Chit Chat Stocks - We're Closing Arch Capital

Episode Date: October 31, 2023

This will be our final Arch Capital episode. We decided to close down our fund and return money to investors. Closing the fund will allow us to put more time and energy into Chit Chat Money. Nothing is changing with the podcast. Listen to this episode to learn about what it takes to set up and run a fund. Brett and Ryan go through what lessons they learned, what went well, and what did not. Enjoy the episode! ****************************** Chit Chat Money is presented by Interactive Brokers. Switch the best brokerage in investing today: ibkr.com/info ****************************** Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome to Chit Chat Money. We have a bit of a random episode, I guess we could call it, something we've never really done before. You typically tune in on Thursdays for our,

well, sorry, this is a Tuesday, not so deep dive episode. And we typically do at the end of the month, an Arch Capital episode where it's something we hold in the fund. However, we are closing the fund. So as it'll probably say in the title, we're going to go through basically the story, I guess, of the fund, what happened, why we're closing it, some lessons learned. And if you've ever thought about managing money yourself or going this route. Hopefully we'll have some lessons that you're able to take away, or maybe if you're just interested in a bit of a life update on us, that's what we're going to be talking about today. It's going to be pretty off the cuff. We don't have a whole lot prepared for

this, but if you're a regular listener, Chitchat Money is going to be the same moving on. We haven't totally decided what we're going to do for the Arch Capital episodes. I think it'll probably just be something that a stock that Brett or I is particularly interested in. Maybe it's something we'll own, but it'll be something where we're not looking at for the first time, but it's maybe something we've owned for a while. So a little more of a, I guess, deeper understanding on those episodes. But with that, why don't we, I jotted down a couple of questions here. sure let's go back to the beginning of the fund and talk about why we started it when did we start it and what was our motivation what was our goal do you want to kick things off here sure i think

it's maybe maybe hard to get one thing for a reason we started it we thought it would be i guess interesting we thought it'd be a good i don't know goal or something to just maybe try and we thought we could be potentially good at we also were big we didn't like how the the management or excuse me the fee structures of a lot of the funds out there that we all know uh we're big fans of trying to lower fees for investors just given that you know it's i don't know a lot of the times you pay you pay high fees for underperformance and you see that time and time again we thought we could try to enter in with unique model and it was the pandemic so we were like hey why don't we try this we get a few family and friends together well why not

and we thought we had a good strategy uh i still think it's a good strategy and that's really it it wasn't more of a like okay this is what we want to do like this is the one thing we want to do okay we're i don't know it's hard to say exactly why we started maybe ryan you had better inspiration because you were the one that i think had the initial idea But yeah, I think, well, we've talked about it before that it would be great if we could run the fund and do this as like a full-time living. We enjoyed the process of managing investments and looking, I think most people that start funds are just equity analysts at heart.

They like researching stocks. They like finding things that are hopefully going to generate good returns for your money. That was really what we were initially. and we had started prior to starting Arch Capital. So for reference, this is the summer of 2020 that we kind of got the idea to start Arch Capital. Prior to that, we had been managing this, we called it hypothetical capital. It was literally just a sub stack newsletter. It was a fund that we would manage together. We had investments in it, but it was really just exactly what it sounds like, a hypothetical portfolio. And it did quite well. And maybe

we're a little naive, but we thought we could try to do this for ourselves and have a real audited track record and potentially invest for some family as well, family and friends. We had some people that had expressed a little bit of interest in having us manage something like this. So we were pretty eager to do it. The fall of 2020 is when we were actually getting pretty interested in it and started to reach out, contact other fund managers, look up what the steps were to establish something like this. And do you want to maybe go through some of that? Because I think a lot of people say, there's a lot of reasons to why you'd start it, but there's actual physical steps to starting it that I think a lot of people are maybe intimidated by?

Do you want to go through what it takes logistically to actually start the fund, or at least in our case? Chit Chat Money is brought to you by Interactive Brokers, but we'd like to call them by their ticker symbol IBKR. Designed for active traders and sophisticated investors, Interactive Brokers offers trading assets in 150 markets with 27 different currencies, charges USD margin loan rates from 5.83% to 6.83%, rated the lowest among margin fees, the ability to trade stocks, bonds, options, futures, commodities, and more with high interest rates paid on instantly available cash balances, and the ability to lend your eligible stock shares to earn passive income all on one single unified platform.

restrictions may apply for more information visit ibkr.com member sipc open an account with ibkr today yeah and that is a good point that we did have some people reach out that was part of the inspiration as well and i would add that we also at its core thought it could be a good business obviously there's been thousands of other examples of these type of businesses that work really well and can be profitable from a small business perspective. But yeah, starting it up is, there's a lot of paperwork. You kind of just go down a few rabbit holes of, all right, I need to fill out this stuff.

