Invest Like the Best with Patrick O'Shaughnessy - Paul Enright - The Buy Side Primer - [Invest Like the Best, EP. 222]

Starting point is 00:00:00 This episode of Invest Like the Best is sponsored by Canalyst. Canalyst is the leading destination for public company data and analysis. I'd heard of Canalyst over the past few years and became more interested after meeting the founder and CEO last year to pick his brain about SaaS businesses. Founded by a former byside analyst who encountered friction in sourcing, building, and updating models, Canalist is now used by over 300 institutions, including the largest money managers in North America and by a number of guests on the show. With detailed company-specific models on virtually every investable public equity, Canalist clients are able to react more quickly. If you've been scrambling to keep up with the deluge of IPOs and SPACs these days,

Starting point is 00:00:39 Canalist has models on Coinbase, Roblox, Qualtricks, and everything in between. Their pre-IPO models are built as soon as the S-1 hits and include all segments, KPI's, and non-gap figures. If you're a professional equity investor and haven't talked to Cannibalist recently, you should give them a shout. Learn more and try Canales for yourself. at Canalyst.com slash Patrick. That's C-A-N-A-L-Y-S-T-T-com slash Patrick. If you're curious to hear more about Canales, stay tuned at the end of the episode where I talk to Canales CEO, Demir Hot.

Starting point is 00:01:11 This episode is brought to you by MIT Investment Management Corporation, also known as Matimco, the Endowment Office of MIT. Matimco seeks to find people who are focused on achieving exceptional long-term investment returns, partner with these firms early, and stick around for the very long term. Matimco doesn't care how small, new or uninstitutional your firm is, if you have the potential to generate amazing results that supports MIT's pursuit of world-class education, cutting-edge research, and groundbreaking innovation. Despite their willingness to invest early, they do not ask for general partner economics, and they commit their initial capital for 10 years. To learn more and check out their recently

Starting point is 00:01:46 launched page dedicated to emerging managers, visit www.mitimco.org. That's m-itimco.org. Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at join colossus.com. Patrick O'Shaughnessy is the CEO of O'Shaunacy Asset Management. All opinions, expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion

Starting point is 00:02:34 of O'Shaunsi asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions and the securities discussed in this podcast. My guest today is Paul Enright, managing partner at Crano's Capital, his family office. Before running his own family office, Paul worked on the by side at Viking Global for over a decade managing their consumer and technology portfolios and before that at Morgan Stanley on the

Starting point is 00:03:04 sell side. I thought Paul would be the perfect person to help me demystify the world of hedge fund investing, explaining the difference between the buy side and the sell side, how long short funds differ from long onlies, and walking through the various jobs in the investing world. In addition to setting that foundation, we also cover the evolution of the buy side, what makes someone a great researcher versus a great stock picker, and various portfolio construction methodologies. Paul brings such a wealth of knowledge and experience to the table. I think this episode will be enjoyable for investing novices and professionals alike. Please enjoy my conversation with Paul Enright.

Starting point is 00:03:37 So Paul, increasingly, we're thinking about these things as sort of like primers on big topics. And a topic I realized that we've never covered, we sort of always taken for granted throughout the show's five-year history is just some of the basics of how the buy side and sell side work. And you've played this game sort of at the highest levels, I think continue to be a student of it, both of investing, but also of the industry and how the space works. And so I've really been looking forward to this. I think probably it's appropriate to set the stage with why you're such a perfect person to have this conversation with, with a sort of thumbnail sketch of your

Starting point is 00:04:11 history, having been a little bit on both the sell and more on the by side. There's a demystification of this whole process that needs to happen. There's no manual to go and look at it. And I am a little bit of a living embodiment of watching it evolve. I actually went to law school. I didn't enjoy being a lawyer. And I pivoted in 1999, 2000 to thinking about and educating myself and these resources didn't exist back then about do I want to go into banking or do I want to go into the cell side? And I found that the cell side was much more interesting for me given my background. So I went to the cell side and then that was really actually quite interesting.

Starting point is 00:04:48 And then the post bubble happened. Elliot Spitzer came in and the cell side looked more and more like it was going to the cell side. to change for the worse. And so I pivoted and I went to the by side just as all that was happening as Reg EFT was changing. And then I spent 12, almost 13 years on the by side and was really starting to feel like that was changing as well. And that was becoming much more mature. And then I pivoted to do more of a family office. So I've been through these different cycles and have been at both points as they were sort of inflecting. So it's been an interesting ride. So as not to assume knowledge of anything, could you just highlight the quickest way you could summarize the difference between the

Starting point is 00:05:27 types of roles on the sell side and the buy side for the audience? The easiest way I think about it is companies need to tap the financial markets to gain capital, either credit markets or the debt markets. And there's really one way to do that. It's to find an intermediary who can connect them to capital. And there are people out there who have money who want to invest it. And then you have the sell side who sits in the middle and tries to figure out ways to convince corporates to issue debt, equity, derivatives, whatever it may be. And then there are people out there that have different pools of capital, whether that's pension funds, endowments, family offices, individuals, the sell sides in the middle trying to match up capital with where it's needed and they collect a lot of money for doing that.

Starting point is 00:06:10 You have to figure out early on what type of experts you want to be because once you start going down one of these paths. It's very difficult to pivot and go somewhere else. And I think some people do it effectively and really develop a broad knowledge, but it's hard to find someone who's going to let you pivot. I'm really lucky. I get people asking me all the time, well, how'd you go from sell side to buy side? It's like, I was just early. It's harder to do it now. It's become much more sophisticated and it's important to understand going in. If you start down the path on the cell side, it's going to be hard to cut over and go to the by side, but also it's difficult to break in on the by side. Can you talk a little bit about the personal characteristics or interest sets that you think

Starting point is 00:06:53 align best with both sides of this equation? Yeah, I think the thing that is missing most from the cell side that you have to be able to do on the by side is you have to have a constitution on the by side that enables you to make decisions. I think that I have this framework for doing research, which is you do a lot of digging to get information. Once you do the digging, you have to do a lot of thinking and analyzing to figure out what to do with that information. Then you actually have to decide. You have to do something with it. And I think when you're on the cell side, you do all the digging. You do a lot of analyzing. And then you make recommendations. But actually having skin in the game and having the constitution to know how to act at points of extreme volatility, that's a very different

Starting point is 00:07:40 skill set. And if you don't want to do that, if you don't want to take that risk, if you don't want to be an actual risk taker, but you want to have the same type of opinions, then the cell side is more likely to be suited for you. But you can develop that skill set over time. In some ways, you don't know whether you have the tolerance for it until you've actually done it. Do you talk about what it felt like for you personally, almost like at an emotional level to have a lot of risk on for the first time in your career? It's a somatic experience. And in some ways, it's this fight or flight instinct inside you is constantly triggered. And you're on the lookout for things that are going to screw you over. And where am I going to get this wrong? And you have this sense of

Starting point is 00:08:22 paranoia when you first put on exposure. And you live and die by every tick on the screen. And it becomes really kind of crazy if you let it consume you. And so you have to develop habits and rituals and tools to stay away from the screen to get yourself back so that you can focus on doing the work and gain a little perspective and zoom out for every once in a while because especially at periods of volatility, it's a roller coaster ride and it can be very difficult to handle emotionally. Say a little bit about how the nature of how the by side has changed from when you first started maybe at Viking back at the beginning through to today. Like what are the most significant ways do you think that the way,

Starting point is 00:09:06 portfolios are run or really anything about the game, if you will, that's changed most substantially. If you look at the period that predated me in through the late 90s into the 2000s, there was a lack of sophistication around the organization of information. So this was pre-RGFD. This was pre-all SEC filings being organized online in a simplistic way. This was pre-s sophistication with Microsoft Excel. This was before there were network research calls. This was before there was a whole host of databases that had historical financials.

Starting point is 00:09:42 So you had to dig. You had to print out SEC filings. You had to go line by line and input hard data into Excel cells. You had to get on the phone and you had to talk to as many people as you could. The flip side of that also, though, was if you developed great contacts within companies, they were free to pretty much tell you whatever they wanted because there was not the same idea about insider trading back then until the law has really changed. So I remember being on the sell side back in 2000, and we would just send our model to the CFO of the company.

