In Search Of Excellence - Steve Romick: Manage Your Money Right | E18

Episode Date: April 26, 2022

Steve Romick grew up in a tight-knit family in the San Fernando Valley and was very driven from a very young age.  Even as a five-year-old, he wasn’t interested in failure and never gave up easily, a personality trait that has carried Steve through his career.  Today Steve manages nearly $20 billion in assets and is a managing partner at First Pacific Advisors (FPA), an LA-based money management firm that manages $29 billion. Steve’s passion to succeed, proficiency with numbers, and strong dislike of losing money have guided him to an accomplished career in money management, including the recognition of being named the 2013 Morningstar US Allocation Fund of the Year and earned him a nomination for Morningstar Manager of the Decade.  Steve’s knowledge and perspective about money management and investing are built on 30 years of experience and understanding of risk and reward.    In this episode, Randall and Steve talk about Steve’s first experience with wealth management as an intern (and later an employee) for Kaplan, Nathan, & Co., the importance of self-education and self-awareness in investing, how to grow a money management firm, modern investment strategies, and how to be a successful money manager. Topics Include: - How Steve’s father influenced his interest in philanthropy- The importance of reading and understanding shareholder reports - How to encourage people to learn and understand their investments- Who shouldn’t invest in a mutual fund - Low risk/high reward investments- Defining a hedge fund vs a mutual fund- Advice for getting a job in this industry - The ins-and-outs of growth at money management firm- The story behind his nomination for the Morningstar Manager of the Decade - What is the S&P 500 and why does it matter?- Defining the MSCI ACWI Index - Active vs passive investing - Why you should avoid secularly challenged businesses when deciding to invest- The two most important ingredients for success- Whether people should use a money manager or manage their own money- And other topics…Steve Romick is the managing partner at First Pacific Advisors, a money management firm based in Los Angeles that manages $29 billion across multiple investment strategies.  Before joining First Pacific Advisors, Steve was the chairman of Crescent Management and worked in for Kaplan, Nathan, & Co. In addition to managing the $10 billion FPA Crescent Mutual Fund, he also co-manages the FPA Hawkeye Hedge Fund and other multi-advisor strategies.  He serves on many philanthropic boards, including Cedars Sinai Medical Center, Our House, and Phase One.In 2013, Steve was the recipient of Morningstar’s U.S. Allocation Fund Manager of the Year and was nominated for the Morningstar Manager of the Decade.  He earned a BS in Education from Northwestern University and lives in Los Angeles with his wife and three kids.Sponsors:Sandee | Bliss: BeachesWant to Connect? Reach out to us online!Website | Instagram | LinkedIn

Some people just not who they are to really understand how to go and allocate their capital. Those people, they should do no direct investing themselves. We all have different tolerance for risk. It's not just a function of how much wealth somebody has. It's about what your predilections are. Welcome to In Search of Excellence, our quest for greatness and our desire to be the very best we can be. To learn, educate, and motivate ourselves to live up to our highest potential. It's about planning for excellence and how we achieve excellence through incredibly hard work, dedication, and perseverance. It's about believing in ourselves and the ability to overcome the many obstacles we all face in our lives. Achieving excellence is our goal and it's never easy to do.

We all have different backgrounds, personalities, and surroundings, and we all have different routes on how we hope and want to get there. Today, my guest is my great friend, Steve Romek. Steve is the managing partner at First Pacific Advisors, a money management firm in Los Angeles that manages $24 billion. He's the portfolio manager at FPA Crescent Mutual Fund that has assets of $10 billion. He's a portfolio manager for Source Capital, a closed-end fund which manages $400 million. He's also the portfolio manager for FPA Hawkeye, a hedge fund with assets of $350 million.

And he's a portfolio manager for the FPA Multi-Advisor Fund with assets of $400 million. In short, Steve manages a ton of money. Steve has been the recipient of the Morningstar U.S. Allocation Fund of the Year Award in 2013. And in that same year, he was a nominee for the Morningstar Manager of the Decade. Steve, welcome to In Search of Excellence. Thanks for having me, Randy. Let's start off by telling us what FPA is in your own words. FPA, for specific advisors, is an LA-based asset management firm that is effectively a home for different portfolio managers of a like mind who really operate with this common

tenet, which is an avoidance of losing capital. We're value investors. We want to invest with a margin of safety. And so we do it in different products across the firm, across the capital structure, whether it be debt or equity. It could be public markets and includes private credit as well. Thanks. I want to start out about our relationship. I start out all of my podcasts this way about how we met. It's a little hard to believe, but we've known each other now for 17 years. We go back to 2003. I've always been interested in finance and investing. And as you know, I manage my own capital. I'm what I call a self-educated investor. I've been reading Business Week since I was 13. And back when we met, I was reading Forbes and Smart Money, which was the monthly magazine of the Wall Street Journal.

Unfortunately, it's no longer in business, but that was my favorite. These and some of the other magazines always have a list of their top-rated mutual funds each year, which are sorted by type of the assets they manage. And as a starting point, before I bought any funds, I compared the list against one another to see how many of them would come up several times. And I would read the reviews. I'd look at their Morningstar ratings. I only wanted a four or five star fund. This was my top-down funnel approach. And as part of this, I became an investor in FBA Crescent in 2000. And by then, I had made a fair amount of money and made a number of investments in mutual funds. And I wanted to meet the people who managed my money in these mutual funds. It was and still is a little unusual for

individuals to call up managers who manage multi-billion dollar funds and say, I want to meet them. And I told one of my investment advisors, wealth managers in New York that I want to do this. And he pretty much laughed, said, no one's going to respond to me, which as you know, does nothing but light a fire in me when someone tells me that. So I started sending cold emails to my manager. Yeah, don't tell Randy Kaplan now. So I started sending cold emails with the subject line, hello from Akamai co-founder. And in the email, I said, I manage my own.

Kaplan would love to meet. It worked. Everyone responded. Of course, that other guy who's one of my best friends was wrong. And I got every meeting that I asked for. And I even had a well-known money manager fly out to see me. He stayed at my guest house for a night. You are on the list. And as part of my standing operating procedure, before I reach out, I always do my homework. I Googled you. And I saw you are on the board of Wilshire Boulevard Temple, where I'm a member. So before

I did anything else, I asked our awesome rabbi, Steve Leder, about you, and he told me to send you an email, and it mentioned that he had suggested it. And thankfully, I appreciate this, Steve. You kept my record intact. I reached out, asked you to get together, and you said, let's do it. And here we are 17 years later. It's a long time, Randy. Jesus. We were young back then. All right, let's start out by talking about your childhood. I'd love to learn what you were like, what your parents would like, what kind of upbringing you had, and what kind of important lessons did your parents teach you and that remain with you to this day? I don't know that my parents taught me any specific lesson that this is. My family's very close.

I grew up in Encino, the San Fernando Valley, and I have a brother and a sister. And the five of us are all very close. So I've been very close, familial relationships. I'll go across ways with everybody. Everybody's quite close.

And I learned to trust my relationships, certainly, because I learned to trust my family members. And that's one thing that stayed with me. But in terms of what stayed with me in terms of being an investor, there really isn't a lot. I think to some degree, it was just more my environment that caused me to take a certain path, as well as just the way I'm hardwired. I think that the one thing that my parents, I really have to give them credit for, particularly my dad, taught me to get involved in the community. And so my philanthropic involvements are entirely a function of my dad coming to me when I graduated.

When I graduated college, I went to work for a hedge fund. And I didn't know anything from anything. And my dad said to me, he was on the board of his temple at the time. And he said, look, it took me too long to get involved in the community. And I regret that. And I think maybe you should think about doing that. And so that was something that I decided to explore. And I got actively engaged in a local charity at that point in time called Vista Del Mar. And I've not looked back since. I've been involved in numerous organizations domestically and one significant one in Israel. And that's a very, very important part of my life.

