Control
Who's got it, who wants it and do you even need it?
Some readers may have noticed that there was no addition to my growing Substack library last weekend. I was literally about to click the button to schedule the post of the first idea I wanted to share on this platform. And then I got Blue Orca’d. Never heard of a Blue Orca? Neither had I. It is a firm that publishes pretty well-researched short ideas on its website. The target this time? FMC Corporation, a stock I have owned for years and have been involved with for almost 10 years. The point of this post is not to debate the merits of the short report. Overall, the authors seemed to have unearthed some unsettling trends that, if accurate, make some of the statements the company has made about its blockbuster Diamides franchise seem far too bullish. Over the years, what I have noticed about shorts reports is that they often find an interesting nugget but apply far too much materiality to it—and thus predict a calamity that doesn’t actually occur. I do plan to post my FMC write-up at some point, once I am able to digest the contents of the short report further.
What this incident got me thinking about is control. As a public company investor, unless you have a board seat or own the majority of the voting stock, you have no control over the choices a company makes or the things that happen it—either good or bad. You can do hundreds of hours of research on a company and understand the nuances in great detail, and then watch a pivotal satellite not work properly post- launch. Yes, there was always some probability that there would be an issue with the launch, but as a long-only, minority shareholder, there was no real way to hedge the risk. You kind of just had to accept it. (Or never invest in a company that can suffer such a large setback due to a single, binary event. Another wonderful investing lesson.) In general, you place your capital with capable people who have a history of successful execution and you hope for the best. You have no control over the outcome. And in this case, neither did the Viasat engineers who spent a good part of three years working on the satellite.
The last twelve-plus years of my investment career have been spent coping with scarcity—of time and resources. In working for a small firm that was essentially a start-up for a lot of the time, I always felt as though there was not enough time in the week to do the type of diligence I wanted on both the existing portfolio and new ideas. I was a one-armed, one-man band running a U.S. SMID-cap strategy and was covering a universe that my colleagues for the most part didn’t touch. My guess is that some of that overwhelmed feeling emanated from a sort of paranoia that stems from my loss averse nature. But some of that also arose from having to satisfice, at times, and always feeling like I was missing something important.
What happened with FMC recently is emblematic of what I am referencing. In reading through the Blue Orca report, the team there clearly put in the hours to collect data and generate the short report. Even though I have read every SEC filing, every conference call, every Tegus call and every sell-side presentation transcript regarding FMC over the last 7 years, the team at Blue Orca cumulatively probably spent a multiple of that on this report. Unfortunate timing notwithstanding, it is that discrepancy that was such a punch in the face. Even if I had desired to try to confirm or disconfirm what management was saying about the nature of the patent portfolio that has come into question, there is no way at my prior firm to devote that much time to FMC.
I am not looking for a pity party because the large active managers on the list of the top-10 holders of FMC were also likely blindsided by the short report to some degree. It is not like the guys at FMR or Jackson Square, both of which owned $100 million-plus of stock as of their last 13Fs, have a full team dedicated to figuring out if FMC is starting to see competition in China and India even before the patents supposedly expire. Having a short report come out on one of your holdings is par for the course for being an investor. It happens to everyone. My guess is like me, the other shareholders were expecting a short-lived inventory cycle and for FMC to keep chugging along after the current excesses were absorbed. Yes, every FMC shareholder knew that the patents would be rolling off over the next 5 years. But this was not a 2023 issue—or so we thought. No one on the top-10 shareholder list had control over how long the Diamides franchise would operate without significant competition. We thought the FMC management team had done what it could and to some extent trusted that they had mitigated the downside risk. But no matter if you own $1000 in stock or $1 billion, there is very little you can ever do to change the course of any events that are going to befall FMC.
Who wants control anyway?