Starting point is 00:10:13 You can't do that anymore. Can you just describe Reg FD just in case people don't know what that is? If you're a company and you disclose any information to one person, you have to disclose it to everybody. You can't selectively disclose who you're giving information to. For example, let's say you're at a conference and you accidentally say something to a small group of investors. You need to put out an AK revealing that information to everybody to make. sure that everybody has it. And the information needs to be material. It's not, we're not talking about speculation or things of that nature. But if you say something about the quarter or say something about

Starting point is 00:10:44 a strategy that you may not have said previously, you've got to make sure that that information becomes widely available. And the person who receives the information has a burden of knowing that they've received non-public information and they can't act on it. That wasn't always the case. I think that's the biggest way that it's changed. And then I would say the by-side itself was unsophisticated. You didn't have the same type of education that you get. For instance, your education at Notre Dame would not have been the same had you graduated 15 years earlier. It's so much more sophisticated around investing, around learning how to pick stocks, around security selection. You can go to business school and you can learn the art of the stock pitch. That didn't exist

Starting point is 00:11:26 back then. And so I think that in Michael Mobuson terms, there were easier games to be found back then. People were figuring it out on the fly and there was capital flowing into the space and opportunities and arbitrages globally that you just don't see anymore because everything is more competitive. There's more technology to help you do what you're doing. And people are more educated and better and more sophisticated and it's just more difficult. And then I would say the fourth piece, and this is probably the most important piece, is that if you ran a long short fund 15 years ago and your fund was a few billion dollars, that was a lot. Now, if you run a long short fund, you can run $30, $40, $50 billion.

Starting point is 00:12:06 When you were short a company in 2005, you might be short 2% of the company, and it was a meaningful position for your firm. Now, if you want to have a meaningful short and you have a lot of capital, you could be short 10, 15, 20% of the company yourself. It used to be a screen that, hey, look, I'm going to short X, Y, or Z company, and we're short 1% of the company, and there's nine other funds that are short 1% of the company, too. So in aggregate, there's a 10% short on here. We have to be careful.

Starting point is 00:12:33 It's heavily shorted. Now, one fund alone, it could be 15% of the float. So you have to be careful about that. And that's perhaps maybe the biggest technical way that the industry, especially the long short industry, has changed over time. I'd love to dive in on long short specifically and maybe use simple long only as a useful contrast so people can understand on a relative basis. So I think everyone will understand in long only terms, you hire an investor, they buy stuff, they hold it or trade it or whatever. You sort of have a portfolio and it goes up and it beats the market or it doesn't. And it's pretty simple.

Starting point is 00:13:05 And the product is like clean to understand. There's beta and hopefully there's alpha. In the long short context, there's a lot of different ways that this happens. But I'd love you to describe the key terminology of gross exposure, of net exposure, of we're going to get into portfolio construction. Like I really want to lay the foundation of the language used in this industry for people to understand. Describe how in many ways you can the differences between the product, if you will, of long short and that of long only. I think the simplest way to level set everybody is to recognize that if you are working at a mutual fund, you're running at a long only fund, you manage a single portfolio of stocks. You own them. If you run a long short fund, you have two portfolios. You have a portfolio of long stocks where you're along the stocks that are similar to what you might do at a mutual fund, but you then have a completely separate short portfolio. So a single manager, you are managing two separate books.

Starting point is 00:13:59 And the way that you have to perform is how you pick the stocks within each portfolio and then how those two portfolios interact with one another. And the difference between what your long portfolio does and what your short portfolio is spread. So if I put together my 15 favorite businesses in the world and I build a portfolio around them, and that's my long book, and then I want to run less concentrated and I put 30 stocks into my short portfolio. portfolio, the difference between the two is my long, short spread. That is an unlevered definition. That's just the average of the long performance versus the short performance. Then the question becomes, well, how much leverage am I using? Because I'm running two books. I could decide to use no leverage and I could put 50% of my capital in my long book, 50% of my capital in my short book. I'd have 100% of my capital invested, but effectively my exposure to beta, my exposure to the market

Starting point is 00:15:01 would be zero because I'd be long 50 and I'd be short 50. 50 minus the 50 is zero. That's my net exposure. So because we're shorting, because we're trying to isolate the spread between the two, you decide that there's a little bit more risk that you can take and you're going to throw leverage on. So then if you put the leverage on and now you've got an unlimited. levered measure, call it long short spread, that is loosely common parlance for people to think about it. That's something more akin to an ROA, a return on assets. Then I layer the leverage on top of it.

Starting point is 00:15:36 And let's say instead of running a 50% short book and a 50% long book, let's say I want to run 150% of my capital in my longs. And I want to put 100% of my capital in my shorts. That 150% long plus my 100% shorts, that's a 250% gross exposure. That's what people think about when they say gross exposure. Then I'm running 150 by 100 and I've got 50 net because so I subtract the shorts from the longs to determine my net exposure. Your ROE then is going to be determined by how much leverage you put on a long short spread. And mathematically, if you produce a positive long short spread, you can run with infinite leverage. And so that's how these folks get caught because if you go through a series where you're constantly producing positive spread,

Starting point is 00:16:24 you keep thinking, well, if I produce a 10% ROA and I put two times leverage on it, that can turn it into a 20% ROE. And a 20% ROE is better than a 10% ROA. And I want to generate higher returns. I want higher fees. And you do it and you keep doing it. And if you're a really good stock picker, 95% of the time, you can generate a positive spread.

Starting point is 00:16:48 The thing you have to be careful about is that 5% of the time when you generate a negative spread with all of that leverage. It's a force multiplier, just like it is in businesses, just like it is in anything when you buy your house. If you're 10 to one levered in your home and the value of the equity goes down 12 percent, you've got no equity left in your home. So the same thing is true here. And so you have to guard against that and you have to know, I'm going to have a really high gross exposure when I feel like the odds are on my side and I feel like I'm likely to produce a positive spread. And likewise, when I've had a huge run where returns have been great and I'm a little worried about producing a positive spread, then I'm going to pull my gross exposure back down. And therefore,

Starting point is 00:17:31 if I produce a negative spread, it won't be something that could frankly cripple or put the value of the business at risk. So there's a million follow-ups on long alpha versus short alpha, risk management, portfolio construction. I don't know to acknowledge that we're going to come back to that stuff. But before we do, how would you create like a taxonomy of long, short funds? So if you had to do some sort of like clustering algorithm or something and there's three, four, five camps, some ideas here might be like a tiger cub and they run 60 percent not long or something. And a platform model, pod model like a Citadel or a millennium, what do you think are the appropriate clusters, if you will, and what defines each cluster? Yeah, the way that I talk about it when I'm

Starting point is 00:18:12 trying to give advice to young folks that are trying to figure out what kind of, fund would be attractive to them. And this is an oversimplification, but there are three types. There's the platform model, and then there's the established manager model where they've been around forever. They're fundamentally driven. They don't run with the same neutral characteristics that a platform runs. And then there are the new up-and-coming managers. But there are a whole lot of funds out there that are fundamental long, short funds. They are trying to pick women. and short losers. And they have been around for a really long period of time, but they're bigger. And when you are bigger, you have certain constraints. You need market cap. If your traditional

Starting point is 00:18:58 long, short fund was premised on the idea that I'm going to find winners and short losers, it was really premised on the idea that I'm going to belong the best companies in a sector and short, the worst companies in the same sector. But if you follow that logic all the way through and how this taxonomy grows over time, as we talked about as the industry evolves, the winners are usually large caps, and the losers are usually mid or small caps. And so if you have $15, 20, $30 billion, it's hard to be long, the winner and short the loser in the same sector. So what you wind up doing is effectively still being a stock picker, but you pick sectors. So if you are going to a dominant, long-standing fund, you're probably going to wind up having a portfolio that looks like

Starting point is 00:19:48 I am long software and I'm long internet. I'm long secular winners and I am short retail and I'm short secular losers. Not because that's their DNA and that's what they choose to do, but because they've learned to adapt to their size and they can still put up numbers. And when you're that big, those funds are more likely to run with gross exposure that sits in that 1.2 to 1.6 times leverage. with net exposure that runs a little bit higher because they have less leverage so they can afford to run their net exposure a little bit higher. If you run at a decentralized pod, you are really

Starting point is 00:20:25 unable to run that strategy because you have to run market neutral, beta neutral, factor neutral. And so you are forced to try to run as much capital as you can because these funds are huge too, but to do it the way we used to do it. And that's hard. It's really tricky. So what they do is they have this machine behind you so that you put on your fundamental trades and then they try to take out the factors that you are unintentionally exposed to. And that is also tricky because you may wind up changing your style to suit the model. So it's not as pure if you really want to be a stock picker.

