The Value Perspective Podcast episode – with Jake Taylor: REPLAY

Hi, everyone. The Value Perspective podcast is taking a short summer break but we have some good news in the meantime. Jake Taylor will be joining us as a guest for a second time when we return on 8 August and so, for those of you who did not catch his first appearance back in January 2021, we are treating you to a replay of his original session. Enjoy!

25/07/2022

Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

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Chapter headings for Jake Taylor on The Value Perspective Podcast

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* Jake Taylor, welcome ...

* How do we know what is ‘True’?

* Best-practice decision-making

* Recognising risk in complex systems

* Keeping track of opportunity cost

* Book recommendations and one big mistake

JTR: On today’s episode of The Value Perspective podcast, we have value investor Jake Taylor, who is the CEO of Farnam Street Investments. He is also the host of various podcasts, including Five Good Questions, The Hikecast and Value: After Hours, the last of which he co-hosts with investors Tobias Carlisle – another guest on our podcast – and Bill Brewster. In that show, he is particularly well-known for his ‘veggie segments’, where he applies lessons from other professions and the sciences to the world of investing. He is also the author of the novel The Rebel Allocator. Jake, thank you very much for being with us today on The Value Perspective podcast on decision-making in conditions of uncertainty. It is a pleasure to meet you. How are you?

JT: I am doing excellent! Thanks for having me on, Juan.

JTR: Please walk us through a little bit of your background – what you have done and how you ended up where you are now?

JT: Absolutely. I took a bit of a circuitous route to get to where I am. It is one of those things where you can never see the dots connecting, looking forward, but they kind of make sense looking backwards. I got an undergrad degree in economics and, right out of school, I got this opportunity to join what is called an ‘operator and training’ programme in the energy industry. It was basically an electrical engineering degree crammed into an 18-month training programme.

After that, I was eligible to get a job running the power grid for the state of California, which I did for about 12 years. So that was really cool. And then, after working for a couple years at running the power grid, I had wanted to keep all my options open. And I went back and got an MBA – while I was working – and, that first year at UC Davis, I happened to win this lottery to go back to Omaha and have lunch and meet Mr Warren Buffett, which was just an absolutely incredible stroke of luck.

JTR: Was that just you or were you part of a group of students?

JT: Yes – it was a group of students he entertained. I don’t know if he does it anymore but, for a long time, he would entertain students. He would come and talk and then take everyone out to lunch to have a steak dinner at Gorat’s Steakhouse, which is his favourite restaurant.

I was obviously blown away by hearing what Buffett had to say and I started researching more about him and his investment style and I came to realise that, oh, he just likes to get a bargain on things. And I realised that I have always been that way my whole life – I just didn’t know that that was called ‘value investing’ when it comes to the context of buying partial ownership of businesses. But that same idea of never wanting to pay retail and always getting a good deal just resonated with me right away. And that whole idea – that, right away, you get that inoculation or not – for me, I was inoculated.

JTR: Yeah, we know that feeling, here on The Value Perspective.

JT: Yeah – it kind of takes or it doesn’t, right? The next step was my boss at the time at the energy place was on the fast track to being the CEO of the place – and he was my mentor. But he suddenly left the company to start his own Buffett partnership – he was a big fan of Buffett as well. It was basically a hedge fund he was starting. And I said, well, can I come sweep the floor for free and just learn as an intern? He was like, yeah, sure. So I started doing that.

And I got to my last year of school and I thought, what if I did an independent study with this internship, and value investing as a class – which wasn’t being offered. And I thought, yeah, I could kill two birds with one stone. And my boss and I put together the course at Davis. We taught it and there were 15 of us in total taking the class. It was mostly just my friends – they were looking for an easy grade! – and I finished up and graduated. Then we got a message that next year, hey, we heard good things about this class, would you want to come back and teach it again? We were like, well, OK, sure.

We came back, we taught it again and we had 30 students this time. And then the same thing happened the next year and it was 45. And then the year after that, it was 60. Then we ran into some bureaucratic red tape because the finance department didn’t really like that we were teaching ‘not efficient’ markets and that we were getting all the students. So they put up a bunch of roadblocks. But it was great. It was absolutely an amazing experience for me – I learned more than the students ever could by having to teach it. And so I am forever grateful for it. It was a great way to solidify your investment approach.

