Subscription Lines and Other Fund Lending facilities

/

The following are my notes collected over several years of working with subscription lines within alternative assets. While not always the most critical issue, understanding sub lines and other lending facilities can help improve LP fund governance, performance reporting, and enable the LP to ask better questions during due diligence and throughout the fund life.

Overview

• Subscription lines are not a new phenomenon in private markets as they’ve been used for decades. They allow managers to borrow to fund bridge financings and then eventually call the capital from limited partners

• The ability to delay calling capital enhances the manager’s flexibility to execute deals and shortens the J-curve, enhancing the fund’s Internal Rate of Return (IRR), particularly early in a fund’s life, and therefore its competitiveness on a quartile basis

• Funds use credit lines to boost Net IRR's and accelerate carried interest, particularly in funds with European style waterfalls

• From an LP perspective, the use of these lines helps smooth cash flows and eases the administrative burden of responding to capital calls.

• Improves capital call logistics – small investment outlays more conveniently aggregated

Read More

Accuracy Not Confidence

/

Confidence and hubris are abundant in the investment world, especially in bull markets. Everyone claims to know where the market is going, what the Fed will or should do, and what the next great idea is. Just ask, and you’ll have plenty of people talking about their can’t-miss ideas.

Confidence is infectious. We all want to know what the market is going to do. We all want to know when the next big crash is coming. We hate uncertainty. So anyone that can remove that uncertainty has our attention.

But it’s not confidence that we want. It’s accuracy. Accuracy in the sense of actually making investment decisions that succeed long term.

Confidence is about predicting success. Accuracy is actually delivering it. That’s a big difference.

Confidence doesn’t improve accuracy; it only appears too. Confidence has no bearing on whether a decision is good or bad. Decision quality depends on your diligence, research, understanding, and timing.

Read More

Identity Investing

/

Identities create comfort and order in a messy world. Identity politics is the best example. Political affiliations shortcut thinking. As soon as we realize an idea is Republican or Democrat, our mind is made up without even evaluating the idea itself.

No need to consider the merits.

No need to examine the nuances.

No need to learn from the other side.

Just let the identity decide for you.

This happens in the investment world too. Investors form identities which hinder the ability to learn from opposing views. We are suckers for identities because it saves us time and energy. And it fuels our ego when we hear nothing but things we already agree with. But it also creates defensive rigidity, mindless groupthink, and destroys the ability to adapt. For example,

· Bullish investors dismiss all bears as doomsayers

· Bearish investors dismiss all bulls as naïve optimists

· Value investors dismiss all growth stocks as expensive/unsustainable

· Growth investors dismiss all value stocks as falling knives

· Fundamental investors dismiss quants as opaque black boxes

· Bottom-up investors scoff at the futility of a macro investor’s economic views

· Active investors dismiss passive investing as lazy and boring

· Passive investors dismiss active strategies as paying high fees for underperformance

· Public market investors dismiss alternative investors paying 2 and 20

· And on and on…

It’s easy to dismiss strategies that conflict with our identity. Why spend time on other strategies when our strategy is superior?

Read More

Organizational Scar Tissue: Stop Creating Rules for Every Problem

/

When things go wrong, companies implement rules to solve them.

· Employees booking overly expensive hotels? – Devise multi-level pricing matrices (with different versions based on location and/or employee seniority) that must be followed

· Someone overpay for computer hardware? – Require multiple approvals for mousepads, keyboards, and webcams

· Booking expensive flights? Mandate the cheapest economy flights, require receipts, and a copy of your boarding pass to ensure the flight was taken

· And of course, make sure you submit a copy of your conference badge or agenda, because we need to make sure you attended what you said you were going to attend

These policies are common reactions to employee abuses and honest mistakes.

And it seems reasonable – identify the abuse and create a rule.

This works in the short term but creates a drag on a company’s long-term success. It drives a culture of compliance and rule following, prioritizing adherence vs. doing what’s best for the company. Rules take away freedom and autonomy. On the field judgment is replaced with behind the desk directives. Rules can’t adapt quickly to the real world. Creating endless exceptions just expands already monstrous rulebooks, adding confusion and frustration to employees who are looking to get things done.

All of this because a select few people took advantage of the system.

Read More

Checklists Gone Wrong

/

Checklists are simple yet powerful tools. A wide array of industries have succeeded with checklists. Pilots use them to improve flight safety. Hospitals use them to improve patient care. Nuclear power plants use them to ensure safe operations.

Atul Gawande, famed surgeon and New York Times best-selling author, wrote the book on checklists – The Checklist Manifesto. It’s an insightful, practical look at how organizations use checklists to succeed in pressure-filled environments.

