Home Stock Analysis Mental Models for Investing – an Interview with The Value Perspective

Mental Models for Investing – an Interview with The Value Perspective

by Vitaliy Katsenelson
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I sat down with the Value Perspective podcast to discuss my value investing approach. Much of the conversation ended up focusing on mental models and frameworks that I’ve found useful in analyzing businesses – and the market as a whole – as a value investor. You can read the transcript or listen to the original podcast interview below.

Mental Models for Investing - Value Perspective Interview

JTR: Vitaliy Katsenelson – welcome to The Value Perspective. It is a pleasure to have you here.

VK: Oh, it is my pleasure. Thank you, guys.

JTR: I should fill in a little background for our audience. We were introduced by email by our friend, Ben Benesch – a great investor, Ben – and we were supposed to meet in Colorado, over the Christmas/New Year period. Unfortunately, I was unable to make it out there, so I am now going to apologize in public to you for missing our live coffee!

VK: I accept your apology, Juan! I think Ben is a phenomenal human being – COVID interrupted a lot of plans over the last two years.

JTR: Can we start with a bit of background, please? Where did you grow up? How did you end up being a value investor?

VK: As you can tell by my accent, I was born in Mississippi! No … OK – I was born in Russia and I moved to the US in 1991. I live in Denver, Colorado, and have for the last 30 years. I have undergraduate and graduate degrees in finance and my CFA, which means I am a geek. And to make things even worse, I am a value investing geek. I have written a few investment books – the first one called Active Value Investing, while the second was my first book, somewhat simplified, called The Little Book of Sideways Markets. And those books – especially the second one – are a good summation of what value investing, or my version of value investing, should be.

I run IMA, which is a value investment firm in Denver, and our clients are basically high net worth individuals. Most importantly for your listeners, I write articles – and I write every single day, with very few exceptions. In the same way people work out every morning, I work out my brain every morning. I get up and I write, usually for two hours, every single day.

And therefore I publish maybe 30 or 40 articles a year – one every two weeks, sometimes once a week. I write about investing, classical music and life; and, if they like, your listeners can listen to those articles – actually as a podcast on Investor.FM – or they can go and read them on ContrarianEdge.com.

JTR: I was going to say, you also have a podcast that goes along with the blog.

VK: Yes. Although, unlike your podcast, which is kind of a sophisticated machine, I would describe mine as a lazy man’s podcast. Basically there is another fellow who reads my articles to you – so it is almost like my articles on tape. If you do not like reading my articles, or if you just want to listen to my articles while you are exercising, you just subscribe. It is on Investor.FM and it is called “The Intellectual Investor” podcast.

JTR: Now, I have never been to Colorado – our meeting was going to be my first time there – so what are the investment community and the value investor community in Colorado like?

VK: Colorado is home to Janus Mutual Funds, which is probably one of the largest investment employers here. There are a lot of people who have left Janus and started their own firms, so they are a little bit more growth-oriented. There are still some value investors, but there is probably, because of Janus, a predominance of growth investors here.

JTR: Do you feel that being far away from some of the main financial centers helps you as an investor, in the way that you approach and think about any specific investment situation?

VK: Oh, yes. I think if you live in New York – especially in New York – the atmosphere becomes very acidic because it becomes this micro-competition. A ‘who has a bigger wallet’ kind of thing.  I do not want to compare myself to Buffett, but the one thing we have in common – and that is where it ends – is we both work far away from Wall Street. And I think actually that is a big advantage, because when you are constantly comparing your wallet to other people’s, then your KPIs switch away from investing. Being in Denver, though, I just kept thinking about investing as a long-term investor.

JTR: That is really interesting. This podcast aims to understand what tools, mental models and frameworks are used by elite practitioners in different fields to help them improve their decision-making and deal with uncertainty. That is pretty much the core of what we aim to understand, so we are very interested if there are any particular tools – from base rates to adopting probabilistic thinking – or any other frameworks or models you have incorporated as part of your process, not only as an investor but to deal with day-to-day life.

