Fellow Partners,
A primary goal of these essays is to provide transparency on the thinking that steers our capital.
To this end, I was recently interviewed by the wonderful folks at DealTeam who asked a very thoughtful set of questions and were kindly willing to share the output.
The conversation is a good summary of some of the philosophies that guide our investment activity and broader manners in which I think about the world.
I have provided the transcript below, though I would encourage you to listen to the audio via the player above. It flows much more naturally.
Blunt, honest feedback is always welcome! I am certain this content provides plenty of opportunities for it….
How would you describe your investing strategy?
It's a global all-cap strategy. Scott Wilson at the Washington University endowment has this great line, which is, "All ideas compete for the same capital.” That's really how I think about things we're willing to invest in: large caps and micro caps, internationally, domestically, etc. Over time the concept of asset classes, if you have a long enough time horizon, starts to become irrelevant. When one's goal is to compound capital at high rates over decades, you mentally end up in the space of looking for what sorts of things are investable and inevitable and that requires having a very long view of how the world works and how it's evolving. I think it really puts you in a space where believing in the quality of the business model, of management, of product, of service, of execution, et cetera, is the only thing that matters. One of my favorite Walt Disney lines is, "Quality is a phenomenal strategy." I view myself as someone who's on a hunt for the highest of high quality wherever that can be found.
What experience(s) most shaped your strategy?
Launching a fund is actually career number three for me. Career one was strategy consulting where our goal was to advise a handful of businesses on how to grow faster and serve their customers better. Career two was building an enterprise software-as-a-service business for the better part of a decade. Behind all that I was investing, and my hobby became an obsession which went fairly well, so it has now become a business. Those prior experiences really impacted how I look at public markets. I studied the efficient markets hypothesis at the London School of Economics, where some of the guys who wrote it taught, and it never made any sense to me. This notion that the past is the only thing that can inform the future and on top of that, the notion of, “we don't know what a good and bad business is, so let's try to buy some version of all businesses,” really makes very little sense when one's career has been advising a handful of businesses on how to get better and then spending a decade trying to build one really good business.
What I often relate to partners or people interested in the partnership is this notion that prior to doing this, I spent about 3,000 days building one really wonderful business. That was a privately funded company. We only had a market value for that business on 3 of those 3,000 days. Those were the 3 days that we raised capital. The other 2,997 days, we woke up and thought about our customers, thought about building a better product, thought about selling, and thought about serving our customers better. Those were really the things that mattered. We knew if we did those things well, then when it came time to raise more money, we'd get a healthy valuation. I take that mindset into the public markets. Although we get quoted every microsecond, price only really matters if you want to buy or if you want to sell. You can ignore it the rest of the time. That's what I do.
What is the most challenging part of executing your strategy?
It's definitely patience. I forget who said this, but there's this notion that an advantage that private equity or venture capital has is that you actually can't sell and you don't get quoted every microsecond. I find that to be absolutely true. Jim O'Shaughnessy said to me a few weeks ago, "What you're really trying to do is act against human nature", which is entirely true. That's what makes it hard; you do have to look at valuations every so often and you have to keep up with markets and it's really against our nature to ignore some of the fight or flight instincts and believe that most things are noise but know the few things that matter and take those seriously and nothing else. That's all a long way of saying patience is both the hardest part of executing the strategy and also, conversely, it's certainly the biggest competitive advantage of the strategy.
What has been your most painful investing mistake? What did you learn from it?
I would give two which tie together. I spent my first career helping grow a handful of good businesses, and a second career building one really good business. It took me too long to port that thinking over into what I was doing at the time investing my own money. I bought the Kool-Aid of diversification almost to an extreme for far too long. Tied to that was this notion of understanding GAAP accounting (and the shortfalls of GAAP accounting). Early in my software career, I was building a business that, if it had been publicly traded, would have been extremely volatile but it wasn't public and so we didn't know the market value. We were just trying to build a really good business, but within that, were things like: the firm had no assets - it was just software and people. The way those things show up on financial statements is somewhere between not very well and not at all.
