We Study Billionaires - The Investor’s Podcast Network - TIP343: How to Invest like the Best w/ Ted Seides

Starting point is 00:00:00 You're listening to TIP. On today's episode, I sit down with Ted CITES to talk about how the world's elite money managers lead and invest. Ted has had an incredible career as an allocator, having started under the tutelage of David Swenson of the Yale Endowment before starting his own multi-billion dollar alternative investment firm. In this episode, we cover the playbook for chief investment officers of hedge funds or institutions where retail investors can have an edge.

Starting point is 00:00:29 when to and when not to invest in a hedge fund, and we took a deeper dive into his infamous bet with Warren Buffett and what he has learned from his relationship with Warren over the years. It was a privilege to sit down with Ted, and I hope you learn as much as I did. So without further ado, please enjoy my discussion with Ted Cydies. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, everybody.

Starting point is 00:01:14 I'm here with Ted Sides. Very excited to have you on the show, Ted. Thanks for coming on. Thanks, Trey. Great to be here with you. So a lot of people might know this, but you started out working for David Swenson at the Yale Endowment. And obviously, he's kind of a titan in the industry.

Starting point is 00:01:30 So I have to ask, how did that shape your investing style to date? Well, I had the opportunity to learn a lot of good lessons before I learned bad ones. So, you know, I think a lot of investors that get passionate about the business start on their own and they read things and they learn from their mistakes. And that's great. It's even better if you can start without any prior knowledge working for someone who already has a lot of things figured out. And that was my formative education and investing. I worked for David for five years and learned everything I knew about that particular process of investing, which is different from picking stocks. It's picking managers and asset allocation. And he's a remarkable investor and a remarkable teacher. And I was just fortunate to have that experience right out of college. And Yale in general, I think you're saying in your book, they're only about 10% even allocated to something like US stocks, right? So it's a very broad portfolio. And is that something that kind of shaped your approach to date as well? The way I describe it is I learned what a hedge fund was the same day I learned what a stock was.

Starting point is 00:02:38 So if you don't have a bias, most people come into a seat like that, even David did, with a particular set of experiences, a particular set of beliefs about how either investing works or certain asset classes or styles work, and then they grow from there. I came at it with a clean slate, and I was taught these first principles of equity orientation and diversification and how just owning U.S. equities is not a diversified equity portfolio. So those were just fundamental beliefs that I learned. And so I did adopt a lot of that as, for me, just first principle common knowledge. And that was before David wrote his book. By the time he wrote his seminal work in 2000, I knew what was coming on the next page because I had lived it

Starting point is 00:03:25 alongside of him for a long time. So you just touched on how his approach was very much based around finding managers underneath him, which I know it's kind of the same career path you've now taken. So what was the key principle you took as far as approaching, allocating to different managers? It starts with the seat, the particular seat or the particular school of capital. So if you think about a seat like Yale or any other endowment or foundation or pension fund, in the institutional market, there are large dollars at work, but they tend not to be very highly resourced teams. You don't have 200 investment professionals, even at Yale, which is one of the bigger ones, there might be 20. And they're trying to cover the world

Starting point is 00:04:09 across asset classes. So you could think about different ways you might want to pursue that. One is you could say, okay, we'll have one person focused on being the best U.S. equity stock picker. And let's have another person just focused on emerging market equities, and another in venture capital, and another in leverage buyouts. Oh, by the way, and another in China. And then you have to say, are each of those people going to be able to compete with the entire rest of the world? Is the person sitting in New Haven picking stocks in China going to be able to compete with someone on the ground who has a full team of people in Asia?

Starting point is 00:04:42 Probably not. And so one of those first premises is rather than try to compete with the very best people in the world across disciplines, go try to find them, develop expertise in how you find them, how you partner with them, how you structure those partnerships. And that was a particular style of investing that David pursued and that I learned from an early age. It is very different. The science part of it, the art is probably more similar.

Starting point is 00:05:06 The science of that compared to the science of doing stock research is completely different. But they're both viable. They're both disciplines that work. It's just a question of how you want to pursue it. And for me personally, I thought when I left, I wanted to pick stocks. And I did that for a little while. And what I found was I didn't enjoy the business analysis as much as I enjoyed the strategy and the assessment of people that went into picking managers. And so I went back to that after a few

Starting point is 00:05:33 years. So having spent so much time around David, what would you say his superpower is? All the great investors that lead the way, there are a lot that follow and do their own thing, have this interesting hybrid of an independent streak and just intelligence and being able to see around corners. And David is all of that. He has incredible temperament in his investing, incredible ability to show up every day with a perpetual time horizon and act accordingly, which very few people can do. And he more than almost anyone else that I've ever met, the only other person that was close was his longtime number two, Dean Takahashi. They could just sit down with a money manager in any strategy, in any asset class, and see right through them

Starting point is 00:06:20 to the underlying assets they owned and have a view on whether that portfolio was likely to do well and fit in with the strategy. They're just exceptionally talented people and investors. He's sort of the classic five tool player. He's clearly a great writer and a communicator. He's a great thinker. And he's just, is one of these people that can think through what the next important aspect of their investment program is. And maybe that's a strategy. Maybe it's a particular set of assets. Maybe it's something in structure, maybe it's something in style. But he always had the next thing to focus on that became important that would drive returns. Well, one thing I learned out of your new book is that it seems that everyone has a boss,

Starting point is 00:07:04 right? Even CIOs, they seem to be somewhat constrained by the boards that they report to. And even, I'm sure David is even no exception. So I'm curious, who is really at the top of the allocator food chain? The CIO of an endowner of capital is probably as close as you can come. The top of the food chain is always the person who owns the money. So if it is a very wealthy individual and they don't really have to report to anybody. But on the institutional side, the CIOs are very close to the top, but invariably it's not their money.