VK: That is such a great question, Juan – thank you for that. I find that I need to simplify complex things. My brain has a kind of very low-powered “CPU”, so I need to simplify things to my level – to “dumbify” things. And, a lot of times, mental models help me to take something that is complex and dumb it down. So I am constantly looking for mental models – in investing, in life, in anything.

Let me tell you about two mental models – I wrote about this recently but have not published it yet. One I call “myopic circles”. Let me tell you about this one. We all live in our bubbles. If I think about my friends, for example, I do not have a single friend who smokes – and it is not because I do not want to be friends with people who smoke. It just so happens that my social demographic circles are people who are somewhat higher-income, somewhat more health conscious, and therefore those people rarely smoke, right? Therefore it would be very easy for me to assume nobody smokes – because everywhere I look, I do not see a single smoker.

But then I have this relative who smokes and, if he looks at the people surrounding him, he finds that most people smoke, right? So the interesting part of the overlap of my circle and his circle is probably going to be that there is very little overlap. And the reason it is important to understand that is that, as investors, a lot of times our view is skewed by our surroundings.

As an investor, I might own tobacco stocks, for instance; but it would be easy to assume, because I do not see anybody who smokes, that people do not smoke – except that something like 14% of Americans smoke and in Europe that number is probably even higher. So, when you look at the world, you constantly have to mentally adjust: Is my view skewed by my surroundings?

By the way, the same applies with, say, vaccinations. I am vaccinated but, again, this is no judgement. There is zero judgement of smokers or people who do or do not vaccinate; but, if I look around me, everybody, all my friends, are vaccinated; the only ones who are not vaccinated have very specific reasons. Therefore, it is easy for me to assume that everybody is vaccinated, but we know that is obviously not the case.

Then, if I look outside my circle, if I find a person who is not vaccinated because of their beliefs, then most likely that person is going to be surrounded by people who are not vaccinated. Again, there is zero judgement here – it is just that we need to make this mental adjustment: Just because we do things in a certain way, it does not mean everybody does.

Taking that on, I am not going to mention the company’s name – just because it is a very small company – but we were looking at a company that does money transfers between the US and Mexico. Now, when you and I think about money transfers, we might think about PayPal or Zoom or whatever – because you and I have checking accounts. You and I are mostly going to transfer money within our own country and to another person who has a mobile device or whatever.

But there is a huge amount of money transfers happening between the US and Mexico, the US and Guatemala – and suddenly you discover only 35% of Mexicans have checking accounts. Also, you have two or three million Mexicans who are in the US illegally – the number may be even higher. And when we were doing our research, we would go to the kiosks where those people do money transfers – it is a world I had never been exposed to.

I do not carry cash, but these people, this demographic, operate on cash. They get paid, usually, in cash. So exposing myself to this world that I am not familiar with was actually incredibly important for me, because I understood, well, actually there is a huge … I forget the number … $100 billion, I think, transferred between the US and Mexico every year – mostly going from the US to Mexico. So that is a market I did not know existed. Anyway, that is one of the mental models I use. We can talk about other ones, too.

JTR: By all means – you mentioned a second one?

VK: Another one is ‘David versus Goliath’, which is the oldest mental model – it is as old as the Bible, right? I am stealing this mental model completely from Malcolm Gladwell, because he wrote a book called David and Goliath. And when you think about the story of David versus Goliath, it is basically the triumph of the underdog, right? It is this celebration of the underdog versus the giant.

But Gladwell tells a very different story. Goliath was, I forget, six foot eight or seven foot three. He was this incredibly huge giant – a mutant, almost. He had armor protecting his body. And if you were to fight him one-on-one, there is no way you would win. In fact, the way the story goes – and I am not going to do a great job describing it – but you had this deadlock between the Israelites and the Philistines; and the Philistines said, pick a champion, we will too, and whoever wins this single-combat fight, that will decide the battle.