Luckily, we have the third person, Brady, that took that on as kind of the leader for that stuff. And he had to do a lot of different filings. What is it? FINRA, the SEC, filing with states. And then you essentially have to, well you don't have to but you really need to is sign a deal with a lawyer they help you set up a lot of these fun documents i believe there's three or four i forget the exact names of them because

they're all kind of just legal type names uh what is it what what is like the one that the investor signed right what's the name of that where it kind of kind of has all the you know the fees work how the strategy works that one's the lp agreement there's the whatever articles and corporation type document and i mean basically we just looked up fund lawyers like lawyers for starting an investment fund and there was a bunch we called the bunch kind of got quotes talked to them got to know them and we found one that we liked so that process really wasn't that difficult uh but i will say it was expensive i mean they do take a lot of the work and it's something they've done before but without them you really can't get it set up at least i don't think and we ended up

paying out of pocket i think it's probably good this episode to be entirely transparent just so people know what the actual costs are i think we ended up paying around 20 000 just to get the fund set up and that is cheap relative we went for the well we went for the lowest possible cost yes yes we maybe even cut some corners to try to save money here and there uh and ultimately it cost us about twenty thousand dollars we're young so it's it's a little more meaningful to us than maybe people that have been in the industry for a while but yeah i mean it was costly initially to set up but you also there's other vendors that you have to talk to as well so you have to have an administrator uh we chose nav and they're they're one of the lower cost ones uh and that's

an ongoing expense so you're paying that out every month you have to have an auditor you have to have tax you don't have yeah you don't have to have an auditor you have to have the taxes and stuff a lot of investors want to see an audited track record after year one or people look for that Especially if you're going towards higher end clients, so pensions, bigger institutions, stuff like that, then they really care. Well, do we ever have any experience with that? I think from our experience, actually, no one cared about the audits. There were a couple of people that were cold reach outs that said, can I see the auditor

sign off? Okay. Yeah. People that are familiar investing in partnerships like this, look for it, I think. But if you're just family or friends, and this is kind of the first time you're doing it, those people cared less as long as they trust you. But yeah, that's kind of the process in terms of the logistical components. So how to get things up and running. Let's talk maybe about the fee structure, because this was something that

we deliberated over a lot. And there's a lot of investors do it different ways. buffett had his way which i think was what was it uh 20 over eight right uh no you remember 25 25 over six but yeah 25 or six 25 over six so what that means is that uh annualized returns and i believe it's on a like if you go back below which you never really had a problem with but if you go back below that like it compounds every year for when you put the money in. So if you are an investor with them and you earn that first 6%, there's no fees associated with that, but the excess from 6% to say 20 for a year. So that's 6 to 20, that's 14% returns. He gets 25% of that taken, which is an interesting strategy. Maybe we should say how

just the structure is of a fund, because I think people might be interested. So it's pretty easy. there are a lot of intricacies for all the paperwork and stuff and where you have to file the business and where you have to do all this legal stuff, which makes sense for when you're handling sensitive stuff like financial information and all that. But at its core, it's pretty simple. You just have a general partner, limited partner structure. We have the general partnership, which is the three of us that run it. We're the ones in charge of running the business. And then we have the limited partners that join if they give us, say, an investment. Say they give us $50,000 or something like that, they become limited partners and it's

all one pool of money. So think of it, it's not the exact same, but almost like one big account that everyone's is combined together. And that's really it, right? At its core, it's a fairly simple strategy. We didn't have separate accounts. I know that's what a lot of people do. It's kind of a big choice. And it is the typical, quote unquote, hedge fund structure, but we wouldn't describe ourselves as that we we like to even if the structure was the same as a lot of hedge funds it's more of a investment fund i would say yeah because i think when people talk about the like hedge funds they mean you know like stan druckenmiller george soros stuff like that that was not the avenue that we were trying to go after yeah i mean typically i don't know how

people classify hedge fund, but typically when I think of hedge fund, I think of hedging and we weren't doing any hedging. We were a long only. So I look at it more as purely just an investment fund. As for the fee side of things, a lot of this was kind of foreign to me prior to really trying to start the fund, but there's two types of fees. There's a management fee and a performance fee. And it varies by state what some of the qualifications are, but for a management fee, this is when you hear the term two and 20, there's a 2% management fee and 20% on profits. So for us, the management fee is something you get no matter what. So if you run a 1% management fee over the 12 months or the year that you're managing money, you're getting

1% of the capital that you're managing. We chose to do no management fee. Ultimately, our investors were family and friends. They were taking a chance on us as young investors. So we felt a little, I don't know, it felt wrong for us to take a management fee. And since they were taking a chance on us, it seemed more like we would be doing them a favor if we chose this structure because they should only pay us basically if we made them more money than they can get with the S&P 500 index fund. And so that was kind of our structure. So the performance fee for us was 33% of outperformance. So if the S&P did 10% growth that year, we did 15% growth, we would get a third of that 5% outperformance. And then

We had the high watermark where if we went down, we would have to catch back up. It wasn't like we would just restart after the next year. If we dropped 30% and then we outperformed the next year, it's not like we got to take outperformance or performance fees. So that's the way it worked for us, zero and 33. Was it the right strategy? I am not sure. No. You don't think so?

