Does your investment manager have soul in the game?
“When you have skin in the game, dull things like checking the safety of the aircraft because you may be forced to be a passenger in it cease to be boring. If you are an investor in a company, doing ultra-boring things like reading the footnotes of a financial statement (where the real information is to be found) becomes, well, almost not boring.”
~ Nassim Nicholas Taleb, Skin in the Game: Hidden Asymmetries in Daily Life
The author of Black Swan and Fooled by Randomness has an uncanny ability to publish with impeccable timing.
Fooled by Randomness came out in 2001, a year that had the world reeling from the Twin Towers attack, which no one predicted. Black Swan was published during the death throes of the hype and build-up to the 2008 global financial crisis. Perhaps his latest book, Skin in the Game, may not have a clear global anchor event (yet), but for South Africans it was timed with perfection on the heels of the breaking of the Steinhoff event.
Taleb’s books are insightful and are always applicable to real life with common sense nuggets that are not always easy to receive. Examples are the reality check about our ability to forecast (yet most of our industry keeps trying) and the inability of the bell curve to help us assess the risk attached to outlying events (yet standard deviation remains a much-loved measure of risk).
Skin in the Game left me with two messages that hit home. It also led me to examine one of our checklist items for assessing management, a very important aspect of our approach to investing. When we rate management, we include in our assessment areas of alignment, integrity of the numbers, capital allocation, reputational issues and regulatory breaches. What can be learnt from recent events is that shareholding alone does not equal alignment, or skin in the game. There are more dimensions to assessing whether management will help or impede our roles as stewards of our clients’ capital. It is encapsulated in their trustworthiness.
The assessment of trust is what we try to cover with our checklist
The first lesson from Skin in the Game is that trust is built on two levels. Firstly, we must believe that the person we are dealing with will behave ethically. Secondly, we must trust that they are competent for the task we need them to do. It is the disconnect between being competent (which can lead to over-confidence, disregard for rules and empire building) and ethical behaviour (always playing in the middle of the field and being transparent) that can mislead investors who only look at the hard business achievements and the ratios.
The most ideal management teams are perhaps those with 'soul in the game'
The second interesting concept is that of soul in the game. It has become popular, and desirable, to partner with management teams who participate in the upside and downside with shareholders via shareholding in the company they manage, distinguishing them from professional managers. Option schemes alone are not seen as proper skin in the game, as the downside is not significant. Entrepreneurs who invest their own money certainly have skin in the game.
'Soul in the game' is usually linked to service of others, and seldom accompanied by popular or comfortable choices. It means the purpose and the processes are clear, and you are not pursuing anyone else’s path. A good example of this would be Capitec, with its simple and focused business model. Working with purpose makes it much easier to prioritise, and to single out what you stand for.
'Soul in the game' may sound far too ethereal to base an investment process on, but what better partner in growing your wealth than someone with a clear mission, a purpose. Looking for a management team’s purpose and mission (not the laminated one) makes it easier to assess management beyond the numbers and to find the red flags timeously.