Dennis Hong, how did you build ShawSpring Partners?

In July 2021, I did an interview with Dennis Hong of ShawSpring Partners. You can find all content with Dennis here.

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Introduction

[00:00:00] Tilman Versch: Hello Dennis! It’s great to have you on and it’s great to have you here again after one year.

Disclaimer

[00:00:05] Tilman Versch: Let me shortly drop a disclaimer – this presentation is for informational purposes only. Nothing should be viewed as an offer, solicitation of an offer or recommendation to buy or sell any investment. And now back to the video.

20x after the first interview

[00:00:22] Tilman Versch: After one year, you’re the first guest that made it 20x after the interview. I’m still fascinated by it.

[00:00:28] Dennis Hong: Me too.

[00:00:29] Tilman Versch: Before we did the interview, you had like 1 300 subscribers on Twitter and now you have 26 000 so it’s a 20x and it’s really a bit of a magic moment that happened. We both know that there’s not that much magic in life, it’s all hard work.

[00:00:50] Tilman Versch: And so let’s talk a bit about this and let’s take a look back at the last seven years, nearly seven years of ShawSpring. In the last seven years, what were you building ShawSpring Partners for?

[00:01:02] Dennis Hong: Well Tilman, from day one, my real goal was to try to hit Hall of Fame returns and really the first seven years were really about building that foundation. When I first set out to build this firm, I knew I wanted to do it in a “one team, one portfolio, one P&L” approach and that was very important to me. So what that meant was that collectively with my team, my fabulous team that is behind me, we had to set out and build the foundations that would lend to a strategy that was scalable, replicable, repeatable across time, across cycles, just across many different iterations.

It’s been an incredible journey and I have to tell you that I’ve been scared to death so many times through the last seven years, not because the task was necessarily hard but I’ve probably learned more in the last seven years of my life than in any given seven-year period of my life. I named this firm ShawSpring Partners for a very reason. I didn’t name it after myself, I didn’t name it after some sort of Greek goddess but what I really wanted to do to achieve those Hall of Fame returns was really to create a partnership – a partnership of our investors, our teammates, the management teams of our underlying companies.

Tilman, we have a long way to go, we’re only through seven years. In some sense I sometimes tell my teammates and sometimes our investment partners, we were in the neonatal ICU for seven years. That was about trying to build something that was scalable and replicable and repeatable. It was the foundational part of our life. Now we’re out of the neonatal ICU and we can start to build or we can start to breathe on our own and in that sense, I’m really excited where we’re going to go because now we have a real shot at building something really, really terrific.

So our first seven years, I judge them to be good but I’m actually even more excited about our next seven years because we’ve just figured a lot of stuff out as a team, with our investors. We figured out a strategy that I think is going to be able to stand the test of time and my team, they’ve forced me out of my comfort zone, created a real intellectual tension that I just think is really, really important to continue to grow and learn as an investor.

Running an investment firm

[00:03:44] Tilman Versch: There are so many interesting points in what you’ve already said. So, we’ll go then deeper through the interview. How would you describe your role as a business builder in all those years? Is it more kind of a fireman?

[00:04:00] Dennis Hong: So as the CEO of this firm, I have four principle responsibilities. So, one is to protect and grow the capital. That’s the most important thing. Number two, which I would argue is as important, is to be present for our investment partners whenever they need me to be there. I think that the one think that I’ve learned pretty starkly in 2020, nobody knows what’s going on, but to be a good partner and to weigh in and give input and just be there, be present for our investors, I think that’s a really, really important thing. I think that many people in our industry forget that we’re in the customer service business and you have to be there for your LPs when they need you to be there. I mean at the end of the day, I’m the one who’s accountable for these results and I have chosen not to have some sort of intermediary.

I have four principle responsibilities. So one is to protect and grow the capital.

I don’t have an IR department, I don’t have a marketing department. I’m the IR, I’m the chief marketing officer and I’ve always said that I’m the one that’s accountable so our partners should have access to me. Now that means that the firm is not infinitely scalable. There is definitely a finite capacity to this firm but I think that I have a reasonable shot at being one of the best partners to the partners that have chosen to partner with us because I have the bandwidth to spend time with them. So that’s number two, it’s to be present for our investors.

So that’s number two, it’s to be present for our investors. third responsibility is to create the kind of firm where my team-mates, if they so choose, to easily see themselves be at ShawSpring for the rest of their careers.

My third responsibility is to create the kind of firm where my team-mates, if they so choose, to easily see themselves be at ShawSpring for the rest of their careers. That’s something that’s really, really important to me. I judge that as a KPI and for me, a personal KPI. I am trying to create the kind of firm where the only reason why my teammates may one to leave at some point, hopefully in the long future, is if they want to start their own thing. And you know, what better legacy is there than to be an investor that helped set up the next generation of great investors. So that’s something that I think is an important aspiration of mine too.

And then the fourth thing that I have been increasingly trying to develop is just to develop a reputation of being the best investor to our portfolio companies and their managers.

And then the fourth thing that I have been increasingly trying to develop is just to develop a reputation of being the best investor to our portfolio companies and their managers. You see in some sense, we have the best job in the world. We study really interesting people building really interesting businesses and we could take advantage of that IP and invest behind some of these ideas and profit off of them, but I also aspire to be the best investor to our management team. So, trying to find some value to add value to our management team, that’s really, really important to me too. So that’s a reputation that’s going to take a long, long time, that’s a reputation that’s going to be earned over very, very long periods and ultimately at some point, maybe over the next 5-10 years, I want to be the kind of investor if we show up on the shareholder registry, I want them to say that team at ShawSpring Partners, we’re incredibly proud to have them on out shareholder bases because they’re good people and they add value.

And so those are the four, I really believe, my four central responsibilities as the CEO of ShawSpring.

Overcoming skepticism

[00:07:50] Tilman Versch: How have you changed over the last seven years as a person and a business builder?

[00:07:57] Dennis Hong: I’ll tell you something – I’ve had to really open up my mind. 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 that I mean, I’ll tell you Tilman, our day one portfolio; our day one portfolio really was the constitution of quite a few legacy investments, just investments that I’ve picked up over the many years of my career but that was a reflection of my experiences. But when I started ShawSpring, I realized that we have a real opportunity to have a blank slate.

I am incredibly, incredibly shocked that over the last seven years we’ve made money in things like online dating and Tinder and Southeast Asian e-commerce, selling used cars on the internet, doing food delivery in Europe. It’s pretty exciting. So it’s been a really, really exciting seven years. I think that the most important thing was that upfront here at ShawSpring, we created an environment where experimentation and an encouragement of exploration, that’s part of our ethos and I think that’s what keeps intellectual tension really, really high, a willingness, a real willingness to try new things and learn new things.

I think that the most important thing was that upfront here at ShawSpring, we created an environment where experimentation and an encouragement of exploration, that’s part of our ethos and I think that’s what keeps intellectual tension really, really high, a willingness, a real willingness to try new things and learn new things.

