Introduction

Patrick: [00:01:19] Our guest this week is John Rogers, the founder, CEO and CIO of Ariel Investments, one of the longest standing asset management businesses in existence. John's resume is nuts. In addition to his success at Ariel, he was the captain of the Princeton Men's Basketball team. He was the co-chair of Barack Obama's presidential inauguration. He sits on the board of McDonald's and he has given back to his community more than I can possibly list here.

John and I discuss Ariel's Investment process and its evolution over the years, lessons from John's basketball career, value investing and asset management's diversity problem among many other interesting issues. There are not many people who have been the chief investment officer at the same firm for more than 30 years, so it was a real pleasure hearing about John's career and learning from his experience.

You can find show notes at investorfieldguide.com/rogers. And now please enjoy my conversation with John Rogers. Well, John, thank you very much for joining me today. This is going to be a blast and I always try to find somewhere interesting or not obvious to start. So I'd love to start with basketball if we could.

You were the captain of the Ivy championship team at Princeton, your senior year, and I'm always amazed by how many ex-athletes you find in the investing world. It seems to be a good indicator of people that go on to have success. So I'd love to hear a bit about your experience playing basketball and maybe more importantly, the key lessons that you learned on that team that have carried you over into your business career.

John: [00:02:51] Oh, well, thank you. You probably noticed when you came we're actually meeting in the Pete Carril, which is named after my coach at Princeton, and he's actually a genius. He's someone that is one of the smartest people that I've ever come across. And the time that I had a chance to play basketball at Princeton really did change my life.

And I was very fortunate because I literally, back when I was playing freshman, couldn't play varsity basketball. You had to play in the freshmen team and then sophomore year I was the last man on the team. There's 15 uniforms, I got the 15th uniform and I barely made it.

And even after I made the team, as he was going down the line, talking about each player after practice one day, he said, "I'm not sure how long I can keep you around Johnny Rogers. You have absolutely no idea what you're doing. You're not a basketball player, no one wants to play with you." So the fact that I got to be captain a couple of years later was just a complete miracle, but again, it changed my life.

The beginning values that I understood originally have been expanded over time. The key value in the beginning that I focused on, that he taught, was that he really made you understand that when you're on the basketball court, you always are thinking about your teammates first. And there was just no excuse for selfishness and that it was just totally unacceptable.

And he pounded it home very strongly and very clearly, but he also taught you to understand how, when you helped others you helped yourself in the end of the day and you helped the team win. And he would be able to show you and stop practice and show you how the unselfish acts led to really great outcomes. And it was just terrific. That was the number one value.

As time's gone on, the other thing that I've learned that appreciates the second thing was that he was someone who believed that you did things the same way every single time. That every pass had to be right in the right spot for your teammate to catch it. Every cut had to be made with the right angle. Every time you dribbled and handed off, you had to have the exact right angle.

You couldn't do it a little bit of a banana cut here, or a little bit of a softer cut there. It had to be done with precision and excellence each and every time and there was no excuse for doing it in a way that wasn't the right way every time. And he would just stop practice, put everyone back where they were and show you exactly what you should have been doing. And he understood what you were thinking when you made the mistakes.

So, that idea of precision is something that was drilled into you to do it the right way every single time. And the final thing that I've gotten as I've gotten older, I've learned to appreciate is he taught you to concentrate. That every possession mattered and every moment that you're on the court mattered, you can never take a play off in practice, let alone take a playoff in a game.

And so as I think about it, that ability to concentrate for long periods of time is something that I think is something that we learned playing basketball at Princeton that's really very, very critical. And all three of those things I think are very important to what we do here at Ariel, just to bring it full circle. We try to create a sense that this is a team here, that we're all in this together. Everybody owns stock in the company.

We try to make decisions collaboratively and make sure that everyone's views and perspectives are heard and that people understand it doesn't matter what your title is. That everybody has important things they can contribute to the team.

Second thing about doing things the right way every time when we do our research reports and when we're thinking about companies talking about companies, we want to make sure you don't take shortcuts. You get to know your companies extremely well. You try to prepare for the meetings with management teams.

You want to read everything there is to read, and you're going to do it every time with precision and consistency. And that's something that I try to pound home here. And sometimes I think I take it for granted that everyone had the same experience as I did and I have to remind people of how important it is. And then finally, the idea of concentration is...

These markets are so volatile, especially the last 10 years and the stress and strains and the ups and the downs, and what's happening, whether it's the financial crisis or what's happening in Greece, or United States debt being downgraded, you've got to be able to keep your wits about you when there's an enormous amount of stress going on and so much change going on. And I think being able to concentrate and stay calm while everyone else is kind of rattled is an important skill in this industry.

Patrick: [00:07:18] You already mentioned an example of that idea of consistency of always preparing the same way and doing the work. I'd be curious what the cleanest analog is on the Ariel side of this idea of stopping practice. I love that, where the coach would stop practicing and reorient or point things out. What have you found to be the most effective ways of doing something like that with the investment team?

John: [00:07:41] Well, what we do, and I'm sure a lot of firms do this, so I don't think it's too creative or original, but we do try to do post-mortems on the companies that have not worked and to make sure that we come in prepared where everyone has read everything and re-read the research reports that we created ourselves, re-read thoughts from other analysts in sell side and buy side, and then come in and say, "What were we thinking? How did we miss this?"

We really do think that's an important part of the discipline of putting everyone sort of back where they were when we made that decision and to try to create an atmosphere so we understand what went wrong the last time so we don't replicate that mistake in the future. I think that's probably the number one key thing that we've tried to do that's sort of consistent with what coach would have taught us to do.

Investment Process and Edge

Patrick: [00:08:27] So, I'm in town meeting with some large capital allocators and the number one question that they all ask is, "What is your edge?" Which is the appropriate question, right? In incredibly competitive markets that are arguably more competitive than ever. I'd love to start exploring your investment process.