And I really did that up to my parents and my dad in particular, as I said. But in terms of, you know, from an investing perspective and who I am, I think that, you know, to some degree, you're just, you're hardwired. And I was hardwired to be A, good with numbers. I was hardwired to be, to operate fairly logically. And I was hardwired to, for whatever reason, to hate losing money. And lastly, I was hardwired to not give up and be rather dogged. In fact, I have at my office at home, I actually have my kindergarten report card. And I was average, normal, above average, and pretty much everything. I wasn't fortunately below average on anything. But the one thing that really, I guess, the kindergarten teacher decided to call out on my kindergarten report card was attitude toward failure.

So at five years old, I mean, somebody knew that I wasn't going to give up so easily. And that's kind of been my personality ever since. What kind of hobbies did you have as a kid? What were you into when you were five, 10 teenage years? Well, I was very much a to-myself kind of kid when I was younger. I played in the playground in school. I had been friends in the neighborhood, but I spent a lot of time reading. I just really, really enjoyed reading both fiction and nonfiction from a very, very young age. And I just couldn't put books down. I always had a book with me.

And whenever I traveled with my parents, and I was very fortunate, they took me to different parts of the world. And I always read. So I was reading. And that was probably my greatest hobby. And then after that, I was very engaged athletically in a host of different sports at a young age. But then it really just honed in on one thing, and I swam competitively from the age of five and a half through swimming Division I in Northwestern. I didn't know that about you, that you were a swimmer.

Yeah. I wasn't the swimmer that was on the Olympic team and certainly wasn't one. I didn't make it to the consolation finals in the Big Tens. But I was a better swimmer in my junior year of high school, relatively speaking, than my senior year. All my recruitment letters in my junior year that I received, they asked for them back my senior year.

And I started having knee problems. So I ended up having knee surgery my freshman year of college, which is not great if you're a brush rubber. You really need your knees. But I also wasn't a swimmer that ended up with the seditious act of invading the Capitol building last week. Unbelievable. What were the people thinking? We'll get to that a little later in the show, and we're going to get to the importance of your philanthropy a little later in the show as well. So did you go to Northwestern to swim? I know you were in the school of education there.

Why education? Why study education and not business, for example? I went to Northwestern because it was my second choice. My first choice was actually Brown, and Brown didn't feel it was terribly important that I matriculated in Rhode Island. So I went to my second choice school, and I wanted to go to Brown, really. It was really my first choice for one reason,

over Northwestern, because I felt I could be more competitive swimming in Division II, and they actually had a water polo team as well, which I played. And that was really the reason, more than academics. So I kind of liked the academics of both institutions. So I went to Northwestern as you know, as the plan B and couldn't have had a more fortunate experience. But I did not go there to swim. So it's interesting

because I went to Northwestern, I was planning to go to law school. And I was actually, ultimately I was accepted to USC and I declined and decided to go to, I was going to get my JD, MBA. I ended up getting this job with this hedge fund, which I thought was more, you to, I was going to get my JD MBA. I ended up getting this job with

this hedge fund, which I thought was more, you know, it was interesting. I think I always go back to law school, but I went to law school. I figured that I would just become an English major because writing would be a very important part of being a lawyer. And I just didn't prefer the English department at Northwestern. I found there, there was a, they were a little too pompous and put themselves up in a pedestal. And I didn't feel that it really excited me. So I looked around to see what other majors might be interesting. And the School of Education had this major in human development and social policy that was particularly appealing because it allowed me to continue to take classes across this local arts institution while taking statistic courses and psychology courses in the School of Education.

So it was a major that allowed to have a little more custom-tailored. And interestingly, it's nice that it carried generational. My daughter is now a senior at Northwestern with the same major. And she also is not going to become a teacher. Is she going to go to law school? No, she's currently looking for a job in Hollywood. Got it. I was a psychology major, as I think you may know.

I may have shared that with you at some point in time. And I did go to law school. And I thought for the same reason, I wanted a broad, general education. I love my writing classes at Michigan and still love to write today. And I think it's really important if you become a good writer. I know you spend a lot of time writing your quarterly and yearly reports for your funds. How long do those take, by the way? So for those people who don't know what we're talking about, when you run a mutual fund

or investment fund, you have to write reports every quarter and each year to the shareholders explaining how the fund did and what you've done and whether you're up or you're down and the things that you like and don't like and your perspective on the outlook. Your reports are excellent. They're thorough. How long do those things take to write? I mean, they are long and they are detailed. They take days to write. I mean, days. I mean, I go through multiple iterations.

I use them much longer at the beginning. I keep adding them down and they end up being more concise. people have been trusting enough to allow myself and my partners to manage capital on their behalf, that we deliver the information that explains why we did or didn't do well, either absolutely or relatively, and to continue to drive home the point as to what our process is and why it is, and why we think it makes sense over time. And to always go back to these touchstones that are the evergreen parts of our philosophy. And I think it's really very important to, A, deliver this information to them so they can make the most informed decision.

And B, I think that we end up as a result with a more educated client base, which I think they will invest more with us or liquidate their position with us for hopefully the right reasons. So the Creston Fund, for example, is managing around $10 billion today. And how many shareholders are in the fund? I don't actually even know the answer to that question. Thousands? Thousands and thousands, yes. And the reason I don't know the answer to that question is it's held in Omnibus accounts at some firms. And so we don't get to look through if it's held through Schwab or Health and Fidelity, we don't get always a clear picture. And there's also some people, you know, like myself, I mean, I've got multiple accounts, right?

I've got my wife's joint account. You know, my wife has a separate account with us. I've got my IRA in there. My wife's got her IRA in there. I've got 401k money in there. I mean, so it's just, it's one clientele. One of the things I notice among nearly all of my friends and 99% of the people I know, maybe it's 99.999% of people I know,

they have mutual funds. They really don't know what they do. They don't know the manager's name. And certainly most of them don't read the reports. I think if you're in the business and you have a interest in the fund, what can you do to encourage people to learn more? If you own a fund, people should really know and learn about their money. They work their entire lives to save money. A lot of them put a good majority of their money, the vast majority, in funds like this. I think it's important to know what you own. What can you do? What can we do to get people

to learn more about their money and where it's placed? Well, I would start with appreciating who each person is. Some people just don't know who they are to really understand how to go and allocate their capital. So those people shouldn't invest in a mutual fund or in a partnership. They should do no direct investing themselves. They need to find an investment advisor who will allocate their capital for them. And that advisor needs to educate them. And that individual needs to understand we all are different. We all have different tolerance for risk. It's not just a function of how much wealth somebody has. I know very, very wealthy people who have no tolerance for risk and people who are very

wealthy who just want to keep betting more. The same is true for people who aren't as wealthy. They want to keep betting, and then people who don't have as much and who don't want to bet at all. It's not about how much you have, it's about what your predilections are. And I think to understand who you are as an investor, first and foremost, is where you have to begin before you take the journey of investing your own capital, before you decide to invest yourself, before you decide to have somebody else invested for you. I think that's very good advice. And I encourage all my friends, like you, I know a lot of people who have a little bit of money, who are just starting their careers, what should I do? And I always encourage them, find if you don't know, and you're not going to read the reports yourself,

and you're not going to really do your due diligence. As you said, find somebody who you trust, who's experienced, and who can help you guide and guide you through and teach you. So you graduate Northwestern. You mentioned a hedge fund. What is a hedge fund, and how did you end up at Kaplan Nathan, my great-great-grandfather's firm? How did you end up there? Just kidding on the Kaplan, by the way. The firm, well, I call it a hedge fundman's, really an investment partnership. They're really, for the most part, long-run. I ended up there because James Nathan was a friend of my father's and he was looking to have somebody work with him to help him invest his portfolio. And he was a well-known investor, very smart, a terrific investor over many years, had proven it with great returns over many years. And he wanted somebody he could teach.

Now, when I was at Northwestern, I had the ability to have an internship and I went to work for a company that he took control of at the time, RV Furniture. And he became president. And I went to work for him as an intern and did a number of projects for him to help him understand what kind of... The different stores, be it mystery shop or shop around stores, understand what kind of credit programs they should provide for their customers. And I just did whatever they asked. And I learned, you know, this is back in 1983, I guess it was, or 84, I think it was 83. It was 83. And I mean, I learned to use VisiCalc at the time. I learned to use, you know, on a computer, and I learned to use the right code for D-Base.

