Letter #176: Joel Cohen (2019)
MIT Investment Management Company Global Investor | RV Capital Emerging Manager Meeting Panel
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Today’s letter is the transcript of Joel Cohen’s responses for a panel on emerging managers. On this panel, Joel gives an introduction to himself and the MIT endowment, then discusses success and failure in investing and life, active vs. passive investing, manager competitive advantages, unwritten advice for managers and avoiding false positives, fund formation incentives, and return targets.
Joel Cohen is a global investor at the MIT Investment Management Company (MITIMCO), where he has spearheaded a number of investing and education initiatives, including one for emerging managers and one for investor education. He started his career at MITIMCO and it is the only place he’s ever worked.
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Transcript
Introduction
So my name is Joel Cohen. I work for the MIT endowment. I'm here with my colleague Nate. Our job is to travel around the world and try to meet the best investors all over the place and invest capital with them on MIT's behalf. The profits from that endeavor go to all the wonderful things that MIT does, from cancer research to alternative energy research and educating the next generation of students. And we think a lot about that mission in the context of our work.
Our business model is basically to go around and try to find great investment firms that we can have very long term partnerships with, and let them do the hard work of doing the compounding. And that's our business model.
We love working with newer types of firms. We're very active in working with emerging-type managers. So we spend a lot of time thinking about what are the success factors in those early years that can help you predict how they're going to do longer term.
And so we're very happy to be here with a lot of very smart, wonderful people. It's great that Rob puts on an event like this and goes out of his way to be helpful to people who are trying to get started. And we want to be part of that as well. So we're happy to be a resource anytime we can.
If anybody has additional questions after this, feel free to reach out to me. My contact info is on our website, mitimco.org. Rob, maybe put a link to that. So feel free to reach out if you don't get a chance to chat with me. I have to run right afterwards to make the train.
On success and failure in investing and life
Yeah, that's an incredibly complex question, and in a lot of ways one we spend a lot of time thinking about.
I think when we look at firms that tend to have extreme success, I think there's a couple of things that tend to work in your favor. I think for us, a lot of it is that when you see people coming at building their business and investing in first principles, you tend to get more unusual outcomes, as opposed to just trying to replicate what's led to the success of others. I think that can work, certainly up to a certain point.
But I think because everybody's personality is different, because the market conditions and everything is different now versus when Warren Buffett was investing in the early days, I think it's really important to bring a mentality of a fresh sheet of paper, think about what is the right way for you to invest in for you to build your business.
And so I think when people start with a very clear definition of how they want to succeed in building a business, and then they sort of start from first principles and ignore what other people have done, ignore what they think of as conventional wisdom, I think that's a really, really important way to go about it. And I think you can really do a lot of harm by sort of inheriting conventional wisdom or the way that you've seen other people do things. And people often have misconceptions that because they first heard from the few people that they know that this is the normal fee structure, this is the normal structure, or this is what capital allocators want, they sort of just start with those things, as opposed to thinking from scratch without listening...
So that sort of covers something—one aspect of what I think is critical for success and also drivers for failure as well.
On passive vs active investing
I mean, I think the key to answering that question is, is it possible to have a sustainable competitive advantage in investing that allows you to outperform passive indices and generate great absolute returns over a long period of time? We still think that it is, and we see a lot of evidence of that in our portfolio and the managers we work with.
I think there's no question that the investment industry has gotten more competitive, and certain advantages that you could have had 10 years ago, 20 years ago, 30 years ago, in terms of just like, knowing more about a company than other people or sort of having an advantage in figuring out what's going to happen in the next quarter or the next year. That is an advantage that you could have probably had 20 years ago, and some people built a track record on that, that edge seems to have been competed away.
So I think the question for us is, are there other competitive advantages that you can build? And we think that there are.
I think the most notable one is that human behavior hasn't changed a lot. We still are subject to the same types of biases, probably new biases. Humans are still naturally short sighted and have a very difficult time taking the five or 10 year view. And very few people take the time to build their business in such a way that they can take their five or 10 year view. And in our mind, that's competitive advantage that’s not–doesn't seem to be competed away, and maybe even is growing. And so we still actively allocate our entire portfolio.
But we're also mindful that it's gotten more competitive. And it's harder to have the same kind of performance that people have had in the past. And so we always want to be looking back and sort of thinking about—are the things that were the case in the past still true today? And should we be thinking about having a passive allocation? But many still feel like the very best of the best investment managers can still generate outstanding, absolute relative performance.
On manager competitive advantages
Yeah, and I think we build mental models of types of competitive advantage that you can have in investing from going out and meeting hundreds of managers every year and from studying the most successful firms and what qualities they have, and try to figure out, if you have 20 or 30 years of great performance, what was the competitive advantage that allowed you to do it?
We're always thinking about how those types of competitive advantage might be changing, and what new ones you might be able to build, and what old ones might be deteriorating.
I think the behavioral aspect is probably the most obvious and most reliable and easiest to communicate—that there are just some people who are wired to think long term and capable of thinking long term and really don't care if their net worth gets cut in half in a given year. And that is a real competitive advantage in terms of the types of decisions that you'll make, and the ability to—even in the depths of a crisis—to take a 10 year view.