I think that we’re still growing and learning, and I still think that we’re just getting started when it comes to really challenging the next level of our investment program. The young people that we have this summer, we have four young people. It’s the largest summer associate class that we’ve had. It’s pretty exciting because it also has really opened my mind to the possibilities of just having increased bandwidth in our team. So, each of our four summer associates, individually they’re taking on two deep dives and it ranges from some internet businesses in China to internet infrastructure all around the world, to some private companies, some private software companies. So, it’s been a really fun, exciting journey and I just think that I’m excited to see what the team comes up with next, where we’re going to take what frontiers we’re going to challenge next, and how we’re going to be able to take advantage of the intellectual tension we have in our firm to just get better as investors.

Development from day 1

[00:11:05] Tilman Versch: So if you look back, or maybe can talk to your seven years younger Dennis self, what three personality traits would you write down and say you have this now in seven years as a result. I think openness might be one, are there any others?

[00:11:28] Dennis Hong: You know when you start a firm there are so many variables that you can introduce into the business. I’ve always said that the investment business is a multivariate problem and there are variables that you can control and there’s variables that you can’t control, so the exogenous variables. So, over the last seven years, it’s been a pretty crazy seven years. I remember when we first started the firm; we had Greece, an economy the size of the state of Maryland here in the United States, was threatening to not pay their debts anymore and that was threatening to bring down the entire global financial system. That was in 2014. That same year, we had the Ebola virus travel from Africa and landed on the shores of the United States and ended up in Dallas which led to a little mini freak out. We had subsequently, a meltdown in the Chinese stock market. The policymakers in China did a snap 2% devaluation which led to absolute chaos. We had Brexit, we had Donald Trump, we had coronavirus, just a litany of things that led to just a spectacular market decline. And in each of these instances, it always feels like the end of the world. The reality is that the market sells off every single year for any reason.

So, if you look at the statistics, by JP Morgan, every single year has a great chart that shows and demonstrates the intra-year decline of the S&P 500 and then the actual return of the market in that calendar year. So that January 1 to December 31, which is in financial market terms, quite a random 365-day period, but coincidently, 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. And by the way, at 13% entry, your drop drawdown is quite significant, and then that one-third of the time, the market finishes down. Now I’m merely illustrating this is context, that’s context. Those are variables that you cannot control, the exogenous variables.

But what about 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.

But what about 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.

So if I were to maybe talk a little bit about where I am now today in my mindset. In the early years, it’s exciting, it’s frightening and there are so many things that it’s easy to get distracted by but it’s important not to lose sight of the long term. I think that I was to sort of look back and meet day one Dennis, July 15^th 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, I’ll get the results for the month the day before our investors get their tear sheet. It’s incredibly freeing for the mind to try to stay away from the day-to-day noise and vagaries from the market which really are just randomness. I mean you know the definition of compounding, right; a constant, continuous, dogged improvement over very long-term timeframes. I think the most operative work there is long-term timeframes.

I mean you know the definition of compounding, right; a constant, continuous, dogged improvement over very long-term timeframes.

You know Tilman it’s really funny. A lot of people say that we’ve grown really fast; I don’t feel like that’s my experience. It’s been a very methodical, slow, gradual, incremental, linear process. It’s been one investor at a time, it’s been one investment at a time, it’s been one teammate at a time. You know in reality Tilman, we actually haven’t raised that much money over the last seven years. Through December 31 of last year, and I ask Paul, my CFO for this figure every single year what the net inflow is at the end of every year, the net inflow into our fund has actually been about $280 million net and we’ve also actually returned some money to our investors too, over the last seven years. And we finished the year at close to a billion dollars. So it’s amazing because in the heat of the moment, it feels so hard and it feels like you’re going too slow but if you’re really, really focused on the long term and you sleep on day one and you wake up seven years later if you’ve done the right amount of work and have made the right upfront investments of time and effort to build a great foundation, I think that’s where magic can really, really happen and you can take advantage of this compounding concept.

Working on important problems

[00:19:20] Tilman Versch: You’ve just described, I would frame is as a door, you did decide to go at a certain moment and you also regretted that you didn’t go before, like the more long-term orientation. Are there any other doors you would describe like this you would have wished to go through earlier?

[00:19:38] Dennis Hong: Actually it’s so funny, I sort of knew that you might ask this question and so I actually posed this question to my teammates and Mike, who is my first teammate on the investment side, he actually had a really interesting observation about this question – work on the important problems. So Mike actually cited this author 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.

Again, in the early years, we’re all just trying to figure out the world and in the heat of the moment it’s often very, very difficult because there’s so much noise but being able to focus again, just focus and orient yourself around what is that goal you’re trying to achieve, that’s what’s really, really important. It’s funny, you know this thing that you said about Twitter followers earlier, we’re definitely not solving for Twitter followers, we’re trying to solve for Hall of Fame returns.

Now the Twitter has been really interesting because one of the things that I’ve really come to increasingly internalize myself, and it’s a 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 and as someone who’s lived this as an entrepreneur in the investment business, it is a truly, truly important tenet.

The role of kindness in Building ShawSpring Partners

[00:22:26] Tilman Versch: You have a great resource or a great strength that helps your networking. I think different people describe you as one the kindest people they’ve ever met. What role did kindness play for building ShawSpring Partners?

[00:22:40] Dennis Hong: Kindness is free. You know I have to tell you that, as I said in an earlier interview with you, I’m probably one of the last people that should really be in this seat and I’ve been incredibly fortunate just over the course of my 39 years, to have had people willing to look out for me.

Kindness is free.

You know I went to an inner-city public high school and I don’t know why this guidance counselor, her name is Donna Kraayeveld, why she was looking out for me but she encouraged me to open my horizons and said why don’t you look at some schools in the United States, and I think I said last time that I didn’t even know what Ivy League schools were. I was kind of a country bumpkin but it’s people like her, it’s people like my mentors at the Yale investment office, it’s the countless numbers of people throughout my career who were willing to just pay it forward to me and open a door of opportunity for me. I think that’s really, really important and in some sense, I know how hard it is, it’s incredibly difficult to get into this business and it’s incredibly helpful to be able to run into people who are willing to just give you a shot or open a door of opportunity for you.

I think about my teammate Mike. Mike, I think has been incredibly influential, probably one of the most influential people in my investment career. I met him when he was 18 years old and I was just an analyst at another fund. I was an analyst at Altimeter Capital and Mike must have went on LinkedIn and wrote a cold email to probably 300 or 400 people and you know Mike is an incredible talent but if you looked at his background, it’s not obvious that he would be someone who would make their way into this business. But he reached out to me and you know I recognized that a lot of people paid it forward for me and what do you have to lose. You could help a young person with their career and maybe they could end up being great. And I took the meeting and I met with him and that kicked off an incredible friendship, an incredible thought partnership and he’s been one of the most important people in my life as an investor. Now today, he’s 31 years old he’s a general partner of ShawSpring and he’s earned it.

[00:26:00] Tilman Versch: Now you have the chance to also be kind by subscribing to this channel, leaving a like or a comment and if you’re listening to the podcast, you can also leave a review on the portal you’re listening to the podcast to. Now back to the video. 

Traits of an exceptional investor

[00:26:17] Tilman Versch: I think there are many young fund managers watching this video, so I have to ask this question. Are there any other free resources that have such a power as kindness has, in your eyes that are easy to copy for instance?

[00:26:38] Dennis Hong: You know, I’ve worked with a lot of young people over the years and I’ve tried to think of a mental model for what makes a really incredible investor an incredible analyst. So my friend, Ram Parameswaran who was a former colleague of mine at Altimeter, I think he lays this out. I’m not going to reinvent the wheel but I think he lays this out really, really well. There are probably four uncoachable traits that make for a really exceptional investor.