So the Philistines immediately picked Goliath, but none of the Israelites wanted to fight him. Then this shepherd, David, says, OK, I will fight him. The Israelite king offers him a sword, but David says I don’t need one. Since David was a shepherd, he was very good at throwing rocks from a slingshot. So you have this situation where you have a huge giant in armor and then you have this little – I don’t know, five-six or five-eight – kind of skinny shepherd going to fight him.

Gladwell spoke to some physicists and figured out that, when David used his slingshot, the rock came out at the speed of a bullet. Goliath did not know that David was incredibly good with his slingshot. So you had one guy coming to the fight with a sword and the other bringing a gun. Here is the key: If David chose to fight Goliath on Goliath’s terms, he would lose – but he chose to fight him on David’s terms. So, a lot of times, somebody’s advantage could be turned into a disadvantage. Goliath’s advantage with his armor made him a lot less mobile, so that turned into a disadvantage because, at a distance, David was so much more powerful because he had a gun, right? You know how the story ends – David throws the rock, hits Goliath in the temple, Goliath falls down and David comes over and cuts off his head.

So every time I look at a company, or I look at my company, I am trying to see … when I run my company, we are a tiny little firm competing against companies like Janus Mutual Funds. Janus manages maybe a few hundred billion dollars, while we manage hundreds of millions of dollars. So how can I upgrade as David – as a company? Well, I do not have the bureaucracy of Goliath or the breadth of Goliath; but when you have a large company, you have a lot of politics – we do not have that.

And we can keep going. I do not want to talk about my company, but let me apply this framework to the company I just discussed that does money transfers. That company focuses just on Mexico and Guatemala – on that corridor – for money transfers. And because that is all they focus on, they can compete with giants – they are one-tenth the size of Western Union or some other giants but, because of their laser focus, they can provide much better service. They have agents in Mexico who speak Spanish; when you call them, they pick up the phone in four seconds; and there are a lot of other things they do, just because they are so focused.

So they have realized that, by being David – if they are focused – then they can fight Goliath and Goliath might actually work against himself. In the client letter I just wrote, I combined these two frameworks – ‘myopic circles’ and ‘David versus Goliath’ – to describe how we were analyzing this company.

JTR: I really like that concept of ‘myopic circles’. I remember the co-head of my team, Nick Kirrage, telling me you should never incorporate the things you like or the way you behave personally into your investment process. This discussion took place many years ago on whether to buy into Bed, Bath and Beyond, and someone said, nobody goes to a shop to buy towels anymore. And Nick said, maybe you don’t, but that does not mean a segment of the population won’t. Is that pretty much what you are saying?

VK: Yes – I think we have this bias and I think we need to be aware of that.

JTR: When Jake Taylor was on The Value Perspective podcast, he made the point that we have all these different tools designed to help us become better decision-makers, which should allow us to become better investors – for example, the incorporation of base rates or the myopic circle … many different frameworks – but they can be very difficult to put together in a coherent way. And sometimes it is just hard from a behavioral point of view, from a personal point of view, to do the homework. So Jake made this analogy that it is a bit like going to the gym – we know it is good for us to go to the gym and exercise on a daily basis but, somehow, behaviorally, we fail to do that. So the follow-up question I would have for you is: How do you incorporate all these different mental models and frameworks and tools to make better decisions or remove biases in a way that is efficient and just eliminates some of the complexity of having so many tools at hand?

VK: It’s a good question. By the way, Jake is phenomenal. He is a good friend – a phenomenal human being, too – and he is very thoughtful about this stuff. Excuse my pun, but I keep those mental models in the back of my mind! I am not sure I have a good system, like where I have a checklist; but if you have been doing investments for a long time, you see something and you are like, oh, this looks like that. But I am not sure I am very systematic about checklists or mental models.