I disagree. Yeah. Too complicated to explain to investors. We came up with this issue when we talked to people. I think we, looking back and we're going to do it again, I would want to do the Buffett strategy or the Buffett fee structure, excuse me, of the zero, or excuse me, the 0% fee up to 6%. And then, you know, the 6% hurdle after that, you get the 25%. I think one, It's so much simpler, a lot easier to explain. And two, from a marketing perspective, it can make people much more at ease with what might be a different fee structure than you normally see, because you can say, hey, this

is what Buffett did. This is what a lot of other value type investors do. Yeah, that's true. I mean, it was definitely hard to explain to investors and it was kind of interesting. It's what the S&P 500 does. No one, you know what I mean? I mean, the index people do, but technically at the end of the day, they actually don't care that much.

Yeah, which I guess I thought they did. I think we were wrong with that. I'm going to talk about this in a second. We underperformed the market. That's probably one of the contributing factors to us closing the fund, but I'm happy that we didn't take management fees to do that. given that our investors were kind of just really investing in us as much as investing in the fund that we can't just charge them for suboptimal performance. So I'm happy we did that,

but you're right. In the raising money process or the capital raising, it was very difficult. They'd hear this zero and 33, they'd be like, okay, we don't care if you take a management fee, but 33 sounds like a lot it literally like it just sounded like a lot but sounds even though to us it's like well it's only if we outperform it does sound like we're eating away at kind of the performance if you do really well which it was hard to sell i mean that was that was probably if we did it again either the 06 25 or i think even 1 and 10 because people didn't really care about the management fee. Yeah. It's interesting where we think, for a fund like this, where you're looking at not trying to necessarily be someone's financial advisor, you may even be

working with a financial advisor, which I always thought was tough when you have the double layer there. I think that's a very strange and usually not, I don't think it's the optimal way to do things when you have just double layers of fees adding on top here. But from our perspective, okay, we want to be not your entire portfolio. We want to be a subsection of it. You're taking a bet on us. We want to go after individuals that might, you know, or families that have a good amount of savings and they want to either take a chance on us. We have a separate strategy, which we'll get into, as I'm sure people who listen to the podcast know, typically our strategy is concentrated long only. I don't feel like a management fee is the right way to do things.

I'd rather just get paid and try to align with investor performance as possible, where basically we get value in the form of a performance fee if we provide value to the investor. But that's not how a lot of people see it. I think the ideal world is to be maybe flexible while you're starting out with the fees you can charge to people given maybe give them a couple of different options but it's not always doable just given the restrictions you have and i think if you were because this is different from when you're starting up like at the beginning i feel like you want to offer like you you want to make it okay we can do whatever you if you like us we don't want the fee structure to be uh something that's

And that keeps you from investing. We want to just figure something out to get you in the door, what you're comfortable with, blah, blah, blah. Maybe when you're scaled up and you have a better track record and you're not really like searching for clients, you can restrict and say, hey, no, this is what we believe. This is what we believe is the best ethically or for type of strategy for our fee structure. You can maybe restrict it. But at the start, I wish we could have been more flexible on that.

Yeah, I agree. And something else that I'll just mention, some of our listeners might know this, some of them might not, but at least in the state of Washington, this is where it varies, in order to charge a management fee to someone or to run a fund and take money from anyone, they have to be an accredited investor. In the state of Washington, there's a couple of qualifications that someone can have. So I think if they have certain licenses, they can be considered one. But the common one is that they have to have at least a $1 million liquid net worth so that that does not include their primary residence. However, we ran a structure that was zero and 33. So we had no management fee.

So if we took someone that had, let's say, a $1 million liquid net worth, something like that. We're essentially managing for free because the performance fee can only be applied to qualified clients, which in the state of Washington, qualified client is someone with, I believe it was like $2.1 million liquid net worth. So as young people, you have to assess, I think, what your network is and who the targets are that you'd go after if you wanted to raise money. Because if you have people that are bright, interested in it, and would potentially invest, or they're saying they'd invest, but they're not going to qualify, it doesn't necessarily help you. It's not money that you could take in. And I think maybe we didn't appreciate that enough,

that aspect of it, of how many people are really going to qualify. so we had the pot we i mean we what part of our strategy which i think makes sense and having the pod basically the investing podcast be a way to market the fund in a hopefully not a clickbait it's not the right term but well you know do it ever so often we would have these monthly episodes and usually we'd say hey subscribe to the fund's newsletter and usually we get a couple there and then ever so often we get an inquiry but nine out of ten times we would say hey here here are the rules for an accredited, whatever the terms are, accredited investor versus qualified client, all that good stuff. And then nine out of 10 times, they would say, oh, I don't qualify,

but I'm interested. So that is something you should definitely consider when starting out. If you're younger, you got to understand who your network is. We thought it would be a bit easier in that regard, but that restricts us from taking on maybe smaller clients and stuff like that. Okay. We've talked a lot about the fund. Let's talk about the investing environment of running the fund. What was it like when we started? Well, we launched officially February 2021. So it was the height of the growth bubble. Maybe we'll call it the innovation and meme stock bubble. So that was quite interesting. I think from a market environment at that time, everyone was saying and we'll get into maybe some of the mistakes uh this is a little teaser for that is

