The Derivative - Allocating Assets and Attracting Allocators with Ted Seides

Episode Date: May 13, 2021

From actual capital allocator to branding his book and podcast “Capital Allocator,” Ted Seides has one of the biggest banks of knowledge in the capital allocation game. He’s a well-known author of two books, host of the podcast Capital Allocators, and in his “free time” invests his own money in some of the best and brightest hedge funds around. In today’s episode, we’re talking with Ted about Capital Allocators (the podcast & the book), the transition of talking to managers for an allocation -> to talking to allocators about managers on the pod, the Yale endowment and incredible opportunity to learn from Dave Swenson, bias in capital allocation, rebalancing without emotion, illiquidity premiums, base rates, allocator’s reaction to competition, blackbox of quants, portfolio construction, “Netflix” allocator selection, and Ted’s favorite guests & favorite quotes. Chapters: 00:00-01:42=Intro 01:43-28:16=Learning from David Swensen 28:17-48:55=Is Private Equity Too Big? 48:56-57:47=Base Rates, AI advancements & Fees 57:48-01:09:20=The Show or Allocators Podcast 01:09:21-01:22:23=Part of the Equation 01:22:23-01:28:39=Favorites (The Buffet Bet) Follow Ted on Twitter at @tseides, listen to Ted’s podcast on your preferred platform here, and purchase his books here. And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, or LinkedIn, and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. All of the allocators probably have an over-diversification problem because you're a little bit misaligned if you think about you're investing in a fund manager, and you might be investing in a lot of fund managers, but fund manager, that's most of their livelihood. So they're inclined to be a little bit more diversified than might be optimal for you

as the allocator if you're investing across a bunch of different ones. So there's a bunch of different ways of thinking about that. And hedge fund strategy allocation manager selection is different from broad asset class exposures. But I would say two things. The first is depends on the game you're playing. And the second is it depends on this particular strategy within that game. Hi, everyone.

In the words of today's guest, this is an open exploration of the people. Well, just one person this time, but the people and process behind capital allocation. So that's exactly what this episode is going to be about with our guest, who's a renowned Bet Against Buffeter, author and podcast host. We've got capital allocators, Ted Seides, on the pod today. We're going to be talking with Ted about his background in the industry, his podcast, Capital Allocators, and his newest book, which he went with just the same name, Capital Allocators, but I love it. So let's get into it, Ted. How are you? I'm good. Thanks, Jeff. Thanks for having me.

How's the book tour been going? Been on a lot of podcasts and videos and whatnot? I've been doing the tour. It's nice to do it virtually. Probably saves a lot of time, but it's been fun. Every conversation is a little bit different. It's really fun. Your last book was how long ago? That one came out, I guess, five years ago. So was it just on the leading edge of all this podcast stuff? Yeah, it was before. It was what led me into the podcast world because I was on a few podcasts when the book came out. But that was, yeah, that was the beginning of it. And I've always wondered, you know, Scott Galloway and he's kind of said on that part of like, no, it's easy now.

You just send it to an editor and they take all the podcasts and turn it into a book. And I spent five minutes reading it. Reading this was a little more involved in that. You're actually putting some thought into the things between the quotes from the podcast. Is that true? Yeah. Maybe I should have done it his way. Probably would have saved a lot of time. Exactly. How long does it take you to write these things? A couple months, I guess. I mean, there's a process, right? Once you start with the idea. And so this definitely started with wanting to distill some of the lessons from a whole bunch of the podcast episodes. And the first step of that was to outline all the episodes, which I hired a couple interns and we did that through quotes. And so that took a couple months. It wasn't a ton of my time

initially and then I had an idea of what I wanted to write about and it just takes a couple months to find the time to do it yeah it's great I um this is a little off top but I keep arguing with my wife she wants to send our kids to camp summer camp I'm like you know how much time do we really have with them let Let's keep them. But then that little passage in the book, I think it was Cohen's CEO or someone who had that little paragraph that you quoted in the book about summer camp. And that teaches you the real life lessons and how to deal with people. So I brought that in. I'm like, okay, you guys are right. He can go to camp.

Yeah. No, Jeff Solomon from Cowan. And he has crushed it since he became CEO. That stock has gone through the roof. He's an amazing leader, amazing guy. I love it. So I buried the leader a little bit. I didn't want to get too far into the book yet, but so where are you? You're in New York? I'm in Connecticut. Connecticut. All right. What part? The good part. In Greenwich. Rough and tumble streets of Greenwich, Connecticut. You guys still have real estate down like 30% there? Is it coming back? It turned on a dime when COVID hit. So Greenwich was literally, I would say, no bit. Yeah.

And I knew because I had a house for sale for a while. Yeah. I remember reading some of that stuff. Yeah. Taxes were slowly creeping up and people were moving and then COVID hit. And probably my guess is, is the first of a multi-decade move from the city to the suburbs. And so Greenwich and everywhere else around all the suburbs in New Jersey and New York and Westchester and Greenwich, all the properties gone up. First day, there's a lot of inventory to clear through. And that's really, I mean, it's insane how much of the inventory got lifted.

And now I think prices are starting to move. What are your thoughts on that overall? Is New York dead? Some people are saying New York will never come back. Others are like, you're crazy. It's New York. Yeah. I don't think you bet against New York or New York has a lot going for it. But and I don't know that the residential market changes that much because it's always been kind of a young person's town. And so you have that constant churn. Commercial space is a whole nother story. And it's definitely not my area of expertise, but it's pretty, you know, there isn't a single person I talk to that isn't thinking about what long-term office configuration they're going to need, 100% of whom are less space. Right.

So even if companies reduce their space by 10%, then the numbers are probably higher than that. That has a meaningful dent on what happens to the property markets. But it takes a long time to play out because it's a long-term lease market. So it's going to be multiple years before people's leases roll off and then you see what happens to the property markets. But it takes a long time to play out because it's a long-term lease market. So it's going to be multiple years before people's leases roll off and then you see what happens. So it's going to be a while before we know. Agreed.

My wife works for Blue Cross Blue Shield here in Chicago and they own their building, which has always been like a, yeah, the insurance company, they own the building, save all this money. But now it's like, crap, we own our building. It's hard to downsize when you own the whole building yeah um so let's get into a little bit of the background it's well covered

elsewhere so i'll just skip over some highlights but um you were investment banking for a little bit and then went into private equity no i mean i started my career straight out in the endowment world um so first job out of college is working for Dave Swenson at Yale. Okay. I had that backwards in my notes. Sorry. So yeah, let's talk about what was it like? Swenson's a Titan. Give us the cliff notes, what that was like. It was amazing. I mean, he's, he's a brilliant investor, a great teacher,

and he was implementing a model that nobody knew about. And so, you know, massive first mover advantage, but more importantly, on a bottom up basis, he's an incredible manager selector. So early in my career, the people I was spending my time with were just extraordinary money managers, you know, around the world doing all different kinds of things. It was an amazing experience. What were some of those names? I mean, my first two or three meetings, there was this young guy named Tom Steyer, who had just started this firm called Farallon Capital. Who knew he'd be running for president as a billionaire years later? That hurt his reputation. Everyone knew him as this genius of Farallon. Then when you heard him in the debates, I felt like it kind of lowered. Yeah, no, Tom's Tom. He's awesome. And, you know,

Jeremy Grantham was one of my first manager meetings in 1992. And he was bearish then at the beginning of a bull market. Bearish pretty much all the way ever since. And it just goes on and on. I mean, if you look at some of the managers Yale had money with back then who were small, and I don't know exactly what's in their portfolio today, but some of them, I imagine they still have a lot of money with Farallon. And there was a fixed income fund that was a woman who had left Goldman named Nancy Zimmerman that originally was called Farallon Fixed Income and now it's called Bracebridge. And Nancy's running, I don't know, double digit billions just wildly successfully a couple of decades later. And they were all effectively startups and Yale was investing really, really early with some of these managers.