But one thing I do all the time and that I think is incredibly beneficial for me is writing. When you write, you tell stories and, a lot of times, you are looking for analogies. And one way to look at this is that, a lot of times, mental models are analogies. So when I write, it forces me to constantly look for mental models – and, remember, I write every single day. That is kind of my superpower in the sense that, when I was born, I was given a very low IQ, and then whatever boost I get from writing, that brings my IQ to kind of average now. So that is my superpower and that is probably how I discover mental models more often than others – just because I write.

JTR: When you are writing on a daily basis, are you keeping a diary of what is happening or decisions you have made in the past and how they evolve? Or you are just putting thoughts onto paper – things you will review over time – but it is just a collage of ideas?

VK: I tried very hard to write a journal – and I think an average person should do a daily journal. But the problem is, it is very difficult for me to do this because I write about so many different things all the time. A daily journal requires a certain discipline, but I have this excitement to write about other things that always conflict with daily journal writing.

So I write about the things I want to think through – like, if somebody asks me a question and I really want to find an answer, the way I find that answer is by writing. Because, if you think about it, writing is basically a forced connection between your conscious and subconscious minds – and everybody’s subconscious mind is so much more powerful than their conscious mind. It is like, instead of an iPhone to come up with ideas, I am using AWS [Amazon Web Services] to analyze ideas. That is what writing does for me. I do it daily and I just write about things I am interested in. A lot of times I write things and they never make it into articles – but then I might come back to them six months later and turn it into an article.

JTR: I heard you recently make the point that, when screening for ideas, it is important to expose yourself to randomness. I found that line very thought-provoking because, on The Value Perspective podcast, we had Maria Konnikova as a guest, who talked about how you do need to expose yourself to the dark side of variance. Now, randomness tends to scare people – they do not feel comfortable being exposed to random events – so why is this so powerful and what needs to be incorporated within your emotional, psychological, and mental process to successfully take advantage of this idea?

VK: That is a very good question. I approach investing as a very creative process. I know you do not look at value investing as being an art, but there are two parts to investing – an analytical part and a creative part – and they kind of meet somewhere in the middle. If you are just doing analysis, then you just turn into software. If you think only in numbers and do not look at the soft side, then you will be competing with computers and computers will outsmart you any day – they do computation better.

So there is a lot of creativity in investing, and I would argue mental models probably belong to the creative side of investing. Think about it for a second – when I talked about David versus Goliath, I was reading Gladwell’s book not because I was looking for a mental model, I was reading it because it was interesting. So by doing that I exposed myself to something that lies outside of investing – completely outside. I was able to turn this idea that lies completely outside of investing into both a life and an investing mental model, right?

So exposing yourself to randomness helps you to build mental models. I can approach it from a mental model perspective, but a lot of times you bring the mental models from a world that is outside of investing. Like the myopic circles – I mean, I thought of this when I was thinking about vaccinations and how come I do not know anybody who isn’t vaccinated? That is how it came to that.

That is a partial answer to your question, but another thing is, you just never know where ideas come from. I remember talking to a friend and we ended up talking about shopping malls. And I am like, well, maybe factory outlets would be a good investment. That was it – just a short conversation and a throwaway thought – then I ended up going down a rabbit hole on shopping malls, ended up spending a lot of time on outlets, and we bought a stock.

That was completely random, but being able to see that … like, investing is not working in the factory for Fiat. It is not an idea per hour. It is not, the harder you work, the better your results are going to be. You live constantly in this world where you are stuck between analytics and creativity and, a lot of times, I find that … let me give you another thing I do. Every day, I go for a walk in the park for about an hour or an hour and a half. So if you look at my iPhone, you will see that, every day, I do at least 10,000 steps. That is good for my health, but I also do it because this is where my subconscious does its best thinking. I walk, I listen to music, sometimes I listen to podcasts – a lot of times, I just walk, or sit on a bench and think. That is me exposing myself to randomness.

