Function Follows Form

Let me go. I don’t want to be your hero.

Those words strung together move me now viscerally after seeing the movie Boyhood, in the running at the Academy Awards, as I write, for best of the year. I’m biased by the video for “Hero” from the band Family of the Year because it highlights rodeo, something bled into the DNA of my youth.  See both. The movie is a cinematic achievement that left us blurry. The song is one I wish I’d had the talent in youth to write.

As ever for the ear that hears and the eye that sees, there’s a lesson for investor-relations. We might have heard MSCI last week refraining those lyrics – let me go, I don’t want to be your hero – to the ValueAct team, activist investors.

Over the past few years as activism has flourished, many companies have longed to be let go but have benefited from the activist grip. Herbalife and Bill Ackman.  Hewlett-Packard and Relational Investors. Dow Chemical and Dan Loeb’s Third Point.  Tessera and Wausau Paper and a raft of others just off Starboard.  On it goes, all around.

A curious condition has laid hold of stocks in the last number of years. It used to be that results differentiated.  Deliver consistent topline and bottom-line performance, do what you say you’ll do, explain it in predictable cadence each quarter – these were a reliable recipe for capital-markets rewards. Form followed function.

Activism by its nature supposes something amiss – that a feature of the form of a company is incorrect or undervalued, or simply operated poorly. By calling attention like the old flashing blue light at Kmart (have I just dated myself?), activists have often outperformed the market.

Meanwhile, the opposite has become more than an exception.  From our own client base we could cull a meaningful percentage of companies following the formula of consistent performance yet missing bigger prizes.

What’s going on?  There’s a brief image in Boyhood of a pastel-colored triangular Apple Mac.  Remember those?  Seeing it skipped me mentally backward in time – stories are time-travel – to Apple’s iconic 1984 commercial with its Orwellian theme of smashing convention illustrated through a hurled hammer crashing through a giant video screen.

In Apple’s commercial, someone broke out of barcode mode, the relentless patterned march, to heave a weapon at conformity.  One of my college professors called this notion Yellow Pencil Theory.  If society and academia are conformed to a standard, the products the standard generates all look the same. A bunch of yellow pencils.

What’s the market-cap factory today?  Sure, corporate results are important. But that’s not the function or form of investment behavior now.  Blackrock and Vanguard dominate an environment predicated on allocation. Target-date funds.  Exchange-traded funds.  Mutual funds.  Over 65% of investment-company assets march along this line.

And we have a National Market System, a marketplace that conforms to rules connecting competitors around price. Over the weekend word broke that the NYSE has asked regulators permission for a midday auction, something to shake up the model.  We’ll write more about this later, but it’s a struggle against conformity. The NYSE cannot operate its business like other businesses can, making decisions that suit its own interests.

All exchanges have to get a barcode before doing something different.  They must seek the leave of regulators, so it won’t be TOO different from the standard. In fact, the market’s success measures reflective collective conformity. Best execution, as defined.  Best price, as defined.  And so on.

We at ModernIR generally are anti-activism because the thesis implies that the market can’t value businesses properly. But activism is a typological hammer through the screen. Activists may not realize it but they repudiate the barcoded nature of today’s market, where function follows prescribed form.

Good companies can struggle to stand out from the crowd because the crowd allocates assets according to a central tendency. It’s not looking for outliers. A market defined around averages punishes achievement by reducing its relative value (stock-picking struggles because arbitragers periodically punch achievers back into conformity with broad measures).

That’s a profound sociological concept, beyond the stock market. We need heroes and yet the market we’ve got depends on uniformity. Averages. So let me go. I can’t be your hero.

The solution is both so enormous as to seem impossible and yet so simple as to be elegant. The problem is that the solution requires more hammers through screens.