Dennis Hong, how does ShawSpring Partners define ecosystem control?

During the RV Capital Annual Meeting 2022, Rob Vinall and Dennis Hong had a chat about the evolution of ShawSpring Partners, the idea of ecosystem control and more.

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The following topics were discussed:

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Introduction

[00:00:00] Rob Vinall: So I’m delighted. On my right-hand side, I’ve got Dennis Hong, the founder of ShawSpring Capital, with me. Dennis, I’ll introduce you very quickly. In a few moments, I should say, but just a few words on the agenda to get started. So we’ve got three sessions this morning.

One, obviously, with Dennis, then we’re going to do a 15-minute coffee break. So quick out cafe night and get back in. I then got another fireside chat with Joel Cohen of MIT and we’re then going could do another 15-minute coffee break. Quick out, quick back.

And then the final session of the day is the panel discussion with three members of a panel that I’ve chosen from three very different types of investors. So there’s a single-family office representative, Claudine. There’s a multifamily office representative, Patrick. And then there’s an endowment with James. So that will be the final session.

But I’m delighted to have my right-hand side here, Dennis, today. Dennis is someone who I got to know several years ago at the event here. He’s someone who has developed incredibly as a manager. When I see the way you’ve built your firm, the track record you’ve put together.

But above all, the network of people you’ve built around you the way you help people. It’s been a pleasure to be a part of that journey. Maybe you’ve played a small role in it and have observed it, and I think nothing illustrates that more, than Friday night. Dennis, tell us what happened.

[00:01:38] Dennis Hong: So it’s wonderful to see everyone here and it feels a little bit surreal because I remember just like it was yesterday when I first got a hold of Rob’s letters. This is probably, 2015? And I was given these letters through one of my university endowment fund investors, and they said, “You have to read this guy’s letters. This guy, Rob, he’s off in Switzerland.”

And at first, I was a little bit skeptical. I thought, who is this guy? And I read them and I just devoured them because as a young fund manager who is very small and sometimes mentally struggling because it was so hard, I just found incredible solace in Rob’s letters.

Anyways, I came here in 2020, January 2020 before the entire world shut down, and I just felt so lucky because I made it a point after I read those letters that one day I’m going to make it to Switzerland and I’m going to visit him. And I’m really glad I did because this ecosystem really changed my life.

It’s been a really special place. So, Rob, I want to thank you. So two days ago, we had our beautiful banquet dinner. It was not intended to be a banquet dinner. I had thought, so a couple of years ago, Rob, you had interviewed Dan Abrahams. Another fabulous manager based in London, a European value manager, and Dan had this great idea of getting together a group of 10 people to have dinner at the Schweizer Haus.

And I said I’m going to replicate that. So I’ll get together a small table. Maybe some people will join. And I was going to invite my friend George and Rafa and Jose Luis, his teammate, and maybe who else would join and that was the intention. And then my friend Chomin posted the dinner on the message board with various different options, as you probably recall.

And I was like, “Oh, my God, now it’s like 60.” And we really stressed the restaurant manager. And you have to give kudos to the Schweizer Haus because they put together a dinner for 60, really, on two days’ notice. So I have to thank the Schweizer Haus, really, I didn’t do anything but it’s really great to see everybody and be part of this special event.

Dennis Hong’s investor story

[00:04:29] Rob Vinall: So, Dennis, just a level set everyone. Tell us about you started ShawSpring, I think eight years ago. Tell us about ShawSpring.

[00:04:47] Dennis Hong: So my journey as an investor was not the most obvious one. And Rob, you’ve heard this story and a few of you have also heard the story in the audience. But I came to invest in a fairly roundabout way. I actually was the son of two shopkeepers in a city called Brampton, which is about 30 miles west of Toronto.

It’s you probably have never heard of the town. It’s just it doesn’t matter. It’s an industrial town just 30 miles west of Toronto. And I was the son of these two shopkeepers. That’s where I learned about business. We basically were purveyors of cigarettes and lottery tickets.

And that was really my upbringing because my parents didn’t go to university. And I thought I was going to go to university because my parents told me I definitely was not going to be selling cigarettes and lottery tickets in the future. So I am the product of public schools in Canada, and I had a wonderful guidance counselor who said you should expand your horizons beyond just going to school in Canada.