Starting point is 00:07:39 It may be the institution's money. So they'll be reporting to someone that is a committee or a board that will ultimately be responsible for the performance of the assets, even more than the CIO. So in Yale's case, just use that example, Yale has an investment committee, which is a subset of the Yale Corporation. And in fact, the investment committee makes every investment decision. David and his team make recommendations to that committee, but the committee is responsible for the decisions. In that particular case, after 35 years of the best performance in the world, it's highly likely that the committee would agree with all of David's recommendations. But he's earned that trust over a

Starting point is 00:08:16 long period of time. It's more common that a CIO will have a lot of say, but there'll be a fair amount of back and forth between them and the members of the committee in the process of getting to an investment decision, sometimes even at the manager level. The last question I'll ask about David is just around his coaching style, because I know you've also taken this role as a coach and leader and mentor, and I imagine when you're allocating to different managers, that's a big part of the job and the superpower that comes with it. Did you take anything away from his style and did it affect the way you operate today? I mean, I hope I took every little bit that I could in five years.

Starting point is 00:08:56 The way David operated, it was, there wasn't training. It was all by osmosis and it's a small team. So there were a couple different things that would happen. One is you'd be in meetings with him. You'd see what questions he would ask, how he would ask them. And then all the investment recommendations got written up in very long, very detailed memos. and he edited every word of every memo. And so I learned a write from David, not a college.

Starting point is 00:09:20 And I probably wrote a thousand pages of memos in five years for the Investment Committee. So I think all of those disciplines go into an environment where you can't help but learn what he's teaching. The other thing I would say about him that's different from others is he's very black and white in how he thinks. He really does make the decisions of what gets recommended. It's not a group decision process. and he happens to be right almost all the time. So if you were someone that were the, you know, the 51% right, it might be hard to figure out, you know, what's the process that's going into that decision. But you see this repeated pattern of great, great thought process and great ideas. And so

Starting point is 00:09:57 it's just an incredible place to learn because you can suck all that up before you really, you know, for me, before I really had any opinions of my own. Well, you recently interviewed my buddies Alex and Damien from Eris. And Damien highlighted that Ray Dalio's ed. edge was only about 55 to 60 percent, and that probably Buffett was very similar. And I don't know about David. It sounds like he might even be better than that. But given that investing is all about having an edge and that these guys are obviously superstars and the best in the world, what chance do us as mere mortals as retail investors have to compete? Well, I don't think you want to compete on the same playing grounds. A big part of Yale's

Starting point is 00:10:38 edge independent of David, or what David's built for Yale, it kind of, it kind of, from a network of relationships that are very hard, if not impossible, to replicate. So you could think about investing with the best venture capitalists in the world, the benchmark capitals of the world, the sequoias of the world. I can't do that. You can't do that. Yale can do that. And they'll do that as much as they can. And so I think what you can take away from it is not so much exactly how Yale does it, but what are some of the inputs that are repeatable for any investment process. And those include being very rigorous about what you're trying to accomplish, what the purposes of your capital, understanding what your own biases are that you bring to the table,

Starting point is 00:11:15 and then being very disciplined and consistent in exercising that set of beliefs towards investing. That can be very, very different for different people and individuals, but the structure of how you go about it and the consistency that you state of that structure ultimately is a lot more important sometimes than the individual decision of should I buy that stock or this other stock. And so there are lessons in how David invests at Yale that are very broadly applicable. Competing with them on their playing field is not one of them. Well, speaking of sticking with a certain style, you also highlight in the book that a traditional 60-40 portfolio of stocks and bonds is really unlikely to keep up with spending needs.

Starting point is 00:11:56 So should the retail investor reconsider that type of structure for their own portfolio? And is there something they can adopt from the CIO playbook? I think so. I'm not big on making market predictions because I believe very, very deeply that nobody knows what will happen in markets good or bad. But there are times where generally speaking you could look out and say, how are assets priced to deliver over a long period of time? And we happen to be at one of those times. It's not hard to look at the 10-year now rising to the lofty rate of 1.5% and say, you have to be kidding yourself if you think you're going to make more than 1.5% over the next 10 years. It's possible. Rates could go down. They could go to zero

Starting point is 00:12:37 and you could get capital appreciation just like we've had for the last 30 years. But that doesn't seem likely. And stocks trading where they are, you can make all kinds of cases for what you want about technology stocks and new paradigms. And we've seen all that before. But the pricing of stocks, particularly after the stimulus, is high. And so generally speaking, you could invert the price of a stock to an earnings yield and think about what the growth of the economy is going to be on top of that, and you get to a number that is not that high. And so if you have just sort of common sense, and you look at that and you say, well, particularly for institutions, institutions are good proxy for individuals, that there is some rate of return that people need to meet their spending

Starting point is 00:13:17 needs. That's more defined for institutions often than individuals, in absent of a good financial planner and a whole path that brings them to where they need to go. But no matter who you are, it's unlikely that investing so that you can make three or four percent is going to get people growth, the growth that they want in their portfolios. And so that lends itself to asking the question, what else should you do? And there are lots of opportunities increasingly so to diversify away from U.S. stocks and U.S. bonds that are reasonable and available to individuals that didn't used to be in the past. We have this proliferation of ETFs so people can make whatever sub-market bet that they want to in a cost-efficient way if they don't want to pick stocks. We have the whole

Starting point is 00:14:00 cryptocurrency ecosystem, and that's kind of an interesting possibility of a way to hedge against fiat money debasement. Harder to access the private markets for sure, but even then you have public companies like Blackstone and KKR, and you can own a piece of the business in addition to what they're doing. You have hedge funds like Bursing Square and Third Point that have listed vehicles that are traded discounts in Europe. So there are ways of getting access to high quality opportunities that are somewhat similar to what some of the institutions do and definitely diversify away from just owning the market. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer.

