Australian money manager Rhett Kessler learned the art of negotiation from the masters: professional FBI Agents who work with terrorists, master criminals and desperate psychopaths who got in way over their head.
Now, the senior fund manager of the $727 million Pengana Australian Equities Fund, is telling Bloomberg that the FBI's interview techniques for getting under the skin of CEOs during criminal investigations - a tool used to catch them in lies, exaggerations and deflections of blame for their actions - can also be useful for investment analysts seeking to evaluate companies and their management.
In a way, Kessler's hedge fund is a lot like the FBI: They're constantly investigating targets, only the fund's targets are usually public companies, not criminals. Like the FBI, "We have a dossier on each management team.”
Here's how Kessler puts these tools to work: Before looking too deeply into a company, he first tries to gauge whether they're trustworthy and competent. The approach has yielded amazing returns for Kessler: his fund has posted double-digit returns, on average, since it was founded in 2008.
But what's most important here is that Kessler's interview technique appears to be producing reliable, steady returns at a time when the hottest funds of the day are dumping millions of dollars into building complex algorithms and embracing other quant-driven techniques to try and gain an edge over the competition. Kessler has apparently found an edge just by talking to people, a much less expensive strategy.
Here's more from BBG:
The Pengana Australian Equities Fund has gained 10.4% per year, net of fees, since July 2008, topping a 6.7% advance in the Australian Stock Exchange All Ordinaries Index, according to the fund’s most recent report on its website. Kessler says the rush into passive investing and quantitative strategies in recent years will "create a better environment for stock pickers as the herd gets bigger."
Then again, the fact that Kesslerr has millions of dollars at his disposal makes it easier to gain access to key figures within companies.
Many of Kessler's best-performing names are small companies involved in ostensibly "boring" businesses.
Kessler’s fund counts among its top holdings stocks such as Aristocrat Leisure Ltd., which sells gaming machines to casinos and clubs, and CSL Ltd., a maker of pharmaceutical and diagnostic products derived from human plasma. Aristocrat is up 45% this year, while CSL has risen 35%.
Here's a rundown of their top holdings:
Presently, Kessler's main fund has 15% of its assets in cash - wary of deteriorating economic data in Australia and high stock valuations. If any young investors ever have an opportunity to take a similar class with FBI instructors, they should jump at the chance. Among the techniques that Kessler learned: Asking questions to which you already know the answers.
This allows Kessler to determine whether the CEO is honest, or prone to exaggeration. These personality traits, Kessler found, can have a tremendous impact on how an individual runs a business.
"For every 10 questions we are going to ask, we all know the answers to three or four of them," he said. Some of them will be to show the person in a good light. Some of them will be to show the person in a bad light. And we know the answers. "
Another technique he employs: What they call "A, B, C, D" questions.
He sometimes asks what he calls the “A, B, C, D question.” In this, the fund manager has deliberately missed the point, leaving out one piece of information that’s crucial to understanding the situation - something that reflects badly on the executive. He’s checking if the interviewee will point it out.
"That’s why we call it the A, B, C, D question," Kessler said. "Are they a volunteer of bad information or not?"
That question is supposed to gauge whether executives will easily volunteer information that reflects poorly on them or the company. Readers can probably imagine how this might be helpful.
Bottom line: If you ever have the opportunity to take a class about interrogation techniques, take it.