I was such a country bumpkin at that time. I didn’t know what an Ivy League school was, but I looked into some of these schools, and I thought, wow, like, these are really cool. So I applied to a bunch of them and one of my lottery tickets hit and I got into Yale, which is a really, really special place, especially for someone who’s the first in their family to go to university.

And it was also actually my origin story as an investor. So when I arrived on Yale’s campus at that time, the financial aid program wasn’t as generous as it is today. And I had to find about $4,000 per semester to contribute towards my education. So I did the most pragmatic thing.

I went to the job board and I did a search for the highest hourly rate on campus. And there’s this thing called the Yale Endowment. And I was like, an easy job. All of the alumni and head up hit them up for money. I could do that. It wasn’t a gift-seeking job or a development job, obviously.

And actually, in my first interview, the interviewer was an analyst at the time and he was very nice to me. I applied and he interviewed me, and he basically said, “You do know that this is an investment job?” And I said, “I guess so.” And you do know that this office is run by a really famous person, David Swensen, and he’d written some books. And I said, “No, actually, I never knew that.”

Needless to say, after that first interview, I got the book and I read it and I started to become a little bit more serious about it because this idea of professional investing was so interesting. So I got the job and I spent a couple of years there, and it was a really neat place to begin one’s investment career for a lot of reasons because—well, let’s just be real since this is 2003 has a really young person and there wasn’t a lot for me to do.

I mean, my highest value-added was getting coffee for manager meetings and going into the filing room and opening up envelopes, and reading manager letters, which was an incredible education itself. But it was very cool to be in the same room, at the same conference table as people like Howard Marks or Seth Klarman, or Chase Coleman of Tiger Global.

So the really famous people, that was super cool. But what was really cooler were these firms, these investment firms, which euphemistically I could call investment boutiques. They were typically one or two-person shops. They often ran quite concentrated portfolios and the investor base tended to be quite curated, very, very intimate, and quite small.

Some managers that we had at the endowment actually had one client, just Yale as an investor, and that manager was solely just focused on doing a good job for a single institution, a single investor. But think about that. Think about the competitive advantage that a setup like that would have as a professional investor.

Think about the competitive advantages that Rob has. These managers had boiled down the variables, the inputs into the investment business to those just necessary to generate what I call a Hall of Fame returns. And it was just so neat because when you think about that type of a setup, this investment boutique set up versus everybody else who I would call the institutional class.

When you think of that, think about March 2020. Every single person’s down. There’s nobody up. Maybe that guy Nassim Taleb is up, but everyone is down. But when you’re…

[00:09:24] Rob Vinall: He was probably down the previous nine years.

[00:09:30] Dennis Hong: I hope he’s not listening. He can be quite an angry person. But…

Dennis Hong & Rob Vinall talking about Ecosystem Control
Dennis Hong & Rob Vinall talking about ecosystem control & more

[00:09:35] Rob Vinall: That’s why I have Tilman to edit the video.

[00:09:39] Dennis Hong: So anyway, in that type of scenario, when you’re an institution, how do you get money too? Do you give money to that manager where you have to make an appointment with the IR team where maybe you get occasional portfolio transparency, if at all? Where you might get access to the actual portfolio manager?

Or do you give money to that manager whom you have a relationship? Or in the very unusual circumstance where you been to Rob’s house for dinner and saw his family and maybe went for a swim in the lake after the meeting. That’s how you build a relationship.

So when you think about a situation where everyone’s down and there’s a massive systematic selloff, and as an institutional investor, you’re thinking about who are you going to lean into? It’s that type of investment boutique because you’re able to build conviction.

So when you think about a situation where everyone’s down and there’s a massive systematic selloff, and as an institutional investor, you’re thinking about who are you going to lean into. It’s that type of investment boutique because you’re able to build conviction.

The early days of ShawSpring

[00:10:32] Rob Vinall: So how did that influence the way you put together ShawSpring and how you started ShawSpring?

[00:10:36] Dennis Hong: So as a young investor. That was a really great place for me to start my career because there was no contest as to where or who I wanted to be. It was. So when I was a young investor, I thought, I’m going to build one of these funds and I’m going to do it when I turn 30 because that’s a bucket list year for me to start my own fund before I turn 30.

So I spent a couple of years at the Yale Endowment. I learned a ton, but I always had this yearning to pick stocks. So whenever I would meet with a manager like Rob, I’d always be clamoring to get on his side of the table, like, how do I do the work that you do?