JTR: My wife did her MBA at London Business School and the credits its students need just to be considered for the value course are very demanding. It is one of the most sought-after electives in the whole course, which is pretty reassuring.

JT: I don’t think we were that demanding, which was why we were so popular! I mean, Buffett has been asked before, what would he teach if he was going to teach a class on investing? And his answer is how to think about markets and how to value a business – and those were the two things we set out to do. And we actually ended up having to teach a lot of accounting early on because the students understood ‘T’ accounts and a bunch of things, but they didn’t really know what anything meant to an actual business person – like, what is happening inside the business? What does this number actually mean? So there was a lot of translation required and bringing in real-life examples of what ‘depreciation’ really means. It is not just some number that shows up on an income statement.

JTR: At some point, you became an actual investor?

JT: That’s right. My business partner – the one I was interning with – and I, we liked working together so much, we started our own company Farnam Street Investments and we have been running it ever since.

JTR: You have your own podcast show, Five Good Questions, where you reach out to the authors of different books you have read and ask them five questions. How did that come about?

JT: I have always loved reading and there was a point – this was before podcasts were as prevalent as they are now – and I would hear some author I really liked and they would just be talked over on the TV, right? They would be doing some interview and they would be just about to get to the important thing they were going to say and then get talked over by some talking head. It would drive me nuts – and I thought, well, I could just sit around and complain about it or I can do something.

I always wanted to encourage people to read more, if I could. And I thought, if I personalised the authors by giving them a platform to talk, maybe more people will read more books and I will get a chance to hear what they were going to say right before they were cut off. And it is really nice – whoever you meet, you have the potential to add some value to their life right away by doing an interview with them. Right? I am sure you have found that so far with what you guys are doing here. So I started it seven or eight years ago and it has been kind of a labour of love. It is not really a revenue thing – I just do it because I kind of feel like I am doing a good service for the community. But I keep it to five, hopefully good questions. Because if I left it up to myself, I would ask 200 questions and each interview would be 10 hours long and no-one would want to listen to it. So I put some constraints on myself.

JTR: You are also a co-host of another podcast, which is more about value and more a bit of a chat with Tobias Carlyle and Bill Brewster. It is called Value: After Hours – what is the story behind that?

JT: I have known Toby for probably a dozen years now – in fact, he came and gave a talk at one of the classes we were teaching at Davis, many years ago, and we have always stayed in touch and been good friends since. And I have known Bill for a couple years as well. And when Toby had the idea of, hey, would you want to just do an hour a week, just riffing on whatever is topical news, I was like, yes, of course – that is going to be so much fun. And honestly, those two guys are some of the most authentically good guys in the industry I have ever met. And it really is so much fun to just basically hang out with your friends – and I get to tell my wife I am working, when it really does not feel like work.

JTR: Well, I like it a lot. And then you also wrote a novel a couple of years ago.

JT: That’s right. It is called The Rebel Allocator. The idea behind it was, I wanted to write something that would be an easy on-ramp for younger people to learn about investing, capitalism, capital allocation ... and really more for my two sons actually. I wanted to write something that would be a good way to convey information to them that wasn’t just dad talking at them, like they have to normally endure.

I kept getting all these little nudges from the universe that I have to tell a story if I want it to resonate. And so I started researching, well, who is good at telling stories? Maybe Hollywood. So I actually read a few books on how to write screenplays. And I used that screenplay mock-up and framework to create the story inside the book. It is painfully obvious once you know but, if you are familiar with the movie, The Karate Kid, it is basically that – but if Mr Miyagi was Warren Buffett! That is it. That is how the story evolved.

JTR: You have this very nice anecdote that comes along with your book – that would be great to hear.

JT: So the phone rings in my office and my assistant answers. She tells me it is Charlie Munger on the other line. And I am like, that’s not funny. Don’t mess with me – there is no way Charlie is calling me! But I pick it up and, sure enough, it’s Charlie and he wants to talk about my book. And I guess the story, whatever it was, resonated with him in enough of a way that he wanted to just reach out and talk about it for a little bit.

So I basically spent 25 minutes trying to not say anything stupid that made him want to hang up! But it was one of the most surreal experiences of my life because here is somebody who I have gone for more than a decade to Omaha to hear him talk; and travelled to the Daily Journal meetings to hear him – basically, anytime he is saying anything in public, I am going to try to be in the audience. And now I am just talking to him on the phone – just an incredibly surreal experience.