Starting point is 00:21:06 Then there are the folks that were trained, the first bucket, that are classic, long, short, stock pickers, and they spin out, they start their own fund, and then they can go back to making these introsector bets, and then they grow into being big enough again, and then they go through the cycle and they do intersector bets. But that's broadly how to do it. I think that you could delve into each of those and say, like, different Citadel and Millennium have different risk models. So they're not exactly the same. And so I think of any one of those appeals to you, you can zoom in and double click on one of the three to find what exactly is nuanced between them. But that's, I think, a relatively simplistic and easy way to bucket them together.

Starting point is 00:21:48 I want to double click a little bit on the pod model because of some terms you used. Sorry for doing this over and over, but I just really want to cleanly define this stuff. So when you say factor, sector, like all these other things you need to be quote unquote neutral to, just describe exactly what that means and how it works and why sort of the residual is you'll hear call like pure alpha or something like this after you've stripped out these other exposures. Draw that contrast. What are those exposures? Why is there neutrality to those exposures in a platform model, but maybe intentional exposure to some of those same things in a traditional long, short, stock picking context? The idea is that if you can extract the market beta, the sector beta,

Starting point is 00:22:33 underlying factors, whether they are growth, momentum, value, large cap versus small cap. And if you take those out, what's left over is pure stock picking alpha. And I think in concept, it's incredible because if you think about the other alternative, the other alternative is you buy a bunch of stocks, they go up a lot and you think you're the world's greatest stock picker. And what you should be doing, and that's totally fine to do. and I do that. I'm more in that camp myself, but I do think that if you are in that camp, you should go and look at it and say, well, how much alpha did I add if I had just owned

Starting point is 00:23:12 an equal weighted momentum basket? How much alpha did I add versus an equal weighted growth basket? Say I'm an analyst who covers biotech. And biotech as an industry happens to be up 100%. I pick the three average stocks in that industry and I'm up 100%. I think, I think I'm the smartest person on the planet. But the reality is I'm just lucky because I cover biotech. Had I been a top two or three decile stock picker, perhaps I would have been up 175% versus 100%. And I think that matters for a lot of reasons. One is you want to understand where your performance is coming from, but also if you run these funds, you want to understand how to compensate people. And I think that what happens at a lot of the funds where they don't constrain your beta and factor the market neutrality. What they do is they let you run a little bit longer.

Starting point is 00:24:04 They say those things are, but the value of those are going to accrue to the firm. We're going to let you run however you run, but then the value of that accrues to the fund, you get paid solely on the value that add, and we're going to figure out a calculation to do that. Whereas what the pod shops do is they say, no, no, no, we're not going to let you even get any of that value out. And what we're going to do is we're going to lower the vol that you can produce in your portfolio. Therefore, we can put higher leverage on it. And if you can still produce returns with those kind of handcuffs on, then we will pay you a much greater payout ratio than we would pay you

Starting point is 00:24:42 on the other side. And so the way that they get their risk is through higher leverage because they've extracted out all the other market risks. And on the other side, and this is where you get dangerous, like if you're willing to take the factor risk, you're willing to take the market risk, you're willing to run a high net and you're going to run a high gross, you have to recognize. You have to recognize you're going to have drawdowns from time to time, and you better be careful to see them coming or react to them quickly. I say those are the two main differences, and it's always easier, I think, to compare them rather than to talk about one in isolation. Having spent time with a lot of investors in all these different camps, the relative strengths, which I think are so interesting,

Starting point is 00:25:21 often if you meet somebody that's had six years at Citadel or something, they're exceptionally good at thinking about risk and portfolio construction, relative to say, a more traditional, a long short investor. By contrast, a long short investor might have spent way longer with five individual stocks and know them in a way that's just kind of frankly stunning, oftentimes like better than the company knows themselves. You can't have everything, I guess, but the different styles create different skills in investors. What are the big chunky skill sets that matter? Stock picking, portfolio construction, risk management, et cetera. What are the ones that you think are most important? Michael Mobuson has been influential to me where, you know, he points

Starting point is 00:25:59 out there are two basic ones. There's security selection and then there's portfolio construction or sizing of positions. I think about it a little bit more nuanced on a progression. There is the process of learning how to pick a security and then pitching that to somebody else who has the ability to decide. And in those pitches, you learn and gain confidence and clarity of thought that's similar to Jeff Bezos's view on writing. So writing a pitch is similar to his view on writing something down and circulating inside Amazon because the clarity you get from writing that down. And then you get instant feedback from the person you're pitching a tube. And that process is iterative and it's great. And that's a great learning tool. And then eventually, if you're really good,

Starting point is 00:26:43 you should try to manage some capital yourself where you're the sole idea generator. So you're still developing this skill of digging, analyzing, but now you're deciding and you want to see what it feels like. And some people, they just get stuck there. They need that other person to help them. And some people, it just takes longer. The curve is longer. If you are good at that, then you have to decide, okay, do I want to work with an analyst as well where they do digging? They do the analysis. And I help them analyze. But I've completely started to outsource the concept of digging to them. Some people get scared. They need to dig. They need to micromanage. If you really want to progress and manage a fund, you have to figure out those things about yourself. For me, personally,

Starting point is 00:27:31 I function best when I'm the dumbest guy in the room. I really do. I like being around really smart people who do a lot of digging, and then I like to help them think through things, and I have a constitution that helps me to decide, which means that I'm eventually going to get displaced by smarter people that I hire, but I'm comfortable with that. And that's always been more my style. I was a better portfolio manager of other people's ideas than I was as an analyst of my own ideas. And I think that that's partially because maybe I wasn't that good of a digger, but partially it's also because I think having a little bit perspective and being separate was good for me. For other people, they really need to control it.

Starting point is 00:28:10 They want to do all the work themselves. They want to do all the thinking. And then they want to pull the trigger. And I think the way that that's different than perhaps being at a pod shop, you're going to do all of those works, but then you can also just cloud your thinking a little bit. And it's all of the great things that make a good company, a good company, or a great company, a great company, or a bad company under threat. You're doing all the same work, but because of all the risk that you put around it, you may decide that something else matters more. And that gets in the way of the

Starting point is 00:28:41 idea of having the great idea, or you can't reflect the idea the way that you want to because you've got to short out some element of it that at other firms you might not care of it. about. And some people really figure out how to navigate that, but it's just another variable, another obstacle that you're putting in front of somebody who wants to be a pure stock picker. And that's a little tricky to do. I'd love to understand what good and what great are in those three categories. So we'll start with digging and then do the other two. What is good and what is great in people that are really good at digging? Good diggers can be told what they're looking for and then they go out and they find it.

Starting point is 00:29:20 And that's table stakes. To be a great digger, you're told or you have a sense of where and what you're looking for, but then you iterate. You think out of the box and you don't go to the normal sources, you go and you find something else. You dig on regulatory filings. You go and you read the footnote of something that nobody else wants to read. You model currencies in a way that other people are too lazy to model.

Starting point is 00:29:49 You go back to the original S1 filing and you read every subsequent annual report from that point forward and you sense the change in language. You read proxies over time and you look at how compensation has changed over time. You go back and you watch for pivot points where the company has changed how they report and whether that's a signal for how they think about the business. Those are all examples of great digging versus table stakes digging, which is, hey, I read the last two 10 cues. I read the last three 10Ks. I pulled the model up. I did some sell side research. And I think I know the company. That might have worked 20 years ago. That doesn't work anymore. You can't do that. You're the least educated person on the stock in the room if you do that. You have to continually dig and find adjacent resources relevant for the competition. You find private resources. and find private companies that compete because they're not constrained in the same way that public

Starting point is 00:30:51 companies are. And you've got to do that and you've got to pull forth as much information as possible. If you're really good at that, you can still get an informational edge. But really, I think one of the best ways to have an informational edge is to just be around the same sector for a really long period of time because the accumulation of knowledge is perhaps the last great informational edge. because everything else is out there if you're willing to do the work and dig and find and try to find it. How, if in any ways, is the analysis layer different in terms of what makes for good or great relative to just digging? I think the analysis level is really interesting because I think there's two pieces to this. Two people can do the exact same digging, get the exact same information, analyze it the exact same way,