And I really took to it because I liked the structure, you know, that it had. And he liked the way, I guess, apparently I worked for him. And he offered me a job to come work for his partnership. And so I moved back to LA, took a job without even knowing how much I might make.

And I went into his office and he had a desk set up there that didn't match his desk. It was shoved right up against his desk. And for the next couple of years, I mean, well, this was 1985 to 1990, I worked directly for him. I sat there and picked up the phone when he was talking to

a company. So he talked to these companies, the CEOs, the CFOs, and we learned about these different businesses. And I learned about these businesses with somebody right there guiding me so I could just be a fly on the wall. It was fantastic. And I ended up in fairly short order in Laguna Beach. We took a drive down there. And he liked having me along because I would drive him. He would just read the whole time. And I drove his car down there with him in it and go down to take him to have tea with this guy who was wearing these odd pajama bottoms at the Ritz Hotel

and there was no other than John Templeton, Sir John Templeton. And I didn't have an internet that I could go and look up his name at the time. And I got to meet people like that. And there was a host of others, a long list I was able to spend time with. I have an internship program now for almost 20 years. And I've hired directly four people from the program. And then I've referred another now 80 plus to the first jobs where if I call someone like you and I say, I have this amazing kid.

He did a great job. She did a great job. You need to meet them. 99% of people will take the meeting even if they're not hiring. And we all know that even if you're not hiring, you are hiring for that special person. You can tell that person or not, but I think it's really cool. You obviously did a great job for him. And I think it's really cool. What a good break for you to be side by side with someone like that. I think it's odd and unusual to find such a great opportunity right out of school. It is.

But it's interesting also, he said to me something at the time I'll never forget this. We were in Chicago and we were having a drink in the lobby of the hotel there. He said to me, he said, quote, I'm tired of unlearning MBS, end quote. What he wanted was somebody who could come with frequency of notions, somebody who he could train and wouldn't have to fight through if somebody was thinking about security market lines and efficient market theory, et cetera. It's interesting. For the first 12 years of my program, we only hired MBAs.

I found for the most part, they had egos. They really didn't want to do the grunt work. I'm an entrepreneur, as you know, and there's a lot of grunt work involved in being one and building a company. And I finally thought, you know, they just didn't want to do the work. And I had an intern named Payam Salahi who begged me for a job. I didn't want to do it. I did it. He was fantastic.

The guy worked his tail off. And at that point on, I only hired the undergrads for a similar reason. They're willing to do whatever you need. They have very good work habits and ethics. And we haven't looked back. You know, for today, I appreciate you doing that. I think it's great. And I have a wonderful member of my team who I did take out of college. But you really need somebody. It takes a lot of time to train people from the ground up. I'm more candidly partial to it. I don't need somebody to have an

MBA. I'm more partial to somebody who's coming at me with some level of experience already. It makes it much easier. And I just don't have the time to spend in bringing up too many people in that regard, unfortunately. Because I think it's a great way to give back and help people. But, and I do, as I said, I have one terrific person who came to me that way, you know, who's on my team today.

By and large, I want people who know how to model, who have a good understanding of business. I mean, there's lots of learning to be done. Hopefully, this business is quite experiential and you become better at it over time. But there's certainly no guarantee of that. But we look for these common characteristics for success with these individuals who are applying. Somebody from high college, it would be the very unusual person to be able to make that entrance into our firm, which doesn't have a clear training program. For us, we're building a company, as you know, called Sandy. We've cataloged 94 categories of information for every beach in the world, more than 50,000 beaches in 212 countries.

It's really for people. Our program is for people who want to learn how to be an entrepreneur like you. There's a thousand ways to be one. They learn my way. And I like them raw. They've never really had a job like this or an internship like this. We really teach them a lot of intangibles. And it essentially is a tryout with me. And then it's a tryout if you do a great job with me. And as you probably know, I'm very tough. I can refer them to somebody like you for at least the meeting. So what happened? You're at Kaplan Nathan. You're working for this amazing guy. Opportunity of a lifetime, really. It's what you want to do. You're learning a ton.

You obviously love it. You're hardwired that way. So how long did you last and what was it like? I mean, you've explained what you did every day, but were you learning continually? And then how long did you stay there? And then what came next? I was there for five years, five and a half years, started my own firm. And when I started my own firm at 27 and a half, I became a consultant to him still. So I still worked for him for another five and a half years or so. And basically delivered research and invested portfolio for my clients, separately managed accounts, as well as doing research for him. So I was able to do both. I was able to do both.

And then I started a mutual fund, the FBA Crescent Fund, which you mentioned in the intro in 1993. It was really a byproduct of what I'd been doing. I used to do a lot of jump bonds back in the 1980s and go to the Drexel Annual Conference and learned a lot about high yield and distressed debt and lived through a cycle in 1990. And it was interesting because I felt like, well, I can deliver an equity rate return. Why do I just have to be in stocks? At the time, most managers were really focused on one thing, one asset class, one market cap size. I just didn't think that made any sense. I just wanted to generate equity rates to return.

I wanted to do so idiosyncratically because of my desire just internally to avoid risk. I wanted to do it. I could do it across the capital structure. If I can buy a bond, it was going to yield me 10% or 11%. I thought that would be at least as well as stock market, if not better. So why not just buy that bond? And I'm not going to have that same, if assuming I believe it will be a permanent pyramid of capital.

I'll get that with some volatility until maturity, but less so on average than the stock market. So if you take what the pitches are thrown, I felt the market was throwing pitches. And I saw people in the hedge fund universe doing this, but not in the mutual fund universe. As I started the FBA Crescent Fund to kind of invest across the capital structure, invest in small cap, mid cap, large cap, distressed debt, high yield bonds. We do some other things within there as well, but there's a certain limitation given the nature of it being a public fund. So you started that fund when you were 27 years old. I started that fund when I was 30. I started the firm when I was 27. I started the fund when I was 30. So you started this fund on

your own. How much capital did you begin with? And then how did you raise money for it once you got started? It's hard to call the small quantum of money that we had capital. It was so little. Like thousands of dollars, hundreds of thousands of dollars? Well, we had a number of million, but it was sub 10 million, I think, at the time. I have to go back and look. It was very, very small. And The idea was, okay, if I can prove this in the public markets, it is an area that I think I can deliver on for these clients or prospective clients. It's an area that's ripe for opportunity because nobody else is doing this in the public markets. And that was the reason for it. And then capital came in slowly, then quickly.

Then it left just as quickly. I mean, it left faster for a period of time than it came in. Because apparently, our main investors thought I'd turned stupid. I didn't do the internet stocks of 98 and 99 into 2000. So if you look over those two years into the first quarter of 2000, call it two and a quarter years, I underperformed the market by 50 some odd percentage points in two years. And I mean, we didn't make any money over those two years. I think we were down maybe 1% in the aggregate. I have to go back and look. So way behind. So investors were leaving quite

quickly as the fund grew from nothing to $300 million, a little over $300 million, and it dropped under $40 million quickly. I mean, I think that the only reason why we had any money left in the fund or even that much money, there were two reasons. One, I think people felt badly for me. And two, I think that some people forgot they had money with me. So I'm all in favor of that. By the way, but an important point I want to close with though on this point is we were right. We underperformed the market by 50 odd percentage points in that

timeframe. But then if you go through 2000, 01 and 02, I made money in each of those three years when the market was declining. And if you look back at 2002, over the five preceding years, going back to the horrible 98 and 1999 relative years, I actually ended up being 40 odd points ahead of the market. We're going to talk about all of that in a little bit and get into some specific numbers. But for now, I want to talk about, we mentioned a hedge fund. And a lot of people know the term, they don't know what it is. What is a hedge fund and what's the difference between a hedge fund and a mutual fund? Most hedge funds and mutual funds are pools of assets, pools of

capital where investors own shares or units in that. In the case of the mutual fund, it is shares. In the case of a hedge fund, it's units. The mutual fund can be an open-ended mutual fund, which allows you daily transactions at NAV, at the close. You can sell our mutual fund today and get today's close, and that show up as a redemption in my tomorrow morning run, and I will go and allocate my resources accordingly. If it's a big redemption, I'll probably sell something down. If it's a big contribution, I'll buy a portion of the portfolio and bring it back up to maintain exposures. But there's different kinds of mutual funds.