JTR: Had you had the opportunity to meet him before that phone call?

JT: No – there is too much security, too many people. You cannot even get within 150 feet of him without being tackled by a security guard. Believe me – I tried!

JTR: Where did he get your number?

JT: I sent him a copy of the book – I sent it to a lot of people as an appreciation – and he was a big factor in the book. A lot of the things that are intelligently conveyed in that book I have borrowed from Warren and Charlie and others. So, as a tip of the cap, I sent him a copy and, after that, he must have done some more research to track me down and find my phone number.

I actually found out he had been reading the quarterly letters I was writing, which is maybe even a bigger stretch of the imagination than just reading the book. Because at the time, he said, I see in your letters you are having a hard time finding good investment ideas – because that is what I was complaining a lot about in my letters around that time period. And he said, don’t feel bad about it – I would be worried about you, if you were finding too many good ideas right now.

How do we know what is ‘True’?

JTR: That is such a nice anecdote. In your Value: After Hours podcast, you do ‘veggie segments’ – as in ‘save the veggies for last’. And so, today, we are hoping to get a lot of ‘veggies’ from you on decision-making under uncertainty. You clearly read a lot and very broadly, borrowing from different areas of life, or different segments of study, to make analogies you can apply to finance – for example, from biology, psychology, economics and history. Which discipline, besides finance or economics, have you found provides a good key to helping you make better decisions as an investor or in life in general?

JT: I would reframe the question to ask ourselves, how do we know that something is – ‘capital T’ – true? How do we find the truth about anything? The scientific method was developed by Francis Bacon and, behind that, is this idea of data collection. So we need to look for, where can we find the deepest pools of data? Take something like the height of Mount Everest – what is the height? If you were to ask Google, it would say it is 29,029 feet. Well, that is true but it is also not true, because the height is constantly changing, based on the plate tectonics pushing up and the wind erosion scrubbing it off. In the time we have been talking, the height of Everest has changed as a fact.

So that is on one end of the spectrum and, on the other end of the spectrum, we have something like physics. Aristotle had a version of physics that was updated and supplanted by Newton, which was then eventually updated by Einstein and relativity. That is a much slower degradation but all facts have a half-life to them and we have to be conscious of that. So when I try to draw my analogies in these ‘veggie’ segments I do, I have three primary buckets I am looking for – and it has to do with how big of an ‘in’ is produced in this particular domain.

Number one is the inorganic universe and that is ‘about’ 13.7 billion years old. That is a lot of interactions of matter and energy running into each other, say, or gravity – with all of these things, there is a very large ‘in’ involved. The next bucket I look at is biology. And that is roughly 3.7 billion years of life on Earth, which is also a lot of interactions of things eating other things and evolution playing out. And then the last bucket is human history, which ... you know, the Sumerian cuneiform was roughly 5,000 years ago so we have written history from then. But we probably have about 200,000 years’ worth of human history and we humans are probably about two million years old – like, if we saw someone from two million years ago, we would identify that as looking like a human and not something else.

So we have these very, very large data sets. And one of the interesting things about finance is there is the illusion of large data sets – but I am not so sure it is always as solid as it looks. Let’s take something like market prices – we could take every single little squiggle per second and have millions and millions of data points on pricing, right? However, the true data we are looking for – the really big moves – according to Fidelity, I think there have only been 16 bear markets since 1926.

So often our real ‘in’ we are looking for is much smaller, which means we have much less predictive ability and we should probably be a lot more humble on when we try to make financial analogies about things. We really just don’t know – we cannot say a whole lot. And I think we often forget that because we are surrounded by so many numbers – we feel like the data are so rich that we have more room to stand than we do. But, compared to the inorganic universe, human history and biology, we are not even close. And so we should probably be a lot more humble than we are.

Best-practice decision-making

JTR: Some people in finance and markets have borrowed tools from psychology or behavioural finance – and we have also asked this of Michael Mauboussin and Annie Duke. You come up with all of these tools, such as base rates, and you try to make people think in probabilities – or even a simple concept, like doing a ‘pre-mortem’ or a post-mortem. Now, in theory, those look quite easy and very logical to follow but then somehow, in practice, they become very difficult to implement and execute. Even base rates sometimes are very difficult to understand. So how do you work around that?