One, just a raw passion for this business and passion can be exhibited in a lot of different ways. It could be everything from trading and having incredible success in your own personal account and today it’s just such an incredible world in which we live. You have platforms like Robinhood and Square, Cash App and even with very small amounts of money; access to the financial markets has been truly democratized. I’m excited actually to see over this generation, which young people are incredibly inspired and become like the next great investors. But passion can be exhibited other ways. I mean think about the world in which we live Tilman, you yourself have been able to find pretty incredible investors and you feature them on Good Investing. The most passionate people are writing Substacks, they’re doing podcasts; they’re sharing widely, insights on Twitter. So, I think just passion. It has to be something that you really, really love to do, this business of investing.

So, I think just passion. It has to be something that you really, really love to do, this business of investing. The second trait is that the most successful investors, they tend to have an insane work ethic. They are just learning and working machines and they think about this business 24/7, 7 days a week.

The second trait is that the most successful investors, they tend to have an insane work ethic. They are just learning and working machines and they think about this business 24/7, 7 days a week. And actually, many of these individuals probably don’t even think about what they’re doing as work. It’s just built into their life. That’s what makes this business so hard. There are so many smart people, so many motivated people, so many passionate people and it’s what makes this business really, really fun because I’m a bit competitive myself but you can’t compete with someone with a passion and work ethic.

You know, a third personal characteristic that I think is really interesting to explore in terms of great investors, is that they typically have something that I like to call, a heart of a champion, so just resilience. Actually, when I look at people for analyst roles or internship roles here at ShawSpring, the kinds of people that really intrigue me typically have a history of professional and personal challenges or failures but just incredible resilience. They come back, they come back fighting really, really hard and they come back even stronger. I love those types of people. They just have an incredible chip on their shoulders and it’s just fun to work with those people because you don’t ever underestimate somebody who has something to prove.

Actually, when I look at people for analyst roles or internship roles here at ShawSpring, the kinds of people that really intrigue me typically have a history of professional and personal challenges or failures but just incredible resilience. They come back, they come back fighting really, really hard and they come back even stronger. I love those types of people. They just have an incredible chip on their shoulders and it’s just fun to work with those people because you don’t ever underestimate somebody who has something to prove.

And then number four, just an open-mindedness. I think that, as I mentioned earlier, I think that negative and skeptical people, sound really, really smart but they can rarely see good. So, I think the best investors tend to have an open mind and they really thrive in environments of intellectual tension, not organizational dysfunction but intellectual tension is the context because they force experimentation and R&D, research and development in areas that are new, that are exciting, that are innovative and that’s also really, really fun.

ShawSpring’s (early) investors

[00:31:16] Tilman Versch: You described your hustle at the beginning of building ShawSpring Partners as being in the ICU or working on the ICU for seven years and you survived it to now, a lot of businesses die in this time. What kind of ecosystem allowed you to keep going through these years and how did you build this kind of ecosystem for yourself?

[00:31:43] Dennis Hong: We’re incredibly lucky. So we have a terrific group of investors who – well let me talk a little bit about our early investors, right. So, we weren’t a huge fund but we had an early group of investors who not only were willing to bankroll us with a little bit of capital but with time, patience, a willingness to let us build a foundation, a willingness to let us iterate on that foundation, a willingness to give us input whenever we seek it, we’ve been really, really lucky.

Now we haven’t grown very, very fast and we actually haven’t even marketed very widely. In fact, I can’t remember a single instance where we actually went out there and we were able to successfully attract an investor to our partnership. The partners found their way to us through an existing partner, through word of mouth or maybe they saw something that I wrote, or maybe they listened to a video interview with Tilman

[00:32:47] Tilman Versch: Maybe!

[00:32:50] Dennis Hong: and something just clicked or resonated. We has this thesis upfront, my teammates and I, we had this thesis upfront that if we do a good job for investors, the right investors will find their way to us. Just to reiterate, I mean we have a strategy where we’re putting our investors’ capital into 5-10 of our very best ideas. That’s not the most obvious strategy for a lot on investors, particularity institutional investors because of the episodic tendency of our returns, and believe me, our returns can be quite episodic at times; it’s not right for everybody but for the subset of investors that really like this, they often will find their way to us.

So, for us, I have to say that there’re not a lot of competitive advantages in this business. We have a great data science team out in New York that helps us but many firms use data science teams to help inform investment decision-making and to keep track of their investments. We have really terrific expert networks where we can source and hire consultants and domain experts to bring us up to speed on any investment that we like. We have access to other alternative data sources but these are all in some sense just table stakes. I think one of the last remaining competitive advantages and especially for a firm like ours, where the probability that we would be here today is a long tail probability. The way we maximize the probability or turn something that’s a long tail probability into something that’s a little bit more probable is by making sure that you have a group of stakeholders that are bought in, that you have ecosystem control with your investors.

So we haven’t grown very fast and every single year, it’s been typically one or two institutions that find their way to us, that spend time with us, that get to know us, that get to know our underlying investments and that’s also another point Tilman. Our best investors, people, like to use the term asset allocator to describe institutional investors. The way I would maybe segment that even further, in our partnership is that our partners, I consider them asset owners. They care about what we own on their behalf. It’s their money, it’s not my money and ultimately it’s their underlying holding. It’s not my underlying holding. So, when we buy something new, they have to be as excited about something new that we buy on their behalf as we are. And I think that’s really, really important when you run a concentrated portfolio of 5-10 stocks.

We need partners who want to know what they own, who care to dig into what they own, and over the last seven years, we’ve had a lot of fun. Our partners dig in, they provide feedback, they challenge us, they make introductions, they travel with us, they make us better investors.

We need partners who want to know what they own, who care to dig into what they own, and over the last seven years, we’ve had a lot of fun. Our partners dig in, they provide feedback, they challenge us, they make introductions, they travel with us, they make us better investors. So, I’ll tell you that it is absolutely true, a fund in its earliest years is incredibly fragile. A lot of things can go wrong but a lot of things can go right if you’ve aligned yourself, have good ecosystem control with your own partners, and their excitement to be along for that journey.

Hurdles that enables progress

[00:36:48] Tilman Versch: So in the last seven years, what were the hurdles and problems and mistakes that enabled your strongest progress and growth?

[00:36:57] Dennis Hong: That’s a really good question Tilman and actually, I’ve been thinking about this a lot lately. So, in some sense, what we do at ShawSpring, and I described this to an investor recently, is that we want to spend high-quality time studying high-quality people, building high-quality businesses on behalf of high-quality investors.

We want to spend high-quality time studying high-quality people, building high-quality businesses on behalf of high-quality investors.

[00:37:23] Tilman Versch: We will dig into this in just a second but continue.

[00:37:26] Dennis Hong: So the operative word being high quality. Now we operate a 5-10 stock portfolio of businesses run by human beings and I can’t tell you how many times where it’s been absolutely critical that we’ve made the right bet on the right jockey. It’s not for us, for us it’s not just betting on horses. If you’re analogizing our investment business to picking the right horses with the right jockeys in a race, it’s not enough just to pick the right horses but because we operate with such a long-term timeframe, you also have to make sure that you pick the right jockeys.