Checklist implementation is very popular. Organizations enthusiastically publicize how checklists have counteracted human and organizational flaws.

But like most good things, checklists have been misconstrued and distorted to become a headache, not a help, to an organization.

Organizations require mindless checklist completion instead of using them as a tool to improve understanding. It’s not the finishing of a checklist that drives value. It’s the thinking that occurs along the way that otherwise would not have happened. Checklists have become another mandated task to get out of the way. After all, bureaucratic organizations love nothing more than adding additional documentation and compliance tasks.

Read More

Stop Trying to Achieve Consensus

/

Many investment firms strive to achieve consensus group decisions. The desire to have unanimous agreement is understandable. There’s a certain comfort level when everyone agrees.

But seeking consensus is a mistake, even though it feels right.

Investment markets are too uncertain and unpredictable to expect unanimous agreement. The goal is not comfortability. The goal is to make the right decision. And that means getting every idea out on the table, debating and disagreeing, and then making a probability-based decision, knowing that 100% certainty is unachievable.

Disagreement is a necessary condition because no one knows the investment future. Opinions and ideas will differ.

Read More

Enough with Credentials

/

Like most professions, the investment industry is obsessed with credentials. It’s rare that a month goes by without another announcement of a new designation to add behind your name.

Investors have lost focus on what matters. Results matter. Good decisions matter. Long-term performance matters.

Credentials do not.

I’m sure I appear hypocritical given I’ve completed several credentials (CFA, CAIA, CPA, etc). But in my experience, it’s the rigor and thoughtfulness behind a decision that delivers value, not the credentials. We conflate credentials with competence because it’s an easy shortcut. But it’s a mistake and its incentivizing investors and their organizations to look good (more letters behind their name) rather than be good (deliver outperformance).

Can these programs have value? Absolutely. There’s useful information learned in these programs. But the question is, how do you judge who can apply that knowledge in the real world? It’s not by looking at credentials. It’s the application of knowledge that matters. And to judge that, you need to do something different.

Read More

9 Ideas I Learned from The Death of Expertise: The Campaign Against Established Knowledge and Why It Matters

/

Tom Nichol’s The Death of Expertise: The Campaign Against Established Knowledge and Why It Matters provides valuable insight on how ordinary humans can dismiss experts by believing they know more than people who have spent decades studying a topic. The ease of information access has caused many people to believe they know more than they really do. Confidence is now substituted for actual knowledge. Egos have grown so large that people are conditioned to attack those they disagree with, rather than try to learn from them. Individuals are becoming more convinced they are right even as their ignorance grows. The book covers several reasons why this occurs. While you can’t prevent others from behaving this way, this book is a helpful guide to help yourself identify and correct overconfidence in your knowledge.

The 9 Best Ideas

o We Prioritize Egos and Emotions Over Rationality and Humility

o We Love Information That Confirms Our Beliefs

o Bad Information Crowds Out Knowledge

o It’s Not That Experts Are Never Wrong, Just Wrong Less Often Than You

o The Illusion of Explanatory Depth: Knowing Random Facts Doesn’t Equal Knowledge

o We Struggle with Uncertainty and Unpredictability and Will Do/Believe Almost Anything to Remove These Feelings

o Objectivity

o We’ve Conflated Getting a Degree with Being Educated

o We No Longer Want to Do the Deep Work

Read More

12 Ideas I Learned This Week From High Output Management

/

Intel’s Andy Grove is considered a must-read in the tech and business world. Grove’s High Output Management provides several lessons for both organizations and individuals, even for those outside the tech industry. Grove was a visionary not only on the technology side, but on the organizational and leadership side. His ideas span big picture strategy considerations to practical advice on running meetings and employee feedback. Every organization makes decisions. Grove’s advice improves the decision-making process. Grove’s insistence on the importance of writing and removing interruptions are even more relevant today than when he wrote his books.

The 12 Best Ideas

o Take control your career and skills – no one else will do it for you

o Be a micro-CEO: even as a middle manager, you still have control over certain decisions, regardless of what the organization has done

o How writing improves thinking and decisions

o Make a tough call; don’t waffle

o Following rules and procedures isn’t valuable unless people understand the purpose

o Interruption destroys the ability to create meaningful work

o Make one-on-one meetings worthwhile

o How to structure employee reviews

o How to run a meeting

o Stop trying to get consensus

o Negate Peer-Group Syndrome

Read More

10 Ideas I Learned This Week From Being Wrong: Adventures in the Margin of Error

/

Kathryn Schulz’s Being Wrong: Adventures in the Margin of Error provides numerous examples of how we fail in our decisions and why we habitually repeat the same mistakes. There are several practical ideas that will improve decision making at the personal and organizational level. The challenge, as with any type of change, is with the implementation. Sure, it’s easy to say you’ll seek out ideas you don’t agree with, but how many of us actually do that? The key is putting ideas into practice and treating these like a skill that can be developed. Reading about these ideas without using them doesn’t improve your ability. These ideas are especially useful for those in knowledge-based fields, where you don’t always get the tangible feedback like you would in a physical trade.