JT: I think a lot of these best practices, when you read about them – whether it is keeping an investment journal; doing a pre and a post-mortem; tracking and scoring your predictions and using some kind of scoring system like Brier scores; using a checklist; seeking an outside view; and base rates ... even one of the most important things, which is making a clear plan ahead of time, before you are in the thick of the battle so you know what you are going to do ‘if this happens’ – all of those things are what Michael Mauboussin would call the ‘man overboard moment’, right?

Like you should have a plan for when the man falls overboard – what we are going to do to get him back in the boat. All of those things are incredibly simple, when you look at them on their own, but they are very hard to execute as kind of a package of best practices. And I think it is because it just takes that extra work. It is the same problem of why you could have a gym membership but you don’t go as often as you should. You know what you are supposed to be doing – there are no secrets here, right? And yet it is hard – you are working against the human tendency to take shortcuts.

I wasn’t going to talk about this but I guess I will tell you about it. I have actually been working on a software package that will hopefully solve a lot of these problems and incorporate a lot of these best-practices into the architecture of the software to make it much easier to stay on the course you know you are supposed to be on. And I have been using it myself for a while now in beta – as the only user. It’s something I’ve been thinking about for years and I finally put a team together last year to start building it for me, but I am excited to see what it looks like as we get more features built in. I think it will be a game-changer as far as saving a ton of time, making it easier and lowering that friction of doing the things you know you’re supposed to be doing.

JTR: Is it like a checklist type of thing? Or does it incorporate data so you can check for certain base rates? Or will it give you guidelines on how to best make a proper pre-mortem and post-mortem?

JT: Yeah – all of that. The idea is really a combination of an intelligent journal that contextually updates itself, along with an investment checklist that adapts to your process. And then all the little things that are kind of a pain – like following up on that post-mortem after you have closed the position. You know you're supposed to do it, right? But a lot of times, it is easy to skip it. Often, no-one is checking your work – especially if you are an individual investor – so it is really easy to skip. But this has it built in so you do it and, hopefully, you learn something and update your mental models. What you are really trying to do is close that feedback loop in a way that will create better intuition for the next round of evaluation.

JTR: That sounds super-interesting. One of the things 2020 taught the world is we live in a very uncertain environment. On 1 January 2020, no-one was expecting what happened to happen. I believe you like financial journalist Jason Zweig so I will borrow a quote he wrote on 30 September 2008. Back then, he said: “‘Investors hate uncertainty’. Well, that's just tough. Uncertainty is all investors ever have gotten, or ever will get, from the moment barley and sesame first began trading in ancient Mesopotamia to the last trade that will ever take place on Planet Earth.” So how do you deal with uncertainty yourself? How do you think about it? And how do you keep a long-term horizon amid all the noise that is happening in an industry that is becoming more and more short-term every single day?

JT: It is very popular for value-oriented investors to say risk is ‘the permanent loss of capital’. Everyone agrees to that – we all say, oh yeah, that makes sense and we all nod our heads. And, unless you are running truly permanent capital, like Buffett does at Berkshire Hathaway, or your own money, potentially, and you can stomach a lot of quotational risk, then I think that is true – that risk is the permanent loss of capital.

However – and I certainly did not appreciate this enough, when I started in this industry – there are strategies that may or may not be appropriate for your client, if you are managing money for them. Buffett’s ‘lumpy’ 15% that takes a really wild ride to get there – you are likely to knock off a significant percentage of your investors with that. And if that is true, then were you actually providing them a good service or not? And I would call into question if that is true. Perhaps the little bit smoother 10% that gets more investors ferried to the other side of success, and they come along with you, may actually be a better service – even though the 15% versus 10% is obviously not as good. And I don’t think we think about that quite enough when we are choosing our portfolios as professional investors.

If you looked at the dollar-weighted returns of a lot of professional funds, you would be shocked at actually how sad the results are. A lot of times, most of the performance came on a small asset base and then, as monies come in, there is a lot of underperformance and then those guys leave and they start to outperform again. And if you dollar-weighted all of that journey, the average dollar they managed actually was not very successful – even though they could point to the whole fund saying it was successful.

JTR: There is a lot of survivorship bias in the mix.

JT: For sure.