So everyone's got their own way of starting with a large universe of thousands of stocks and narrowing it down to a portfolio. So in as much detail as you're comfortable, I love to hear about people's different investment processes and how that can manifest in an edge versus an overall market. So how do you start?

John: [00:08:58] Well, that's an interesting way you talked about that because I think the process is actually different than the edge. Because for us, I think it's important to have the process, as I said earlier, to make sure you do things consistently and the research reports are written thoughtfully and as thoroughly as possible and that you've explored everything.

And that each of our analysts knows their industries extremely well, so they know the best companies in their sector and the worst companies in their sector. And they know the cheapest stocks in their sector and the most expensive stocks in their sector. And so for us as a process, you've got to make sure that the analysts, who are the experts in their industries are constantly resorting their names and understanding which ones are the ones that have the best opportunity for us to look at.

And I think that's really, really important. We're going to use computer screens also to enhance that, to make sure we're looking for companies that meet our basic criteria, the kind of industries that fit the kind of consistent earnings' growth that we like to see, the kind of industries and the companies that have the appropriate debt levels and the appropriate valuation levels, because we think we can find a great business that isn't over leveraged and you can buy it at the right price, you're going to end up with really, really good results.

But a key part of that process though, as I've said earlier, is that you've got no substitute for getting out and doing the homework and seeing that management team, looking people in the eyes, seeing them face to face, going to the conferences, going to the trade shows, talking to competitors, talking to customers, talking to other people who own stock, talking to the sell side.

You've got to do all of that as a big part of the process and it has to be done consistently every single time. Charles Bobrinskoy, our Head of the Research Group and Tim Fidler, our Director of Research, they're responsible for making sure that process is done consistently.

Now, I think there're things that we do that are different that maybe I'll start to get at what the edge is about is, the number one theme here, when you walk through our offices, you'll see turtles everywhere. And so we are one of these rare people who looks at this business with a long-term perspective through a long-term lens and we do it by wanting to own names.

For sometimes we've owned stocks now for over 20 years, and that's highly unusual today. And when we go out and talk to management teams, they all tell us, "You're one of the rare firms that comes in and wants to talk about three and five year and seven year strategic plans, not the three and five and seven month results."

And that ability to have that long-term perspective is something that I think really does distinguish us and it helps us to build better relationships with our management team. And it helps us to, from a behavioral finance standpoint, not get caught up with all the recency effects and all the noise of the current moment that can sometimes distract from making the right judgments about the quality of that company.

Because we're going to be buying companies often when there is that temporary bad news, and that ability to look out over the horizon and see what that business can be like once you get back to normal is something that I think is rare in this industry. I think maybe that's probably at the heart of our edge, that ability to look out further than others and to see kind of what things would look like once the sun is out again, and the clouds have drifted away. And I think most people have a hard time doing that. They just get caught up in the now.

Patrick: [00:12:24] Everyone pays lip service to being a long-term investor, but very hard to actually execute on. One of the trends that interests me is the decline in the average tenure for CEOs of public companies. So I'm curious how you think about finding companies and then management teams behind those companies that are set up or the incentives are longer than the three months to one year, which unfortunately that quarterly earnings report has been such an important thing on Wall Street.

Screening for cheaper stocks responsibly, leveraged stocks, that really resonates with me obviously as a quant. But if you're going to hold the company for up to 20 years or at least five years, how are you investigating or evaluating managers?

John: [00:13:07] I think a couple of things are critical here, and I think these are things also that's a second part of the edge, is that, one, we learned this from Warren buffet. We borrow this clearly from him of staying within your circle of competence. He often talks about this shouldn't be like Noah's ark where you own two of everything.

And so number one, if you know your sector really, really well. You know the companies within the sector, you're going to know then the management teams within that sector, and be able to determine by talking to all the companies, who are the most outstanding managers and who are the weakest? And who's been there for the longterm? Who's had the best experience? Who are the honest brokers who are going to tell you the truth as they know it?

And I think, again, that sense of expertise allows you to evaluate managers from top to bottom. And I think that's really, really critical. I think also this idea we talked about earlier, being a longterm, we build relationships over time and so you really get a chance to see which management teams deliver on what they said they're going to do.

We talk to managements every quarter and you can see which management teams are doing what they said and executing their plan consistently and not finding excuses when things go off track to explain a way why things didn't go well, but are going to be saying, "We had to make this adjustment. Here are the reasons why. We made a mistake here, here's how we fixed it." You want to see that kind of directness as you're looking for management teams. And I think that's more of an art than a science.

And then the final part of it is when you're talking to managements and again, this is something that I think we can do well. And we've actually used BIA Associates to help us be better questioners. They really help advise you on how to ask the best questions and determine whether people are telling you the truth.

You really want to be with people where you can sense that they are truly committed to doing what's right for shareholders. And as you ask questions and talk with them, you can get a sense that they really want to come through for you because they know that we're big shareholders and they know I have a responsibility and we have a responsibility to our customers.

And I found that when I found those management teams that are rooting for us to be successful and realize that they have a responsibility to deliver results to help us be successful, that's when we've gotten the best results.

Patrick: [00:15:23] You mentioned BIA, I've heard that name come up a couple of times of being able to detect lies. So maybe I'll ask the question the opposite way, which is what are the biggest red flags or things you look to avoid, things that would scare you.

Let's say you found a business that quantitatively and the industry checks out, and it seems like a really attractive opportunity, but then something happens that you say, "Okay, we've seen this before and it doesn't end well." What would be some negative screens, things to avoid?

John: [00:15:49] I think that one I touched on earlier is when management teams are giving you excuses, "The weather was bad."

Patrick: [00:15:59] Things that go on all the time.

John: [00:16:01] Right. Yeah. Weather. It's like, "Come on, you guys have been working your plan, you should be able to overcome most of those kinds of challenges." But I think the other things we're looking for and clearly one thing we've learned over the years, hopefully we've improved on, is that managements that, instead of thinking about how to build a stronger better business and do a better job of their customers are constantly looking to make acquisitions all the time and they're willing to leverage up to make the acquisitions. And so we think they're making bad capital allocation decisions.

