Over the last two decades, TDM has managed a highly concentrated portfolio of companies consisting of only 10–15 at any one time. It has meant as long-term investors, that we’ve only ever made c.60 investments. We believe this high-conviction approach is the basis of compounding capital for our clients at high rates of return. This imposed constraint forces us to constantly be raising the bar for what makes a great TDM investment.
This model of thinking is straight from the wisdom of Warren Buffett’s punch card approach to managing the Berkshire portfolio. The ‘Punch Card Mentality’ is common vernacular in the TDM Investment Team, particularly when new ideas come to the table, and so it is not by coincidence that it has also become a framework for reflection.
In a display of vulnerability and humility, Hamish Corlett shared the below reflection with our team about his investment performance over the life of TDM using the punch card framework. When this very idea came up during Tom Cowan’s recent discussion with David and Ben on Acquired, Hamish’s reflection seemed too good not to publish.
By Hamish Corlett
On my recent holiday break, I spent time reflecting on my contribution to TDM’s investment decisions over the last 18–24 months. In my gut, I wasn’t feeling satisfied with my contributions as a senior member of the team. I felt the need to dig deeper.
This reflection process is probably not surprising in the midst of a bear market. It’s easy to slip into regret when share prices are down. Despite that obvious bias, my strong instinct was that my performance had been disappointing. I was compelled to diagnose how I was feeling and look for opportunities to improve.
Coincidentally, I listened to an interview with Quentin Tarantino on the Joe Rogan Experience podcast. Having watched a few of his movies but not knowing much about the man himself, it floored me to learn that Tarantino had committed to only making ten movies in his lifetime. Ten. Despite his success and ample opportunity to create many more movies with the world’s best actors, he has purposefully constrained himself to ten.
His rationale: This tight constraint will ensure each decision to make a movie has the highest levels of passion, belief, energy and conviction. He even went so far as to say, ‘When I make a movie, I want it to be everything to me, like I would die for it.’
This is the punch card mentality, a powerful framework for investing and life that has been foundational to TDM’s investment philosophy. It’s a lesson I learnt early in my life and career from Warren Buffet:
‘I’ve told students, if when they get out of school, they’ve got a punch card with 20 punches on it and that’s all the investment decisions they got to make in their entire life, they would get very rich because they would think very hard about every one. You don’t need 20 right decisions to get very rich – four or five will probably do it over time.’
It seems obvious in theory – make fewer, well-informed, high-conviction investments. Though once you consider putting that theory into practice, questions begin to emerge. What is the right number of punches? And how do you know when it’s the right time to punch and when to hold back?
The Tarantino interview caused me to reflect on my own adherence to this mentality. How many times have I been punching my card? Have I been punching wisely? Would I have made the same decisions if I had been more rigorous with my punch card mentality?
I’d like to share with you my process for assessing my performance as objectively as possible using the punch card approach. But before I do that, it’s worth explaining how the punch card mentality has influenced TDM’s investing practices.
At TDM, we have always believed that the punch card mentality would be a cornerstone of delivering strong long-term returns. It has been purposefully embedded into our portfolio management principles. We limit the number of companies in the portfolio to 15 and our investment horizon to 5–10 years. These two requirements structurally limit the number of ‘punches’ we can make.
Theoretically, it implies around 2–4 investments in new companies each year, allowing for inevitable mistakes or exits due to price, take outs or situations where the facts change. On reflection, the data suggests we are broadly adhering to these constraints. Since 2008, we have made 3–4 new investments each year. The largest number of new investments made in a year was seven in 2019. The lowest was in 2011 when only one new investment was made.
The 15-company constraint is somewhat arbitrary. It could be 10 or 20, just like Tarantino could have chosen 8 or 12 movies. It’s the mentality around the constraint that’s most important.
I began by looking back at all past TDM investments since 2008 –around 60 in total–and identified the investments where I either led the investment or felt like I advocated for it in an extraordinary manner. I left out others where I was supportive of the investment but didn’t lead the investment or extraordinarily advocate for it.
The line used to define if I had used a punch is blurry, but as I went through the 60 odd names, it became reasonably clear to me to which category each company belonged.
This exercise focused on reconciling how many punches I had been using. It was less about how many of those punches were successes and mistakes, although I have also taken a view on that.
Here are the stats:
A primary motivation for this reflection is determining how many punches are optimal over a 15–20 year period. Clearly, I am well over Buffett’s 20 lifetime punches. But what is the correct number of punches for me in the context of my role at TDM?