Neither of the situations I discussed above should be surprising to people who understand how the public equity game works. Aside from in the case of investors who run super concentrated, most clients expect investors to accept that they don’t have control and mitigate that risk by owning a bunch of different securities. Diversification helps blunt the blow from having something completely outside of your control impact a strategy’s performance. Outside of those investors who run an activist strategy, the rest of us click the button to buy and sell stocks, and that is where our active control over the outcome stops. For sure there are benefits to doing deep diligence on companies and assessing which management teams with which to partner. But those are stable stakes when it comes to an investing process. (In fact, executing a repeatable, meticulous process is one of the only things public investors can control.) Gathering differentiated information may protect you from loss or help you find a diamond in the rough. But you still must rely on the people at the company to execute and even they may have limited control. As public investors, we are so far from holding the joystick in our hands that beyond a reasonable amount of diligence and a portfolio construction that spreads the risk, we leave a lot of our investing success up to vicissitudes of the global economy, as well as to chance.
What oftentimes can feel like a helpless lack of control is a feature of being a minority shareholder of a public company. Some people may even prefer to be hands-off and to leave a lot of up to chance. For instance, I am sure there are probabilistic, downside-focused thinkers whose form of control is to put themselves in situations where the risk of loss is statistically low. Additionally, the more optimistic crowd likely copes with the lack of influence by placing bets where the chance of success is high—or the payoff is huge even if the probability of success is low. Investors of every stripe find a way to live with, and maybe even be at peace with, the fact that things are going to happen that they could neither foresee or control. Furthermore, most people probably wouldn’t even want the ability to control the outcome if it was presented to them, mainly because public investors are generally not equipped to handle such responsibility. A friend of mine who runs a technology company whose product is used by public equity investors once told me that the reason they don’t hire from their customer base (former buy-side analysts and PMs) is that, as a group, we don’t know how to do anything. We are handicappers, not executors. Most of use are totally fine trusting other people to execute on our behalf.
It’s not that I am a control freak or believe necessarily that anything good would come from trying to exert control over the companies in my portfolio. I have just become much more keenly aware of how much luck—both good and bad—can influence the career as an investor. Plus, when situations like with Viasat and FMC happen, while I understood and acknowledged the risks, I am reminded of all the things that I can’t control—and the impact that can potentially have on whether or not I am successful at my craft of investing. Let’s run through a quick list, shall we?
Things minority public shareholders have no control over:
Major capital allocation decisions
Who runs the company and establishes the culture
Strategic direction
End market dynamics
Customer and supplier relationships
What other shareholders—or even short sellers—do
Regulatory changes and enforcement actions
Product design and distribution
The use of the balance sheet
Director and officer compensation
Recessions, depressions, pandemics, wars, etc.
Fiscal and monetary policy changes
Some of the items on this list cannot be controlled or influenced by anyone, including the people who are tasked with steering the ship. But, for fun, let’s go through the same list but through the lens of a private equity (PE) owner of a company:
Major capital allocation decisionsWho runs the company and establishes the cultureStrategic directionEnd market dynamics
Customer and supplier relationships
What other shareholders—or even short sellers—doRegulatory changes and enforcement actions
Product design and distributionThe use of the balance sheetDirector and officer compensationRecessions, depressions, pandemics, wars, etc.
Fiscal and monetary policy changes
As an owner of the business, the PE firm is also subject to plenty of things that are beyond its control. However, this hypothetical firm sure can control a lot more than a public shareholder. If unforeseen things are going to happen, wouldn’t you rather leave as little up to chance as possible? At least you have some agency in the outcomes that inevitably determine if people consider you a good investor. Plus, if things aren’t working, there are levers to pull—and you have to do so because you own it. In the case of public investors, if things are not going the way you had planned, your easiest exit path is to sell and give up. The availability of liquidity is unquestionably a benefit when an investment mistake has been made, as is the ability to change your mind. But what I highlighting is that you sure give up a lot for that privilege.
My guess is that when most people think of the benefits of private equity structures versus those of their public equity counterparts, what immediately comes to mind is locked-up capital, the 2/20 fee structure, and not having to mark the asset values to market, even when public equity markets fall 20%. Don’t get me wrong, those characteristics are nice but to me the cherry on top is the control aspect. As a public company investor, you must willingly (blithefully?) accept that there are dozens of external forces you cannot influence, on top of all of the company-specific, internal decisions whereby the whims of management can blindside you. Owning or controlling a company certainly doesn’t protect you from errors of omission or commission within the C-suite. But the ability to change out management or pivot to a new strategy if things aren’t working is a luxury that most public investors should salivate over. Isn’t the better model to eliminate as many variables as possible that are outside of your control?