And so watching carefully and understanding which management teams understand that if they're going to make an acquisition it should be within their circle of competence and that the leverage should be something that they can manage. And we try to really look closely at that. And when management teams often they stretch the balance sheet, they try to justify it, they've got everything prime for perfection.

It's like, "Okay, we're going to be able to handle this because the economy is going to stay strong for the next seven years. There's not going to be a recession. Everything will be perfect. Interest rates will stay low. We'll be able to redo our debt," and not understand that maybe rates can go higher, maybe the economy can get weak.

Maybe there'll be a problem overseas somewhere in one of your divisions and now you don't have that margin of safety because you've levered up to make the strategic acquisition. So that's where this whole idea around capital allocation is critical. And then the final thing, I guess, there's so many things you could be, but one of the things is how much are they groupthink people? Or how much are they doing what's right, because they know it's the right thing in their heart.

So, you see management teams now all the time. Making sense of the buyback stock, because everyone else is buying back stock. And they've been taught by the investment bankers or the sell side that if you keep buying back stock, you can goose your earnings growth rate. People will be happy. You'll keep activist away from you because you're buying back stock.

And they're forgetting that you've got to be buying that stock back at a significant discount to its intrinsic value or you're going to be destroying shareholder value. And so when you see people who've just drank the Kool-Aid and are going down a path without being thoughtful about it, it's something that we want to be away from. We want to stay away from groupthinkers. We want original thinkers as our management teams.

Patrick: [00:18:19] You said two things that really resonate, not only with me, but with our work empirically in the data. The first being that one of the best ways to avoid companies is we call them empire builders. So the largest percentage increase in capital spending, in the asset base, which sounds like growth and sometimes people think is a good thing, but actually the companies that have the largest ramp up in CapEx have tended to underperform and acquisitions goodwill have tended to go on to underperform.

And then the same thing with buybacks, where buybacks as a whole, obviously it's a huge trend, a return of capital trend in place of dividends often, but companies that buy back at expensive prices relative to the market destroy value, do very badly versus the market. Whereas those that buy back at discounts versus their peers, those stocks tend to go on to outperform pretty significantly. So, this idea of...

You're one of the first that's talked a lot about capital allocation as a key part of the value equation, and I think that that is an understudied and underappreciated way of finding great companies, CEOs that are thoughtful about allocating capital. I'd love to go way back to the beginning of Ariel.

So in the early 1980s you run one of the longest standing asset management businesses in our industry and now it's great that you've got a team of analysts that know industry so well, but at the beginning, I think it was basically just you. So I'm curious, kind of what the origin story is for your interest, your curiosity, your spark in the world of investing. How did you get so interested in this job?

John: [00:19:56] Thanks for asking because it is a well-known story, I think, here in town, in Chicago, around the fact that my father bought stocks for me every birthday and every Christmas after I was 12 years old instead of toys. And I always joked that it wasn't a lot of fun to go to the Christmas tree and find an envelope instead of a toy.

But it got to be kind of neat after a while because what he did was he let me keep the dividend checks that would come in the mail every three months. And my parents are divorced, so when I'd go visit my dad on the weekends, I would read through the quarterly reports and annual reports of the blue chip companies he had bought for me. And I just loved it and we would talk about it.

And then he subscribed to different newsletters and I would read the newsletters when I was there and it just became his passion. And then that led me to going to visit his stockbroker, a man named Stacy Adams at Freeling and Company on the South street and I would watch the ticker tape go by the old Trans-Lux machines and it was just fun. It was exhilarating.

And so then finally when I went off to Princeton my father turned the portfolio over to me and let me trade it on my own. I found a broker across the street from campus, Mike Perkins at Laidlaw Adams & Peck. And I would just go sit with him whenever I had a free moment. And he took me to the library at Princeton and showed me where I could find all the publications and all the other newsletters that I didn't even know existed where you could get data and information and ideas of what stocks to buy.

I just loved it and just had so much fun with it. And so that's why at the end of the day, as I was graduating, I thought, "Well, if you love the stock market, you became a stockbroker." I wanted to be like Mike and Stacy. And that's where why I went to work at William Blair here in Chicago and got my career started.

Oh, and the other thing that I had was an advantage. While I was at Princeton, we had to read a random walk down Wall Street in our Corporate Finance course. And Burton Malkiel was actually the head of the Economics Department at the time. So I went to see the author of this iconic book and to talk about the markets back in 1979, 1980. And I look back on that time and I'm like, "Jeez, I had this great experience to have that kind of exposure to one of the great thought leaders in stock market history."

Patrick: [00:22:09] You were a very young entrepreneur starting Ariel, I think in your 20s still and you tackled the portfolio early on with far less support where it was really just you. You mentioned industry and sector knowledge a lot. It sounds like a key part of your bottom-up process. So I'm curious if there were particular industries early on that really fascinated you or drew your attention and sort of how you were building portfolios when it was just a one-man band.

John: [00:22:38] Yeah. That's interesting. No one's talked to me about those early industry sectors and as I think about it, it was really fun to have a couple of sectors that you thought you knew better than your peers and your friends, so you're right.

I had a friend who was my deputy who sort of ran the office, I remember her name was Jessica Berger, and I was there doing the stock research on my own and going and visiting companies and talking with them on the phone and thinking about the markets and the sectors that I focused on early on, where one was the...

I borrowed some concepts from William Blair, some of the ideas that were there on their better buy list and things, and the office product sector was a sector that they knew really well, and that I sort of went off and ran with. So it was those early companies like United Stationers and companies like General Binding that made binding machines, one of our great companies. Sanford, they made Sharpie highlighters. [ACO] , Staplers. I mean, all these kind of-

Patrick: [00:23:37] Simple businesses.

