Idea Brunch #2 with Brian A. Finn
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Brian A. Finn!
Brian is currently the chief investment officer of Findell Capital Management, a long/short Smid-cap focused equity fund he founded in July 2019.
Since July 2019, Findell Capital has annualized 22% net (1.5/20), compared to 9% for the Russell 2000 and has never had a down year while more than tripling the Russell’s cumulative returns (~300% vs. ~91%). Findell launched with $14mm and manages a little over $400mm today. Brian was previously featured on Sunday’s Idea Brunch in April 2023.
Brian, thanks for doing Sunday’s Idea Brunch! Maybe tell us how you got interested in investing?
Towards the end of my freshman year of college, I read A Random Walk Down Wall Street (1973), where Burton Malkiel famously argues that markets are efficient and impossible to beat, and you are better off in a passive index fund if you want to build wealth.
For whatever reason, that inspired me to open an Ameritrade account and I started actively trading stocks – basically doing the opposite of what Malkiel suggested.
The first stock I bought was a company called HealthSouth. HealthSouth operated a chain of rehab centers and was run by a charismatic high school dropout named Richard Scrushy.
The stock had traded as high as $110 a share but nose-dived in late 2002 after Scrushy was accused of fraud. By the summer of 2003 when I stumbled upon it, the stock was trading for 40 -50 cents a share on the pink sheets.
I didn’t do any fundamental work (nor would I have known how to at the time). I just thought that the stock was cheap at 50 cents for the simple reason that not that long ago it was worth more than $100.
However, foolish that logic might have been, the stock did phenomenally well. Within several weeks, the company gave signs that the business could survive the fraud claims. Within a year, the stock was in the mid-teens – up over 35x. The company would eventually settle with the SEC and re-list and now trades as Encompass Health – EHC – for $100 a share.
That experience made me fall in love with markets and I started studying economics. More specifically, I wanted to understand how such an outsized opportunity like HealthSouth could exist if markets were efficient. I quickly discovered the field of behavioral finance.
In the early 2000s, behavioral finance was just becoming a thing. Within the economics department at Harvard, a young Russian economist named Andrei Shleifer published Inefficient Markets (2000), which essentially created it as an academic field.
The basic premise of Behavioral Finance is that the efficient market theory is wrong because its core assumption is wrong - humans are not rational decision makers.
We are quick decision makers whose internal algorithms are optimized for surviving the pre-historic savannah, not pricing securities on a computer screen.
Just consider how you would act if everyone on the street started to run in a certain direction. You too would run in that direction. That is called herding and makes sense evolutionarily – you are a descendant of the humans who ran, not the ones who sat there analyzing whether it made sense to run.
While adaptative in the state of nature, this bias can lead to irrational decision making in financial markets. Just as we overreact to harmless noises in the wild, markets can overreact to harmless noise and those over reactions can cascade and compound on each other until you get very dislocated prices.
Herding is one of dozens of heuristics that behavioral finance brought forth and explained.
I got so into it that my senior year, I co-authored a book on the subject matter with a Harvard post-doc student called The Story of Behavioral Finance (2006) where we tried to outline all these different heuristics.
The book didn’t become a best seller, but I at least was now armed with a framework that could explain HealthSouth – how did this stock get so dislocated that it subsequently 35x’ed in 6 months?
The behavioral finance explanation was that HealthSouth was a victim of recency bias, which causes humans to overestimate the probability that unusual things that have recently happened will happen again.
When HealthSouth blew up in 2002, the traumatic memory of Enron was still very fresh.
HealthSouth like Enron involved smooth talking southerners accused of accounting fraud and so the market was quick to assume that HealthSouth like Enron was a zero. No one did the work to discover that the business was fundamentally sound and the financial improprieties the C-suite was accused of, while real, did not mean the business was failing.
When I bought the stock, my reasoning was profoundly unsophisticated - but now armed with this behavioral finance framework, I could look at markets and begin to make sense of them.
Stock prices didn’t move like a drunk person randomly staggering home as Malkiel suggested, but moved to the beat of our evolutionary psychology and when crazy things happened that evolutionary psychology is where you had to look for answers.
Interesting, so how did behavioral finance inform your subsequent experiences?
After graduating in 2006, I had a random sequence of jobs. My first job was on a prop desk at Deutsche Bank in New York trading mortgage derivatives but then that blew up in the GFC. I then worked in Switzerland at Glencore trading commodities but then the commodities collapsed. I finally arrived back in New York City in the equity space at a hedge fund in 2012.
Being in these unrelated situations might have hurt my early career momentum, but in the long run it was good because I was able to build a mental model for how smart people made money. And that again took me back to behavioral finance.
The best investors and traders were the ones who had some sort of intuitive appreciation of how behavioral biases manifested in markets and how to take advantage of them.
I remember a great trader at Glencore telling me that he knew he had made a good trade because it always felt awful at the time he made it. And I think that is probably generally true – when buying something makes you want to puke that generally is a good sign.
The reason why those trades feel bad is because you are fighting against a behavioral bias – and your evolutionary psychology was designed to reward you when you give into a bias and punish you when you don’t.
So how did all of this lead you to create a fund?
I developed this approach focused on Smid cap names offering dislocated valuations apparently caused behavioral or technical factors and likely to be resolved through a foreseeable catalyst. Obviously, the approach in practice is not exactly that simple—and also involves substantial fundamental analysis-- but that is thematically what I try to do to gain an edge.
I began to build a track record using this approach in 2016 with a managed account and then in 2019 I turned that account into a limited partnership to start Findell.
Why is now the time to look at this sort of strategy?
I think there are a few reasons. The multi-strats have gotten way too big and increasingly boxed in by their own risk parameters. They are blowing in and out of stocks for short-term reasons, creating enormous dislocations that you can exploitif you are patient.
I also think that now is the time to get exposure to the small cap space. The Russell is just due for a long period of outperformance over the SPY and Nasdaq and we are starting to see that this year. You can still find lots of value in the smaller cap universe of names.