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Starting point is 00:18:35 Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. One thing I think that particularly lacks in retail investment is risk management. So talk to us a little bit why you think risk management is as much art as it is science. My favorite line about risk comes from the late Peter Bernstein, the brilliant economist. And Peter used to say, risk means we don't know what will happen.

Starting point is 00:19:10 And if you really internalize that, it's pretty profound because he's not saying, hey, yeah, we don't know what's going to happen. But what he used to say on top of that is we don't know what will happen, even if we think we do, that the probability distribution of outcomes is really wide. And so in any investment strategy, you could think about what could go wrong. And then you know that the thing that's likely to go wrong, you haven't thought of yet. And maybe it was knowable and you didn't get there, or maybe it just wasn't knowable. And so part of the idea of risk management is to have a deep understanding of how much can you lose

Starting point is 00:19:44 and still stay in the game and not get shaken out of the position or the posturing that you have that's likely to reach your long-term objectives. And that sounds super simple. I just went through this example two weeks ago. So I own a portfolio of SPACs in the public market, and that's a whole investment thesis I could work through. and it has a very finite known downside. These things have $10 of cash sitting in a trust. And yet when the portfolio, SPACs as a group,

Starting point is 00:20:10 traded off about 20%, I didn't have SPACs that were more than call it $10.60. But when that $1060 went down to $10 across the board, I even felt myself with butterflies in my stomach saying, maybe I was wrong. Maybe this is a bad investment. I shouldn't have done this. Oh, by the way, I took more risk by owning some warrants.

Starting point is 00:20:27 Well, those things really got killed. And that was a tiny tremor after a long period. in markets of muted volatility and everything seems great. Now, I know, I've read all the books about behavioral finance. I've talked to a lot of the experts. It still happens to me. So that real question of how do you prepare for the time when risk plays out, risk is not upside. People call that performance, upside volatility. It's hard. And it's, it's behavioral and emotionally based, and we're all wired to kind of get shaken out of the position. So you have to live through that a number of times to understand what is your quote unquote risk tolerance, which then determines

Starting point is 00:21:03 how much, call it, risk you have in place in any given portfolio. And, you know, we can read all this that. Howard Marks writes brilliantly about this, about cycles, and we know this, and greed and fear, and all of that's true. It's completely different from the moment when it affects you. And that's what every individual has to figure out for themselves so that why they're investing, the purpose of that capital, what they're trying to grow that money to over time, doesn't get affected by that one moment when they shouldn't be touching anything, or as I like to say, that moment where you have to remind yourself, don't just do something, sit there. I love that quote. So on the flip side of that, obviously these money managers are not immune to this bias either. So as you just

Starting point is 00:21:43 kind of highlighted there, so if I'm a retail investor and I say, you know what, I actually just want someone else to manage this, but know that they're susceptible. What have you seen be put in place to kind of help manage that for allocators? In the book I've just, written, it's called Capital Allocators, there's a chapter on decision-making processes that comes from some of the conversations I've had on my podcast with people like Annie Duke, the former professional poker player and Michael Mobison, the great strategist. And there's a bunch of tools knowing that our behavior will get in the way that you can try to put in place to make it a little bit less bad. And most of those have to do with being in a decision-making

Starting point is 00:22:21 group where people hold each other accountable. So there are lots of things I walk through in that chapter about how do you structure that group? How does that group conduct themselves? How should they be thinking? All of those things go into setting up processes to try to mitigate the risk that you won't individually just react on your emotions at the wrong time. So at what stage, maybe it's a certain amount of capital or what have you, should an individual consider investing in something like a hedge fund, which you know all about. You've written the book on it. Well, I am now an individual investor. For 20 years, I was not. I was an institutional investor, mostly overseeing non-taxable money.

Starting point is 00:23:00 And with one exception that I'll describe, I do not invest in hedge funds because they are relatively tax inefficient. And I don't think that in most instances, hedge funds will let me get to what I'm trying to achieve with the capital. The exception to that are in retirement accounts. So I am on the cusp of making my first hedge fund investment in five years. It is in a portfolio of biotech-related hedge funds, but it's in a retirement account, so I don't have to worry about the tax consequences.

Starting point is 00:23:26 Interesting. How available are hedge funds to retail investors, in your opinion? They're not particularly available and certainly not the ones you likely want access to. There are some alternative, what they call them liquid alternative products that are okay. Blackstone has one that's a fund of funds. But what I would tell you from looking at that and knowing that organization, which is they're really quite good at investing in hedge funds are the largest in the world, what they're able to put in that liquid product is not the best stuff. The place where you can get around it, I had mentioned earlier, there are certain hedge fund managers who have listed vehicles, mostly not in the U.S., but Bill Ackman.