John: [00:23:37] Simple businesses. Things you would find in your desktop that you can know really, really well which worked and what didn't work. And it was a sector and all those companies got bought up. They all got sold and they did extraordinarily well. Just phenomenal. And then other sector was sort of toy related.

I was kind of a kid at heart and remember owning Kenner Parker Brothers and Tonka, View-Master Ideal, Topps, the baseball card company, Hasbro, but a lot of these smaller ones all got bought up also and it was interesting.

Now it's kind of like Hasbro Mattel or the big giants. There's not many left, but back when I was getting going, there were all these independent toy companies that were doing extremely well. And the stocks did extraordinarily well, and they all got bought, which gave you a nice exit. So those are two of the sectors that really worked well for us in those early days.

Value Investing

Patrick: [00:24:30] Really interesting. I'm curious how much the value investing ethos or philosophy was there from the outset for you and whether or not there were sort of formative mentors, whether they be through books or people you actually knew.

I always tell people that the first book I read that really just rewired my brain was David Dreman's Contrarian Investment Strategies. And I'm curious if there was something similar for you in the early days and how much... Kind of what the evolution has been in your thinking of value investing from start till now.

John: [00:25:00] Well, those early days, you're exactly right and you captured it perfectly. There's some people you read about and some people you got to know. So, I'll start with the people that...

There wasn't a whole lot that I could talk to early on because who wants to meet with a 24 year old kid who's just started a money management firm, but I had this newsletter that I had at the time and we were trying to build a track record and get people to take it seriously. It was called the Patient Investor. That was how we got our going with our turtle theme.

And I remember going to interview Ralph Wanger because he was one of my heroes and he had built the Acorn Funds into one of the most successful top performing funds in the country. He focused on smaller companies, that are value-oriented, but extraordinarily creative genius.

Even today, when you go and talk to him or read things that he says, he's so original in his thinking. Just a fascinating person. So, Ralph was one of those early mentors. Ned Jannotta, who was the Managing Partner of William Blair and Mr. Blair was still alive and the idea of focusing on smaller, faster growing companies, they had a big impact on me in those early days, as I was thinking about the markets.

But the first book that really had a big impact was the Money Masters by John Train, where you read about the great value investors in that book. You can read about John Templeton, you can read about Warren buffet. You can read about Ben Graham. They were all there. And they had just this extraordinary impact on me. I just loved that book and I would send it to everyone, give it to everybody. You've got to read the Money Masters. It's the best ever.

And after that I evolved and I read everything I could, of course from Warren buffet. Because that's what we all do. We read for a living. You read every book. I've read two investment books this last month and then I ended up reading David Drummond's The Contrarian Investment Strategy. And then the second one that he came up with afterwards, and they were amazing and it was so consistent.

And I think it was consistent with my own personality, of course, of being someone who could think independently, that didn't feel the need to follow the crowd and the idea that you can be a true contrarian. It has to sort of be in your DNA. And so I love that book and I used to send that to all of my friends and talk about it, write about it.

And so some people I got to meet like Ralph Wanger and Burton Malkiel. And then there are others that you ended up reading about like David Drummond and Warren buffet and then as the years have gone on with the nice things, then you get to meet people like Warren. And he's been here at the Ariel offices, and he has a conference room named after him. So he'd seen this conference room and those people just had a tremendous impact on me.

And the final thing I would say, David Drummond's book, I think it's directly tied now to the book that I just read on Daniel Kahneman and Tversky. Behavioral Finance, I think really got going under Drummond's leadership about psychology in the markets, and it didn't have a title. It didn't have a-

Patrick: [00:27:57] Department.

John: [00:27:58] ... behavioral finance. Exactly. It wasn't a department. Well, we didn't have a Dick Thaler and others doing this kind of work. But I think he really was the early pioneer that hasn't gotten the appropriate credit for how it's all evolved.

Patrick: [00:28:08] As somebody who's Seen such a long stretch of the market in general, but also as a dedicated value investor throughout that whole time, obviously a value investor implies that you believe markets to miscalibrate, whether it's for behavioral reasons, they get too pessimistic at the value extreme, too optimistic at the growth extreme or for risk-based reasons. There's lots of potential we can't know for sure.

But do you think that anything has changed about the prospects for value investing from when you started, when it was still certainly none of the papers had been written about demonstrating the value just works, right?

And now there's quantitative strategies like ours that find this evidence and orient portfolios more and more people probably chasing this idea of value. Does that concern you as a value investor? Or do you think that the difficulty of implementing it will always be a moat around the value strategy?

John: [00:29:01] I would go with the latter. I think the difficulty of executing it and thinking independently does allow for the moat that you suggest. And there's been times over the 34 years we've been in business where you underperform and you sometimes wonder is it because there's more competition and the game's gotten harder, but in this last 10 years or so to watch what's happened, these are going to go a little back longer.

If you go back to the internet bubble bursting and how value investing came roaring back, you saw what happened during... We also have the financial crisis, that if you had the courage to buy during the spring of 2009, how everyone had given up on names and stocks that people said weren't worth $2, a couple years later were worth $50.

And so you've seen this in real time how the groupthink takes over and the momentum takes over and everyone just gets completely convinced that this way of thinking is the right one, about an industry sector or a company. I just think we've just seen it proven more clearly since the internet bubble and the financial crisis.

And then finally, it's exacerbated now by what's happened with these active ETFs they're parsed in all these different kinds of segments and people are buying company stocks for reasons that have nothing to do with underlying fundamentals and based upon a backward looking data and then they're put into these indexes.

And so stocks are moving for reasons that have nothing to do with the underlying discounted future cash flows. And so I think there's even more opportunity being created because of this sort of indexing that's happened, and particularly the specific indexes around the ETFs.

Patrick: [00:30:41] Maybe to puts them some very tangible context around it today so people can grasp the idea even more, whether it be individual stocks or industries today in the Ariel Fund or other funds that you manage, have some of these characteristics that you look for. So out of favor, maybe the reason the market has it wrong. To give a more recent example, it might be an interesting lens through which to view your philosophy.