And so I spent a number of years at the Yale Endowment, and then I successfully networked my way to one of Yale’s hedge funds at the time, a firm called Matrix Capital, based in Boston. And it was a rush. It’s an incredible experience. I was there for two years, but I probably traveled to like 50 countries and I was probably working on a different idea every couple of days.

It was a really special place for me to just absorb a lot. And then early in 2009, so near the end of 2008, there is an individual called Brad Gerstner, who became a really good friend in Boston’s Hedge Fund community, is really small, and he had launched this firm called Altimeter Capital and he asked me to join him as his number two.

Early on, we had $2 million, and let’s just be real. We are in the throes of a financial crisis and the probability of a $2 million fund like Altimeter scaling. There’s a long-term probability. So I just turned 25. I was feeling a little bit more risk-seeking, a little bit more entrepreneurial.

I thought I’d be there for two years. Again, small launches are really hard and the dynamics of two people have never worked together. It’s also very unusual. So I closed my eyes thinking I’d be there for a couple of years and maybe I’d go to business school. But I close my eyes, I wake up and I turn 30, and Altimeter at scaled from 2 million to $400 million. And I said it’s time for me to go.

Yeah. So, you know. I know you’re going to ask her about this chicken and the egg story. The way I thought about my situation at the time, I’m 30 years old. I’ve worked at some interesting places, including Yale, Matrix, and Altimeter. But at that time, they were not brand-name places.

So I just thought about who was somebody in my shoes, many decades ago, there was a young investor who’s now incredibly successful, and the person that came to my mind, genuinely, was Seth Klarman. So Seth Klarman, I think, was 26 when he started his fund from zero. He went to Harvard Business School.

He must have networked really hard, and he impressed four professors with the amalgamation of those four professors. Their names formed the word Outpost. And we kind of that story went. So I said, I’m going to go do that. So I applied to Harvard Business School. I got in.

And the intention was to network really hard with 900 smart, driven, typically rich, men and women, who are my classmates, and see if I could impress them about business investing and hopefully compel them to give me a little bit of money to start my fund. And that was the plan.

But what I didn’t intend to happen was near the end of my first year at Harvard Business School, there was a very wealthy family in Boston who reached out and their CIO reached out to him and said, Dennis, let’s catch up with what he up to. And his name is Neera at the time.

And I said, Neera, I’m actually at Harvard Business School. And I try to replicate what Seth Klarman did, going to try to raise some money from my classmates and see if I can launch a small fund and go on my way. And he said, well, Neera said, “Why didn’t you just come to us?” And at that time I said, “Well, I don’t think a group like that…”.

[00:14:32] Rob Vinall: Question a lot of the managers here are dreaming of.

[00:14:35] Dennis Hong: And I mean it was an incredible opportunity because this family had invested in my previous firm, Matrix, Altimeter and the principal of the family is actually on the board of a very, very prominent university endowment that has been run by one of my former bosses at Yale Endowment.

So there’s just a lot of connectivity. And he said, “Why don’t we just help you?” And that was pretty cool. So I had a sort of a really difficult decision to make because I could take the money now and launch this thing right away, or I could finish my time at Harvard Business School and continue on the plan and I think the only reason it was difficult and I say this a lot, was it really offended my command sensibility to even think about dropping out of Harvard before finishing.

But it’s also not so often that you get the opportunity to do something kind of at scale. So I dropped out of Harvard and we launched ShawSpring on July 15th of 2014 with an initial $10 million. I’m not sure that the family exactly knew what they were getting into because, you know, a who had never really run a company before, who had never really launched a firm or really ran a portfolio, really.

And he said, “Why don’t we just help you?” And that was pretty cool. So I had a sort of a really difficult decision to make because I could take the money now and launch this thing right away, or I could finish my time at Harvard Business School and continue on the plan and I think the only reason it was difficult, and I say this a lot, was it really offended my command sensibility to even think about dropping out of Harvard before finishing. But it’s also not so often that you get the opportunity to do something kind of at scale. So I dropped out of Harvard and we launched ShawSpring on July 15th of 2014 with an initial $10 million.

I was really just glad that I had a shot. So that was kind of the origin story.

Ecosystem control

[00:15:56] Rob Vinall: Wow, that’s a wonderful story. I also really enjoyed your letters, too. And one concept that I’ve learned from them is the idea of ecosystem control. Can you describe what that is?

[00:16:10] Dennis Hong: Yeah, it’s a great question because one of the things that we have to optimize for as a small team so that the current team full time is five today. So it’s me, Mike and John on the investment side. And then I have two operating professionals, a teammate called Paul and another teammate called Jay.