So, I was having this lived experience of knowing what a good intangibles-based business looked like while simultaneously working through the traditional value-investing literature, and focusing fairly heavily on things like book value and price to earnings. It's not that any of those things are wrong, but the point is that it took me far too long to realize that the only way to invest well in the beautifully complex world we live in is just to start from first principles and understand things like price to sales and price to earnings are all shortcuts and they can be really useful shortcuts if you know exactly what they're good for and exactly what they're not good for.
Flipping it around and saying, how would I think about the worth of this business forgetting our shortcuts? It took far too long for that to resonate. The reason that was painful is because there were many potential home runs that I watched go by because I thought they were pricey for the wrong reasons while simultaneously, I was building a business that was that same thing. Fortunately, I hope I stopped doing that by now, but that was a lesson learned by many misses.
What are the top 1-3 things you want to build in the next decade?
I strongly believe anything that's worth doing is worth doing well. As I thought about launching a fund — in a lot of ways I don't think the world needs yet another hedge fund — but I learned through my other careers that the world absolutely needs people who serve their clients very well. The Munger notion of, if you want more business, the place to find it is within the work that's in front of you. That resonated. So I got into my head this idea of, what would the world's most LP-friendly hedge fund look like? I'm still figuring that out and an easy way to start was a fee model. I had the lived experience of working with some other managers who, let's just say, were not architected as the world's most friendly folks. So I have the lived experience when I wasn't focused on my own investments of investing in ways where managers grew wealthy off of me, but I didn't grow any wealthier.
I think it's hard to look around the world and find a lot of other places where it's possible to not serve your client well and not get fired for years and years and years. For some reason, that’s possible in asset management. It's just viscerally repellent to me, so I've really tried to determine, “what would the world's most LP-friendly hedge fund look like?” That's things like a win-win partnership model, a win-win fee model, a generous (hopefully extreme) amount of transparency, frequent communication, all kinds of obvious things. I'm excited to learn. I'm only a year into this journey. I'm excited to find more ways to become a more LP-friendly hedge fund.
The other big one, which is a related point, is I don't know anyone who doesn't get frustrated by this idea of accredited versus non-accredited investors. That’s not to say what I do is right for everyone but one's accreditation status is probably not a great screen for that. With technology, there are now ways to have vehicles where non-accredited investors could pretty much invest in the same way as accredited investors, at least for what I do. I look forward to building a model where that becomes possible as well.
What are you most compulsive about? What do you like doing when there’s nothing to do?
I very much can be a dog with a bone on things. Part of this really relates back to the investment strategy in the same way that I like to invest in what I deem to be inevitable and then just have the patience to let it play out. When I'm sitting quietly with my mind (which I try to do for much of each day) usually I'm trying to figure out what the end state is in a system of incentives.
I studied economics in undergrad and the most useful thing I learned there was economics in three words: people follow incentives — the Munger notion of, “Show me the incentives and I'll show you the outcomes.” There are things I think about where I'm basically trying to figure out, what is the end state of the incentives that are in front of us? An obvious one was when COVID hit, the world had to go remote, but once everyone, including senior managers and so on, could no longer force everybody into the office, the world started to collectively realize that actually, maybe we don't need an endless stream of cities where everyone's piled together. We just need good internet connections and airports. So you're starting to see migrations out of the Northeast and the West and to more desirable places to live, depending on people's preferences.
But I think it actually could go further than that. I'm in the middle of an experiment right now where my family and I are just living from the road. We've been to 23 states in four months and I'm not saying we'll permanently do that, but my point is, I'm not sure the end-state of the incentives is just, everybody moves to Florida and Texas. I actually think it's that the world opens up and everybody moves around quite a bit. We're experimenting with that. I could give you similar examples for things that I think are just inevitable. For example, YouTube being an extremely dominant form of media that is starting to compete against all different forms of media that aren't video, is another one. The attributes of video make it the most information-dense media we have. It doesn't make it perfect for everything but generally makes it more compelling than most other things that compete with it. I can imagine a world where the concept of a book starts to go away and starts to get replaced by content which is video in nature when that's useful and text in nature when that's useful and audio in nature when that's useful, and all of those things together when that's useful. The platforms that control distribution amongst that I think, are already compelling but become even more compelling.
