Post -Apocalyptic Investing
By Richard Marin, Managing Director of SEDA Experts, LLC
During my forty-year Wall Street career I went through some pretty serious crises. At a relatively young age (34), I once sat in the anteroom of the ornate office of the Minister of Finance of Venezuela on a warm and humid Caracas afternoon. I was with our Vice Chairman, Carl Mueller, who was a wizened veteran of the Street. Carl had been the Managing Partner of one of the last white-shoe Wall Street firms, Loeb Rhoades & Co. He had the good sense to get out of Dodge before the shooting between John Loeb, Hornblower & Weeks and Sandy Weill of Shearson started soon thereafter. We were trying to collect on a $50 million debt and it was my collection job, but Carl was along to help. That was one small piece of the $4 billion I was tasked with collecting from defaulting Latin American sovereigns. Carl was such a regal guy that I found myself apologizing for the arrogant Minister’s obvious tactic of keeping us waiting for several hours (and probably turning off the A/C).
Carl was totally nonplused by the sandlot tactics and told me a few stories while we waited that have stayed with me all these years. I asked him if he had ever seen a crisis this bad in his career (which had spanned WWII as an Air Corps. Major, 1945 – 1960 in go-go commercial banking, and then 1960 – 1976 at Loeb Rhoades – surviving the paperwork crisis in 1969 that led to the dematerialization of the securities market, the NYC fiscal crisis and the REIT debacle.). The LDC debt crisis that occupied my entire field of vision at that time seemed to a youngster like me to be the worst financial crisis I could imagine. Carl laughed and said that there were two kinds of crises. He contrasted the REIT crisis of the the last decade to our current LDC debt crisis. Both represented exposures that far exceeded the amount of capital our firm had to absorb such blows. He explained that a crisis is a problem when it singles out your firm and can therefore easily bring it to its knees. A more workable crisis is one like the LDC debt issue where everyone in the banking system is plagued by the same problem as it threatened to bring the whole banking system down. He was right, many firms have crashed and burned over bad credit crunches like the REIT crisis, but the banking system always seems to survive and that time it swept the deeply discounted LDC debt under the corporate rug long enough for it to fade away. By the way, when the Minister finally saw us and told us to go to hell with out $50 million, Carl made a call to New York and told them to offset the loan against cash Venezuela had in their clearing account with us. He was told by our lawyers that if Venezuela cabled us asking to transfer the money before closing we were legally obliged to transfer the funds. He thought for a moment and simply said, “pull the plug on the telex machine.” Problem solved, crisis averted.
If only every crisis was so easily solved, but there is a lesson I take from this. I have come to see crises as mere problems to be addressed and solved and the beginning of new regimes that are filled with both risk and opportunity. This is especially so for grand geopolitical crises, which tend to affect everyone. Such is the case of the Coronavirus economic crisis. I do not need to add to anyone’s knowledge about the human and social issues of the Coronavirus, but I do feel inclined to address the implications for investment management. I think after a week like we just had in the markets, I am not overstating things by calling this an apocalyptic moment. But apocalypse does not need to mean an end of days, it can also mean “destruction or damage on an awesome or catastrophic scale” and that does not feel very far off what we have seen in terms of the volatility and record-breaking market declines (including triggering of circuit-breakers) as well as the the cracks in the U.S. Treasury markets and the flailing of central bankers desperately seeking monetary policy levers in a near-zero-percent interest rate environment.
The question is no longer what can be done to protect against the apocalypse upon us, but rather, what happens now and what do we do now. To start, watch the first season of the Netflix series The Crown and remember that in 1939-40 when the Battle of Britain was pummeling London, the phrase “Stay Calm and Carry On” came into popular use. The second thing, is to stop and think about where things stand. I am a General Partner of a small Fintech seed venture capital company. Among all the “Coronavirus Update” emails I have gotten over the last two weeks, I plucked the one sent by the Managing Partner of that VC fund and took note. First of all, instead of a nice viral note from some vacation-selling company, this was from a company in which I was an LP and a GP so I had every reason to pay attention to it. I was glad I did, not only because of what it told me about the state of our fund, but because it set a standard I would like to point to as excellent investment management practice.
Let’s face it, sooner or later most investors have a gripe with their investment manager to some degree. Reversion to mean and the normal cycles of life mean that sooner or later investors will be less than thrilled with their manager. The difference between a good and bad rapport over the long haul between investor and manager lies in communication. This Managing Partner of the Fintech VC sent out a 2,300-word email to his investors (notably, a month before, but not in lieu of, the Annual LP Letter). I would like to highlight some of the important messages he gave his LP’s at this difficult and challenging time:
• There is no precedent in living memory that we can use as a guide to navigate what lies ahead.
• We felt it prudent to spend considerable time assessing the potential impact of an economic slowdown on our portfolio.
• The situation surrounding COVID-19 is a humanitarian crisis that continues to gather pace.
• Firm Policy – Policy of work from home (WFH).
• Portfolio companies were ready with updated business plans and projections.
• Recent Local Government Actions – Social distancing as official policy.
• Bottom Line Impact on Investment Activities
• Thoughts on How our Portfolio is Positioned for the Turbulence Ahead
• Overall Thoughts – To be clear, let us also note that there is 100% certainty that 100% of our portfolio companies will feel the impact of a period of economic turbulence.
• The peak of the global financial crisis was almost 12 years ago, which means there is a non-trivial population of founders and VCs/investors that have not yet experienced a market dislocation!
I don’t feel the need to be pedantic, but this redacted letter to investors has all the good elements of investor communication that are more important now than ever. It is informational, honest, to-the-point and cautiously optimistic. I recently saw an advisory to mangers from a major law firm that works in the investment space. Their recommendation to managers distills down to these points:
• Pursue a policy of extreme disclosure and transparency.
• Insure that your Business Continuity Planning (BCP) is fully tested and ready for implementation, including considering governmentally-imposed limitations.
• Working remotely should be given priority and the infrastructure ready to handle that.
• Coordination with service providers that are vital to the deal flow and other aspects of the investment process.
• Valuation and liquidity should be given added attention and fully disclosed to investors.
Sound familiar?
As my friend tells his investors, we are in uncharted waters and that means that there will likely be plenty of wreckage with which to contend in the coming days. There is little doubt that we are facing a big geopolitical crisis that will have far-reaching implications. This is the type of crisis that will impact everyone and far more people and companies will be impacted negatively than find opportunity. There will not likely be a simple plug to pull, it will take hard work to do the right thing by investors. Nevertheless, doing the right thing about communicating aggressively, being honest and prudent, but also looking for the means to take advantage of the new world that will evolve from the changing playing field.