Maybe what we are really discussing here is a different skillset. I like to joke that public investors, by in large, are button pushers who fly at 18,000 feet. Even those of us who believe in a robust, lengthy diligence process only get down to 10,000 feet before we click the “buy X shares” button. At that level, you know enough to be fluent in the business but you still have to speculate (with a very long feedback loop) about things that you just can’t appreciate: strength of company culture, true aptitude of management, how active and helpful board members are, quality of technology and systems, and operational excellence. Through a thoughtful process, it is possible to collect data points that can be aggregated to provide some level of conviction on each of those topics. But you are still simply making a bunch of probabilistic calculations that inform an overall impression of a company. The skilled among us are able to take those various data points and use a combination of intuition and pattern recognition to make good decisions under uncertainty. That is without question a highly lucrative and admirable skillset. And there are plenty of examples of people being tremendously successful without ever exerting any influence over a company’s direction.
In contrast, the skillset among successful PE investors also likely includes the ability to structure and finance deals, to negotiate with companies in a way that doesn’t leave returns on the table, and to meaningfully improve the operations, incentives and governance of the companies that are acquired. Those latter items are related to control and wielding that control in a holistic fashion that creates value for LPs. Outside of certain activist investors, most people in public equities have never flexed those muscles. My experience has taught me that many investors wouldn’t want that burden if it was offered to them. They prefer for to keep a level of distance from the companies they invest in. Most of us don’t want to get our hands dirty. The ability to get out of a positions without hiring bankers and lawyers and waiting for a buyer to show up, shields most of us from heavy lifting. As a result, our skillset doesn’t translate too well to the private equity world. They would rather hire former bankers, consultants and people who had operating positions at companies. Those are the kind of people you need on your team if you have control.
Do you even need control as a public investor?
Summarizing some of the major points above:
For any investor, it is no fun when something wholly unexpected impacts one of your companies negatively
Diversification is the antidote for most public investors
PE firms have a lot of control—a necessity because most funds only have a 8-12 companies in them—but also have teams of people who know what to do with that power
Most public investors would rather partner with competent management teams and boards so that they don’t have to even consider taking control
In my post entitled License to Concentrate, I talked about some of the elements I thought should be in place before a public fund manager has earned the right to run a concentrated portfolio. In hindsight, one element I neglected to discuss was control. If you can help pull the internal levers at a company it is logical to believe that you don’t have to diversify your bets as much. In other words, as you eliminate potential risk factors, the level of conviction can rise and, instead of having 60% confidence in 30 stocks, you can have 85% confidence in 10 or 12. Which is the better model? I think that depends on the level of trust you are willing to place in other people—and the types of companies you invest in. What I learned over 12 years at a shop that trafficked in small and microcap companies is that, if you don’t have control or a lot of influence, management teams are going to find new and unusual ways to permanently impair the business. To reduce the severity of the impact of such events, it likely makes the most sense to run a 50-plus stock portfolio and be mostly hands-off. If you are going to run a concentrated portfolio, my experience has taught me you need some mechanism to influence decision-making and outcomes. I know some will argue with this point but being a concentrated, passive, small- or micro-cap investor in my estimation is a recipe for not being one the survivors I discussed in my first Substack post.
What I am proposing is that there is a high correlation between concentration and the need for control, whether public investors recognize it or not. The private equity guys understand this fact intuitively. Maybe I have been punched in the face by what my old boss coined “off-spreadsheet events” too many times. Or, it’s that I have seen too many terrible capital allocation decisions (Really Tapestry? Michael Kors? Come on.) to actually trust that management is aligned with minority shareholders. Maybe watching a company I was about to highlight as an interesting potential investment get knee-capped by a short report added salt to a perpetually open wound. Potentially it is I who have been running my portfolio too concentrated and that I am too attracted to what is only the illusion of having control. But after being in the public investing game since 2007, I have the urge to do more, be more involved with companies, and potentially exercise control over investments. I can’t quite articulate what that looks like at the moment. But it is a path I am pursuing with vigor.
Searching for a steering wheel to grab,
Ben Claremon