In search of elusive catalysts and the paradox of managing money

It seems as if a public investment pitch isn't complete without a "catalyst".  The catalyst is some supposed future event that is predicted to unlock value.  Catalysts give many reasons to invest in specific stocks, and the lack of a catalyst is usually given as a reason to avoid a stock.

Many times a catalyst is nothing more than a mirage.  In very inefficient markets catalysts do exist. I have found a number of dark or illiquid companies that issue press releases with future plans to unlock value only to see the stock show no reaction.  In inefficient markets finding a catalyst can be like finding the keys to the kingdom.  But outside of tiny stocks and forgotten foreign markets catalysts are about as rare as NYSE listed net-nets.  Theoretically they're possible, but they seem to have all disappeared in the 1950s.

What is mentioned as an investment catalyst is sometimes a generic statement of how potential value can be unlocked or more often wishful thinking. In many cases the probability of a catalyst prediction coming true is no greater than that of a lucky guess.

A friend of mine is a movie director and he likes to say that all movies fit into one of seven basic movie plot patterns.  Business is similar, companies and industries have profit and lifecycle patterns.  Predicting what might happen at the end of a movie (or business story) because one knows the pattern isn't spotting a catalyst, rather it's good investing.

I understand the attraction to catalysts.  Investing is dominated by professionals, and professionals need to generate results in order to keep their jobs.  While we'd all like to think that investment managers are beholden to their fiduciary duty we should first recognize that they often have a greater duty, the one to their families, friends, significant others, or themselves.  Hungry mouths at home and the pursue of lifestyle ultimately drive investment returns.  A manager is going to take an action that preserves their job over one that maximizes capital.

Markets are short term oriented because the managers who manage the majority of the markets need to be.  They are graded on their weekly, monthly, quarterly and yearly results.  In a world where hourly results can be measured you can be sure someone is measuring them.  I believe the reason that the investment world became short term oriented isn't because managers are greedier now than in the past.  It's rather than short term, and extremely short term results were hard to measure before the mass computerization of finance.  When trades were settled via paper it was hard to know where a fund stood hourly.  The information wasn't available.  Now a manager can know where they stand tick by tick.

We all say that we're not short term oriented, but many of us do check our portfolios daily or hourly.  No one can really turn off the market forever.  Even when we own extremely long dated assets such as a house we're noisy to know what the neighbor two doors down sold for, even if we're not looking to sell.  There is some primal urge to know our financial position when possible.  In the iPhone age we can have our net worth balance at our finger tips.  In the past this was a task to be completed with a calculator and stack of financial statements at year end.

Patience doesn't exist in the professional investing world.  Many managers can't afford to be patient, they have too much career risk.  Even if a manager has a patient personality their investors do not.  This is especially true for funds that are larger, quoted daily and thrive on asset flows.  Hedge funds have a bit more runway due to redemption periods and lockups.  But make no mistake, no matter how patient John Paulson is assets are running out the door because of a patience mismatch between himself and investors.

It's easier for a smaller manager to practice patience.  At the lowest level someone managing their mother-in-law's wealth might have the most latitude.  A manager who finds a dedicated group of like minded investors will likewise have the ability to think longer term, but they are still beholden to their investors.  Outside investors, unless extremely unusual will never be as patient as many managers.

The textbook solution to this problem is for a manager to adopt permanent capital in the form of buying up an entire business and rolling shareholders in like Berkshire Hathaway did.  The problem with this route is that a business requires attention and dedication to keep the wheels from flying off daily.  Anyone who says anything otherwise has never worked in business.  Where people are involved there are problems.  A business that generates abundant idle free cash flow without any managerial input is mythical and as rare as a goose that lays golden eggs.  Ask yourself, why would someone who owns a company generating cash in absurd amounts with zero management work decide to sell?  Either the seller is stupid and foolish, or there is something unseen.

The only capital that can be invested freely is what I term 'careless capital'.  This is capital that the holder or manager doesn't need.  A wealthy individual can afford to invest in illiquid stocks or private businesses with multi-decade holding periods because they don't need the money.  There is no penalty to locking up money.

This is true for myself in some senses.  I don't live off my portfolio, and the proportion of it invested in illiquid stocks is an amount that I can be eternally patient with.  I don't need the money for anything, and if it turns out that it's passed onto my kids in 50 years that would be a result I'm satisfied with.  I have other parts of my portfolio that will eventually be used, and I can't afford to take the lockup risk with those funds.