Starting point is 00:31:41 but then synthesize it and focus on the most important. thing differently. That's the step before deciding, because then what they do with that synthesis is the deciding. Some people just have a way of processing things. Some of it's partially because of time horizon. They process something and they get stuck. They can't see past the one month negative. And other people look and all they can see is the positive once they get through this one month negative. And that just different frame of mind to make it more concrete for folks, if you think about where we are in the market right now, we're about to lap some really tough comps for some stay-at-home companies. And that's wait on those for a while. And the information

Starting point is 00:32:24 is the information. It's out there. And you can keep digging to try to figure out how tough the comps are going to be. But some people are going to analyze it in a way, looking at the stock and how the stock's performed and looking at what is baked in the price and have a view, I don't care because we're almost through it. And on the other side of this, this is amazing. And other people are going to say, no, you don't understand. This is not something that is just going to be a one-quarter tough comp. Here's how the second derivative works. Here's how the deceleration is going to work over a multi-year period of time. And this is going to turn out to be the peak. And those different nuances and the different analysis you do with those same information often determines whether you make an amazing

Starting point is 00:33:07 investment or you sit something out or maybe you even short it. Perfect excuse to roll into the decision phase of this. And you said something interesting, which is that you think you're a better decider on others people's ideas or work than your own. Just walk through what that means. And what is that, assuming, you know, at some point you were great at doing this, which I think you were, what is it about you or someone like that that's great that's different than someone that's good at deciding, especially when it's on other people's work? I think that when you are so close to an idea, you start to think about it solely in the lingo. of the sector or the company that you're looking at.

Starting point is 00:33:45 We can use an example. I've been public that I'm positive on T-Mobile. Analysts that know T-Mobile really well will give you a pitch that is so bogged down in T-Mobile-specific language and telecom-specific language that if you were just a generalist or if you were just a random person off the street, you would have no idea what they were talking about. Whereas I have learned to listen to the information and process it and think,

Starting point is 00:34:09 well, this is a top-line story because they have a... competitive advantage on their share of gross ads in the market is going to be greater than their actual current market share, and they've got lower churn than their competitors. Therefore, mathematically, they will grow faster than the industry and blah, blah, blah, blah, you can continue all the way down. And I think that I fell victim to that as well. I learned to normalize all of these different pitches across different sectors. So now when I hear a pitch, I am able to abstract it and think about it and decide in a way that is universal across all ideas and is not specific to that one idea. Now, if you were to take the knowledge that I have now and the way I process information now and go

Starting point is 00:34:51 back and make me an analyst, I'd probably be just fine. And I do that a lot now. In my new role, I do a lot of research myself. I leverage the digging of a lot of people that I know, but I am making decisions more directly related to my own analysis than I was at the time. But I think that I lack that skill set and it took being a portfolio manager and not doing the day-to-day digging for me to get that little bit of distance that I needed to gain the perspective. And I think that some people do it automatically. For me, it was just difficult. Would it be fair to summarize as the recipient of so many of these pitches of other people's work, that the best pitches are some combination of dimensionality reduction, like isolating the variables that will really drive outcomes and then

Starting point is 00:35:31 having some sort of variant perception around what's going to happen with those variables. Are those sort of like the key building blocks of a good pitch? There's three elements to it. One is you have to have a narrative and be able to tell a story about where the world is currently placing the company that you're interested in. What bucket is it in? How does everybody think about it? And how is that reflected in the numbers and the stock price. And then you've got to be able to step back from that narrative, and you've got to be able to take the story and convert it into math in a way that is crystal clear. Sometimes I think about it as that first part is you have to have the consistency and

Starting point is 00:36:19 conciseness of a poet in your ability to communicate, but then quickly pivot and have the analytical rigor of an accountant. And then you have to finish it up. And this is where some people really lose it. You have to own it. You have to be able to take the conviction that you feel and to transfer that into the body of the person who's making the decision. And a lot of people tell this great story. They lay it all out in math, but they're wishy-washy on it. And you can sense that they're uncertain because they don't know what to do. And that sometimes translates to a portfolio manager too. So the very best pitches have this mix of narrative plus math and then come through with the confidence and the conviction to make you believe that they know exactly what they're talking

Starting point is 00:37:13 about. You can have it all there and you can be limp about it and it's just going to fall flat. Can you say a little bit more about this idea of the market knowing what bucket it's in? because it seems like very often the best ideas in hindsight were placed in one of these buckets. Some agreed upon narrative. Some agreed upon this is one of those. And maybe this would be best illustrated with an example from your career of like something that was in a certain bucket that you thought belonged in a different one. And it was the act of changing in the market's perception of that thing from one to the other

Starting point is 00:37:45 that drove an outsized outcome. That goes back to a little bit what I was saying before, which is I think that there are no original feces. I think that everybody that gets bogged down and the, well, this does this and it's specific for this, you can abstract that and you can generalize exactly what it is. For instance, if you go back, way back, this is probably my favorite one to always use, but when the iPhone was coming out and people were wondering how big the iPhone was going to be and whether it can take on traditional incumbent cell phone carriers. Everyone had this view of Nokia that they had iterated over their 70 years. They weren't always a cell phone maker either, right? They were always well-run.

Starting point is 00:38:31 They always figured it out. And what people didn't realize is that every time they iterated, it was a hardware company. And hardware companies pivoting to hardware decisions, generally good outcomes. Nokia was a hardware company with a software problem. Hardware companies have a hard time figuring out software problems. Apple was always selling hardware products, but they were doing it within a vertical software solution. And the market had Nokia in this bucket for a really long period of time of they'll figure it out. We were thinking, no, they're in the bucket now that they can't figure it out. And Microsoft came in and bought that handset business, which was not a good decision for Steve Balmer, but that's a classic kind of situation. I'll give you a more recent one, which was

Starting point is 00:39:15 Facebook comes out and goes public. And during the road show, they're missing numbers. And people are really starting to be confused and not really understanding what's going on there. And really, Facebook was a desktop company at the time with a mobile problem. They had a desktop product and the world was pivoting to mobile and they couldn't figure out and adapt their product quick enough. because of that, they went public at a really difficult time in that transition. And they felt it for the first six months of being public. And it was in this bucket of innovator's dilemma.

Starting point is 00:39:53 Someone else is going to come. Someone's going to usurp them. It's over. They fix the mobile problem. And boom, the rest is history. And now, I didn't mention a number in any of those because I don't remember it. But just telling that story is compelling. And then when you layer in on that, oh, by the way,

Starting point is 00:40:10 there was a point in time in the summer of 2012, I think, if I'm remembering this correctly, where Facebook was up 30% on the day of earnings, and it was a buy because numbers needed to go up 70%. And I remember the analyst I was working with at the time, I went into his office, like, oh, this is such a bummer that we missed this. And he was, we have to buy this right now. And I was like, wait, why? And that was the only sentence I remember him saying. It's like, the stock is up 30, but my numbers need to go up 70. And I was like, I got it and ran out of the office. and I went and we bought a zillion dollars of Facebook, but that's compelling. That's simple. You don't need to give me 10 paragraphs on why it's interesting. One sentence summed it up right there.

Starting point is 00:40:49 Yeah, I love the idea of something so simple, some paradigm shift that causes an unlock of return. When you think about the way those portfolios looked that you were managing at Viking, so professional, big, long, short context that you described earlier, talk us through like what portfolio construction tended to look like and how you got better at that through your career. So you mentioned already Mobeson's concept of stock selection and then portfolio construction. Talked a little bit about stock selection here. Say a bit more about how you got better and what you think sort of the cutting edges is, if you will, of good portfolio construction. I think good portfolio constructions, whatever works for the person who's managing the portfolio.

Starting point is 00:41:27 If looking at the index and then just subtracting away what you don't want to own is your way of constructing a portfolio, that's fine. If owning one stock and being highly convicted, in that stock and doing all the work that you can possibly think about is the way you want to run your portfolio, that's fine. I don't know that I would consider that a portfolio. But I think one of the most amazing things about working at Viking, and there's a lot of amazing things about there, is that they teach you how to be a portfolio manager. A lot of firms teach you to be an analyst and an investor. And if you want to become a portfolio manager, you kind of need to figure it out on your own. And so over time, you have to learn to adjust as the firm gets bigger, as your universe expands. And

Starting point is 00:42:14 I think that I've always been someone, when I covered two sectors, I had four great ideas. I had two great longs in each idea, and I had three to four shorts in each sector. My portfolio would just naturally get broader as we added more sectors. As I grew out, covered more of TMT and then covered all of consumer. It was always concentrated within each sector, but it became a little bit bigger over time. And then if you look around Viking, Viking style was similar. So each analyst generally had their two or three best ideas in the portfolio and their handful of favorite shorts in the portfolio. That's, I think, a function of our style of this having this force ranking mechanism where you say to somebody, you're an analyst, you cover internet, what are your three favorite ideas?