So it's just amazing to see. And there's been some papers and some research that basically they were garnering the illiquidity premium. What are your thoughts on that? Is that true? Or was it more of this manager skill? You know, it's a good question. It depends on the time period. You know, Dave's been there 30, 35, 36 years. So what was interesting is that when David wrote his seminal book, Pioneering Portfolio Management, that I think published in the year 2000. Up until that time, he joined in 1985, you pretty much had a roaring bull market. And so Yale still had top percentile returns, but it was in spite of the asset allocation, because diversifying away from public equities wasn't really a winning strategy, particularly US equities. So that was really manager selection. And there was venture capital and early interest there that helped. Post 2000, particularly 2000,

2002, a little bit of both. But if you look at Yale's long-term returns, asset class by asset class, so independent of the construction of the portfolio, they have generated significant excess returns from manager selection. And that's net of fees and then a lot of alternative net of high fees. So they've been extraordinary at that. And then the asset allocation has been more broadly adopted, but it's just different. Sometimes it's better, sometimes it's worse, but it's different. I always get mad. I can't remember who puts that's worse but it's different i always get mad i can't remember who puts that out but there's the uh bar graph of the ivy league endowments and brown university is like a purple bar and yale is red and columbia is green i'm like

at least match up the colors with the school colors what are you guys doing that's an easy fix um but yeah, Yale's perennially at the top of that list, right? And their bar's a little larger. Yeah. So hard to leave there? Why would you ever leave? Or you didn't know he was a legend at the time or you knew and didn't know? I thought I wanted to pick stocks, right? And that wasn't what they did there. So I had a chance to go to business school at Harvard and just took it. It was very hard to leave the people. And I loved what I did.

But it's also hard to do the only thing you ever knew out of college. And this is, by the way, this is pre-Fintwit and pre-the internet. I mean, we didn't have email until the year I was leaving Yale. So the ability to learn about what other people do is much, much less back then. Next to impossible to leave the people because I loved the people that I worked with. And that was really hard. It was fairly easy at that time to leave New Haven. It wasn't a hotbed of activity for a single person in their 20s. And so that was, you know, that was something that made it easy to leave. And then to get a chance to go to a

place like Harvard Business School also makes it pretty easy to leave, to take that step. Now, are you the kind of guy who says, I went to school in Boston, or do you say I went to Harvard? Nobody asks me anymore. It was too long ago. There's been that pushback of late of like, oh, people who say they went to school in Boston. Yeah. I mean, it was like that then. It just depends on who you're talking to, I guess. Right.

It's like cut them some slack. So from there, you left and went out to do your stock picking. And where'd you land? So I did my summer job at business school at Brahman Capital. It was a long short hedge fund that back then Yale had money with. And that was the summer of 98. And they were kind of valued long and growth short, which meant they were short things like this little, you know, tech company, Amazon that went from 40 to 260 over the course

of the summer and Starbucks and all those things. So it was a great shop and they've been around, still are for a long time. And I came out of that thinking I'd learned a lot in a short period of time, but I wanted to learn more about businesses. So I thought about private equity and I ended up working at two different, Yale had money with them then, and I ended up working at two different private equity shops that Yale had money with over a couple of years. And that got into the sort of past the bubble period. So that was sort of into 2000. And by then David had written his book and I hadn't really found the right fit for me and just decided to go back to the manager side. And I didn't know exactly

what I wanted to do. I didn't want to stick in the nonprofit world for then. I have incredible respect for the people who do that, but it wasn't what I wanted to do. And hedge funds were something I had some exposure to at Yale. I kind of knew what they were, but they also had ultimate flexibility in the public markets. And so through a couple of friends, I met someone who I ended up partnering with and we formed a hedge fund of funds back that launched in 2002. And it was a pretty cool mousetrap back then. So we were investing in small hedge funds and also seeding funds and the fund would take an interest in the economics of those businesses.

And it was a cool mousetrap because if you go back at that point in time, a lot of the established funds were closed. And they were closed because they were big. And big then was considered $1 billion in assets. So some of the funds that subsequently reopened and grew to multiples of that size were closed. And so if you were going to run a portfolio of hedge funds, you kind of had to have relationships to know where to go. And if you wanted to seed new funds and put it together with your best ideas of other funds, the people who knew the relationships knew it because they were already in the business. And if you wanted to seed new stuff,

you couldn't put it together with your best ideas because back then it was too sexy. It sounded too good. So we had this opportunity to do it. My former partner had worked at a family office. I had come from the endowment. We had knowledge of the manager relationships and we had a de novo platform to build a mousetrap that was just super, super cool. And we used to say, look, this will work as long as we don't mess it up. And we tried hard, but we failed to mess it up. So it worked quite well for a long time. And then, but also during that whole period, it seems like you were starting to get this fund to fund headwind, right you were starting to get this fund to funds headwind, right? There started to become this pushback against layers of fees and fund to

funds. Did you experience that? Or you were guys? Yeah, no, no, we did. I mean, you had to, but we started in 2002 and I would say the real headwind started in about 2011. So we had, you know, close to a decade of, you know, really very strong returns and a great business. It was a little frustrating. I had this conversation recently with someone because we were in a fund to funds box, which meant we had another layer of fees. But we also had a portfolio of hedge funds and an income stream that came from these funds we seeded.

And in some years, the income stream was more than our fees. So we would tell people, yes, fund to funds charge more, but we charge less. And what I used to say was that we called those seed cash flows. If we had called them instead management fee rebate, people would have understood it, but we didn't. So yeah, no, we had the same scrutiny and fees came down and that composition of the client base change. Also, returns were harder to come by. I mean, I think we had compounded it north of 12% net of all the layers of fees for the first five or six years. And then if you include the financial crisis, it was half that or less for the next bunch of of years so there's a big change in the performance yeah performance to me it was all fees right like you don't care as much when the

you don't see it when you're earning four percent you start to feel that feel that's exactly right or you think you do at least um and what let's just dive into that while i got you what do you you know who is it that uh was it Dalio who said there's a thousand planes in the air and only 15 good pilots or whatever? Speaking of all the hedge funds, what do you attribute that lack of success after 08 kind of? Yeah. I mean, there's a lot of dynamics at play and it's like any multivariable equation.

It's not just one. The biggest driver was the reduction of interest rates. So the structure of a, call it a long short portfolio, you have a basket of longs, you have a basket of shorts, you have a basket of cash that comes from a short rebate and then you earn, well, sorry, it comes from the short positions and then you earn the short rebate. And so when rates, I think when we started Protege, we had put in a 5% hurdle rate to simplify the cost of capital.

I think short-term rates were 4.5%. When you go from 4.5% to 0%, you probably lose 3% to 4% in return, period. That's a big difference, right? When you're talking about 4% people are giving scrutiny, if you make like the magic numbers between 7% and 8%, right? If you make, call it 8%, every client can meet their spending needs. So if you go from four to eight, just because of interest rates, you go from underperforming client needs to meeting client needs. It's a big deal. So that was the biggest. And then of course, you know, competition continued to increase. I love, I love quoting. When I started at Yale, a crowded short was like two to

4% of the float. Now a big hedge fund that wants to take a reasonable size short position is more than that themselves. Yeah. So that causes all these… Disastrous effects, as we've seen. Yeah, exactly. And that's not… I mean, this is the most high-profile, in some sense, case, which happened earlier this year. But it's not the first time that there

have been all kinds of tricking things happening with short positions because of crowding. So long-short equity is a big chunk. It's obviously not all, but it's at least half of the hedge fund universe. And that structural box has been under pressure and continues to be. Then what you also had on top of that over the last 10 years, which doesn't necessarily affect performance, but it does affect how people perceive performance, is the proliferation of ETFs, which didn't really exist pre-financial crisis in any kind of meaningful size, meant that you can create exposures in ways that are very cost-effective that you couldn't. So from 2000 to 2002, which was the bubble popping,

if you knew ahead of time, and a lot of long-short hedge funds did, that their valuation spreads were really askew and you wanted to go long value or small cap value and short high flying growth, if you wanted to access that as an investor, the only way to do it was a hedge fund. There were no ETFs that you could go long value and short growth. So what happened then is the definition of what is adding value, what makes sense to pay in terms of incentive compensation. What does that mean changed and got more granular and more sophisticated? So the long short equity piece is just structurally been challenged for a number of years, increasingly so.

And can you, how does it remain so large given all that, right? That's always curious to me of like, why aren't assets flowing out of there? Yeah. Well, it's changed. If you look at where the assets are, it's changed a lot, right? So there's a ton of assets in platform models. So think of a Citadel 0.72 Millennium for sure. And then a couple of the quants, a Disha, a Two Sigma. And what those models have done is create, they deliver the really efficient use of leverage. So they're able to take a portfolio manager that can eke out alpha, really risk-controlled alpha, a small amount, and lever it up to the point where they can deliver on client needs. But that's where if you really count the dollars, there's a bunch of legacy funds that have been very big and

continue to succeed over time. And then there's a lot of growth that's come into those platforms, probably more than they can even handle. They struggle to find portfolio managers that can add true alpha that they can plug into their models. So the composition from just a Jones model, long, short fund, spinning out a tiger and raising a bunch of money, the dollars there are a lot less than they were. And it's really shifted in composition. Makes sense. And so what, at Protege, what was your ideal manager? Did you have different buckets you were allocating to?

