In our industry, “due diligence” is a big buzz word. It’s this idea that one needs to ask all the right questions and turn over all the correct stones before confidently investing in a strategy. Which I think is both prudent and wise.
Even so, one could be incredibly thorough in their due diligence and still be disappointed or even surprised by the particular outcome of an investment strategy.
But what if you could ask only one question, what would it be? I would opt for Nassim Taleb’s candor, “Don’t tell me what you think, tell me what you have in your portfolio.” For me, this question instils that image of a head chef walking across the street for fast food versus enjoying something out of his own kitchen. It’s the eat-your-own-cooking rule.
Today, I would like to share a few anecdotes that help expand on this truism…
Do as I Say, Not as I do
Many moons ago, I was on Twitter. No social media for me these days, but in that season of life, Twitter was actually quite a helpful resource and community for curating personal finance content and research.
I remember making a “Twitter friend” who I actually had the opportunity to connect with in person. I say this as a compliment, he was a financial geek; a graduate from a prestigious university, majoring in something like Computational Finance with an emphasis in exotic derivatives. He had quite the following on Twitter and an impressive resume, so I was eager to learn from him. He owned and operated an investment fund, so his motivation for connecting was to pick up a new client.
He walked me through his strategy, the research, the results, and the whole Greek financial alphabet (alpha, beta, gamma, etc.). I listened and I was intrigued. He concluded by asking if I had any questions. Slightly fearful of my inferior intellect, I just blurted out the first thing that came to mind, “How do you invest your money?” His answer has always stuck with me, “I invest with a Dividend Growth manager out of Boston.”
In that simple reply, I forgot everything he had told me previously. I chuckled in my head and thought of the head chef opting to dine elsewhere.
A Buffett Deal
Lately, I’ve had this insatiable appetite for consuming literature on financial history: The Great Depression, The Financial Crisis, Long-Term Capital Management, The Savings & Loan Crisis, etc. I enjoy the history and the biographical nature of it all. I also enjoy the clear themes that come through: the hubris and leverage often leading to financial demise.
I recently read about the fall of Bear Stearns and Lehman Brothers, and how Goldman Sachs found themselves up against the ropes too. Often when significant financial troubles arise, many turn to the Oracle of Omaha, Warren Buffett, for capital. Goldman did just this.
I loved the story of how Warren crafted the deal. He inked a deal that was favorable to Berkshire and then included a small caveat in the contract: the top four executives couldn’t sell more than 10% of their stake, even if they left the company, and if so, Buffett would be able to sell his ownership first. He told the executive team, “If I’m buying the horse, I’m buying the jockey, too.”
Simply put, Buffett wanted to make sure leadership had skin in the game.
Peace Child
Now, for the most literal example of “skin in the game” and one that comes to us outside of the world of finance.
One of the first reading assignments I had at Biola University was to read an account of a missionary, Don Richardson, who lived among the Sawi people of New Guinea. Richardson was having trouble relating the story of Jesus to his foreign audience; the text didn’t seem to relate or relay the message of the Gospel. Eventually, Richardson learned of a local practice that he believed modeled a redemptive analogy to sufficiently deliver the gospel message.
The Sawi people had a practice of giving an enemy tribe an infant from their tribe, as a “Peace Child” (the namesake for Richardson’s book). This gesture kept the two tribes at peace, committing to never war with one another as long as that child lived.
I could imagine no better example of two parties being invested in one another’s best interest.
Cleaning Up After 1929
The speculation and market manipulation leading up to the Great Depression may be unmatched in the financial history books. The postmortem of this era created a smorgasbord of critique and regulation coming from Capitol Hill.
My intent here is not to advocate for or criticize this legislation, but I do think Section 16(a) of the Securities Exchange Act of 1934 is fitting to mention in today’s article. This section of code created a requirement for insiders to disclose their trading activity.
Simply put, if you were a shareholder in a company and the executive leadership was heavily selling shares would this potentially impact your view of the investment? Is this information you’d deem valuable?
The Wild Wild West of 1929 not only revealed heavy selling, but even shorting (betting against) from insiders. Why do we care about this information? Incentives drive behavior, and if the CEO, with a deeply intimate understanding of the company, is bearish then I as an investor need to know this.
Limitless Questions
The biggest issue with the title of this article is that you will never be limited to asking just one question in your due diligence. I simply wanted to emphasize the importance of taking advice from someone who practices what they preach.
Accompanied by this one question, should be a myriad of other important inquiries. Obviously, I can give you countless examples of when practitioners ate their own cooking and still ended up with egg on their face (e.g. Long-Term Capital Management). So, the burden is on us to peel back the curtain and pull on all the threads for sufficient diligence.
But, to save you some time, you now know what question to start with: How do you invest your money?
Trevor Cummings
PWA Group Director, Partner