Now we’ve been really fortunate, particularly in our later years where we now today have a portfolio of 10 businesses where I believe that our managers are some of the highest quality, it actually could be the best portfolio managers that we’ve ever had in the last seven years. It’s these kinds of managers where when push comes to shove, in the face of adverse circumstances, these individuals steer their businesses in a way that is admirable, that is proactive, that takes advantage of the crisis. I think last time we talked a little bit about a 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.

“Bad businesses are destroyed by crisis, good companies survive them, great companies are improved by them.”

So, you know in some sense, there’s another quote that I really, really love. It was a Chinese proverb, “A true warrior, like tea, shows his strength in hot water”. 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’ve learned a lot over the last seven years. At one point Tilman, we may have been fine investing in a really high quality company with a professional manager, and some professional managers are quite exceptional. We’ve been very, very lucky to have invested in companies like Visa, which are run exceptionally well by great professional managers but our evolution as investors, we probably lean more and more towards increasingly towards owner operators; towards those managers with significant skin in the game, to those managers that have very significant stakes of their own personal net worth tied up in the business’ own equity.

So in the beginning, we may have been a little bit more relaxed on managerial character and quality but today, I don’t think that it’s possible to compromise because when we get excited about something, we want to be there for the long term and we also want to be there for our managers for the long term and we want to be able to trust that our managers are going to do the right thing in every circumstance. So, we’ve had a lot of learnings just about assessing managerial quality and character over the years and that’s probably something that’s been a dramatic evolution and improvement in our process

[00:41:44] Tilman Versch: How would you boil down these learnings?

[00:41:48] Dennis Hong: How would you boil down these learnings?

Relationship with fund manager

[00:41:50] Tilman Versch: What are the key takeaways, if there are any? I think you named them already a bit.

[00:42:00] Dennis Hong: I mean the most obvious thing is to have good alignment with your managers. That’s something that’s really, really hard to achieve unless the manager has very significant stakes of their own personal net worth tied up in the company stock. The other thing actually Tilman, is that we require a relationship with a manager. So, when I started my career at the Yale endowment, we probably would have never invested in a fund where we didn’t have some kind of access to the portfolio manager. Just having a relationship with IR is not enough. We have to have some ability to be able to spend some time with the manager, the capital allocator who’s ultimately the one who’s accountable for the results of a business.

We’ve had to really, really hustle to get that access. We’ve had to show even though we were a small fund, we’ve had to show an ability to be thoughtful, to add value, to be long term and show up quarter after quarter, month after month, year after year, that we are really long-term investors. And that stands out; it really, really stands out.

So, over the years, we’ve had to really, really hustle to get that access. We’ve had to show even though we were a small fund, we’ve had to show an ability to be thoughtful, to add value, to be long term, and show up quarter after quarter, month after month, year after year, that we are really long-term investors. And that stands out; it really, really stands out. So over the years, we’ve tried to be thoughtful and find ways to gain access, to make it compelling for managers to want us involved and that’s something that I hope we don’t lose. I mean today, we’re a little bit bigger now than we were when we first started. So, our check sizes, our initial check sizes into a company are a lot larger but I don’t want to lose that hustle and the ability to add value and be thoughtful and compel our managers to meet us even though we’re not a large shareholder.

The ShawSpring motto

[00:44:12] Tilman Versch: I think for the next part of our interview, I want to go through your ShawSpring brand motto I would call it. It’s “Work with a high quality team, to invest in high quality businesses on behalf of high quality partners”. Did I miss something in this quote or is it right?

[00:44:33] Dennis Hong: So I want to stress that we are “one team, one portfolio, one P&L”. So, we want to spend as a team, “high-quality time studying high-quality people, building high-quality businesses on behalf of high-quality partners”.

[00:44:52] Tilman Versch: So what is your definition of team? Is it more than the people in your office or is it an ecosystem definition? How do you define team?

[00:45:00] Dennis Hong: Tilman, that’s a great question and it’s a question that’s no one’s really asked me before. I think of course we think about this idea of team more broadly but if I want to focus the conversation just internally to ShawSpring, within these four roles, I think about team as how our teammates are incentivized and what we’re trying to achieve. Where I always have said, we’re “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. So, for us, for me in particular, it’s about how do we create system where we take the advantage of having a collective knowledge base as a team and just make that better. I think one of the things that I’ve always thought about, in an approach like ours, is how do you create intellectual tension? 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 intellection 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.

This institution already has wonderful managers in their portfolio, amazing managers, the best managers, so the bar to get into that portfolio is very high and that process, that institutionalization of that intellectual tension, I though was really unique. And so we do it here internally here at ShawSpring as well.

I potentially could be involved in sourcing an interesting idea but I don’t take initial sponsorship of the idea. See, here’s the problem with an approach like ours today, one team, one portfolio, one P&L, we might succumb to group think that could be a big weakness. And I could tell my teammates, by the way guys you can tell me my ideas are not very good, you can tell me my ideas are crap but can I really expect that to happen? I’m the one who pays all the paychecks so there’s always going to be, in some sense by default; my ideas are going to be the best ideas. So, we have to build into our process, some level of intellectual tension. So, I could be involved in sourcing an idea, I could be involved in trying to push the research team to a certain direction but one of my teammates has to be that principle sponsor for an individual idea. That principle sponsor takes it to a point and then the principle sponsor has to bring in a secondary sponsor.

I’m invited to come in but my role at that point is to try to kill the idea. It’s to try to be the chief pain in the a** and that’s important because we already have 10 wonderful portfolio companies with great managers that we know, and they know us. And ostensibly, those 10 ideas, those are our best ideas. So the bar to get into our portfolio is very, very high and that’s what keeps the quality very, very high.

We have weekly investment team meetings here at ShawSpring and so I’m aware of what’s marinating in the pipeline all the time. But about a third of the way through the underwriting of a potentially new idea, I’m invited to come in but my role at that point is to try to kill the idea. It’s to try to be the chief pain in the a** and that’s important because we already have 10 wonderful portfolio companies with great managers that we know, and they know us. And ostensibly, those 10 ideas, those are our best ideas. So the bar to get into our portfolio is very, very high and that’s what keeps the quality very, very high. So ShawSpring’s current iteration today; that is the way we have to maintain intellectual tension. I have to be the one who creates intellectual tension, not organizational dysfunction. I have to be the one who creates intellectual tension. So in some sense, every one of our teammates individually has an important responsibility but collectively we’re trying to push towards this goal or creating Hall of Fame returns in a one team, one portfolio, one P&L approach.

Intellectual tension instead of organizational dysfunction

[00:52:00] Tilman Versch: How do you make sure that there’s intellectual tension and not organizational dysfunction? Where do you draw the lines?

[00:52:09] Dennis Hong: Well one of the most important things is that we’re all incentivized on the single P&L, we all own the book together. There’s nobody who says that, that’s my idea and I want to be paid on the basis of that idea. Everybody has to be excited about everything we own. So, while I do create the 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.

So, while I do create the 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.

So, you’ll see here there’s this row of desks and I sit on the same floor as everybody else. There are very healthy levels of debate and Tilman, you should come and spend a day at our office one day and you’ll see that there’s quite a bit of energy, not kind of like trading floor crazy stereotypical market-driven activity but there’s really, really healthy debate on all the different projects that we’re working on constantly. It’s not a quiet place to learn, there’s a lot of great chatter that happens.