JTR: I have been following you for many years, but did I see you were a columnist for Institutional Investor?

VK: Oh yes. I wrote a column for Institutional Investor for seven years. I was the only outside columnist who wrote a monthly column for them.

JTR: OK – I think I got this from there. I am actually going to read the note I took many years ago – at least five years ago. You said back then: “Just as it is easier to draw lines than to think in nonlinear terms, it is simpler to buy stocks that have gone up a lot over the previous decade than to remain committed to the ones that have done nothing. However, linearity is for suckers. Success in investing comes from being able to see not what is in front of you but what is lurking just around the corner.” I thought that was a very powerful line – and, of course, I made a note out of it. What is interesting is this concept of linear thinking, because that is another bias – that is a tendency we have, to protect ourselves, to sometimes take shortcuts and make certain decisions and extrapolate into the future things that maybe should not be extrapolated into the future. So, do you think you were born to avoid linear thinking, or you have trained yourself over time to avoid it?

VK: That is a great question. I am always questioning myself how much being born in Russia has had an impact on me as a human being. When you read my writing and you sense the sarcasm, I think that is my Russian side coming out. But the funny part is, I am 48 years old and I have lived in the US for two-thirds of my life. And if you adjust for the fact that for the first eight years of your life you probably do not remember anything, then arguably I have lived here for 80% of my life.

Let me give you one of the best examples of how linear thinking can be very dangerous. At the time of the 2008 housing bubble in the US, if you looked at the housing data going back as far as it went – maybe 40 or 50 years– housing prices had never declined nationwide. And that is the key word: nationwide. So if you were a rating agency or a bank or any financial player, you would have looked at this data and said, if I take a house from Wisconsin and a house from Alabama and an apartment from New York and I put them together in one portfolio, because of diversification, this portfolio is very unlikely to lose money. If prices decline in Alabama, most likely they will not decline in New York or vice versa.

But here is the interesting part. Just because something has happened in the past does not make it a law. It is not a law of physics that housing prices never decline nationwide – it is just something we have observed over the last 40 or 50 years, right? If everybody confuses 40 or 50 years of data with a law then, because of reflexivity, you are most likely going to get in even more trouble, because you are going to build more houses, people are going to use more leverage, and then you have a financial crisis.

And the same thing applies when it comes to stocks. A lot of times, people get confused about price-to-earnings. If you think about price-to-earnings, by definition it is a mean reversion – it is a mean-reverting metric. And my books were actually about that topic, right? Whenever a stock price is going up because of price-to-earnings expansion – just solely because of that or that is the big driver – when price-to-earnings goes to above-average and starts heading into the stratosphere, at some point price-to-earnings stops going up and then declines.

If you look at every market cycle, that is what happens, and we kind of experienced this over the last eight months. If you look at the arc of the technology stocks, all those companies traded at 60x revenues and actually they are down 50% to 80%. I looked at them, and now they are trading at only 30x revenues – with “only” in air quotes – and that is still not cheap. So it is very important to understand which metrics mean-revert and which ones do not. So when I look at the metrics, I always have a mental note to ask myself, is that a mean-reverting metric or not?

JTR: I guess that connects with your myopic circle framework as well – the fact that, if you do not look outside of what you are exposed to, you might default towards thinking in your usual terms, rather than understanding that maybe things are not linear.

I am going to butcher this story, but there were two money managers … I am not going to mention names because they are good people. But there were two money managers; one was kind of king of the stock market and the other one was king of the bond market. I am not going to mention names. One had a great 2008 and one had a horrible 2008 – and I think, in part, it was because one lived in California and the other one lived on the East Coast.

The one who lived in California saw that the housing bubble there was much greater than the one on the East Coast saw. So the one who blew up did not see it as well, because, you know, he looked around him and probably did not see housing prices going as crazy as the one who lived on the West Coast and was directly exposed to the insanity of the housing bubble. You see what we just did – we married two different mental models together, and that is how they become more powerful.