There's also closed-end funds. Closed-end fund is a fixed number of shares. Open-ended fund is open-ended because the shares go up or down. Somebody can come in tomorrow and buy shares and sell them the next day, so the share count's always moving around. Closed-end fund is a fixed amount of shares. It trades on an exchange, and you raise a few hundred million dollars, and then you invest that capital for those people. And those shares that they own, they have to go and trade on, say, the New York Stock Exchange. The source capital fund you mentioned earlier is such a fund.

So that can trade at a premium or a discount based upon how desirous it is, people have owning it in the marketplace. And now, of course, we have ETFs as well. There's certain advantages clearly to that as well. And in investment partnerships, typically, what you gain in a mutual fund is liquidity, which you don't get in a partnership. Partnership you're referring to? Partnership is I'm using partnership and hedge funds interchangeably.

A hedge fund, by definition, really is a fund that goes both long. It's usually in partnership form. They do have them in public mutual fund form, but usually in partnership form, where it's here it's an llc or an lp and you end up owning um stocks long making it making a bet and the subject are going to increase over time and then also selling stocks short borrowing the shares selling those

shares with the hopes of replacing them in the future at a lower price when the name hedge fund was created it was really supposed to be an uncorrelated partnership investment fund that was not correlated to the market in general. But I think it's a misnomer today. I think a lot of hedge funds do the same thing as mutual funds, but the future. Yeah, they're just long-running managers and they just charge a higher fee. Yes, you're right. So you've been running Creston for a very long time at this point, and you were running it for a few years.

And then how did you get to First Pacific Advisors? And why did you move? And who's Bob Rodriguez? A lot of questions on that. First Pacific Advisors. Well, I ran this mutual fund, and I realized over time that it was somewhat problematic to really want to spend your time managing the money, spending time speaking to companies. And you didn't really want to spend the time, I didn't, managing the business. And there's a lot to do in managing the business. Writing the letters I didn't mind doing, having to supervise the back office, accounting, client relations, making sure you're compliant from an SEC perspective.

It takes a lot of time, a lot of supervision. And also then, our returns are good. I also have to spend time on the road marketing. I wanted to focus on investing first and foremost. And Relink is the responsibilities on the side of the marketing and business development. I'm sorry, marketing, which is business development, marketing, and back office, and let somebody else take care of that in compliance. And so First Pacific Advisors provided a home for me at that point in time. I looked at a couple of different firms. I'll leave one other firm nameless. They're also run by friends of mine. And I joined First Pacific specific advisors because I was friends with Bob Rodriguez. We were part of an investment group in LA where these different

investors would... It was an idea dinner. I talk about being a fly on the wall. James Nathan goes by Jeff Nathan. Longer story there. I go to these dinners and he had to come up with an idea and and he had to talk through the idea. That was the price of admission. That's where I met Bob Rodriguez. I go, well, that guy's smart. This guy actually had the number one performing stock fund in the country over 25 years.

This is diversified stock fund. Unusually, he also had the only bond fund in the country that had gone 25 years out of losing money. So there's nobody else I've ever met that had a stock fund and a bond fund, let alone excelled at the top of class in both, where he's one of the only, if not the only, managers ever to receive the Morningstar Mutual Fund Manager of the Year award for two different asset classes. So Bob was a friend, still is a friend, he's retired now, and gave me a home. I brought my assets over to my firm, my mutual fund over there. I had a partner at the time and he went a different direction. And we ended up having

a good working relationship over many years. The fund's grown a bit since then. And I want to talk about how do you grow a money management business and a mutual fund? Does money management business work like a normal business where you have a business plan and you then plan to grow it? Is it performance-based? Is it enough to have good performance? Will the investors just find you

or do you have to have a marketing person? And at one point, do you have or do you need a marketing person, if at all? I don't think there's a runway path to heaven here. I think if you have performance, people will find you. They will. People find good performance. They hear about it from their neighbors. Now, you won't necessarily be the biggest person in the world, but you certainly will do a good job. You'll have capital and you'll make a good living. If you want to go in and manage a lot of money, you need somebody to be out there marketing for you, telling your story. My goal is never to manage a lot of money. I ended up managing a lot of money. It was incidental. It was a byproduct of a process and philosophy that led to good performance numbers that

people ended up becoming my partner's friends, investors. You obviously wanted to make a good living. You're a professional. You're intelligent. You're building a business. But money was never the number one priority for you. Never. The money is very good. What are the management fees on 24 billion in assets? If you look at, is it 1% as a rule where you're getting 240 million in fees coming into the firm? There is no rule. I mean, it depends on those. Lots of different products that make that up.

We have private credit affiliations in there as well. That's a higher fee than base fees and incentive compensation. We get a percentage of the profits. The mutual fund business has been under fee compression for decades, and it continues. But it also depends whether you're managing equities or managing bonds. Our fixed income business is a lower fee. So it's different across the board. I don't want to dive into the details like that.

Right. The point is, if you build a successful money managers business because you're a good manager, the assets will grow and your income will grow as well. Yeah, but I want to be careful because I think you called it a business. Very few asset managers are genuinely businesses. I'm not sure we can even give ourselves that credit to have that moniker. A business is something that can be replicated and transitioned generationally. It is very hard for an asset manager to do so. Usually, it's driven by one or two or a few key people.

To make sure that transitions generationally and people operate with the same philosophy and operate as successfully or as capable, it's very, very rare. There's very few. Some of these are businesses. Some of them are big brands that you know out there that have lots of different products. And one can be wildly successful, and one can be a complete disaster. And they've got huge marketing arms. And those are businesses.

Those businesses will survive the failures of any one product. That's not as likely with a company like First Pacific Advisors. We don't have that same breadth. But you could if you said, if you put your hand up and say, I want to sell the firm, there'd be a lot of people who would say, okay, I'd like to buy your firm. I think at some point you sold the firm one time, and then I think you took it back. And I didn't mean it. No, no, I never sold the firm.

The firm, First Pacific Advisors had been owned when I joined it. It was owned by United Asset Management. And United Asset Management had bought it from a group called Angelus Corp, which had owned this from, I think it was the 1970s, at least, if not the 1960s. And so it had been corporate-owned for many, many, many years. We bought it back and made it employee-owned. And I think that an employee of it. I was approached over the years when we were much larger, and it would have been very lucrative for me to have sold the business. It would have been certainly the best thing for me financially to have done, was to sell the business at a point done. I chose not to for a number of reasons,

not the least of which was selling a business. if you think about it, why would anybody want to sell it? You want to sell it because you either, A, want to capitalize for yourself and you could make, you know, somebody's going to pay you a lot of money for it, maybe too much. Or B, this somebody, this other entity can help you in the management of your business on a day-to-day basis or for its future growth because you want to seek that future growth. Well, I didn't need number two. I didn't want to be bigger. And we're smaller now than we were then.

And number one, it's just a tax arbitrage. I would have, at that point in time, been able to convert ordinary income into capital gain because somebody's going to buy me and they're going to take a piece of my revenue stream prospectively and they're going to pay me for that revenue stream. I'm going to get something, but a smaller share from that point forward once I sell it. And what they give me is capital gains. And I pay less in taxes for that with capital gains treatment as it's been lower than ordinary

income. And so it's a tax arbitrage and pulling forward the future income stream. And the last thing, as I said before, my most important goal was to make a lot of money and make the most amount of money possible, then I would have sold the business. At some point, didn't you even close the fund because it got too big and you had nowhere to put the capital? Well, I closed the fund because I wasn't comfortable with where markets were at that point in time. This is back in the early 2000s, from 2005 to 2008.

