• Monmouth Capital

Q3 2018: Let them eat Cake

The renowned entrepreneur Luke Johnson is one of my heroes. He has had an illustrious career as an entrepreneur, private equity investor and business leader. I have seen him at conferences and read his columns and articles avidly. And yet I am not writing here to eulogise his incredible achievements, intelligence or business acumen.


Instead, I will spend a few minutes considering how last week he ended up facing the prospect of losing £160m1 of his £260m2 wealth almost overnight and what lessons all of us – whether we are investing £100k or £100m – can learn. How could someone so skilful and wealthy end up with his financial security threatened?

Why do we diversify?

Diversification is one of very few “free lunches” in investment (as we have written about before here: https://www.monmouthcapital.co.uk/optionality). We preach the virtues of taking the earliest opportunity to diversify one’s wealth, especially if you are an entrepreneur with most of it concentrated in one asset.


Diversification means to allocate surplus capital to assets that draw returns from sources different to one’s main business or source of income.

Overconfidence

But this sermon often falls on deaf ears, especially to entrepreneurs. Successful entrepreneurs win not by spreading their bets but by going all in on something. The ones that succeed face a higher probability of suffering from overconfidence. They may overestimate their own part in the success of one outsized bet and underestimate the role of factors outside of their control.


If reports are accurate, Luke Johnson had £160m [1] of his total £260m [2] wealth invested in a single company, Patisserie Valerie. Given his amazing record, I do not doubt for a second his belief in his own ability to create value by acquiring and transforming a business such as this.

But his own ability was far from the only factor that would influence the success or failure of the business. Was a 60% allocation to this single company the right asset allocation for Mr Johnson? I cannot answer that without knowing the full picture and in particular understanding what other options he had.


What I can say is that 60% of his wealth was at least partly exposed to factors outside of his control; in other words, 60% of his wealth was exposed to risks which, it turns out, were not reasonable to anticipate, not easy to mitigate and, if they transpired, risked destroying his entire investment.

Adaptive behaviour

It does not matter how skilled or intelligent you are. It is not possible to control every factor that will influence the outcome of your investment decisions. The notion of an entrepreneur bending the world to his or her shape through sheer force of will is likely rooted in a small set of cases (think of Musk or Branson) and our desire for heroic stories.


Recognise this and you can start to adapt investment decisions to ensure that the chances of being wiped out are very low.


I wish Mr Johnson good fortune in rescuing the business somehow in the coming days and weeks. For the rest of us looking on, there can hardly be a more stark demonstration of the importance of diversification.

- FS


Notes

(1) The Sunday Times has excellent coverage, including interviews with Johnson, who was a regular columnist for the paper (although he has for the time being decided to stop writing until he has greater control over Patisserie Valerie): https://www.thetimes.co.uk/edition/business/nightmare-at-the-cake-counter-for-patisserie-valerie-9zjvw3fl0

(2) According to The Sunday Times Rich List 2018, Johnson’s overall wealth was approximately £260m. https://features.thesundaytimes.co.uk/richlist/view/group6/1/name/asc/luke%20johnson#profile-0

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