We’re a small team. And the number one, the number one principle that drives everything that we do is that we have to maximize the return on time and effort spent. So everything that we do has to have some form of scalability, applicability, or repeatability.

We’re looking to put together a portfolio of five to 10 stocks. Our intention is to try to generate Hall of Fame returns. And the thing about this principle of ecosystem control that we seek in our companies, if you think about so I love this definition of compounding from Peter Kaufman, who’s an incredible manager.

He runs a company called Glenair. He’s one of Charlie Munger’s board members. And the definition of the compound is a constant, continuous, dogged improvement over very long-term time frames where fundamental investors and many of us here are.

If you’re trying to compound capital, ostensibly you’re looking for companies that are compounding their revenues, earnings free cash flow, and earnings power at constant continuous dogged improvements over the very long-term time frames. So that implies a kind of quality characteristic.

And I think these are the type of businesses that Rob also seeks, the kind of businesses that no matter the exogenous circumstances, still find their way to grow in some kind of positive linearity, their revenue, earnings, free cash flow, and earnings power. Now, that is a very special type of company.

So it probably implies that there’s some sort of robustness or quality control characteristic. And when you go to Google and you actually do a Google search for how to search for high-quality companies, you get like probably millions of hits. You get something about switching costs, maybe something about pricing power, or something about Michael Porter’s Five Forces.

But the thing about these types of elements is that it’s not a mental model, so to speak, or a heuristic that is repeatable, replicable, or scalable. So my teammates and I, and I cannot take full credit for this, my teammates and I embarked on a study, a year-long study.

And Rob, I think you’ve read those studies about what is quality and can we develop something with replicability, repeatability, and scalability. And that’s this dynamic of ecosystem control, which is a very simple concept, but a very elegant one, where if you think about every business as an ecosystem of itself, a customer is the catalyst of cash flow into that ecosystem because the business is providing something that the customer wants.

[00:19:07] Rob Vinall: Solving a problem.

[00:19:08] Dennis Hong: That’s right. And the cash flow, it passes through all the different constituencies. It could include the suppliers, the manufacturers or the producers for that business, the employees, the management team, and the investors. And if you think about all the case studies that we’ve kind of done, the very best companies or the highest quality companies exhibit this characteristic of ecosystem control.

It’s a simple one where you have all the constituencies sort of lock-in, they lock into the business, and the lock-in is so compelling that is economically irrational for that constituency to unlock themselves from that ecosystem. You’ve got a competitor ecosystem, and that is an incredibly, incredibly rare dynamic.

But why is this important? Because it helps us sort through the universe of 50,000 investable public company options out there. It allows us to sort through fairly quickly and efficiently again this principle of maximizing the time, return on time, and effort spent.

If it doesn’t have this characteristic of ecosystem control, you just sort of drop it and go to the next one. We’re looking to put together a portfolio of five to 10 stocks. Can we find those five to 10 out of this universe of 50,000 that exhibit this type of characteristic? And that’s what we’re trying to do. And that’s the principle behind ecosystem control.

[00:20:33] Rob Vinall: Yeah, it’s a wonderful idea. And I think it extends beyond investing as well.

[00:20:38] Dennis Hong: Yeah, Rob. I’m excited that you asked that because actually when I think about RV Capital and this idea of ecosystem control, I mean, we’re running businesses ourselves. So as much as we seek quality or ecosystem control in our companies, we do not expect ecosystem control and our own partnerships and investment firms.

So this very idea of ecosystem control, I think about this constantly inside of my own firm because we are in some sense also managers of our own businesses, and our clients are our customers and we have to delight them through performance. But there are also other activities that extend beyond just performance.

We’re not just renting capital that’s not locked in. And in fact, I think one of the pitfalls that I think many managers, many young managers make is that they make compromises. Now, I’m going to make one caveat.

I don’t mean to be preachy when I sort of think about seeking ecosystem control in my own partnership or ecosystem control in our companies. It’s an optimal framework. It’s not the only framework. It’s an optimal framework. And I understand that if you think about one’s own individual circumstances, one might have to make some compromises, but we’re trying to achieve the ideal.