JTR: Yes. It is interesting how you started your answer to the previous question with a reference to your roots in Russia. I am Colombian, which leads me to my next question. I believe we are shaped by the context and environment in which we grow up. And our understanding of risk and the perception of it is shaped by experiences very early in our lives. You were born in Russia, as you explained before, and then immigrated to the US, so do you believe your understanding of risk is different because of your background and those very early experiences? And is this way of thinking about risk – all these different perceptions – a weakness or a strength?

VK: It’s interesting. If you grew up in the US, mostly only good things happened to the US, right? I mean, you have this country that has the largest economy in the world; you have this abundance of natural resources; you are surrounded by two oceans; you have two friendly neighbors – the polite one to the north and the happy one to the south – so you have almost a micro bubble. I mean, it is a huge bubble, but it is an environment where, since the Second World War, mostly only good things happened to it.

If you grew up in Latin America you had a very different experience, right? Let me give you an example, where I fell into a kind of non-Russian thinking, or less skeptical thinking than I should have had. I am embarrassed about what I am about to say, but that tells you something about my … this so embarrassing!

JTR: Go for it! Go for it!

VK: OK, so it is early 2020 and this virus is blowing up in China. In early February, I am in Venice, and there are a lot of Chinese tourists in the city. I am thinking, well, they might be infected – again, I am so embarrassed about this because it is just unfiltered thought … now I look at this thought, I am like, my god, this is just such an idiotic thought. I am like, well, if they are infected, I will not get infected because it’s a Chinese problem.

Just think about how idiotic those thoughts are; but my point is, if you take it on a more thoughtful level, after I came home to Denver, I remembered that two weeks earlier I had been in Milan. I’m watching TV, and suddenly in Milan the stores are emptying, as a huge wave of COVID-19 washes over Milan – and I was there just two weeks ago! And at the time, I could not imagine something like this might happen in Milan.

And I also realized that when most of us looked at COVID, we thought it was just a Chinese phenomenon, because every time a serious epidemic happened in the past, it never really came to the US. Even SARS was mostly an Asian phenomenon. So, if you lived in Asia and you read the news about COVID in China, I bet your reaction would have been very different than this dumb American’s.

So now I am very aware of this flaw. Now, I am very aware that we think bad things can only happen somewhere else. And by the way, growing up in Russia, you become skeptical. In Soviet Russia, it was easy to become cynical about the government and about your future, because they promised you a bright future – and it was never bright. It actually always got worse.

I wrote a huge article about this, because now, when you think about the US dollar, for instance, if you have lived in the US since 1945 – if you were born any time after the Second World War – you basically saw the growing dominance of the US dollar, as it became the global reserve currency. Again, what we are going to do is just put a few mental models together. The linear thinking that the US dollar will always be the reserve currency is dangerous because, as a country, we start to behave as if it is our God-given right to have the reserve currency. It is not – it is something you earn. And we earned it for good reasons, right, because we were the strongest economy after the Second World War.

But if we behave as if it is a God-given right, well, now we have $30 trillion in debt – and we keep spending money. We could have $40 trillion or $50 trillion in debt, but at some point the world is going to look at us and say, OK, maybe the US is a stronger economy than whomever, but it is not as strong as it used to be– and they will start allocating money away from the US dollar. That doesn’t mean the US will stop being a reserve currency overnight, but, you know, we are going to start seeing kind of a basket of reserve currencies or something like that. So it is not going to be a binary situation.

And that is another thing. You want another mental model? I always try to catch myself – am I thinking in binary terms or nuanced terms? So when we talk about reserve currencies, it is usually a binary discussion, right? In other words, either the US dollar is a reserve currency or it is not, but if you think about nuances, it does not have to work this way. It might just become less of a reserve currency.

JTR: I have yet to read Seth Klarman’s most recent letter, but I have seen commentary on his point that democracy is not a given and, to a certain degree, people are taking it for granted in the US.