Or was, hey, it's just as long as there's an absolute return, I'm good with it? Yeah, there was a lot of thought behind it. So first of all, the firm was called Protege Partners. The idea was to invest in the proteges of great fund managers. So we were often looking at spinoffs of established firms. We were investing in smaller funds and smaller thoughtfully done as a qualitative assessment, right? The appropriate size of small for a long short equity strategy is different from a convertible arbitrage strategy, which might need more assets to be able to play the game.

So in different strategies, size was different. But generally speaking, we were investing in earlier stage funds that we just didn't think were encumbered by excess capital. And we did it across strategies that make sense. So think about statistical arbitrage. You just need a big infrastructure to compete. It doesn't really make a lot of sense to have a small statistical arbitrage fund. Now, it might if it's small meant that they're capturing a niche and they're a couple hundred

million dollars. But we weren't investing in a $20 million statistical arbitrage fund. But we did. We invested across long-short equity and event-driven strategies and some relative value strategies. And I didn't really invest much in macro and quant. And that as much as was my bias from things I learned at Yale than anything more sophisticated than that. And it was a good run.

What was that bias? What was that grounded in? Just Swenson had the equity bent to him and that's what you've got passed on? Well, there's a couple of things. I mean, they're different than those two buckets. I think that macro strategies are very, very difficult to invest in effectively. My partner for a while at Projet Games, Scott Besson, used to say that macro is a slugging percentage business

and fundamental investing is a batting average business. The problem with a slugging percentage business and fundamental investing is a batting average business. The problem with the slugging percentage business from an allocator perspective is signal versus noise when they're striking out. Are they striking out because it's just part of the slugging percentage and they're about to hit a home run or are they striking out because there aren't any good? And we're talking mainly discretionary macro? Yeah, discretionary macro. You're talking about the trader's edge. You just don't know. So what you found over time, I used to tell people, go ahead and name when institutional allocators talk about macro.

In the past, they didn't talk about macro. They had an allocation of Bridgewater. Maybe now it's Bridgewater and Element. There aren't a lot of macro funds. And then if it was Tudor, well, Tudor became a long short equity platform that also had macro in it. So structurally, you just didn't see, people couldn't name who are the top five macro funds that are pure macro. They didn't exist because they would turn over so much. And then-

They were also adding a lot of quantitative, which you said, hey, there's a new toolbox. There's all these quantitative tools. Why not add it? It only makes sense. And the quant stuff was just a bias that those strategies are hard to make work. And there's a principal agent information asymmetry that's really hard. So if you're investing in quant shop and the performance isn't great, how do you know what to do? That means one of two things. Either the model doesn't work or the model works, but it's just not working right now. And what's the incentive of the portfolio manager to tell you?

If they know the model is not working, they're not going to tell you. So it's tough. There's tough strategies to invest in but for us it was also it was also a size issue right like it was just you're not gonna it's hard to see how you can identify a value-added quant fund that's small and quant there you're talking like black box kind of quant like you don't really know what's going on behind the model um and what about managed futures where i applied my wares yeah i mean we didn't do it at protege and part of it was just we just said we're going to go out and invest more fundamentally driven strategies than trading driven strategies and not that it was good or bad but that was just

what we were doing yeah um and so who were the winners that came out of protege like the ones you seeded who are are the household names today? I mean, I don't know that any of them are. Of the ones we seeded that are still around, there's a fund called Gladstone in London that's a couple billion dollars. It's still doing well. But most of the ones we seeded came and went.

Some of them, like Brenner West, had a great 10 or 15 year run, but they kind of retired maybe two years ago. But I don't know that there are any others that are still up and running. And was it more, was it a true like venture capital model? Like you're going to miss on nine out of 10, but the 10th is huge or it was flip? Like you wanted to succeed on nine out of 10. Yeah. I mean, so the seeding business is, there's a reason why the seeding business doesn't really exist in any scale.

Because ultimately, it's a very tough business to generate the kinds of returns investors expect. And there's also a mismatch of expectations. From the seeder perspective, right. Yeah. Well, or the investor in a pool of seeds or something like that. Right. Instead of doing the strategy itself. Correct.

So we were much more focused on the underlying returns and strategy. And those two things are a little bit in a binary, right? If the manager isn't any good, the returns aren't good, they have no chance of monetizing the business side. So you might as well just focus on the returns that are good. And if we measured it that way, we did fine. It was probably in line with the rest of our portfolio. On the commercial side, it was just tough.

It was just really hard. We had been doing really, really well in the seeding up until the financial crisis in that we had invested in a bunch of funds. A couple of them grew to north of a billion. At the time, I think it was in 2006 or 2007, we added 200 basis points just from the seed economics in a year and we were charging 1%. But what happened in 08 was not only did performance come off to some extent, but then assets came out and it was like a reset button on this because it takes years to invest

in these and have them grow their businesses over time. And we had know, we had this six year run and had a whole portfolio of managers. We had seeded some at different stages, some were growing, some were getting traction and they all hit reset. And, you know, mostly the allocator community, when you go through a crisis, they're going to refocus on what they're already doing. They're not looking at new stuff. So it got really tough. And it was like, we, you know, went to rebuild it again. It just takes years and years and years. Yeah. We experienced that in a way, like the things that did well, that performed in a way it became a piggy bank, right? It was like, okay, cool. I need to grab that money and put it back to work in the stuff which i guess is from your time at protege you were talking about golfing with a uh a guy and he treated the caddy poorly so you didn't allocate

like to me i'm reading that and i'm like are people gonna be like is this really how that works like aren't you doing math and all this stuff? And like, is it really based on just the guy yelled at the caddy? So it's a little bit different. We had money with them. Okay. And this was a fun, this goes back years, but it was an event-driven fund. I'm not going to say who it was, but it was an event-driven fund and he had struggled. It was a small fund, right? It was maybe, it was like 250 million bucks or something like that. And he had struggled to keep people on his team. And that's a tough business to be in as a one-man show.

He'd done really well with it. And so, you know, we had questions. And performance is generally good, but it's hard, right, with a one-man show. And it's constantly telling you, oh, he's going to grow the business and it just couldn't keep people. But yeah, I played golf with him one day at an outing and it was just bad. Right. It was just like, this guy was just not a good person. Which we all know that golf person. That's like a golf style of like, Oh my God,

that guy's yelling at this person. And that person, you know, what I like to say about that is that doesn't mean that that like, that that's a fund manager person and that person. You know, what I like to say about that is that doesn't mean that that's a fund manager that people redeem from. In fact, long after we had money with him, he caught fire and grew to, I was north of a billion. I don't know, maybe it was two at one point in time. But I thought that that told a lot about what was happening because as an allocator, you're not

in the office with them every day. You don't know exactly what's going on. You can hear stories, you can do exit interviews with people and everyone has their own bias. You have to put things in context. But I thought that was informative of why he wasn't able to develop a business. This wasn't a manager we had seated, so we didn't have any extra economics in it. And, you know, for me personally, I always prefer to invest in managers that I'm comfortable with as a partner. There are other people who say they don't care. It's a guy, let's say it's a guy because we're assuming it's a bad guy. But if a bad guy can make them money, and as long as it's on the right side of the law, some people are fine with that. But that's not how I preferred to go about the business. And so, you know,

that it's not just like, Oh, I played golf with him. He was bad. It sort of is one of a number of factors that really was kind of like, yeah, I don't, this is not someone we want to be with long-term. I liked my version of the story. He was rude. You said, forget it. But I was imagining like some trustees or something of like, hold on, this, this is really how this works. You just, you gulped with them and said, no. And I was asked this on a pot a while back and want to ask you the same thing of like, what are, what are the biggest differences between these

institutional allocators and a high net worth guy who's investing in hedge funds? Or I kind of said my answer, I'll tell you, my answer was surprisingly not all that much. They both chase returns. They both get out of the lows. It's more to me like their process, but they're emotionally are pretty darn similar. Well, I think that's exactly right. And the process, because I've been on both sides, right? I was an institutional investor for a long time. Now I invest my own money. The thoroughness of the process is night and day. The other thing that's night and day is the breadth of understanding of how a particular manager fits in context. In that golf example, this was an event-driven manager. I already knew who I thought the four or five other great managers were.