Starting point is 00:43:06 And you watch them struggle to come up with three because they have five. So then you say, okay, let's talk about number five versus number one. And if they don't mention six or seven, then you know you've at least locked in on the five that are the most important. If you're talking to somebody who's covering telecom and they can only mention T-Mobile, then don't ask them for their second, right? And a lot of this comes about organically. And so then the question becomes, if you've got one, you now start figuring out, how do I size T-Mobile relative to those five Internet ideas?

Starting point is 00:43:38 You start from the bottoms up. You get the best ideas you can from each analyst. You aggregate them all together. And then you force them rank them amongst themselves. So the way that we found and where I found still, the way that you get the best portfolio, is organically from the bottoms up. You get the analysts to generate the best idea that they have to continually ask them for something that could be better until it's clear that there's nothing else, aggregate them all together, and then you figure out how to force rank them amongst each other.

Starting point is 00:44:06 Yeah, it's such a fascinating process, and obviously it happens in a different way, different funds. You've mentioned TMT, consumer a few times. Why is it that those sectors, so TMT being tech media, telecom, and consumer being kind of what it sounds like, Why is it that hedge funds seem to so often traffic most heavily in those specific areas relative to other sectors? I think that the way that the style of fundamental long short hedge funds has changed over the past 10 years at least in maybe 20, if you go back that far, it's a little maybe gray. But everybody wants to own great businesses and short bad ones. We are, if you believe Carlotta Perez, we're in, what, year 30 of a technological revolution, and we have at least 30, 40, I don't know, Gavin Baker might say 60 years to go in this.

Starting point is 00:44:58 So tech and consumer tech, enterprise tech, specifically are going to generate some of the best businesses along with biotech and some of the other sciences. So if that's your style, if your style is, I want to own the best businesses in the world, and I want to short the worst businesses in the world, then that's where it's going to lead you. And I think you can take that one step further, which is if you're so big and you can't really do intra-sector shorts, and by the way, shorting within a sector that has all of these growth characteristics is not really that fun because a lot of times you're just playing for spread and you're getting killed on these shorts.

Starting point is 00:45:38 So a lot of people start just owning the businesses they want and they short the market because you don't really cover some of the sectors that might be shorted against this. So that desire to really own these great businesses has definitely changed the model for sure. What are the elements of when you see something, it means great to you in a business? I think there are a couple of things. One is, is there capital flowing in or capital flowing out? Because that to me is a reflection of whether competitors and investors fund these types of businesses have given up. So there hasn't been a new well-funded search company since 2005, 2006, because Google won search. So the question then becomes with Google, a regulatory question and a capital allocation

Starting point is 00:46:29 question, are they going to take 80% gross profit dollars, 90% gross profit dollars, and allocate them in a way that destroys value over time or adds value over time? To me, that's the first and most important thing. Shame on me. I made the mistake of investing in Uber late, just as everybody else in the world was flowing capital dollars into some other ride sharing or food delivery kind of company. That doesn't necessarily mean it's a bad business. It just means it's going to be Uber competitive for a really long period of time, which leads to the second thing, which is whether or not a business is good or bad in and of itself, usually hard to determine. The market structure of where the business operates is usually more important than the business itself.

Starting point is 00:47:13 If you have a really interesting, fast-growing secular tailwind inside of an industry with a few pretty protected players, no new entrance coming in, then it just comes down to, well, which one has the better product and which one has the better management and which one allocates capital the best. And when you find something like that, that's the what everybody's looking for, and then you just own them for as long as you possibly can. I would say those are the two big things for me. I like to think about and learn about the underlying sector and become an expert on the sector and then decide who's the best within this good sector. And that's how I determine whether it's a good business, because we've seen what we used to

Starting point is 00:48:00 think of as good businesses get torn down and go away all the time. What's the favorite example of that? It seemed like a great business that just went away. Nokia maybe is one example you already gave. Software is a great business, right? But we are pivoting to a world where a lot more is going to be done vertically and where somebody like Amazon came in and said, historically within the software industry, you have these different layers. And that is all owned on premise. We're going to, Barksdale's famous quote, we're going to unbundle the stack and we're going to give you this layer and then we're going to let everybody else build on top of it. So there are horizontal software plays out there or things that benefited from the stack being bundled together that come under pressure,

Starting point is 00:48:52 IBM. At one point, people would have thought IBM was one of the best companies in the world. Now it's under pressure. CA, similar. Oracle's done a better job of pivoting and diversifying their base, but they have certain parts of their business that are under pressure. So I would say that that's about as relatable of an example as you can get. Even something like software with huge margins that everybody thought was going to be the best business forever gets disrupted and pivots and it becomes great still as an industry, but in a different way and for different winners and different players. I'd love to ask a question back to sort of the hedge fund ecosystem and the companies themselves.

Starting point is 00:49:27 That's probably like the most common question I get from those outside of the industry, which is always framed in this sort of way. It'll be talking about some specific person, and they'll say, how the F does this person make that much money? They're not saying they're a bad person, but it's just like on a relative skill set basis, if I compare my subjective interpretation of this person versus someone super talented in some more traditional industry, somehow the hedge fund person seems to be making a lot more money, even at like a junior level.

Starting point is 00:49:55 Can you talk to why that is the outcome at the end of all this? why the labor market in this space that we've been talking about from analysts, the diggers, the analyzers, the deciders, the PMs, the people that run the firms. The labor market dynamics are very interesting here. Can you just talk us through what matters there and why the compensation tends to be so extreme? I'm not sure I have the best answer for that, but I would say that it is true that some of the smartest minds that our best universities are producing over the last 20 years have migrated towards this space and away from places where they could perhaps make a bigger impact on the world. And I think that's partially because the fee structures

Starting point is 00:50:38 is so favorable to the firms. Take a step back. The investment management industry used to be you pick a lane. You're either an alpha generator or you're an asset gather. And if you're an asset gatherer, you're going to have enormous scale, but your fee structure is going to be relatively low. You'll get rich if you do it for generations like Fidelity, but can you really scale, can you be an alpha generator at major size? And I think that most of the places where you're seeing this enormous compensation, either they've added a ton of value and created enormous wealth for somebody and they took a percentage of it, in which case, good on you. Or they are working at a fund that just has enormously favorable fee structures on enormously outsized scaled assets. And there's a lot of money

Starting point is 00:51:31 to go around, just the nature of it. So the question is, Ted Seydie's a friend of ours in common, has this great line where he says, the hedge fund model is not an asset class. It's just a contractual arrangement. That's always struck with me. I heard him say that a number of years ago. And it reminds me of when I was in law school and the contracts professor was this classic, larger than life figure. Most law school contracts professors are. And he used to always say every contract needs a quid pro quo. We would do case law and he would say, what's the quid for the quo? What's the quid for the quo? What is being offered for what's being exchanged? And I always think about that when it comes to hedge funds because we know what the LPs are paying. We know the fee structure,

Starting point is 00:52:15 but we don't know, and it's not specifically delineated, what are the hedge funds supposed to do to get that? They get paid for absolute performance. But should there be more thought given to how the fund needs to be run and what kind of risk needs to be taken in order to justify those fees, management fees scale with size of AUM. So there are all sorts of reasons why hedge funds are arguably over earning. And I would say that you saw this in the active mutual fund industry. where the cost of alpha was going up. And what you got was disruption from Vanguard and passive flows.

Starting point is 00:53:01 And that scales like immediately. And the problem is, is the alternative to hedge funds that are alpha generators that are pure. They don't scale. And that's tricky. So if you're a $40 billion endowment and you have to figure out how to allocate that money, you need someone you can write a nine-figure check to and keep the money there. And so if you overpay a little, you feel okay. It's kind of like Cisco back in the day when you talk to IT managers.

Starting point is 00:53:33 No one got fired for using Cisco. No one gets fired for paying a little bit more fees than you want to to a safe, consistent, slightly underperforming large manager. And that just leaves a gigantic wealth transfer from one group of people to another. Say a bit about how the dynamics of firms impact the success or failure of the firm in its returns. Like what does well run mean when it comes to a hedge fund, especially if it's one with large size, lots of people, maybe even a second generation of investor running it or something like this? Like what does a well run firm look like? So there are four principles in my mind.