a lot of people were too hyped up on growth uh focusing on quality over price not caring about price i remember ryan uh who you were an intern at the motley fool and you know we love the motley fool we worked there but you said you learned a ton but the influence they may have is well focusing exactly that like right focusing on quality over everything else and maybe not focusing on price enough which i think a lot of people at the motley fool and again these are the mistakes we made as well would admit i remember when we were starting you were trying to pitch a company called pro core at like 25 times sales or something it's a good business good business so like hey look that's even i made obviously these same mistakes too and hold on like we

it wasn't public yet i said it was not public yet so i said oh right right it was hype if it goes public at a certain price i would be interested and you thought we disagreed on the price yeah i was like hey maybe 20 times sales let's hold the brakes here uh i don't think i was obviously 20 times sales just to be clear just just to set oh i oh i remember it was 20 times sales oh i remember way oh 20 hey it was a different time period we're talking about you know if we're gonna have mistakes yeah uh but i mean we're both doing the same type of thing there so that was maybe some context on the market environment and yeah i mean it's hard we have other question here which i'm trying to hold back on is you

know mistakes and what we did right what we did wrong from an investing perspective but i don't know if there's anything further to go into there or else we kind of spill the beans on that next topic no the only other thing that i think is worth mentioning here is that and this is kind of one lesson that i would take away from the whole experience is that if you run a focus strategy so let's say it's around growth growth oriented stocks which whether or not that was like our stated strategy it was kind of where we did the most research if the easiest time to raise money is potentially the worst time to start a fund for that strategy because you can sell past performance, but if that strategy is done really well over the last two years,

which is exactly what happened in our case, even though you might be drinking the Kool-Aid and believing a lot of the hype around lower interest rates, lower cost of capital, being able to grow quicker, it's probably not the optimal time. And that really goes for, I think, anything. You probably see it with energy-focused funds, how the easiest time for them to sell performance is when they've done the best, which in a cyclical environment is maybe not the best time to start a fund. So it is kind of this weird catch-22 where you want to raise a lot of money, but you don't just want to do what's worked for the last couple of years. The other thing I'll say here is that even though we tried to run it like we would our own personal money, there are some differences between managing someone else's money and managing your own.

First of all, you don't have a consistent income stream. So you can't just – averaging down isn't quite as easy. Let's say we talked about the full style where they're very long-term oriented, very growth focused. Buying thirds. Not afraid to buy a little overpriced at the start, take a little starter position almost. Because as something comes down, you get your income the next month from your salary, whatever it is from your job. You can buy more if that's come down.

With a fund, you have to raise capital. If you're underwriting an investment with the idea that I can buy when it comes down in a fund, that does not work super well. So, I mean, it's probably not a good strategy to begin with, but it doesn't work particularly well and uh we ended up in a number of time really a number of times having to sell something else in the portfolio and in order to buy positions that we thought were more attractive which really was not the optimal way to do things yeah and what was running saying is not like you can't just say okay i'm gonna continue holding this one thing you kind of gotta look at the opportunity cost

uh of in kind of a closed not a black box but just kind of a closed box there instead of saying okay i'm gonna have a few thousand dollars coming in then and then maybe we can change things up yeah and i guess maybe i'll ask this next one because it'll lead into i i'm trying to refrain from going through the analysis of what went right what went wrong because as the that's going to be very easy to talk about because it's really easy to remember the mistakes you made but i guess for context what were holdings like at the start i can see you made some notes here and how was and maybe let's do just an overview of the performance we'll get full context here didn't do well we never earned any performance fees and we'll obviously go through why but yeah so what were the holdings

like at the start and what was the performance like let's start with the performance we we ran the fund for two years and eight months, essentially. And in that time, so since inception, our investments declined by 20%. The S&P 500 did 20% total return, positive 20%. So we significantly underperformed. Looking back at our holdings when we started, I'll go through some of them. I don't know if it's worth going through all of them, but but we had Spotify at 17% of the portfolio. Kind of insane. That was the big, yeah.

I mean, that was the big mistake. Yeah. Huge error on our part. Nintendo was a big chunk. That was 15% of the portfolio. Almost Altria was 11 and a half. Nelnet was 10%. Sprouts farmer's market was 9%.

EA 9%. Dropbox five. Activision five. Match Group 5, Autodesk, 3%. And then we had 10% in cash. So it kind of- It's frustrating because a lot of those did well. Yeah.

Yeah, they did. Yeah. But a lot of them did poorly. And one of the ones that did poorly in particular was 17% of the portfolio. So position sizing matters. I think maybe a lesson to take away from this, for one, And I stand by the idea of buying your losers is for losers. What's that saying?

