“Failure is more common than Wall Street wants you to believe,” veteran equities PM Scott Fearon argues in “Dead Companies Walking,” his debut book

By Josh Friedlander

Wed Aug 20, 2014

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The quietly profitable manager talks to Absolute Return about the strength of creative destruction and his antipathy to asset gatherers.


 

With the upcoming publication of his debut book Dead Companies Walking, Scott Fearon of Crown Capital Management is unlikely to remain one of the best hedge fund managers you’ve never heard about.

Fearon’s book meshes the story of his own career with his views on corporate America and the prevalence of mundane failure against the backdrop of Wall Street cheerleading. "I’ve shorted the stocks of over two hundred companies that have eventually gone bankrupt," Fearon writes in the book, which is being published by Palgrave Macmillan and is set to debut in January. "Many of these businesses started out with promising, even inspired ideas: natural cures for common diseases, for example, or a cool new kind of sporting goods product. Others were once-thriving organizations trying to rebound from hard times." They all failed anyway, and Fearon knows why.

"To me, Scott is a purist in the manner he invests and runs his partnership," former hedge fund manager and Fearon friend Reid Walker told Absolute Return. Walker, who now runs family office Five T Investments, retired from full-time hedge fund management in 2012 after closing Walker Smith Capital, the onetime-$1.1 billion hedge fund he co-founded and managed. Having finished reading a draft of Fearon’s book last week, he was already recommending it to friends. "Scott is constantly on the road visiting companies. From his tales of short selling, to the challenges our industry and country face, this book has it all."

Fearon is an old school hedge fund manager. He's obsessed with earning performance fees rather than management fees, making him an increasingly rare breed. His flagship Foundation Partners Fund had produced a net annualized return of 11.23% from its November 1990 inception through yearend 2013 with a long/short equity strategy that employs little leverage, a substantial stock-specific short book, and a net exposure hovering around 30%. He’s only had one losing year, 2009, during which the fund fell about 12%. He doesn’t hang around hedge fund conferences, but he does spend a lot of time on the road; he’s interviewed the managers of 73 companies at their headquarters so far this year. One dollar invested with Fearon in 1990 would now be worth about $11.50 (that dollar if invested in the S&P 500, with dividends reinvested, would be worth about $8.70).

But getting a dollar into Fearon’s fund would not have been easy. He is an outspoken opponent of asset aggregation, and his peak assets never exceeded $220 million. "Asset size is the mortal enemy of investor returns," he told Absolute Return in 2012 when we picked his former analyst Brian Freckmann’s Lyon Street Investors as a Fund to Watch. "Some hedge funds lie that they can be the ones to command a billion or two as well as they managed a hundred million or two. None of 'em can. They like the money more than being right."

Fearon’s decision to write a book was a long time in the making. For the past four years he’s spoken to the students of his friend Lowell Bergman’s class at the UC Berkeley Graduate School of Journalism. Bergman, a former producer of 60 Minutes and director of investigative reporting at ABC News, encouraged Fearon to put his views and history as a hedge fund manager down in print, and helped connect Fearon with his co-author, professional writer Jesse Powell. In addition to working on the book, Fearon began blogging in April 2013. One of his first posts, "Grandpa is killing us," was about the urgent need for U.S. entitlement reform. In May 2013, he wrote about how the real estate and higher education industries are "badly in need of some creative destruction."

Fearon’s focus on failure is interesting, in part, because his career, at least on paper, has been a nearly unbroken series of successes. He graduated from Stanford University in 1981 with a degree in Economics, earned a masters degree in management, finance and marketing from Northwestern University’s Kellogg School of Management in 1983, served as an equity portfolio manager at Texas Commerce Bank in Houston from 1985 to 1987 and at G.T. Capital Management in San Francisco from 1987 to 1990, and then launched Crown. He then doubled his clients' money in less than five years. But he’s not infallible. When he tried to start a Cajun restaurant in geriatric health-conscious Marin County, he failed spectacularly, as described in hilarious detail in chapter 3. He begins the chapter with a quote from Bill Gates: "Success is a lousy teacher. It seduces smart people into thinking they can’t lose."

The overriding narrative of the book is that "things go wrong more often than they go right," failure is normal, and "the people who are willing to acknowledge that fact can make a hell of a lot of money." Letting companies fail is one of the great strengths of the U.S. economy, Fearon believes. "Once you’re actively bailing out corporations that, through terrible decisions, are heading toward bankruptcy, your economic growth ends up being much less than it would have been," he told Absolute Return in a phone interview from his office in Greenbrae, Calif.

"Failure is more common than Wall Street wants you to believe. Failure is OK," Fearon says. "Failure in corporate America is almost never due to fraudulent or deceitful or dishonest behavior. People just make goofy mistakes. And these are smart people."

"I hope the message is clear that America’s economy is the marvel of the modern world, and that’s because we’re constantly going through a cycle of creative destruction," he says. "Free markets work as long as you let them be free, and part of that freedom is the freedom to fail."

ISSN: 2151-1845 / CDC10004H