Invest Like the Best with Patrick O'Shaughnessy - Will England - A Primer on Multi-Strategy Hedge Funds - [Invest Like the Best, EP.342]

Starting point is 00:00:02 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 and founding partner of Positive Sum and the CEO of O'Shaughnessy asset management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of positive sum or O'Shaunacy asset management.

Starting point is 00:00:44 This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of positive sum or O'Shaunacy asset management may maintain positions in the securities discussed in this podcast. My guest today is Will Inglift, the CEO and co-CIO of Walleye Capital. Walleye is a multi-strategy hedge fund quartered in Minnesota that manages around $5 billion today. Our conversation is a primer on multi-strategy hedge funds, which have become a force in markets through the success of firms like Millennium, Citadel, Point 72, and Ballyazni.

Starting point is 00:01:20 We discussed the operational complexity behind the model, which managers best fit this type of investment style, and what happens in stressful events like the GameStop short squeeze in early 2021. We also talk about performance culture, the all blacks, and Will's experience, as a U.S. national team rower. Please enjoy my great conversation with Will England. So, Will, maybe we can begin by you telling me why you are so interested in robber barons. I love learning about that time of history. And many things are different, but many things were the same.

Starting point is 00:01:52 And the scope of what some of these individuals accomplished was incredible. So I lived in Minnesota in a town called Wizzetta. And in Wysetta, there's still a train station there built by James J. Hill. It was one of the lesser known robber barons, but was still a little. at the time, one of the top five or ten, I'm running a railroad, I'm building this entire network. And what they're able to accomplish is just the force of personality of saying, I'm literally going to change the landscape of the U.S. I'm literally going to bring people physically move them across. That is so inspiring. And so much of that was because of who they were as

Starting point is 00:02:24 individuals. And yeah, obviously the robber barren term is because they're pushing the boundaries in certain areas. James J. Hill, relatively speaking, was one of the better robber barons, but really inspiring. And so when we talk today about people building great companies changing the world. It doesn't even fucking appeal a comparison to what these people were able to accomplish. And it's really inspiring and very applicable to today. World was different then in all sorts of ways, both positive and negative, but the core concept of someone who decides I'm literally going to go and have an impact still very applicable today. I think a lot of these people that we were talking about at lunch, whether it's Vanderbilt or James Jay Hill or any of

Starting point is 00:03:00 these characters through history, would be fun to weave how they've impacted your thinking throughout the rest of the conversation. But before we go too deep into a history lesson, I'd love you to level set for the audience and explain the style of investing platform that you are building and have built. Many call it the pod model or the platform model. I don't want to take for granted that we explain this in lots of detail. We'll spend probably half hour here or something because I think it's become such an important part of the investing landscape. And many people know Citadel and Ballyasni, who I've had on the show before. Many will also know your firm more soon. But I think just explaining this method of investing first and foremost would be a great

Starting point is 00:03:41 place to start. And you can take that whatever direction you want, and then I'll poke and prod on aspects of it. The technical term is a pass-through multi-manager. So it's a very special type of hedge fund. That term passed-through, it sounds like it's an operational nuance, but it's extremely important. What that is essentially saying is that investors are putting the trust in you as the investment and manager to pass through essentially all the costs of the business in order to generate very high-quality risks, just returns. The way to think about the landscape today is there essentially four big firms in the industry that have all been around for decades. There's Citadel, there's Millennium, there's 0.72, which used to be SAC, and now Ballyasne and Swell, growing

Starting point is 00:04:19 that have been around for a number of decades as well. Realistically, there's only four or five that have sufficient scale, sufficient track records, competency to be able to, again, take advantage with the full benefits of reciprocation. Core concept of the multi-manage. model is to say this should be a pure alpha vehicle. And the way to get that is by putting together multiple different types of essentially relative value strategies. And that could be long short, stock picking, both from a fundamental standpoint and a quantitative standpoint, various different forms of macro strategies, various different forms of volatility trading. It would be inaccurate to say that everything has an arbitrage element to it, but relative value or arbitrage-esque is

Starting point is 00:04:55 certainly pretty common across most of the different styles. And multi-managers, the biggest ones, the best ones really putting that together, putting those strategies together in a single format. It's very easy to articulate, why that makes sense. And again, you take essentially just from a pure time series to employ multiple different uncorrelated time series, you put them together, voila, you've got a multistrate. What is very fascinating about the model and why there are realistically so few players that are doing this is to do that is incredibly difficult. Not only do you have to have excellent individual managers. And we're talking, in some cases, hundreds of excellent individual managers or pods as they're referred to, but George will have to run a world-class

Starting point is 00:05:31 operating company, so that means world-class technology systems, even some of the less sexier functions, operations, legal, compliance, accounting, and be really able to invest in that and be world-class is very, very difficult. And so if you think about the elements of a traditional hedge fund or investment model, this was talked about in the previous podcast, if you're running an investment firm, you have to essentially pick your investments. So you've got your alpha of your signals, of your quantum visual. You've got number two, portfolio of construction, how do you put everything together in a balanced manner? And then number three is building the business. For most single manager hedge funds, that's things like raising capital, it's hiring, do we have a cool fancy office, stuff like

Starting point is 00:06:08 that. But for the multi-manager pieces, that third piece, that's just magnified dramatically because you're operating at such a scale across essentially everything to be done in hedge fund land and putting it all together. Complexity doesn't scale linearly. It scales exponentially. So that's a really key differentiator of do you have the ability to run a world-class operating company. And it is why, in many cases, Citadel is amazing. And in the past couple of years from a return standpoint, have differentiating themselves. And a lot of goes back to the investments that they've made in building just this machine of an operating company is very impressive. I've been really interested lately in studying asset management firms for whom scale is an advantage or even a requirement.

Starting point is 00:06:48 Because typically the story in investing is that scale or AUM is the enemy of performance. That as you succeed, you get more assets, and as you get more assets, your universe shrinks, and you can't perform like you did early on. It's like a tail as old as time in the investing business. But there seemed to be this small number of firms, not just in the multi-manager model, but someone like Blackstone, you could argue, has benefited from their scale and a lot of their strategies. So talk to us about what scale means in all its meanings for a firm like this, where you said there's only four, five, six, I'll say contenders to those top four firms who all have enormous scale in assets and all these other measures. What does scale do for you? How do you get it?

Starting point is 00:07:28 Why are the barriers to entry higher here than for a stock picking hedge fund? So let's separate scale into strategy scale versus company scale. With strategy scale, all things being equal as you get larger, positions get bigger, effectively become less nimble transaction costs go up. So it's not like we're changing the laws of gravity in our particular type of world for any individual strategy. And that can be a fundamentally driven strategy, You can be quantitative and strategy. The market is still there. You can't outrun those factors.

Starting point is 00:07:55 What is different, going back to our earlier comments about building an operating company, is that there definitely are economies of scale and even network effects as you get bigger. So just to talk from a size standpoint, you've got Citadel Millennium or approximately $60 billion of actual AUM. There's a lot of leverage that's evolved in these models. So the balance sheet is multiple turns higher than that. These are very, very big investment businesses. And we're considered one of the smaller players in industry, and we're still above $5 billion.

Starting point is 00:08:20 So smalls for all the more 300 people versus 3,000 or something, other places. But that second element, just returned to it for a second, the notion of company scale, operating scale, as you get bigger, you can get better. Think about what I was just saying before is the model is not just about having good individual investment strategies and why is it that you might have hundreds of them. It's really to say for any particular type, you don't want that to get too big to have too much market impact. But then you've got to start putting these things together.

Starting point is 00:08:47 So it goes into, okay, I'm only going to build world-class technology. if I can build it for dozens and dozens of people because otherwise the fixed cost investments are going to be too high. I'm only going to build an accounting department with dozens of accounts that are going to implement again, world-class systems, be able to track all the individual arrangements we'd have if you're doing that again at scale. So the true notion of the barrier to entry is that you need to be great at all of these non-investment functions in order to frankly justify what they're doing them. And I'd really just go back to underscore like technology is a huge, huge piece of what we're doing, just like in other business.

