Strategy Chain by Michael Roberson

August 20, 2020 035 - Easy Series #10 - Reset: the shared tactic of Jocko Willink, Coach K, and Bill Ackman

Errors snowball, and compounding is like the Marine Corps—no better friend, and no worse enemy. In this episode, we’ll talk about how Jocko Willink, Mike Krzyzewski, and Bill Ackman use a tactical “reset” to get back on track.

Let’s start with the opposite. Time’s running out, everything is on the line, mistakes are being made, and it looks like the window of opportunity is closing. The position is going from bad to worse, and a vicious cycle is forming: bad position, bad decision, worse position, worse decision. And on, and on. Balls are getting dropped, emotions are running hot, and stress is widespread. Chaos reigns. Corners are being cut since time is in short supply. Confusion, haste, sloppiness, complexity, errors, anxiety, weariness. It’s a nightmare situation.

This description could apply to a crunch period at work, the fourth quarter of a basketball game, or just about any part of life where results matter.

We all know the phrase: “when the going gets tough, the tough get going.” But sometimes even the toughest know it’s time to take a beat.

In this episode, we’ll talk about how Jocko Willink, Mike Krzyzewski, and Bill Ackman use a tactical “reset” to get back on track.

Jocko Willink: “Detachment”

First, let’s talk about resetting through the frame of “detachment.”

Let’s start with the toughest of the tough. If you know Jocko Willink, you know he’s no wimp. Jocko is a huge proponent of what he calls “detaching.” In the show notes, there’s a link to a podcast episode where Jocko dives into this idea and the experience that drove it home for him.

https://fhww.files.wordpress.com/2018/08/107-jocko-willink.pdf

In a nutshell, during a complicated, stressful training mission on an offshore oil rig, Jocko realized that by taking a few steps away from his team’s position, he could re-assess the situation with fresh eyes. When you “detach,” priorities become clear. You can stop spinning your wheels and get back to ticking off your priorities.

If you listen to his podcast—and I highly recommend it—you’ll hear from tons of people who had to reset mid-battle, right in the thick of the fog of war.

Coach K: “We Will Win”

It’s February 12, 2019, and 22,000 Louisville fans have packed the KFC Yum! Center to see their Cardinals beat the Duke Blue Devils. At 9 minutes, 54 seconds remaining in the game, a Louisville player hits a 3-point shot that puts Lousiville ahead 59-36. At that point, Coach K had never seen a Duke team recover from such a dramatic deficit.

Before we discuss what Krzyzewski said during his own timeout, let’s take a timeout of our own. I’ve included a bunch of links in the show notes. The first is the full video highlight reel for the comeback. The second is an incredible article by the NCAA (written in conjunction with ESPN’s data) laying out the highlights of how the game progressed along with a chart showing the statistical probability of victory in a time series graph. At its trough, the win probability was 0.1%, meaning that Duke had a 1 in 1,000 chance of victory. It’s times like these that coaches like Coach K and programs like Duke don’t show up in the numbers.

https://youtu.be/OydPe7ZtdRY

https://www.ncaa.com/news/basketball-men/article/2019-02-13/improbable-duke-comeback-vs-louisville-explained-coach-k-and

So what happens?

Coach K calls a timeout and makes a tactical shift (more on that in a moment), but more importantly, he communicates the message that he believes Duke will earn the win. In the article, he mentions that he wasn’t necessarily being 100% truthful. Tactically, Coach K shifts to an aggressive, attacking form of defense that doesn’t concede any ground to the opposing team as they try to maneuver the ball from under their own basket into their opponents’ half.

The results are unbelievable. Louisville implodes under the pressure, giving up 9 turnovers in the final minutes of the game, and Duke wins by 2. I didn’t see the stats to prove it, but I’m relatively sure that most of the points Duke scored in the comeback were transition opportunities directly resulting from opponents’ turnovers. If you can visualize a steal where two defenders strip the ball from a lone ballhandler steps from his own basket, you know that this is asymmetry at its finest. Oh—and regarding frustration, the tables have completely turned. Two points to Duke, and the Louisville transition starts right back over again. Right back into the jaws of the full-court press.

This is coaching at its purest. (A) don’t panic; we can win (B) let’s re-take the aggressive, proactive stance in this game by rapidly forcing a situation that favors us drastically—a suffocating, flustering, frustrating, exhausting, and in-your-face defense that plays to all of our strengths.

Coach K knows how to reset.

Bill Ackman: “Back to Basics”

We can also frame the tactical “reset” as “back to basics.”

Bill Ackman lays out his basic investment criteria in an interview (and I’ve linked it in the show notes).

Before we move on—because I know I’d be wondering if I were listening—this is what he says he wants.

Businesses that are:

Simple
Predictable
Free Cash Flow Generative
Dominant

And that have:

High Barriers to Entry
Limited Exposure to Extrinsic Risk
Strong Balance Sheets (and as a result no need to access capital markets)
Excellent Management & Good Governance

https://www.youtube.com/watch?v=sU83fZF6HcU&feature=youtu.be&t=669

Now, if you follow the financial media, you might be wondering why he needs to go “back to basics” at all!

What am I talking about? Bill Ackman has been in the media recently after a windfall profit from what’s been called the “best trade of all time” since he spent $27 million to make $2.6 billion dollars with extremely limited exposure (but I should mention that the total exposure was probably about $700 million on a worst-case basis). So still a 5-bagger.

