I was listening to this Warren Buffet interview, and Warren began talking about Ted Williams and his book on hitting. (Ted Williams is one of the greatest baseball players of all time).
In his book, Ted broke out the strike zone into 77 square boxes, and highlighted certain boxes. He said:
“If I swing when the ball is in this part of the strike zone I’ll hit .400” (which is amazing). “But if I swing at pitches that are strikes yet low and outsize, I’ll hit .250.” (not amazing)
Warren goes on to say that Ted Williams was at a disadvantage because sometimes he’d be swinging with an 0–2 count. On an 0–2 count if you don’t swing at a strike (even if it’s a pitch you don’t like), you strike out looking. During an 0–2 count he has to swing, even if the ball is painting the low and outside corner. Warren then went on to claim, “in investing, we don’t have to swing at pitches we don’t like because the count is never 0–2.” You can be patient and no one will fire you for not investing.
I am nowhere near the investor Warren is, but I disagreed with that comment. In a permanent capital vehicle, that is sort of true… Warren doesn’t have a term on his entity and can go a long time without making an investment. But if he just sat in cash during a bull market, investors would likely sell equity in Berkshire (or at least would have before he had become famous), and so there was some pressure to make investments. To swing at pitches even if they weren’t down the middle.
But it’s even less true in a private fund model on a 10 year term, and 3 year investment period.
And this is even more true with new managers. If you’re on your 5th fund and don’t deploy all the capital — your LP’s might be pissed, but they appreciate the discipline and invest in the next fund. New managers would never see re-investments from their LP’s, so are screwed.
So think about to messed up incentive. If you think the market is bad (the pitches are out of your sweet spot), you either don’t swing, and get fired, or are forced to swing, may miss, but at least you have a fighting chance of getting on base.
You’re damned if you do, damned if you don’t, so you swing just in case.
New managers are automatically forced to swing at pitches that may not be great — because they are investing on an 0–2 count.
The same is true for endowments with liabilities they need to match, or pension funds, etc.
It’s not that people are dumb — it’s that the vehicles we have set up for ourselves to invest out of force us to invest as if the count’s 0–2. And the pressure is even higher right before a credit cycle, when we’re all most vehicle, because that’s when you look like the biggest idiot for being patient.
It’s the type of thing we all know, and that the market generally ignores anyways. But I loved the analogy that too many capital structures force investors to invest on an 0–2 count.