Their market had run up. I was very, very uncomfortable with what I saw happening on the subprime side of the equation, very uncomfortable with where financials were trading and how they were leveraging their balance sheets. And you can read letters of mine historically going back to that point in time where I talked about credit default swaps as early as, I think, 2002 in my old shareholder letters. Some of this is on our website, but I don't think we actually archive this going back into that point in time.

Because it has to be, now in this compliant world we live in, every letter has to run through compliance. Those are letters we've not washed, if you will, from a compliance perspective. But I talked about all of these things and these disconnects in the market, and I was very concerned. I didn't want to go and commit capital at that point in time. And I also wanted to build a team. And so I felt I would reopen at a point in time when the team was more robust and we had investment opportunity.

I'd say things have gone pretty well over the years. Since 1993, you've had one of the best risk-adjusted returns of all mutual funds that invest in equities and that has been managed by the same person since inception. It's been 27 years since you've been running the fund now? Yeah. How many managers have been running a fund for as long as you have? And why are there so few with that kind of tenure? I mean, there's got to be less than 10 of us. I don't know the exact number. And I mean, active running and being active about it.

There's people still at the firm, their name's on the door, but they're not actually running the money anymore in some cases. There's very few. Why? I mean, you'd have to ask them. I don't know the answer. But it's something that I enjoy doing. I mean, and you talk about, yeah, it's been a good run.

We've been very successful over the years. But our performance relative to the indices over the last five years or so has not been very good. I mean, we're not covering ourselves in glory by any stretch of the imagination. We look good relative to value investors, I would say on average, but we don't look very good relative to the market as a whole because the market's been incredibly top-heavy with growth in tech stocks. And valuation and pricing hasn't seemed to matter particularly as much in the last couple of years. I want to share a story with our listeners and our viewers.

We were meeting at a restaurant called Il Moro, which if I didn't know better, you would own it. I think you ate lunch there every day. It was your cafeteria. And you're looking super sharp that day and a suit and tie, which is unusual for you, or at least it's unusual when we get together. And I asked you if you got all dressed up for me and you quickly assured me it was not for me.

And I said, what's up? You said you had a photo shoot for something and you're pretty nonchalant about the whole thing. It was sort of like someone was making you get dressed up for something. And I'm not a big fan of non-answers, as you know, so I pushed you a little bit on this and said, why the suit and tie? And you said you'd been nominated for Morningstar Manager of the Decade. And I said, wow, holy shit, seriously? And you said, you know, you shrugged and said, took you like a millisecond to respond.

And I don't know if you remember what you said, but it was very quick. You said, it's only a matter of time before I look like a fucking idiot again. That stuck with me. I prefer to think that I didn't use the F word, but otherwise it sounds like that. Okay. Well, that is what you said and it's fine. We want to keep it real, but it stuck with me forever. I've told that to so many people when I talk about you and the fund and what a

money manager should be like. I'm in the VC business for a lot of what I do, and our model is very unusual. We invest in 10 companies, eight will go to zero. That means you have a total loss of capital, and then one may make some money, and then you hope one makes up the return for the whole fund on a weighted average basis. But what's the message there with what you said? Look, we were nominated for manager of the decade because it's a calendar year. Performance is calculated, generally speaking, on calendar years. So starting in the calendar year, at the beginning of that decade, it was the greatest bifurcation and valuation between growth in value in large cap and small than at any point in time in history.

So the starting point was a setup for great returns that decade for somebody who was sensitive to paying a reasonable price for good businesses. So the starting point was I was buying a portfolio of companies at the beginning of the decade that were very inexpensive, that were growing, and the market as a whole was growing, but the companies were very expensive. I mean, you had Microsoft as an example. And Microsoft, at that point in time, was trading at a multiple that was so high that even though it grew over the next decade at an 18%, 19% compounded rate on its earnings over that next decade, called 2000, 2009, or 2001, 2010,

whatever it was, that stock did nothing. How many companies grow 18% to 20% over a decade, and the stocks do nothing? And that happened because the starting point was so terrible. And so the universe we were being compared to had a bunch of overpriced stocks in it. And my portfolio had a bunch of underpriced stocks. And so we had a great starting point to at least be compared to the market relatively over that timeframe. And then I happened to get the 2008-2009 downturn right because I saw some of these issues as it relates to subprime, that they would manifest themselves and affect the market

in its totality. And so there are some good calls along the way as well. It wasn't just because of starting at that big benefit. But I knew at that point, all of a sudden, the decade is over. And I was looking forward to having lunch in O'Moro. And as I looked forward in 2010, there wasn't that bifurcation in the market that I had in the decade prior. So I wasn't set up for that same level of success going forward.

I could see that already. Now, what I didn't realize was that people that once again, people would pay stupid prices for companies, which is what we see happening today. There is just a wanton disregard for what these businesses are likely to earn over time. Or if not a wanton disregard for what they're likely to earn, a gross misunderstanding of what they're likely to earn. And they think they can earn this, but there's really nothing to support that. You mentioned your performance against the market. And again, I want to keep things simple. When you talk about the market, you're talking about the S&P 500, I think, all other things being equal. And I think there aren't a lot of people who actually

know what it means when you talk about the market was up or down. So what is the S&P 500? Why does it matter? And then is that a fair... I'm not talking about the S&P 500. I'm talking about really the MSCI Acre, which is an index of global stocks. So it's just an index to benchmark, to compare yourself to, of stocks that are both domestic and foreign. The S&P 500 system is 500 companies that are comprised of that index. And it's a US-based index. Although there's many international companies in that index where more than half the revenues of the companies in that index are sourced from divisions based outside the United States. Right. So I'm hearing you that it's not the correct comparison, but for most people, they think that is, right? I'm just, we're talking about 99.99% of people. These are people who are not reading your reports and who really don't know you own

the fund and they have a fund manager or some wealth advisor. And they're generally going to compare the performance against the S&P 500. And if you're looking at that, you've returned 9.5% a year since 1993, and they've returned 9.75% per year. To the average person, it looks like you're not performing as well as the market, but we know differently. So why isn't it apples to apples? Well, for one, as I mentioned earlier on the call, I don't do just stocks. There's three significant differences that will drive that difference. One is we do debt in there as well.

And so we're not just a pure stock manager. Two, we will invest in companies outside the U.S. If you look at the MSCI Acquia index over over that time frame, although I was more US-centric back in the 90s, I became more international starting mid, call it 2000. I've always had international in the portfolio, but it's increased from 2007, 2008 on, particularly after 2011. We saw more better opportunities. And then lastly, we also are not uncomfortable running with cash, where cash is a byproduct of our investment process. So our returns at 9.5 are averaging 30% in cash over that timeframe. So 9.5 is after fees, 30% in cash, and well under 60% in stocks. So we outperformed all the underlying aspects for what we delivered.

As you said, during the bear market from October 2007 through March 2009, you only lost 27.9% to be exact. And the market lost 55.3% to be exact. So huge difference. And you know it takes a lot of years to make up for those losses when you're down. What percent of Crescent is in cash today? I know it's a little bit lower than average. Yeah, it's not only lower than average, it's also more in stocks than historically we've held. And there's a couple reasons for that. The greatest driver of market returns, I'd argue, over the last 35 years has been interest rates. Interest rates coming down. Interest rates coming down

make, if you think about it simplistically, if you look at the value, what is the value of a business? What is the right price for a business? I mean, reasonable people can disagree, but if you really think about how you're going to evaluate a business, it is going to be a present value of a stream of cash flows. People always dip in discount models, but there's lots of considerations. But the lower rates are, the more valuable that business might be. So if rates all else equal, if you drop rates, that equity value is greater. The stub is greater.