Starting point is 00:09:20 And that's not a cliche, like, oh, yeah, tech's important everywhere. You're literally dealing with your toast without it. Yeah, bits of data. The exercise that we're running, it's like a nuclear reaction. You've got to keep it controlled. And if you've got great systems, be able to contain it because you're using five, six, seven turns of leverage in this case. If something goes off the rails, you just blow up. And there are firms that have blown up historically. So the sophistication of the risk systems is very much tied to sophistication of the technology systems. So if you don't have that as part of your DNA and abilities, no, you absolutely can operate skill. But as you get bigger, once you're able to develop those systems, again, to really

Starting point is 00:09:57 say these are our core central functions that allow us to plug great investors onto the platform, you can get bigger. And then that's where the momentum can build in. As you get bigger, you can offer the best people, which again, we can define what best means. But high quality practitioners, larger book sizes, economics in our industry become very important. If you're not operating a certain scale for too small. I can't offer that to someone. It's not going to be attractive. And again, that relates to this pass-through concept that we've been talking about earlier. It's different than in most hedge funds where might be a two-and-twenty model where the firm gets paid two-and-twenty, no matter what. You could have five individual teams that are doing great,

Starting point is 00:10:34 but the other day they've got to split that two-and-twenty. Now, when we go and all these other places that we've been talking about going strike a deal with a PM, that's formulaic, it's contractional. There is an element of which you kill there. And so as you get larger, yes, you can definitely incentivize people more with larger book sizes. So that's definitely important. On the other hand, the pace is really, really important. You can't go too fast. So that's what I tell people. It's inaccurate to just assume just raise as much money as possible. And because you're a multi-manager, it's going to be great. No, you need to do the things that are precursors to success, just like in any business. You need to be able to build the platform properly. So when you absorb that capital, you can deploy in a ways,

Starting point is 00:11:12 which ultimately are respecting the trust that your investors are giving you, whether I'm entrusting that in the first place. That balance is really the key point. I'd love to take this return stream that some listing might be familiar with, which Canon often does for multi-managers look very different than like a tiger cub or something that's effectively stock pickers, some of them really, really good stock pickers, but more of a market-like exposure. And I'm just going to make up a number. Let's say the return in a given year is 15%. The average return is 15% over time or something. And in the case of the multi-managers, the best ones, often the volatility is quite low relative to what you have to endure for a 15% return elsewhere and hopefully uncorrelated to

Starting point is 00:11:54 your point earlier with just the broad, let's say, S&P 500 or something like that. So I'm an LP. I give you money and I get back at 15% return. I'd love to walk through the component parts of that 15% at every layer. The costs, the leverage, the return streams themselves, what those things are, the portfolio construction tools and the risk really break down what's underneath that return stream and maybe going one by one. You pick the order, you probably can build it up from the ground up. But it is confusing probably for a lot of people that haven't thought through this strategy that I'm getting this simple return, but underneath that is all this fairly complicated stuff going on. So I'd love you to explain that in a lot of detail.

Starting point is 00:12:40 Sure. So I'm just going to speak in the context of assuming everything, was trading equities. There's analogs for fixed income products, but just to make the numbers a little bit easier to follow. And again, effectively relative value investors, so let's assume when we're talking long short, this true market neutral long short. So if you have $100 in a fund, if you had one turn of leverage, that would just be 100 long, 100 short, 200 is 200 long, 200 short. So the way the numbers work out, and when you're just talking return on GMV on gross market value is collectively the individual strategies are really looking to make two to three percent return on GMV.

Starting point is 00:13:16 The individual strategies. Yeah, the individual strategies and then collectively. So if you have 50 equity long short managers and you say, okay, pick your number $10 billion ballot sheet, you're looking to make a couple hundred million dollars of P&L off of that as a whole. And so those are the individual return of streams, but the average, the expectation is the same no matter where you are. So let's just say it's three percent.

Starting point is 00:13:37 go back to where your numbers are. And then that's at the GMV level. And so the way to back into the leverage is depending on the type of firm, you can have up to 10 turns of leverage. So let's just say it was 10 to make the math really easy 10 and 3% to get to your 15. So I make 3% on GMV, but using 10 turns of leverage, that'd be a 30% gross return on the actual AUM. The way that the fees shake out and the fees per unit of exposure, again, are very fair, but you've got a lot of them and that leverage comes in. Effectively, the investor gets half of the return. And because you're paying the individual PMs, there's a fixed cost element of it. You're paying this analyst salary. There's the technology cost. There's a central team costs. There's a whole fixed cost piece. And then individual

Starting point is 00:14:17 PMs, depending on their tenure and their strategy, paying between 15 to 20% of the actual P&L. So when you add that up, the investor gets about half of the return. And that's how you go from that 30% gross return to 15%. So people talk about, yeah, there's a lot of fees in a multi-manager. model, which absolutely there are on an A1 basis. And it's extremely important in our industry to remember that you are the steward of your investor's capital. They are giving you a blank check. Let's not abuse that. We actually look on the fees per unit of exposure. It is analogous to your standalone tiger-style investor that's charging 2 and 20. It's just because of the leverage that gets magnified a bit. And that's justified because of the benefits of putting all these different

Starting point is 00:14:57 strategies together is really when it comes down of having this giant risk management exercise. And I can't underscore that enough of running a proper multi-manager. It's risk and people. Plug great people into a great system. Risk managed a hell out of them. That's what allows you to use those numbers and create a profile that ultimately is very retracted. Let's zoom into a specific strategy and manager and we'll call them Jane Smith or something.

Starting point is 00:15:21 So Jane Smith is a talented investor. They come to a platform like yours. And as you just articulated, their job is effectively earn a 3% long, short, spread. Let's say they're inequities and keep this really simple. And they're market neutral. They're not allowed any basic market exposure. And that's one market risk factor to which they are neutral. So her job in this case is have the longs that she picks, outperform the shorts by 3%. You don't get the basket out and that's what you're looking for. Layer more nuance on top of that. If you're recruiting a new Jane, let's say, what else are you telling her she needs to do to be

Starting point is 00:15:56 successful beyond just earn 3% better returns on the long versus the short side? For a long short investor, like that is not just about market neutrality. We give someone a risk sheet when other firms will give someone a risk sheet and saying, okay, effectively, you're driving a car down the highway, here's the guard rails. The guard rails are there, just like in a car, so you don't drive off. So what would some of those be? Obvious things going one step down for that. Don't be too concentrating a single position.

Starting point is 00:16:21 So if something surprising happens, you're not punched in the face. So that's another element of saying, what's your universe to be in? Let's just assume if you're focused on picking tech stocks, don't all of a sudden go dealing with industrial companies. Or if you're a biotech manager, you should be hyper-focused on this particular set of what you're doing. So that's another element. Liquidity, a big part of the risk elements is the worst place to be in investing is something that you don't like and you can't get out of in private market investing. That's very clearly going on.

Starting point is 00:16:49 Same applies to public market investing as well. So being cognizant of liquidity profile of your positions so you can stay in and am I'll do a reasonable degree. Those are some of the obvious core elements. And that final piece of that, which gets talked a lot more recently, we act this way. All the firms are going to act this way is to say, okay, effectively as a stock picker, and the same concept applies to a quantitative investment strategy, that inquisdustad, RAP strategy, really, is your job, my earlier comments is to produce alpha. So let's think of all the things that are known.

Starting point is 00:17:17 Factor models are common factor models. And you can bifurcate that in two ways in terms of the style factors, momentum, value, growth, etc., which are effectively more statistical than anything. And then there's the other side is the industry factors. You're just betting on tech stocks. You're betting on health care. And let's actually take that out to a reasonable degree. And the reason for that, and there's tons and tons of statistical analysis that we've done that other firms have done, is humans ability to consistently not only time the market, but to time when is the value of factor going to switch, when it's the gross factor going to switch. Humans just aren't very good at that.

Starting point is 00:17:52 That's really a macro call. The law of large numbers is not in your favor. And so as a stock picker, let's just isolate it out. Focus on stocks, focus on like for like relative value. And I can even make an argument for the market as a whole. This is a huge part, especially nowadays when so much talent has left long onlys, of what actually keeps market efficiencies. This software company versus that software company, which one is better or worse. And that's what we want people to be doing because that's where we believe they have edge. That is where the law of large numbers is in your favor, again, whether you're a quantum investor or you're a fundamental investor in saying, yeah, take out all the noise, all that other crap, because it's so

Starting point is 00:18:26 fucking confusing what actually is driving movements in any given day. And that's when you get this notion of idiosyncratic returns. What is your idio number that needs to be above a certain degree? And that's where firms can differentiate themselves effectively how locked down, how tight are you going to be. And that is not to say that the machine is doing all a portfolio construction for fundamental stock pickers. Obviously for quantitative strategy there is. But canonical example is someone's going to have their universe 50, 60, 70 stocks. Some firms is the low as 40. Other places could be as high as 100. But here's your sandbox. Focus on those. But we're going to give you tools. And again, this is why skill does really matter because you need to be able to provide analytics and

Starting point is 00:19:06 technology to be able to help identify this problem to say, okay, now that I've got, since with the companies that I want to be long, the companies that I want to be short, how do I do that in a ratio that really takes out all the variance in P&L that is a distraction? And you do need to do that in conjunction with the machine. You're just giving those picks to a machine and it's just giving you back the answer, but it is definitely an interactive experience. And that has been an evolution over the past 10 or 15 years. Citadel was probably a pioneer in doing that.