When you look at investors who are pursuing permanent capital they're already wealthy.  The ones who aren't wealthy yet and are pursuing it via fund management fees or or buying companies in an effort to turn them around.

If one were to plot investor patience on one axis and wealth on the other I think you'd see an extremely strong correlation between very wealthy and very patient.  Buffett talks about buying and holding forever because he can.  If Berkshire went belly up this week he'd still have around $1b in personal wealth in his personal portfolio.  It's easy to invest 'forever' when you have a $1b backup plan.

Along with the lack of patience another trend I've noticed in finance has been the move towards more extreme investment strategies.  Most investors would be best served with a simple strategy, and most funds fail to beat simple strategies.  It's strange that every professional is pursuing the oddest and most complex approach out there as if doing simple there were too elementary for them.

I like to ski and I enjoy watching ski movies.  But ski movies have been changing in the last decade.  The pioneer of ski films is Warren Miller who made excellent movies that showcased skiers and locations that seemed accessible to anyone with determination and practice.  But that's changed in the last decade.  Now ski films are in a race to outdo each other with bigger mountains and more extreme locations.  If someone could shoot a movie skiing on the moon they would.  Even something formerly extreme like skiing in Antarctica is too passé now.  Instead viewers get to watch skiers on camels and in dune buggies trying to get to the most remote peaks in Africa or Asia.

Investing has followed a similar path.  Everyone wants to be in bankruptcy restructurings or turning retailers into hedge funds.  There are very few investors like Walter Schloss who are happy to continue implementing the same strategy year over year.  Even if Schloss' strategies work for a manager they eventually become boring for full time practitioners who want to move onto more exciting things.  Look at the evolution of any successful large investor.  How they started is not what they're doing now.  In most cases they've moved from buying passive stakes in companies to either actively attempting to influence management, or purchasing entire companies outright.  Ask any investment manager who used to invest in net-nets why they moved on, the answer is always either "too big" or "too boring".

It seems the grass is always greener no matter who you talk to.  Ask any business owner what they see themselves doing someday and you'll probably hear some variation of "quietly managing my investments".  They want to leave the stress of day to day business management to be involved at a more abstract level.  Anyone who's ever ran or owned a business can confirm that simply reading and buying stocks is much easier.

Yet aspiring investors want to take the opposite path.  After having years of abstract experience with business they somehow decide that "getting their hands dirty" is a good next step.  Exchanging annual reports, research, trading and industry gossip for endless meetings about strategy, positioning, growth initiatives and other corporate mumbo-jumbo.  Not to mention actual human interaction with the people doing the work to move a business forward.  Hundreds if not thousands of little fiefdoms with little warlords fighting each other for the status of running high profile projects or having the largest reporting groups.  Why anyone would aspire to this is beyond me, yet many do.

The grass is greener for everyone.  Business people want to get out of business and invest.  And investors want to throw themselves into the fray of buiness and take action.

What's the moral to this story?  The moral is that you need to beware before outsourcing your thinking to someone else.  Everyone in the market and business has different motivations, some visible, most invisible.  Some are playing for status, others for money, some for vengeance, or reasons unknown.

When following an investor into an investment realize that it's highly unlikely that both of your motivations are the same.  Even if both parties are satisfied with the investment outcome that doesn't mean motivations were aligned.  Searching for a catalyst in the predicted action some investment manager, or corporate manager is a fools errand.  People don't act the way anyone predicts, especially if they're aware of the prediction.

Think about who's money a person making a recommendation is investing.  Many recommend things for other people's money.  The managers share in the upside and very little of the downside.  This is compared to an individual who retains 100% of the upside but also 100% of the downside.  If I ever seem risk-averse consider that it's because I'm investing my own capital verses client capital.

If an investment manager losses all of their clients capital they are out of a job, but will find another one relatively easily, especially with the right brand on their resume.  If an investor losses their portfolio they don't have a backup plan, they are broke and in search of something to keep the lights on and stay off food stamps.

The best catalyst for value is something that's under priced to one who has the patience to hold it until value is realized.  If it sounds simple it's because it is.  Two components are needed, value and patience.  Buying anything at a low enough value and waiting always results in satisfactory returns.


  1. Thanks Nate for a great post again. Michael Mauboussin released a paper looking at "short-termism", more or less related topic to this one ( Take a look if you haven't yet.