John: [00:31:04] One that we've been talking about a lot, the one sector is the real estate services sector and over quite a long time, we've owned Jones Lang LaSalle or JLL and then we added over time CB Richard Ellis or CBRE. And we were on phone with the management teams of both those companies in the last few weeks and talking about the fact that this exact phenomenon was happening, their stocks are trading based upon the fundamentals, based upon how they traded in the last downturn.

So, because these companies didn't do well during the financial crisis when real estate collapsed, people thought people wouldn't buy and sell real estate anymore, people wouldn't be leasing real estate, people wouldn't be doing outsourcing and everything and so everyone just gave up on these companies.

So, now whenever there's a de-risking type of environment, or when people start to get fearful about the economy rolling over, these companies underperform dramatically, but that's based on the past not the future, because now these companies since then have diversified their product lines much more dramatically than people have imagined.

So they're not so dependent on capital markets for buys and sells of real estate, but their outsourcing businesses have become quite huge. Their real estate money management businesses are quite large, and that goes nicely with their traditional leasing and capital markets businesses. So they're much more diversified product-wise. They're much more diversified geographically.

They're both worldwide companies and they've gone out and acquired strategic businesses throughout the world. So, two things have happened. It's become kind of a duopoly, two big global brands when it comes to commercial real estate and they get all the diversification of all the different economies around the world.

And then finally the balance sheet has been strengthened significantly since what happened. A lot of people, they went into '08 and '07 and early '09 not ever dreaming we could have the kind of catastrophe that we had. And so they didn't have the margin of safety with the balance sheet they should have.

Well, like a lot of companies they've learned their lesson and so now they're going to have a bulletproof balance sheet so in case there is another economic downturn, they'll be able to weather it. So all those things come together to make this company a much more stable, consistent business for the long run than it was 10 years ago. But the market is evaluating as if it's still the company it used to be.

And that's in particular when they get to put into these different indexes and real estate indexes or financial services indexes, or high beta indexes and it really shouldn't be traded that way. And we've often said they almost are hoping in some ways for a recession just to be able to prove that they're going to have much more consistent cash flows during the recession than they did the last time.

Patrick: [00:33:51] You mentioned the idea of brand for those two companies. And I'd love to hear what you think about brand as an important dimension of evaluating a company, whether that's something that you are seeking out when making an investment and if so, how you qualify or quantify a good brand. What does that mean to you?

John: [00:34:10] You've mentioned the term the moat during our conversation today and Warren buffet, I think is the one that sort of invented that term and Morningstar uses it effectively. And when we look at the Morningstar universe, a higher percentage of our companies are higher moat companies than our peer group by a very wide margin.

We really are doing what we say we're doing, buying wide moat companies or narrow moat companies and staying away from the companies that don't have a moat at all. So I start with that to say that your question on the brand, if you have that strong brand, you should have a strong moat and they should go hand in hand together.

And we spend more time, anything in our research trying to determine whether that brand is going to be able to continue to maintain the moat over the next five to seven years. Now, sometimes certain industries having a strong brand is not going to... The moat can disappear, you know the brand name is strong.

We always use the obviously examples of the Blockbuster videos of the world, the Blackberries. Great, great brands and the moat just disappeared overnight. So you've got it. I mean that's a big part of art of this, is to be able to see which companies are going to be able to use their brand strength to maintain that moat. And that's the art. It really is that ability. It's funny.

Going back to what Coach Carril used to teach, he used to always say, "Vision is critically important to being successful as a basketball player to see what's happening before it happens." And he said, "If you don't have vision, I can't teach it. If you're legally blind, I can't teach vision."

I think determining whether the brand is going to be strong over the next five to 10 years, it takes vision. Some people have the ability to see that far into the future and other people don't, and I'm thinking you can teach them. Warren has the greatest vision of all time.

He makes it sound simple, but he has that ability to see five, seven years down the road, which of those brands that are the ones that are not going to be damaged by new technology, that are not going to be damaged by a new international competitor or something that can't be foreseen.

Patrick: [00:36:22] I want to come back to the role of technology and Blockbuster is a perfect example of new technology completely disrupting or making obsolete an entire industry. And that's I think a big hurdle for value investors because that change can be exponential and it's hard to stay away from that.

But you mentioned this idea of vision, which brings me to a question that I was probably most excited to ask you today. And it relates to running the investment business, so less about the investment strategy, but actually running a business specifically around hiring and hiring talented young people or seasoned people to work with. Because obviously, especially with your ethos of patience and slow and steady wins the race, I'm imagining that getting the right people is probably the most important thing that you do.

But I'm always interested in this interplay of nurture versus nature, of someone who just has it, who has the vision that can't be taught versus skills that can be cultivated over time. And I would love to just hear you riff on this idea of... Let's say for example, you can only choose one. You can spend all your time in a group of people just hiring and then you aren't allowed to mentor them beyond that.

Or you will just be given a random batch of people with some minimum experience or intelligence what have you, and you'd have to expect that everything would come from the nurture side. Which would you pick?

John: [00:37:41] I would wish and hope that you could teach and train. But I do think my coach is right. The hard stuff is really, really hard to teach and to change people's DNA because whether it comes to selfishness, people during tough times are going show up or this idea of being contrarian.

You can be a contrarian contrarian, but then when the stock market's collapsing like in '08 and '09, the headlines are horrible and Cramer screaming on television and stocks are going from 30 to 20 to 10 to five. It's just so easy to fall into the groupthink of the moment. At the end of the day, I think these things are born in you and grow into you at an early age.

Coach Carril used to always say, "By the time you're 18 or 19, I can't teach you to see." But I think he was also saying if he had gotten to you when you were nine or 10, he probably could have helped you to see.

Hiring and Business Success

Patrick: [00:38:41] So how do you do that in the hiring process? How do you screen for someone that has that vision?

