It was pitch black and a frigid -30 degrees when we began our descent. What meagre light we had came from beat up headlamps and the muted glow of stars. The occasional word in Swahili broke up the grunts of my companions as they worked their way down the rocky path in the cold mountain air. They were all jogging; I, however, was strapped into a rickety, antiquated wheelbarrow. After throwing up for several straight hours at base camp, I had been secured with ropes like an inmate into what can only be described as a death vehicle. Down the mountain we went. With every turn or drop, the wheelbarrow would lurch forward, someone would lose their grip, and someone else would scramble to catch it before it veered over the ledge with me inside. This would have made me anxious had I not been delirious from altitude sickness. As it was, I was content to keep my innards intact and marvel at the rather “over the top” end to my climb of Mount Kilimanjaro.
Source: Andrea Moroz
My attitude was not so pleasant the next day.
I awoke to the smell of breakfast cooking and a realization that I had not succeeded in my objective. The failure was crushing. After weeks of preparation, five long days of trekking, and coming within sight of the final leg of my journey, I had been unable to summit. To say I was gutted would be an understatement. While my friends were basking in the glorious sunrise at the top of the highest mountain in Africa, I was stuck in a tent with nothing to do but play solitaire and brood.
The human relationship with failure is curious. Like salt in a wound, failure aggravates and is a deeply uncomfortable experience. This discomfort is made worse by the knowledge that society tends to exalt winners and shame losers, implying that those who fail are lesser human beings. Yet society also concedes that failure is integral to progress. It is a paradox. On one hand, failure is disdained and viewed as something to avoid. On the other, it is recognized as imperative to progress and seen as, well… human. Still, like jury duty, most of us recognize its importance but pray to never experience it.
My climb of Mount Kilimanjaro opened my eyes to the idea that failure plays a role along the path to success, and as I sat in the warmth of the East African sun, I questioned what this role could be and what it takes to accomplish something truly remarkable. These reflections followed me home to Calgary and ended up sparking a number of productive conversations within my team at Mawer. As it turns out, how to achieve audacious goals is a question that applies as much to investors as it does to mountaineers.
Life is full of really difficult objectives that are worthy of effort. Our team firmly believes in pursuing these objectives, and yet there is no secret sauce, no magic, to attaining the audacious. In our experience, a straightforward approach containing only a few necessary first principles can improve the odds of successfully attaining our goals. It is this approach, along with our view on the role of failure in both life and investing, that we present in the following discussion. While our commentary is directly applicable to investors seeking to generate above average, risk-adjusted returns, these insights are also relevant to any of life’s major endeavours.
Launching Rocket Ships – Attaining the Audacious
Hundreds of people stood motionless as the video feed cut out. It was August 3, 2008 and SpaceX was launching its third, and possibly final, flight attempt of the Falcon 1, the rocket ship that the company hoped would become the first privately manufactured vehicle to reach Earth’s orbit. With over 350 employees watching, the Falcon 1 successfully executed the first- stage, effectively getting away from Earth’s gravity and past maximum dynamic pressure. But just as the vehicle was meant to decouple and continue on to its ultimate destination, mission control cut the video feed. Those on the ground knew that this meant something had gone horribly wrong.
Was SpaceX’s Flight No. 3 a failure? Yes. SpaceX’s objective was to launch rocket ships into space and Falcon 1 had unceremoniously fallen to Earth. However, if we only focus on SpaceX’s three failed attempts, we miss something important. The company was engineering at a high level, learning fast, and mitigating the impact of errors. While they hadn’t yet hit their target, they were progressing at a rapid pace and their process was increasing the likelihood that they would eventually succeed.
Highlighting this progressive and success-oriented mindset, Elon Musk, founder of SpaceX, walked outside of mission control mere minutes after Flight No. 3’s failure, bypassed the media, and spoke directly to his employees.1 His rousing speech shifted the mood of the crowd from one of despair to one of resolute determination. He informed his team that because he had pre-secured a sizeable investment in the company, they had enough financing to run two more major flight attempts. With the team re-energized, SpaceX mobilized an impressive failure investigation effort: they discovered the likely cause of failure within hours, updated their stakeholders within days, and built an entirely new rocket within weeks. All of this could have reasonably been expected to take months, if not a year. The SpaceX team accomplished this in under sixty days. By September 28, 2008, SpaceX became the first private company to successfully send a rocket ship into orbit.