This notion of just working hard to figure out, if you layout incentives, where do they terminate? Where's their end-state? That’s generally what I'm obsessing about.
What are you optimizing for?
That's one I've thought a lot about. I got this notion of a regret minimization framework from Jeff Bezos and the more I've thought about it, the more it's boiled down for me to be the only thing worth maximizing for which is minimizing regrets. I think there's an important aspect of that, which is across what time horizon? Minimizing regrets by the end of the week is very different from minimizing regrets at the end of your life. For me, a lot of my logic starts from when I'm hopefully quite old and looking backwards, I hope to have very little that I actually regret. So, I start a lot of my logic from thinking about the end of my life and working all the way backwards to saying, “What do I need to be doing now?” So hopefully, the list of regrets by that point is fairly minimal.
What have you subtracted from your life over the last year that has had the most additive effect to your joy and well-being?
Most meetings, which is an obvious one. Prior to launching the fund I, like many people, was on Zoom for 10 or 12 hours a day. When I was back in the office, I was in meetings all the time too. There’s nothing wrong with that, and some people really thrive in those environments. There's this notion, I want to say it was Pascal, that had this idea that most of man’s problems stem from his or her inability to sit quietly in a room with their thoughts. I've always connected with that notion, and I'm one of those folks that actually really craves sitting quietly in the room with their thoughts.
This connects with the first principles reasoning and investing in the inevitable and understanding incentives and how they play out. The ability to have enormous swaths of unstructured time to read and think and write are really where I get energy and engagement and excitement, at least from an investing standpoint. Cutting out most meetings and largely sitting quietly in a room and thinking and reading and writing has been by far the most additive thing I've done in the last year or so.
You've got to take ownership of your schedule. It's either you control your schedule, or it gets controlled for you. For me, I was in a setup where my ability to add value was heavily dependent on a lot of meetings. There’s nothing wrong with that, but it took me too long to realize that's one of the reasons it wasn't the right role for me. I could do it well, but that didn't mean it was the thing I should be doing. I hope the way the world is evolving and some of the incentives we've got in play — where we're really being forced to rethink how we structure work — I hope some of that leads to more efficiency on the meeting side. I hope this is true. I'm not necessarily optimistic about it, but I hope that efficiency gets translated into more coffees and more chats, where you actually get to develop real relationships.
What consistently surprises you?
Almost every week, I say to my wife or my friends or my partners, some version of being surprised at the degree to which people prefer their version of the truth over what is absolutely true. I suppose that means I'm in the camp that believes in absolute truth, and I do. But it's so easy for me to look at the world — and this relates to investing as well — we can want the world to work a certain way and we can invest behind the stock that we really want to do well or a change that we really want to see or whatever — and that's fine. Sometimes it works, but sometimes it’s really painful and when it's really painful, it usually has something to do with the fact that you were just wrong about how the world works.
So, I try to cultivate as much humility as I can. I think humility is an enormous asset that's not often talked about. I try to really just force myself to say, this isn't about how I want things to work, to be effective as an investor, and I would even argue as a person. It really goes back to understanding what is really true. How do humans really work? How do markets really work? How do businesses really work? Then, aligning yourself behind that and acting accordingly. In our modern/postmodern world, we're just deluged with people who, I'm not even sure how aware some people are of this, but they just insist that what their preferences are is the truth. It seems like a really hard way to live. It's full of disappointment and frustration and there's impacts on education, there's impacts on public health, there's impacts on just our general ability to get along with each other. Every week, there's something else where I'm like, man, I don't know why people can't just say, let's forget what we want to be true and just figure out what's actually true. That seems a better way to live.
What class could you teach? Bonus points if it’s not investing related.
