Changing the Game

On the occasion of East Rock Capital approaching its 15th year of operation, we are initiating a series of writings on world-class performance, both inside and outside of investing.

Changing the Game will focus on areas of competition in which an innovative strategy or subtle edge allows one competitor to separate itself from its peers. David Swensen disrupted endowment fund management as an early adopter of private equity and hedge fund investing, which was a significant leap forward from the old stocks and bonds model. East Rock’s founding investor, the Miller family, built Lennar Corporation into the largest homebuilding company in the United States by controlling all aspects of the construction process and meeting all needs of the homebuyer. In baseball, the Tampa Bay Rays have made the playoffs 5 of the last 12 years with payrolls that are consistently among the league’s lowest. They have been called “more ‘Moneyball’ than the Moneyball A’s themselves.” The team’s owner, our client and informal advisor Stu Sternberg, has selected team executives who have successfully pushed data-driven strategies to new levels.

In this series, we will draw from academic research, studies of high achieving organizations, and our own experience with outlier investment managers. We will examine the potential for outperformance in the investment sector, where markets often appear efficient until an inefficiency is unmasked. And we will discuss our efforts to bring a higher standard to family investing by focusing on talent, sourcing, and alignment. The goal of this series is to create a collection of our learnings on what it takes to outperform.

In this second issue, we explore the path to high-volume idea generation.

Creative Masterpieces—whether works of art business ideas or scientific breakthroughs—are often the result of two key behaviors.

The first behavior is “create lots of output.”

The second behavior is “put your work out there.”

In his book Originals, Adam Grant highlighted the fact that the high volume of work produced by Mozart and Beethoven contributed significantly to their success.

But their approach to prolific output is a tough model to emulate. Most of us are not born with genius, and prolific output did not come easily to these composers despite their gifts. In a letter to his sister in 1782, Mozart described a daily routine so intense that it left him only 5 hours for sleep.1

The composers not only toiled to produce a large volume of compositions, but they were also unreliable judges of their own work. According to a study of Beethoven’s letters, there were at least eight occasions in which Beethoven disliked a piece he had created, only for the world to judge it a masterpiece.2

If Mozart and Beethoven’s model was to toil alone and then reveal to many, open-source software pioneer Linus Torvalds followed a radically different approach. Torvalds, the principal developer of Linux, started by toiling alone, writing 10,000 lines of code. But then he released “Version 0.02” of the Linux kernel and made its source code available for free. This unusual move started a process that propelled his work beyond what he could have imagined—to 2 million lines of code and massive adoption across servers, smartphones, supercomputers, and many more devices.

When we look back at the prolific growth of Linux, we are struck by three elements of Torvalds’ approach that appear most impactful:

  1. Torvalds brought together a community of talent. The opportunity to contribute to Linux attracted many thousands of great developers who believed in its mission. Torvalds motivated their passion and acknowledged their accomplishments, to great effect.
  2. Developers were able to focus on their craft: Torvalds was known for the quote “Talk is cheap. Show me the code.” If you were passionate about device drivers, or memory management, or networking, he wanted to see what you could write to improve those subsystems. Developers concentrated their time on projects that best fit their skills and interests.
  3. Peers helped to quickly identify good and bad ideas. In the early years of Linux, Torvalds and a small group of programmers approved all proposed changes to the Linux kernel. Once accepted and released, new work was tested through hacking by large numbers of volunteers—a process that quickly revealed weaknesses. In assessing proposed changes to Linux, Torvalds had the benefit of being a “programmer judging programmers,” much like we at East Rock feel it is important to have “investors judging investors.”

Torvalds has been prolific in a way that resonates deeply with us at East Rock. The goal of our investment process is to access a large quantity of investment ideas from a network of talented investment partners. We know we can’t do it alone and we take inspiration from Torvalds’ groundbreaking work in collaboration.

In this issue of Changing the Game, we discuss how East Rock and creators in a wide range of fields have utilized similar elements to those that helped make Linux what it is today.

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Build a Community of Talent

“In open source, we feel strongly that to really do something well, you have to get a lot of people involved.” —Linus Torvalds

Mike Reiss, writer and producer of The Simpsons TV show, agrees with Torvalds about getting a lot of people involved.

“Who’s the one genius responsible for The Simpsons?” he asks in his brilliant memoir Springfield Confidential, “My answer to the question narrows it down to three people. Actually four. No, five. Make that thirteen.”