Being skeptic

[00:53:30] Tilman Versch: How does your personality that’s behind the chief pain in the (bleep) acting, what does your personality look like if you’re like this?

[00:53:45] Dennis Hong: I’m naturally pretty skeptical. See, I remember just distinctly when Mike was trying to pitch this idea, Tinder, to us; and at that time, so this was back in 2016, and at that time, Tinder must have been on a $50 million revenue run rate at that time. Tinder was an asset that lived inside a Match group and it was a $50 million revenue run rate. It was growing very fast but Mike sort of put his hand up and said this is going to be maybe a $300-400 million dollar revenue business and grow 8x over the next couple years. And at that time, I scoffed because how could this be possible? It’s like a dumb game; it’s like a video game. You know the swipe left, swipe right. We were both pretty wrong. Last year, Tinder finished the year at $1.5 billion in revenues and doing like 70% gross profit margins and probably about 50% operating profit margins and it’s still growing very fast.

And so we were both wrong. But I’ll tell you at that time, it was a really, really healthy and heated debate that we had about how big Tinder could be. And I think the one thing that really, really helps me as a skeptical person is that we tend to follow a quite data-driven approach. I always say I’m long term but the long term is the summation of a lot of short-term accountabilities. So we are believers in long-term trajectories of business but there are also KPIs or milestones along the way. The other part of the process that I also want to mention, in the vein of keeping intellectual tension, is that I own all the positions in the portfolio, and actually, I am the one who assesses, who evaluates the outcome.

hen we make an investment, we identify a set of KPIs and we track those KPIs very, very carefully. KPI, if you’re not familiar with the term, is key performance indicator. So we identify what are the most important drivers of this investment thesis over the long term. And with our internal resources and the various different data resources, we’re consistently and regularly tracking how these businesses are tracking towards their longer-term objective.

So when we make an investment, we identify a set of KPIs and we track those KPIs very, very carefully. KPI, if you’re not familiar with the term, is key performance indicator. So we identify what are the most important drivers of this investment thesis over the long term.  And with our internal resources and the various different data resources, we’re consistently and regularly tracking how these businesses are tracking towards their longer-term objective.

Now there are some firms that are quite sensitive to very small fluctuations that might be off trend line. So, I remember working at some firms where a long could be had if a business consensus estimates said that this business is going to grow its earnings 35% and the data was saying it’s going to grow 37%, then that’s a long, but if you think this is growing 35% but it’s only growing 33%, then that’s a short. What’s the difference? Not much. So what I mean about just the longer-term trajectory is that within an XY plane, it’s the business tracking somewhere within the upper right quadrant of that XY plane. Does this business have linearity, positive linearity towards that longer-term outcome? That’s what I mean about just tracking and evaluating those KPIs.

[00:57:27] Tilman Versch: Maybe we’ll talk about the key KPIs in the episode.

Identifying the right variables

[00:57:30] Tilman Versch: I want to talk a bit about the inputs that are important for your team. Are there any publications or other sources that you especially want to name or how do you structure the input for the team as there’s an information overflow and you have to boil down to the core points?

[00:57:49] Dennis Hong: That’s absolutely right. There’s so much noise and there is an infinite amount of knowledge and data but we try to be very thoughtful especially because we’re a small team and one overarching ethos in our team is that we need to be engaged in activities that are maximizing return on time and effort spent. So when we are looking at something new, we need to be able to identify quickly, what are the most important variables that are going to drive the success or failure of investment. And that can be achieved in a lot of different ways.

We just over the years, as our assets have grown, we’ve just been able to have larger and larger research budgets that help us save time and help us get more efficiency out of our research process. It used to be, we had quite a manual and laborious process to find experts and to find people that’d be willing to help us learn about a new business but today, the research budget that we have at our disposal is quite significant so we’ve been able to find more efficiency out of our process just by simply deploying our R&D budget in ways that are timesaving, efficient and help us achieve that goal of maximizing time, maximizing return on time and effort spent. So, the name of the game in our firm is to be creative.

So, since the firm’s started, I’ve always allocated some sort of a discretionary research budget to each of our investment professionals. It started out very small. When we were a really small fund, the amount was quite small, it was probably maybe $5000 per year that you can invest how you see fit, do whatever you like. And our team actually deployed this money in very creative ways.

So, since the firm’s started, I’ve always allocated some sort of a discretionary research budget to each of our investment professionals. It started out very small. When we were a really small fund, the amount was quite small, it was probably maybe $5000 per year that you can invest how you see fit, do whatever you like. And our team actually deployed this money in very creative ways.

One year, one of my teammates put up his hand and said, I want to go to Japan and learn about Japanese technology companies and I think this is a good use of time. And I said, at that time you know, I have never, in the course of my investment career found really interesting ideas in Japan, I’m not sure that you’re going to find anything interesting there but I think that you should take your resources and go study. Actually Bernard Arnault at LVMH, he’s brilliant and also has this concept of go look, and he encourages his team actively to take a budget and experiment and we have that here internally as well.

So, we have a central research budget that goes towards supporting the research efforts of our existing portfolio companies as well as any potential new ideas that are potentially investable for us, but we also have some level of experimentation that we actively encourage. It’s an R&D budget. I think it’s probably the best way to analogize that budget.

So, my teammates, they’re free to deploy this budget however they see fit. It could be that I want to go explore a new area. I want to go spend a month in India and I want to meet private companies, public companies and I really want to understand what’s going on, on the ground there. That’s an option. If they wanted to go spend it on, and now this would probably raise my eyebrows a bit, lots of first-class tickets to visit Europe, they can go do that too. It’s their choice, it’s their choice. And I think that’s what creates an excitement of working here because we’re actively encouraged to experiment; we’re actively encouraged to find creative and new ways to deploy this R&D budget. And sometimes it ends up, actually in a way; helping us tap optionality, find new areas and new sectors and new businesses in which to invest.

Translating research

[01:02:08] Tilman Versch: With these experiments, you’re creating new knowledge. How do you make sure to integrate this new process and where’s your hurdle?

[01:02:18] Dennis Hong: So one of the things that is part of our process – I’ll talk about it in a couple of different ways. So my current research team, my full-time research team, is three; me, John and Mike, and collectively the three of us, we can probably end up doing 7-10 deep dives a year where we make a really concerted effort to study a business that’s very, very interesting, that potentially has ecosystem control which is our arbiter for quality, where we can really, really understand what’s going on inside this business and could become a potential investment in our portfolio. 7-10 deep dives a year but one or two make it to the finish line.

The reason why something doesn’t make it to the finish line and get into our portfolio, there are really two principle reasons. Number one, the idea is not quality enough. In those instances, we try to fail fast, in those instances we try to move on from that idea very quickly and efficiently and document why we passed. And it still is tracked because we also want to be aware if we’re making errors of omission and if we are making those errors of omission, we need to systematically unpack how we came to that decision to pass.

The other reason why something doesn’t make it to the portfolio is it exhibits all of the quality characteristics that we like; it exhibits ecosystem control, but it doesn’t meet our hurdle rate. 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.

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.

