Lessons from Shinsei: Duration Over Short-Term Returns

During their recent episode, Taylor, Carlisle, and Asif Suria discussed Lessons from Shinsei: Duration Over Short-Term Returns, here’s an excerpt from the episode:

Tobias: Good one. JT, top of the hour. Give the people what they want. Vegetable time.

Jake: Well, I’m not sure about–

Tobias: Give the people what they came for.

Jake: Yeah. [laughs] All right. So, today, we’re going to explore this concept called Shinsei. I’m just going to take you on a little journey here. You’re in the heart of Kyoto. And beneath the shadows of this ancient [unintelligible 00:29:05] and the fluttering cherry blossoms, there’s a serene little teahouse. It’s a sanctuary for those seeking solace and connection. Here, in this teahouse, there’s a gentleman named Sen Genshitsu. Don’t hold me on if I’m saying that even remotely right. He’s not merely a custodian of tea. He’s also a living embodiment of this Shinsei spirit.

Sen was born into an illustrious lineage of tea masters. He’s 15th generation, a direct descendant going back to the 16th century master who’s considered the founder of this Japanese tea ceremony.

And around the same time of this tea ceremony was adopted by the samurai class, who saw it as a way to develop their spiritual and aesthetic sensibilities. So, Sen has dedicated his life to this meticulous practice of tea ceremony, which is called chanoyu, I believe. I’m probably saying that wrong also. Everyone’s groaning, our Japanese audience. But this guy’s a living embodiment of the concept of Shinsei. So, what is this word that I keep using? Shinsei is a Japanese term that refers to a company that’s thrived over a really long period of time, particularly one that is known and trusted for the quality of its products and the unique management practices.

Shinsei are long lived Japanese companies, some over 1,000 years. The oldest one is this 1,400-year-old construction firm called Kongō Gumi. There are approximately 28,000 Shinsei companies in Japan. They concentrate in sectors like sake brewing, hotels and inns, and kimono and fabric retail. But most of them are small family businesses, and more than half of them have 10 or fewer employees.

So, let’s stop for a minute right now and just think about the investment return equation. It’s 1+R(n). Everyone tends to be focused on that R number, the annual return. Every lap around the sun, we need to get that number up right. Those are rookie numbers. In the equation though, the R is linear. It’s preceded by a plus sign. It’s additive. Maybe even ephemeral in a shorter cosmic sense. But the n in the equation is the duration of compounding. How many years are we going to multiply out our returns? And in the equation, it’s nonlinear. It’s a compounding series, a power function. So, just purely from first principles, shouldn’t we be focusing on the n much more than the R? And yet, where does most of the investment world’s preoccupation lie? It’s on the R.

So, these Shinsei businesses to me are really fascinating, because they’re real-life examples of duration in the wild. It’s hundreds and hundreds of years of n that have been captured here. You really can’t fool nature for that long. So, it makes sense, I think, to study this species and look for what does duration actually look like.

And so, here are some things about these companies. Unlike Western firms, that are often driven by growth and beating competitors, Shinsei prioritize continuance of their values. The goal is not necessarily to grow at all costs or hyper scaling or all these other things, but it’s the continuance and transfer of principles, customs and values that have been handed down for generations. The employees are trained more through mentorship programs than formal training. There’s a saying in Japanese leadership like,” Show them your back.” Meaning, do the actual work and the mentee can observe like looking and seeing what you’re doing.

The Shinsei businesses leaders really, example. Like, they show their backs. They also prioritize integrity, and responsibility and societal harmony over short-term profits. So, fairness and honesty matter. Profits that were made by deception or even during an economic bubble are not considered honest profits. And yet, they really have to live and work within the society.

There tends to be a focus on quality over quantity, obviously. There’s also even a little bit more reliance on intuition and experience over quantitative metrics. They still look at those numbers, but there’s something deeper happening there. This goes back to our recent segment we had a couple weeks ago about chicken sexing and pattern matching. When you have these deep values, you know what matches your values or not, and then it’s more obvious what’s the strategic choice.

So, right now, you might be rightfully wondering, how do the Shinsei then stay relevant in an ever-changing world? How do you stay important for your customers when the world changes as much as it does? Really, who has time for tea ceremonies when we’re going to Mars or inventing flying cars or whatever? The thing is, they don’t shun new ways of doing things, but it has to be in service of their longstanding values. So, there’s a give and take to that. They innovate very cautiously and preserve their core competencies. They tend to be in slow changing industries that are built on tradition. I think that the business environment selects for these type of businesses.

So, they also maintain really strong community ties and stakeholder relationships. In fact, there’s a concept in Japan called Sanpo-Yoshi, which translates to three-way satisfaction. Toby, I’m going to let you get your mind out of the gutter there with what that—

[laughter]

Tobias: I was eager to hear what it was.

Jake: Yeah. So, three-way satisfaction. But it’s a business philosophy that emphasizes the importance of ensuring that it’s a win-win for the sellers, the buyers and society at large. Those are the three-way transactions. So, it’s a much more holistic approach. It aligns the ethical practices and long-term sustainability, which is, obviously, you have to have win-win across all these parties in order to survive for thousands of years.

So, anyway, next time that you’re having a cup of tea, think about Sen Genshitsu, the 15th generation master of tea ceremony, and his dedication to his craft and the continuity of purpose. And then think about the businesses that might embody some of the principles of Shinsei, and what that might mean for maximizing n of duration over the R of returns.

Tobias: Someone should study that construction company that’s lasted 1,400 years. How did that happen? Because a construction company that’s lasted one cycle is [crosstalk] impressive.

Jake: Yeah.

[laughter]

Tobias: What are they doing?

Jake: Yeah, it’s a good question. I wish I had more– [crosstalk]

Tobias: Money up front?

Jake: Yeah. Well, one of the big takeaways I think often in these, is that if anytime you have super high volatility, there’s a drag to that then you end up with path dependency issues. Like, you could end up with the biggest wins with high volatility, but you could also end up with the biggest losses.

So, you have to really tamp down your bet size on everything. Like, that’s how you constrain. If you max Kelly bet, that gives you the highest geometric return, but it also gives you huge variance around that. So, you can end up blowing up, if you’re even a little bit off, if you’re a little bit over. So, I think you just have to stay pretty far away from the edge as far as bet sizing goes. That’d be my guess.

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