Not every company can achieve this type of turnaround. A mediocre company with mediocre leadership would not have been so quick to evaluate its errors, galvanize its troops, and set itself up for a successful fourth launch. But SpaceX had designed its processes to ensure that they were maximizing the probability of their success, which was important because, as it turns out, rocket science is really hard.
A Framework for Accomplishing the Really Hard Stuff
(i.e., The True Challenges)
Let’s say, like Elon Musk, you seek to accomplish something exceptional. Where do you begin? As obvious as it sounds, the first step is to select something hard. It is remarkable how many people underestimate their abilities and instead shoot for goals that are safe. Your selection must be what we refer to as a True Challenge; something that redefines the boundaries of what you believe to be possible. The beauty of a True Challenge is that it tests your limits, forges character, and ensures that you learn something even if you fail.
A True Challenge is personal. It is something that you believe to be worthy and difficult, regardless of other people’s opinions. As an example, our team has an objective of beating the market over the long-term without taking on undue risk. Considering the vast amount of literature that argues that markets are efficient and successful active management is, at best, an illusion, this objective is audacious. Yet it is one we believe ourselves capable of accomplishing and one we perceive as worthy.
What does it take to accomplish a True Challenge? In our experience, there is a three principle framework that can be applied to help successfully attain audacious goals:
- Define the objective clearly
- Put the odds in your favour
- Fail right
Define the Objective Clearly
Once you’ve selected a True Challenge, it is necessary to clearly define your objective in terms of what success will look like and how it can be measured. This is integral because you need to know where you’re going in order to get there. This is part of the argument that Josh Kaufman makes in his book, The First 20 Hours: How to Learn Anything Fast, where he presents a framework for acquiring new skills such as playing the guitar or learning a new language.2 Kaufman argues that setting very clear performance targets is one of the most important steps a beginner can take when learning something new.
We believe the same process is necessary when approaching a True Challenge. For example, if our goal is to beat the market, we must take a step back and ask: What does this even mean? Does it mean beating an index over one year? Ten? Does it matter how much risk we take?
Clarifying your objective will also help you to assess its reasonability. There is a difference between having an audacious goal and beating your head against the wall trying to attain the impossible. For example, if an investor’s goal is to consistently generate returns above a particular benchmark over a ten year period, this would be difficult to achieve, but it could be done. In comparison, we would argue it is virtually impossible to beat the market every single day over the next ten years. Likewise, it would be unreasonable to aim to get every macroeconomic predication right, given the complex adaptive nature of asset markets.
Put the Odds in your Favour (Process)
Imagine this scenario: a 43 year old man is planning to run 250km across the Moroccan desert in 7 days. He must do so in 40+ degree heat, carrying all of his food, water, and gear on his back. And, oh yeah, he has never run a marathon in his life. What is the likelihood of success? Probably very low.
But now give this man a year to train, along with expert coaches, nutritionists and doctors who help him plan everything from his diet to the shoes he needs to wear. Give him two supportive, athletic friends with whom to run the race. Then make that man Jim Hall, our CIO, one of the most doggedly determined men around. The odds of success change. This is exactly the scenario that happened two years ago when Jim decided the manifestation of his mid-life crisis would be to complete the Marathon Des Sables. Having never run an endurance race before, even Jim will admit he was uncertain he would make it. But he did everything he could to put the odds of success in his favour. And Jim completed the race.
To achieve a True Challenge, it is imperative that you maximize the probability of success. This is where process is key. I didn’t just randomly show up at the foot of Mount Kilimanjaro and expect to climb a 5,895 meter mountain. Jim did not show up to the Sahara desert with his smelly, old sneakers and start running. Months before our trips, there was extensive preparation, rigorous research, training, and meetings. During both his race and my climb, we had very specific plans of attack for each day. We followed a process to improve our odds.
Within investing, process is of utmost importance. While the media likes to paint investors as eccentric characters making daring calls, this is mostly an illusion. The reality is that most great investors are not Wolf of Wall Street types. They have processes that put the odds in their favour and their processes are boring. It takes a lot of digging, hard work, and fact- checking to get an investment thesis right. Most of the time, investing is about as sexy as an Excel spreadsheet. But these processes are important because they make decisions systematic and this helps to guard investors against their own biases.
Source: Andrea Moroz
How does our team put the odds in our favour? The Mawer equity investment approach is to focus on compounding wealth over the long-term instead of being right about stock price movements in the short-term. By purchasing wealth-creating companies, run by capable management teams, at less than what we think they should be worth, we believe we will be able to generate an attractive return for our clients over the long-term. We also believe that it is far easier to be successful in investing when your process is systematic and repeatable, and fostered by a culture that facilitates effective decision-making. Of course, there are other approaches investors can take. This is not the only way; it is simply the one we have found to work over time.