Starting point is 00:24:05 My largest holding is Pershing Square Holdings, which is Bill Ackman's fund with some leverage because he doesn't have to worry about liquidity, trading at a discount, and he buys back shares. I mean, it's a very attractive, broad opportunity. So there are some, but for every bill, there are, you know, 40 or 50 other incredibly talented hedge funds that, generally speaking, individual investors do not have access to. And that's okay. There's a large world of investment opportunities. They don't need to access everything. It's interesting. I noticed that Seth Clarmine also holds a large position of Pershing Square. So even someone, you know, as established as he is, is investing in bill. Very cool.

Starting point is 00:24:42 I just want to touch on the hedge fund fees involved. And I love this quote in your book by Rahul Mudigal that says, if you pay peanuts, you get monkeys. What level of fees, though, do you consider to be appropriate? I don't think you can answer the question. I think that every investment in a fund is driven by net returns and some of the best performing vehicles in the world that we would all chump at the bit to have access to if we could have the highest fees of anything. So think about the Renaissance Medallion Fund that seems like it's a money printing machine. The last time Renaissance had outside money, they charged 5% of assets and 44% of performance. Is that worth it? Absolutely. They were still compounding in the high.

Starting point is 00:25:22 20s net of those fees. You could say the same thing for benchmark the venture capital firm. I'm not sure what their fees are, but it's probably two or two and a half and somewhere between 20 and 30, but you'd pay it all day long if you could have access. And so by the way, if we were able to give money to those organizations today, there's no guarantee that they'd compound the way they have in the past. So we have a belief. We are investing in a story based on the past that they'll continue to do what they did in the past. And that's what all of investing in managers is. You're trying to figure out an unknowable future. And it's based on a story that you've made up, a narrative in Bob Schiller's words, an economic narrative of what you think will happen. And so it's very easy

Starting point is 00:26:04 to say, oh, I know I'm paying those fees and those fees are too high. But if you can't access that opportunity any other way, and you have a sense of what you think that manager will deliver net of those fees, you may well be willing to pay it. And the market tells you right now, for any particular manager, because they're different, what the fee is. It's a matching of supply and demand. And so one of the funny things I found in my hedge fund years is that you'd have a lot of institutions that would give lip service to fees being too high and would go as far as to bring other institutions together to write papers like white papers saying, this is what we think the optimal fee structure should be. And then they would go around that group and go invest in the next

Starting point is 00:26:42 new hot fund that had none of the terms that they had espoused as the quote unquote right thing to do. So there is no consortium that could say, we think fees are too high, they're lower. It really is a question of how much people are willing to pay to access certain talent. And so the market tells you what those rates are at any point in time and they can change. But by and large, hedge fund portfolios have delivered on expectations for the institutions that have invested in. You highlight another interesting quote from Michael Batnik in your new book that says, there are limits to value investing.

Starting point is 00:27:15 Ben Graham got crushed in the depression. He just couldn't resist the values. He went in early and got destroyed. Is the takeaway here that an investor needs to be more dynamic in their approach? And if so, how do you know when you're evolving as opposed to just performance chasing? So I think the message in that is that the classic Keynes line, the market can stay irrational longer than you can stay solvent. Many people, including Dave Swenson, are Dye in the Wool Value investors.

Starting point is 00:27:46 They have a belief, and these days it's more well articulated based on behavior and why value stocks are systematically cheaper. And you could look past at history and say value outperforms. What you find, though, is that except for the rare instances where you're dealing with the ultimate asset owner or someone like David who effectively speaks for the asset owner, Almost everyone, including institutions, don't have an infinite time horizon to be in their own seat. And as Andy Golden said, who's the head of Princeton's endowment on my podcast, to finish first, you first have to finish. So the lesson of what Michael was talking about with Ben Graham is that value can be out of favor for so long that even if you're right over 20 years, if you only have 10, it doesn't matter.

Starting point is 00:28:31 And it's one of the big lessons that I took away from my own investing and what I did for my clients in my years. as a protege that was different from Yale, which is I always preferred balance on style. In any way that I felt like there was some belief that could go wrong, even if you were ultimately right, for longer than was comfortable for your clients, because your risk tolerance, my risk tolerance isn't my own risk tolerance when I'm managing money for other people. It's the shorter of mine and my clients. And so value investing may work over the long term, but you could look at what's happening right now to AQR as they're bleeding assets. because they've been wrong or their style's been out of favor for too long for their clients to

Starting point is 00:29:12 withstand it. And so that's my takeaway from that. It isn't so much about performance chasing. It's really more about understanding that investing isn't just what do you do with the money. It's what do you do with the money? Who are you doing it for? And how are all of those people responding to results? You point out in your book, this sort of money ball approach that's shaped the industry, especially in recent years. And Buffett has been making this analogy for decades, referencing the Ted Williams book, The Science of Hitting. How can an independent investor determine their sweet spot? I think it comes from the experience of figuring out what works for any individual.