And he did it by buying credit default swaps or CDS on three credit default swap indices (both high yield and investment grade) as a hedge on the credit markets. Again—for those interested, I’ve linked to the letter where he both describes the position and gives a brief primer on the mechanics behind how CDS works. It’s really awesome reading if you’re into this stuff.

https://assets.pershingsquareholdings.com/2020/03/26222617/Pershing-Square-Capital-Management-L.P.-Releases-Letter-to-Investors-March-26-2020.pdf

And I’ve also linked to an excellent interview he did with Shane Parrish of Farnam Street (although his podcast—which is excellent—is called The Knowledge Project). He talks with Shane about the rationale behind the hedge as well as his thoughts on bouncing back from failure. It’s an excellent listen.

https://fs.blog/knowledge-project/bill-ackman/

Now if you’re not familiar with Ackman, I know you must be asking yourself:

“What on Earth does all this have to do with resetting? Seems like Ackman is doing just fine.”

And I hear you—in his interview with Shane, he also acknowledges that much of what I’m about to describe is firmly under the umbrella of “first world problems.”

But if we re-wind the tape, Bill Ackman had been having an incredibly difficult run from 2015 until about 2019. Let’s go back in time. During its 2015 peak, Pershing Square was running $20 billion in AUM.

Ackman was in the middle of a battle over Herbalife, which he believed was a pyramid scheme. Between 2012 and 2018, Ackman held short positions (first outright short positions in Herbalife stock, and later put options). Ackman ran a very public campaign to out what he considered to be unethical practices (and make money if the share price dropped). Carl Icahn, another billionaire, had built an enormous position on the other side of the trade, aiming to catalyze what he called “the mother of all short squeezes.” This squeeze would basically make the short side submit and unwind the position, causing a big run-up in the share price.

With this long and ultimately unfruitful campaign in the background, he began to have serious problems with an investment in Valeant, a pharmaceutical company. Over the life of Pershing’s investment, Valeant dropped from $190/share to $11/share during a very public activist stake (and I have a really interesting article from the New York Times linked that includes a timeline, for those interested). And for a Murphy’s Law moment, Pershing was sued by Allergan shareholders, who claimed that Pershing bought Allergan shares with insider knowledge of a looming takeover bid from Valeant. All told—per the Wall Street Journal—Valeant cost Pershing $4 billion (there’s a link in the show notes to that too).

https://www.nytimes.com/2017/03/19/business/valeant-ackman-timeline.html

https://www.wsj.com/articles/william-ackmans-pershing-square-sold-stake-in-valeant-1489439314?mod=article_inline

What a nightmare.

Now let’s skip ahead

So the mid-teens were a rough few years for Ackman and Pershing. But now let’s skip ahead to 2019. Let’s start with a headline from Yahoo! Finance on January 5, 2020. Hedge fund manager Bill Ackman delivers 58.1% for investors in 2019. The article, linked below, was written by Julia La Roche, and I certainly couldn’t sum things up any better:

“Like Buffett, the mission at Pershing Square is to have a permanent capital structure. Ackman said the firm took a step in that direction, launching a publicly-traded fund in 2014 with the long-term plan to have a majority of capital in that vehicle.

After posting a return of 40.4% in 2014, the hedge fund experienced negative performance for each consecutive year—until 2019. At the April conference, Ackman attributed the string of poor performance to a couple of bad investments. Those mistakes led to significant investor redemptions, or what Ackman characterized as a “rough patch.”

Pershing Square Holdings, the public vehicle, is now 80% of the firm’s capital, Ackman said at the time.”

The link to the article is in the show notes.

https://finance.yahoo.com/news/bill-ackman-pershing-square-2019-performance-130053673.html

So what happened?

In the interview with Shane, Bill mentions that recover is a “slow, plodding, one-step-at-a-time process.” I think there are lots of reasons for the comeback. I’m sure I’ll leave some out, but I think these ones are critical:

He revamped the investor base
1. I believe it’s impossible to be a good long-term investor without committed, locked-in, and relatively under-updated capital
He swore off public contests, especially on the short side
1. These drain his time, energy, and attention—his most valuable resources
2. In the interview with Shane, Bill mentions that he’s focused on avoiding catastrophically low “return on invested brain damage”
He swore off bets with 100% downside (even if they have the potential to be a 4-bagger)
1. This one speaks to me
2. I just made a mistake with just such a company
3. It was an enormous waste of time, energy and resources
4. And it was pretty embarrassing to do it in public!
And last but not least, he returned to his basic criteria, which he literally has engraved into tombstones (also known as deal toys) that sit on every employee’s desk

For good measure, I’m including one additional fun article on Ackman that the Wall Street Journal ran. The byline: With performance bad and investors fleeing, Mr. Ackman ‘went activist’ on Pershing Square.

https://www.wsj.com/articles/after-suffering-bruising-losses-ackman-pursues-quiet-recovery-11553176760?adobe_mc=MCMID%3D69363972300789071000526555740666532794%7CMCORGID%3DCB68E4BA55144CAA0A4C98A5%2540AdobeOrg%7CTS%3D1597609842

Bottom Line

Compounding is the 8th wonder of the world, and we need to do everything in our power to make sure we aren’t on the wrong side of it. Well-oiled machines shouldn’t constantly require downtime, but in critical moments, it can be an extremely high-yield decision to pause and reset. Errors snowball, and compounding is like the Marine Corps—no better friend, and no worse enemy.

So that does it for this episode. I hope it shows some threads to pull.

If you’re interested in show notes or supporting the podcast, check out strategychainpodcast.com. If you want to get in touch with me, you can find me on social media @strategychain.

So until next time—thank you.

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