Starting point is 00:19:33 You're activating parts of my brain from my quant days that lead to a lot of interesting questions around why do it a certain way versus the other. But before we get to some of those, I'm curious for your reaction just to what you think about efficient market hypothesis in general, because we're going to talk a lot about how you've built your system to make the most of these two to three percent return streams. But these two to three percent return streams themselves, there's another name for that, which is alpha. And the efficient markets would say, no, no, no, that doesn't exist. Do you think that some of these multi-managers' unbelievable success in terms of the returns that

Starting point is 00:20:08 they've earned, let's take Citadelus as the one everyone knows, like the best counter to efficient markets? You can lever something a million times. If there's nothing to lever, there's nothing to earn. Markets are not efficient. They're closely efficient. They're nearly efficient, but they're definitely not efficient. The reason why private markets taking out all of the hype and the fads and the low-industrated environments that you can see. But people will say, I'm in private markets because there's an information asymmetry and I want to access something for various different reasons. So the core concept that there's a return to hard work and study very much exists. Empirically, you look at the track record. And this isn't just a, here's a needle in the

Starting point is 00:20:45 haystack arguments, the number of shots on goal that the firms have had with a hundred of disinvestment strategies really refutes that. Absolutely, that's a counter to say that there isn't consistent out of the market. The point is, it's really hard, and that's why running in a very tight construct, taking out all of these essentially low law-offarch numbers type bets, that's why that's really important. And just to say, the obvious adage of you only need to be right, 55% of the time. The difference between 55 and 57% of the time is huge. It's just really hard to. It's just really hard to do that, and you want to take essentially as many small bets and add them up as many times as possible to squeeze out that alpha over time. And I view it as we'll probably get into

Starting point is 00:21:26 quantitative versus fundamental stock picking. What is the place? It's very much a place for both. And it'll always be the case. Human's ability to synthesize information, even in a world of AI, on a multi-month time scale. I think that is timeless. I'm definitely plagiarizing one of the leaders in our industry who said that recently, but I think it's a great statement. But it's hard and need to be very dedicated to doing that using tools available to you. Let's talk about what happens above the individual manager level. So a simple way to think about this would be, let's take a bigger number, 100 managers, all of whom are doing something a little bit different, different sectors, different strategies, different asset classes. And they're all

Starting point is 00:22:04 trying to earn that 2 to 3%. Naively, you could say, okay, great, we've got 100 of those. We're just going to allocate capital to them. We get the average of those. They all just get to run their own books and we just get what we get on top of that, maybe with some leverage. But I think there's more going on at that second layer, whatever you want to call that, the center book or the core strategy or something. So I have more questions about the individual manager level, for sure, but just at a high level first, what is happening when you start to roll all those things together? What literally is happening at the firm and in the portfolio above the individual level? So this is really going behind the curtain, which is fun. Definitely

Starting point is 00:22:39 there's a lot going behind the curtain. The basis for your question was saying, okay, let's think It was a simple hypothetical problem in which you've got 100 uncorrelated time series. Well, the optimal solution to that would just be to give each one the same amount of risk. In practice, they're not uncorrelated, and the correlations move around a lot, which is what makes this really hard. And so earlier statements around this being a giant risk management exercise, very true. And so there's a couple questions to act there. What is going on as far as the center book or the back book or the AlfaCatch portfolio,

Starting point is 00:23:07 the magnifying portfolio? that's different than just the true risk management exercise of what is the risk team doing every day? What is my head of risk doing? What is the head of risk doing at Citadel Millennium? Again, technique is the same. Style might be different at different firms. So number one, of course, every individual strategies has their lane. And that's a machine is looking, are you staying in your lane pretty much in real time?

Starting point is 00:23:29 And if you go outside of your lane, the machine is going to flag that and it might get mad at you. And there's all sorts of nuances of how is it going to get mad to you? But practically speaking, you're staying in your lane. And that's, you put on a position that you shouldn't have or you lose more money than you're effectively allowed to lose. Yeah, absolutely. There's an low automation to that. But then there's another consensus.

Starting point is 00:23:49 This is where machines can do a lot of it, but human intuition, human thought, human's ability to essentially architect a risk management system is really important. That's a living, breathing exercise of, okay, we have different strategies that we didn't think we're going to be correlated. All of a sudden, they're becoming correlated. Why is that? Is there something in our baseline risk model that we didn't see before? when I talked about this concept of idiosyncratic returns or alpha, something that's not in the model.

Starting point is 00:24:13 It's literally saying that just because something looks like an idiosyncratic return, it could be that there's a factor that's not actually in your factor model, so actually trying to think through that and dynamically adjust for that. And that is constant. And that is definitely going on our firm. I know what's going on at all these different firms that being like, okay, is there something underlying that could be sort of resonant frequency, which could impact multiple different types of strategies and screw up this perfect analytical concept

Starting point is 00:24:38 of having actually uncorelated return streams. And it can appear in weird ways. You can have a biotech manager all of a sudden become correlated to someone training European consumer stocks. Why is that? That could be something in the markets. And it could be flows driven. What fundamental stock picking is, and again, multi-manager do a lot more in fundamental stock because it's a huge part of it. It's obviously fundamentals. This is a big element. The other part is game theory is that what are all the super smart people that effectively all went to the same schools were trained in the same banks and think the same way. What are they doing? You're all fighting with each other. And so this notion of positioning and crowding, and it is really game

Starting point is 00:25:15 theory, is hugely important. And that's another thing that there is teams are constantly trying to think about a lot, is what is my crowding factor, which is this boogeyman of what's co-holding's risk, what are positioning dynamics? It's all basically saying the same thing of if everyone is positioned the same way and they all move their feet at the same time. It's like you run from one side of the boat to the other, well, everyone's screwed. The whole thing might capsize. And so thinking around that, constantly monitoring that, it's just very amorphous. It's really important. So it's all of that is the risk management exercise. The other part of your question is, what is this boogie man center book that gets talked about? And PMs really hate that at a lot of firms. And the reason for that is not

Starting point is 00:25:55 because they disagree with it intellectually. The core concept of centerbook, again, just using equity long short managers is to say, once you get to a critical mass, again earlier, an economy of scale, another argument, you've got 30, 40 individual stock pickers, they're all sector focused. Well, a machine can essentially take an automated eye, look across what positions that PMs are having the trades that they're making, and say, you know what, that's actually a pretty interesting signal when you put on that position or the fact that you have this position. I can do this across a large number of managers, and I can take that information, and I can either throw it into one giant machine to holistically say, I'm going to call it the best picks, which is hard to do,

Starting point is 00:26:37 but again, there's an approach to that. Or a simplistic approach is just be like, you know what, I'm just going to copy what everyone else is doing. And the reason why PMs don't like the latter, which is quite prevalent, is because oftentimes they're copied, and then the PMs are not actually compensated for that. So there's this notion of, well, you're stealing my IP. And it may sense for the firm to do that, and this is where there can be tensions, because it's just more efficient, particularly from that cost standpoint, obviously, if you're running X hundreds, millions of dollars in a given sector, and half of that is the PM, and they're getting carry on that, and half of that is run by the center team, and there's no carry on that before it goes

Starting point is 00:27:12 to the fund, then obviously that's more efficient for the fund, but it can also create tension. So years ago, and we were starting our center book program, that is not the path that we chose, and not all firms do it that way, some firms do. But it's not. not the path that we chose because we wanted to be transparent to the PEMs and have them participate in the economics, which I think is important. But that's the core concept of saying you have a critical mass of people doing all sorts of different things and a machine can take all the information simultaneously and do some interesting things with it and then do that as a huge scale. Again, 30, 40, 50 percent of exposure in an equity long short program and multi-manager model

Starting point is 00:27:49 can be these center books. It does make a ton of sense for first principles, but managing some of those human elements, the dynamics interaction with the PMs. Our view is very important. I'd love to get into the nitty-gritty of the people. I'll call them the managers in the multi-manager sense that live at these firms and apply their trade at these firms. It's so interesting to think about what you've built, which is effectively a company for whom the finished product is money. Let's stick with that 15% a year just because it's convenient and maybe in the right ballpark. and the raw materials that go into this factory and then produce the finished product of money for the outside investors for the LPs are these people and these teams that are in many cases,

Starting point is 00:28:29 and I know a lot of these people, incredibly talented investors. To earn 3% of return is shockingly hard. And you're up against the market and that means someone else has to lose what I want to come back to as to whether or not all the talent in the world get sucked into these multi-manager platforms. But there's got to be so much interesting nuance going on around who these people are, how you recruit them, the incentive packages that you have to give them where your competition might be them starting their own firm or something like that because they're so talented. So talk me through the universe of the people. How many people out there do you think could earn that 3% return? Is it thousands? Is it hundreds?

Starting point is 00:29:10 Is it tens? and what is important to them? And maybe we're starting to get into the style versus the technique here. But the people are, without them, there's nothing here. It's just a house of cards. So tell me everything you can about what you've learned in this part of the business. There's not an infinite supply. And actually, this is getting to an important point of just where we are.