Starting point is 00:29:55 And I can just give my example, coming out of institutional investing, investing on my own, there are a lot of things I thought would work. So for many, many years when I was managing outside capital, I couldn't pick stocks. We did not allow it because we were concerned about potential conflicts, even though we were picking portfolios of managers. So when I left, for the first time, in 15 years, I could pick stocks again. And I knew a lot of great managers and I knew some of their positions. I said, this is amazing. I'd watch and if something sold off, I would buy it. But I never knew enough to know when to sell it. And what I learned quickly was, as soon as there was a tremor, I would get nervous. And I quickly changed that strategy. And over time for me, got back to saying,

Starting point is 00:30:35 what? My real comfort zone where I know I'm a good investor is when I'm investing in a fund, and I know why I'm there, and I know what the signposts are to make changes. And that's my sweet spot. For somebody else, it could be a value type situation. It could be a stock that they know people who own it and it gets beaten up and they love buying it when it gets beaten up. For other people, it could be momentum investing. It could be GameStop on Reddit. You know, that could work for someone as long as they understand that that is the pitch that they're hitting. So in the analogy you used, Ted Williams had a particular spot. He had mapped this out in the strike zone. I don't remember what it was, but I kind of feel like it was high in the strike zone. But somebody

Starting point is 00:31:13 else might be a low ball hitter. Someone might be an inside ball hitter. Someone might like a ball out over the plate. And so people just have to figure out for themselves, it's a big investment universe. What is it that works for them and then have the discipline to stick to it? And wait for that fat pitch, as Warren likes to say, right? So speaking of Moneyball, I love the quote from Ben Ryder in your book that says, we are taught to think that numbers are far superior to human intuition, but that humans can detect things that numbers can't describe. Try to get the best of both man and machine.

Starting point is 00:31:46 So it's more of the machine part, I think I'm really interested in, how we can incorporate more of that into our own investment processes. Where I've seen a lot of investment managers go wrong is not so much in the stock selection and certainly not in the buying of positions. It's in the way they construct portfolios. And that is more of a science than an art. There's some element of art. And so there's only really two ways that that makes sense. One is that people believe their stock pickers and they don't necessarily believe in their own ability to weight positions. And so they just equally weight their portfolios. Maybe they rebalance every so often and they let things go. The other is people

Starting point is 00:32:22 that weight their positions based on their conviction. And what I found over the years is, When that's not measured and people haven't determined that they, in fact, do add value from waiting their positions based on their conviction, they often don't. They often would have been better off just equally waiting positions. And there's a lot of reasons why, or hypotheses, why you could make that case. If people don't know positions equally, their attention drifts in different ways. Stock prices move around and it's a multivariate equation to optimize what you think your price target and downside would be as stocks are moving around.

Starting point is 00:32:54 But when portfolio managers either from conviction weighting or equal awaiting kind of flutter back and forth, they end up losing a lot of money relative to their own idea generation because of the lack of rigor in their portfolio construction. And that's one of the ways you've seen kind of the science come into investing. And you see it most pronounced in certain hedge funds, particularly the platform multi-manager hedge funds, places like Citadel and .72 and Millennium that are very rigorous about portfolio construction and risk management. And what they're trying to do is get the stock selection alpha or the ability of their portfolio managers to pick good stocks over what's available, over the market, to allow that to speak and not let portfolio construction get in the way. But certainly when you talk to individual investors, they don't often think nearly as deeply about their portfolio construction as they do about their individual positions. Well, all of these quotes I've been referencing so far are from your new book, Capital Allocators, and it's a great book.

Starting point is 00:33:51 I highly recommend it. But I did also touch on the fact that you wrote the book on hedge funds as well. It has another great name called So You Want to Start a Hedge Fund. And I think a lot of our listeners probably have at least thought about starting a hedge fund, myself included, right? So can you kind of distill down to us the premise of that book and what drove you to write it? So my years at Protgege Partners, Brodrege was a hedge fund of funds that invested in early stage funds and also ceded new funds.

Starting point is 00:34:17 So I spent 14 years regularly evaluating and investing in startup hedge funds. And what I found from doing that was that there was a series of mistakes that portfolio managers consistently make, but they never know they're making it because it's always the first time for them. And so I put that all in a book. And if there are a couple takeaways, I think it's that people just need to first understand what they're going into as it relates to a business and in an industry that they're entering. And it always, particularly with equity related managers, it always surprised me how rarely someone who says, oh, I want to go start a hedge fund. And in that hedge fund, they're going to analyze stocks and buy some to go long and short others. They haven't really,

Starting point is 00:35:03 for a second, thought about what is the hedge fund industry? What is the structure of the industry? Is this a good business? What is my place in it? What is my competitive advantage? Would I go long my stock or would I go short my stock? And some of what's happened over the years, and some of the people who read that book said, oh, boy, this is pretty sober. So some of what's happened over the years is that the industry matured. And in any industry that matures, there's much less of a demand for new products. And you get more concentrated. So the bigger hedge funds get bigger, and it gets harder and harder for a new product to come in because there isn't necessarily that much differentiation. So it is a difficult landscape to enter. And part of the reason I wrote

Starting point is 00:35:44 the book was in spite of that, it's an incredible adventure for someone who is deeply passionate about investing and wants to give it a shot. As long as they understand the base rate and the challenges and the difficult probability of success. But to do it and to succeed, you don't really have a lot of degrees of freedom. You really have to do things the right way. And some of those lessons can be taught quite easily. And so I took 25 or 30 of those stories from actual hedge funds, put them into a bunch of case studies and put it together in a book that's now, I guess, five years ago. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:39:41 Well, Ted, last time you were on our show, we talked about your infamous bet with Warren Buffett. And you're never going to live this down, right? But the long story short is that you lost the bet, but it's interesting to note that you would have made the same decisions looking back, I've heard you say. And essentially, the bet was a basket of hedge funds versus the S&P 500 over a decade. And if you want to learn more about the bet and Ted's experience, you can definitely go back and check out episode 170, where he highlights it in detail. So we're not going to go through the whole story here. But what I'm curious about is that since the S&P performance was essentially

Starting point is 00:40:20 tied to the Fed's intervention, I'm wondering why the hedge funds didn't benefit in the same way. And of course, by definition, they're hedge funds, right? They're hedging if they're, right? But why didn't they also get a boost from that? Well, let's start with that premise. So if the premise is right, which I would agree with, that the Fed coming in in 2009 strongly boosted the market, flooded capital into the market. So the S&P had a big run. And the question is, why didn't hedge funds benefit as much? And I think you hit the nail on the head, which is by definition, hedge funds are hedged. So the degree of risk, the degree of market exposure that they would have to those rising markets is much less than the S&P.