I knew what their positions were. I knew how you could question people differently about it. When you spend all of your time doing it, you're privy to a lot of information. And as an individual investor, most individual investors, at least my experience, even the clients that we had at Protege, the thesis might be the same. The behavior might be the same. the thesis might be the same. The behavior might be the same. The outcome might be the same. But they don't have the time and the resources to go in as deep on the process. And then who you just talked to this morning, Jason Buck would say like,

but is that just the illusion of skill? Like, is it just, I'm putting all this process in place. So I have, so I feel comfortable, but I can't really know that I'm, you know, I can't really know that I'm actually solving anything. Yeah. It's hard to put data to it, but everyone talks about evaluating process over outcome. So the question is, do you think results are likely to be better? Let's say for the same person, are the results likely to be better if they do more homework or less homework, if they're more informed or less informed? It doesn't mean the results will be better. There's a lot of noise in investing. But I think there are a lot of really, really smart people that spend

all of their days looking at managers and thinking about strategies and do a really good job. And that is the one advantage that institutions do have over individuals. There are disadvantages. There are definite disadvantages, but that's a big advantage. And no investment committee wants to hear like, well, you know what? We don't really know what's going to happen in the future. So we didn't do any of the process. We just picked some out of a hat.

Hope it turns out well for you. So going into portfolio construction a little bit that you touched on in the book um and back with protege like what was your view on how many until you get to a you know law of diminishing returns yeah especially in the fund of funds is it 10 is it 50 yeah i mean i think it depends a lot on what you're doing um and what the underlying is so all of the allocators probably have an over-diversification problem because you're a little bit misaligned. If you think about you're investing in a fund manager and you might be investing in a lot of fund managers, but the fund manager, that's most of their livelihood.

So they're inclined to be a little bit more diversified than might be optimal for you as the allocator if you're investing across a bunch of different ones. So there's a bunch of different ways of thinking about that. And a hedge fund strategy allocation manager selection is different from broad asset class exposures. But I would say two things. The first is depends on the game you're playing. And the second is it depends on this particular strategy within that game. So the game you're playing, and I just thought about this recently because of something I've been doing with some of my own capital in the SPAC market, in the post-secondary SPAC market.

If you're around an opportunity set that's structurally attractive. So just to go right to it, when we started Protege, we thought that investing in small hedge funds with the lens of quality was so structurally attractive to investing in large funds that you didn't want to mess it up by having one fund blow up. So if you're in an area that you think has structural advantages, that calls for more diversification. If you're investing in hedge funds today, where people would look at it and say, boy, rates are low, competition's high, even great funds are getting whacked. You don't want to have a widely diversified portfolio. You want to concentrate in the ones that you think are idiosyncratically positioned to do well. So back then, so that's that part of it where when we were running Protege, in the earlier years, we had portfolios of 50 managers, which is a lot.

Now, part of that was also the strategy piece, the other piece, which is that we decided that if we were going to invest in smaller funds, the way that those fund managers were most likely to have a competitive advantage was if they were specialized. So you're not going to find a small fund manager that can compete with a much more well-resourced multi-strategy fund as a multi-strategy fund. And so if you have a TMT manager, a healthcare manager, an industrials manager, a real estate manager, someone in Asia, that actually lends itself to more diversification in number of managers. If it were 50 multi-strats, that would be overkill. As the years went on in Protege and particularly post-crisis, post that 2011 period where it felt like some of the structural advantages

weren't as strong, we concentrated the portfolio. I think when I left, there were maybe 30 core managers in the portfolio. And then you talk in the book about, I like the rebalancing is one of allocators' best things because it takes away the emotion. It takes away the committee, right? It's just a, here's what we do at the end of every month or quarter or year. How did you view rebalancing and how do you view it overall in terms of what allocators are doing? It's a necessary evil. It's a great tool. They're earning extra alpha out of it. It's a mathematical exercise.

Andre Perrault wrote this up in a research paper in 1990. Andre, the professor at Harvard Business School, a former now. He runs high-visit strategies now. If you have two assets that are more volatile than one directional in their performance relative to each other, and you systematically kind of buy low and sell high relative to each other. So you could think about, I'm going to have two assets and they're going to have 50% of my money in each. Yeah, Shannon's demon, right? If one of them always outperforms, you're better off just having that one. So as it grows, you want to let that grow. But if they're more volatile, even if one does outperform over time,

if they're more volatile than one directional, you can add value by every so often rebalancing back to 50-50 and you end up going through this exercise of buying low and selling high. That mostly happens in liquid markets, so stocks and bonds. You can't do it in private equity. Hedge funds are kind of in the middle. One of the things I found that was different in an annulment world from a fund of funds is a fund of funds is a flowing pool of capital. So when you have money coming in, you can effectively rebalance by deciding where you're going to put it. Same thing, though, it's harder when money's coming out. Because there's a little bit more friction in the timing when money's coming out. But when money's going in, you could, and we would do that, right? You would, you would generally try to give money to the someone who you had

confidence in who hadn't been performing quite as well in the short term. The, yeah, because I have this debate with people. If you have, right in theory, that Shannon's Demon paper, you could have two losing assets that you could rebalance and have a winning trade. I'm like, fine for a toy model, but show me a real-life example of that. Yeah. Well, it's hard if they're both losing assets. It's more about assets that are growing over time, but the volatility between them is higher than the absolute magnitude of the growth.

Another thing you briefly mentioned in the book was, I'm not sure if you're talking about teachers of Ontario or whom, but more and more people bringing all the, all the alpha in-house. What did you see in your time and in the people you're talking to on the podcast, is that becoming more and more of a, of the game? Piece by piece. Yeah. I mean, there, there are some institutions that are well-resourced enough to take that on and they're just orders of magnitude. So you can start with, say you have a portfolio that's all invested in managers. There are certain things that you can do quite easily. Even when I worked at Yale, Yale always managed their bond portfolio internally because it was low turnover. They were trying to replicate a US treasury portfolio. I managed it as a 24-year-old in 1994. You would do one trade a

month and you'd basically hit the benchmark. So some of the things that are really low cost and easy to do, that's the first step. The next step are kind of these co-invests. So you see a lot in private equity and some increasingly in public markets where there is the benefit of lower costs structurally because say say, the private equity fund will charge less. But there's a lot more flexibility in terms of liquidity, ownership of the assets, being able to control your flows. So there's a lot of benefits that come from that.

And then if you go all the way, there are some institutions, and it's really the Canadian pension funds that have adopted this more for a whole bunch of different reasons. They're able to create a compensation structure that is competitive with alternative places where these people could apply their trades in Canada. So a lot of the big Canadian plans have like 90% of the assets are actually managed internally. In a world where ostensibly valuations are high across the board and therefore returns are less and you're, you're in cringing on this, like need to make five, six, seven, 8%, depending on benchmark. It's one of the things that you'll see more and more, uh, is just as a way of reducing the cost

of getting access to exposures. Uh, a lot of these institutions who can are doing whatever it is they can internally. And do you feel like there's, or you're saying if the compensation's right, you won't have a skill mismatch there and it's not going to necessarily, right. If I'm the manager, I'm going to be like, go ahead. You're not going to have the tools and the skills and the talent in order to produce that alpha. But, you know, a lot of the plans are showing, no, we can do it. I mean, the Canadian plans are, it's an interesting or even like Ash Williams at Florida SBA, the retirement fund in Florida, they do a bunch of stuff internally. And his take is they can find great people who would rather be close to the beach than close to Midtown Manhattan.

Yeah. And so they can do it, but what they do is they're not trying to do the breadth of what the most sophisticated managers do. They might do a simple quantitative value investing strategy internally, but they're not- Like value for example, yeah. Yeah. I mean, they could go as far as that, but I think most of what they do is not even quite at that level.