Starting point is 00:29:32 Because the multi-stranger model has generated this amazing alpha in the recent years, it's not as if you can just plant a flag and say the model generates so much alpha in and O itself, that even if you've never done this, you're an analyst, you've never been a portfolio manager, or you're at a bank, you're at the sell side, and you've really never done this before, but voila, we can plug you in and imagine that you can be there. I don't believe that is true. So there is a finite pool of talent. That pool of talent in terms of how big it is, is I don't know the exact number. It's probably more hundreds than thousands at some level. And when I say that, that's less about the technical aspects of the job. You can learn how to

Starting point is 00:30:06 mild companies, you can learn how to be a quant wizard. You can do all those pieces. But the job of being a PM, whether you're quantitative or fundamental, is psychologically extremely taxing, because you're going to be wrong, basically just as much as you're going to be right. You're going to get kicked in the face a lot. And you're going to be someone who's the smartest person that they've known their entire life. And then they're just going to get beat up all the time. And that's what the job is. And that takes a certain psychological profile. And that requires training. And I just don't think many humans are wired that way. So I don't know. the exact number, but it would be inaccurate to say that you couldn't just take anyone with a

Starting point is 00:30:40 resume and assume that they're going to do well on the model. And if anything, probably the multi-manager space, in my opinion, is a bit too crowded at the moment, which is natural in finance because something works when we know more people get drawn into it. And in some ways, we're seeing that right now. The other thing that I found really interesting, because we did not start off as a multi-manager, we ended up here really by accident. And when we concluded reverse principles that the multi-manager model is a great business and makes a ton of sense and iterated there over a number of years. Once we really reached a certain scale in a very intellectually honest way, where we could start hiring people, we had to think, what is it that someone is actually looking for?

Starting point is 00:31:17 This is a very high-quality person that you're dealing with. And frankly, this is where I think the big four maybe are a little bit vulnerable. These are humans, and especially if they're humans where they're part of their career, or it's not just about the incremental guaranteed dollar, they care about the firm that they work for. This actually does matter, just like in other businesses. And I'm not talking about it in a fake way of, oh, let's give someone a fucking ping pong table and they're going to be great or some of these gimmicky things. Really, if you're a high caliber person and maybe you're at a point, the PMs that we're

Starting point is 00:31:49 talking about in many cases, they might need to work, they may not need to work, but they've done very well for themselves. So they're trying to think, what is my experience going to be? after the assumption that all of what I need to do, to just do my job is there, do I actually want to work for this firm? do I respect the people that are running it as humans? Do I respect where they're going? And there is this notion of these PMs, even though it is neat what you kill model, what we've found in growing our firm, and I can say this because we wouldn't have been able to grow and produce if this wasn't the case. There's a group of PMs out there for where for them, that's really important. They don't want to be

Starting point is 00:32:29 motivated by fear or they've already been burned out, maybe doing that elsewhere. That doesn't mean that they want to sacrifice performance-based environment because you need to be hyper-focused on performance in all aspects. But those other elements that in a cliche way can sometimes be wrapped up into culture, that really does matter. And I think that increasingly, as the multi-manager space evolves, it's not just about providing capital. It's not just providing great technology tools. It's not just providing flexibility in the same way that VC investing years ago, because the supply, demand and balance of capital was about providing capital. Nowadays, if you're a VC firm and you're not actually adding value to a company in some way that's authentic to who you are, you're not going to be as

Starting point is 00:33:11 successful. And they're seeing that now in the multi-manager space is because the capital is there to go after a finite supply of people. You really need to be thinking about what is your value add. It's not in a fake. We're all going to be super poly-anelish and claim that we're going to hug each other all day. But no, really, are you treating people with respect? Do they respect you? And if you have a track record of doing that for an extended period of time. So there's many data points where they can point to that way. I think that is increasingly going to really differentiate firms. Can you tell the why backstory and from this existing in Minnesota, probably even just the fact of where you living and spending your time is quite a bit different. Almost all these firms are in a

Starting point is 00:33:51 couple places. So tell the story why Minnesota, Minnesota's state of mind in this case, I think, to some degree at the firm culturally. Talk about the history and the culture. So this is a a very true story years ago when we first started raising capital because we were a prop firm. My partner and I were in New York. We'd have multiple meetings with people and say, we're walleye and they're like, the Disney movie like Wally? And I'm like, no, it's not a fucking robot. It's the state fish of Minnesota. How do you not know that? But it just, it tells the story of, yeah, Minnesota is different. And I can say that as an East Coast person married to someone from Minnesota, as I'm from Minnesota, so I can corroborate. Having the duchess East Coast background

Starting point is 00:34:32 imagineable I can straddle both worlds, it would be irrational to assume that a firm, we were started at 2005 as a proprietary options market making business. So a Chicago style training firm, effectively building an engineering technology machine to quote single name options prices, a very, very complex problem, but much more of an engineering problem than an investment problem. And especially around the financial crisis earlier on, had some great success doing that, but literally based in a warehouse in Minnesota, didn't even have a website, no one had even heard of us, it'd be totally logical to assume that we involve in terms of where we are today. And even at the start of 2017, the history of a firm, effectively, we started as mentioned

Starting point is 00:35:13 the single strategy, prop trading firm, breaking our history down to a couple chapters. That was about the first five or six years. I had very good success for a capital base up until around 2011, 2011, 2012, never losing money, but markets became much more challenging for various different reasons, some structural changes. And today, Citadel securities, which is different in Citadel, the hedge firm, and Citadel Securities in Susquehanna really are the only pure options market makers left. So we had an existential crisis, really, a little over 10 years ago, saying we've had really great profitability, but now the magic money machine is going away. We've got a lot of

Starting point is 00:35:46 capabilities just like in industry, we need to transform ourselves or shit, we're going to die. And many firms that did look like Walleye years ago just died. And the reason why I run the firm now is I was a driving force or not the only force, but a driving force of saying we are going to transition effectively into a multi-manager model while being a prop firm. We didn't do this to raise capital. We didn't do this because it was fadish. We did just to fucking survive. And as a prop firm, again, prop meeting is all the partner's own money, conveys intellectual honesty, where if you're not making a really high gross return on capital, you're dead very quickly. And the only way to do that is a very high sharp ratio is very consistent. So we spent all five years transforming ourselves from a

Starting point is 00:36:27 single strategy firm into a multi-manager and in a scrappy way. I mean, we were a $60 million prop firm all over 10 years ago. And it worked. And it didn't work because there was this one thing where it was this lead bullet and we just, we threw it all in there. It worked because there's a lot of trial and error. There's a lot of throwing things against the wall. Even when we were starting to build our fundamental equities business, originally we do that with managed account relationships with external firms because we were too small and even higher people. So that was a process. And we got to the started 2017, we had retooled the business. Again, that was our chapter two. Chapter three starts at about that time. We said, okay, we're a hundred million dollar pro firm. We have

Starting point is 00:37:05 multiple different businesses now. We think we have some scale. We'd seen what some of the larger multi-managers had done and there was another prop firm that had evolved from being a prop firm to starting to take an external capital. We think we can do that. It makes a lot of sense. And it's an intellectually honest proposition for us to do that to grow a bit. It's better for our investors, better for our employees, better for the partners, just to get a little bit more scale. scale I'm talking in that time of going from $100 million firm to a $200 million firm. And I remember in 2017, and we were able to double as a firm pretty quickly largely through people that knew us. And even though we were a prop firm, we structured the capital and hedge fund format so it could point

Starting point is 00:37:41 to a true track record. And we thought that was big. And when I say track record, again, to give a sense of the numbers, at that time, we effectively hit a $100 billion firm with $30 million of expenses, another $20 to $40 million of variable expenses. So effectively, if we weren't making at least the 50% gross return of capital every single year. Actually, the investors, the partners were losing money. Crazy. Yeah, it really conveys, as I said, intellectual honesty. And so chapter three, basically the past six years, it's definitely not like everything has worked. Got a lot of scars over the years. But we've just incrementally grown and grown and grown. And so when people hear our story, you asked about being in Minnesota, we've obviously spanned it to other geographies.

Starting point is 00:38:22 At this point, New York is our largest presence. It's about 300 people now. We still have. have our warehouse of Minnesota, but it will look from the outside, oh, okay, this is one of the real multi-managers. But the core DNA of having been through that experience of fighting for survival maybe a little bit too strong, but there was an element, we got to figure this shit out or we got to find something else to do is really helpful. And there's a youth element to that as well, because I personally was given a lot of responsibility at young age. I'm only 38 now. So back then in my early 30s and my partner who's 30 years older me give a lot of responsibility. I was very much entrepreneur himself, was saying, okay, go and figure this out. So when we recruit, when we talk

Starting point is 00:39:00 to PMs, it's not like I go out and say, we're the best in every single dimension. I think we're great in some areas. We're good in other areas. And we still suck in certain areas. And that's fine. We want to accept where we are. And I'll tell people that. But definitely when someone interacts with me, the other members of the senior team, you'd be like, that's an intellectually honest person. That's someone who's not bullshitting me. There's a realism to that. And because there is so much bullshit in finance. If you're really high caliber individual and you're selecting, because there is a little bit of supply, demand, and balance, you're selecting across a number of firms, they want to work with the intellectually honest person. But they don't want to sacrifice competency. You need to have both.

