By Pontus Dackmo, CEO at Protean Funds: In many aspects of professional life, there is a lack of symmetry between risk and reward. War mongers propagating for a war but are certain never to suffer personally in a battle. Fund managers taking outsized risks (or no risks) but not investing their own money, therefore are not impacted along with investors when returns are negative or insufficient.
Nassim Nicholas Taleb, famous trader-turned-author, a few years ago devoted an entire book to the concept. Reading it was described by the FT as “being trapped in a cab with a cantankerous and over-opinionated driver”. I concur. But he still has a point: many players only have incentives, no dis-incentives. If you carry zero downside for your actions, you have no Skin In The Game. In a nutshell: don’t put someone else’s skin in the game, unless yours is right in there with it.
In a nutshell: don’t put someone else’s skin in the game, unless yours is right in there with it.
It’s not a new concept, but perhaps forgotten in certain industries today. Already Hammurabi, King of Old Babylon (1800 B.C.), codified, in what is widely considered the first set of laws, that:
“If a builder builds a house for a man and does not make its construction firm, and the house which he has built collapses and causes the death of the owner of the house, that builder shall be put to death.”
Harsh, maybe, to translate to asset management in 2023, but you get the point: no skimping on construction standards if your own skin is in the game. No shortcuts allowed. Utilize self-interest – the purest and powerful interest known to man.
This is what shapes Protean’s whole being, by explicit design. Avid readers of our monthly partner letter will recognize that we started the fund company to be able to manage our own capital. But the crux is we need institutional access. We need size to be relevant to company managements, liquidity- and research providers. Skin In The Game is not a marketing pitch – it’s the consequence of us needing to entice other investors to co-invest with us. Our skin is in the game by necessity and outright design.
Our performance since launch offers an early proof we can and will be adaptive to changing markets. We have participated reasonably in up markets, and protected capital in down markets. Reflecting heightened uncertainty, we continue to run the fund with a diversified portfolio and a net exposure in the lower end of what we expect to be the long-term average.
Our performance since launch offers an early proof we can and will be adaptive to changing markets.
There will always be times of sub-standard performance. It’s a mathematical certainty. Particularly over shorter periods of time. We manage the portfolio with a multi-year horizon and optimize for long-term performance (at least three years). This is not an excuse for short-term underperformance: we will always choose action ahead of inaction and try our best to minimize friction and mental biases that justify drawdowns, also in the short term.
Since inception in May 2022 we have beaten most indices, but we do not expect this to be the case for long in strong upwards moving markets. The real feature of the strategy is however that the return is generated with significantly lower risk. Our approximate standard deviation since launch is below 8 percent, less than half of what the market has realized in the same period.
A consequence of skin in the game, and an owner-operator mindset, is that we think of the portfolio in dollars and cents (or, rather, kronor och ören). We work for ourselves, and every basis point of absolute performance matters. It reflects on our positioning and work ethic: we hate losing money, but we don’t have a business (or a livelihood) if we don’t generate returns.
This owner-operator mindset means we are an unusual fund. Funds are often “products”, where buzzwords are piled on to incite asset growth. You are buying an exposure (sector, theme, style) and you as an investor, therefore, need to think about changing allocations between products every now and then. We don’t think that way. Or work that way. This is our sole vehicle for investing, and we rely on being able to change when the market changes (or preferably right before). We cannot afford, literally and metaphorically, to underperform and blame “our style is out of fashion right now” – we are trying hard to be an all-weather fund.
We cannot afford, literally and metaphorically, to underperform and blame “our style is out of fashion right now” – we are trying hard to be an all-weather fund.
So far, we’ve done alright, but the real test will be when a new paradigm emerges. Will we be able and willing to change? The one tenet we keep repeating is this: the real money is made being long. Pessimists don’t build skyscrapers. Therefore, we remain stubbornly net long despite heightened uncertainty. We’re not overconfident enough to believe we will pick the bottom when it occurs. But, to paraphrase Buffet’s 2020 shareholder letter:
“We remain unable to promise results. We can and do pledge to treat you as partners.”
With our long-term ambition it is our wish that anyone who invests with us evaluates our performance on a multi-year basis. This is how we evaluate ourselves. If we fail to generate decent risk-adjusted returns on a three-year-rolling basis we promise to close this fund down and return the capital because there is an evolutionary argument to skin in the game we wish to honor: if you don’t suffer when making poor decisions, evolution stops working and keeps sub-standard organizations alive. We do not want to fall down that rabbit hole.
This article features in HedgeNordic’s Nordic Hedge Fund Industry Report.