The Simpsons is the champion of TV shows when it comes to high-quality prolific output. It is the longest running American sitcom with a record 684 episodes over 30+ years. “The Simpsons has won so many Emmys,” Reiss writes, “it was parodied on the Simpsons/Family Guy crossover. Peter Griffin picks a fight with Homer Simpson. Homer yanks open an enormous cabinet stuffed with Emmys, which he hurls at Peter one by one.”

Much of the credit for the show’s success goes to the legendary Simpsons writing room. According to Reiss’ book, there are two basic things that allowed the writing room to churn out all those Emmy-winning scripts:

Success Factor

Reiss Comments

Writers were selected for the right reasons: they were great at writing jokes.

“Our writers aren’t clowns or performers—they’re introspective, hardworking people who will spend two hours trying to think of a title for an Itchy and Scratchy cartoon. (Winner: ‘Of Mice and Manslaughter.’).”

“These cats are squares, daddio, but, man, are they funny. After thirty years at the show, I still walk into work intimidated by how sharp the other writers are.”

Camaraderie and respect.

“One irritating or obstinate writer can bring the entire machinery of a show to a halt.”

One writer left after being asked to change his attitude: “I discussed it with my wife and she agreed—I can’t stop being an a**hole.”

“The writers’ room is a democracy where you vote with laughter.”

In sitcom writing rooms, you want people who write great jokes and get along with each other. In investing, you want people who find great investments and execute them well—generally with the support of a large trust network. This concept seems simple but is surprisingly underappreciated. Too often, career advancement at investment firms is tied to participation in large, visible, and often risky investments rather than a tedious search for hidden gems. At East Rock, the goal of our investment model is to build a community of partners with a track record of consistency—lots of winners and very few losers. Often, these partners are themselves hidden gems, and we need to go looking for them.

Occasionally, our search for investment partners leads to encounters that Mike Reiss might appreciate. Just as Reiss obsessed over Simpsons jokes, our partner Nichole Wagner obsesses over who is responsible for an investment firm’s best deals. Several years ago, she built a digital tool that alerted us when the profile of a private equity professional was removed from a firm’s website. Shortly after launching the tool, Nichole was meeting with a senior advisor to a $50 billion private equity firm. “Tell me about Michael3, why is he leaving?” she asked. Michael was one of the firm’s top contributors. He was a young partner, and not broadly known, but Nichole had pieced together his track record and knew it was among the firm’s best. The advisor was confused. “Michael is leaving?” he asked. It turned out, Michael was removed from the firm’s website before an internal announcement had been made, so Nichole found out before most of the firm! Ever since that meeting, their conversations always begin with him asking—“Is there anything about my colleagues I should know?”

Help Block the Noise

When we look at the success of Linux and The Simpsons, a clear similarity is that developers and writers were able to focus their time and energy on their craft. In all disciplines, one of the keys to prolific output is to strip away distractions.

An organization with an extraordinary track record of letting creative artists focus on their craft is Yaddo, an artist retreat in Saratoga Springs, NY. Yaddo offers short term residencies to artists who are accepted to their program, with all expenses paid. Collectively, Yaddo artists have won 78 Pulitzer Prizes, 31 MacArthur Fellowships, 69 National Book Awards, and a Nobel Prize. Prior residents include Saul Bellow, William Carlos Willams, James Baldwin, Hannah Arendt, Leonard Bernstein, Truman Capote, Langston Hughes, Sylvia Plath, Philip Roth, Mario Puzo, Jonathan Lethem, David Sedaris, and David Foster Wallace.

Sylvia Plath and her husband, the poet Ted Hughes, stayed at Yaddo in 1959. Hughes’ biographer Jonathan Bate writes: “Very few Plath poems written before Yaddo stick in the mind; almost all the hundred or so that Sylvia wrote thereafter sear themselves into the consciousness of the attentive reader. Years earlier, Plath had dreamed of gathering forces into a tight tense ball for the artistic leap. At Yaddo, she made that leap.”

What makes Yaddo so successful? Getting rid of distractions seems to be a big part of it.

Jules Feiffer, the Pulitzer Prize-winning satirist, said, “The place just puts life on hold for four or five weeks so you can turn out the work with no pressure or demands on you. You get isolated in time with no phone calls, no family pressures.”

But Yaddo is not pure isolation. The daily program consists of silent time from 9am to 4pm, followed by intense interaction in the evening hours.