VK: Probably the best article I wrote last year was in December to mark 30 years since I came to the US. I wrote this article about my thoughts on America over the last 30 years – and the country has changed tremendously. Ironically, the longer I live here, the less I understand the country because it has changed so much over the years. And we are taking democracy for granted now. We are taking freedom of speech for granted. We are becoming more tribal. And so, yes, democracy – just like reserve currency status – is not a God-given right. If you behave in a certain way, you can lose it over time.

JTR: Changing gears a little bit, something we explore a lot in my team – and we also have in this podcast with many of our guests – is how do you communicate these concepts with people. Because some of these concepts, frameworks or tools may seem easy to understand but they are very difficult to practice. Then again, the whole idea of thinking in probabilities is not something that comes very naturally to many people at all. You have pointed out that you like this process of writing – and you are very good at that, by the way – but I think many people say they understand the importance of, say, long-term thinking or a focus on process over outcome or avoiding and controlling noise; and yet, when there are periods of underperformance or markets get choppy or things just get very volatile, even outside of markets, people tend to completely forget and ignore all of this. So how do you communicate to current and future clients so they understand and embrace many of these concepts?

VK: As you mentioned, I write. And the beauty of it, I just realized, is that a writer has such a great advantage. I am a better writer than I am a speaker, because when I write I get to polish … I have the flexibility to think about every single word I use. When you speak, you think for the most part in real time, so you don’t have this ability. I do not have this luxury of carefully thinking about every single word I am going to put together and then say to you.

But also, writing is a lot more scalable. I can write one letter and send it to all my clients – or I can have 250 conversations, which would take hours and hours and hours, with my clients every quarter. So instead, four times a year, I write a letter to clients. I call them ‘seasonal’ letters, not ‘quarterly’, which is an important distinction. Quarters kind of happen –in our industry you expect to get a quarterly letter, somewhere between the first day and the two weeks after the quarter ends.

The problem here is that most companies start reporting numbers maybe a week or two after the quarter ends, but I would like to write about what happened to our portfolio after all my companies report their numbers. So I write the 25- to 35-page letters, and in them I try to bring my clients as close as possible to their portfolio.

Let me give you an example. I had a meeting with one of my clients, a retired airline pilot, and I was telling him that I am afraid of flying. I fly all the time, but I have this fear, like, when you are at 15,000 feet and the plane starts shaking, I become a little bit more religious. And he said, “It’s kind of funny, but when I was a pilot I wasn’t afraid of these things but now I’m a passenger and I’m afraid, too.” And I realized this applies to investing as well, because when he was a pilot he had all the information in front of him and he had control. Now that he is a passenger on the plane – even though, intellectually, he understands what is happening – because he doesn’t have control, he is more nervous.

Now, think about this. As an investor, when we buy a company, we spend tens and sometimes hundreds of hours doing research as a team on it. So we understand the business very well and, if the stock price declines, we actually have a good idea of what the risks are and what the company is worth. To our clients, however, if they know nothing about it, it is just a ticker that is now worth 50% less than it was three months ago, right? So they are just like the passengers sitting on the plane. When I tell them how we look at the business and how we value it, then, I try to bring them as close as possible to the cockpit without their actually kind of flying the plane. So this is why I find my communication to clients to be incredibly important.

Let me take it a step further. Go to March and April 2020, when the market was going down 10% a day or whatever. I went from communicating to clients once every three months to once a week. It would not be 27-page letters, but we would basically update clients on our thinking every week, because our thinking was changing because we were learning a lot of new information. And I would argue that we reduce volatility – and our clients’ blood pressure – tremendously just because of that.

In other words, instead of hiding under my desk and just going quiet, we went the other way – you could argue we over-communicated to clients. Still, when things are going well, nobody cares. It is when things go badly that your communication becomes important. But here is the thing. In the good times, I still want my clients to read my letters because, over time, if they read them, then when the bad times come, they will already know what they own because they have read my letters for a few years. And then they will panic less.