I would say value-based thinking. I publish my family values on my website, (johncandeto.com if anyone's interested). But the backstory to all of that is my wife and I got married fairly young. In our first few years of marriage — and in any relationship, especially marriage, it’s something that's built, not intrinsic to itself — we were thinking about how do you build a good marriage? One that's built to last a long time and is high quality and wonderful in all the ways that a good marriage can be. We kept coming back to this notion of, what are our family values? That was something that my father used to do — he wrote down our family values and published them every so often. So, I took that idea from him, and we sat down and said, “What do we believe is true that can be a bedrock for how we act in the world?” That cuts across all sorts of things.
Our first stab at it was probably five pages long. Over the years, it went down to four then three and then two, and we finally got it down to a page. What that means is we're now able to make enormous decisions (or at least enormous decisions for us) very fast and often without even needing to talk to each other or needing to talk for two minutes and then off we go. And that really came back to the notion of trying to root our thinking in our values.
I often get asked the question, “So what the heck is values-based thinking?” The best example I've come across is the notion of, if you're hungry, an options-based thinker or somebody who just accepts reality walks over to the fridge, they open the fridge and they say, “All right, well, what's in here? These are my options. I'll pick my most preferred option.” But that's really letting the constraints of the fridge and whenever you last bought groceries and whatever dictate how you satiate your hunger. A values-based approach to that is to say, “Okay, what do I value and how does that get translated into what I eat?” So you might be someone who every now and then needs a really good Ben and Jerry's, and if it's not in the freezer, then maybe you go out and get it. Or you might be somebody who really wants to eat healthy so you feel better later and if that's not in the fridge you go out and get it or you order it from Uber Eats or whatever. It's a subtle but really important distinction because your thinking doesn't start from what the world gives you. Your thinking starts from, “How do I intend to live?”
The more that one attempts to figure out their values and then live from that, the more one aligns themselves to: “Here's how I think the world works, and here's how I want to act as a result.” It's constant practice. It's iterative practice. You start to slowly but surely over years end up in spaces where actions start to align back to intention in a much tighter way. I don't know that I ever will teach a course on that, but I think I probably could.
One of the things that got me onto this was the notion of deliberate practice, which I still think is under-talked about and under-reported. When you study people like high-performing athletes — when you study Alex Rodriguez and how he learned to hit a baseball — unlike me, he didn't just go out with his buddies and knock the ball around for hours and hours. He actually would go hit two or three balls with a coach. Then, his coach would correct some minor thing he wasn't doing well. Then he hit two or three more and was corrected again.
It's a much harder, probably more boring, probably more painful way to learn to hit. But you see 10 or 20 years later, these guys are just machines. It's because they rarely learned very bad things. They just obsessed about only learning to swing the bat as well as they possibly can. In a sense, I think the decision architecture and value-based thinking is all a version of the same thing. It all just starts with, “How do you want to live? And then how do you put that into practice?”
What are you seeking to understand more deeply?
As a dad of a four-year-old and one-year-old, one that my wife and I talk a lot about is how to educate our kids really well. We're applying the same values-based reasoning and first principles thinking to this as I do to investing and other parts of life.
I imagine most listeners will have some notion of the idea that our current education paradigms were crafted for the industrial age, not the knowledge age or the information age.
I think learning happens when you can hang out on the cusp between what you know, and what you don't know. If you're just in the realms of stuff that you know really well, you get bored. If you're in the realms of stuff that's just way beyond you, you get bored and frustrated and lost. So, there's something special about being right on the cusp between what you know and what you don't know.
When I think about my years of education in college and master's degree and all that, I think at best less than 10% of the 10,000 or whatever hours I spent in formal education was spent on the cusp between what I knew and what I didn’t know. I cannot get out of my head this question of, “Why can't we bump that up? Like way up?” Why can't that be 50% or 60%? It's never going to be 100%. But imagine the product of a kid who spent 50 plus percent of their learning time right on that cusp of what they know and what they don't know. You alluded to this earlier, but imagine a kid that was taught to confront how the world really works, rather than being taught the theory of how it might work.