Starting point is 00:40:59 So it's not that they didn't benefit. In fact, they did. And after a difficult 2008 for the market and certainly for hedge funds to a lesser extent, both recovered. And that was probably There are a bunch of other interesting dynamics as well, which is you could make the case that it wasn't just the Fed. It was central banks around the world to some extent that lowered rates. And so all equity markets went up. But it turned out that if the benchmark for the bet was the Morgan Stanley World Index instead of the S&P 500, the bet would have been pretty much a wash.

Starting point is 00:41:29 And that's in spite of a pretty challenging performance for a bunch of reasons from hedge funds, definitely disappointing relative to expectations, including mine. But just the gap in the S&P from markets around the world was so wide during those, call it, eight and a half years after mid-09, that that in and of itself was a big determinant in the bet. And the hedge funds invested globally. So you did have exposure, that underlying market exposure, was much more global than the S&P 500. Well, regardless, one of the biggest winnings, it seems, from this bet was that you got to spend a lot of time with Warren.

Starting point is 00:42:02 And I know that when I had dinner with Warren once, I had prepared one. question in advance. And I think I blew it looking back. It was something about the efficient market hypothesis and whether it's still, you know, value investing is still relevant and something he's probably been asked a hundred times. But I'm curious, when you walked into that room thinking about, you know, about to sit down with him, had you prepared a question of your own? The first time I sat down with them, I hadn't. I had some ideas of things I wanted to talk about, most of which were non-investing and we got to those. But I will tell you a story that echoes yours. So a number of years ago, I brought Patrick O'Shaughnessy and Brent B. Shore out with me. And we had

Starting point is 00:42:42 dinner with Warren and Todd Combs. I think Tracy Britt may have been there as well. Tracy Brick, cool. And before we went to the dinner, Brent had a list of questions. And he said, okay, we're going to have dinner. It's really your dinner. Let's make sure that, you know, I'm not going to monopolize this time. And Patrick had a few questions. And I said to Brent, you better pick one or two because you don't want to get frustrated. And we went into that dinner. And I remember going to the bathroom when I came back. There was this full-on conversation about Notre Dame football.

Starting point is 00:43:13 And then it went into something else. And you could see after about a half hour, Brent's ears were sort of smoking because he wasn't remotely close to being around the subject matter where he was going to ask his questions. He eventually did get to it and it was terrific. But I would agree with you. Warren is so, he's such a polymath. He's so entertaining to be around. And yeah, you can go in and ask the questions you want, but I always find conversations are much more

Starting point is 00:43:37 enjoyable when they're somewhat free-flowing and they go wherever they go. I'm just curious. After all of those experiences, is there a longer-lasting impression that he's made on you or something that you could really grab onto? I think there are a lot of little nuggets. So much of what he says is in the public domain. And so there are little stories and you pick up more anecdotes than lessons, I think, privately. The biggest takeaway I had from when I first met him and then it's been consistent all the way through is that he's the real deal. And what I mean by that is we all know he's compounded capital in an incredible way.

Starting point is 00:44:11 But he really is a humble Midwestern guy and remarkably humble for what he's accomplished. And he's put himself out in the public to teach people. And over the years, we've all seen critics say, oh, he's hypocritical because he's He's investing in, you know, energy, but saying that, you know, the environment should be cleaner, whatever it is. There's always a litany of things where people come down on him. And, you know, life isn't so clear cut ever. It's never so clean. But what I would say from having spent a fair amount of time with him is he really is the person that he presents. He's just a wonderful, brilliant human being. Well, one reason I was especially excited to ask you that question was because

Starting point is 00:44:57 you've made a career in allocating capital to money managers, right? So you are, of anyone I know, very attuned to what makes a great manager. And you've interviewed hundreds, if not thousands of people to manage money. You have probably picked up on the characteristics that make a good manager, I imagine. So did you see any of those same things in Warren? Or did Warren have anything else that you've now applied to your hiring process? Oh, it was far more the former. When I first met him, I was so pissed off that I hadn't met him 20 or 30 years before because it was completely obvious to me after two hours. I've said this in the past that from being in the business, there are a number of people I've met who have gone on to become billionaires. He is one of the very, very few that I have a high degree of confidence that you could put him with next to no money alone in a room. And sometime later, it might be 20 years, but sometime later, he'd be a billionaire again. He would do it. in a completely different way. But he has this combination of an incredible mind and a drive that he probably hides from the public. But I was stunned when I first met him of how much everything he

Starting point is 00:46:10 thinks about and cares about is that company and compounding capital. Set aside his family. Does he care about his family? Absolutely. Is he interested in talking about his family? Not at all. Is it because he's hiding them from the public? Not at all. He just cares about the business. And so he has that deep, single-minded passion. And you can just see it in his mental acuity and flexibility that if he wasn't doing this, he would do something else. And the stories he tells about his early business ventures well before he was an investor from a little, little kid, like when he first, they bought a gas station and he was pumping

Starting point is 00:46:44 gas and he learned about pricing. And then he bought gumball machines when they were inside of barbershops and had the mob come after him and all these kind of crazy things. You could just see he was just a natural entrepreneur. And so, yeah, I mean, it's not easy to pick someone who you think will be a phenomenal money manager over time. And most won't, right, just by the probabilities and base rates. But he was one that one of the very few people I've met that you just, you could tell that he would just figure it out. So, Ted, the last thing I want to talk about is coaching and leading, because you've made this career out of investing.