Recognising risk in complex systems

JTR: You recently talked about nuclear disasters and how a combination of small events – each with a low probability of happening and being meaningless individually on aggregate – could cause a disaster. Your point was that, nowadays, we have very complex systems that are very tied together so any small accident can have a knock-on effect on the system. When I was listening to that, it brought to life the whole concept of understanding independent probabilities. What’s the best way to think about such a complex system, especially when people can sometimes not even be aware of any connectedness in different systems or they are sometimes not that obvious? How do you make better decisions?

JT: The book I was drawing from is called Meltdown: Why Our Systems Fail and What We Can Do About It by Chris Clearfield and Andras Tilcsik. They talk about the Three Mile Island disaster early on in the book and it is amazing because it was just a simple plumbing problem. There were a couple of things that failed that were connected to each other and it led to a meltdown and a release of radioactive coolant into the river that ended up poisoning people. But there was no giant hurricane, there was no tsunami that caused it – it was just these little plumbing problems and, because they were connected, it led to a cascade of failure.

Now, I think it is interesting to imagine on the x axis is ‘complexity’ and how that increases – and I think we have to recognise increased complexity inherently means we cannot just think through all of the problems that can occur. One of the hallmarks of complexity is it doesn’t yield to just purely thinking about it, right? There are moving pieces we cannot predict very well. And on the y axis is ‘tightness of coupling’ and how mistakes, or interactions even, propagate throughout a system. So the higher the complexity and the tighter the coupling puts us up in this quadrant where the really big mistakes happen – that’s where you get a nuclear meltdown.

And the finance world is incredibly complex and incredibly tightly coupled – and, really, our whole world is like that now. I mean, a ‘just in time’ supply chain greatly increases the tightness of the coupling of the world. A lack of transparency will increase complexity. Actually, interestingly enough, higher trust creates tighter coupling because people stop doing their own calculations. So, if you just trust that the system works and you don’t actually and go check the math behind to make sure that it actually is doing what it is supposed to be doing. Not to be political, but the kind of bailouts that were done in 2008, I think, inevitably lead to the moral hazards that create more implicit trust that future losses will be socialised. So the disturbing side-effect of those bailouts is the message is you need to get bigger, you need to get more complex, you need to get tighter coupled if you want to create the situation where heads you win and tails everyone else loses. It’s rather gross.

Now, with 2020, I feel Covid-19 kind of called ‘BS’ on a lot of our tightness of coupling or just-in-time supply chains. It called ‘BS’ on a lot of our complexity. And I feel like a lot of the things that we have been sweeping under the rug for, well, maybe all of human history, but at least in our careers, has been called into question now. Do we have our supply chains configured in the right way? Do we have our organisations configured in the right way to have enough slack in the system to be able to absorb these external shocks that can happen?

So in general, if you think about living in a world with high complexity and tight coupling, I think you really  need – again, like we were talking about with data sets – to go back and be more humble about the findings you have and especially about the narratives that get written, right? There is so much time and energy spent on trying to explain what just happened and explain what is about to happen. We have all these things we are trying to measure to bring those two things together and really there is so much complexity and so much coupling that you don’t know exactly why something happened, and you don’t know exactly why something is going to happen. And I think we could all just take a little breather on trying to write the narratives for everything and just understand that we have to be a little bit more humble than that.

JTR: To bring it back to the world of investing, that is where the whole concept of having a margin of safety comes in – that is why it is important to incorporate a margin of error in anything you are trying to do because, as you were saying, things are so complex you have no idea what you are going to miss.

JT: Exactly right. That is a really huge implication of a complex, tightly coupled world – is that you should be seeking even more margin of safety when there is that kind of uncertainty.

Keeping track of opportunity cost

JTR: That is very interesting. In the past, you have made a point of the importance of keeping track of your opportunity cost, which somehow often gets lost when you are investing. And also the importance of writing down – or being aware of or being very true to yourself about – the reasons you are saying ‘no’ to something. Why have you found this so powerful and what is the best way to implement it?

JT: We all readily remember, say, the big Amazon IPO you didn’t buy and that it was ‘obvious’ I should have bought Google. I use it all the time – of course, that should have been a good investment, right? And we remember these very bright, shiny, large data points but we ignore all the close calls – the things that maybe you thought about buying but you didn’t buy and that turned into a zero, right? So we are not treating this in a very scientific way when we try to assess our opportunity cost. We just look at these little anecdotes that float around in our brains and go, oh man, I missed out on that big one. If you’re Buffett, I didn’t buy Walmart in the 1980s, even though it seemed like a lay-up. So I think we have to be a little bit more scientific and actually track, what are the things we rejected? And what did that mean?