John: [00:38:46] Well, what we've tried to do is to... And we're still learning. I mean, this is a constant, a constant battle. So we've tried to be involved with a few key institutions and build institutional knowledge and relationships within those institutions that can help us to identify talent. And by far the best example of that is that I was fortunate to go to the University of Chicago Laboratory School, which is owned by the University of Chicago.

I went there for high school, but it was pre-K through high school and I got very involved as alumni of the Lab School and started having students here at Ariel for what they call the May Project, where the kids senior year take off, I think the month of May and they come and work in the business somewhere or do something creatively or philanthropically.

And I got on the board, became chairman of the board. I was on the board for 24 years. And so actually had lots of contact and access to up and coming talented Lab School people. Eventually that led to me being on the University of Chicago board and then started to have an internship program where we would have University of Chicago college students as interns and then business school students from the Booth School as interns.

And funny thing is a lot of the parents of Lab School students are professors at the business school. And so we really are kind of in the ecosystem of the University of Chicago all the way from high school to college, to business school, to law school, through the faculty, through the administration and being able then to get deep insights of which students are special and which people are really loving the investment world and they send us those students.

And so we've had several people that we've got to know when they were ninth or 10th grade and watch them grow and had them as an intern, not only as a May project student, but then later as a college intern or a business school intern and then hire them full time. And several of our best people here at the firm are people, again, I've known since they were 14, 15, 16, 17, and you pick the ones that you think fit the culture and have the values.

And we work at it though. It's not easy. We just actually helped to advise and fund the investment club in the University of Chicago Lab School. And we just had a whole series of the kids who were here for an afternoon and we're starting to get to know all these young people. And some of them I already knew and we were pleased to be a part of all of that.

And then finally, as you can imagine, because we've hired so many Lab School people in University of Chicago, people in Booth school, they tell their friends and then it becomes kind of a self fulfilling prophecy.

Patrick: [00:41:27] Yeah. It flips the other way and it becomes easy for you.

John: [00:41:29] Yeah, It gets easier, but it's still a challenge, but that's how we've been doing it. And finally I do use Princeton as another institution that I'm close to and we find talented interns through that. Mellody Hobson, our president started out as a... I met her at 17 years old as a prospective Princeton student when I used to be involved with making sure that the local Princeton students got interviewed by alumni. Charlie Bobrinskoy, our Vice Chairman, went to the Lab School with me. That's how we do it.

Patrick: [00:42:00] As someone who wants to run an investment business for the next several decades, or help run an investment business for multiple decades, from someone that has done that, what are some of the key business lessons you've learned in running a firm? Things that you feel have led to the success and the survival of a firm which is rare for an asset management company to be around as long as Ariel has. What are the key underlying reasons for that success?

John: [00:42:24] Well, I mean, as you know this business is all about performance, so we were just talking about this earlier today. I'll start with that. The Ariel fund, our flagship fund started in 1986 and it's in the top decile of all mutual funds that go back to 1986 and number one in its category. And there was only eight funds in our category that go back that far, to be open about that.

And then since the March 9th 2009 lows, there's a story in the journal a couple of weeks ago that showed we were the 13th best performer out of, I think over 1700 funds. They go back to 2009 and again, number one in our category out of 251 funds. So I think performance is really great and to be able to show 11 and a half percent compounded since '86 and over 25% compounded since '09, that's been extremely helpful to our success.

I think the second part is how do you get the best talent and keep it? So we talked about attracting talent. Now, the next part to be successful is how do you keep it here? So we mentioned earlier that we try to make sure that everyone's an owner in the business. I think that's been really, really important and keeping people's a part of the team.

The second thing that I, maybe, alluded to earlier is we try to give real responsibility to our leaders so that... Sometimes they think of the founder as someone who's going to be micromanaging everything and involved in all aspects of the business. And people I think are surprised when they come here and realize that...

And then probably the reason we've been able to keep Mellody Hobson here is that from early on, I just kept giving her more responsibility, the things that she owned, that she could feel proud of and get excited about and make decisions on her own and not have to run everything by me to the nth degree.

And then now that she's president, she runs all the non-investment parts of the shop and allows her to pick her team and negotiate the real estate lease in New York and whatever. All the different things we have to do. And I'm not looking over her shoulder and second guessing her judgments or her decisions.

Arne Duncan worked here for six years before he became a school superintendent in the city of Chicago and we allowed him to create the Ariel Community Academy, a small public school that he thought that was the thing to do. And we teach financial literacy there, but we kept Arne here for a long time because he was able to find creative things to do that he could own and be proud of and things I would have never thought of on my own.

Arne and his assistant thought of this idea of the school and we got an, I have a dream class and we did all kinds of things like that. It's a long way of saying how do you give people freedom to find things that are exciting and that they can own and feel really good about accomplishing success within those fears that they own.

Patrick: [00:45:06] What's the, I Have a Dream class?

John: [00:45:07] That was where you adopt a sixth-grade class from an inner-city urban school and promise to help those young people get to college basically and make sure the college is affordable for them. And so it's a very enhanced nurturing program for one specific group of students. Eugene Lang made this famous in New York city. He created the first I Have a Dream program and it became kind of a national program.

Arne decided that starting in sixth grade was too late and that's why the Ariel Community Academy starts in kindergarten and it's 20 years old. And as I mentioned earlier, we're teaching kids about the stock market there and giving kids real money to invest and it's kind of Fun.

Community and Giving Back

Patrick: [00:45:44] So you have done a tremendous amount in the community in all sorts of different ways. And I'd love to hear about those endeavors through the lens of kind of investment and rate of return. So you've dabbled in a lot and I'm curious one or two things or categories of things when you're trying to give back to the community have had the highest sort of rate of return on your time or investment.

Areas that others that are interested in giving back to their communities that there's a lot of bang for the buck or a high rate of return on your time. What has really stood out of all the things you've done?

John: [00:46:19] One, I already talked to the volunteer work for Princeton and for the Lab School. It makes me feel great to be a part of those families, but the rate of return has been amazing because of all the gifted people that have ended up here at Ariel that have made us a better firm that I met through my volunteer work at Princeton.