And the multiple you'll pay for that business in the future is probably greater, too. That terminal value. I'm using a lot of this. I realize not all your viewers, this might be a little bit more arcane to them, but suffice it to say that rates go down, it makes a value of a stream of cash flows more valuable because you're willing to pay more for it. If I were to tell you that I'm going to give you $100 a year for the next 10 years, and you're going to go, great, fantastic. You're going to go, but you have to give you $100 a year for the next 10 years. And you're going to go, great, fantastic.

You're going to go, but you have to give me, and then I'll give you, give me $1,000 a day. I'll give you $100 a year for the next 10 years. And I'll give you the thousand bucks at the end. And you could go and borrow at 2%. You're going to go and do that all day long. If you had to borrow at 12% to do it, it would be uneconomic. So it shows you that the lower you can borrow at, the more willing you had to borrow at 12% to do it, it would be uneconomic. So it shows you that the lower you can borrow at, the more willing you are to do something like this. The other important

point of having low rates is a company that is leveraged becomes more valuable still because the debt that you have at the corporate level, now you're paying a lower rate of interest. So the levered companies are even more valuable. They're going to go up even more, assuming they're delivering on their earnings, you know, they're good businesses. And then lastly, the third reason is, is the lack of alternatives. What do you tell the person? If you think about it, a decade ago, and somebody unusually, unusually had, you know, two and a half million million in savings, which I realize is well above average. And over the last decade, you've had something on the order of 3% inflation. And so if you think about what the present value of that might be over that timeframe,

over the 10 years, let me take a step back. At $2.5 million back in 2007, you could go and get 5% in treasuries and intermediate-term treasuries. A treasury bond could give you a 5% yield. If you had $2.5 million, you could take out of that every year, $125,000. $125,000 back in 2007, 2008, whenever that was, today is only worth, assuming you could get it, it would only be worth $93,000 because of inflation. But let's flip this a little bit. You're not getting 5% on your coupon, on your treasuries. You're getting less than 1%. So if you call it like 0.8%, then that $2.5 million is only going to give you today, is only going to give you $20,000 of income. And $20,000 of income today, inflation adjusted because you're not the same.

Dollars don't buy you as much in 2020 as they did back in 2008. So that $20,000 is only going to be worth today something on the order of $15,000. So what is somebody to do if they had $2.5 million in 2008, and they just wanted to buy treasuries, they didn't want to assume a lot of risk, and they're bringing $125,000 in to finance their life? And today, in equivalent dollars, they only have $15,000. What do they do? They only have three choices.

There's no other choices. There's three choices. Well, I guess there's a fourth. First choice is, I mean, one choice I should say is they can reduce their lifestyle. It's pretty hard to do. Pretty hard for people to do. One other choice is they could go in and spend some of their principal. Easier to do than reducing their lifestyle, but still, at some point, you're going to incur some psychic pain that you've watched your principal eroding. So it's not entirely easy. The third choice is that it can go and take on more risk. And that's what most people will do. That's what most people have done. The fourth choice is they can steal. But let's leave that one aside.

Yeah, we're not recommending that one. People have taken on more risk, Randy, and that's what we've seen. So it's been a risk on the market, not just because rates are low, because a value of an equity is worth more today than present value, more today because of those low rates, but also because it's worth more because people just want to pay more for them because they have such little alternatives. And so the reason that we are more invested today than we've been in the past is, A, there's a lack of alternative out there that we see at high yield. So we end up with more

inequities. And then we're so concerned with the way the governments are spending money so wantonly that we really are concerned about what value cash might have for us in the future. Cash could be trash. And we just. Whatever you leave in cash is going to get eroded every year by the rate of inflation because you're not earning that. I'm going to borrow that one. Cash could be trash. I'm going to put that on the podcast advertisement at some point. I have to think about how we're going to do that, but I like that. Cash could be trash. Let's talk about something a little more simple, active versus passive investing. This is one of the most hotly and frequently debated topics in the investment world.

I've read something like less than five people in the world have beaten the S&P over the last 30 years. I think Warren Buffett has won. I don't know who the other four would be. You're right neck and neck there. But if no one can beat the index over the long term, why not just index all of your money on a tax-adjusted basis?

It's even harder to do. I think that it's a great argument. Most people can't and don't. I mean, we've been very fortunate. We've outperformed, even in the last 10 years, which is more of a growth environment, our underlying equities have outperformed the market. And so we've delivered on the underlying equities.

We have not delivered on the total portfolio versus the stock market because we've been sitting with a lot in cash. But our return on invested capital has been quite good and been better than the market over long-term terms, even more recent in the last decade. Every good idea gets taken to extremes. I mean, there's a lot of, you know, so much money chases this thesis that, well, it's low cost. Most people can't afford the market, so let's just go buy the market.

And that's a great idea until one day it isn't. Why might it not be at some point in time? And I'm not saying that point in time is today. I don't know when that point in time might be because we now have more than 40% of the world is that the U.S. is indexed. I can't remember the exact number. I saw it across the 40% threshold a couple of years ago. I don't know where exactly we are today. But at some point, you lose price discovery. There'll be a point in time where the active managers are really going to excel because so many companies will be left out in the cold. Index funds are great momentum vehicles because they end up owning the index.

The indexes are capitalization-weighted, which means the bigger companies have a greater weight in the index. As the bigger companies get bigger because they're doing well and they start doing well, so they attract more money. So the stocks go up further and they become a bigger weight in the index. That makes the index funds do better still. So more money flows into the index, which then goes and buys that same stock and pushes it up higher still. And it becomes this virtuous circle. At a point in time, that just doesn't play anymore. And I'm not smart to figure out what that might be. So we believe that we continue to add value as we have in the past, and we'll continue to believe we'll be able to add that value in the future. But at some point

in time, there will be hell to pay, particularly in those businesses that are getting very, very crowded, where there's too many index funds that own the shares. I think there's a risk. Personally, I think there's a risk with Tesla joining the S&P 500 and trading in the stratosphere. They don't have a lot of room for error there. If something happens to Tesla, I think the index is at very high risk. I don't agree here, Andy, because I think if you took out high, I would agree. I think you could substitute Tesla and a lot of other names and throw them into that mix. But Tesla's weight in the index, I think it's like 1.7%, something like that.

So let's just say it drops by 75%. I mean, you can quantify what that risk to the index is. So I don't think that it's... I mean, it certainly will make the index more volatile. There's lots of companies like that in the index that have their stratospheric valuations where people are assuming an economics to that business as to how many cars they'll sell in the future,

that their solar is going to have X value, their batteries will have Y value, and they're going to be the ecosystem for all that is EV, electric vehicles. I mean, some of that may come to pass. All of that may come to pass. None of it may come to pass. And so it's too hard.

I put that in the bucket as too hard. But you're right. It does create greater volatility in the index, but that is just an exemplar of other companies in the index as well. And many of those companies trade at very, very high valuations. Let's talk about your investment process now. Where do the ideas come from? Do you look at what other good managers are doing for ideas? And once you've identified the prospects, then what do you do? How much time do you put into the due diligence? You mentioned when you were with Jeff, you would go to CEOs and you would meet

with them. What's the whole process on a step-by-step basis? Every company, every investment is a little bit different. Ideas can come from lots of places. It can come from other managers, people we have conversations with. It can come from letters we read from other managers for their own quarterly commentaries. They talk about positions that they hold. It can come from filings where we see a manager we respect has made a smile on something. It could come from an interview in various magazines. It could come from screens that we run. It could come from industries that we find that are out of favor that we just look for

the best companies in those industries. It comes from lots of different places. There isn't one place that we source ideas from. Once we get the idea, we mobilize and begin to do the work on it and ask ourselves and or our team, and we do it together, we say, let's underwrite this company. Let's try and understand what the prospects for this business are over time and the industry in which that business operates. How might they be disintermediated? How might they be successful? So we really want to own those businesses that really have secular growth. They don't have to be wildly growing. They don't have to be growing at 30% a year,

but they have to be businesses we think are going to be that business 10 years from now, possibly earning more money than they do today. So if you looked at Sears in 2000, we couldn't look at Sears. It looked like it was a value trap because in all this hidden value, value investing to us simply means investing with a margin of safety, right? Avoid losing money, buying a asset at a discount. In the case of historic value investors, really the protection for that margin of safety really was from the balance sheet. Owning that business with the protection of the balance sheet.