The averaging down. It's important to have it in the back of your mind. You don't really realize how much of your portfolio it was at cost when you do that. I think it's easy to forget because it might say it's only 7% of your portfolio, but at cost, it's come down. Maybe you put 15% in. uh we probably were should recognize that earlier but the other ones here you know some of them did do well i think position sizing was probably our biggest issue i will say i mean nintendo's down a decent amount um match group not a desk haven't done

well activision as well but yeah we can talk about it's frustrating because i guess the individual positions but we also another one that we averaged down on which was probably the biggest impact under performance besides spotify would have been wix which wasn't in the initial portfolio here uh that one we averaged down a lot and it's a mistake so yeah big thing to learn there is i'd say position sizing is something to very much consider think about a lot and probably just want a basic strategy of maybe everything's also the same at cost you regardless of your conviction ratings and then averaging down you should be wary of it and if you're going to like if you have a plan for it okay you should definitely have a plan for it and rules they

said at the start for averaging down but i'd also say maybe invert it and if you have a plan to average down in something maybe it should just remain on the watch list because right right if you're like okay maybe we could just average down this thing well if you're thinking about that it probably means you're worried that it's overvalued yeah the the other thing that's potentially worth mentioning here the i kind of lost my train of thought but in terms of portfolio turnover We actually ended with, well, for one, we were a lot more concentrated than maybe we should have been at the start, even though I do like a concentrated portfolio. But 50% of the positions were the same as when we ended the portfolio as when we started.

The other thing I was going to mention here, and I think if you're a long-term investor, you can maybe tend to forget about this, but it's important to think about what sector the stocks you own are in. So Spotify, Nintendo, electronic cards, Dropbox, Activision, Match Group, Autodesk, those are going to generally trade in line. And I know a lot of long-term investors will say, well, I don't care about how they trade in the short term, yada, yada, yada, because I care about the business results in the long run. When running a fund and you're not getting consistent capital in the door, you don't that consistent income it's harder to buy things it's harder to reallocate capital because things

come down together and we're trying to make money we're trying to build a business and i think you said you said sectors those are in different sectors factors factors factors yeah so over time and i think we got better about this we started to add stocks that were very uncorrelated stocks that they were a little more illiquid, which given that we were such a small fund, I think in general, we probably should have spent maybe a little more time

looking at illiquid securities where bigger funds can't really... Oh, yeah. Maybe an advantage for us. It is. I mean, definitely. I mean, looking back, hindsight's 20-20. I wish we embraced that at the start

because February 2021 was the perfect time to be looking at micro and small cap, maybe idiosyncratic, very you know value-oriented opportunities okay so long story short we we held a bunch of tech at the top of maybe one of the biggest tech bubbles of all time we underperformed significantly I will say however unless you were in the Magnificent seven or energy stocks you probably lagged the S&P 500. So it would have been difficult

for a lot of managers in this environment. Not trying to make excuses, just that kind of plays into the, if your strategy has been working, it might be easy to raise money, but it might not be the perfect time to start a fund. Yeah, and I still think we would have underperformed, but it probably would have been a bit less.

Like there were some clear mistakes that we probably wouldn't go back to, but I still think there's a lot of decisions that I would make today with a lot of these companies. And I still think we would end up underperforming the S&P, but probably not by as much, just given that we generally don't have as much exposure to the Magnificent Seven. Yeah.

Okay, so anyway, we're closing the fund. We underperformed. We're closing the fund. let's talk about other reasons why we're choosing to close it what are some of the ones i mean the biggest one for me it's too costly to run do you want to go through how kind of costly it is so people that are thinking about this can kind of know what to expect yeah and i would say this is the bare bare bare minimum that it costs to run something like this we went for the cheapest options as possible which is because we didn't really need as robust of tools i honestly think

we've got would have gotten into more trouble if we had some of the more sophisticated research stuff that a lot of the big funds have access to or have the budgets to pay for i don't think it would have made a lick of a difference but yeah so we have the the three of us run the same uh that run the podcast or running the fun it was the same three of us you could essentially think of it uh if there was a parent company which there really wasn't uh we were you know using any sort of profits from the podcast to help pay the budget for the fund because it the fund didn't make any money and as you people could see that there's no performance fees earned we we made zero money so we had the budget there it probably was about a thousand a month but

there's you wrote down 12 000 a year which makes sense there uh but i there was also some stuff that would pop up from time to time so i think it was probably even more than that so we're taking i mean the podcast just for full disclosure makes a little bit more than that uh amount but we were taking a good chunk of what we're earning from the podcast which we work hard at and it was going to run this business and there probably wasn't too much light at the end of the tunnel of the next one to three years of this turning into something that can be sustainable on its own so we thought hey we're going to be keeping you know throwing money into this thing and it'll probably cost a lot of them profits that we earn from the podcast business yeah we would like to keep trying this

it's it's something we think can work over the long term we believe in our strategy but it it's just the right move i i don't really have any presentation closing yeah it's just cost money so i mean the number one thing is money i wouldn't say it's the other performance i you know disappointed in that but it's not going to change how i invest my personal account kind of looked very similar to our fund holdings. Yeah, I agree. Now, the performance, I think it did contribute in the sense that if we had outperformed, it'd be a lot easier to raise money. Raising enough money, we could potentially cover the costs associated with the fund. However, given that we underperformed, it was going to be quite

