80/20 Rule for Investing

EMS:Likewise. Leon, before we go into how the 80-20 rule applies to your investing philosophy, DEI, and more, I wanted you to tell us a little about Palladium and how you got to where you are today.
LB:Awesome. Again, thank you to you and the Eisner team for having me. I'm excited about the conversation today. A bit of background on me is that I was born in Mexico, raised in Argentina, and my parents are from Peru. I came to the US 20 years ago, and I began my career in Wall Street as an investment banking analysts at Lehman Brothers, and as you shared, I have been at Palladium for nearly 15 years.

Palladium is one of the oldest minority-owned private equity firms in the US. We're currently managing over $3 billion of assets, and our focus is investing in middle market companies where we see opportunities for transformation. I am one of 11 partners at the firm that sit on the firm's management committee. I split my time between our origination efforts and helping lead our business services efforts. I am also heavily involved in a nonprofit organization called the New America Alliance, whose mission is to increase access to capital to women and minorities, including fund managers, which is something that I'm extremely passionate about.
EMS:Leon, you have a very interesting and inspirational background. Since our discussion, as I mentioned, will focus on the 80-20 rule, I wanted you to share your outlook on it and first discuss how it applies to investing.
LB:Thanks. The 80-20 rule is a fascinating subject to me, given its prevalence it has in our life and how little it is discussed. First, a little bit of history. In 1896, Italian economist, Vilfredo Pareto, discovered that 80% of the land in Italy is owned by 20% of the people. Later, Dr. Joseph Juran, a Romanian/American electrical engineer, discovered that this effect went much farther than Pareto envisioned. Juran named this effect the Pareto Principle, which we colloquially known as the 80-20 rule.

It turns out that the 80-20 rule is a phenomenon that happens a lot in our everyday lives. One prime everyday life example is that 20% of patients use 80% of the healthcare resources. The principle also manifests in many other areas, including nature. For example, 20% of pea pods contain 80% of the peas. When it comes to investing, whenever you have large data sets that have a wide range of outcomes, the 80-20 rules tends to manifest.

Let me go over some, a few investing examples. 80% of your returns will usually come from 20% of your investments. 20% of your investors will usually represent 80% of the capital. For portfolio companies. 20% of your customers will usually represent 80% of your profits. 20% of employees are responsible for 80% of the results. You will likely generate 80% of the return on your investments in 20% of the time you hold your investment. In due diligence, usually it takes 20% of the work to get to 80% of the underwriting decision. You get the picture.
EMS:Leon, it's evident you're very passionate about the 80-20 rule when it comes to investing, and I wanted to ask you, what are some of the greatest opportunities you have achieved through this investment thesis?
LB:Thanks. Look, there is a quote from novelist, Joshua Foer that says, "It is forgetting, not remembering, that is the essence of what makes us human. To make sense of the world, we must filter it. To think is to forget." In investing and in life, there is a lot of noise. To get things done, you need to focus and prioritize. I think this is where the 80-20 rule can be a tremendous asset, since 80% of your success will hinge in 20% of your actions.

Therefore, identify the things that are urgent and important, and do those first. Take note of the things that are not urgent, but important, and do those later. Things that are not important, but urgent, do them only if they are not time consuming. Lastly, things that are not urgent and not important, simply don't do them. When it comes to investing, once you have identified those 20% of investments that will represent 80% of your return, you want to make sure that you nurture those, and if possible, invest more since that will give you even more return.
EMS:Leon, what about the greatest challenges, on the other hand, that you might encounter with the 80-20 rule?
LB:Yeah. I think one of the greatest challenges of the 80-20 rule is that it's not a hard and fast rule that you can apply to every situation. It's a scientific theory based on empirical data. Often, you don't know initially which of your 20% investments will give you the 80% of your profits. In that sense, the role is a little bit more retrospective than forward looking. The Pareto Principle is sometimes referred to as the rule of the vital few. It is important to highlight that often data sets can yield much more extreme results at the simply 80-20 breakdown. Take sports betting or gambling, for example, in general, in those scenarios, the top 1% of earners get 99% of the payouts.
EMS:Very interesting Leon, and obviously there's been a lot of news with the SCC, and their proposed changes and approach to 100% disclosure with regards to transparency. I wanted to ask you, how does the 80-20 rule align with this and what they're doing?
LB:It's a great question, and of course you will need to disclose 100% of whatever the SCC is requiring; however, 80% will not cut it, but where you will find the 80-20 rule manifest in the question that you just asked me is that it will take you 80% of the time to get to that final 20% piece of information that needs to be disclosed.
EMS:Leon, obviously something you're very passionate about is DEI with your heavy involvement in New America Alliance, so naturally I wanted to ask you how the 80-20 rule could be applied to DEI.
LB:Thanks. Yes, indeed DEI is something that I'm very passionate about, as it's something that is very important to me and my colleagues at Palladium. I have said this in other podcasts before. I believe that diversity equals alpha. That means that diversity helps you achieve better returns. Studies have shown that more diverse organizations tend to have better results than their less diverse peers; therefore, it should be no surprise that the top 20% companies, the ones that provide 80% of the returns, are likely the ones that are more diverse.
EMS:Leon, we've covered a lot of ground today, and I wanted to see if you have any final or concluding thoughts you'd like to share with us today.
LB:Absolutely. Look, even though the 80-20 rule isn't a predictor for success, I like to challenge myself and my team to actively consider how this plays out day to day, week to week, and we can use it to ensure we are focusing on the right things. I look at my calendar monthly, and assess if I'm spending my time on the activities that I think will make the most impact to our portfolio and our origination efforts. For example, when we're performing due diligence on a potential transaction, at the 20% mark of the time spent, I meet with my team to discuss what we've learned. Since by now, we should have 80% of the information that we need to make the investment decision, at this point they need to make a compelling case to me as to whether or not more time spent on this deal is necessary.
EMS:Leon, thank you so much for sharing your perspective with our listeners, and thank you for listening to the EisnerAmper podcast series. Visit is EisnerAmper.com for more information on this and a host of other topics, and join us for our next EisnerAmper podcast when we get down to business.

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