Pergola in Yaddo’s gardens, photographed c. 1900–20

Composer Nathan Barr recalls: “Come dinnertime, I would find myself seated between a painter and a novelist one evening, between a choreographer and a poet the next. The conversations always felt fresh and exciting, and a day’s writer’s block would be washed away by dessert.”

At East Rock, a goal of our work is to free up investment managers to focus on making great investments. Many of our investment partners have recently left large, blue-chip private equity firms. They love investing but are reluctant to build a traditional firm like the one they left because of myriad potential distractions: time and travel for fundraising, the cost and effort to build operations infrastructure, and the pressure to invest at a minimum pace and show early profits. We offer our partners a user-friendly alternative. Within the context of small, independent firms that they create, our partners use our balance sheet as a substitute for a traditional fund. These creative and aligned partnerships allow them to execute a wide range of investments. We enable them to keep their organizations small, their overhead low, and get started right away. Some even co-locate with us in our New York City offices—designed by Yaddo Board Member Deborah Berke—where she achieved an ideal combination of privacy and collaboration.

A Braintrust of Peers

Since 1995, Pixar has released 22 feature films that have won 21 Academy Awards and grossed an astonishing $680 million per film. According to Pixar Co-Founder Ed Catmull, a special group called “The Braintrust” has been a key to the company’s success.

The Braintrust is charged with giving feedback on films in development. It is populated by creative people with a knack for storytelling—mainly directors, writers, and heads of story. The group exists in part because Pixar understands that even great directors have blind spots, and that peers tend to identify blind spots better than others.

“All directors, no matter how talented, organized, or clear of vision, become lost somewhere along the way,” Catmull wrote in his book Creativity, Inc. “That creates a problem for those who seek to give helpful feedback. How do you get a director to address a problem he or she cannot see?” The answer is feedback from peers that comes in the form of suggestions, rather than mandatory changes.

Part of the Braintrust’s job is to identify insurmountable problems early and help reduce the cost of failed projects. The other part of its job is to rescue ideas that need saving. According to Catmull, the Braintrust is keenly aware of how lost perspective—as directors “internalize and almost become the project”—can hinder an otherwise promising concept. Directors can become overwhelmed, with temporary inability to move forward. In response, Pixar encourages the presentation of early mock-ups and lowers expectations by calling them “ugly babies.” Throughout Pixar’s history, the give-and-take that occurs at these presentations has been considered so important that Catmull and Steve Jobs mutually agreed that Jobs should not attend Braintrust meetings. They were worried that Jobs’ incisiveness and dominant personality would throw off the subtle ingredients of Braintrust meetings that made the artists comfortable and helped transform the “ugly babies” into 15 of the 50 highest grossing animated films of all time.

The Power of Candor

Pixar’s Braintrust played an instrumental role in their unprecedented success. One of the key cornerstones of Ed Catmull’s Braintrust was that its members all had a stake in the game—that is, they all wanted the film to succeed because it ultimately benefited them. Also, members had empathy for the director of the film being analyzed, because they had all been in that vulnerable position before. This unique methodology created trust amongst members that allowed Pixar to break through plot and character barriers producing 15 consecutive blockbuster hits—an achievement no other studio has ever accomplished.

At right: 15 of the 50 Highest-Grossing Animated Films are from Pixar4

1. The Lion King (2019)$1,657,713,458 2. Frozen II (2019) Frozen (2013) 3. Incredibles 2 (2018) 4.$1,242,805,359 Minions (2015) 5. Toy Story 4 (2019) 6.$1,073,394,593 Toy Story 3 (2010) 7.$1,066,969,703 Despicable Me 3 (2017) 8. Finding Dory (2016) 9.$1,028,570,889 Zootopia (2016) 10. Despicable Me 2 (2013) 11. The Lion King (1994) 12. Finding Nemo (2003) 13.$940,350,086 Shrek 2 (2004) 14. Ice Age: Dawn of the Dinosaurs (2009) 15. Ice Age: Continental Drift (2012) 16. The Secret Life of Pets (2016) 17. Inside Out (2015) 18.$857,611,174 Shrek the Third (2007) 19. Coco (2017) 20.$807,082,196 Shrek Forever After (2010) 21. Madagascar 3: Europe’s Most Wanted (2012) 22. Monsters University (2013) 23.$743,559,607 Ne Zha (2019) 24. Up (2009) 25.$735,099,082 Moana (2016) 26. Kung Fu Panda 2 (2011) 27. Ice Age: The Meltdown (2006) 28. Big Hero 6 (2014) 29. Sing (2016) 30. Monsters, Inc. (2001) 31.$632,316,649 Kung Fu Panda (2008) 32. The Incredibles (2004) 33.$631,442,092 Ratatouille (2007) 34.$623,726,085 How to Train Your Dragon 2 (2014) 35. Madagascar: Escape 2 Africa (2008) 36. Tangled (2010) 37. The Croods (2013) 38. Cars 2 (2011) 39.$559,852,396 Puss in Boots (2011) 40. Despicable Me (2010) 41. Madagascar (2005) 42. Brave (2012) 43.$538,983,207 WALL-E (2008) 44.$533,281,433 Ralph Breaks the Internet (2018) 45. Hotel Transylvania 3: Summer Vacation (2018) 46. The Boss Baby (2017) 47. The Simpsons Movie (2007) 48. How to Train Your Dragon: The Hidden World (2019) 49. Kung Fu Panda 3 (2016) 50.$521,170,825