You could have a lot of book value there. It could be something of inventory or receivables or something like that. It could be real estate they own, et cetera. Now, we would argue it's transitioned more to the value of the business. We want to understand what that business might be worth over time. How successful might that business be? In the case of Sears, to use that just for a moment as a poster child, it was kind of that historic example of a business that had these terrific assets with all this real

estate. They owned all over the United States. And they had this terrific market share in retail. But then, at the same time, they were being disintermediated. And they were not by online retail. And they weren't growing. And they weren't competing well in that area. And unlike Walmart, that rose to the challenge. Sears did

not. And to fund their operating losses, they kept selling that real estate and mortgaging that real estate. So what you thought was a margin of safety gradually disappeared. So we focused on those businesses and have our team because those businesses that have that secular growth. It could be a cement company that's a global business that isn't a wild grower. It could be that. Or it could be something that has more growth. We first bought Alphabet, Google, back in 2011. We bought it in the midst of bad news when the economy was viewed as being weak, or Facebook in the midst of the Cambridge Analytical scandal. So we bought that when it was weak. So we asked our team to underwrite these and look at these businesses and explain

the businesses to us. Let's not worry about the valuation. Let's think about, is it a good business? Is it a bad business? Is it run by good people, good corporate governance who allocate capital wisely? If so, we then consider what the valuation is and is it something that we want to own over time? We want to avoid because success is driven not just by what you own but by what you don't own as well, what you've avoided over the course of your career.

So we avoid these secularly challenged businesses, those businesses that are going to get disintermediated. We sold all of our retail years ago, bricks and mortar retail, I should say. And we stayed away from radio stations. We stayed away from the video rental companies, not because of Netflix, but because this was pre-Netflix. This was before the stuff was being delivered to you via the mail before they had streaming. But this was because we saw the pipe into the home getting bigger, and we saw pay-per-view becoming something that was going to become more and more of a reality. And we said, look, how can we invest in business?

We're not comfortable with what it might look like in 10 years. And so we stayed away from it. We stayed away from TV networks. And we stayed away from a lot of restaurants that we felt that were overstored in the United States. And so we always look for these businesses that have got the secular tailwinds, the growth, to focus on and then stay away from those businesses that have got these headwinds. They're secularly challenged and possibly being disrupted or disintermediated. And then when we get this work and we do this deep work, and we've got a member of our team that's a journalist and helps us underwrite these companies from a qualitative perspective as we try and become industry experts and talk to people who operate in the space to educate us.

Because we go into so many of these industries as rooms. We don't know a lot. And so he wants people to teach us. We don't presuppose great knowledge going in that we're smarter than everybody else. We want somebody to teach us. So we want to find the smart people to teach us. And then we go in and bring those people along and ask them to teach us. Some of them are very kind, you know, and some of them we have to pay consultatively. And so we do that work. And then at the end of the day,

if that business is a, you know, offers an attractive opportunity to make money in the base case assumptions, we don't try and determine, we build models, we build, you know, good models, but we don't try and say, what are our next quarter, what are our next year? We try and determine, we want to make sure and say whether we're going to earn next quarter or next year. We try and determine,

but we want to make sure it's still going to be a good business 10 years from now. And in the base case, are we likely to make money? And in the high case, can we make a lot of money? And in the low case happens,

how badly might we be hurt? And if that's set up, that risk reward is attractive, we get engaged in those companies. And the same is true of the debt side as well. And look at high yield and distress. You've talked a lot about your team and with any business,

and I'm going to call it a business, even though you don't think it that way, but you have a team and for you to be successful as a money manager, you need a good team around you. We've already talked about the junior people. You know, today you want people who have worked in the real world

in the money management business so they can hit the ground people. Today, you want people who have worked in the real world in the money management business so they can hit the ground running. How hard is it to get a job there? How often do these jobs come up? And how many people, when you have a job, apply for that one job? We have 10 of us or so on our team, and people tend to stick around. We've got a lot. We've got good tenure with our team. We're very, very fortunate. And my partners, Brian Sumo and Mark Landecker, Brian Sumo, to whom you introduced me to a number of years ago. So thank you for that. If you have good people who are smart, who think in a fairly similar fashion, I say fairly similar because nobody's exactly the same, but we're concentric

circles where that Venn diagram has enough overlap that we can operate successfully within that overlap that everybody likes each other socially. They've got good integrity. They're smart. We all teach each other different things, and it makes it fun. We try and have a little bit of fun. We try and have a stone crab one day for lunch. We try and go on a ski trip with the team. We tell people, take the team to a Laker game back when we were losing horribly. And now that we finally are winning, we can't go to a game. You mentioned the journalist on your team. And I was thinking about you and not having a background when you went to go work at the hedge fund. And it reminds me of a great example of this in the venture capital world is a person named Mike Moritz. He went from a journalist at Time Magazine to a venture capitalist at Sequoia, one of the best firms in the world. And I think we may have talked about this,

but he invested in Google, LinkedIn, PayPal, Stripe, Instacart, and according to Forbes, he's worth over $5 billion today. So I think you can come from a different background and learn the money management business, whatever business that it is that you're trying to get into. Sure. A lot of it's just being logical. You don't have to be a rocket scientist in this i think people try and sometimes push the pencil

too hard too far say am i paying a good price a fair price for this good business which will allow me to make money over time so you gave me an entry and i want to tell the story about your partner brian selma because i think there's a lot of lessons here to be learned. And around 2005, 2007, I was running my investment firm. We were doing primarily VC. I wanted to start another business where I would actually try to run the business and grow the business. And one of the businesses I liked from a business model perspective was the investment business. I think when you're considering to start a company, you should do something you love. And I loved investing and I love to learn about it. I love to read about it.

I mentioned this before. I had a lot of meetings with money managers like you when I wanted to meet people who were managing my money. And I ended up meeting around 10 to 15 of them and three things popped out at me from those. Many of the people who were doing the investing didn't have the best social skills. Many of them were introverted. Some were a little awkward, not exactly the kind of outgoing personalities that are best suited to raising capital. Second, similar to why you wanted to go to a larger firm, nearly all the managers wanted to focus on managing the money. They didn't want to spend the time running their firm, speaking with the clients, or raising the money, which, as you already mentioned, very time-consuming. And third, from a business model perspective and profit-making opportunity perspective, to own and run a hedge fund was significantly better than running a mutual fund. And we talked about the incentive,

and I just want to run through this with people. So in a mutual fund business, a manager will typically earn one and a half percent on the assets they manage. And yes, it's come down, but I just want to use that number as a nice round number. So if a fund is running a billion in size, the fund generates revenues of $15 million per year. The hedge fund model works very differently. Instead of one fee, there are two fees. The first is a management fee. Instead of 1%, it's typically 2%.

And it also gets a second fee of 20% of the money it makes each year. So that's called a carried interest, which is really just a fancy name for the performance fee. So if you use the same example, if a hedge fund is managing a billion dollars and it collects 2%, that's a $20 million management fee. Then if it gets a performance fee of 20% of the gain as well. So if the fund has a billion that it's managing, it gains 10% a year, total gains $100 million. The managers get 20% of that number, which is another $20 million. So when you compare the- You have to take out the basic out of that calculation. So it would be 20% of the $80 million. Okay, 20% of the $80 million.

So it's making $36 million as opposed to $15 million for managing the same amount of money. The point is, it's a superior model from a business perspective. So for me, I thought there was a good fit here, right? I love the investing business, wanted to grow a company. I think I have good social skills. I'm good with people. I like meeting people. I like to cold call people. And I love the model. If the performance is good, which is the key, you could make a lot of money. So the result of all this was I want to create a new hedge fund to join or partner with a junior person at a senior firm looking to create a new fund. I would run the business and the marketing, and they would handle all of the money management.