We like to call it an ‘anti-portfolio’ – all the things I thought about and I rejected. And like you alluded to, the real magic happens when you start to track why you rejected it. What was the filter that was used to screen that out? And now you can start to see, as you gather data on that, where are your filters helping or hurting you? Now, for me, personally, I am wired to be a little abhorrent to too much leverage in a company. And I know that about myself but I cannot tell you for certain yet whether that helps me or hurts me. And I will eventually be able to tell you – when I have a big enough data set of tracking my opportunity cost – whether that particular filter has been a hindrance or a help. But it is too early to tell for me.

Another possible place this might be really helpful is ... Buffett famously has this tray on his desk called the ‘too hard’ pile. And things that are too hard to figure out, he throws them in that pile. Well, especially if you are starting out, it is very possible that everything goes into the ‘too hard’ pile, right? Like, you know hardly anything about anything. What if you were tracking what the opportunity cost was of things you were putting in your ‘too hard’ pile and you saw, oh, my god, there are all these returns in there that I have been rejecting.

Maybe I need to dig a little bit harder – maybe there is gold just a couple inches down under the dirt. If I just put in a little bit more work, maybe that would be the impetus to try a little bit harder. Or maybe it turns out it is not the case and it was smart to reject those things in the ‘too hard’ pile and maybe you are properly calibrated – but you don’t know that answer until you actually keep track of those numbers. So it is really good practice to track the returns of the things you rejected – and also why – and draw correlations between your filters and the eventual outcomes and use those as a way to adjust your process.

JTR: Annie Duke suggested it was maybe a good idea to run a portfolio where you would actually put some money behind some of the things you were rejecting – maybe a very tiny amount, just a little bit –so you made it real. And actually making it real then forced you to look at how things were playing out because sometimes you can have things on paper but you're less invested in the paper portfolio than in one that actually has the backing of some funds. But how feasible is that to do in practice – to have this ‘dark’ portfolio of very small positions to see how they play out?

JT: It is tough because we all only have so much time in the day, right? We only have so much bandwidth of research time we can dedicate to this. So you want to get the most out of your time. And I wonder sometimes about some of these small tracking positions, whether they serve more as a distraction and keep you from really understanding better the big bet you are making. I like the idea and I do agree that having that little bit of skin in the game definitely makes you more of an interested party. But it can probably go too far and you end up with a thousand things you are trying to track while you are not minding the big eggs in the basket very well – because you're worried about these other little things – and something bad can happen to that. That is going to be much more material to your outcome.

What you want to do is untangle what you knew at the time and the decision you made and then how it played out eventually – and what was it, if anything, that you missed? And then try to figure out – if you could have known that ahead of time, could you do something a little different for next time? It is so easy to forget what you knew at that time, when you were making the decision – your brain will misremember, you will rewrite the story of what you knew, and what was available to you at that time.

Your brain is always trying to tell the story of why something happened. We are wired to just create stories. And we will readily misremember what the story was if it helps us – and especially if it protects your ego. That is where your brain will really work double time – to protect your ego and your identity. So having it written down somewhere – what you were thinking, what was available as the information and then working backwards later to see, well, could we have done anything better during that time, I think, can't help but make you a much better decision-maker.

JTR: It is easy to miss sometimes that a lot of the decisions we make are driven by the context of the decision – what is happening right now. And then, looking at those things many years after, it is very easy to miss what the context of the situation was – especially when you are not dealing with big events. It is easy enough to think back in time to, say, where you were in 9/11 or some other major event but when it is, say, 14 September 2014 and were making a decision about buying or selling X company, who knows what was happening that day and how what was happening in that moment affected that decision?

Book recommendations and one big mistake

JTR: Now, we are coming to the end of our session, Jake, and we always ask two questions of our guests. The first question is about decision-making. Can you provide us with an example of a decision you made or saw others make that ended in a bad outcome? And can you identify whether this was because of bad luck or a bad process?

JT: I will share a personal mistake I made. I guess, Juan, you are trying to make me cry this morning – but that’s OK?

JTR: It’s 2020 – everyone's crying!