Starting point is 00:47:23 in people and these managers that you're allocating to, how much of your career have you found yourself being a coach or a mentor? Increasingly so, I would say. In my time managing money, yes, you're managing money, you're investing in managers and you're partnering with those managers. So as you gain experience, oftentimes I would try to be helpful in different ways. And sometimes you'd see that in portfolio. Sometimes you'd see it in iterations of what happens inside businesses.

Starting point is 00:47:52 And when I stepped away from that, you don't lose that experience. And it's taken me a number of years to even explain to the people that I work with, like ahead of time, like what it is that I do until my wife, who's not in the business, said to me one day, I just heard you talk to them. And like, that didn't, you know, I'd say people, well, I kind of understand how the business works. I understand how investing works. I understand how the two work together. And I think I can help.

Starting point is 00:48:14 She said, why don't you just tell people you're going to help them make more money? And that became how I described what I do. And it's not money because everyone's greedy and they want to make more money. but it is kind of fun making more money. And I just have enough experience in around investment organizations that whether it's how people are thinking about just as simple as their marketing and business development, to are they making mistakes on their portfolio? Are they making mistakes with their team?

Starting point is 00:48:36 I've just seen enough iterations of people making mistakes that I have a pretty good sense in real time if something doesn't seem right. And so it's just fun to be able to share that. And I do it from time to time. I don't really do it with startups anymore going back. to what we're talking about with people wanting to start hedge funds. And the reason is, it's just too hard. I can't do anything about the fact that the industry as a whole doesn't have a large demand for new funds. I can't help people get through that chicken and egg game. So I do

Starting point is 00:49:07 tend to work with a little bit more established funds, but they're not mega funds, a couple hundred million dollars under management or more. And it's a lot of fun. In a career that's defined by such quantitative outputs as investing is. How do you measure effort versus outcome? Well, I'd refer to as process over outcome. Effort is certainly part of the process, but sometimes the best inputs are not from the most effort. People say they get their best ideas in the shower or something like that, and it doesn't mean because they're working harder in that moment. So assessing process is incredibly important, and it starts with an articulation, which, again, I have a whole chapter in the book about this, about what is that process.

Starting point is 00:49:47 And it's not rocket science, what it is. How do people find their investment ideas? How does a CIO find their investment ideas? And if you talk to enough of them, you realize there's a pretty set way that they go about prioritizing what comes in the door. How do they go through that process before they're interviewing managers of what they're going to learn and what do they know, what are they trying to find out? What kinds of questions do they ask in those meetings?

Starting point is 00:50:10 What kind of work do they do afterwards? and how do they monitor the managers that are in that portfolios? And so, you know, I've dedicated a whole chapter to how does that whole investment process work. All of that has to do with the process. There is a part of the process that comes from thinking about the outputs of the managers you invest in and the quantitative assessments that go into that and the qualitative assessments that go into that and what's important. And that's a big part of, you know, how I spent two decades investing. And so I tried to share some of that in the book, and it's not easy to distill in a quick answer. Well, you've definitely outlined an amazing playbook in your new book about hiring especially,

Starting point is 00:50:53 and you list a few questions that I would like to ask you, and you can either answer them yourself, or I would also be interested in hearing the best answer you've heard from managers you've hired. So the first one is, how do you position size? Yeah, we touched on this earlier. I think that there's a very important. really only two ways, equal weight and conviction weight. And I just tell people, if you're going to conviction weight positions, make sure you're measuring your ability to add value relative to equally weighting positions. Next up is, how do you decide when to sell? So there have been studies recently that I've read that said that generally speaking active managers are quite good at buying. They add a lot

Starting point is 00:51:32 of value in their buys, but they detract value in selling. And there aren't a lot of people that articulate it well. One of those is a guy named Richard Lawrence, who I've had on my show twice, runs probably $6 or $7 billion in Asian equities, long only Asian equities, fairly concentrated portfolio. And he has one of his many investment tools, a framework for thinking about selling that I think is sort of spot on. And so he describes as five different reasons to sell. One is you recognize you made a mistake. You made a mistake in your process, in your investment thesis, and if that happens, sell immediately. The second is rebalancing. So within a portfolio and stocks move up relative to each other, you can trim. And there's a bit of a selling there,

Starting point is 00:52:14 and you can add value over time if those stocks relative to each other have some volatility. The third is competition for capital. So his portfolio is only 20 or 25 names. If you find the 26th name and it's better than what you have, that's a reason to sell something in your portfolio. The fourth is a change in outlook. So that could be an outlook for the company. Your investment thesis has changed. You don't think the prospects for that company, or in my case, that investment manager are as strong as they were when you made the investment, then you sell. And the last, which I think and have pushed Richard on is the most controversial, which he refers to as you get tomorrow's price today. And the reason I think it's controversial is that in his investment style, which is long-term

Starting point is 00:52:52 compounding, sometimes it's okay to hold on to things that have gotten ahead of themselves because you might not be right, because it might run higher, or because it might not go anywhere, but the company may compound into that valuation over a period of time. So it's a very subjective measure of when do you sell just because the stock feels expensive to you. And I know most value investors make the exact same mistake of selling too early. And for years and years and years, I would push them and say, well, why? Why don't you hand off the decision to your trader and just tell them, don't sell less than

Starting point is 00:53:26 this and make more money along the way? And generally speaking, people who are value investors really, really struggle with that key component, which is what happens when a stock is running and gets to your price target. Yeah, I think I heard recently Charlie Munger say something to the effect of, you know, one of the biggest offenses value investing is disrupting the compounding involved. It kind of speaks to that. Love that answer. All right.