Read More

The Jungle is Neutral

/

Between stimulus and response there is a space. In that space is our power to choose our response. In our response lies our growth and our freedom.1

In his book, The Jungle is Neutral, Freddy Spencer Chapman describes his experience as a World War II British soldier fighting in the Malaysian jungles. The fighting was intense, but the effect on the soldiers’ mindset was even more unsettling:

My experience is that the length of life of the British private soldier accidentally left behind in the Malayan [modern day Malaysia] jungle was only a few months…to them the jungle seemed predominantly hostile, being full of man-eating tigers, deadly fevers, venomous snakes and scorpions, natives with poison darts, and a host of half-imagined nameless terrors. They were unable to adapt themselves to a new way of life and a diet of rice and vegetables; in this green hell they expected to be dead within a few weeks – and as a rule they were…

It’s not surprising how the terror of jungle warfighting took a toll on soldiers.

However, not all soldiers capitulated. Some soldiers viewed the jungle opportunistically, with supplies and cover available for all:

The other school of thought, that the jungle teems with wild animals, fowls, and fish which are simply there for the taking, and the luscious tropical fruits-pawpaw, yams, bread-fruit and all that, drop from the trees, is equally misleading. The truth is that the jungle is neutral. It provides any amount of fresh water, and unlimited cover for friend as well as foe – an armed neutrality, if you like, but neutrality nevertheless. It is the attitude of mind that determines whether you go under or survive. There is nothing good or bad, but thinking makes it so. The jungle itself is neutral.

The jungle was neither for nor against any soldier. Neither good nor bad. Just neutral. How soldiers responded to this neutral environment determined the “good” or “bad” outcomes.

Read More

Consistency as the Hidden Driver of Investment Success

/

Many factors contribute to investment success, but consistency is too often underappreciated.

Consistency isn’t exciting. And consistency doesn’t get headlines. But consistency does allow an organization’s investments and people to compound and grow over time.

Consistency means showing up, day after day, improving little by little.

Consistency lacks the excitement of the next big thing, but it’s not the big things that generate durable returns.

Instead, it’s the consistent improvement in your people and the consistent value added by your portfolio over long periods of time.

Consistency in investing is like consistency in athletics, music, or art. It’s the constant grind of consistently pushing yourself towards a common goal. But, it’s a slow and invisible process – you don’t see improvement every day. You have to trust your process.

Investors lack the staying power to build impressive results. People want variety and stimulation. Sticking with the same thing can be monotonous, even if valuable. It’s during the boring stage that we get the itch to do something more and make a big change. But doing something more is often used as an excuse to do something flashy, something that excites us. It’s not excitement that drives returns, it’s consistency.

Read More

The Illusion of Explanatory Depth: Why We Know Less Than We Think We Do

/

We know less than we think we do.

Most of the time, it’s not a big deal. We can navigate our days just fine.

In many areas, however, it’s critical to acknowledge what we know vs. what we don’t know.

We need to be well-calibrated. That is, we need to make sure our confidence matches our actual knowledge. When we think we know more than we do, we make bad decisions, even though we remain supremely confident in our decisions. This mismatch has real consequences:

· Thinking you know more about money and investments than you really do means you will lose money

· Thinking you know more about leadership and management than you really do means you will lose good people

· Thinking you know more about communication than you really do means strained relationships

· Thinking you know more about parenting than you really do means you will struggle to raise good kids

Read More

Security Theater

/

Security theater is a concept that you’ll experience everywhere once you know what it is.

Bruce Schneier, a security expert who created the phrase, explains:

Security theater refers to security measures that make people feel more secure without doing anything to actually improve their security.1

Here’s how Schneier describes the concept:

An example: the photo ID checks that have sprung up in office buildings. No-one has ever explained why verifying that someone has a photo ID provides any actual security, but it looks like security to have a uniformed guard-for-hire looking at ID cards. Airport-security examples include the National Guard troops stationed at US airports in the months after 9/11 — their guns had no bullets. The US colour-coded system of threat levels, the pervasive harassment of photographers, and the metal detectors that are increasingly common in hotels and office buildings since the Mumbai terrorist attacks, are additional examples.

