When You Should Know Everything
This recent piece (“Ignorance Really is Bliss When It Comes to Investing”) in The Wall Street Journal is mostly spot on. Its conclusion? That knowing more doesn’t help you make better investing decisions.
Back when I ran a team of public equity analysts, we had a rule that no financial model could run longer than 20 rows in Excel. The reason? Limiting your inputs forced you to boil down your thesis to the metrics that really mattered.
But there’s nuance here in that ignoring the fine print is really only something you should do when you have asymmetric upside i.e., your potential gains are uncapped but your losses stop at zero. Because if you have losses that could generate additional liability, then you should absolutely read the fine print. The reason is that if you don’t dig into everything you could inadvertently wander into uncapped pain.
Here’s a real life example. We were recently looking at a company where the core business looked strong. But we discovered in the course of asking a lot of questions that its warehouse abutted a property that was a contamination site. Moreover, they’d never had a phase 1 let alone a phase 2 environmental assessment done on the property yet the lease held the tenant liable for remediating any issues caused by said tenant. So if we took on that lease without knowing what was already in the ground on that property we could end up on the hook for a multiyear multimillion-dollar clean-up.
Was any of this germane to the core investment thesis? Of course not. But could it turn a promising potential investment into a massive loss. Of course it could.
This is among the reasons we have Taylor (our CLO) on staff and why his diligence request spreadsheets run way longer than 20 rows.
See, when you’re in charge of upside, you need to focus on what matters. But if you’re accountable for the downside, you need to know everything. So who carries the day? We should all always be in charge of and accountable for everything but still, we come from where we come from and so that’s always the subject for debate.
– By Tim Hanson