And most of, you know, it's a tricky thing because if you bring everything internally, you lose your window onto the world of what the competitive landscape's like. So yes, you're not paying that level of fees, but you might not be getting as high net returns. And that's ultimately the right math. And then you mentioned in there, the target returns for these endowments and whatnot, like how do you view that of knowing right like you mentioned Grantham I think they came out with their return forecast that's like two percent or whatever it was like either all the institutions are collectively deranged right still having these five six seven eight percent targets or like what is going on there why don't they just adjust their

targets down or they can't because the duration mismatch? Yeah. I mean, so. Sorry, that's a thesis paper in and of itself. Yeah. No, I mean, so your question's right about the asset side, but the most important thing is what are the assets for? Yeah.

Right. So if you're a university, you're not managing the money because you like managing money. You're managing money to support the operations of the university, which means you're spending money every year. If you're a pension fund, that money is to, you know, to pay for the retirements of all the people sort of under auspices of the plan. So it starts with, that's what the purpose is for. And those purposes have spending needs. And so that's where you get to the five or six or seven or 8%, whatever it is. Are pension funds who have an actuarial rate of return at like 8% invested in these capital markets kind of like not likely to get there? Sure. Yeah. But they're not keeping the rate of return at 8% because they're naive. It's just structurally incredibly difficult to go from like eight to four. And what does that do for funding needs and all that kind of stuff? So there are a lot of friction.

There's a lot of friction year to year, even over multi-year periods in what that spending is. We saw that in the endowment world during the financial crisis. So these are effectively perpetual pools of capital, but it turns out if you draw down 25%, you still have to spend. Well, you're spending the year before at 5%. Just to keep the same amount of spending, you're now spending 6% or 7%, which means that extra 1% or 2%, you're pulling out and you can't compound for the long term. So you're going to massively crush the purchasing power of your capital. So it's not that they don't know, it's just that the investment challenge is that much harder. Right. A few things. There's a lot of negative

press for Ivy League schools in this crisis of like, why are you laying off cafeteria workers when you have a 50 billion dollar endowment? Like what what are your thoughts like that money is there in order to support this stuff? But they were kind of caught in the middle of like, well, we're doing wise like business cost cutting at the same time. Yeah. Weighed into those ethical waters. No, I mean, it's it's I don't think there's an easy answer. I think there's a lack of understanding of how these pools work and what they're there to serve that comes from the people saying, oh, why aren't you paying the cafeteria worker? So let me give you some simple examples to describe that. When I worked at Yale, my first year at Yale, so 1992, the endowment was $2.5 billion.

Last year, I don't know the exact number, but Yale spent probably $1.5 billion out of the endowment. If you spent $1.5 billion in 1992, there would be nothing left right now. So it's hard, right? This is all like why people can't understand compounding. It's just, it takes too long and people don't quite understand it. There is at some point in time, you could say, okay, the original assets have grown so far beyond their purchasing power that maybe we want to do a special, you know, special payment and a crisis. And I think that the universities will think about that. But it's very tough to explain that you have a pool of capital that is supposed to support the university's operations 250 years from now, not just the cafeteria worker today. And it's difficult. And especially hard because the dollar sizes, because they've done so well in investment performance for so long, and the dollar sizes are much bigger. But what happens as a result of that is the universities can spend

more. They can get better teaching, better facilities. The experience for the students is better. There's more financial aid. So it's not that the money disappears, it gets spent. And as it gets spent, it's just structurally hard to reduce. So that's what you saw from 2008, 2009. If you have a billion dollar budget, and this year, you're spending that on facilities maintenance, on your employee salaries, on grants and all this stuff that goes into university, it's not that easy to just cut 20% next year. Right. So it's tough math and all of these things. And yeah, to me, it just feels like it's for the future,

but the future is never coming. Like, okay, if I said it's for the future and now 40 years from now, they're like, well, we can't do it. It's for the future. Right. That's the tricky part. The future is never if I said it's for the future, and now 40 years from now, they're like, well, we can't do it. It's for the future. That's the tricky part. The future is never now, but it's always a moving target. Where do you think endowments today stand and would they have allocated to Protege today?

Like a lot of stats on emerging managers can have better returns, have better, more flexibility, but it feels like they're never willing to invest in emerging managers can have better returns, have better, more flexibility, but it feels like they're never willing to invest in emerging managers. We had an institutional client base. So we had, I don't remember, and it varied over time, but 20, 30, 40% of our capital was from endowments and foundations. So it's not a question of what they're willing to do, what they're not willing to do. It's a question of their feeling like the wide number of opportunities available to them, that the one they're seeing is the one they're choosing to invest in. So said another way, just if the opportunity is right, they don't really care if it's small or large, they're just going to go with it. Yeah, absolutely.

Going back to your private equity experience, and I wanted, we talked about this a little bit with the illiquidity premium, it was that Yale's success factor. And there's been some stats now that that's reversed, right? That there's actually a illiquidity discount, that the price to earnings multiples for the private companies are higher. Like what are your overall thoughts on this private equity too big? Is it getting too big or the deal's too high? Yeah. So I've, I've, I've gone back and forth on this like a couple of years ago. I just thought pricing was too high. And in a world where hedge funds went through this massive pressure on fees, private equity hasn't at all. And it is because they've delivered the returns that investors need. And I wrote about this in the past. I was just like, this day of reckoning is coming. It's going to be a couple of years out, but it's coming. And I've changed my perspective on it because I think in that process, I was losing

sight of absolute versus relative returns. Both matter, but most of the money that's coming from private equity or into private equity is coming from public equity., the multiples are not demonstrably different. And private equity has significant structural advantages to public equity. So I think that as you look out, if that magic number for everyone is 6% to 8%, I do think returns will come down. But they're not there yet. So if a private equity firm is doing a buyout at 10 times EBITDA, and maybe that filters down to high teens, kind of multiple of earnings or whatever it is, you're still at an earnings yield that's 4%, 5%, 6%. And they can lever that more than you can in public markets. And you can see a path to them getting to 8%. It's very hard for me to see how multiples can come down when there's so much money on the sidelines. So just to give you an example, we know there's all this money on the private equity sidelines. You had the SoftBank Vision Fund.

You have all these venture funds. And now you have the SPAC ecosystem. And SPACs have raised as much money as the Vision Fund. That's north of $100 billion. And I'm on the board of a SPAC. And I'm watching the behavior of SPAC sponsors and deals. And there's a lot of money that has a huge incentive to get put to work. And it's almost a magnified version of private equity. Private equity firms don't have a gun to their head to do deals over two years the way a

SPAC sponsor does. Can you explain that real quick for the listeners? There's the SPAC structure in a way that they get paid basically if the money gets to work. Yeah. So it's even more aligned than that in one sense. So the SPAC sponsor raises capital for an IPO. And so you now have a public company that's a pool of money that has two years to find a deal that merges into the public entity. And what's different about a SPAC sponsor than, say, a private equity manager or something like that is that to do that business, there needs to be working capital, right?

You have to pay the bank fee for the initial IPO. You have to pay the expenses of the people that are running around doing the deals. There's just money that has to go out. And the SPAC sponsors raise that working capital. If they don't do a deal, they lose that working capital. But the money they raised in the public company and the IPO, let's say it was $10 a share, that goes back to the investors. So it's a very low downside proposition for the investors and the IPO. In exchange for taking that risk capital and the working capital, if they do a deal, the sponsor generally gets about 15% to 20% of the proceeds of the money they put to work. So let's say they have a $200 million SPAC and they buy

20% of a business that's valued at a billion dollars, they will get equity to the amount of 20% of the 200 million, or in that case, $40 million of that business going forward. Now, the working capital that they put in to get access to that might be $4 or $5 million. So if they do a deal, that $4 or $5 million turns into $40. If they don't do a deal, they lose the $4 or $5 million. into $40. If they don't do a deal, they lose the $4 or $5 million. So there's significant risk capital, but the incentive to do any deal at all is incredibly high. But that's their own sponsor's risk capital, we're saying. That's the sponsor's risk capital. Not the people who invested in the spec.