We’re a small team. And the number one principle that drives everything that we do is that we have to maximize the return on time and effort spent. So everything that we do has to have some form of scalability, replicability or repeatability. We’re looking to put together a portfolio of five to 10 stocks. Our intention is to try to generate Hall of Fame returns. And the thing about this principle of ecosystem control that we seek in our companies, if you think about so I love this definition of compounding from Peter Kaufman, who’s an incredible manager.

And Rob, I know that you’ve been very thoughtful about intentionally staying small and intentionally staying selective, intentionally making it difficult for access to you. But when you’re a partner here, you’re really locked in and you’ve created this ecosystem.

You go the extra mile to put together an incredible event for your partners, but also complete strangers. But somehow they all self-select and are drawn to you. And I think that that’s a very, very powerful idea. And I think it’s an important one as we think about ourselves as fund managers.

The optimal size for a partnership?

[00:22:46] Rob Vinall: Yeah. I had an insight very early on that I think everyone enjoys being surrounded by successful people. Successful people are happier. They’re more fun to be around. And so you have kind of two options in life. You can either try and go out and find successful people in trying to endear themselves to them to you, or you can take your existing friends and try and make them more successful.

And I think the latter option is much more fun and somewhat counterintuitive to ambitious people who have a tendency to be competitive. And the most likely people you ought to be competitive with are your close associates and friends. But it actually should be the other way around.

But you mentioned the idea of size, which is one that fascinates me. I’ve obviously stayed relatively small in the big scheme of things. Your firm is also very small. How big do you think is the optimal size for ShawSpring and how did you get to that realization?

[00:23:41] Dennis Hong: Well, so I picked a strategy that’s quite difficult to sell, and I think you may have probably experienced something very similar. So a five to 10 stock strategy embraces concentration and the possibility of highly episodic returns with very high levels of tracking error.

If I were to put an institutional term in there, that’s pretty freaking hard to sell. And I learned that pretty early on. As a GP, I think GPs typically have two optimization problems. The first optimization problem is good for the GP. It triggers the AUM.

Ultimately, that’s why a lot of people get into this business because they think they can build an extraordinarily profitable business for themselves. The other optimization problem is that you have to find some way to make your clients money. And oftentimes if you kind of look at these two optimization problems in conjunction with each other, they conflict.

So I learned pretty early on that I’m definitely not going to be able to build the biggest font. Actually, it was pretty freaking hard the first year that we were in business. Our lovely prime brokers and their lovely, lovely prime brokers set me on a global roadshow. So I found myself on, I probably did 200 meetings in the first six months.

I found myself in places like New York, San Francisco, L.A., Charlotte, Charlottesville, London, Hong Kong, and Singapore. And of those 200 meetings, I don’t know if it’s a similar experience to you, straight-eight years in exactly zero of them have been an investment. What a waste of time.

But I should have learned that early on. The product that we had is very, very niche, very specific. So we kind of made it that early on that, all right, you’ve got $10 million. The family that backed me would eventually put in another 10, but I think they’re kind of seeing how things went.

They put in another 10. And so we were $20 million. But that’s not a very large firm to run a successful and incredibly expensive research program. So we just had to make do with what we had and it was just heading down and we kind of made this bet that if we do a good job, our capital base will grow.

And you probably experience this as well. If we do an extraordinary job, then our clients will be delighted and they’ll tell other people about us. And that’s exactly what happened to us. We are small for a very, very long time. When I look back, so we’ve been in business for eight years.

We manage capital now for 16 institutions and it was a very, very slow but linear process where we managed to attract or have one or two institutions sort of finding their way to us every single year on average. And it was a slog. It was a real, real slog.

So when you ask this question of size, you know, the thing that is very true in our business is that I can’t optimize for optimization, problem number one, because I can’t raise money from everybody on the planet.

We don’t have an appropriate strategy for that. But for optimization, problem number two, that should be our principle. That should be our principal optimization problem. And so when I think about your size and you’re probably already thought about this in quite a sophisticated, structured way, I think about the size.

The ultimate size is just my personal bandwidth. So my ability to have close, productive, active relationships with each one of our LPs, that’s probably the arbiter, the ultimate limit to size, because just like you, I have personal relationships with each one of our institutions and our individual investors. And I enjoy it. I embrace it.

There’s no IR. There’s no marketing person. I’m the IR. I’m the portfolio manager. I’m the marketing person. I’m the CEO. And I embrace that responsibility. I think that’s really important for ecosystem control.