    You said in the beginning that you think investments and businesses usually follow a pattern (as movie plots), of which there's a handful of different kinds. This is something that I find very fundamental, and therefore would be very interesting to hear your thoughts on what you think these "business plots" are, whether you have some "KPIs" that you try to identify different patterns from etc?

    This might be a broad question but if you have any time it'd be superb to hear your thoughts on the topic. Understanding the fundamentals (applies to other things as well) is what one should build on I believe, and this is something that often seems to be getting too little emphasis.

    Thanks again Nate.

  2. Fantastic Post Nate.

    I think the idea that the guys on WallStreet want to be something they are not is very common. All actors want to be musicians and vice versa.

    I've never worked on Wall Street but I have worked in IR and dealt with the analysts that come with it. Every analyst I worked with always wanted us to lever up beyond what mgmt. was comfortable with. We never did and even then we almost went bust in 07/08.

    For a guy on Wall Street they know they don't get to make the optimal decisions that the company makes. The company guys know that each decision they make affects others. Until one has been there and done that one doesn't realize. I recently completed an analysis that recommended closing an office and 50 employees losing their jobs. Yes we would rehire 30 people at a different location but we were going to massively displace 50 people most of whom have been with the company for atleast 10 years and many beyond 20 years. The 22 year old version of me would have had no problem with this analysis, now I looked for anything (product risk, etc) that I could use to justify keeping the office open.

    I've been told that the business will be told in early December. Our CFO hates the timing and could wait until after the holidays but he also knows that people would rather not ring up expenses and not be able to pay for it after. He's a realist.

    He's trying to build a business to compete worldwide with competitors that are 1/3 of our costs and he has to do what is right for the business both short and long term, the employees (all of them vs just 50), and shareholders. Until this last year business has done well even comparatively but the last 6 months we've sucked wind. I see it in him. I expect that in 2-3 years he will retire, he will do some executive consulting and trade some of his stocks. Its easier, much easier.

  3. Great Post Nate! Thanks for sharing.

    As someone who manages an investment partnership I can relate to the following quote:
    "The grass is greener for everyone. Business people want to get out of business and invest. And investors want to throw themselves into the fray of business and take action."

    For those who have kids, Dr Seuss's Book: "I Had Trouble in Getting to Solla Sollew" has a similar message. Just read it last night to my daughter and was amazed by how applicable the message is to adults.


  4. Great post! There's twist to the saying that the grass is greener on the other side. It's greener because it's fertilized with bullshit haha.

    Nate, have you thought about venturing in the money management business?

  5. I've been sort of saying similar comments to this in various comments throughout the year but I'll sort of repeat myself non-the-less.

    There are 5 basic elements that I look for in an investment that can make a security valuable:
    1. Cheapness
    2. Quality (treasuries are higher quality than biotech companies)
    3. Growth
    4. Timeliness (a hodgepodge of elements which gives credit to liquid investments as well as to lower duration investments)
    5. Control

    If you exclude other variables: a company that has a catalyst is probably worth more than ones that do not. The same could be said for other elements of an investment such as: lower time horizon, quality, growth, control etc. (Time horizon meaning you'd rather a stock reach its fair value tomorrow than in a year). Each of these elements can add to your margin of safety.

    A company that contains many of the five elements is worth more than a company containing just one element. A company that contains only one element may contain a special risk (cheapness may be an exception). If one is only cheap it may be cheap forever. If the only element is growth or quality there is a huge risk you are overpaying etc.

    The problem is determining how much do you pay for adding the element of a catalyst to an investment. If I think I can get a 20% annualized return on an investment with high probability I'll make an investment. If there is no catalyst and the company is of lower quality I usually bump up my number to 26%. (These are sort of lame rules of thumb that I stole from Mohnish Pabrai and Ben Graham so don't ask why these %s)

    As an aside I would encourage people to make a list of variables that they would like in a business or asset. For example probably cash generation is the number 1 variable people are interested in. But there is also: tax shelter, scarcity, flexible use, lack of maintenance, lack of debt encumbrances, highly liquid assets, highly salable assets, assets readily borrowed against etc. I find this mental exercise to be very enlightening as to helping determine what the private market value of a business might be.

  6. Hi Nate, great article. Just a random thought that came to me as I was reading this and I am not sure why when reading your article, probably the beginning bit. Have you had a trawl through stocks in Cyprus ? After declining 98% after the euro crisis, it has since gone down 98% from that, reaching another all time low for their index this month. One presumes there must be a few net-nets there especially in the property and industrial stocks.