Starting point is 00:39:35 You can't just tell a great story about where great people, we've got this great culture, we treat each other really well. You need to be really fucking good. If you're not, it doesn't work. But if you can do both, that's really powerful. And because the biggest firms in our industry, who are amazing institutions, I have so much respect for all of them, especially Citadel, and I think Ken Griffin is truly brilliant. It's like if Michael Jordan was still playing basketball, that's the analogy to think of, or is the Elon Musk of money making? Like, really? And that's such a gift to people like me to say, okay, there's someone up there who is still pushing it, who is still going to the limits, who is not satisfied. That is amazing. But I think the one thing or those firms, and partly could

Starting point is 00:40:12 just be science or a little bit vulnerable, is this notion of thinking about the individual PM experience. And what are they looking for? What is the attachment that they want to look for? Because they still want to be part of something, I believe, or a certain group of people that want to be part of something. They don't just want to be a mercenary sitting in some random ass office in Dubai or Spain or you name it. And you see all these places poking up. They still want to have a connection to the firm. And we can tell a story of our Minnesota roots, of our prop treating roots, of realism in all the partners. How does that feel different live? If I'm one of these hundreds, there's incredibly valuable resource, these individuals that can go do this.

Starting point is 00:40:48 And let's say I'm the best and I'm a free agent and I have my choice. Every platform's after me. What would be the felt experience difference of being at walleye versus being somewhere else? Sure. I'll give an example of that of someone that we just hired who was definitely having that profile. And we still try to get the entire firm together. And we're 300 people so we can still do that. But we're all over the world.

Starting point is 00:41:09 So that's harder. But we brought the entire firm out to Minnesota in early August. Minnesota is an absolutely amazing place to visit six months a year. The other six months a year absolutely do not go there. Unless you like ice fishing. Yeah, ice fishing is not a joke. I literally live in a lake. People ice fish.

Starting point is 00:41:25 There are pickup trucks that will drive a mile offshore. That's not exaggeration. So come there in August. But we brought the entire firm out there, had a party on the lake. And I had my office door open the entire time. People coming in and asking questions, like, how do you think about this? How do you think about that? What is a firm doing in these dimensions? So there's a notion of accessibility and just, again, it's not complicated. It's not overly complicated, but doing it the

Starting point is 00:41:47 right way, not putting on errors, it would be totally inaccurate to say that this is a family. It's not a family. It's a business. It's a professional sports team. But professional sports teams can still operate with respect or respect for everyone across the organization. So that's one element. The other element, which does, I think, come from our firm a bit more in the particular people that are running the business, myself and by other partners. And very fortunate because we have effectively our chairman who's very successful, who's almost 70, and then there's a group of us young guys that are running the business, and there's a great balance there. The young guys, we're really, really hands on, and I think that also really resonates with PMs. If we bring someone into

Starting point is 00:42:25 our firm, and let's say that it's a little bit of a new category for us, we haven't necessarily done this type of strategy before, or we're not perfect in some dimension, which can happen. You don't have certain product types enabled or you need a new technology piece. Even at this day, I'll get really evolved because years ago, that's what I was doing. And I have the knowledge to be able to do that. Same with the other partners. There's this notion of no one's above that. No one's a figurehead. And that can be really, really in the details at times. It doesn't mean that I'm micromanaging or getting lost in the weeds. But there's definitely a place to be like, yeah, be hands on, get after it, show people that it's important. And I've had so many new PMs that have come here and

Starting point is 00:43:03 be like, I can't believe that you actually took the time to look into that personally. Or when you said that it's going to get taken care of. Just even something is simple and need some new futures options enabled in the system. Can we actually go through and do that? Okay, fine. I'm not saying we're the only firm that operates that way, but definitely from my experience, the best firms. You still have very hands-on senior people that are also, frankly, very confident, able to do that. And you're showing PMs really that they're important and they care. It's not just about hiring PMs, but you're really building teams of investors. You have a PM, they can have sub-PMs, they can have analysts, and sometimes there can be competition for those analysts as well.

Starting point is 00:43:39 So PMs will come to me and say, hey, I really like this person. They're in process in a number of places. Can you speak to them? Absolutely. And people feel that in all various different ways, as I mentioned, whether that's getting the weeds in a technical problem, whether that's helping with recruiting. And that doesn't mean one of the things I haven't mentioned, it's not like we're saying we're soft on anything goes and you can lose a ton of money and there's no problem to that.

Starting point is 00:44:01 That's not the attitude. I think we're very fair in that respect, which is a third piece, is that When you talk about all these risk parameters in the corridors, sometimes from the outside, people like, oh, well, this group, they run with such tight limits, and here you basically can't operate. Generally speaking, I don't think that's true, maybe with the exception of one farm. Overall, the risk corridors are fair, but what PMs want to feel is that is just that, that they are actually fair, and if they have a question, or they want to actually have a discussion with a reasonable person, let's say someone's going through a drawdown, and they get close to the point at which there's this drawdown limit.

Starting point is 00:44:35 which every firm has, including us, and that's really a way to say, from a statistical standpoint, let's automate the off-boarding process. Obviously, the hardest piece in risk allocation, whether that's allocating individual positions or allocate individual managers, is one to actually call a quiz because there's this human psychological bias to say, oh, okay, if I fire someone, or if I change my idea, that I failed in some way. So drawdown limits are very helpful to just automate that and take the human emotion out of it. But the PMs want to feel, well, shit, there actually could be situations. They're rare, but there are already. situations where the path matters, and that could be not the right decision to do. So what we tell

Starting point is 00:45:11 people, look, that is rare. This is definitely not, oh, if you've got a great story, you can just keep going indefinitely. But we're willing to have that conversation that we are investors ourselves and have a lot of experience of what it's like to be in that situation. And that is what PMs really respect. Again, going back to reasonable, competent people that are doing the obvious things well, yeah, if you're in a tough spot, you want to have a fair conversation about it as opposed to just essentially being fired by some 23-year-old because in a spreadsheet the sell goes from green to red. That's again what these high help people want. Do you identify personally more as an investor or as an entrepreneur systems builder?

Starting point is 00:45:47 Me personally? Yeah. Definitely the latter. Earlier in my career, I went to grad school for math, started off at a big Kwan firm in London. I was able to, in a random experience, spent some time at a now one of the great growth equity firms in Chicago. So for people that have my seat, I've had just a wider range of experiences. And even when I first came to while, I was running my own quant strategies that I wrote personally

Starting point is 00:46:12 has running code all day. And then it was evolving into hiring teams of people in quant strategies and then more broadly across effectively over time, everything that can be done in our world. And in terms of the differences between being a PM, it's essential for someone in my position to have been a PM. That's for the psychology aspect of it. And to be successful in doing that, You need to prove your bona fides and you also need to be able to say, I understand psychologically how hard that could be no matter who you are. But in terms of where we are now, my role is I'm designing processes. And increasingly as we get bigger, I'm interfacing with people and putting in place people that I really trust that are experts in their domain. My official title is CEO and CIO's

Starting point is 00:46:53 the chief investment officer. But the investments that I'm making are investments in strategies. I'm not making a call on individual stocks. I'm not making macro calls. And effectively, the individual strategies are, to use a normal company analogy, they're like individual products. And I'm saying, how much do we want to invest over here in our equity longshore business as a whole? And then maybe in particular areas and how do we get the right coverage across the map? Do we want to start bulking up our quant business just like, again, another division of the firm? And for me, having a quantitative background and the ability to abstractly architect out has been very helpful. What I personally really enjoy is because it's such a

Starting point is 00:47:28 human business. And I really think that is overlooked the multi-strait model. This business is risk and people on the people side is so important. Being given the opportunity to lead groups of people that effectively are coming together. Look, this is finance. This is the money-making business. We're taking money from rich institutions and we're trying to make it into more money. So as humans, you need to find purpose in doing that. And yes, there's all sorts of stories you can tell about who those institutions actually are in their core purpose, which is true. But for the people that are in there day to day, this notion of how you do anything is how you do everything. And let's be excellent for the sake of being excellent. That doesn't mean that we are excellent

Starting point is 00:48:07 in every way, but at least that's the goal. And my role now is leading that across our investment and our non-investment functions and the non-investment functions are so critically important in our business. That is what I personally enjoy the most. I have to ask, since we share this background, coming up as a quant, a couple of quond questions. What can you say about the half-life of successful quantitative strategies. So if you think simply as a quantitative strategy is just a predetermined, pre-baked set of rules for making investment decisions based on some model, I'm talking about the models themselves. How long do you think the average model can or does quote-unquote work for? It's related to sharp ratio. You can't just group quant into one bucket.

