Extended time with the grandchildren always leads to the irresistible logic of A.A. Milne and his principal spokesperson, Winnie the Pooh. One of Winnie’s most insightful observations is about doing, or in his case, doing nothing:
“People say doing nothing is impossible, but I do nothing every day.”
The investment world has apparently not heard of the House of Pooh preferring the more action oriented House of Morgan or The Rothschild Bank. In fact, if Winnie the Pooh visited any investment web site or read any financial publication he would find the incessant bias for action a long way from “doing nothing” at Pooh Corner.
Eeyore Investment Philosophy
His gloomy friend Eeyore reminds me of the host of value investors who are predicting the end of days or, at least, the end of the stock market going up. But Pooh’s advice to Eeyore is the same advice that Grantham, Mayo’s James Montier, a big fan of Winnie the Pooh, gave Barron’s in a recent interview by Leslie Norton:
“You can’t stay in your corner of the forest waiting for others to come see you. You have to go to them sometimes.”
So GMO, a value oriented investment firm, actually suggests how you act if you are an Eeyore and want to stay in your corner:
- Build a robust portfolio where you can survive many different outcomes
- Concentrate your investments in one thing that will generate returns
- Look at alternative assets that are not correlated to the stock market
- Consider the option value of having cash when dislocations occur
For James Montier this means emerging markets, merger arbitrage, TIPS, and short duration bonds. He suggests taking your equity risk where you are getting paid the most for it. Use leverage but not to the point where it forces you to sell a perfectly good investment at the wrong time. James Montier sees a stock market reversion in a short period of time (over 7 years), but Jeremy Grantham, his partner and the eponymous founder of GMO, does believe it is different this time and we will see a slow, 20 year reversion to the mean in the stock market.
Private Equity Can Learn From Pooh
In the private equity world we have remained disciplined around Winnie the Pooh advice as well. We try to understand the intrinsic value of industrial and service businesses in the lower middle market. We look for strong and predictable cash flows. We stress test optimistic growth assumptions; if you are surprised on the upside it will take care of itself. We use leverage, but rationally. We return capital to investors when leverage falls below the chicken index-1.5-2x EBITDA. We own 6-10 companies in a diversified portfolio. We are actively bidding in a sellers’ market and succeeding by patiently waiting for reversion through “busted deals” or a seller’s preference for co-investing with us.
We have our own recipe for successful investing that both Pooh and Eeyore could endorse:
- Buy at a reasonable valuation
- Have a margin of safety
- Align your rewards with investors
- Be transparent
- Partner with management teams
- Engage knowledgeable limited partners
- Do hard things early
- Sometimes do nothing
- Don’t be afraid to change your mind
- Challenge convention
These principles are not flashy but they are the foundation for our own House at Pooh corner.