JT: I know. That’s a good point. So there was this company I had owned for a long time and it was closely held by management. They were big owners – so they held most of the cards. And in March of 2020, they repriced their options at an incredibly low number. And, of course, it went back up after that so there was an incredible amount of value stripped out by management for all the other remaining shareholders. And, oh man, I was so mad about it. I just felt like I was getting stolen from.

I went back and thought about it – and the mistake I made was, one, there were little red flags along the way before that, which I should probably should have recognised and maybe even anticipated that that was a potential thing that could happen. The other thing was, I didn’t sell right away in March. I was mad, I should have probably but I didn’t, because there was this little part of me that was greedy about it and felt this is the worst time to be selling this company, right? Like it is so beat up at the moment. You know, this is like peak pessimism. It is a travel-related stock so this is the worst time to sell it. So I didn’t sell it. And this was where my process was sloppy because I should have had pre-programmed that ‘man overboard’ moment. Like, if the company does this to you, you should sell right away and don’t ask any more questions, because who knows how many other million little ways they are getting over on you, if this is what they are going to do publicly?

There is this idea called ‘a Ulysses contract’. Ulysses was a Greek mythology character, who tied himself to the mast of the ship he was sailing as they went past the Sirens so he wouldn't be able to steer the boat into the rocks to go see the Sirens – their singing was that alluring. So the idea is I should have had a Ulysses contract with myself that said, if management ever does this to you, you sell right away – you get out and that is that. You know, I am pre-programming it beforehand, while I am calm – I am not pissed off in the middle of it happening to me and then making the decision. So that was a mistake I have recently made. You would have thought, at this point, I had already made all the mistakes to be made in this business but apparently I am still learning new ones all the time! But that was one for me personally.

JTR: That is fascinating. Have you implemented the Ulysses contract before that or did the concept come to you after this specific experience?

JT: I have to profess my own stupidity here because I have known about the Ulysses contract for plenty of time but I haven’t used it yet in a real way.

JTR: So we go back to how difficult it is to execute and implement the things we know we're supposed to be doing.

JT: Exactly. I knew I was supposed to go to the gym – I just didn’t go!

JTR: And our last question is – we are always asking people to recommend us some good book ideas. We know you read a lot so we are very keen to hear some recommendations from you.

JT: I have a couple for you. The first one is called The Nature of Value: How to Invest in the Adaptive Economy by Nick Gogerty. As much as I draw from the world of biology, obviously this was right on the nose for me because it takes a lot of ideas from biology and shows how value investing is simpatico with nature. It is great confirmation bias for someone like me to read things like this! And there are great ideas in there as well – and Nick is a great guy. So that is number one.

Number two is this book called Nonzero: The Logic of Human Destiny by Robert Wright – and another book by him that is great is called Why Buddhism is True: The Science and Philosophy of Meditation and Enlightenment but I will save that one. This is Nonzero and it basically argues that biological and cultural progress are driven by increasing ‘nonzero-sumness’. So, you know, creating new interactions and playing win-win cooperative games – not zero-sum win-lose games – has been what has led to both biological and cultural progress. So it is definitely a little bit of a deeper dive when you go all the way from eukaryotic cells co-operating and all the way up through to the win-win of businesses and culture, but I enjoyed that one a lot.

And then the last one – and here you’re going to say, yeah, Jake, no-duh, that's a good one – but it is The Essays of Warren Buffett. I went back and reread it recently – like, in the last month – and I have probably read it 20 times now. And what is amazing about it is that he is so careful with his word choices. And there is so much nuance that I somehow still keep missing so I keep coming back and finding new nuance. And it is so good – like, if you could only read one book on business, this is probably the best one. What I find really interesting is to see highlights that I have done at different points in my life while reading that same book. And it is almost like this self-Rorschach test of, like, what did I think was important at that time? Like, what resonated with me and how I have changed over the years of reading that book – even though the words have not changed. It is an incredible experience to just keep reading it over and over again.

JTR: Jake, it was a pleasure having you with us and thank you very much for your time.

JT: Thanks, Juan. I really appreciate you having me on. I think you guys are doing a great service with this so keep it up.

JTR: Thank you very much for the veggies!

Author

Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

I joined Schroders in January 2017 as a member of the Global Value Investment team and manage Emerging Market Value. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet, I was a member of the Customs Solution Group at HOLT Credit Suisse.  

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