the uphill battle to get enough capital into the fund to cover the expenses so that certainly was the two contributing factors highest cost or too much cost and uh worse than expected results what did we or maybe what did you underestimate when we were starting this what did you maybe not recognize about how difficult running the fund would be i underestimated how inflexible you have to be if you have a low budget in what you can revise right we've had we had discussions about oh shoot we kind of want to revise the fee structure like we talked about and we're like hey that's going to cost money that's outside of our budget so i think i underestimated that for sure uh i mean and clearly from an investment perspective we

underestimated the importance of paying the right price for a quality company you know a lot of us learned that we learned the same lesson as a lot of you guys during that time period yeah the it wasn't i mean more specifically to the fun side of things i was i underestimated how much of running a successful fund comes from capital raising, comes from the sales process, not just investment performance. Sure. I think if you've like, whatever, 10X the market over five years, you're going to have a pretty easy time raising capital. But there's certainly a sales process associated with this. It's not just people like, oh, you seem smart. I listened to your podcast a couple of times. I'll invest money with you. It's just not realistic. You have to

have good marketing materials, good way of demonstrating past performance. And frankly, you have to be a good salesman and give potential investors the sense of security that their money is safe with you. Maybe we were spread too thin, but we didn't spend a whole lot of time dedicated to the sales process, dedicated to raising capital. And I think for the big funds, I mean, they've got people doing that. They've got people where their specific job is go out, race capital. And then you have the equity analysts that are separate. So just, if you're thinking about starting it, no, that's going to be a big part of it. The other one, less people will probably qualify than you think, depending on the state rules.

And try to be as honest with yourself as you can of, has this been like, is it just an easy time to start or is it the best time to start? Is it the easy time to raise money or is it the best time to get some money in the door because investment returns will look good? If you're buying energy stocks at the bottom of the cycle, it might be hard to raise money, but that money that you do raise, it's going to look really good potentially when things turn. And then it becomes easier to raise in year three, year four, year five. So that's maybe something we underestimated as well let's go a little more investment specific here what were our best investments and what were our worst investments well looking at the initial ones

i would maybe i'll just read them off from this initial one some of this uh i mean spotify was clearly the biggest drag and we also did average down a little bit into that which is unfortunate uh nintendo wasn't very good uh altria did well i guess at the start it's kind of an interesting one it popped at the beginning but not really too big uh our best one which is a good example i guess our two best ones because we kind of one of them we bought and sold twice well i guess sprouts we did too but sprouts farmers market and dropbox were probably the two best examples of stocks that worked. And you have the notes here. They were cheaply priced and we had a different view than what the market was implying. We thought they had a durable growth strategy

and it turned out that when you have that and a cheap price and a management team that returns a lot of cash to shareholders, sometimes it works out quite well and you have a margin of safety on the downside. And then when both these things, we had that thesis on a few other things and they probably didn't perform very well but when it works like with sprouts and dropbox that can lead to pretty strong market outperformance yeah i was trying to think through like lessons from our best performers our best performers just on a pure percentage basis were sprouts farmers market silicon motion probably the highest irr and dropbox silicon motion it's kind of an outlier here this was one of those where it was more of a special situation uncorrelated to the market

and it was merger arbitrage for people merger arbitrage for people that aren't aware it was merger and uh news got announced that the deal was going to go through and we ended up selling it that day and it was just really fortunate timing i think on our part the other two though i'm trying to think of why they worked out so well and maybe maybe it's not something we'd own forever, but Sprouts, Farmers Market, and Dropbox, when I think about both those businesses, they were generally pretty hated. So it had had maybe subpar performance for quite a while. Investors were frustrated. They had both gone through big sell-offs. So Dropbox had just consistently declined and people were really writing them off as the tech darling of yesteryear.

And Sprouts was, at the time, people seemed to believe a flailing grocery store. both of them also traded at less than 10 times cashflow and had big buyback programs. And I think maybe that's the big lesson here. And both of those shot up, we sold them, came back down, we bought them. I think my lesson for those two is just because you sell something, don't stop tracking it. Keep a close eye on it. Follow the business progress. It might get cheap again, you might get a second bite at the apple. If they have a huge buyback program, you're going to get that margin of safety. And I'm not just talking about nominally a big buyback program.

I'm talking as a percentage of their market cap. It's setting a floor. I know that's obvious, but some of these other businesses, it was a different thesis, but i'm wishing we focused more on the big buyback programs and instead of the growth orientation but i mean maybe i'll hit the maybe i'll hit this point on the mistakes but what i want to uh add on there is a sustainable and track record of consistent buyback so using the cash that's coming into door the door returning that to shareholders and doing it in a consistent manner not only are they saying, hey, we have an authorized buyback program, but we are actually

doing it. So it's not necessarily, they can tell you a lot of things, a lot of companies do that, but show me that you're actually going to return the cash. What were our worst investments and what are some of your takeaways in terms of what would you try to hopefully do next time? well the yeah you wrote them down here the big ones i think probably in order would be from just worse drags on performance and if you take these out obviously it's not it's not an excuse it's just like these are the mistakes we made and it's why we did badly it would be spotify wix and then match group the biggest takeaways i would say are price kind of running valuation isn't just an earnings multiple or comparative multiple or a saying hey it's training at a sales multiple

