED."
Never mind that I'd lived through a couple of tough markets by then, was in my thirties, and had already been part of building one billion dollar firm with good numbers. The older we get, the harder it is not to get jealous of young blood.
But just because blood is young, it's not stupid. That's why the shrewdest thing we've done around here lately is hire a few smartypants in their 20s to keep us on our toes and our minds from fossilizing.
There may indeed be "50 ways to leave your lover," but there are at least a thousand ways to lose money in this business. If you lack experience, you'll want to learn what those ways are, and quickly,
with as little damage to your portfolio as possible and as much chance, therefore, that you'll hold onto your clients and your job. Which is why I told our visitors to get off their asses and read up on financial history.
For a handful, I'm sure that was not the answer they wanted to hear - maybe they went into finance to avoid dealing with words. Too bad. Financials are just a story told with numbers - but it's still a story.
And the sooner you understand what drives these narratives - the motivations of the main characters, the broad cultural, political, environmental landscape in which they were played out and so on - the sooner you can see how an investment might play out differently than people expect. Hindsight may be 20/20, but by reading about the past you develop an appreciation for how the present emerges
from the fog of the future.
It makes you comfortable with ambiguity; expectant of random acts of fate; knowledgeable about human folly; and a connoisseur of how sentiment changes and why. Not only do you learn to see how potentiality becomes reality, you develop a more concrete understanding of how a business actually operates in the real world.
After all, if you haven't run a business and all you know is what you've been taught in books, you won't be able to take the abstraction that is investment and business jargon and translate it into day-to-day reality. Reading about industries long gone
teaches you about competitive forces and technological obsolescence. Reading company histories
helps you appreciate the miracle that is a well-run enterprise. Reading memoirs of investors
as diverse as Bernard Baruch, Martin Sosnoff
or Jesse Livermore allows you to apply the lessons they learned without having to live through them yourself. In short, knowing what has happened in real life will allow you to spot inflection points and exploit misunderstandings on the part of other investors
. You know, those duck-spotting, trend-extrapolating types who, because they are not students of history, are doomed to repeat it.
Speaking of the contrast between young and old, the pugnacious thirty-year-old chef Eddie Huang of Baohaus catered my mom's surprise 80th birthday lunch last weekend. He pulled out all the stops and we had an amazing feast, from lion's head meatballs to breadpudding with salt caramel sauce.
The Young and the Old
Two days later we went to Barnes and Noble for the launch of his memoir, Fresh Off The Boat. When asked by Chef Tom Colicchio why he wrote a memoir at the age of 30, he said that if he waited until he was older he might forget all the things that made him angry growing up as a Chinese kid in Orlando Florida. Age does mellow you, in life as in investing.
Read the book. It's brutally honest and brilliantly written. Or catch Eddie on his show, Fresh Off The Boat, on Youtube's Vice channel. Warning: the F-bombs fly fast and furious in both.
For those who actually WANT to take my advice, I can recommend the business history profiles in Investor's Business Daily, as well as the historical charts they highlight each week.
Where to Get Your Business History Fix
For a cool blog with well-curated content featuring interviews, letters and musings of interesting and thoughtful portfolio managers, check out PMJar, written by Vivian Y. Chen, CFA. I say this not just because I've gotten a shout out on the blog here and there, but because there's a lot of content not easily found elsewhere featuring less well-known portfolio managers with fine track records.
And finally, if you're super ambitious, reply to this newsletter and I'll email you a list of books to help bridge that dreaded experience gap. Or better yet, email me with your favorite business or investing histories!