I mean, as I said earlier, I met Mellody as a volunteer helping to make sure she got interviewed for Princeton. And she's now our most valuable player and our President of our company. So I can't... Those things have just been clear, have been extremely important.

The other parts of... I've been active politically and some of the best experiences in my life have been involved with helping a progressive candidate, being the finance chairman for Carol Moseley Braun when she became the first African-American woman in the United States Senate's history and to feel like you're a part of that in some small way, the memories are just magical.

And similarly getting to co-chair the Illinois Finance Committee for President Obama in that first term, and then getting to co-chair the inauguration. The fact that you feel like you're a part of this team that helped Barack Obama become President of the United States was just magical.

But then the experiences of walking on the stage as the co-chair of the inauguration and getting introduced with my daughter to 2,000,000 people out there and getting the chance to go to Camp David or hang out in the White House a little bit and just see that world, it was just such a great return. It's just something that you never forget.

You feel like you're part of something special, you're part of a special team, hopefully you're making a contribution for the country, but then you end up with these memories that you can never replace. I've seen my best friend, Arne Duncan, get to be the Secretary of Education and go visit with him and hang out with him and see what that life is all about.

And then the final area where it's been fun is that I've done a lot of volunteer work, like being a trustee of University of Chicago and of Princeton and other places, and then getting to be on the investment committees. So, being on the Princeton investment committee, I got to meet Daniel Kahneman when he came after he won the Nobel prize to talk to the investment committee about behavioral finance.

It's like, "Wow, I'm learning about this firsthand from this genius." That if I wasn't volunteering for Princeton, I would have never had a chance to meet Daniel Kahneman and learn all about behavioral finance from that perspective. And then to be involved with University of Chicago and then get to know Toby Moskowitz and Dick Thaler and others. Steve Kaplan, and other people who've thought deeply about the investment world and how to be better investors.

And then to be on the investment committees with other leading investors who are running private equity firms, running hedge funds, running quant shops from AQR to some of the biggest firms in the world. So you're learning about their thoughts on the markets and their thoughts on the world. And you can then compare yourself to them and figure out what you need to do better and how you can try to emulate and learn from those folks.

So, all those things come from being a volunteer. When sometimes people criticize, "Jeez, John you're so active. You're not sitting at your desk, you at that investment committee meeting." I was like, "Wow, I'm here with Daniel Kahneman. Where else should I be?"

Patrick: [00:49:46] I'm always struck by the nonlinear payoffs of networking. And you've mentioned Mellody Hobson a few times where that's one person who's had an enormous impact on your life, on your firm, that I'm sure there's lots of other people who are great, but didn't have that sort of impact.

So there's this undercurrent in a lot of your answers of the power of network and that building a quality effective group of people may be the best investment that you can make, certainly on the business side, but also on the investment side, because if who you get exposed to and their ideas and how they might shape your thinking.

One of the things that I'm interested in, especially given how much leadership you've shown on this issue is the problem of under-representation of women and minorities in the financial services space. I don't know all the stats. I know the New York City one, because that's where I'm based. But I think it's something like maybe 8% of financial services professionals are minorities, even though it's 16% of the general population.

So, a huge under-representation. I know you've done a lot, but looking back decades to today, what, if anything, has gotten better? How's it gotten better? And what can we do collectively as a financial services community to make it better in the future?

John: [00:51:00] I think the first part of the answer is things have not gotten better. Here in Chicago, there's still the major private equity firms, I've never had an African-American professional or Latino professional let alone partner. It's kind of like baseball in 1940. It literally is like that.

Some of the major investment banks have 200 partners. There'll be one African American. Again, very few female. Crain's Chicago Business had a cover story on the private equity world and the lack of female representation and lack of partners. It's embarrassingly low. And again, it's similar in investment banking, it's similar in hedge funds.

Things have not gotten better and in some ways they probably gotten worse. So much of the wealth and jobs and influence in our society comes through financial services in these specific areas of getting investment banking, hedge funds, private equity, et cetera.

So, at Ariel, though, what we try to do is, like my friend, John McCarter, this other friend who said, "You shouldn't admire the problem. You should try to figure out solutions." One is this idea of being a model of how financial services companies can partner with urban public schools.

We think that if we get actively engaged and involved with public schools, not only are we teaching kids financial literacy, which is important, the kids get to see us in our day-to-day work worlds, and start to think about financial services careers.

So we have two full-time employees here now who I got to know when they're six, seventh and eighth grade at the Ariel community Academy. And now they're here full time after spending a summer internship here. And we think if all financial institutions did that kind of thing there'll be much more diversity in their executive ranks.

Second thing we've done is a relatively new thing. I gave a gift to the University of Chicago, where minority students are now going to have paid internships in endowment offices. So the University of Chicago has agreed already to have four of our interns work in the endowment office and we're hoping they'll be at the MacArthur foundation and the Ford foundation and other universities and nonprofits throughout the United States.

A lot of these minority students might've come to the University of Chicago thinking about careers in law, or maybe they were going to be a traditional banker or go to medicine. But now as they get exposed to this world of the endowment world, maybe they'll think, "Well, maybe I'll make a career and try to become the next David Swensen."

Or they'll say, "Once I'm in there at the endowment office, maybe I'll learn about hedge funds or private equity and make a contact and a networking opportunity that'll lead to a career in financial services that wouldn't have happened otherwise." So I think that's where we can start to do, is we need to create opportunities where kids get exposed to these careers at an early age.

And then final thing that we have to do and we have to do this ourselves is we've got, if we're on an investment committee at a university or a museum or a hospital, or you're on a corporate pension plan, to ask your advisors about the lack of diversity.

Because if the customer asks, then all of a sudden those institutions will start to look more diverse. If the customers don't ask it doesn't change. And so I think that that's the other part of it. We've got to have more supply, but we also have to have the demand side that often people forget about and that's critically important.