Starting point is 00:54:16 There's the culture of stock selection, how you teach that, how it's replicable, and the quality of your ideas. If you don't have quality ideas, you will die. Then number two is the portfolio management, the sizing of the positions around that. Number three is, how well do you manage internal relationships? How well do you retain talent? How do you recruit talent? How do you treat people? How do you compensate them?

Starting point is 00:54:40 And then number four is your management of external relationships. Who have you chosen to partner with? who are your counterparties, et cetera, et cetera. And I think that great funds play zero-sum game to some extent. I think that it's a necessity to treat this as a series of one-year sprints. If you want to stay in this and you want to be great at it, if you get too far in the future, you could have a really poor run of performance at a time where capital is not locked up

Starting point is 00:55:11 and then you lose your LPs. So to be great, to be sustainable, you have to be thinking about this. The head of the fund that I used to worry, he used to call it the Tour de France. He would say, we're running the Tour de France every single year. And sometimes people don't want to get on the bike after they've just run the race. That was relatable to me because I got off the bike one last time and I was like, I don't want to do it again. I viewed it as a sprint and I look at it as similar to pro sports leagues. You're trying to win the championship and then you're trying to win it again.

Starting point is 00:55:42 And that's the approach that great funds have. And that will result in people coming in, having a career, similar to an athlete, and then moving on. And I think that the best funds are constantly reinventing themselves because they bring in great talent at the bottom. They let them grow. They let them promote. The senior folks move on.

Starting point is 00:56:04 They make money. They grow tired of running that race. They move on. And then the other people continue to move on. And you keep the cycle going. And I think the enemy of great is good in that context. But I think because there's so much capital that has flowed to the sector, you could probably be mediocre and die of blah over a much longer period of time than you used to be able to. Because the alternatives for where folks can go relative to the amount of capital that is allocated to managers is a lot.

Starting point is 00:56:37 And that's tricky to do. Just in closing on sort of like the young audience in mind here, those early in their career, considering a career on the bice that maybe most specifically, but sort of in investing more generally, what does a bat signal look like to you? Like if you were to shine a bat signal up in the sky, if you are X, yeah, you should probably consider it because those are the characteristics that I think a lot will align best with potential success and enjoyment in this space. Like how would you frame that to somebody that's young and considering it? You should think about whether or not you're these things, because those are the things that matter.

Starting point is 00:57:08 It's interesting. I think that there are a whole bunch of different analogies you can use, but one of the tests that you have to screen for when you're recruiting really smart people is that they have had a history of going to the best schools that test you repeatedly over and over on what you know or what you've already learned. And if you're really good at getting a bunch of information and maybe, making a bet or analyzing it in a way that is uncertain, then you could be good at this. I found that the best signal for why I was going to be a good investor was the fact that I had gone to law school. And one of the things that I take with me is that when you are given law school exams, they're actually all open book. And they're these random fact patterns that you've never seen before. They're completely insane. They're like things that would never happen. And what you're job is, is to go through the exam, and your job is to issue spot. And every issue you spot, you approach with the same formula. You start with the conclusion. So you say right up front,

Starting point is 00:58:19 this person is going to jail. And then you apply the rule. They're going to jail because you can't commit murder. Then you do the analysis of everything that just happened. And then you conclude. And you say, therefore, they're going to jail. And that's kind of what investing is. You're out there. You're issue spotting. You're trying to find things that don't make sense. You're trying to find facts that don't match up with the narrative. You're trying to find information and do analysis that tells you that the numbers that are in print are too low. And if you can do that based on your skill set and make the bet that you can see what others don't and then actually take the risk and put money behind that, then this is well suited for you. If you prefer to just analyze things, then maybe you want to be a consultant, right?

Starting point is 00:59:09 If you like to have an opinion, but you don't really want to manage the risk, maybe the sell sides for you. If you want to be a part of being a player, of putting things together, maybe you want to be a banker. One of the great ways that I've always thought about this is, do you want to be a revenue driver for an organization, or do you want to be a profit center? Are you comfortable being out front and being responsible? responsible for generating the revenues of X, Y, or Z fund. Because on the sell side, equity research is a cost center. They're not really generating any money. The guys that make the money are the bankers.

Starting point is 00:59:45 And if you're on the buy side, if you're on the investment staff, you have to make the money. That's one way to think of it. If you're comfortable doing that, then that's the way to put yourself out there. And there are different ways you can do it. And those are generally, if you're analytically oriented, finance oriented. It's somebody who's going to work at somebody like McKinsey. You're going to work in banking or you're going to work on the sell side or you're going to the buy side or a totally different route, which is quasi-analytical. You can just be a relationship manager and you can go into private wealth, but you have to really love clients and really want to work with clients because that's a much bigger piece of the pie than it is with some of those other ones that we previously

Starting point is 01:00:22 mentioned. Is there anything else about how one of these styles of hedge funds works? that you feel like we haven't covered that's important to understand? We've talked about the funds and styles. I think that the people are extremely important. So you may have the world's greatest mentor inside of a fund that people may not think is the world's greatest fund. And that might be a much better experience and propel your career in a way that working for an atrocious mentor inside another large, well-established, highly respected fund.

Starting point is 01:01:07 Mentors and portfolio managers in this space are so incredibly important. They will determine, forget about compensation because money doesn't matter as much during those first few years, but they will determine how you think about risk, how you think about analyzing. They will morph your style in some way. And the single most important thing I can think of in making that initial decision is who are you going to work for, not where are you going to work. Yeah, it's a fascinating closing concept, I think, especially in early in one's career. Like, that can make such an enormous difference that it's the right vector. It's the right way to approach it. I have to ask a series of questions kind of in this last segment here,

Starting point is 01:01:50 stepping away from the business of hedge funds and towards just the thing I think you're and I love, which is businesses and markets and your accumulated experience, starting in telecom, TMT, consumer, your great points about why a lot of the best businesses and maybe tailwinds are going to create great businesses in those spaces. What is your take on the market dynamics today? Like, what has your interest most? Where have you spent time learning? What concerns you? Just like at a high level, like, what does this market feel like to you relative to the many markets that you've seen in your career? I'll take that out in two ways. is the quality of businesses that are in the market and the opportunities you see to invest relative to value and then the structure of the market.

Starting point is 01:02:33 And I think that there are more interesting businesses today than there were 10 years ago. And there will be even greater businesses 10 years from now than there are today. If I have a worry, my worry is that a lot of those businesses will come in the life sciences sector. and I'm not an expert there. And so I have to get smarter. There's an area where I need to get smarter. And part of the reason why I love not being a fiduciary to others is because I get to figure out and expand. Whereas if I was managing other folks' money, I would feel nervous about getting outside my comfort zone.

Starting point is 01:03:09 So it scares me that the world is going to move away from me and I'm not going to be able to keep up with it because I don't have that core expertise. That definitely worries me. And then I would say the structure of the market, I have some concerns. about because the way the market works, it used to be that if you needed to source liquidity, you could go somewhere. You could go to Goldman and you could say, I need to do X, Y, or Z. That happened all the time. Block traders were a fixture at all firms. The idea of a block trader at a big bank now doesn't exist as much. And so much of the volume, so much of the transaction

Starting point is 01:03:49 in the markets occurs in the dark pools. It occurs in the machines and the systems behind this. And so much of the flows are passive. And when the trend is good, the flows are passive and it feeds into the trend. And when the trend turns negative, the flows go negative and a flea. And so I worry that we're getting whipped around here and where that could create some sort of liquidity systemic risk. I think what you've seen from a few of these events over the past six months is that when you take that type of market structure on top of high leverage. So the lower liquidity, the difficult to find pockets of liquidity coupled with everybody's got leverage and crowded in names, and you have these fires that are going to pop up from time to time. Now, the good thing is, is they've all remained

Starting point is 01:04:35 contained. And if that's the way this continues to play out, then that's fine. If you just get a fire here, a fire there, a fire there, and they keep getting put out, that's fine. The worry is that you get some sort of fire that then has real ripple effects and it hurts a lot of folks that are not really sophisticated and don't know what they're doing. And that would concern me. I'm not overly concerned about valuation or all of these other things out there. I think that there's a lot of great businesses and I think that there are individual stocks that are expensive. But I think for the most part, there are a lot of great businesses that you can own for a really long period of time right now that you'd be pretty happy owning and even if you bought them here. My philosophy is if you're

Starting point is 01:05:16 not selling them here, you're buying them here. So I'm not selling them. Looking back on all the time that you spent making decisions and thinking about businesses in TMT and consumer, etc. What are the most useful and reusable frameworks that you've alighted on for approaching a new business? I approach the same formula for every business regardless of what it is. And I start at the top of the income statement and I work my way down. How do they make their money? What's the revenue driver? Is it a subscription-based business?