Starting point is 00:48:51 And there are quant strategies that are double-digit sharp ratios. And if anything, the half-life of those is lot shorter. And that's because if you just think about it from an analytical framework, the higher the sharper ratio, the closer it is to a pure arbitrage. And at some point, capital is going to flow in and close that arbitrage. And there are real 10 sharp ratio strategies out there. I've seen them that can run for years. So it's not like anything that the higher the sharp ratio, the faster it dies. But generally speaking, something could be great for six months because of some strange anomaly and then go away. At the other end of the spectrum, you think of something like trend falling strategies. I started my career after grad school, it was at the time the world's largest trend flying manager.

Starting point is 00:49:30 And trend followers are very simply, I'm going to look at momentum, typically measured by moving average crossover, and that's going to determine how long I am or how short I am. It's still a huge part, particularly of futures markets, and it does even impact equity's markets because of the positioning of that history. Trend followers have been around since the 70s and generated decent, uncorrelated returns for quite a while. and last year was one of the best trend follower years in quite some time. Now, the sharp ratio of those strategies is less than one. If you're a good trend follower, you're like a 0.8 shirt.

Starting point is 00:50:04 And I can say this because I wrote a trend following strategy over a decade ago that still runs. So I actually know everything that's in there and the nuances are different, but it doesn't necessarily mean it goes away. So that's how I think about it a bit more. In Quant landed multi-managers, most of what Kwan is, is Equity Stadarb, and that's analogous to what I was mentioning before is that you're long $100, you're short $100, you're looking for idiosyncratic returns. So what people are fighting over now is there's a signal aspect. Is there some new bit of data that could help improve my signals? But at the same time, Arkway style or business running at scale for almost eight years, a lot of the data that

Starting point is 00:50:43 they're using has been available really since the 70s. You go back, copy stats been around for a long time. And when you read about Princeton-Newport, what they were doing in the 80s, they're talking about fucking value and momentum. Yeah, that book about it is great, but the core concepts have been there for a while. What does change, it is still very competitive. I'm not trying to say it's not competitive, is that even in Quant, there's still artists. And this is what we find in evaluating. There's definitely quantitative artists. They're saying, okay, quant, especially that style of Equities at our Quant investing, is less about finding the thing that no one else has. And I think that's totally ridiculous to think that you really are going to find something that no one else

Starting point is 00:51:22 has found, especially when you realize that at least since 1990, people that go to the elite universities of the world have been pouring into quantitative finance, and everyone's really fucking smart. You have the same technical abilities are there, and I can say that with personal knowledge. So what differentiates people is how you're putting together everything in the soup as one. That's a bunch of small decisions that are much more akin to artists making painting on a canvas than necessarily following a terministic standpoint. And that can be how you're combining balance sheet data with technical price data, which type of machine learning model you're using, and then that feeding into the portfolio construction piece of how much you're trying to

Starting point is 00:52:05 optimize for sharp ratio versus how much you're trying to optimize for drawdown and all these different elements, how much of your exposure is going to be in the U.S., how much it's going to be outside, how are you going to shift that around. There's all these tiny, tiny decisions, even in building an equities start ARB strategy. If you had, let's just normalize it to 100 managers or 100 points or whatever, if you had to break down both for walleye and generally, how you think those are allocated to the different styles, whether that's traditional equity long short,

Starting point is 00:52:30 quantitative, equity, quantitative other macro, et cetera. What are the major buckets and what are the percentage roughly of managers in each bucket? We started as a volatility specialist, mostly in single name options. We still are very active training options. It's a different style than what we started with, is still very active. There are a lot of single name equities trading, but most of some asset class level volatility. Across our entire business, that number is still at this point, 25% or so, 25% to 30% is related to volatility trading. We do a lot in long, short equity, so that would be

Starting point is 00:53:01 another 40% or so. And then the balance is split up between capital market strategies and fixed income macro strategies of various different formats. And I'm not to say that's the ideal fashion. As I said, the history for us, we started as a volatility specialist, then we started pushing this other areas. Sorry, I forgot Kwan in that as well. That would be in that last bucket, Kwan is a decently large part of what we do, about 20%. Fixed income macro is a small piece. That was the point I was trying to make. And that's not because we don't believe that there are good things to do in that category. It's just, it's not our background. It's not in our DNA. And that's a thing as well, when you're building a multi-manager platform, you think about playing to your

Starting point is 00:53:38 strengths. You can't do everything all at once. At scale, if you're millennium, if your Citadel, you've been around for 30 years that you've had time to build these different businesses and build them in high quality fashion. And that's where there can be attention because there's definitely benefits of diversification. But if you expand too quickly, then you just lose money in diversified ways. How many is it? How many managers is it total? In our case, it's about 100. Oh, so it is about 100. It is about 100. But Millennium, I think about 300. So the scale is large. And that's where it's a very complex management exercise. But what's crazy to me is to think about, there's plenty of investment firms.

Starting point is 00:54:12 I'm sure that the investors listening will have encountered. That's a leader, a small team, $500 million, a billion dollars, whatever. And just to think that there's a hundred of those under one roof, let alone 300 of those under one roof. Again, we're relatively small. It's crazy. And that the scale is dramatic. And that's what I was saying before is the model that makes a lot of sense.

Starting point is 00:54:32 It's very easy to articulate. Oh, you just earn two, three percent on gross market value. I can do that. But I don't know, you have to do that at scale, not just from an AUM perspective, from a strategy standpoint perspective. It's very difficult to execute. It's very much execution challenge. Well, let's talk about leverage. So I'm also curious about how you control the portfolio, why you push down the limitations to the individual manager level versus just take whatever they give you and manage everything above them. But leverage is probably important that we haven't talked a ton about other than just saying there's lots of it. So what determines how much

Starting point is 00:55:06 much leverage you use and how much does it range? What does it mean to be great at applying leverage versus just good? This seems pretty damn critical. Three percent's uninteresting, 30 percent's really interesting. The difference there is leverage. So, explain it to us. So ultimately, we're targeting a return profile for your investor base. It's much easier to target a volatility profile than return profile. So you're really backing into, okay, if I'm trying to make 15 percent return to investors, and I want to do that very consistently. Really, really good net returns would be about a three sharp ratio. So just again, do you simple math. The sharp ratio for the best platforms has been at that level the past couple of years, but three sharp ratios and are realistic, but not

Starting point is 00:55:45 less, let's say it's 5% annualized fall at the fund level. So the leverages you're taking and say, okay, I need to be in this category and returns day to day you can't necessarily measure, but you can get a pretty good sense of your volatility profile just by looking at the distribution of your P&L. And there is an element of we're backing into with the range of possibilities that can happen of I'm generally speaking going to be five to seven percent analyzed wall. And I don't want to trivialize that problem because it is not simple. But it's also not that complicated to say if you go bit by bit and block by block and that piece is really important, I think it's insane to try to start one of these businesses from scratch. There's a few weeks that have tried.

Starting point is 00:56:26 The results of that have not been great. But if you're going bit by bit and saying, okay, I'm $100 million firm and my standard deviation is plus or minus $500,000 a day. So it analyzes $8 million. Okay, I'm in range there. Then I get a little bit bigger and a little bit bigger. And you keep it at that same level. The leverage overall at the firm stays relatively constant. For us, it's been 5 to 600% over the years and that's reasonably stable. But no one is specifically saying I need to apply this leverage concept. You're really backing into, I need to deliver interesting returns for my investors in order to do that. with a variable that I can forecast, which is much more around volatility, and also the potential

Starting point is 00:57:03 for loss as well, because realistically, if you're trying to make call low to mids double-digit returns a year, having a 10% drawdown, 15% drawdown is not particularly good. So that's a huge piece of it as well as saying within that distribution of outcomes, what leverage level might comfortable with. Another thing that is pretty critical, you ask the question of how much does it vary, especially at the larger platforms, being able to, and this is true for us too, being able to say, okay, I'm confident that I actually can have a view on the potential range of outcomes, so I don't need to be like, oh, my risk management strategy is just to take down gross. That's stupid.

Starting point is 00:57:37 And there's a lot of investors, very famous ones that have made mistake over the years of, oh, when it gets a little dicey, I'm just going to pull back from that. You kind of need to prepare for that storm ahead of the fact, which is where vector analysis does come into play. So it's cliche, but you can play a position and strength maybe when everyone else is a little bit weaker. So that's another maybe misunderstood, but certainly important point to make is that the risk management policies, I think this is a technique thing, they're built to withstand crazy things that can happen in markets. And that's not to say that there's this eyes closed, will be fine no matter what,

Starting point is 00:58:10 very much paying attention. But definitely being able to hold your ground when you're going through it's really important. What is typically going on when there is a storm for this investment strategy in business? I'm curious about, is there a red button somewhere in the firm that can be pressed in the times that have been toughest, what is usually going on? I'll use the GameStop week of January of 21, maybe as a more isolated example, to just our industry. So if you remember then, it's really a four-day period started on a Friday, and there were some rumors that Melbourne was really having some trouble with their GameStop position. And then Monday, Tuesday, and Wednesday, for a very period of time, people, our industry just absolutely freak the fuck out. And there is this

Starting point is 00:58:51 idea of... Technical term. Yeah. Sorry, this is how I talk. I love it. But it was like, wow, you could never short a stack again. So, holy shit, we have to take down our entire books. And so what's happening in those periods, again, as mentioned, and I believe that everyone

Starting point is 00:59:07 of my seat at the top firms is very much in the weeds. And we can see a lot of what's going on in our portfolios. That's where having the systems in place to be able to watch that in real time, very helpful. And even in that case, it'd be like, okay. we didn't really think about what the fuck is going on in Reddit could actually impact this world, but we need to pipe that into our system real fast and pouring Twitter's feet into our system, building tools on top of that to identify. It's like, oh, this is the next one that's there.