No, no. So it's a fascinating ecosystem. Behind the scenes, are they raising money for that? I'm sure, right? I mean, if it's someone like Chamath or something, they're putting their own money in, but other SPACs are raising that sponsor money behind the scenes. Yeah. I mean, up until a couple of months ago, the SPACs, and there's more to it and to what

the structure is, but the SPACs, say $10 SPAC was trading in the public markets that call it between $10 and 50 cents and $11 based on kind of the optionality that the sponsor would go do a deal that was worth more. So that made it that IPO. That's why the IPO market was so ebullient for the last couple of quarters until recently, because why wouldn't you invest? I'm going to put $10 into this company that's worth $10.50 overnight. I could sell it then. Oh, and by the way, if they never do anything, I get my $10 back. And so if you're a hedge fund and you're borrowing it next to nothing, you're doing that trade all day long. And so it was really easy for SPAC sponsors to raise money until in the public markets, that $10.50 to $11 has now traded down

to where you might think it would, like just below $10. So there's a little bit of a spread. But it's very hard to do an IPO at $10 if the day after you can buy the same thing for $9.90. Right. I'll wait. And so for now, the IPO market's completely shut down for new SPACs. Which is amazing because, yeah, that was like all-time records in terms of issuance thing yeah it was crazy and then come back to something you said on pe has major structural advantages

you mean just their ability to borrow and and lever up or all kinds of things so so one is that right they can access very cheap financing right now one is just the the locked up nature of the vehicle right if you go through all the behavioral bias stuff, people make mistakes with their decisions. And to get from a private equity firm buying a company, right, you have the decision of the private equity manager to buy the company. You have the decision of the investor to invest in the private equity fund. You have the decision of the board who approves the investor's decision to invest in the private equity fund.

Or you make one decision and nobody else gets to say anything for 10 years. And so we all as investors get in our own way and we know that. It's chasing performance and all that kind of loss aversion and all this kind of stuff that goes away in private equity. Is that almost why private equity has done so well? It's a big part of the reason why. If you give people money for a really long period of time, they're going to do really well. So that's a big structural advantage and probably the biggest of all of it. That's weird, right? If you had tried to run protege with those terms, people would have laughed you out of the room, right? Then like- Well, it wasn't, yeah, the underlying, I wish we had, right? There's a period of time where

that would have been great. But yeah, structurally locked up capital actually works really well for everybody. And then you have all these other levers of performance, right? They own the company. They have the ability to change management teams, to change strategies, to bring in all these experts. So there's all kinds of reasons why a private equity owner has more, they have more levers to pull than someone in the public markets. Yeah. And the ability to call more cap. Yeah. By the way, the most recent one, which I've enjoyed a little bit as I've done some investing for my health is you have perfect information. So I invested in an SPV with a friend of mine of a company that recently went public. And while it was private, he had showed me this SPV and I didn't really know

anything about the company, but a friend of mine said, well, why don't you look at who's on the board? It turned out I knew one of the board members of the private company. And someone I hadn't spoke to in a while, I called her up and I said, and she literally told me everything. She told me this is what's happening at the company. And this is what's happening with the management team, what valuation you're buying. Of course, it's a private company, right? There's no inside information because... So as a private equity investor, you have much better information about the companies.

Now, there are tough dynamics, right? It's very competitive for deals because there's so much money. But relative to public markets, there are a lot of structural advantages in private equity. There's those tweets that go around every now and then of like, if you could be anything else what would you be i'm like private equity manager i don't have to mark the market the

money's locked up and i can call more money like three three beauties in the book i love the chapters on, you know, the due diligence, how those allocators approach that with the interviews and the quantitative stuff, the qualitative stuff. One thing I noted here of like, you had one thing on competitors and how do they, what was it? How are they better than competitors? What do they do different? I find when we're talking to managers, they hardly ever answer that. Is that a sign of their pass on them? Or did you experience the same kind of thing? I mean, it depends on the situation, right?

Sometimes managers don't answer it because they're coy. Sometimes they don't answer it because they're not aware of what other people do. And it's up to you as the allocator to know the differences. Yeah, a lot of times I think they're trying to be polite right like i don't want to talk about maybe yeah i mean a lot of that real information you're not going to get in that context you're going to get it from triangulating separately um yeah and i think to the point in your books more of like how are they how do they react to the question not necessarily what they say but how they say it

um and then also love the part on the base rates. So I wondered if you could talk a minute about that of, I feel like that's not done quite enough. So what did you mean by base rates? How have you seen that put it on? So this is Michael Mobison's done a ton of work on this and it comes out of Danny Kahneman's work on the inside view and the outside view. So the idea is that if we're looking at an investment idea, I think the stock's the easiest way to think about it, we tend to look at that bottom up. We tend to look at it and say,

is this a good company? Do we like the management team? How's the industry? We tend not to look at the outside view, which is of all of the companies historically that look like this one, how have they done? So Michael uses the example of Amazon. You could say, I'm going to grade a model of Amazon and I think they're going to grow at 15% a year, which is less than they've been growing. And they're going to do that for the next 10 years. And this is what the valuation is as a result of that. Or you could say of every company that's ever been north of $250 billion of market cap, how many of them have grown at 15% a year for the next 10 years? And you might find the answer to that is zero. It doesn't mean Amazon won't. It just means you might want to think differently

about the probability of them achieving that when there's this outside view. So the base rate is the concept of what is the average of all of the experiences of similar companies or similar examples tell you? The base rate might be the base rate of growth or of something like that. What is the metric that all of the companies that are comparable in a similar situation have delivered to the one you're looking at? Right. And that's, I feel like I noted that passage because that fits with my personality. I'm like, well, hold on. There's no example of this, but I also feel like it hurts me personally investing and other people investing

of like, oh, that's way too crazy. That's way too much of an outlier for it to happen. So how do you weigh that of like, okay, you can identify that it has to be an outlier, but maybe you still want to go with that outlier. Yeah. A lot of it comes into prediction assessment. So think about hedge funds or someone investing in hedge funds. If you ask investors, almost every investor I've had on the show who invests in hedge funds, they would not be happy earning the return of the average hedge fund.

Right. But they're perfectly happy investing in their portfolio of hedge funds. Right. It's like 68% of people think they're better than the average driver, right? Correct. So their expected return for their portfolio of managers of hedge funds is higher than their expected return for hedge funds as a whole, the hedge funds as a whole return would be the base rate. So the question is, should they recalibrate their, it doesn't mean that they're not, they won't succeed, but when they think about what return do I think I'm going to achieve in this portfolio, they should be very cognizant of the fact that the base rate for that expected return is probably lower than their initial assessment of what they

think they're going to make. Right. Just go with the base rate instead of betting all your courses on the outlier. Two more things on the allocators. One, we talked a little bit about, like I'm reading through all your processes you outlined in the book and everything. Like to me, that seems highly, you could disrupt all that with a lot of technology um do you think we'll ever get to a point where there's like a netflix type of ai recommendation engine right that allocators can just click click click okay it matches my personality screen it's going on social and you know doing a personality screen quantitatively right i can crunch all the numbers. What do you, what do you think on that?

I don't piece some people are looking at it. I was just, I had Cade Massey on my show. Cade's a professor at Wharton who does a lot with the NFL draft and a bunch of other really cool analytics. And we've been talking about it. I don't think it works. And the reason I don't think it works is when you get to the level of the manager. So think of you've got the manager, they own a portfolio of companies and the companies are performing. The amount of data that you have as you work your way up the food chain is just less.

And so I don't think you're ever going to get to a point where you have sufficient amount of data at the allocator level that you can create a robust algorithm that gives you signal more than noise. There are aspects of it, particularly in the public markets, right? You can imagine the more trades you do, the more data you have. And so there's more to assess that may have some signal. But you start thinking about private markets and those are big parts of these people's portfolios, right? The private equity, venture capital, private credit. And you just don't have enough trades that you'll ever get to the point, I think, where you're going to have a very robust data-driven decision process. And similar question on just AI in general, like how in the allocator seat or the ones you've

talked to, how in the world do they go about assessing that? It seems like you need a whole nother team. Yeah, it's hard, right? It's a process and they're going to try to do it. I know Ash Fontana is coming out with this new book on his venture capital firm, Invests in AI. He calls them AI first companies. I've been reading through this book And I think there's technological innovation that can happen on the process, but not on the outcome. Meaning, you know, maybe there's a way for allocators

to help screen through their filters a little bit better based on some data. But where you really see technology is like, how are they going to process all this paper flow better for their internal operations? It has nothing to do with the investment decision. see technology is like, how are they going to process all this paper flow better for their internal operations? It has nothing to do with the investment decision. It's just like, what do we do with all this information?