So here's what I did. I put word out to my friends in the hedge fund world. I contacted institutional trading firms. These are the firms that place trades for the hedge funds. The people that worked at these firms knew all the newer funds and the smaller funds. And they also knew people at the larger firms who were thinking about leaving their own firm. But for this to work for me, I needed a few things. First, I needed to find a manager who had a track record of at least three years. Experienced investors required this. And if they didn't have a good track record, I would not be able to raise money. Second, I needed to

find the right personality fit. Just because it's a good fit from a skill set perspective doesn't mean you're going to be good partners. And I talked to around 30 people that year who generally fit the profile, and I met with around 10 of them. And in late 2007, I met Brian Selmo. And at that time, Brian was 26 or 27 years old, and he was managing a $250 million hedge fund. From a product perspective, it was a good fit with my investments, which similarly were value-oriented. And from a performance perspective, he was doing phenomenal. His fund was up 41 of the previous 44 months, and his net return was in the mid-teens, even after these huge fees, the 2% and 20% fees. He was interested in only managing the money and didn't want a part of the marketing. He had a partner in the fund, a very large money management firm

that ran $4 billion in total. Brian owned 50%. They owned 50%. And they had given him $80 million to seed his fund. And they did all the marketing. So they raised 100% of the money. And I got to know Brian very well over a few months. I really liked him. Very smart guy. We had many meetings. We had a bunch of lunches. We had dinner with the wives. We had him over one night. And once I passed this hurdle, I needed to do my final due diligence on him. I couldn't just rely on his numbers and the reports that I read. And I read every single one that he had written. But I needed someone more experienced and qualified than me.

Someone who managed money for a living, who was at the top of their game. And luckily, I knew the perfect guy. He ran a somewhat similar value fund. So I call you up, gave you the lay of the land. The following week, the three of us sat down in your conference room for 90 minutes. And when you guys talked about a lot of things, the portfolio, the companies, this research process, the risk, the tax efficiency, and a whole bunch of other things. And I think it went very well. When you left, you told me it was

young, but very, very bright. He knew his things cold. And you thought it was a good fit for me. So check, check, check, check, check. Super pumped about this. Now we had one more hurdle. The final one was talking to the money management firm and trying to figure out how much of this fund I would own. I wanted to own 20% of the business. I was going to grow it. I had the contacts. I could really raise a lot of money based on his performance. Brian didn't want to give up his half, which meant that the money management firm was going to have to give up some of theirs to allow me to join the company. We had a number of meetings with them. Unfortunately, they didn't want to do it.

They had $4 billion under management. They were making a lot of money and they were happy with the way things were. It was 2008 by then. And as we already talked about, the market imploded, was down 39% for the year and at one point down 55%. And it happened very fast. Everyone suffered. Investors panicked. Brian's partner had redemptions all over the place and managed a whole bunch of other funds. The investors were fleeing and they wanted their money. And as a result, they had raised all of his money and they wanted their $80 million back to stem the bleeding. And when they pulled their money, the short of it is Brian had to close his fund down, that he worked very hard to build and build this track record.

And he had to sell into a market that was falling like a knife. So the fund was over, unfortunately, very quickly. And all of a sudden, Brian doesn't have a fund and he's unemployed. And it was a hard time. I mean, I know you and I had a bunch of conversations about the market at the time. And I was divorced and had a certain amount of money and thinking, oh boy, this is not good. Brian called me two months later one night. I remember I was reading books to my twins.

They were five years old at the time. I was putting them to bed. They sounded very down. Told me what had happened. He wasn't sure what he was going to do next. And the market was still terrible. He had to close his fund. Prospects were very poor for finding a job. It was going to be impossible for him to raise a fund then. And I love helping people. I always have. I think you know that. And I asked him, how can I help? And then the purpose of the call came out.

He asked me if I'd be willing to call you up and see if you would meet with him. And I said, of course, I'll be happy to do that. And called you the next day. And the rest is history. There's a lesson here. There's a few of them. A lot of things can come from due diligence. And I have a saying, sometimes our biggest disappointments lead to our best opportunities. And three, you really find out who your friends

are when you're down. Let's take it from there. What happened? You go in for, he comes in and he meets with you and what happens next? Brian came in and what I asked him to do was give me a report. I do this with anybody I interview. I asked them to give me a couple of reports on gun companies that they like. And I read them as I want to be able to climb inside their heads. I don't, I don't care what somebody's track record is in and of itself, because you can just, just like I track record over the first of the 2000,

2010 period was so great because, you know, people were, were, were doing something that was the bifurcation of the market started. A text that came through the middle of the screen. Then I think that what happens is if you can

understand what somebody said, you can understand better their ability to replicate over time. I try to read reports and I don't even look at resumes without reports. It's always a resume. It's a lesson for everybody who's applying and working in this business. I mean, give somebody something to chew on, a prospective employer, something to chew on. Don't give them a resume that shows where you went to school.

And show them the resume. Write a really great cover letter. And then give them something that shows you why you fit in because you've done the work on their organization and why this company is attractive. That's something. If you get a couple of those things, then you can get a pretty good understanding of what the opportunity for that person to be successful over time is. And that's what

I was able to do with Brian with reports that he gave me. And I brought him on as an analyst at the time, just one of a number of analysts I had on my team. And then cream rises and Brian clearly was able to evince a capability that not everybody has. There's a point in time where I realized, well, this person's either a partner or he's going off on his own. I felt like it was time to begin to broaden out what I do and relinquish some control and bring in others. I brought in Brian Selma, my partner, Mark Landecker as my partners, as the product, as well as partners in the firm.

I love the story. You rise from a junior position now to one of three partners in the firm. What are the most five important ingredients of success? There's a lot of people listening to this today. One of the reasons is they want to get motivated. They want to hear from successful people, regardless if they want to be a money manager or not. That's one of the themes of the podcast. How can we all get better and how do we get better? But give me five things that you think are the most important for anyone to be successful, whether it's in money management

or any other field. I mean, I'm not going to, I don't know if I have five, but if I were to narrow it, if you think about it, I think it's really quite simple. First and foremost, it's a marriage of two things called one and two. It is a skill at doing something, whatever it might be, and two is a passion for doing that something. You need to have both of those in concert in order to be successful in any business. I don't care what it is. To succeed, not just financially, but to have that high happiness quotient for whatever career choice, career path that you've set yourself out on. And I think that is incredibly important to consider the juxtaposition of those two things,

skill and passion. Look, I play guitar. I don't play terribly well. I play reasonably well. My timing's terrible. I would love nothing more than to go and be in a band and sell out the Coliseum or Staples in LA. It's just not going to happen.

Because as much as I have a passion for it, I just don't have the skill. So it's just not really particularly helpful to have one without the other. And if you have the skill without the passion, you're still not going to be, you're not going to go in and invest your time in it to allow yourself to be successful. If you don't have the passion, you're not going to be happy. So those are the two most important things, is the skill and passion and marrying the two. And everything else falls from there. Continuing education,

working at it, you know, and all of that. And there's so many more things you can do. Those two rise, you know, above everything else. What do you want to leave us with today? What final thought, if you have any,

for everyone who's going to be listening today? Is there something I didn't cover that I should have covered that you just want to share with everybody? Nothing particularly jumps out. I think this has been a very far-ranging discussion. I think that, look, I think if it's somebody who's curious about investing, I think it's important, as you pointed out earlier, to highlight the importance of reading somebody's shareholder letters. I think it's important, even if you're investing your money, is to make sure that you do understand what you're doing and to make sure that you can do it correctly, which either means having somebody do it for you

and get the right person or finding somebody or buying those securities yourself, whatever the case may be. So I think that self-education and self-awareness combined are two incredibly important things. Awesome. Steve, it's great having you today. I really appreciate your time. Thoughtful, educational, inspiring as always. Randy, thanks for having me. I think that this kind of discussion is really helpful for people if they really take the time to listen. And in offering that kind of education I spoke about earlier, through such things as these podcasts, I think could be incredibly beneficial. Thanks. We'll talk soon. Thanks, Randy. Talk later. Take care. Bye-bye.