Starting point is 00:59:36 Do we have high, short interest stocks? Could something become targeted? That's very much a whack-a-mole exercise. So you asked about what is about what's actually going on, just to give some examples of that. I remember hearing a rumor during that week, Citadel's taking down, telling their books to cut and half. And I was like, there's no fucking way they're doing that. But nonetheless, those are the rumors that are coming in. And the human piece, and this is really, it's these low frequency moments where you really can distinguish yourself as a firm is you need to be able to manage that personally. And I can even say managing that personally, because I've been through a number of these periods now. And I'm not saying I'm perfect by any means, but absolutely, was I better prepared in January

Starting point is 01:00:13 21 than in March 2020? Having been through March 20, yes. And so what came out of that is you're watching what's going on, you're thinking about whether you're exposed to these factors that are now obviously coming up as the meme factor or the game soft factor, whatever craziness you want to call it. And if the answer is no and you see that your absolute strategy is losing money because very clearly there's people across the street that are freaking out, then the best thing to do is to say, we're not in a position where we're impaired. We understand what's going on. You need to have situational intelligence about it. You need to triangulate information and need to be able to weather that storm. That was absolutely the right call because it rebounded very quickly.

Starting point is 01:00:50 How did you know that Citadel wasn't taking down gross like that during that period? People in industry definitely have channels of communication. I did not speak to anyone there personally, to be clear. There is an element, and you read about this and entrepreneurs of all types, but there's an element of just being disagreeable and backing your own intellectual intuition. And I remember thinking when I heard that, I was like, that's just not true. That just wouldn't make any sense to me, so I'm going to ignore the job. that are freaking out and saying of that, there was certainly a piece.

Starting point is 01:01:19 Because it just wouldn't make any sense. Why not? Why wouldn't it make sense? Well, in that firm, in particular, that is a core mandate of basically doting down your exposure. There will be a huge departure from effectively a stated operating principles. Also, the potential market impact of that would be enormous. And it's almost like, okay.

Starting point is 01:01:41 Literally hundreds of billions of exposure. And that's like someone saying you have a bloody nose, well, let's just cut off your fucking knows, that doesn't make any sense. So there's a skepticism about how well, I'll actually validate. And underpinning that assumption is that you have extremely smart, sophisticated, competent people that are running those businesses that would make sound decisions. We're in a game of relative, not absolute talent, which is, I think, a really important thing that people often forget. When you are selecting people to play that game on your team, aside from strategy, actually abstracting away from strategy, are there things that you are always

Starting point is 01:02:16 looking for when you're interviewing a PM that feel like just necessary conditions of someone that you would hire the key traits of a PM in this relative game? Yeah, there's a few things. And some of these are going to sound cliche, but they really matter and you feel them. So intellectual honesty is the biggest one. You meet a lot of people. They need to really understand why they made money in the past because we're not underwriting the past or underwriting the go forward basis, which is an obvious statement, but very few people really understand that. Did you just make money because of the market call? Or did you make money because you followed a process which has a probability of repeating itself in the future? Are you doing things in the right way? Are you putting

Starting point is 01:02:54 yourself in a position to be successful? And can you evaluate and analyze that? And experience matters, but it would be inaccurate to just say you're just hiring based on experience. If anything passes a certain point, there's a U-curve where you have almost two experienced people that were trained in a different world back in the 80s or 90s or even early 2000s picking stocks or before reg FD. They're not equipped with a modern tool. sometimes to be able to be successful, as I said, to kind of interface a little bit more in a gray box style for fundamental stock picking as the most salient case. A core tenant of our firm, when it was started, my partner, who's said it's almost a mall of 70s, been in the business

Starting point is 01:03:29 since the 1970s amazing career. When he started Wally, one of the things that he said is, I don't care how much money someone can make us. We're not going to hire high-maintenance people. Believe me, there's a lot of high-maintenance people in finance. And sometimes it can be tempting to say, you know what, let's hire that person, even if they're a pain in the ass and they're going to drive us crazy, they're going to make us so much money that it doesn't matter. Well, you know what, that's never the case. So that's actually really been a court tenant refer. It does come from our by partner. And we do think about that a lot. How do you screen for that? Reputation. Reputation, you can get a sense in meeting with someone. Interviews are easy to fake,

Starting point is 01:04:09 but it's a small world where someone's been before usually follows them around. So there's obviously limits to how much you can screen for that. One of the things that I've definitely learned is it's not germane to our particular model is you can get a sense pretty quickly when you're actually working with someone and the romance has gone away of where they really follow that tenants. And so I do think that we put a bit more emphasis on the human side of it and less just trying to hire pure mercenaries and looking people on numbers on the screening and not to say we're perfect. We benefit a lot from those that have gone before us. And your question was about relative talent game. Absolutely that is true. Our sweet spot is people that are typically in their

Starting point is 01:04:44 mid-career where they've spent time at large institutions and for various different reasons, they want to pursue a different path from being there. Some of that is structural, some of that can just be environment. I'd let's talk a bit about performance. I don't mean investing performance. I mean cultural, individual philosophy almost of performance. At lunch, we were talking about the all blacks. And I know you're working with the author of that book on the company's culture. I'm dying to hear about that. But even at the personal level, you won't say, but I will, I think you deadlifted like 700 pounds or something absurd. It seems like. like your philosophy of performances that you said earlier, how you do anything is how you do

Starting point is 01:05:18 everything. Just say more about the philosophy behind all this and then how the notion of culture and performance blend into aspects of your life. One of the reasons why I love our particular model is that notion of, yeah, be excellent is celebrated. Actually, in many parts of life, people that want to be excellent are somewhat pushed to the side. And what I mean by that is personally, probably still can't, I left under pounds, but I was an athlete in college and afterwards, it was in rowing, which is a totally ridiculous sport because you essentially sit down next to someone else and then say who's going to pass out first. But if you can be successful in that and you really understand, okay, inputs and output and rowing is just this amazing sport,

Starting point is 01:05:57 because you can get pretty darn good on very little talent and just being incredibly pig-headed. So that is definitely defined me. But the things that I've done personally in my life for the years, whether at first that was academically and then athletically and then as I've gone on in my career, and I've definitely had my own faults in my personal career. The thing that comes for that is when I'm personally the most happy is when you pursue something that is hard and it's a struggle, but you persevere and you do that. And you're doing that with other people that are in it for the same reasons. And the people that are really attracted to or from them that I've joined working with, we've got people that, and not to override it, but spend time in the SEALs program,

Starting point is 01:06:36 people that have played athletics at very high levels. There's this core notion. There's certain types of people that are wired in a way of they just want to be great of what they're doing. And over the past couple of years, as I've been in a leadership position, I've been embracing that a bit more, be like, you know what, that's okay. And if other people find that inspiring and want to come along with that, that's great. But that is what gives me a meeting is what gives a lot of the senior folks at our firm meeting. The final piece of that is to be able to demonstrate to people, you know what, you can do that while also being an excellent human, excellent individual in your personal life, how you take care of yourself physically. Definitely, that's hugely important to me.

Starting point is 01:07:09 And I believe oftentimes people don't stress enough the connection not to get too crunchy about it, but actually between your mind and body and how you're physically prized to a machine and how it's going to impact your ability to just have energy to perform all of that really matters. So all those things together, personally, I think that's why I've been able to have some success and also to be able to drive a firm forward of saying, we're going to do this thing, we're going to do this thing that's irrational because if we do it, it's going to be great, and we're going to feel great about it, and then we're going on to the next thing, the next thing, next thing.