So where does the value of this trigger-ready list come in? Think of about a month like March of 2020. Everything is down, there’s nothing up and you sometimes have this really rare circumstance studying a business that you’ve really, really like for a very, very long time and you get an opportunity to invest. Some of our institutional investors could probably appreciate this. There are many, many great funds that are closed to new capital but on fairly rare occasions, sometimes they’ll open up and that’s often very exciting to our institutions. They open up, the manager says we have some capacity and many of the great institutions raise their hand and say yep, I want to go and invest in this fun because it opened up and it has capacity.

And in some sense, that’s what happens with us. So in the month of March of 2020, we actually purchased a starting position in Square. Square is an extraordinary business. We’ve been following it since the IPO. It’s great and the managers are incredibly thoughtful, the have very good ecosystem control. But every single year was just a little bit too expensive. It took a 60% off sale in the month of March of 2020 for it to be for us to come into the range of something that’s investable for us.

So this description of our process is really for us, there’s a lot of satisfaction just studying great businesses and building a library of trigger-ready businesses that in the hypothetical circumstance the prices become attractive, we could make a decision to upgrade the overall quality and returns of our portfolio at the appropriate bottom-up driven time.

Decisions during the crisis

[01:07:42] Tilman Versch: Maybe this point in time, March 2020, is a good point to ask my questions. How did you make sure at this time that your team ends up with the best decisions? Also in this limited time frame, because the market was going up at a certain point, it didn’t stop.

[01:07:58] Dennis Hong: I’ve actually thought a lot about this recently and I want to bring it back to that singular quote by Andy Grove: “Bad companies are destroyed by crisis, good companies survive them, great companies are improved by them.”

I thought a lot about this for ShawSpring. So building a strong and resilient ecosystem control for ShawSpring’s partnership, ShawSpring’s ecosystem control – that is probably singularly one of the best ways to prepare for an exogenous event like a march of 2020. Every day, we need to spend; we need to spend time getting better. We need to spend time preparing for opportunities to present themselves.

Predicting tail events like March of 2020 is impossible but preparing for events that create opportunities like a long tail event, that’s what’s really, really critical. So, what that means for us is to continue to refine this idea of a target list, this trigger-ready list. We may not make investments for months or even years, but it’s really, really important to continue to refine our process, continue to build this library.

Predicting tail events like March of 2020 is impossible but preparing for events that create opportunities like a long tail event, that’s what’s really, really critical. So, what that means for us is to continue to refine this idea of a target list, this trigger-ready list. We may not make investments for months or even years, but it’s really, really important to continue to refine our process, continue to build this library. It means being ready to reallocate capital from current investments in the portfolio that may be down, down more than the market and reallocate into better investments.

This idea of Square was a really interesting one. You know, it was just really a collective effort being ready to pull the trigger. But if we’re being really introspective, we still need to keep doing a better job building and refining this list. I think it’s an important tenet to what we do.

The potential of expansion

[01:10:02] Tilman Versch: To sum up point on the team, in your motto, is there anything that you want to add?

[01:10:10] Dennis Hong: Yes, I do. We have some wonderful young people spending the summer with us and it’s been very fun to see what increased bandwidth could mean for our firm and our ability to do more deep dives and to continue to build our trigger-ready library. It’s been really fun because each of our summer associates; they’re working on two dives a piece so we concurrently have eight deep dives going on this summer.

I’ve had to be very energetic to keep track of all of these eight deep dives and it’s a pretty diverse group of companies that we’re looking at and that’s what’s really, really exciting. I think for me, I think the next iteration of our firm is to really think through, do we want to expand our team, what does it mean to expand the team? See, we’re five full-time today, including myself. We’re 20% positions in our operating culture portfolio, in our human capital portfolio. That’s a very concentrated human capital portfolio. This next person that comes into our team, this next full-time person, it’s going to be a 17% position, so we have to get that really, really right.

See, we’re five full-time today, including myself. We’re 20% positions in our operating culture portfolio, in our human capital portfolio. That’s a very concentrated human capital portfolio. This next person that comes into our team, this next full-time person, it’s going to be a 17% position, so we have to get that really, really right.

It’s really, really important because that person is going to influence our culture in their own very unique way. And so it’s been really fun to be able to work with really exceptional young people this summer because it’s really, in some sense, inspired me to really think through, how could we continue to improve and how can we continue to grow, how can we keep creating intellectual tension and how can we find ways to continue to build our library of knowledge, our library of trigger-ready ideas; when we do face the next exogenous tail event, that we’ll be ready and we’ll be responsive and we’ll have a process in place where we can make the correct capital allocation decisions that are going to power the portfolio going forward.

Support systems

[01:21:25] Tilman Versch: Tilman here. I want to invite you to support my work and to allow me to produce further videos like this. Below you can find the link to my thank you page. Just click on it and there you’ll find different options to support the content production of this channel. Thank you very much!

High-quality partners

[01:12:42] Tilman Versch: So let’s move on to the high quality partners. What or who is a high quality partner for you?

[01:12:52] Dennis Hong: This one’s a really easy one for me and we’ve talked a little bit about it earlier on. I think singularly, the kind of partner that I think is the best for us is what we would consider an asset owner. They really, really care about what they own, they care to dig in, they care to learn with us, they care to share with us and they want to be part of this partnership. I have always said in our letters that our partners are our competitive advantage.

The kind of partner that I think is the best for us is what we would consider an asset owner. They really, really care about what they own, they care to dig in, they care to learn with us, they care to share with us and they want to be part of this partnership. I have always said in our letters that our partners are our competitive advantage.

We have something that no one else has. We have this terrific group of institutions and individuals who not only provide us with capital but a runway, a framework and a foundation to invest and make decisions especially during tail events. I have to tell you that in the month of March of 2020, well actually in almost every single sell-off, I have this hypothesis that we built a good partnership and whenever we have some of these big sell-offs, I always have this thesis that, you built a good partnership so nobody’s going to call panicked, scared, afraid, ask for their money back or are angry. Now of course it’s okay to be afraid, it’s okay to be nervous but that’s why we have a partnership so that we could steer through the storm together.

I think that one of the things that is really, really interesting to me is that we haven’t grown very, very fast but all of our partners have sort of opted in to us and it’s been incredibly heartening to see the kind of partners that find their way to us – they are long term, they are thoughtful, they’re really nice and they want to be part of this and they want to own the businesses that we own on their behalf. And as I always say, it’s their capital, it’s their underlying holding. We’re merely the intermediaries that are introducing these ideas to them.

So that was really fun about our partnership. It’s not right for everyone; it’s not an infinitely scalable firm. We have 17 institutions today. I’ve always said that this is going to be a partnership of 15-20 institutions. I want all of our partners to have access to me, that’s really, really important. I don’t want to have an intermediary; I don’t want to have an IR department. I’m the one who’s accountable. If the results are bad, it’s nobody else’s fault. It’s my fault.

I want all of our partners to have access to me, that’s really, really important. I don’t want to have an intermediary; I don’t want to have an IR department. I’m the one who’s accountable. If the results are bad, it’s nobody else’s fault. It’s my fault.

It’s really, really important that our partners have access to me and I’ve been very, very fortunate that we have a great group of partners that have allowed us to flourish and be who we are and have brought us to this point.

Vetting prospective partners

[01:16:05] Tilman Versch: So if a potential partner reaches out to you, how do you make sure it’s a match?