After my bout of altitude sickness and a harrowing ride in a wheelbarrow, waiting at camp for hours was about the last thing I wanted to do. Alone, except for the constant presence of Mount Kilimanjaro, I found it nearly impossible to escape my failure – which was literally looming over me. Yet it was during this time that I began to understand the role that failure plays in self-actualization, investing, and life. I realized that there will be times when you fail, no matter how well you plan. What matters is whether you fail right.
As I discovered during my trek, the first step in failing right is mindset. It is inevitable that you will experience setbacks in life, whether you lose money on a stock or get carried down a mountain in a wheelbarrow. The kind of mindset you adopt in these situations can have a huge impact on your success. What we believe is that there are two factors that matter the most when it comes to mindset: (1) fixed vs. growth and (2) tenacity.
As Carol Dweck explains in Mindset: The New Psychology of Success, there are two kinds of people in the world: those with a fixed mindset and those with a growth mindset.3 People who have a fixed mindset believe that qualities like intelligence or talent are fixed traits; they see success as a product of inherent abilities which cannot be changed. In comparison, people with a growth mindset believe that talent is just the starting point and abilities can be developed through dedication and hard work. Unsurprisingly, individuals with growth mindsets are far more likely to tackle problems well, grow from failures, and achieve great things.
The power between these two mindsets is illustrated in “Praise for Intelligence Can Undermine Children’s Motivation and Performance,” a study of 400 fifth-graders conducted by Carol Dweck, Claudia Mueller, and a team from Columbia University.4 The authors were interested in the direct effect that praise for ability, as opposed to effort, had on participants’ goals and future levels of achievement.
One experiment involved in the study, had a group of children take three tests. After the first test, comprised of relatively easy questions, the children were either praised for their intelligence or for their effort. The second test was composed of very difficult questions, ensuring that the children failed. The third test contained a much more reasonable set of problems, similar in difficulty to the first test.
The children who were initially praised for their intelligence performed approximately 20% lower on the third test. They perceived their failure on the second test as a lack of ability; when they began to think that they weren’t as smart as they originally believed, it influenced how they performed on the subsequent test. Meanwhile, the children who were initially praised for their effort believed that they had not worked hard enough on the second test. Consequently, on the final test, they worked more persistently, performing approximately 30% higher than they did on the first test.
As the study above shows, having a growth mindset is clearly an important factor. Yet having this mindset is only half of the equation. The other half is sheer tenacity.
When the Falcon 1 crashed to the earth, did Elon Musk give everyone on his team a hug and tell them that “it’s OK, we tried and that’s what counts”? No. He implored his team to stick with him and said that, for his part, he would never ever give up. While high performers accept that failure is a necessary stepping stone on the path to greatness, they also do not view it as a true possibility in the long run. There is a fine line between approaching failure with a mindset that allows you to progress, and approaching it with the kind of indifference that leads to mediocrity or quitting. At the end of the day, outcomes still matter. Tenacity allows you to summit.
This begs the question: when is failure acceptable? While someone like Jim would be tempted to say never, the reality is that our team does allow for failure, but only if it results in a productive learning. That is one reason why our team created an “It’s Acceptable to Fail, If We…” list, which provides some guidance on dealing effectively with setbacks.
It is acceptable to fail, if we:
- Did our absolute best.
- Are not repeating a previous mistake.
- Learn something.
- Adapt our behaviours or attitudes based on this learning.
- Own our actions.
- Shorten the innovation window.
- Let it go and move forward
Two clarifications might be necessary here. First, when we say “own our actions” we mean that we seek to take responsibility for our mistakes. It is bad enough if an error is made; it is worse if you try to hide or deflect it. This is an incredibly important philosophy for an investment management team to understand, as errors must be corrected as soon as possible. A culture that views some types of failure as productive helps to create an environment where employees own their actions. In cultures that demand perfection, individuals have the tendency to hide even small, innocuous mistakes out of fear of blame or punishment. The problem is that this hiding behaviour is counterproductive to solving issues and creates a risk that the problem gets worse before it is uncovered. This can lead to even greater damage.