The ultimate size is just my personal bandwidth. So my ability to have close, productive, active relationships with each one of our LPs, that’s probably the arbiter, the ultimate limit to size, because just like you, I have personal relationships with each one of our institutions and our individual investors. And I enjoy it. I embrace it. There’s no IR. There’s no marketing person. I’m the IR. I’m the portfolio manager. I’m the marketing person. I’m the CEO. And I embrace that responsibility. I think that’s really important for ecosystem control.

So I mean, you probably also experience having a conversation with the IR team at a public company is fine. But what’s even better is if you have access to the CEO, because there’s just that kind of level of conviction that you develop. If you are able to look that CEO in the face, it’s pretty awesome that Trupanion CEO was up here.

First of all, it kind of speaks volumes about the kind of relationships that Rob develops with his managers. But I view it the same way that our investors deserve access to me. There’s no way that they can build conviction if I had some sort of intermediary that governs their interactions with me. I want them to have access to me.

ShawSpring Partners’ long-term vision

[00:28:22] Rob Vinall: I think it’s a great way of thinking about it. One final question from me. I want you to go past it very quickly and then off of the microphone to the audience. What is your long-term vision for ShawSpring? Where will Dennis be in 20, or 30 years’ time?

[00:28:37] Dennis Hong: 20, 30 years’ time? I’ll be older. I don’t think that there’s going to be very much change. So I view my role, really, as four principal responsibilities. It’s been the same four principal responsibilities from here on out, and they’re all co-priorities, by the way.

So I’ll talk about each of them and they’re multiplicative in nature. So if any one of these co-priorities is a zero, I think the whole function falls apart. I lose ecosystem control. So the first is most obvious, protecting, and growing the capital, is the most obvious.

My second responsibility, as I alluded to earlier, is to be present and available for our partners whenever they need me to be there. I’m the one who’s responsible. I’m the one who’s accountable for the results of the firm. If the results are bad, it’s nobody else’s fault. It’s my fault.

Number three, it’s to create the kind of company where my teammates, if they so choose, could see themselves building a satisfying long-term career at this company. I am a big believer that the only IP that we really have is our human capital, generally.

So I have four other teammates, will soon be six teammates, full-time. I want people to be at my firm for the rest of their careers. And it’s something that’s very, very important for me as a value because we’re all growing and learning together. The ecosystem control concept is mental models on vertical integration, cognitive reference, scale aggregation, or marketplaces.

This is IP that we developed together collectively. So if any one of our individual investment professionals decides to leave that it’s a bit of a gut punch to the compound the internal value creation of the firm.

And the number four, which I think over the next 20 to 30 years, I want to embrace even more. I want to add value to our managers. So I want to be the kind of shareholder where the managers, if they see us show up on their 13F that the manager says, like, wow, ShawSprings on our cap table or on our shareholder registry. That’s so cool. But that takes time and that takes a long-term reputation to cultivate.

[00:30:53] Rob Vinall: It’s a wonderful idea that you look for a great ecosystem in your investments, and you also try to build a great ecosystem around your own firm. Wonderful. Okay, so now it’s your turn. Do we have a volunteer to take the microphone around? There he is.

Operating budget and cost of funds

[00:31:11] Matthew Brown: Hi, Rob. Hi, Dennis. It’s Matthew Brown from London. That made me smile, Dennis when you mentioned going to rob towels and having a swim in the lake. I did the same thing with Rob and is definitely the most enjoyable managing meeting that I’ve ever done.

So, Dennis, I was wondering if you could just comment a little bit on those early days, when you were at that $10 million, $20 million level, just about what your operating budget was like, how you were able to pay for fund costs and things of that nature? Thank you.

[00:31:51] Dennis Hong: Yeah, it’s a great question. And maybe Rob can also weigh in as well. I made the conscious decision to start the firm with two teammates. So Paul, who is my operating partner. I made a conscious decision to have professionals. So he’s my CFO and he comes incredibly, but he was also just the right person.

We had developed a great personal rapport over many years before going into partnership with each other. And then I also hired a young analyst and an investment professional. His name is Michael and he’s an exceptional star. But I’d known him since he was probably 18 or 19 years old, and he joined the firm when he was 24.

So I had a chance to have like a five or six-year underwriting period for him. And I knew that he was the right teammate for me and I wanted to start a firm with somebody who could eventually grow into the role of a counterpart on the investment side. But in those early days, it was really, really hard.

We economize wherever we could. So there are so many bells and whistles that a GP can bring into their business. They can have a fancy office, they could have a big travel budget, they can have a big entertaining budget for clients to entice clients to meet you and spend time with you.