JTR: That is really interesting. You have talked in the past about the importance you ascribe to management quality, and I want to approach this question from our behavioral angle. We know that many people, when they make it to the top – in business or otherwise – tend to be very good at sales and building a narrative. And so every time you meet with anyone, there is a risk you will be biased by their narrative or how good they are at communicating their story. How do you protect yourself from becoming biased and allowing their narrative – good or bad – to shape or impact your decision making?

VK: That is a phenomenal question. Let me do a small plug. I just finished a new book. It is coming out in May and it is called Soul in the Game: The Art of a Meaningful Life. This book has absolutely nothing to do with investing – not a single chapter in that book is about investing – while about one-third of the book is about Stoic philosophy. In ancient Rome, there was this group of Sophists –the word sophisticated has the same root as Sophist – who ran a school where they would teach you how to be a very elegant speaker.

Stoics never liked that group much, though, because they taught people how to speak but did not teach them the morals that Stoic philosophy did. In fact, Stoics usually took the opposite approach – they would want to speak very efficiently and not try to amplify things, because a lot of times, when we describe things, we over-amplify. And by the way, I am guilty of that because I write a lot.

So while Sophists might say “I am having absolutely the worst day of my life”, the Stoics would say “Well, my portfolio is down 3%”. Now, what is important about this is – you are absolutely right – to become a CEO, one of the prerequisites is, you have to be a good speaker – you have to be a Sophist to some degree. You can have Sophist and Stoic in the same body, or you can just be a Sophist.

So, whenever I encounter somebody who is an incredibly good speaker, I become a lot more cautious. By the way, that does not mean the person is a charlatan – that is not the point – I just try to distill what they say to the bare facts a lot more than I usually would. So, if somebody says they are having a phenomenal year, I would say, OK, let’s look at the numbers –he’s up 7%. OK.

I do not want to get into political problems, but if you think about it, President Trump was a Sophist. He would use these sweeping terms, and so if you wanted to be analytical about what he was actually saying, you probably wanted to go to this more Stoical level and try to break it down to basics. If he says, “We have a great economy”, OK, well, GDP grew 3.2%.

So anyway, when we analyze companies and I encounter somebody – and by the way, a lot of management teams learn how to cater to the value investing community; they use all the Buffett terms and they quote Buffett every third sentence. And when I see this, well, first of all, if they truly believe this, that is one thing; if they are just saying this and do not believe it, that is something else. So I become more cautious and I filter their speech more when that happens.

JTR: We are coming to the end of our session but we always ask our guests two questions: for a book recommendation and for an example of a bad decision where you can identify that the poor outcome came from bad process rather than bad luck. It does not even need to be investment-related.

The book is easy – actually, I will give you a couple books. One is Alchemy, by Rory Sutherland, which is a phenomenal book; and I would especially recommend his audio book, because he reads it and he does so extremely well. The other book is a Stoic book, A Guide to the Good Life, by William Irvin. That is the book that turned me towards Stoic philosophy, but I have to issue one caveat: When you start reading it, skip the first three chapters, because they are very technical. So start with chapter four and I think it will prove a much easier read.

As for a bad decision, I just gave you my COVID-19 story, where I saw the Chinese tourists and thought, I cannot get COVID because I live in the US. That is probably the dumbest decision I made in recent years – it is the most embarrassing one, for sure. Let me stick to that, because then I can keep my embarrassments to just one per podcast.

JTR: That is perfectly fine. Vitaliy, thank you very much for your time. This was an absolute pleasure.

VK: It was fun. Thank you so much.

  • The information contained in this article represents Investment Management Associates’s (IMA) opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Vitaliy Katsenelson, CEO and CIO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, countries, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, IMA has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by IMA within the past twelve-month period is available by clicking here.

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