First heard of Dennis Hong from one of Guy Spier interviews and wanted to know on his investment style and ideas.
First principal responsibility is to Protect and grow Capital
We want to be the best investor to our portfolio companies and their managers
I’ve consistently said this over the years that my general tendency is towards skepticism, maybe even bordering on a little bit of negativity, but skeptical, negative people, they could sound smart but they rarely see good. I’m really lucky that I have this terrific team of young people that have really forced me to open my mind, open my mind to incredible possibilities
Investment business is a multivariate problem and there are variables that you can control and there’s variables that you can’t control.
if you look at those statistics over the last 50 years, the market peak to trough draws down on average about 13%. But over the last 50 years, two out of the three years, the market finishes up and is sometimes quite positive.
The variables that you can control; you can control who your investors are; you can control what types of investments you’re going to focus on. You can control your team, how many team members you need. You can control where your office is located, you can control how many hours a day you want to work. All of these endogenous variables, they are important and I think selecting the variables that are necessary to optimize for what you’re trying to do and in our case, we’re trying to optimize for generating Hall of Fame returns. So, what that meant for us was a small team, a small number of investors, and a small number of investments that you know really, really well.
I think that I was to sort of look back and meet day one Dennis, July 15th of 2014 when I launched this fund, I would encourage myself to think really, really hard about what is going to matter five years from now, not what’s going to matter five weeks from now, five months from now or even a year from now, what’s going to really, really matter over the very, very long term and I think that if you sort of can clarify that for yourself, you start to then narrow down the variables that are necessary to build the skills that we’ll be enduring as an investor, as a long-term investor and hone in on the variables, that handful of variables that are going to result in the best long-term investments. I wish I have learned that on day one.
Naturally, when you start, I’m looking at this red and green blinky video game and I’m getting the P&L from Paul, my CFO, every single evening but in the grand scheme of things, that’s all just noise and randomness and can be very, very distracting. Actually one of the changes that I did make at the end of 2018 was that I told Paul that I don’t want to see the daily P&L.
Richard Hamming and he has this piece called “You and Your Research” and so let me just dig up this quote: “If you don’t work on important problems, you’re not going to do important things”, except by the dumbest of luck, dumbest of dumb luck. So I think that even our entire team, the culture, the ethos of just really, really thinking long term and figuring out the variables that are necessary and important to achieve our goals, I think that’s been an important insight that we’ve had.
Piece of advice that I give to everybody is to network intensely. This business does require luck and there’s no better way to maximize your luck that to know as many people as possible. This is a piece of advice actually that Byron Wien, vice-chairman of Blackstone, he has a really great list of predictions that he has every single year, but that was one of the proverbs that I’ve internalized in my life
We want to spend high-quality time studying high-quality people, building high-quality businesses on behalf of high-quality investors.
Quote that I really, really love by Intel’s founder, Andy Grove: “Bad businesses are destroyed by crisis, good companies survive them, great companies are improved by them”. And there’s no better manifestation of this quote than what happened in the spring of 2020 when the world was absolutely, it looked like it was going to burn down.
You want to make bets on people, in the face of adverse circumstances, that are going to do the right thing, that are going to be proactive, that are going to be opportunistic, that have made thoughtful decisions upfront to create a foundation that is going to prove to be resilient in the face of exogenous variables that they just simply can’t control.
We are “one team, one portfolio, one P&L”. There are no sleeves in our firm. Sleeves meaning that in some firms, it’s sort of an “eat what you kill” type mentality. We’re all truly incentivized as owners. We own everything inside of our portfolio. We’re all responsible; we’re all accountable to ShawSpring
See, in a team-oriented approach like ours, one of the biggest weaknesses potentially is that we all start to believe in our own crap. So how do we create intellectual tension ? And when I first started ShawSpring, I probably interviewed a number, probably dozens of just peers of mine who are portfolio managers, and I would ask them a simple question: how do you make sure that intellectual tension happens in your firm? And a lot of people will say nice things like it’s a horizontal environment. Anybody can talk to me as the portfolio manager and tell me my ideas are shoddy ideas, or their bad ideas, they’re crap or open-door policy. So those are pretty, I think important but how do you institutionalize it, how do you build it into your process? And a couple of the institutions that we’ve talked with over the years, I think do it really, really well.So, in one institution’s case, the CIO, the chief investment officer actually doesn’t really get involved in the sponsorship of an initial idea. So, he might actually source an investment manager and say a thing, oh this hedge fund is very interesting but he won’t get involved in the initial sponsorship. He could put it into a pipeline, but it’s up to one of his teammates to go ahead and sponsor that, to be a primary sponsor for that idea. And that primary sponsor then takes it to a point but then it has to invite a secondary sponsor to sponsor that idea and by the time work is maybe about a third of the way through. That’s when the CIO steps in and the singular responsibility there is to try to kill the idea.
intellectual tension, it is ultimately an iterative, collaborative process where there’s open debate and open disagreement. That’s really important. If there isn’t disagreement, there’s no growth but ultimately, the process’ main goal is to try to achieve consensus.
We have a very high hurdle rate for positions to enter into our portfolio. Our bar is typically 30%, 3-5 year IRR and actually internally, I tell my team now unless you can get like a triple of quintuple out of this thing over the next 3-5 years, let’s not even bother.
So, the bar is really high, but it’s not wasted work. Actually, one of the most important things we can do as a form is to continue to build what we call our trigger-ready list. So we have the shopping list internally at ShawSpring. It’s about 200 businesses where the starting hypothesis it that this business exhibits ecosystem control. But within the subset of the shopping list, we have something called a trigger-ready list. A trigger-ready list where we’ve done the upfront work, we really like the business, the managers are really good and they welcome out involvement and the only criteria that’s missing is the price, and hypothetically, if the business’ stock price came down to a point that met our hurdle rate, it could be a candidate for inclusion into our portfolio. Now if that happens, that’s usually in the context of fairly exogenous market sell-off. So something on our trigger-ready list sells off and becomes attractive for us to invest, it often is happening in the context of a major market sell-off, so our existing portfolio is also attractive. But the priorities for free cash flow, of new free cash flow are almost always to our existing portfolio
Most of our partners are actually through inbound inquiry, they often end up being pre-vetted by another one of our partners. So, we have a fairly good understanding and insight as to the quality of the partner even before we have an initial discussion. It’s very rare actually to have a partner come in inbound where we had no first or second degree of connection to that partner.
What percentage of the wealth of your partners do you recommend them to put in your hands, if you recommend anything? For our partners, I’m almost certain that we range somewhere between one and 10% of their overall balance sheets but it’s all up to a partner’s comfort.
Our optimization problem from the beginning was to try to generate Hall of Fame returns and isolating for just those variables that are necessary to achieve Hall of Fame returns. I think that that was an important decision that we made upfront. Now it was by necessity. We didn’t have huge AUM, so we had to make do with the fact that we have limited resources, limited dollars. We had time because we had really great investors that were willing to give us time to really figure stuff out, but I think that you really, really need to think through what is it that you’re trying to achieve.