A joke that I say to my wife all the time, that she's not a big fan of, and I'm not entirely serious, but it's an interesting thought experiment: I read about a guy one time who took his high school, I think it was a son, and gave him $10,000 and shipped him off to rural China and said, "All right, you're a venture capitalist. Go." And you imagine the kid probably lost all the money. I'm sure it didn't end well but imagine what they learned, right? You really have to think about people and human nature and who you can trust and how you create win-win opportunities and how you know what a good investment opportunity is. How do you even know what an investment opportunity is? How do you craft one? All that stuff. There's just a million things one could learn. That seems like it could be a really good use of $10,000. That's an experiment worth running.
On the flip side of this, and I'm excited for some folks that I'm close with who are working on companies in this space. What if you optimized for your kids meeting and hanging out with the best people on the planet who share their obsessions? There's no reason we can't do that now. You and I were limited to the neighborhoods we grew up in and we had good friends and it was fine and we rode bikes together. But man, imagine if my four-year-old starts to meet people who have the same obsessions that he does and spends a lot of time with them. Learning wouldn't even feel like learning, it would just feel like playing. And these things compound, so imagine compounding, optimizing for that learning instead of eight hours a day, seven classes a day, rote homework, et cetera. It just seems to me like this isn’t just an opportunity to double the output or the quality of education, this is an opportunity to exponentially change it and produce a future by way of the people who populate the future that are just an order of magnitude beyond what we're capable of. Hence, my interest and obsession and excitement around it.
On Twitter, I probably post too little and read a little too much, but like you, I've really enjoyed the community. James Clear has this idea of making everyone's best ideas your base ideas. I try hard to do that in investing and in life in general. I just think about the people I've quoted in these last 30 minutes, that's intentional. On an education point, I've been saying to people for a little while, why shouldn’t my son learn physics from Richard Feynman? Nobody disputes he was one of the best, not just the best physicists ever, but one of the best, most gifted teachers. And it’s possible, right? You can go to YouTube and get it now. And that's probably not sufficient. There are other things that need a physical person, and that's fine, but why should my son’s lectures on basic physics ever come from somebody who's not Richard Feynman? I've not found a good answer to that, and Twitter and the web make this possible. So yeah, I agree. I obviously share your excitement. I think there's some really exciting stuff that is going to come out of people taking seriously this idea that education is one of the most important things we have, and we need to radically change it.
Tell us something about your space that outsiders would find surprising.
A common one, especially for folks who don't know me, is that my office just looks like a library. A trading screen that flashes red and green at you all the time is just so obviously not a great way to cultivate good thinking. But maybe a more interesting one is that I do believe over a long enough time horizon that this whole concept that the industry obsesses about called asset classes is nonsense. Over shorter time horizons it absolutely matters. But if you really are trying to think in decades and your goal is really to take money that you're blessed not to need now (and not to need for a little while) and grow it at reasonable rates of return, having style boxes and assuming that a bunch of market studies that tell us about how the market behaved in the past is the only way to construct portfolios for the future just makes less and less sense.
Basically, human behavior doesn't change. There will always be manias and panics and so on in markets. But businesses change a lot. It wasn't possible until the last few decades to have businesses that had zero marginal costs. I built one for 10 years. It's a real miracle. Why would you say, “All right, we need to allocate some money to small-cap value and some money to large-cap growth and some whatever, and we need all of this coverage?” Buffett’s got this idea that that kind of thing lets people use math that they already know. I think that's a lot of why it’s become so popular is there's just a critical mass of people who know how to think that way. Then of course, there are very important investment problems that are solved on shorter time horizons and things like endowments I think have incredibly hard challenges because they've got to provide real cash flow to their universities today but also need to grow the endowment for tomorrow. But for purely long-term capital, asset class based reasoning doesn’t make much sense.
All the best,
John
Founder and Managing Partner
Zeitgeist