Second, when we say, “shorten the innovation window” what we mean is, how long does it take to perceive an error, learn from it, and correct it going forward? It is important not only to learn from little mistakes but to do so quickly. Moreover, when small failures lead to greater learning at a fast pace, better solutions and processes can be developed.†
Limit the Loss
So if you’re going to fail, it is better to fail small. Failing small allows you to avoid the errors that can take you out of the game entirely. Unfortunately, our emotions and biases can encourage us to take much larger risks than we even realize we are taking. Had I stayed at the top of Mount Kilimanjaro, I would have been risking my own life, a reality underscored by the fact that multiple people die on that mountain every year. It is easy to get carried away by overconfidence, hubris, and stubbornness. This is why we believe it is important to create processes that limit your losses.
It’s ironic that by avoiding small failures, you may end up accepting bigger ones. Managers that get stuck in their old ways and refuse to evolve are often subconsciously assuming a greater risk, resulting in their organizations’ inability to keep up with the market or their evolving customer base. This is the quandary presented by Clayton Christensen in The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail. Christensen argues that successful companies can put too much emphasis on customers’ current needs, and fail to adopt new technology or business models that will meet customers’ unstated or future needs.5 What is novel about Christensen’s argument is that companies falling into this trap are not normally being blind-sided; they are aware of the innovations in the market place, but they choose not to change because they are successful in their current environment. And then they fail. Big. Often it is better to fail small and fast because there is less risk of an unrecoverable blow-up in the end.
As an investor, it is critical to mitigate the big losses because it is difficult to recover once capital has been significantly impaired. At Mawer, we mitigate the large losses on both the company and portfolio levels. At the company level, we emphasize those that exhibit convexity: companies with limited exposure to the downside and with a positive exposure to the upside. An example of this is Vicom, a Singaporean company which provides government- mandated emissions tests on cars, as well as testing for corporations to help them meet quality, safety, and regulatory standards. Vicom’s protection on the downside comes from: a) its near-monopoly position in vehicle testing, which creates a steady stream of revenues every year, and b) the 78.5 million Singapore dollars Vicom has on its balance sheet, equivalent to roughly 50% of its assets. On the upside, the company benefits from the trend of higher quality and safety standards and an increased demand for testing throughout Asia.
At the portfolio level, one of the main ways we limit losses is through diversification. We seek to invest in companies that benefit from different kinds of environments. As an example, we have exposure to both real estate and insurance companies in our equity portfolios. While real estate investments are more attractive businesses to own in low-interest rate environments, many of the insurers we own are more profitable in environments with higher interest rates. In addition, losses are limited at the portfolio level through process rules, such as our sell discipline and the weight limits that we permit for each stock or bond in the portfolio.
Failure is not always obvious. In investing, failure can be especially hard to spot because feedback loops are long and it is hard to differentiate signal versus noise in the chaos of asset markets.
Let’s imagine Mary buys 100 shares of Hot Stock 99. Her thesis on the company is based on the view that customer orders are picking up, sell side expectations are wrong, and there will be a positive “earnings surprise” on the stock in ten days. In ten days, Hot Stock 99 does release their earnings, but the company has taken a write-down and earnings actually fall 10%. Fortunately for Mary, the Fed surprises everyone on that same day by announcing a massive quantitative easing program. All equity markets rise 4% and Hot Stock 99 is up with the market. Was Mary right? Of course not. The stock went up for a reason completely unrelated to Mary’s thesis, which turned out to be wrong. However, if Mary hadn’t read through the earnings release, she would have never recognized her error.
In investing, there is often confusion between outcome and process. In the short-term, it is possible to have a positive outcome from a flawed process and a negative outcome from a good process. Mary might get lucky with her buy of Hot Stock 99. But if Mary’s process is only right every 3 times out of 10, then over time you would expect Mary’s success rate to be about 30%. How you identify success and failure matters. Is a blackjack dealer a bad dealer if he loses a hand? No. Over enough hands and enough games played, the odds of blackjack are in the casino’s favour. Likewise, an investor is not a genius just because a stock goes up in one day. When it comes to asset markets, investors must be careful about how they measure success and failure.
Quitting vs. Stopping
In evaluating whether you have “failed right,” it is also important to recognize the difference between quitting and stopping. Quitting happens when you give up before you give your best. Stopping occurs when, even though you did your best, your desired outcome did not occur. This distinction is an important one because there is no shame in stopping. When I was climbing Mount Kilimanjaro, I never quit, but I was forced to stop. At some point a rather jolly Swedish Doctor/Mountaineer poked her head into my tent, had one look at me, and informed my guide to get me down the mountain stat. Stopping was rational in that moment.