Starting point is 01:05:50 Is it a velocity of unit business? Do they make a product or is it services? Okay. What are the main cost of good? What are their input costs? Then I go down and I think about the OPEC structure and keep going all the way down. The further you go down, then you get a real good sense. Okay, these guys are a huge options issuer or shares are shrinking.

Starting point is 01:06:09 What does the balance sheet look like? it is it efficient relative to the type of businesses as or not efficient relative to type business as and then I step back and I say okay now I have a snapshot for this one company I want to go and do the same thing for all of its competitors and I want to understand and force rank them relative to each other and then I want to dig in and I want to find what the sell side or what other experts in the area because there are some amazing experts on the internet now like Ben Thompson who isn't technically on the cell side and figure out how does he think about things? How does he contextualize this company within a framework that maybe I'm not even thinking about?

Starting point is 01:06:47 So I start at the bottom. I get a framework for one and then I go and I get a framework for another and then another. And then at some point, now I've got an industry view. And once I have the industry view, then I can flip it and invert it and look down from that industry view and say, this is the winner. And this is going to be the winner. If it's the winner today, great. I'm going to say that it's going to continue to be the winner, or actually, number three is going to catch up and win for all of these different reasons.

Starting point is 01:07:16 And I think where it becomes a little trickier is when it's not exactly clear who the competitors are. And I think that that's one of the interesting things. It creates opportunities, but it also creates risk within technology. Google, Amazon, and Microsoft, as an example, they all have huge cloud businesses. And one of the most interesting dynamics, I think, about big tech for the last decade is the biggest tech companies didn't really compete with each other. And that's unique in the history of tech. Usually the gigantic companies in Silicon Valley were all killing each other. And now maybe they're competing a little bit.

Starting point is 01:07:58 But even those instances where they are competing, it doesn't seem extreme. So it still makes me feel really good about them. But those are things to keep a lookout on when one big tech guy is poking over into his neighbor's yard. That worries me. Going back all the way back to the beginning of your career, one thing I don't think I've ever talked about on the show is the telecom space specifically. Just talk me through why this was interesting to you, maybe remains interesting, and sort of the role that it plays, like the role you see it playing in like the market economy of the U.S. or the world. What is interesting about telecom businesses? what are their defining features?

Starting point is 01:08:37 The reason why telecom was interesting to me was because it was the gateway for me to go from being a lawyer to getting to the cell side. Because the 1996 Telecom Act went into effect around 1998, 1999, and it was a large document, and there was a lot of nuance in there, having a law degree and being able to pour through that document as well as other regulatory filings because it was a regulatory paradigm, you took AT&T and and you broke it up effectively back in 1984. And then in 1996, you basically deregulated every single piece of the telecom network. When you think about the example before I gave of Amazon of how Amazon came in and competitively unbundled the software stack,

Starting point is 01:09:25 what the 1984 and 96 acts together did was they took this bundled concept of the last mile of telephone infrastructure. what's at your house that goes to your local switch, the middle mile, what goes from the local switch all the way back to the central office. That's the long haul, which goes from your central office to your grandmother's central office all the way over in California when you're trying to make a phone call and said, we're going to unbundle each piece of that. And it led to just incredible, incredible deflation. But it also led to the modern infrastructure that we have in this country on which the internet is based. And if you didn't have the 1996 telecom act, you don't have the 2000 internet bubble and you don't have all these amazing businesses that ride on top of that

Starting point is 01:10:12 infrastructure. And so we've had this unbundling of all the internet is is a distribution mechanism and it is built on top of the telecom network and its utility like in its function, but it perhaps is the single most important utility or service that anybody has in their lives. If you take someone's internet access down, they would lose their mind. We couldn't be doing this conversation without the internet, right? And that wasn't always the case. We could always pick up a landline phone that was plugged into a wall. It is the most vital infrastructure in this country and in the world. What do you think are the most interesting things that we'll see in the coming decades in terms of how that infrastructure changes, evolves or gets upgraded? Like the entire modern economy rides on

Starting point is 01:10:56 this infrastructure, as you point out, probably no one's ever really thought about it. Like that thing you did about local line to long haul. I couldn't even describe the way this all works. And obviously, I'm a very, like everyone, a very interested user of the infrastructure. In what ways are you excited about or hope that it will continue to evolve to accommodate what I assume will be continually growing demand? Yeah, it's interesting. I'm more worried about the electric grid than I am worried about the internet drive around this country. And we're talking about flying electric vehicles and most electric wires are still above ground. and literally nailed together or paperclip together on old 50-year-old poles.

Starting point is 01:11:38 That could go down at any point in time. I think there's more risk to disruption in the electrical grid than there is in the infrastructure grid at the moment. I think that for the most part, what we have is a little bit of inequality. Because where it was economical to build, you've dug up the ground already, and you've laid fiber or coax that can support demand into the future in a meaningful way. And what isn't supported currently can be upgraded through electronics. It doesn't need to be upgraded by digging up the streets. But the problem is, is there's lots of places in this country.

Starting point is 01:12:15 And the infrastructure bill that President Biden proposed last week has some elements in there to try to get broadband to rural communities. because if you have broadband, currently it's pretty darn good and it's relatively affordable. The question is, to what extent do they flex their pricing power to stay out of the regulators' crosshairs? So I think on that side, I think you're fine. On the mobile side, we're going to undergo a major upgrade from 4G technology to 5G technology over the next several years. And I think that this is an example. A lot of people who are bullish on T-Mobile will get into the spectral efficiency of their 2.5G spectrum versus what Verizon and AT&T have, which is another way of saying

Starting point is 01:12:59 they can spend less capex to get more capacity, which will give them the opportunity to offer better service. And there's real differentiation that can be had there. And I think that that will continue to evolve. I don't think 5G will be the end of it, but I think they'll continue to be innovation and upgrades on top of that. So I don't think anything structural needs to change inside our fixed infrastructure. I think our wireless infrastructure will continue to improve. And then the question really is where there's a bottleneck where we need help is that if we start to see more and more data go through the wireless pipe and not over Wi-Fi that goes to the fixed line, you need better infrastructure that goes from the tower that captures the signal back to the

Starting point is 01:13:46 internet. And there's all sorts of satellite applications. You can do a whole bunch of research. we're going to send satellites up there that try to do fixed backhaul and things of that nature. But that's where the bottleneck is. So when you have five bars of service in a condensed, crowded area and your email is not going through, it's usually not because there's traffic at the tower. It's because there's traffic at the bottom of the tower as everybody's trying to use the network at the same time. And the analogy that I like to use, there is on ramps and off ramps of a highway everywhere. The on-ramp is the connection between your cell phone and the nearest tower.

Starting point is 01:14:23 The tower is the highway. And then the off-ramp is getting off the tower, off on the highway. And that's usually where the traffic jam is. And you get stuck there and you get hung up there. There needs to continue to be infrastructure and improvement there. Not sure it's a huge investable theme, which is interesting given how important it is for our mobile broadband communications. It's a totally fascinating topic and one that I definitely need to dive deeper on.

Starting point is 01:14:47 It's funny how these things reveal how little you know about basic things that you rely upon and the potential fragility of those things. I'd love to close on sort of a philosophical note. We've talked about some things that I think will filter into this interesting framework you have, I think developed that matters to you a lot, which is a picture like four quadrants, an abundance mindset versus a zero-sum mindset, fixed versus a growth mindset. I know a lot of people have talked about these general terms, but why is that two-by-two quadrant-based system interesting to you, why do those terms and those ideas matter? How do they make your life better? There are two separate theories that I brought together and realized how well they encapsulate

Starting point is 01:15:28 how I'm trying to think about my career and my life. And so I grew up a kid that had a fixed mindset. I was one of those kids that. I was like, well, I'm good at this and I'm not good at that. I'm good at math. I'm not good at English. I can't spell. I can't do this, right? I'm a good athlete at this, but I'm not particularly strong. I use that language. And then I read Carol Dweck's book. I read The Art of Learning by Josh Waitskin, and I was like, I've been thinking about this all wrong. And so there was this pivot in my life where I realized, you can grow, this idea that you are who you are, people don't change. I don't believe that. I wish I had learned it sooner, but I learned it later. And then I learned about this zero-sum versus abundance mindset.