I'm saying more if I'm at Yale today, maybe they're a bad example or I'm wherever. And I'm like, hey, here's this AI fund, right? That's using AI for their investment decisions. It's doing lights out. Let's invest in it. How in the world do I go about? It's really hard. Yeah. Right. They're going to underwrite the people and they're going to try to learn what they can about the process, but they'll do, you know, if someone wants to look

at those areas, they're going to do a deep dive into understanding what are the most important attributes of a successful AI driven quantitative strategy, and then line those up with what they're seeing. And they're not going to meet that one. They're going to go meet 50. Yeah. And it comes back to what you said in the beginning about the discretionary macro guy. It's kind of oddly the same thing, right? Like you can't really trust what he says about the performance. And on a purely AI model, there is no discussion on the performance. So you're kind of in the same spot. So what happens in these seats is that, and you just said it, whether it's AI or macro or venture capital or private equity or long,

short in Asia, all the strategies are different, but there are common characteristics about how successful investment management organizations run and what they look like. And that's what the allocators focus on. Yeah. And I was going to ask that too, because we do some stuff in China and doing due diligence on some of those mainland managers, language barrier, the tax is different, the regulation, right. It's like, okay, how do I go about, you're saying same process, just different pieces on the chessboard. Yeah. Where are you seeing fees? The whole fee discussion seems like it's tempered down a little bit from three, four years ago. But what are your thoughts there? Yeah. I mean, there's a balance, right? Like, yes, at the end of the day, investors would like to pay less and access more of the gross return. But part of the reason they're paying the fees is to support the infrastructure of an organization that can deliver that gross return.

So I think there's an appropriate level of fee, which hard is that as the industry has matured and gotten more concentrated, the management fee side of the equation hasn't really scaled down with assets. And so you do have management fees, income streams that are just far beyond what anyone would have imagined the size of assets in these pools could have been. But there's no market power in the hands of the incremental allocator to change that. And was it Texas who came up with the one in 30? Yeah, which is a fascinating, call it innovation, that has been fairly broadly adopted. But it also is an interesting'll either receive like, say, a 1% management fee or a 30% incentive fee. And that might be defined on an absolute basis or a relative basis. But ongoing, not choose up front, right?

Ongoing of like, hey, if you've had a so-so year, you can get the management fee to keep the lights on. If you have a lights out year, you're getting this huge incentive fee. You don't need the management fee. Yeah. So there's a lot of different ways of approaching it. But the problem is if you're zero and 30, like you do need a management fee to run the business. So you can't have everybody on an incentive fee only basis.

And so even if those structures are put in place, so the one or 30, there are elements of it that can, like you said, Jeff, toggle back and forth. But there are others that say, no, we you said, Jeff, toggle back and forth. But there are others that say, no, we're going to pick, we're going to pay you 30. And if that ends up being beneficial, it's a bit of a free rider to the other people that are paying the management fee. So larger organizations that have plenty of stability for the management fee, they can innovate on different fee structures, but you can't do it for everybody. You can only do it for the incremental investor. And so again, what you tend to see is,

yeah, Texas teachers can do it because they're billions and billions of dollars under management and they're an important incremental client. So people will innovate it for them, but they won't for the masses of their clients. And then I forgot to ask you, when you were talking about the fund to funds model,

how did you approach and view, and this ties in with fees, a little bit of like the netting effect, right? And if you're paying out fees, but the portfolio is down overall, incentive fees. Yeah, you got to be long-term to mitigate it. That's the only way, right? Because you can get chopped alive by redeeming from the guy who's down and giving it to the guy who's up and watching him go down. But if you're invested with someone for a long enough period of time, and most of your managers over time make money, it doesn't go away,

but it makes it much less of a frictional cost. So tell us what else in the book that we should have covered that we didn't. Oh, I don't know. I mean, there's a lot of fun quotes in the back. I don't know if we can cover them on this, but it's probably the most fun part of the book. All these great quotes from the people on the show. I know. Well, I'll ask you who was going to save her favorites, but what are, yeah, tell us some of those favorite quotes,

some of the favorite people you've had on the show. Well, the quotes, I put a top 10 list in the back. There's no rhyme or reason to it other than they were the quotes that kind of most stuck out to me. And there's everything from a quote from Jim Dunn at Verger, who also manages the Wake Forest University Endowment, that told the story about a woman trying to get in the door when he was running Wilshire. He was running the big consultant in Wilshire and sent him a red stiletto in the mail with a note that said, I got my foot in the door. Can I come get my shoe? Everything from that to some pretty interesting... So one of my favorite kind of insightful investment quotes, Margaret Chen, who runs the endowment practice at Cambridge Associates, had said that clients want to be different and the same. Pretty interesting thought process. Yeah, they want to be different, but not that much. You only want to be different

if different is better, but sometimes different isn't better. I wrote a blog post once that said, the problem with alpha is it lacks beta and the thesis there was right like people are like oh what do i anchor to right if i'm if the market's down 20 and i'm with everyone else i'm fine yeah i'm up four percent and the market's up 30 i don't really have an anchor and i'm like that's right yep uh and all those quotes are from people's talking about it on the pod are you yeah Or you told some just from the show? Yeah. No, no, no.

They're all from the show. Yeah. I don't know, 160 of them in the back of the book. And how many episodes have you done now? It's over 200. It looks funny because it's like coming up onto episode number 200, but there have also been other, you know, I did a whole set of manager interviews I had branded differently. So it's probably about 220.

And what, what keeps you going? Just intellectual stimulation? Yeah, it's fun. I mean, it's fun. There's just always lots of interesting people to talk to. And it's, it's become the core part of a whole bunch of activities I'm doing around it. But it's actually not that much different from how I spent most of my career. So most of my career, I spend talking to investment managers and talking to other investors about the markets. And so one small piece of that that I'm doing every week is sharing a conversation publicly, but I'm kind of talking to most of the same people I would. And if anything else, the podcast helps. It helps the people who are coming on the show which is nice like if you and i are just chatting on zoom it's okay we're just like have a nice chat on zoom but to be able

to share that and then have them get something out of it is really rewarding yeah the same journey for me and our pie was basically all these people coming through the office and we're like why aren't why aren't we recording this yeah like some of the most in being in the futures world the people are even a little bit more of characters right so it's like got some great characters here that we need to shed some light on and coming back you mentioned two of your quotes the two consultants so i wanted to press you a little on consultants good bad evil indifferent um from the manager side i know a lot of times they're viewed not in the best of light. Yeah, I've been on all sides of it because running a fund of funds, you have clients or consultants. So I

think that the core function serves a great purpose. There are a lot of fools of capital that need help. And even some of the shows that I have coming up, huge pools of capital, ridiculously huge pools of capital that were managed so unbelievably poorly in the past. So someone has to be able to fix that. And governance is a real challenge and consultants do a great job of that. The challenge is that the business, the consulting business is not a high margin business unless it's at significant scale. And when you get to significant scale, you have the same problem that, you know, if you're

trying to put a lot of money to work, it's hard to do that well. So it's a tricky business model. And you end up in situations where good consultants, I think, can do a nice job. They can do fine for their clients, but it's hard for them to do really, really well because they're just serving. They have to serve a lot of people to get the resources that they need to be able to serve them well. So it's just, it's a very tough business model. Right. And I was coming at more from the, which you know more than I do on how they all work, the governance. I hadn't thought of that, but right of just the manager selection and like getting that checkbox from the, from the consultant is such a big deal for managers.

And it seems like their checklist is so incredibly small that unless you have 10 billion under management these days and cybersecurity experts and, you know, padlocks on the door and the eye scanner, like you can't get in through the consultants. It's always been hard. Yeah. And I put the numbers in the book. I hadn't thought about it until I wrote the book, but if you, to break down how a CIO, it's no different from a consultant, spends their time and what their responsibilities are, at the end of the day, the amount of time they have to meet with a new manager and the number of managers participating in capital markets, broadly defined, yields a situation where it's like four or five times harder to get a meeting with an allocator than it is to get into an Ivy league school as a college grad.

