Invest Like the Best with Patrick O'Shaughnessy
· John Kim
So when you're trying to raise money, look for that motivation that they have because they're in that spot for some reason. The fear piece is also really important, and fear might as well be another word of saying trust. It's the anti-trust. The way to inoculate yourself against fear is trust. In fact, the more fearful somebody is and the more trust you can develop, the less desire they need. If they just trust me absolutely, then everything else will pale in comparison. If they have no fear — in other words, it's riskless — they will do it And this is one of the things that ties into — so many hedge fund professionals that appear on your podcast as well will talk about risk-loving, risk-aversion. I think that's kind of bullshit. I don't really think there's such a thing as risk-loving, risk-aversion. I think that there are only people who perceive there's no risk. I think that no one actually really invests with a lot of risk. I think that people actually convince themselves that the risk is far less than what it really is in order to justify the risk they're taking so they can receive the reward. And where do we see this? Gambling, right? The casino. It's part of the human condition that we rationalize away the risk. And so if somebody says, I'm risk-loving — no you're not. You're just really good at rationalizing away the risk. And not to zero, but if you know your outcome is gigantic, you just have to rationalize the risk to half of what it really is, and you'll say yes. And that's where a lot of cognitive mistakes are made in investing for sure.
· Patrick O'Shaughnessy
[00:00:00] S0: A lot of this equation is — you've talked about applying it early to get going. I'm also very curious about applying some of these ideas much later on. So if I think about your time at General Catalyst — you're on fund 8 or whatever, you're established, people know who you are. There's somewhere in the book you said the path of least resistance is often that money goes to stuff already in motion. Fund 8, let's say, or Series D, you're already in motion. What have you learned about doing a really great job at that stage? What happens there that's distinct from just the early stuff of total uncertainty? We don't even know if you're any good. How would you do that even? I'm even thinking literally about you sitting down like, okay, we're going to go raise this thing.
· John Kim
[00:00:00] S1: So we basically set out on a campaign of consensus. One of the ways to get rid of fear is consensus. Consensus, by the way, is the hardest and maybe one of the most powerful things to move entire markets because consensus is a macro view. And by definition, if you have a macro view, you've influenced the macro world. So you'll see this, why propaganda in its best and worst forms creates a consensus. There are a couple ways to go about it. You could argue that there is the classic innovator, early adopter, early majority, late majority, laggard. In which case you have to close the gap. And lots of people have written wonderful books about early adopter to early majority. Once you cross that gap and all of a sudden consensus starts to happen, that is a really powerful framing. So we know the winner on the other side of that gap is actually winner-take-all. So therefore it's worth it. The second way you can get at it is that big money tends to hide behind committees. Because if you've got a committee of eight or nine people and you have to vote, what then by definition is happening? You have a consensus decision. I have never seen a consensus decision-making process make a contrarian bet unless the group is designed to make contrarian bets. That's very hard to do. And that's why it's very hard to find good venture capital firms, because they tend to be contrarian firms. So how do you build consensus? You build it with consistency. Find people who you can do things for that are actually part of the group that you want consensus around. State pension plans, let's say. Consultants, sovereign wealth. Do they care about co-investment? Do they care about fees? Do they care about access, transparency? Do they care about intellectual property? Do they care about just being entertained? Find it, give it to them. They come back to you, build. Now you've got a sovereign wealth plan. Now you've got a pension plan. From there you start to meet people and they say, hey, you realize that this state pension plan's invested this. And next thing you know, the next round you end up doubling it. And so if you take a look at the experience, all of a sudden General Catalyst and others are starting to become consensus. And this is true for any of the other folks who have amassed capital.
· John Kim, Patrick O'Shaughnessy
There's a consensus that they're the winners of the class, and General Catalyst created a consensus. And so that was the whole goal, but you had to do it fund by fund by fund, but it was very intentional. And by the way — here's the thing — you have to have the courage then to lose the people who actually were the people who invest with you because you're a contrarian. In other words, you had to have the courage to get past the innovator's dilemma. And so if there's a set of folks, high net worth family offices, endowments, or whatever it is, or small fund of funds that say, hey, you're now too big for me, — you're going to lose them. And you have to have the courage to do that. The only way you're not going to succeed is if you actually want to have your cake and eat it too. Now, there is a truth to if your performance is so dynamic, you're so differentiated — then you'll be able to run the table. And there are firms who do that. You can't get into the fund. You can't because their performance, their track record is so absurdly strong relative to the industry that you trust that they're going to actually develop these returns again. [00:00:00] S0: I remember once one of the partners at Benchmark, I asked them, how do you fundraise? And they said, well, we send an email on a Tuesday night and the fund is closed on Wednesday morning.
· Patrick O'Shaughnessy, John Kim
[00:00:00] S0: I remember once one of the partners at Benchmark, I asked them, how do you fundraise? And they said, well, we send an email on a Tuesday night and the fund is closed on Wednesday morning. [00:00:00] S1: Right, right, right. So in that case, let's talk about trust. The consistency — they consistently perform exceptionally well. Consensus is they're actually one of the best funds in the world, and there's scarcity. You don't have to have experts like a consultant say, well, that's the best one. Look, I already know. Consensus is there. They don't have to do anything for you. There's no reciprocity but returns. But I'd say, but returns, again, that isn't everybody's desire. It's most people's desire because it makes them look good, but it's really about the consensus and the scarcity that allows them to have the advantage and the privilege of keeping their funds small and keeping their fundraising energy or calories very, very low. [00:00:00] S0: You mentioned the word differentiation before. Can you explain your law of differentiation?
· John Kim
[00:00:00] S1: If anybody wants to learn three laws of physics that are the most important in fundraising — law of differentiation, law of trade-offs, and law of pipeline. Let's talk about law of differentiation. This is the law. This is your track record, plus your differentiation, and you divide all that by the complexity of your story. So, track record — that isn't just your returns, but is how do you behave? So if you're an elected official, your track record is your voting record, right? Or it's the way you show up in the media. It's your consistency. Differentiation could be anything. It can be, I can take contrarian bets. It can be I only do one or two things, but when I do them, I'm highly operationally intensive. It can be I access this part of the market that no one else does. It could be my GP commit is abnormally large. So let's take those two positive features, when you are trying to build a portfolio, because almost everybody at the institutional — the big money, not the small money — the big money has a portfolio. So you have a portfolio of diversified assets and you try to have those assets not replicate what each other's doing because if they're autocorrelated, then you didn't do a great job. So you kind of want people who are differentiated. And you're trying to add something that is additive to your portfolio somehow, some way. Then complications. Complications are usually the enemy of trust. The more I have to explain — like when my daughter comes back late at night and I said, look, you're supposed to be back at midnight, but gosh, it's 2:00 AM, explain yourself. And there's this long story of this and that. I'm like, I don't trust this. My daughter's pretty smart. She knows, oh, Dad, you know what? I just blew past it. I was having fun.