Starting point is 01:16:06 And there are certain games and certain activities, certain careers, certain moments that are zero-sum and they have to be zero-sum. Like, only so many kids can get in. to the college they want. Somebody's got to win the NBA championship. I get that. But there are certain things that could be more win-win and don't have to be zero-sum, but they're framed as zero-sum. I just decided that I had spent so much of my career playing a zero-sum game and playing it quite well. Don't get me wrong and winning, but it's a bit of exhausting. And it became a bit of a governing philosophy as I thought about what was going to be the next stage of my life and how I wanted to integrate work and raising my family and reclaiming parts of my health, frankly, that I

Starting point is 01:16:55 traded for those zero-sum games. I just decided that entering in another series of zero-sum games, even if they were directed by me, even if I was the leader, if it was my fund, was not what I wanted to do, because I do believe strongly to win in long short investing. You have to treat it like that. So I've just decided that I want to live more in the quadrant where everything is about growing and every situation is not meant to be at someone else's expense. It's a win-win. I'm doing things and putting things out there where I don't know if I'm going to get paid.

Starting point is 01:17:32 I don't have anything I'm trying to do. I'm just trying to get smarter. I'm trying to develop relationships that will last. a long period of time. I'm trying to think about ideas that I want to do now and think I want to be able to continue to do 50 years from now. And I don't want to do anything. I don't want to put on a position in my portfolio that I know I'm going to sell for sure. That doesn't mean I won't sort of actively trim it or management, but I just want to be playing a long game and be playing this more infinite game of investing and learning than a series of finite games. And

Starting point is 01:18:09 that's become the melding and the governing of the two together. I think you know my traditional closing question for everyone, just to ask, what is the kindest thing that anyone's ever done for you? As you know, I listen to your podcast a lot, so I've thought about this question. I've decided that kindness can't be something where it was mutually beneficial, right? Something that someone did for me. There are a lot of things in my career that were kind, but the other person benefited from it as well. So I've decided that the kindest thing that anyone's ever done for me in my career,

Starting point is 01:18:38 where they had zero upside for doing this was when I was back at Pricewaterhouse, Cooper. And I was there right after the merger between Coopers and Libran and Pricewaterhouse. And so I was the first class that was not a legacy P.W. or a legacy Coopers and Library person, which is interesting because culturally those two firms were very different. And so I didn't have a specific team I was assigned to. And they used to sort of fight over who got the new analysts that came in. And the partner on the Cooper's and Librand side was a guy by the name of Rich Klein. And after a couple of years, when I went into his office and I said, I'm thinking about making a change.

Starting point is 01:19:16 This isn't for me. There's just something missing. And we walk through it. And he said, well, what are you going to do? And I told him I was quitting to go work at a law firm doing the taxation of sale leaseback transactions for capital equipment. And he very astutely was like, you're doing it. that for the money. Those are the highest paid junior lawyers at any firm because it's the

Starting point is 01:19:41 worst work. Go sit at your desk for six months, read, explore, do whatever you need to do, but do not leave this for what it isn't. Go to the next thing for what it is or you will spend the rest of your career jumping around from thing to thing. I repeat that advice as often as I can to people that are struggling with the same question. And I think about it in terms of relationships. I think about it, it's okay to be single. Don't jump into a new relationship because your old relationship stinks. Don't take a new job that is mediocre because your old job stinks.

Starting point is 01:20:17 Whatever you're doing, go and do it for what it is, not because of what the old thing wasn't. I love that advice and I repeat it over and over again. Well, Paul, this has been so much fun. I love that closing story. And again, hopefully we shed some light on sometimes I have to take a step back and realize like some of this terminology speaking a different language, I think you've done an amazing job of laying out some of the basics and the details of how this space works. So thank you so much for your time. Thank you, Patrick. This episode was brought to you by Canalyst. In this four-part miniseries,

Starting point is 01:20:46 I sit down with Canalist co-founder and CEO Demir Hot to learn about the origins of Canalist, the problems it solves for professional investors, and what the future of Canales looks like. In this week's episode, Demir and I discuss the speed at which Canalist can help you update your models and how it has adapted to a huge influx of IPOs and SPACs. How timely is this? I live in an area that's sort of the hedge fund capital of the world. And I always know when it's earning season every quarter because none of my friends are around or want to hang out with me because they're all busy doing this crap. How quickly does this happen?

Starting point is 01:21:18 So a company releases its earnings, what happens next? And how does that flow through to someone that's using the product? Our goal is if you care about a name, it's sort of 30 minutes to an hour. And obviously, if it's a G model, it might take a little bit longer. but that's what our clients expect and that's what we tend to deliver. There's a long tail of within 48 hours, we've updated every single thing on our entire coverage universe and an hour 47 is probably the $100 million market cap, rural, regional bank or REIT somewhere that no one has looked at in three years.

Starting point is 01:21:49 We maintain that because one day it'll be valuable. The practical aspect of it is our clients get to identify what they care about in their portfolio, what their watch lists are, anything that a client has actually taken the time to watch list, on our product, that sort of done in that hour window. What does it like to see the capital markets evolve and change and then adapt the product? So I'm thinking specifically here of things like obviously SPACs in the most recent year. IPOs, obviously there's always been IPOs, but we've seen a huge explosion of not just more of them, but of huge, enormous companies that are finally coming public after a long private

Starting point is 01:22:22 to public drought. How do you adjust for things like SPACs and IPOs that seem to be, but not only outside the normal scope of a traditional company model, but present unique challenges. I'm sure there's demand for those as well. Yeah, tons. We've adjusted by resourcing sufficiently to make sure that we keep up with the number of these new listings versus kind of what our plan was. You know, we always budget for a certain number of whether it's spinoffs or mergers or IPOs from a team capacity perspective. IPOs and SPACs, our perspective is there are, you know, new things that are within the coverage that we've promised our clients. And so we do have a number of clients who highly value

Starting point is 01:22:58 our IPO coverage and always have, and usage by those clients has gone up in the last six months. But at the end of the day, IPOs and SPACs are really just an illustrative point of something that's a principle of ours, which is we are truly independent. Our reliance is exclusively on public filings. As long as there's an Edgar, we have all of the data that we need in order to provide our product. And so we don't have to wait model an IPO until we're off of restriction. And so I think having IPO and SPAC models that are done right off the filings that are kind of there in time for the road show pre-pricing, all that kind of stuff, is an extension of the same value proposition that we offer on kind of the longest standing well-established public companies, which is just

Starting point is 01:23:39 you've got the data and you've got it formatted the way you want it when you need it. Say a bit about the opportunity that you've seen this unlock in clients. And I'm thinking maybe most specifically, I'm guessing that typical analysts will have a capacity to cover a certain number of companies. And that's a lot of that is just the manual work required in keeping up with them. So obviously, if you remove that work, it seems like it would stand to reason that they could cover more companies, which I think generally would be a good thing. How does the use of panelists change the nature of an analyst's work or the way that the firm invests? We started with an assumption of this is a workflow efficiency time saving tool, which it obviously very much still is at its

Starting point is 01:24:18 core, what we've realized kind of in speaking with our clients, you know, there was sort of, there was a period where we asked clients why they signed up, why they bought, and then why they renewed. And the why they renewed was interesting because what it was all these times that a company, otherwise you wouldn't even really have the time or the capacity or the clarity of mind to look at it and think about it. If you see a press release, you can just grab a model and look at it. On the IPO side, there were a number of clients who said, look, this was the first time I could really focus and ask smart questions of management during their roadshow process because I had a model that I really couldn't have justified the time to build.

Starting point is 01:24:56 So what we see is these opportunistic, oh, actually I have an ability to quickly look at what makes that company tick, having working models on your entire sort of shadow coverage universe versus just on your core positions. These are the things that clients fall in love with. With the best funds in the world, you know, the reason they're looking at us is actually opportunity to look at things that they just aren't looking at because the market's moving real time and it takes the best human a little while to make them all. If you enjoy this episode, check out join colossus.com.

Starting point is 01:25:29 There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.

Invest Like the Best with Patrick O'Shaughnessy - Paul Enright - The Buy Side Primer - [Invest Like the Best, EP. 222]

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.