Read More

Nine Rules to Fight Deception in the Investment Process

/

Independent, critical thinking is an unnatural process, especially for investors. It’s easier to go with our gut instinct, instead of relying on the facts. It’s easier to go with our emotion than diligently follow the evidence. Above all, we gravitate towards stories and promises rather than logic and reason.

Carl Sagan was one of the great astronomers and scientists of the 20th century. He published more than 600 scientific papers, co-wrote Cosmos, the most widely watched T.V. series in American history, and wrote the novel Contact, which was later made into a movie.1

One of his most important efforts was his support for independent, skeptical thinking. It’s the application of the scientific method to our daily interactions. In his book, The Demon-Haunted World: Science as a Candle in the Dark, Sagan includes a chapter called “The Fine Art of Baloney Detection.”2 Sagan proposed 9 simple rules on how to apply the scientific method to better understand the world around us and protect against deception. It’s advice that fights against lazy thinking and raises our standard on what we choose to believe.

Read More

Bob Maynard on The Challenges of Complex Investing

/

While many institutional investors have flocked to alternative assets, few have been able to translate these allocations into successful performance. Allocating is easy, performing is hard.

Bob Maynard, CIO of the Idaho Public Employees Retirement System, illustrates the difficulty of executing on alternative strategies:

All of these additional areas add complexity and require time for Boards and staffs, and are often not worth the extra effort unless there is a clear organizational commitment or belief in a certain additional approach that can survive changing Boards and staffs over the years that may occur before the extra efforts pay off. One of the most valuable resources of an investment organization is not the assets in the portfolio, but the time required of the Board and staff. After the basics have been accomplished, additional investment efforts in more complex areas have to expressly trade off the requirement of additional resources and time compared to the often problematic longer-term return benefits.1

Read More

The Battle of Passchendaele and The Madness of Blind Effort

/

In his book, Good Strategy, Bad Strategy: The Difference and Why It Matters, Richard Rumelt illustrates the folly of blind effort and unyielding motivation:

In Europe, motivational speakers are not the staple on the management lecture circuit that they are in the United States, where the doctrine of leadership as motivation is alive and well. Here, for example, is H. Ross Perot: “Most people give up just when they’re about to achieve success. They quit on the one-yard line. They give up at the last minute of the game, one foot from a winning touchdown.” Hearing this, many Americans nod in agreement. Many Europeans, by contrast, hear the echo of the “one last push” at Passchendaele. There, the slaughtered troops did not suffer from a lack of motivation. They suffered from a lack of competent strategic leadership.

Read More

After Action Reviews: An Essential Method to Accelerate Your Team’s Improvement

/

I think avoidance is the enemy of great. Avoidance – particular avoidance of discomfort – is even the enemy of good. It’s the enemy of the growth and change that lead to flourishing.1

In all organizations, mistakes are guaranteed to occur. What’s not guaranteed to occur is learning from these mistakes. The one positive that comes out of failure - the ability to reflect and correct mistakes, ends up neglected by the organization. Avoidance of intellectual discomfort is usually the preferred route.

There are several reasons organizations avoid learning from mistakes:

· Organizational ego prevents honest discussions about what went wrong

· Busyness means that people immediately move onto the next project

· A rush to judgment centers on superficial issues, rather than deep-seated problems

· Blame is quickly directed at external factors, absolving any need to discuss internal responsibility

Read More

The Overton Window: Why Bad Ideas Prevail Over Good Ideas

/

Why do good ideas sometimes gain little traction and bad ideas flourish despite obvious flaws? It’s rarely related to the merit, logic, or evidence behind the idea. Instead, acceptance is based on political and cultural popularity. If it’s an unconventional idea that disrupts tradition, it will fail. If it’s a terrible idea, but falls within a group’s norms and expectations, it will likely succeed. The Overton Window illustrates why mediocre ideas triumph over great ideas.

Read More

High Resiliency Organizations – What Investment Firms Should Learn from High-Risk Industries

/

There’s a small group of organizations that have learned to excel despite operating in extremely complex, dangerous, and unpredictable environments. For example nuclear power plants and aircraft carriers all operate in rapidly changing environments with deadly consequences for failure. They’ve learned to handle the unpredictable surprises that would decimate a typical organization. The fact that many of these organizations operate for years without failures is a testament to the deliberate design of their organization and carefully constructed team training.

Investment organizations should pay attention. Investing occurs in volatile and unpredictable environments. The future is unknowable and full of surprises. The most well-researched plans will be disrupted. For many institutional investors, the consequences for getting it wrong are measured in the billions.

Many investment firms are comforted by their highly educated and credentialed personnel, extensive technology/software resources, and a deep roster of consultants. While these components are certainly essential, they’re missing one major component.

Resiliency.

Read More