At East Rock, we aspire to play a role within our investment network similar to the Pixar Braintrust. Many members of our team have worked previously at private equity or hedge fund firms or in other direct investing roles. We believe that our team’s experience helps us identify flaws in potential investments—in particular those due to blind spots—that might be difficult to see otherwise. Occasionally, we can also recognize the potential of an investment that an outside manager is unsure about.

On the long list of “bullets dodged” that we maintain at East Rock is the name of a candy company that we were asked to invest in several years ago. It was presented to us by one of our smartest and most important investment partners. The company was growing fast and had a great brand. But when we heard the pitch, our antenna immediately went up. The opening line explained how many smart and accomplished people had already invested in the company and were likely to invest in the next round. The group included famous CEOs, well-known venture capital firms—even an actual rock star. We immediately braced ourselves for one of the great blind spots in all of investing: the comfort taken by investing alongside an impressive group of co-investors. Once we got to work on the investment opportunity, our concern grew. It turned out that the company’s brick-and-mortar stores were struggling. A lot of hope was being placed on unproven strategies such as e-commerce and international expansion. Questions that our partner would typically analyze to great length were glazed over. We decided to pass on the investment. While we agreed with our partner that the company might be acquired for a big price, the risks seemed too great. Unfortunately for those involved, the risks were too great. The company filed for bankruptcy 13 months later.

A happier story started with a phone call to discuss a longshot idea. Our partner EB Advisors felt it might be possible to control and liquidate a Collateralized Debt Obligation (CDO) entity called Augusta X. If it worked, it offered a large gain in less than one year. But the execution was complex; we would need to acquire CDO securities from three different sellers on multiple continents simultaneously. The probability of pulling that off seemed low relative to the cost of what would have to happen first: months of expensive due diligence. However, a member of the East Rock team realized in short order that we had a perfect resource in our network—an attorney who knew the CDO documents and structure inside and out. A two-hour meeting at the attorney’s office put the due diligence process on fast-track with a streamlined budget. One-by-one, we became comfortable with the complex steps required to complete the liquidation. As our understanding grew, so did our confidence in the investment. Within a few months we purchased the target securities, and EB’s longshot idea became one of the largest investments we have made. EB’s decision to share its work with us, and the collaboration that ensued, paid off for all of us.

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We have built a community of proven investing talent; have worked to free them from obligations beyond investing; and need each to discover significantly less than a single great idea every year.

Conclusion: It’s a Marathon, Not a Sprint

As sources of prolific output, Linux, The Simpsons, Yaddo, and Pixar all distinguish themselves by not only producing a lot of great work, but producing a lot of great work over a span of decades.

This longevity is a challenge for any organization, but for a show that operates within a defined setting such as The Simpsons, it is especially challenging to keep things fresh and interesting. But Mike Reiss doesn’t worry: “I’m often asked if I’m afraid the show will run out of ideas. It’s never a concern of mine. It helps having a big writing staff: twenty-three writers have to produce twenty-two stories a year; which means each writer needs to have only one good idea a year.”

As we approach the midpoint of our second decade, we at East Rock don’t worry about running out of ideas either. We have built a community of proven investing talent; have worked to free them from obligations beyond investing; meet with them often to help guide them in promising directions; and need each to discover significantly less than a single great idea every year. Rather than fatigue, it fills us with energy to be a part of this community of talent. We look forward to prolific output together for decades to come.