Starting point is 00:53:50 Next one is, what is your favorite idea today? So my favorite idea, I own a portfolio of post-IPO, free-indexam. Merger Spacks, trading around $10. These days, really right around $10. And I love it because you can't really lose money. If the way that SPACs work, if the sponsor doesn't go out and conduct a deal, you get your $10 back. So you know your downside is $10.

Starting point is 00:54:15 You know your cost of capital is basically zero. Interest rates are close to zero. And you have all kinds of interesting optionality on the upside. They could go out and do a deal that you think is really attractive and you can continue to an company. They could do a deal that you don't think is attractive, but other people do, and the stock pops, and you can get paid that way. And sometimes the stock moves because of the sort of democratization of the IPO pop. So this is a form of a private company going public, and sometimes just on the announcement, the stock will pop 10 or 15 percent because it's undervalued.

Starting point is 00:54:47 And all of those ways, you can sort of capture a little bit of value. And so I'm doing a whole bunch of rins, lather, rinse repeat on that portfolio as deals get announced. and it's a really fun area to watch. It's definitely an exciting area to watch. That's a very interesting perspective that I haven't heard yet, so fascinating. The last one is how do you define risk? Is it simply that you just don't know what you're doing, or do you define it some other way? I define risk not as you don't know what you're doing, but you don't know what will happen.

Starting point is 00:55:17 And so risk is everything, everything about risk goes into what will happen on the downside. How can we lose money? and people can try to map out and think through all the different ways that they might, but it usually is the thing that we don't know ahead of time that plays out. I don't know of anyone before, you know, last December for the forward-thinking people that knew a pandemic was going to come and the markets would go down 20%. I don't view risk as, oh, the market popped back up, therefore that wasn't a risk. Lots of things can happen and do happen that we never anticipate.

Starting point is 00:55:51 and the probability distribution of outcomes is much wider than the one outcome that we see. And so that to me is risk, is really having a deep appreciation that we really don't know what's going to happen. And so we need to prepare accordingly. So Ted, I love your podcast, Capital Allocators, and I suggest everyone go and follow and subscribe to that feed. You've interviewed some of the best names in the industry and captured a lot of value and wisdom and knowledge from them that you've put into your new book, Capital Aller. I am curious, if you could recommend one episode from your podcast for a new listener, which one would it be?

Starting point is 00:56:30 It's very hard to choose among your 200 children, but I'll name two. If I were picking a single episode that I think with great consistency people have learned a lot from, it would be the first one that I did with Annie Duke. So in and around when she released her book Thinking and Betts. I've done four or five with Annie, but that, first one was just amazing. If there's a second one they should listen to, it will be the one that comes out on March 22nd when I get a chance to describe my book. Patrick O'Shaughnessy agreed to interview me for my podcast. So that would be it. Love it. All right. Well, the book is Capital

Starting point is 00:57:09 Allocators, How the World Elite Money Managers Lead and Invest. And I really enjoyed the book. I found that there were a lot of applicable takeaways for not only CIOs, but CEOs or anyone in business, really. It's a great lesson on people, on leadership, on management, and investing. Ted, with that, I want to just give you a chance to hand off to the audience where they can find your books and any other endeavors you're working on. Well, thanks so much, Trey, and this has been really fun. It's fun to be on the other side of the mic. Well, my website is Capital Allocatorspodcast.com, or if you forget that, I think Capitalallocators.com goes right to it. And that lays out pretty much everything that's going on, the podcast, a bunch of activities around it. I also am on Twitter and

Starting point is 00:57:54 LinkedIn and tend to post the episodes with some quotes on there. And for people who are really interested, we have premium content available as well that they can access from the website. Well, Ted, I have to thank you again for coming on the show. Really enjoyed it. And I hope we get to do it again sometime soon. It sounds great. Thanks, Trey. All right, everybody, that's all we had for you this week. If you're loving the show, Don't forget to subscribe to the feed in your app so you get these episodes automatically every week. And while you're at it, go check out theinvestorspodcast.com and be sure to look into our TIP finance tool.

Starting point is 00:58:30 This is the dream tool I've been looking for for years, and it's finally available on our website, incredibly intuitive and a real game changer. And lastly, don't forget to follow me on Twitter at Trey Lockerby. Give me a shout, give me some feedback, and let's be friends. All right. With that, we'll see you again. next week. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to

Starting point is 00:58:57 achieve financial independence. To access our show notes, transcripts or courses, go to The Investorspodcast.com. This show is for entertainment purposes only. Before making any decision consultant professional, this show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcast. Stay.

We Study Billionaires - The Investor’s Podcast Network - TIP343: How to Invest like the Best w/ Ted Seides

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