But we kept it really shoestring. I mean, my main priorities at that time as a small fun were to try to find a way to make rent and make sure that I didn’t default on the salaries of my CFO and Michael. I hadn’t made a ton of money up until that point because I was still a very young manager when I started.

So I was watching my checking account drain itself every single month as I made rental payments and salary payments. We really, really got fortunate in our first year because there’s a fairly well-known endowment fund that is renowned for making investments in early-stage managers, and they were willing to give $40 million to us, which really changed our fortunes.

But even then, we still operate at a pretty shoestring budget. We don’t charge hedge fund fees. I think that’s another thing. We have a much lower total cost of ownership for our funds because I think our fees are probably less than half of the quote-unquote, rack rate hedge fund fees.

I really, really firmly believe in just being a low-cost provider in that way, too. But…

[00:34:11] Rob Vinall: I think that’s the key concept, is keeping costs low. So you have as long a runway as possible. I see some funds do the exact opposite. They start with fancy offices and lots of employees and they just run out of runway.

[00:34:22] Dennis Hong: I had enough personal savings to keep the company supported at some reasonable level for about three years. And I just decided that if it didn’t work after three years, then, you know, it’s kind of like a restaurant. If the restaurant doesn’t work after three years and then, of course, it doesn’t work out.

Paul, my operating partner, has this great analogy when he tells her story, says, we were a little food truck. A food truck, kind of trying to build some just key recipes. So we also kept it very simple. We weren’t trying to boil the ocean when it came to our investment approach.

We only really genuinely focused on three mental models. We just specialized in those mental models. Like, hopefully, over time we develop more mental models, but we kept it very, very simple and eliminated any extraneous menu variable that was not necessary to generate a Hall of Fame returns.

And again, to just echo Rob’s point, we economize. We kept costs very, very low and we kept costs low for a long time. I still don’t pay myself a salary. Even years later, I’ve prioritized investing that money back into R&D, research, and development. I think it’s really, really cool.

And again, I’d like to just echo Rob’s point, we economise. We kept costs very, very low and we kept costs low for a long time. I still don’t pay myself a salary. Even years later, I’ve prioritized investing that money back into R&D, research and development. I think it’s really, really cool.

Now we have a like a pretty big budget to do things for our managers. So we commissioned field study is kind of like McKinsey-Esque type field studies. We ask our managers like, you know, we’re thinking about commissioning a study in this area.

Do you want to work together on it because I’m sure that you’ve probably hired McKinsey or BCG and paid them $5 million for this case study but will eat the cost and we’ll do it for free. And that usually is received very well. So the level of R&D budget now is pretty, pretty interesting for us now, but I still don’t pay myself a salary.

I make a point to spend it all down, and spend the management fee down every single year. So but that’s I think that’s what the management fees for the keyword being management fee.

Launching a fund

[00:36:15] Rob Vinall: Great. Any other questions?

[00:36:18] Neil: Hey, guys. Neil from Miami. You guys have started to talk about this point and dig into it. But Dennis, we’ve had the chance to read the HBS study about ShawSpring. And again, you’ve started to go down this route. But curious when you thought about launching the fund, why did you decide to bring on, granted a small team, but a team nonetheless at the outset?

And then, Rob, obviously, if you wouldn’t mind weighing into it, it seems like you took a different tack and have continued down that path. So just curious, as you think about generating a Hall of Fame returns, why do you think maybe having a team at the beginning would help rather than maybe adding it on later?

[00:37:00] Dennis Hong: It’s a great question. It was a pretty bottom-up-driven decision. So, Paul and Mike, I had a chance to underwrite them as human beings and they were just the right people. If I didn’t have the right human beings to slot into those roles and form my human capital portfolio.

I wasn’t going to force it. Years later, I probably would be in Rob’s shoes, actually just running a solopreneur shop, and that would be totally fine because now in this day and age, there are so many ways that you can outsource institutionally any of the functions, especially the operating functions, you can outsource them to quite professional firms that are institutionally acceptable.

But at that time, I decided that I wanted to have teammates that I knew very, very well, that I knew I work well with. So it’s really a purely bottom-up-driven decision. I wouldn’t have otherwise forced it.

[00:37:58] Rob Vinall: Yeah, I think I would say I’ve always been skeptical about the scalability of research and investing. You know, if there was an economy of scale to research, then the very largest fund management houses would simply have the best performance. Even if you had a 0.1% advantage from having more people.