[01:16:12] Dennis Hong: So, when we talk to prospective partners, we tell them that we’re probably going to end up doing as much due diligence or DD on you, as you might do on us. And actually, because 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.

So, it’s a two-way street, it’s a long dating process and it’s interesting Tilman. At the beginning of any given year, I can’t tell you for sure who’s going to invest. It’s always been a mystery to me. Paul and I, my CFO Paul and I, we speculate at the beginning of every single year of who potentially could be the next one or two institutions that partner with us in that year. We’re almost always wrong and I think it’s great. It’s great because we want our partners to take their time. We’ve never rushed anybody into a decision.

One of our partners, they took probably almost four or five years actually to get to know us, get to know my team, get to know our process, get to know our underlying holdings and it gives me great comfort that if it took you four or five years to come in, it must mean that you’re going to probably be with us at least like four to five years too.

So, we haven’t grown fast, so Tilman, we’re at 17 institutions, we’re seven years old and it’s always been one or two partners that find their way to us in any given year. It’s never been a fast process. It’s been fairly linear but it’s never been a fast process and I can’t predict who that partner is going to be. But when all is said and done, and when that partner gives us the green light and says that they want to invest, we have a fairly good understanding of who that partner is and I believe that, that partner also has a fairly good understanding of who we are and I think that’s a very, very important, at least for ShawSpring’s ecosystem control, that’s a very, very important characteristic to our process of building a partnership.

[01:18:45] Tilman Versch: How do you make sure, in this longer dance that you do before investing, that it doesn’t end up in a transfer of ideas from your side to a potential partner who’s more interested in the ideas than in investing?

[01:19:02] Dennis Hong: You know we don’t mind necessarily if a partner wants to invest in our underlying holdings themselves. I think that that’s fine but fortunately for us, many of our partners actually just prefer to let us manage a portion of their capital and be the research arm for those ideas. I haven’t really been in a situation where a partner would invest a small amount of capital with us and then size those positions in a significant way outside of our fund, but I know that that happens.

But typically, many of our partners are quite upfront if they do have a big internal portfolio and they’re pretty open about if they do have an interest in investing in our underlying holdings on their own balance sheet themselves. But typically speaking, our partners rely on us to have the right insights to track the right KPIs, to judge whether or not the business is a good investment or not. So, we haven’t necessarily have had that situation happen. But you know, generally we file 13F and if they wanted to clone what we do, they certainly could clone what we do but we haven’t had that happened in our partnership to this point.

How much do you recommend to invest in ShawSpring Partners?

[01:20:30] Tilman Versch: What percentage of the wealth of your partners do you recommend them to put in your hands, if you recommend anything?

[01:20:40] Dennis Hong: 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. I mean, the customer is always right, and we have to respect the individual strategies and philosophies of our partners. For my friends and family who ask to invest, I often just tell them, invest enough that if we do a very good job, it’s going to make a difference in your life but don’t invest so much that if I lose it all and it goes to zero, that we’re no longer friends.

But in that circumstance that I have all my money invested, that’d be a pretty bad situation if that were to happen.

[01:21:28] Tilman Versch: I think it doesn’t happen, or at least I hope it doesn’t.

Align with high-quality partners

[01:21:34] Tilman Versch: Do you have anything to add on the perspective of the high quality partners?

[01:21:38] Dennis Hong: I think that a lot of managers feel an incredible pressure to grow very fast in the beginning. It’s a really, really hard business, especially at small scale. There’s so many different competing demands on time and resources and dollars and I think that the one think that I will say for a new manager starting out, is don’t compromise on the quality of the partner. A quality partner, no matter what size, can make your ability to have staying power, enhanced. If you have partners that are mismatched to what you’re trying to do, it can make your life a living nightmare and, in some sense, the failure rate of many funds is very, very high.

I think we talked a little bit about this last time, but we certainty talked about this in our letter. If you have a fund and you start with less than $200 million dollars, your ability to survive, kind of that 3-5 year run rate, I think is less than a coin toss. So having a very, very high-quality group of partners that are aligned, that you have good ecosystem control with, in your partnership, it’s absolutely critical. It can be your competitive advantage.

There are not many competitive advantages, as I’ve mentioned, out there today, but the one thing that you can control, which is a variable that you can control, is the quality of and the type of partner that you are seeking to partner with because they can make your life a lot easier.

[01:23:14] Tilman Versch: We’ll talk about the high quality partners, next episode.

What has changed over the years?

[01:23:18] Tilman Versch: I want to still cover two aspects. You had a successful year of 2020. Your AUM at the beginning of the year were around 350 million and now you’re 1.6 billion. You said that over this seven year period, you weren’t growing that much but in this year, you did grow a lot. How did it change your approach or what is still the same with this AUM? How do you adjust this big inflow of AUM?

[01:23:52] Dennis Hong: I think it’s a really good question. When it comes to process and execution of our portfolio management, not much has changed. It genuinely, Tilman, it feels the same. It feels the same as when we were running a $10 million dollar AUM portfolio. What has changed is just the amount of resources that we have available today. I think it’s been so cool to be able to hire data scientists to help us understand what’s going under the hood of our businesses.

Our data science team in New York, they send us a daily snapshot of what’s going under the hood of all the various different businesses that we have under our coverage. We’ve been able to retain two expert networks where we can hire consultants and domain experts and industry practitioners to really, really help us understand a new business from the very start.

The R&D budget, I think the ability to have a larger R&D budget has really expanded the imaginations of our team. I think there’s just so many different things and aspirations that we want to achieve and now we have the resources to do it, and that’s what makes it really, really fun today.

My guess Tilman is that we’ll also probably start a research office in Asia at some point. And I think that there is a real case to be made for us to invest some resources in developing a presence, in developing a brand, in building an ecosystem out in Asia because I think that Asia’s going to be the source of some of our very best ideas in the coming years and I think it makes a lot of financial and commercial sense to establish a presence there.

My guess Tilman is that we’ll also probably start a research office in Asia at some point. And I think that there is a real case to be made for us to invest some resources in developing a presence, in developing a brand, in building an ecosystem out in Asia because I think that Asia’s going to be the source of some of our very best ideas in the coming years and I think it makes a lot of financial and commercial sense to establish a presence there. I want to have a on the ground presence there and I want to have a that’s studying businesses over there and we’ll talk a little bit about why we’re really excited about Asia in our next conversation.

But the only thing that’s really changed is just that our R&D budget’s a lot bigger and we can really expand our imaginations into the possibilities of just having a larger R&D budget.

[01:26:07] Tilman Versch: One thing that also changed, and greetings go out to Iron Castle, at this point, your invitation to microcap conferences did grow also with your assets under management.

Community exclusive

[01:26:18] Tilman Versch: But I think the definition of microcap is changing a bit for you because with higher AUM, you have a problem if you want to deploy 10% in the potential position of your fund in the business, it’s 160 million you need to deploy, so it’s a bit of a challenge to find ideas or is it not?

[01:26:42] Tilman Versch: Hey, Tilman here. I am sure you are curious about the answer to this question, but this answer is exclusive to the members of my community, Good Investing Plus. Good Investing Plus is a place where we help each other to get better as investors day by day. If you are an ambitious long-term-oriented investor that likes to share, please apply for Good Investing Plus.