that's what you would call it, like relative to other stocks at the time, that's kind of meaningless. Relative valuation is meaningless. And really, yeah, because if you look at these companies, yeah, match it a little bit of a rough patch. Wix's revenue growth slowed down, but what we mistakenly made there, maybe that's a different topic, is looking at a period of doing really well, not normalizing growth rates. all three of those the businesses i think are fine even spotify's has done quite well i think

and it's really the price we paid there now with wix i remember we looked at it we're like hey it's trading yet and at that time it didn't seem crazy but we're like it's growing at like 30 i think you could do that for a long time and it's trading about 17 times revenue and margins are really going to inflect higher here. I think, you know, it's a good value. Clearly, we should have said, hey, this is a business to watch. Let's keep it on the watch list. It's disappointing because we saw that with some of the probably most egregiously valued

stocks, Shopify, stuff like that. And we said, hey, we would never invest in those, but I think we should have just taken that lesson a little bit further, or clearly, we should have taken that lesson a little bit further. Yeah, I think something I take away from those investments is that it's really easy to conflate knowing a business well with thinking you know the potential returns well. Just because you know it better doesn't have any bearings on the potential investment or potential returns. With Spotify, we were very familiar with the product, the platform. We were

very familiar with the distribution side on podcasts. We thought we knew the business really well. We obviously didn't appreciate base rates enough or just didn't appreciate some of the red flags. Well, I mean, we were right about a lot of the stuff with Spotify. Obviously, they were a little egregious on their operating expenses, which we don't need to make this a Spotify investment. But with the stuff we wrote down, we were like, hey, we were actually right about a lot of this stuff, but it doesn't matter. Yeah. I mean, Match Group, we knew the products. Wix, we knew the products. Our websites were built with Wix. And we thought, wow, these platforms are really great. And I think maybe we prioritized that a little more than our financial

analysis, which is really what we should have focused on. The other thing, and this kind of leads me to what were some of the biggest mistakes. We overpaid. We've talked about that a lot on this episode that we overpaid for a number of businesses. Frankly, to be completely honest, I'm glad this happened when I was 22, 23 years old, because it's given me a new appreciation for what overpaying really looks like. And you could have felt like you overpaid in 2019, but you would have done all right purely probably because of multiple expansion or low rates. But now I think this is a really valuable lesson to learn early on in our investing career. But my takeaway here is that, and I know this means I might miss a number of really good stocks,

a number of really good businesses. But if I'm estimating double digit revenue growth, just 10 plus i'm estimating margin expansion and i don't have any multiple compression baked in and i'm still not getting a 15 potential return i'm probably overpaying that's i think a rule of thumb yeah kind of take from here on out yeah and then i would just kind of thought of this now but with wix and match those are two that we overpaid for but those wicks we actually the stock really collapsed and we kind of made a little bit back by saying hey we sold it for a tax loss harvesting thing and then bought bought back uh at a cheap price made a little bit of money there which i haven't run the math on but still lost money as

a whole both those stocks well actually wicks started working when the stock um how would i say it oh and like it totally got it well yeah well i combined yes the buyback program was initiated but on top of it this can happen with individual stocks compared to the market where the stock for whatever reason just totally collapses after an earnings report and it goes down like 30 40 an example right now i think obviously do your own research something like adyen where you're like man it just keeps falling and then you combine that with okay they're starting to finally buy back some stock now hey turns out that was a decent time to buy with match i actually think famous last words that could be happening right now but regardless

of whether match group works from here it's a much better risk reward at these prices versus what we paid at a hundred dollars a share yeah it's kind of making me i don't know it's making we went looking back at some of these investments and seeing the prices on like our cost basis yeah and what's what's interesting is we we've we've pretty much internalized this in 2022 and this year i would say for this full year well it's been about 10 months we have had the same strategy where or not the same strategies as we started but we became much more value oriented much more price oriented and we kind of stated that for anyone that reads the investor updates we follow we stated that i believe at the start of this year either way that's what we were doing

i think we explained it a couple of times it's talked about these mistakes that we're making and the returns this year have been you know solid even with underperformance from not having as much exposure to the magnificent seven so i think the strat like this is just a much better strategy to have going forward. And it's how I'm going to be investing in my personal account. Okay. Last question here, as we wrap up this episode, would we ever do this again? Would we ever start a fund? Would you ever want to, I should ask? And what would you change? Okay. So are you saying at the same time period or just in general, like the same exact situation? No. Let's say you were 35 years old

later on down the road is this something you never want to do again yeah and i will say that at the same time we shouldn't have done it we should have had a sustainable business first and then uh got into this but uh that kind of leads into the answer here is i think i would want to if again we we kind of said we're going to build the podcast and the fund at the same time but in reality we should build the podcast business first which has some promise and get that sustainable get that giving us a you know a better margin of safety on our own you know uh company's balance sheet and then i would be interested in doing it but i would have to be it would have to be a very very comfortable position because honestly i'm pretty excited to

talk more freely just about what we're investing in and stuff like that and there's a lot of busy work and i'm not exactly sure i'd want to do it but those situations or excuse me that criteria of having the sustainable business being much more comfortable with the the workload and stuff like that um i think you have some notes on that as well so yeah it would be a tbd i'd definitely be interested but definitely or obviously not at this moment yeah same not not for a while but But I think if you're interested in going into this business, whether you're starting your own fund, whether you're going to go work at a fund, it's a lot easier to have a defined role. So if your job is to raise capital, that's your job. You can get really good at that.