And fidelity would just be, you know, completely unbeatable. And, you know, as we know, it’s often the case that the larger a firm becomes, the more mediocre the performance is. So my strong belief is that there are just economies of scale.

And that is the case, the smaller the shop, the better. But I do see firms like Dennis’s and several others with small, tightly knit groups of individuals who work really well together. I can definitely see that that works really well as well. I think we’ve got time for one last question.

And that being the case, the smaller the shop, the better. But I do see firms like Dennis’s and several others with small, tightly knit groups of individuals who work really well together. I can definitely see that that works really well as well.

Rob Vinall

Starting out with a small check

[00:38:48] Speaker 3: Thank you. Hi, Dennis. Hi, Rob. So it’s just a question for actually for you both. You start all over again with a very small check. What do you do differently? And also if you have any regrets.

[00:39:04] Rob Vinall: We both started with small checks.

[00:39:06] Speaker 3: Correct. But now you have all of this experience, managing money for several years. What would you have done differently? Thanks.

[00:39:16] Rob Vinall: Thanks for the question.

[00:39:18] Dennis Hong: I’m actually interested in hearing Rob’s response to that, but I know for sure what I would have done differently. I wouldn’t have felt such urgency to try to raise capital. And I know that sounds incredibly Pollyannish to say, because I know there are a lot of managers out there that are struggling.

And believe me, I felt it. I think for probably about five years the firm felt very small and actually felt very tenuous. We were economizing because it was just really small. There are years when I say, “Oh gosh, I think we’re okay.” Like, “I think we’re pretty good, but no one’s giving us any money.”

And there were many, many times where I thought, like, man, that last year at Harvard Business School sounds pretty good. And but we persisted. I have a great team and I cannot take credit for everything that’s happened at ShawSpring. I can’t take credit for that.

But in the early years, I wonder if we had invested in just developing the mental model infrastructure upfront from the very beginning. We, I think lost like maybe that first year because I was traveling so much trying to sell this fund when it’s completely fruitless. I also just wasn’t ready.

I mean, the problem is, when you’re a young fund manager, you often are saying, here’s what I plan to invest in. Here’s who I plan to hire. Here’s my plan to have my office. Here’s how I plan to make things work. But it’s like probably have a venture capitalist feels when they’re looking at a seed investment.

It’s like two guys in a garage and a PowerPoint deck. Nothing’s happened, right? So I can sort of sympathize with those early investors who don’t see it. So I wish I just spent more time probably not being so urgent about fundraising and just gone right to work and developed this mental model of ecosystem control and just invested more time upfront.

I sometimes call our business, a very high-end PS business, and net promoter score business because the clients that we have, talk about us with other investors, and our management teams now actually talk about us with other investors. So I think that’s a pretty cool position to be in.

And I wish I’d just maybe just dispense with this notion that I got to go hustle around all the financial capitals of the planet to see who would take a meeting. Everyone’s going to take a meeting. Everyone will, right? For many of these individuals, it’s free. What do they have to lose?

And maybe they get smarter on an idea that they already own in their portfolio to another manager. But for a young fund manager, you have to think about, again, this principle of maximizing return on time and effort spent the singular, cultural, internal principle that should guide every decision.

[00:42:09] Rob Vinall: Yeah, I would really echo that as well. And one of the ideas I stumbled across and if I could dial the clock back, I would be more deliberate about targeting it. It is this idea of self-selection. So as Dennis said, when you go out there speaking to random people, the chances that they are lying to you is almost zero.

But if you just put your values out there, ideally through a letter or through talks like this one, people will find you and those people will be exactly the right type of person because that’s the reason they reach out to you. So this idea of self-selection is an incredibly powerful one.

Dennis, I told you the time is going to fly by. This has been so much fun. Thank you for coming. Thank you for all of your contributions to the group this weekend.

[00:42:55] Dennis Hong: Rob, thank you so much. And I really have loved this weekend and it’s wonderful to see you after two years in person, finally. So and I’m sure everyone echoes the same. Thank you.

But for a young fund manager, you have to think about, again, this principle of maximizing return on time and effort spent the singular, cultural, internal principle that should guide every decision.

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Tilman is a very enthusiastic, long-term investor. Over the last years he has taught himself important investing concepts autodidactically. He tries to combine a positive climate and environmental impact with his investments.
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