Halo, reshaping habits and altering thesis

Ten times in ten years! That was the dream run ABB (created in 1988 by the merger of Sweden’s ASEA and Switzerland’s Brown Boveri) was having at the turn of the previous century. The speed of integration between the two businesses was breathtaking and the cost savings unprecedented as plants were shut, jobs were cut and overheads slashed. ABB also expanded its global footprint through a series of expansions–in NAFTA, Central & Eastern Europe and Asia. At the helm of the company was a tall and lean man, with sharp eyes and trimmed goatee, Percy Barnevik, who Phil Rosenzweig writes in his book ‘The Halo Effect’ “was unprecedented for a European business leader–a Scandinavian who combined old world manners and language skills with American pragmatism and an orientation for action.”

As ABB’s profits rose and market capitalisation soared, there were numerous stories that nearly elevated Percy to god status. Business Week, Forbes, Industry Week, among others, wrote pieces praising his ability to make swift confident decisions, his workaholic culture and unpretentious candid style with occasional American profanity to cut bureaucratic bloat and push through. Academics joined the chorus as well, with Europe’s best-known professors of management at INSEAD complimenting his style. In 1996, the Korean Management Association named him “the world’s best honoured top manager.” Essentially, Percy was getting an award for receiving the most awards!

Over the next century, ABB was yet again ready for what it did best–reinvent itself; this time by entering many new areas including financial services while selling stakes in Daimler Chrysler and nuclear fuel business. Did it really bother anyone that the company was straying from core at the time? Not really. The board of directors was happy, the stock was surging to its all-time high and a business school case study talked about ABB’s transformation as if it were already a success.

In the decade that followed, while ABB’s operating revenue and profit slid, it also had to set aside close to half a billion dollars for asbestos litigation. The Chairman had to take over control from the then CEO, course correct, divest non-core businesses and raise loans to avoid a liquidity crisis. With the stock now down 90% from its peak, ABB’s Chairman remembered, “we had a lack of focus as Percy went on acquisition spree. The company wasn’t disciplined enough.” Later, managers recalled poor co-ordination among countries and dysfunctional competition. Lots of articles emerged criticizing ABB, but importantly none suggested that the company had changed in any way; it was the same organization, but the emphasis now was on ABB’s flaws.

Reshaping habit: Contrast the above story with what Annie Duke recollects in her book ‘Thinking in bets’ about Phil Ivey. Phil is an American professional poker player who has won 10 World Series of Poker bracelets, one World Poker Tour title and appeared at nine World Poker Tour final tables. He was, at one time, regarded by numerous poker observers and contemporaries as the best all-around player in the world.

In 2004, Phil smoked a star-studded final table. After his win, Phil and Annie’s brother (another pro player) went to a restaurant for dinner, during which Phil deconstructed every potential playing error he thought he might have made, actively seeking opinion. Most champions would have taken the night off to celebrate the win, but not Phil. He had earned half-million dollars and won a lengthy poker tournament over world-class competition, but all he wanted to do was discuss with a fellow pro where he could have made better decisions.

Altering investment thesis: While we might ridicule the press for the convoluted reporting in case of ABB (giving more credit than deserved and vice-versa), the bigger question for us is, how often do we mistake a great result for a great process? It’s natural for humans to boil down every outcome to one clear and distinct root cause (could be a person) that meets a plausible explanation.

In the world of investments, a profitable equity investment is not necessarily a reflection of just the quality of decision or investment acumen. Seldom we get lucky and end up generating a positive return despite questionable decisions. Of course, the opposite is also true–good decisions do not always result in profitable outcomes. But since all equity frameworks should be open to feedback loops, taking a profitable outcome as proof of quality of decisions will invariably lead to adverse outcomes in the future.

We recollect one such investment in a metals & mining company. One of the potential risks we had noted at the time of investing was the likelihood of cancellation of a newly acquired mine. A few months into our investment, the company’s mining lease did indeed get cancelled. Although we were sitting on close to 40% gains, we were bracing for a big downside on opening trade. However, the thesis in the market had changed overnight. Steel prices were on their way up and it chose to focus on strong pricing rather than the absence of mining leases. In our case, however, one of our major investment risks had materialized and we decided to exit the investment fully aware that the market has decided not to focus on that issue (stock eventually rose 40% higher than our exit price).

Like Phil who chose to strengthen his feedback mechanism despite having the best possible outcome, we hope that sticking to the discipline (booking gains when a potential risk manifests) helped us improve the quality of our investment framework despite losing out on the potential 40% returns.

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