If your job is to manage the portfolio, there's certain skills required for portfolio management that are different from equity analysis. right? Portfolio management specifically depends on who your investors are and what they're comfortable with. If you want to be an equity analyst, which I think a lot of people do, and they just want to start a fund, there's a lot more that goes into it than equity analysis. So I think if I were starting one, I would want more of a designated role if I ever did this again. If I wanted to be an equity analyst, that's what I'd do. Not necessarily. So have the balance sheet or the funds, like I'm not saying funds, but the money to outsource some of those functions. I won't call them busy work because it's a lot of important stuff, but for the person that wants to do the equity research, such as ourselves, it feels like busy work.

Yeah, and the other thing I'll say is who your investors are matters a ton. And we were fortunate to have a lot of investors that weren't that bothered by our performance. They were investing in us, like I said, as much as they were investing in the fund. That was great. It's difficult and a little bit awkward in the capital raising process to talk to family and friends. It's just a little... So if you think your strategy is going to be, oh, I've got uncles and my parents' friends and a bunch of older people that I know that are in the business world that might want to invest, if you have a relationship with them outside of professionally, it might not be the best strategy because it can get awkward. They might not want to invest.

It might kind of have some sort of an impact on your personal relationship with them. You got to keep that in mind. The other thing is, I think it's a lot easier to have, if you're starting from the ground up, and we've talked to some other managers where this was the case, they had one person, ultra high net worth potentially, that said, I'll kickstart things for you with $5 million. It's a lot easier to do that than to have 50 clients with 100,000. well have the soft or you could have multiple clients but have the soft commits for the money before you file the paperwork and get things started we started before the money raising we probably should have explored that a little bit further uh looking back on that that's probably a big regret of mine and i'm sure the the other two guys here as well and then yes for

the family and friends you're like what we we found is we were like okay well and we were grateful for the people that joined, but we had, I would say a very high bar for who we reached out to because we wanted to make sure they were people that had high integrity or people that understood the financial world, all that good stuff. Because we were, I think that's one thing we were right about is being very, and we weren't right about a lot of things with running this business. And I mean, what we're grateful is that we learned a lot of lessons and hopefully get better as investors going forward. But having a high bar in general for the investors that you accept is important because a bad investor can be very, very detrimental to a fund. I'm sure a lot of

people have heard that lesson before. Yeah, I think that's pretty much it. I'm trying to think if there's anything else I would say to anyone that's interested in starting something on their own. I would say, first of all, you could probably do a lot better than us. Don't let us be a discouraging uh don't let us prohibit you from doing it the other thing i'd mention is logistically doing it is more achievable than people think like it sounds intimidating but you just kind of take it one step at a time hiring a lawyer even though it's expensive really helped ease the whole process they kind of put you in contact with all your other vendors suppliers stuff like that and if you don't need that large of a budget you don't need some people

talk about needing the operating expenses being in the multiple six figures. You don't need that. Yeah. Unless you have a team of analysts, Bloomberg terminals for everyone, the most expensive consultants and auditors, you can do this fairly cheaply. I say fairly cheaply. I mean, it's still expensive, but it's not as expensive as a lot of people say. But I think we can leave it at that. We don't really have to do that disclosure anymore, which is nice i guess we can kind of finally we will yeah we will have to change a few of the things that go along with the podcast i will say i'm excited to focus like more on the podcast it'll probably free up a little bit of our time it'll also be a little bit more exciting

to talk more openly about what individually you know we are buying and selling maybe doing a little debate there and stuff like that uh for example we could do like one of these research episodes like you know it could be like ryan's buying x and here's why brett thinks he's wrong or vice versa why brett's buying something and why ryan is hesitant and thinks he's wrong or stuff like that a little teaser here we can talk about literally what we're yeah that's actually i'm not as high on it you know we can hey so far you're right but the the price is looking a little bit better for me now because the the discount there is getting uh quite uh is getting a little bit better but yeah we can do that's a perfect example uh and we can just be more open on like

what we're doing in our personal book for those obviously you know we still work at the motley fool and we have to follow their they basically do like a t plus two thing where if you're buying on a certain day you just don't discuss it but you can besides that be pretty open about things we'll obviously follow all those rules but we can be just way more open i'm kind of relieved about that. Yeah, I agree. We should throw a disclosure on it that Brett and I, even though we did all this fun stuff, we're not financial advisors and anything we say or discuss is not formal advice. It's not a recommendation. Thank you everyone for listening to this episode and we will be back in a couple of days with a new one. See ya.

Bye.