Recommendations for young fund managers

[01:27:22] Tilman Versch: You already gave some recommendations for young fund managers in this interview and I’ve heard over time that some have reached out to you. What were some key recommendations you gave in different talks you had with young fund managers, besides the topics we’ve already mentioned, if there are any?

[01:27:44] Dennis Hong: Tilman, so I’ve been thinking a lot recently about culture and leadership and I think it’s something that’s really important to study, not only for identifying really high performing cultures in our companies but just having an introspection on culture internally at a firm. So, if you’re a young entrepreneur, if you want to be a one-man show, or one-woman show, that’s one thing, but if you want to build a team, I think being able to be thoughtful and introspective about your culture, you internal culture is really, really important.

How do decisions get made, how do decisions get made if there’s a disagreement? How do you correct from that and what do you want to achieve in terms of your own internal culture? So, I’ve been thinking a lot about that. When we first started ShawSpring and we were small shop and we were three people full time. The three of us actually got together and we actually formalized our culture in a team formation document. And it’s a document that lives inside of our cloud, that we revisit on an annual basis just to see what we were thinking in the beginning and where we are now and what’s working now, and what’s not working now.

And I think that’s really, really important just to be able to formalize that or institutionalize that. I’ve actually been given two really good book recommendations recently about culture that maybe your listeners would find interesting. I haven’t read these books, so I’m going to take these books with me on a summer vacation and I’ll try to crank through them.

Dan McMurtrie, who’s a FinTwit superstar, recommended a book to me. It’s a book by Bill Walsh and the book is called, “The Score Takes Care of Itself” *, and Dan’s really hyped this up for me. He says it’s the singular best thing that he has read on team building, leadership and culture. So you know I trust Dan, so that’s something that I’m going to read and maybe next time we talk, we’ll talk a little bit about learnings from that book.

And then my really good friend Kevin Wang, we recently had dinner and he recommended the book by Reed Hastings, the Netflix founder, called, “No Rules Rules” * and he said that that’s been an influential book about culture and about how he has structured his own sort of cultures and incentives at my old firm, Altimeter Capital. So those are two books that I think are very interesting.

[01:30:48] Tilman Versch: I’m happy to link these books.

What ShawSpring does differently

[01:30:52] Tilman Versch: Over the years, what were quality enhancing elements for ShawSpring where you still wonder why all of the other firms are not doing this? Especially if they are free; we had kindness already as one topic.

[01:31:15] Dennis Hong: I think people want to go fast and it’s understandable. It’s really, really hard. This business is really, really hard and it’s very easy to be distracted by a lot of different things and there’s so many different variables that you can introduce into this business. It’s very easy to lose sight of the fact about the key objectives that you’re trying to achieve. I think having a clarity about what is your optimization problem, is really important and then trying to find or identify those variables that are important to helping achieve that optimization problem.

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.

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.

I mentioned last time actually that in the investment business, there are probably two optimization problems. One is really good for the GP. It’s to build a successful financially viable business. It’s to build the AUM and that’s really great for the GP. The second optimization problem which is often in tension with that first optimization problem is to generate enough investment returns so you don’t get fired from your clients. And it’s totally fine to be able to have these two optimization problems but you have to also understand that some of the decisions that you make to achieve optimization problem number one and to solve for optimization problem number two are often in tension with each other.

So it’s really, really important to be able to make sure that you understand that and try to find some way to mitigate those tensions.

ShawSpring Partners in 10 years

[01:33:30] Tilman Versch: So a second to last question, it’s just a small and easy one. Where do you see ShawSpring Partners in 10 years?

[01:33:45] Dennis Hong: Tilman, genuinely, I’m not sure that we are going to deviate much from sort of the path that we’ve set out from the very beginning, which is to achieve Hall of Fame returns. I hope, just over a long, long period of time, so think that I’ve probably got 40 years left in this.

[01:34:06] Tilman Versch: I hope more.

[01:34:10] Dennis Hong: m 39 and I think I’ve got 40 years and if at the end of that 40-year period, there’s not a two-handle on my return number, and I’m not talking about a 2% annualized return, then I’ll be really disappointed. But along the way, I hope to be not only a good partner but the best partner. I hope to be not only a good investor, but the best investor. I hope to be not only a good shareholder but the best shareholder. I hope to not only be a good teammate but the best teammate.

I’m 39 and I think I’ve got 40 years and if at the end of that 40-year period, there’s not a two-handle on my return number, and I’m not talking about a 2% annualized return, then I’ll be really disappointed. But along the way, I hope to be not only a good partner but the best partner. I hope to be not only a good investor, but the best investor. I hope to be not only a good shareholder but the best shareholder. I hope to not only be a good teammate but the best teammate.

In many respects, I’m still quite young and I still want to work on things that I’m not as good at and I do hope that I’m in a mindset of continuous self-improvement, even 10 years from now. I’m still young enough that there are still a lot of things that I want to work on. There are still a lot of things. So, I hope that that’s something that doesn’t change over the next 10 years.

But I don’t think that we’re going to deviate that much from the path that we’re on today. We’ll never be the biggest firm, just by definition, because my bandwidth is quite limited in terms of my ability to be the best partner to everybody. So other than that constraint, I just want to try to achieve to be the best partner, the best investor, the best shareholder and the best teammate.

How to keep evolving

[01:35:50] Tilman Versch: Today’s interview had the headline “Building ShawSpring Partners”. Is there anything you want to add that we didn’t cover in the story of ShawSpring Partners, for the last seven years?

[01:36:02] Dennis Hong: Yes, actually Tilman, there is. It’s day one. We’re still growing and learning as a team. We still have to figure a lot of stuff out. We have a good foundation. We have a good set of heuristics and mental models that I think maximize the probability that we’ll be able to scale, replicate and repeat our investment process but we also need to keep evolving. So actually, my teammate Mike has this great quote that he took from Richard Hamming again, “Progress requires change. Change doesn’t mean progress but progress requires change”.

It’s day one. We’re still growing and learning as a team. We still have to figure a lot of stuff out. We have a good foundation. We have a good set of heuristics and mental models that I think maximize the probability that we’ll be able to scale, replicate and repeat our investment process but we also need to keep evolving.

I hope that we’re going to continue to learn and grow as investors, as people. There is so much to figure out, it’s an incredibly competitive, it’s an incredibly challenging world and I don’t think we can rest on our laurels. It feels like day one. It feels like July 15^th of 2014 and I think that’s what’s really exciting about where we are today.

[01:37:20] Tilman Versch: Then I’m happy to meet with you on another day one for the second part of our interview.

Goodbye

[01:37:25] Tilman Versch: Thank you very much for your time and your great insights. And bye bye to the audience.

[01:37:32] Dennis Hong: Thank you Tilman. Bye everyone. See you soon.

Disclaimers

[01:37:34] Tilman Versch: As in every video, also here is the disclaimer. You can find the link to the disclaimer below in the show notes.

The disclaimer says; always do your own work. What we’re doing here is no recommendation and no advice, so please always do your own work.

Thank you very much.

[01:37:52] Tilman Versch: Let me shortly drop a disclaimer: this presentation is for informational purposes only. Nothing should be viewed as an offer, solicitation of an offer or recommendation to buy or sell any investment.

Disclaimer