I think you can build that based on your personal temperament, you can build that based on the way you set up your environment and your business, from everything from the types of investors that you have—if you're not getting calls from people in the middle of a crisis, or even getting repeated calls from one person, even if you have 100 investors, 99 of which are wonderful, if one person is calling you every hour to ask what the market did the last hour, that's going to make it really hard to make good decisions—to how you set up your life—if you're sort of set up in a major city where you can see, in a crisis, you're walking around town, and you're seeing people in suits that are really stressed out, and hurrying from place to place and in chaos, then you're likely to be affected by that. So that's another component to it as well. And the way that you set up your business. If your capital is locked up for at least a couple of years, rather than being redeemable any day, then it’s more likely that you're going to be able to take a longer term view. So I think that's probably the most reliable competitive advantages.
But I think you can build analytical advantages as well, in the way that you think about companies, you spend your time studying certain types of business models, and you focus your energies on a couple of types of companies or industries or in a certain country. Just having some sort of focus that you carve out for yourself, where you think you might be able to build a competitive advantage. That's going to be easier to do than trying to have competitive advantage across a lot of different countries and industries, and if you're sort of trying to compete with everybody and everything, I think that’s…
On unwritten advice for managers and avoiding false positives
I think there are certainly examples of that, that we've experienced, which is why we often get to know managers over a longer period of time before allocating capital. I think that's one of the reasons why we tend to not necessarily start with the full allocation up front, but sort of get to know people over a period of years and build up that context and understanding, because you can get arrogant if you have a few successes and you say, Well, I predicted that this manager who was managing $5mn at the time was going to become a big success, and so I can clearly do that perfectly. And so I might as well just start writing billion dollar checks to all those managers, and it's going to go perfectly well. But I think it's important to have some humility in there. Some managers that we saw at that stage that we thought were really wonderful that had all the kind of qualities that we looked for, and they just didn't evolve the way that we hoped…
There was one example of a manager that we met, who was relatively young, in his late 20s, managing a relatively small amount of money. Had built up a really great track record, starting from virtually nothing. Just really hustled to build his business, and was evolving as an investor and was really passionate, really hungry, and really enthusiastic. And he was sort of evolving towards more of a focus on investing in quality companies with a longer time horizon. And that is a successful transition that we've seen quite a number of investors make.
But it turned out that his temperament actually wasn't well suited to that. If he really—he just couldn't sort of, get over that hump and make that type of investing work. And so he invested in what he thought were long term compounders that turned out not to be. He just couldn't figure out what were the inputs to that, and he couldn't make that transition work, and it turned out that the type of investing that he was suited for was not that. And so he struggled in making that evolution. And whereas his performance was really excellent when he was performing a slightly different strategy earlier on, his performance has been less good since he tried to make that transition.
So that I think is a lesson for us that what works for some people may not work for other people, even really hungry, passionate people. And it's important to make sure that you're investing in a way that makes sense for you and not necessarily following the successful evolution that you've seen other people in your time.
On Fund Formation Incentives
Yeah, so that's certainly a situation that we see a lot of people in, especially in today's world, where the costs of starting a fund are a bit higher, the regulatory regime is a bit tougher, and so it's much—it's a bit harder to start a fund from your spare bedroom today, and certainly in certain parts of the world, than it was in the past. So it's something we see a lot.
I think—without me having ever started a fund or ever been in a position of managing a really small amount of money and trying to make it work and being tempted by something like that—what I can say is that it's incredibly rare that we see that turning into a 10+, 20-30 year exceptional track record. Maybe there are a few very rare exceptions, but that almost always can lead to maybe some success up front, but sort of sows the seeds of destruction over 5-10 years plus.
So we don't really know many firms that have built a great track record making that type of trade off for all kinds of reasons. And so for us, it's a huge, huge red flag to see that. I think it really is sort of very good evidence of something that makes the short term a bit easier but causes problems in the long term. What we look for is the opposite of that, which is doing things that make it more difficult in the short term, but create long term success. And that's how you can succeed where other people fail. So that's how we think about it.
And we as MIT, because we manage a large pool of capital, and are happy to work with emerging managers, people always ask us, do we ever do a seed deal? Do we ever take economics in funds that we work with? And we never do, and never would, because I think we would be setting up a manager for failure, and ultimately, doing ourselves a disservice in the long term by sort of destabilizing a business, perhaps, and causing misaligned incentives that would cause our investment [in a fund as an] LP to be less valuable.
So we're much, much happier to try to set up really well aligned incentives and have a great 20 year compounding investment as an LP.
On Return Targets
Yeah, I would say for us, it's broadly similar, somewhere between 8-9%. It's sort of what we need to earn in order to have MIT be able to keep doing the same wonderful things that it's doing today in terms of providing scholarships and funding for research and education.
But of course, we're very mindful that if we are better than that, MIT has way more ideas for ways to help the world than it has money to fund those projects. So if we can earn 10%, 11%, 12%, the benefits of that to MIT and to the world are enormous. And so we set our ambitions much higher than that in terms of what we hope to earn.
But we're always sort of thinking about that minimum amount that we need to be able to earn just in order for MIT to keep doing the things that it does today, which is the absolute minimum for us to consider ourselves to have done a decent job.
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Wrap-up
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