Whoa. Yeah. I mean, it's just, it's just, the numbers aren't good, right? There's just a lot of money managers. And so it's tough and it's no different for the consultant, right? Yeah. I think it was, was it like 33,000 or something you had in your... Yeah. It's an insane number when you add it up. We had went to a talk at the kids' schools, a private school in Chicago here. And the lady started out the talk and these parents were all alpha dogs, right? And like the lady started out the talk with none of your kids are going to get into an ivy league school and they all like they're almost attacked her and she's like yeah not trying to be

mean i'm just quoting statistics here like the statistics are none of them will get in so putting that pressure on yourself and on them like okay uh which might be good advice for a manager too right hey maybe you'll never get into those like can you make a business and make a life for yourself without getting to that level? Yeah. Make it happen. And then who, do you have any,

like, who's the best at all this in terms of the endowments and the, and the institutions that you're working with or that you have had on the pottery? I mean, at best is a funny, I mean, I'll never, I'll never work with anybody as talented as Dave Swenson. So, you know, Yale is still amazing. And, and some of the people I worked with at Yale,

who are in have left and are in different seats are also amazing. You know, Andy Golden at Princeton and Seth Alexander at MIT and Paul of Lent who just, just retired from Bowdoin and is joining Rockefeller and, and Martin at Wesleyan. They're so, so good. And all different, right? Different size. They're slightly different variations on the theme and how they do it, but with great consistency, you see these people at the top of like all the rankings over time.

And that's just the tip of the iceberg. I mean, one of the things that's fascinated me by doing the show, when I worked at Yale, there were only a half a dozen offices like this in the country. Yeah. And if you added serious family offices, there probably weren't more than a dozen more.

And that wasn't, it was a long time ago, but it wasn't that long ago. There are so many more talented people in these seats, which again, makes the competition harder. But ultimately, they're not really competing against each other. They are trying to achieve returns that meet the unique needs of the people in the institutions they're serving. So it's not a zero-sum game in the way that money management can be at times. So it's kind of rewarding to see, even when markets are doing well, that relative return doesn't matter as much

because they're doing just fine and they're meeting the needs of their institutions. And that's what we've seen over a long, long period of time. So yeah, you look out and capital market pricing is really hard. And part of the reason I wrote the book was that with capital market pricing where it need to be good at because they just can't afford as many mistakes as they used to be able to in the past. And you think we'll see the day when Yale maybe comes out with, right? Why aren't there courses? Why can't you get your PhD in CIO level? Yeah, there are some. I think a lot of endowment leaders, in particular for universities, do teach at their institutions. There's not a lot behind the basics, but we're starting something called Capital Allocators University, where we're going to do an online course for maybe early and mid-stage career allocators to just try to get them to the next level, leveraging the experience that we've had over decades of investing. Because there are things you can learn and it's hard. If there's no courses to teach it,

it's hard to learn. You've made me think of one more thing and I'll go to our favorites and wrap up. So they're not competing against each other, but it makes me think of, especially in the factor world these days, right? If you come up with a factor that works, almost by definition, by the time you get it rolled out to market and you've taken it to Yale and they have invested it, it stops working.

How do the endowments view that? They have to work that allocation process of like, does our very investment into this make it stop working yeah i it's part of the equation right and particularly as asset sizes get bigger and there are more people doing it there are definitely crowding effects um and you could look at you could look at assets over time that you would not have thought would have those pricing dynamics. So one example is like timber. So in the years I worked at Yale, Yale was not invested in timber.

Harvard was. And in learning about it in the late 90s, you realize it was a pretty attractive asset. And they found a couple of managers and invested as did a couple other people. If you fast forward five to 10 years from then, there were so many institutions wanting to get into timber that the pricing of these limited resource tracks was going up and the yields were going down. And it became like a financial asset, not like an actively traded financial asset, but the returns weren't attractive as they had been. And so, yeah, people are always looking for the next thing. And maybe right now, the next big thing is going to be everything in the crypto ecosystem and it'll be the next wave of technology. But that's mostly, if it does, it's going to replace existing businesses, existing assets, existing technologies. And so like everything else, there's going to be winners

and losers. And now you tiptoed in there. So I got to ask, what's their crypto appetite? Is it growing? Is it ever going to be as big as the holders want it to be? Yeah. It's starting. It's starting this calendar year. I just did a mini series called Crypto for Institutions because it is in the minds of the people managing these pools of capital. I think there's a couple of different ways of thinking about it, about Bitcoin and other or Bitcoin, Ethereum and other. But most of it right now looks to them like a venture capital investment. So whether that's through a manager, it almost doesn't matter in the early days, whether it's a hedge fund or private equity manager, it all looks a little bit like venture capital. And so you have allocators that have given money to dedicated funds. And I've had conversations with others that said, we're paying attention to this. First step is, let me look at what we already own. And a former client of mine looked at their portfolio and saw they had two or 3% in crypto assets without having done a thing, like their managers moved them into those crypto assets.

So we'll just see how it evolves. Yeah. And for me in the future, what interesting, were they going to do it through futures markets, take away the exchange risk or the key risk and all that nonsense? But that'll be for another time. Quick, fast facts. Some of your favorites. Favorite investing book besides your own and besides David Swenson's because I know I have two. Let's see. Recent, I would say Morgan Housel's The Psychology of Money. And over a long period of time, uh, podcast besides your own.

And besides this one, of course. Yeah, of course. Um, so I got started in podcasting through Patrick O'Shaughnessy, his good buddy of mine. Um, and now he's got three different podcasts. It's, it's impossible even for me to keep up with what he's doing. Um, but I, I, he's a remarkably good interviewer and a total polymath. So I listened to his as much as I can. I listened to Shane Parrish's knowledge project as much as I can.

I love, I, you know, Meb Faber interviewed me for his show and he's just, he's an awesome guy and an awesome interviewer. One of the things, you know, which is when you're running your own podcast, you don't have that much time to listen to other people because you have to listen to your recording so much. So I probably consume podcasts far less than I would like and less than other people, but on the investing world, those are some of my favorites. Love it. Were you bullish on the whole movement? You think we'll start to see some of these people you mentioned get signed by Spotify and whatnot?

I have no idea. I mean, it's fun for all of us, right? Because it's sort of, it's a side project, but it's not necessarily, I got asked a lot early on in the book tour. It was Jim Williams at the Getty. He was the first person to ask me, do I see myself as an investor who's doing a podcast or a podcaster that talks about investing? And I was like, I'm not a podcaster. I don't even know what that means, but I'm just

an investor who happens to be doing this publicly. So I think there's a case that the medium grows. I think there's a case that it's so saturated that oh yeah people don't know what to do with it um so i don't really know i'm just you know if they come along and i'm you know we'll sell this thing for billions so it's fine if a spack wants to come along and buy the podcast that's where they can do that there it is uh the the bids out there the offers out um so dream podcast guests that you haven't been able to land yet. Yeah. So there are three and one I am shortly, we'll be scheduling an interview with. So that'll be great.

He is a former professional athlete who does a lot of investing. The other two are Buffett and Swenson. Both have said no multiple times for different reasons. And I don't think either one will come on, but you never know. And we never even talked. Is this the longest you've ever gone without someone asking you about the Buffett bet? It's getting there, but it doesn't come up as much. The bet ended a couple of years ago now, so it doesn't come up as much.

But that was interesting on meb spot talking about the collateral was the best part of that bet yeah um just quickly on him what's what's he like so you were talking to him throughout that bed and is he yeah no i never actually never spoke to him so after we consummated the vet but i've had you know i've had dinner with him a number of times uh almost every year since he's amazing and i I did not, I was not a, you know, Buffett worshiper going in. I knew who he was. Obviously you have to respect what he's done. But he is, you know, people have different opinions and it's easy to poke holes when you're involved in as many things as he has. And all I could say from my own experience is he is so the real deal. And what I mean by that is he is unbelievably brilliant about business.

He is a humble, Midwestern, earnest, authentic person. And that's my own firsthand experience. Like I've just, he's incredibly funny. He's fun to be around. Are you showing him, he's like, oh, the M be around um are you showing him he's like oh the mets got killed last night is that kind of normalcy or is it um not no i mean he he mostly wants to talk about business yeah but he's an incredible storyteller and that's what i was trying to get him to do on the podcast let's just like rehash a bunch of your early business experiences and stuff that i'm sure he's told right he? He tells the same stories over and over, but, but not quite in the same place. And so I am, you know, I just feel very lucky to have had the chance to spend the time with

him that I have, because he's just, he's just an amazing, amazing person. And then lastly, we're here recording on may the fourth be with you um but we ask all our guests favorite star wars character uh i guess yoda yoda yoda proper not baby yoda no yeah the original the real deal the wise man you know with all those great little cliches he's kind of cute too yeah yeah i love it he's the man uh all right ted this has been fun thanks so much good luck with the book go out i'm gonna give it to everyone in our team awesome some must must read stuff in there um and we'll talk to you soon thanks again sounds great thanks jeff enjoyed it the derivative is brought to you by CME Group.

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