I think this timeframe is appropriate as it most likely captures various market cycles which could influence frequency. I would expect frequency to increase in a bear market and decrease in a bull market.
Investment experience would also appropriately influence punch card frequency. In the early days of my career, especially pre-TDM, I didn’t feel like I had sufficient pattern recognition for advocating for investments with a high level of conviction.
Broadly speaking, my frequency of punches has remained reasonably stable over the three phases of TDM listed above. I am punching my card approximately three times per annum.
My overall gut feeling is that three per annum on average is higher than optimal. There are likely benefits to limiting my punches to one to two per annum.
A big part of that gut feeling is an awareness of my bias towards optimism. An uncomfortable constraint limiting punches to one to two per annum feels like a healthy place to be.
Another factor enforcing a tighter constraint on myself is our larger investment team and increasing tenure amongst the team. This reduces the requirement for me to spend punches. In the early days of TDM, we had three people advocating for ideas in a portfolio of up to 15 companies. Now we have 10–15 people who can champion investments.
Finally, over the next 15–20 years, we will be deploying much more significant sums of capital. Liquidity will likely reduce substantially. Our ability to exit positions will diminish. This factor makes me feel that even a constraint of one to two times a year could be too generous.
I would classify 11 of the 44 investments as unequivocal mistakes – a mistake rate of 25%. This is not determined by whether or not they made a profit; if it were, the number would be lower. It was determined by getting a critical aspect of the investment thesis so wrong that it would be highly likely to lead to a material impairment of capital over a 5–10 year period.
These mistakes were distributed reasonably evenly over the three phases – four in phase one, three in phase two and four in phase three. What struck me about the mistakes in the most recent phase was their magnitude. It became clearer at that point that the disappointment I was feeling was more about the magnitude of my mistakes than the frequency.
I distinguished mistakes from situations where the facts changed materially post-investment and I changed my mind. This happened on six occasions. I haven’t classified these as mistakes. We closed out these positions decisively.
Finally, there are three of the 44 more recently where the jury is still out on the success or failure question.
I have spent time reflecting on whether a more constrained punch card mentality would have reduced this error frequency. This reflection is loaded with bias; it’s difficult to answer conclusively. But two themes were common for all the mistakes.
Firstly, the mistakes were characterised by a materially lower level of conviction on the investment thesis at the time of investment compared to the investments I advocated for that had an unequivocally successful outcome. Secondly, and even more glaringly obvious, I got the people and culture part of the investment thesis very wrong. This second attribute doesn’t necessarily prove causation. However, there is no doubt that there is a high correlation between bad investments and bad people and culture over the long-term.
Given this assessment, there are three key takeaways:
1. Tighter punch card constraint: I can’t help but feel that a tighter punch card constraint would serve me well by forcing a higher level of conviction each time I punch.
2. Keep a record of my self-assessed conviction: I have never kept a record of my level of conviction at the time of investment. This is a practice I will implement going forward, i.e. What is my self-assessed (rate from 0–10) level of conviction of a successful outcome at the time of investment?
3. People & Culture due diligence: Keep raising the bar on people and culture due diligence. This is a major strategic focus for TDM to keep building on how we diagnose P&C.
Of the 44 investments I have extraordinarily advocated for, I have been ‘all in’ on 15. These are instances where I have advocated for large or ‘all chips in’ position sizes (>8% of the portfolio). I would classify two of the 15 as mistakes, and the jury is still out on one. The mistake rate in the ‘all in’ category is lower (13% for ‘all in’ vs. 25% in total).
‘Big opportunities in life have to be seized. We don’t do very many things, but when we get the chance to do something that’s right and big, we’ve got to do it.’
This is the reminder Buffett often includes with his punch card analogy. Those truly outstanding investments, the life-changing ones, are in limited supply; the punch card mentality provides a necessary sense check for when to let a few ‘good’ investments pass so that when the time comes, you’re ready to go all in on the great ones.
Our goal of continuing to compound capital at 25% per annum for many years to come is no easy feat. Mistakes will be made. Calibrating the optimal setting of conviction, risk, and reward must be a conscious and purposeful process. The punch card mentality is a valuable tool in getting that calibration right.
Hopefully, my more constrained punch card for the next phase of TDM will mean I will avoid some mistakes. But it will also likely mean that I don’t advocate for some good investments. I am OK with that trade-off. The most important thing is that my punch card isn’t so constrained that I miss those great opportunities that need to be seized.