Starting point is 01:07:38 What have you learned that's valuable about the all blacks? Maybe say what the all blacks is just for those that don't know. So this book, it's called Legacy by another name, James Kerr, James embedded himself within the All Blacks. The New Zealand rugby team, arguably one of the most successful sports franchises. Teams ever? Yeah, just amazing degree of success. And when he came away from that, in a nutshell, was saying you have these individuals who are

Starting point is 01:08:00 incredibly high performing, but in the book, he has this line of sweep the sheds, mantra, and that's a New Zealand terms. It means like, pick up the fucking locker room. Even if you're the god, the rugby god, and you physically look like a gigantic human, do the little things well. And that's not just talking about all blacks. You find that in all areas. I love the line. How you do anything is how you do everything. And the notion of humility, the notion of supporting your teammates. Another key takeaway from that book is don't be a dickhead. So similar to what I was mentioning for about not hiring hire main people. Just some really great values. that you can have this organization that has those pieces, where you have this collection,

Starting point is 01:08:38 a team strength, a team of support that's also really high performing. And so the reason why we're working with James is that he had worked with a firm where I had spent time years and years ago that I have tons of respect for helping them to articulate and institutionalized elements of their own culture at scale. And then we were the next getting you pick up to do that. And as far as what that means, there's artifacts to that, of course, there's words. He's an author, so as an amazing writer, but it's more what are the rituals involved, even things like getting the whole firm together, what is the right communication cadence? And in talking with James about it, these are things that all firms face as they go from. There was this core group of people that was seeing each other every

Starting point is 01:09:17 day. And there was a lot of nonverbal communication to once you get above 150 people, this magical barrier in human cognition and lose the ability to keep track more 150 faces. You have to really focus on institutionalizing that. And there are organizations that can do that at scale. Typically, side finance, but certainly the military, they're the case, the obvious special forces teams. Some sports teams do this better than others. And so we're spending time in that. What aspects of the ingredients that go into the recipe that is the firm, maybe even like the most insider-ish type things, have we not talked about that you think a lot about? How big to get and how fast. So the past couple of years because the returns of platforms have been

Starting point is 01:10:00 strong and there's this general intellectual acceptance that there's a better mouse trap. There's been money that's just been thrown at institutions like ours that have a credible shot. The biggest firms have effectively doubled in the past few years to just scale that boggles my mind and many other's minds. There's effectively blank check, SPAC type multi-managers that are being started by very smart people, but very different coming from a massive institution to starting one and yourself. So the space is crowded. There's a lot of money that's come into this base, investors of all sizes. And we've grown, but on a percentage basis, we've definitely grown. We've also turned down a lot of capital. But the conversations that we have internally are how do you get that pace right?

Starting point is 01:10:50 And I'm sure that startups that are in a bit of a bubble have had similar types of conversations that absolutely happens in our industry. And finding, that right balance is really important. So that's certainly something it happens behind the curtain is talked about. I guess the other one that is worth mentioning. And just to come out and say it, because people, we all have good manners in our industry. Or maybe I don't always at the time, but at least I was brought up to have good manners so I can fake it. But the fact is it's a relative talent game. And there's only a small number of firms. It's extremely competitive. And that's not to say that firms hate each other, but absolutely probably a big part of what drove Millennium

Starting point is 01:11:29 and Citadel to be so excellent is a huge rivalry there. Then maybe you could extend that to other firms as well. And we have our rivalries too. And I grew up in a sport. It's literally you're either going to sit down an erg or line up and yeah, who's going to pass out first? And the level of intensity and competition around that behind closed doors, yeah, people care a lot about that. And if you're going to play in this arena, you have to embrace that. And be like, you know what? I want to compete day in, day out. Because if you're not, you're going to get past by. We talked about some of the robber barons early on in the conversation. Is there anyone else that you find yourself returning to, whether that's reading about them, studying,

Starting point is 01:12:10 thinking about the way that they lived, that has been most impactful on your thinking or way of living? It didn't mean to compare you to a robber baron either. No, I don't think of a robber baron, either. No, I don't think of a robber baron for sure. It's less about one individual because I don't think anyone's perfect. I think it's quite dangerous to be like, this is the one person that I think is ideal. If there was one person that I'd be like, you know what, if I could have that guy's life holistically in every helm and not just business successful personal success, it probably would be Ed Torp, who's one of the pioneers of quant investing has been successful across many areas. He's like 90 years old, but he looks like he's 60 and has a good family. Okay, that's successful.

Starting point is 01:12:48 But it's not like I study that guy intensely. What I do find myself studying, and it's why I love the Founders podcast. It's not just a shapeless plug. It's really true. Because learning about successful people of the past, whether they'd be in finance, going back to Robber Baron age, Vanderbilt was a fucking psychopath, but he's still extremely admirable in many ways in certain parts of his life.

Starting point is 01:13:09 Same thing with Jay Gould, James J. Hill. You go down the list. You can't be serious without studying Rockefeller, you name it. And human nature doesn't change. And so what I find myself doing constantly, just because I'm so curious, reading books about these people, how did they think when they were my age, what was their life, how old were their kids, what were the problems they're facing, what were the stresses that they're facing, how did they interact with their partners, how do they interact with their employees? Because all that stuff doesn't change at all. And then ultimately, not trying to copy

Starting point is 01:13:39 anyone, but you take bits and pieces from what other people have done before. And that's true of those really outsider industry as well as even with their own industry. And you ultimately come up with your own mosaic of saying, I'm learning from others because you'd be crazy not to, but blindly copying is also equally crazy. You want to come up with your own recipe. So I'd study, I'd say the personality type as opposed to one individual personality. This has been such an interesting dive into a model which has become one of the largest gravitational forces in markets. And I think because it's fairly complicated, maybe other than my conversation with Dimitri, Ballyasne, there hasn't been a good summation of what is going on. What are the component parts of this? So I've really loved how much

Starting point is 01:14:22 detail we've gotten into. I think you know my traditional closing question. What's the kindest thing that anyone's ever done for you? So I'm going to tell a story involving one of the previous members of your podcast, which as I've gone on and gotten a little bit older and have a little bit less I think about more and more now. So I used to work in a firm called Valor Equity Partners, run by Antonio Gracios. And the way I got there, and two people know this story. After grad school, I was at Oxford doing math, and I was a hardcore math nerd and a big time rower. I thought I was awesome. And then I started working in a quant firm in London. I was doing really well. And back in 2009, effectively my best friend is 20 years older than me, my son's godfather now, is like, well, you're a smart guy in your 20s,

Starting point is 01:15:03 but you know jack shit about the world and investing. And I think you should come work. I just joined this firm with this guy Antonio. He's really great. They're doing really cool things. It's a private equity firm in Chicago. And I was like, that sounds crazy. But you know what?

Starting point is 01:15:16 I wanted to come back to the U.S. I'm very curious person. I met those guys. I love those guys. Okay, great idea. So moved to Chicago in 2010. And I was terrible. Really, I didn't know how to model.

Starting point is 01:15:27 I didn't even know what a fucking LLC was the first state. I was a hardcore math guy. And I thought that was the ultimate intellectual achievement. but I just got my ass kicked and it was super helpful in hindsight. But the specific story that I wanted to tell, the answer your question was, I remember distinctly this one day. It was about when I was two months in. And I was really not doing a good job. I just was not trained properly. I was not mature enough for the role. And I thought I might get fired. I was like, oh my God, this is the first time I've ever failed in anything in my life. And Antonio sat me down and he said, you know what? You're

Starting point is 01:15:56 fucking up. Yeah, I know. But we're going to help you. We're going to give you tools to support you. We're going to send you to company modeling school, which everyone does in an investment bank what I'd ever done because it was a math guy. And so we're going to give you the tools to do that. You still got to carry your own backpack. This is a culture of excellence. You need to perform, but we're going to support you and give you the option and put yourself position to do that. And at the time, I didn't think, oh, wow, this is really kind. But as I've gone, particularly now in running a larger firm, I realize how kind that actually was when you have someone that is just not performing, it would be so much easier to be like, you know what, this is not a fit in to move on.

Starting point is 01:16:29 but seeing something in me and the intensity within me and be like, you know what, this is a person where I'm going to actually go not really out on the limb. That would be way too strong, but to be like, I'm going to be supportive here. That was extremely kind. And it's been kind to me because I had not had the experiences of being in that firm, which were in hindsight, truly crazy. About three months after that, they were leading an investment in this rocket company called SpaceX that I never heard of. I didn't know what the fuck Elon was. And then I was crawling on rockets, literally, had I not had just those literal experiences of being there, throughout relationship with someone, these individuals,

Starting point is 01:17:04 seeing what's possible that firm has gone on to be extremely extremely successful. It would not have set me up for the next thing and the next thing. And I think about this notion a lot when we talk about combining excellence in a performance-based culture, but also being supportive and thinking about the human a lot. It's been extremely, extremely helpful with me, so I'm very grateful for that. One of the great little sayings I picked up from the Special Forces community is deeds over glory. And one of the funny things about Antonio, who I think the interview we did with him is like the only way you can hear him say anything is he'll always show up in these pictures. It'll be Elon in a room, fixing some problem.

Starting point is 01:17:40 And he'll be off on the corner helping solve problems. Such a fascinating guy and a really neat story to hear that would not have been my expectation that Antonio would pop up in this story. But a great closing answer. Thanks a much for your time. Thank you. If you enjoyed this episode, check out join colossus.com. 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 - Will England - A Primer on Multi-Strategy Hedge Funds - [Invest Like the Best, EP.342]

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