In investing, there are also times when it makes sense to stop. Although fundamental investors like to believe that they are right and the market is missing something, this is not always the case. If a stock plummets 15%, it doesn’t necessarily mean it is now a better deal. Markets may be irrational sometimes, but most of the time they are efficient. A 15% drop in a stock is always telling you that a lot of people see something. There are times when a very sensible investment thesis goes awry. In those moments, it makes sense to evaluate whether you might be wrong and, if so, concede the error, cut your losses, and move on.
Look Back and Learn
By far the most important factor in failing productively is learning. There is nothing gained from failure if no new knowledge is acquired. Not only should you be learning from your own failures, but there is less pain and a lot of wisdom in learning from the failure of others (easier said than done). That is why it makes sense to systematically embed “learning points” – prescheduled times to reflect, share, and grow – into your process. Not only can this be done on a personal level, it should be done within teams.
There is a saying on our team that no one has a lock on knowledge. Ongoing learning is a requirement within our group, whether you are the most senior portfolio manager or the newest analyst. In our view, it is dangerous when you start to believe you know it all. Moreover, we treat knowledge as if it were a plate of food that we put in the middle of the table: there is an expectation that you share with others. This is true even if your experience was humbling and requires courage to share it.
In our experience, there is one overarching factor that is necessary for this type of learning to occur: an open and curious culture. Teams that are flat, open to new ideas, and collaborative are much more likely to share failures as they occur, allowing everyone to benefit. In our team, how we share our insights is an ongoing experiment. From weekly team meetings, to post mortems conducted on failed investments, to annual reviews with the whole group, we are constantly experimenting with “learning points” that can help us progress.
Re-framing the Mountain
It took nearly six hours from the time I woke up to the time when my friends finally came down the mountain and joined me. By that point, I had filled up the rest of the pages in my notebook, ate a full two bowls of plain spaghetti (I avoided the Mount Kilimanjaro version of pasta sauce, which believe me, you wouldn’t have wanted either) and finally won a game of solitaire. Even though I was not over my disappointment, I smiled to see my friends again. I was happy for their success and inspired by the looks of sheer pride on their faces.
Upon reflection, I realized it was my attitude that needed re-framing. After all, I had not quit. I plodded along on that mountain until my body refused to go further. And while I did not make it, two of my friends did. We had succeeded as a group, which was something to celebrate. Moreover, I left Mount Kilimanjaro with a deeper understanding of my limits, a greater appreciation for my health and homemade pasta sauce, and memories with friends that will last a lifetime. The experience was most certainly worth it even if I was unhappy with the final outcome.
Did my freshly acquired perspective make me feel much better? Honestly, no. I wish I could say that I shook my frustration. When you want something badly enough, setback only fuels your hunger.‡
Similarly, setbacks on our team only inspire us to push further, harder, better. When we lose money on a stock or a bond, we feel terrible. There is no way around this. We are a team that aspires to perform at the highest level at all times and being wrong about an investment is never an easy thing. But we also keep our objective in mind. Our objective is to generate above average, risk-adjusted returns for our clients over the long-run. This is the mountain we have set for ourselves to climb and we are undeterred in the pursuit of that goal. While setbacks make us more irritable, they fuel a fire in our bellies and inspire us to do everything within our power, and values, to succeed.
Kara Lilly, CFA
Mawer Global Investment Research
† Companies in Silicon Valley have developed processes that use failures productively for years, mostly through methodologies like the “Lean Start Up” movement. For an excellent introduction to these methods, read The Lean Start Up, by Eric Riess.
‡ My next challenge is the 24 Hours of Adrenalin race in Canmore, a grueling 24-hour mountain bike race that requires participants to overcome challenges such as dehydration, sleep deprivation and hallucination. Having not touched a mountain bike for over ten years, my goal is to finish the race and raise funds for charity.
1 Singh, Dolly, “Elon Musk: What is it like to work with Elon Musk?” Quora.com, Web. 1 April 2014.
2 Kaufman, Josh, The First 20 Hours: How to Learn Anything Fast. New York: Penguin Group (USA) Inc., 2013.
3 Dweck, Carol, Mindset: The New Psychology of Success. New York: Random House, 2007.
4 Mueller, Claudia, and Carol Dweck. “Praise for Intelligence Can Undermine Children’s Motivation and Performance.”
Journal of Personality and Social Psychology. 1998, Vol. 75, No. 1, 33-52.
5 Christensen, Clayton, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail. Boston: Harvard Business Review Press, 1997.