Patrick: [00:54:12] I really want to highlight that last one, because we have started to hear that. Literally I heard it presenting to a board of a client of ours within the last two weeks where they were very curious, looking through our org chart. They said, "Okay, we want to get a sense for your diversity, your people and hear very deliberately how you think about it."

And we think about it a lot, but hearing that directly from the mouth sitting across the table from a client is really impactful. And to the extent there's anyone listening that is in that capacity that's an allocator or on a board that's allocating money, I think that that is probably something that's not really talked about as a way of improving this problem, but one that is very clearly effective.

So, all really interesting stuff. I wish there was more to do, but I think what I take away from your answer is that you just need to do it yourself. And you can control that very directly if you're running an asset management or a financial services, any business, and hopefully that model can spill over. But it's disheartening to hear you say that it hasn't gotten better. Because it's been a long time. And so something's busted about the system. Something, I need to think more about.

Turning to a totally different topic, this is a question I ask everybody because it always leads to an interesting answer, unexpected answer. If you had to identify the individual most memorable day, one day of your professional career, what day would that be?

John: [00:55:34] In my professional career day, jeez. Well, I mean clearly the day I remember most was when the stock market crashed in 1987. I was actually at my wedding planner planning on my first wedding and we're getting these calls constantly that the market was collapsing. And I remember at the time thinking that Warren always said you want to buy when there's maximum pessimism or John Templeton talked about the same thing.

I guess John Templeton said that, "You want to buy when there's maximum pessimism," and Warren always said, "You want to be greedy when others are fearful?" So I was trying to execute that from the wedding planners office saying, "We got to be buying." I think the other memorable day was after the president got elected, he spent three days here at Ariel and we were the temporary transition headquarters.

So that first day after the celebration in Grand Park to walk into our little offices here at Ariel and the President of United States was starting to form the government and working out of our offices that morning, I think that's something that all of us here at Ariel could never forget.

And it's kind of psychic income. You're talking about how do you try to make place fun where people want to come and stay? I think people remember that this is kind of... A little bit of a special place doesn't happen to every LaSalle Street or Wall Street firm.

Patrick: [00:56:50] It must have been totally surreal. What a cool experience. The other common question that I ask everyone is, what is the kindest thing that anyone has ever done for you?

John: [00:57:00] I think that those early days there was people who really looked out for us. And so Cecil Partee was the City treasurer at the time and he gave us our first million dollar account. And here I was, 25 years old and he didn't have to do it, but he had influence over the City of Chicago Pension Plan and he told my parents I'd go into grade school with his daughter.

And he said, "I've been waiting for someone like John to come through the door hoping I could be helpful to someone like John getting going in this business." And so that's probably one of those best memories of just surreal kindness that helped us to make it to another level.

Patrick: [00:57:42] For people that are early in their career, looking forward now, what excites you most about markets or what's changed, the huge trend being the rise of passive investing, which all of us active managers spend a lot of time thinking about and answering questions about. I won't ask you your thoughts, but what excites you most? What dynamics or aspects of change, whether it's in our business or in markets or in industries, has you most used? What's got you coming into the office excited every day?

John: [00:58:13] We talked a lot about my coach Pete Carril, and when I got to Princeton as a recruit, I was a very minor recruit.

Patrick: [00:58:21] Number 15.

John: [00:58:22] I was convinced at the time that I wanted to be a basketball coach. That was going to be my life's work. And the coach of the Bulls during those early years, Dick Motta, was another role model.

So I like coming to work everyday thinking about how I can coach the team and that it's so much fun to be hiring these dynamic young people and sort of pulling them together and getting people to where they need to be, or trying to help them get where they need to be.

And teaching, coaching, preparing, that's the fun of it for me and I really do love it. I feel like I'm getting back to what I always wanted to do it's just doing it here and not within the basketball world. Yeah. So, that's what I love. That's what I look forward to.

Patrick: [00:59:03] How did you... I did a little bit of research for this. I stumbled on a video of you playing Michael Jordan one-on-one and beating him which I'm sure does not happen all that often. So, how did that little scenario come to be?

John: [00:59:16] I always like to try things. These fantasy camps, as you know, have gotten quite popular around the country and so Michael Jordan had this senior flight school fantasy camp for campers over 35 years old, and the best coaches in the world would be there. The [Mike She Shefskis] of the world and Roy Williams and everyone you can think of was there coaching. And one day each year at the camp he would challenge any camper to a game one-on-one.

They were very short games. There were the first person to score three baskets would win. In the first seven years of the camp no one had ever beat him. I think through... Obviously he's so much better than everyone else, but also people would get intimidated.

You're in front of the whole camp here playing the greatest player that ever lived. And I think what happened was for me, two things. One was that he was very tired. He'd played and beaten about 20 campers by the time he got to me. I think he was overconfident because he'd always won.

Patrick: [01:00:10] Michael Jordan overconfident?

John: [01:00:11] He'd always won, so he'd let people get a couple of baskets. And then the final thing was, I was always... Coach Carril said I had no vision and I couldn't see. I was a good one-on-one player and I could make tricky spin shots with either hand. And so I used one of my favorite trick left-handed spin shots, and you can hear him on the video say, "Oh no," as the shot is just about to go in and he just misses blocking it. So it was one of those memories of a lifetime.

Patrick: [01:00:39] Two little funny things from the video. So the spin shot, for sure, but sort of this mid-air box check because he's obviously huge, right? That was really effective. I think you might've done it on all three. And then what made me laugh in the video was he asks you, "What hand you are?" And you say, "Right," and he says, "Oh, you should never give up that information. Rookie move." Then you beat him. What a fun little episode.

John: [01:01:02] Yeah, a lot of fun with a lot of YouTube video visits. I run into people on the street who say they saw the video.

Patrick: [01:01:08] Well, a fun place to end. This has been really fascinating, learned a ton. So thank you so much for your time. I really appreciate it.

John: [01:01:15] A wonderful interview. Thank you.

Transcript by @ScarrottKalani