Founder’s Corner – March 2020 Article
February 16, 2020
Structure and Discipline Lead to Superior Returns – Marc A. Gineris
Having guided Incyte’s own investing together with our investment partners’ capital to consistently superior returns over the past twenty years, I am in a position, as are many managers who have delivered strong investment returns, to reflect upon elements of investment success. In our experience, success has come from a particular structure, combined with unwavering, almost unnatural discipline, as I review below.
The financial goal of investing is to deliver consistently superior returns or “alpha” as known in the investment community. If your tombstone is engraved with an IRR experience that far exceeds the market, and you have also done much to better yourself, your fellow citizen, your family, and the community at large, you can likely consider the journey a success.
To achieve superior returns, the structure of the investment firm and its approach is paramount. Conventional thinking dictates that your investing should diversify holdings, consistently deploy capital, regardless of the valuation levels, and regularly harvest returns. These concepts, however, can be in our experience anathema to consistently superior returns. The more one pursues them, the more likely the returns will revert to the mean or be average. Warren Buffett has been a virtual mentor and, having met him on several occasions, and read all the books written about him (he has yet to write a book), I view him to be a financial genius. Yet his strength as an investor also evidences high concentration in his investing and an unyielding value and hold discipline. He is famous for stating that there are no called strikes in investing. This also applies to imposed capital deployment requirements. When you are at the plate, you wait for the pitch that you want, the one you know how to hit, and then you swing, for the fences. If you have to stand at the plate, waiting and waiting, and even go to the movies (another famous Buffett saying), so be it. Creating more deals to diversify, even in a high price environment, is believed to improve the chance of good returns and of minimized losses on one big deal. However, the better philosophy is to make better decisions, with discipline and knowledge in what you know, not to dilute your best ideas to the average or overpay to maintain deal flow. At Incyte, our highest return deals have consistently been our largest investments and we have no set rate of capital deployment. Ideally, you do not want capital burning a hole in your pocket.
In harvesting an investment, it is no different. A company that creates extraordinary free cash flow annually does not have to spend capital to grow, or have to be sold or go public. It is naturally the “third” exit, as professionals say. It is a superior hold. Selling the winners to post IRR’s and raise the next round of funding does not assist in creating alpha. (It does serve to increase the size of the firm, however, and the attendant management fees paid to the managers). Consequently, many good cash flow companies are sold off too early, or overlooked entirely by investors today, believed to be old school and obsolete in preference to “change the world”, sexy ventures and the desire to raise more capital.
Certainly, some early ventures indeed lead to home runs, and to almost celebrity status among early investors. In practice, in fact, the discipline to place risk mitigation ahead of possible returns phenomenal does not make the front page of the news or garner wide, adoring social following. Risk/reward in today’s environment increasing favors the desire for the reward over the mitigation of the risk.
Yet, over the long run, in our experience, this bias in structure serves to undermine alpha. We have found that the long, dutiful ability to avoid the greed and the fear of the day, in an almost non-human-nature manner, provides a structure with the real possibility of achieving superior returns ten, twenty or even thirty years running. It is not easy to “do nothing” when prices become frothy, and may remain so for months and even years. But this philosophy creates the conviction and financial dry powder to be bold when the opportunities do appear, when the pitch is right over the plate.
