Yet Another Value Podcast - Fundamental Edge's Brett Caughran on setting up for success in the pod shop world

Episode Date: January 16, 2024

Brett Caughran, Lead Trainer and Founder of Fundamental Edge, joins the podcast to discuss Fundamental Edge, Brett's background, how pod shows think about earnings season, fundamental stories, liquidity and market efficiency, small caps, pod shops, risk management and pod shop culture. To sign up for Fundamental Edge's Analyst Academy, use the code "10YAVP" for a 10% discount: https://www.fundamentedge.com/ Chapters: [0:00] Introduction + Episode sponsor: Fundamental Edge [1:33] Brett's background and overview of Fundamental Edge [6:34] What do pod shops look at when they're thinking about earnings season [15:54] Fundamental stories [20:31] Liquidity and market efficiency, small caps [24:58] Pod shop strategies, stress tests, blow ups [33:53] How interest rate environment affects the pod model [37:45] Revenge of the small caps [43:27] Going to work at smaller startup pods vs. larger pod shops [47:49] Risk management [51:03] Pod shop culture Today's episode is sponsored by: Fundamental Edge You’ve probably heard it’s an “apprenticeship” system, or that you’ll “learn by osmosis”? But what if there was a better way to learn the equity analyst job? Fundamental Edge is re-defining training on the buy-side. Use the code "10YAVP" for a 10% discount. Website: https://www.fundamentedge.com/ Whether you’re already in the seat or looking to break in, the Analyst Academy from Fundamental Edge offers a thorough and flexible path to developing the tools and frameworks employed by leading hedge funds. Breaking in: https://www.fundamentedge.com/breaking-in Check out the Academy syllabus and sign up for future free content: https://fundamental-edge.ck.page/academyinfo

What if you could learn in weeks what it takes the average hedge fund analyst years to learn on the job? What if you could stop guessing at what your PM wants from you or how you should be spending your time and instead feel confident you were putting your efforts in the right direction? If you want to accelerate your byside career, the Analyst Academy from Fundamental Edge will give you the tools, frameworks, and confidence to excel in any fundamental equity analyst seat in the industry. The Fund Edge Academy is taught by a veteran hedge fund analyst in PM, Brett Coffron. Brett teaches a practical approach informed by his years of experience at some of the top funds in the world, such as Maverc Capital, D. Shaw, Citadel, and Schoenfield.

Wonder how top long-turt funds approach earnings season? That's covered. How will your PM expect you to add value in the first year on your job? That's covered too. Worryed about what makes a good stock pitch? There's a whole module on idea generation and thesis communication. Plus, you'll get access to the Fundamental Edge alumni community, a highly engaged community, which in just one year has grown to over 400 investment professionals.

Fundamental Edge alumni get access to exclusive webinars, case studies, and an invite to their first annual analyst spring training conference in Arizona. If you want to fast track your byside career, go to Fundamentedge.com for more info. That's Fundamentedge.com. All right. Hello, and welcome to the Yet Another Value Podcast. I'm your host and the founder of Yet Another Value Blog, Andrew Walker. If you like this podcast, swimming a lot, if you could rate, subscribe, review wherever

you're watching or listening to it. With me today, I'm happy to have on the founder of Fundamental Edge. Brett Kaufran. Brett, how's it going? I'm great. Thanks for having me, Andrew. I'm really excited for this. I think we're looking forward to hopefully doing a lot.

lot more together in the future, but excited to kick it off with this. Brett is the founder of Fundamental Edge. Fundamental Edges, well, I'll let you explain it, but, you know, Brett's pedigree is the list of pod shops and funds that he's worked at is probably longer than the list of pod shops and funds he hasn't worked at it. So Brett, do you want to quickly go through like kind of what fundamental edge is and then I'll walk through what we're going to do in this podcast? Sure, absolutely. And to start working at a lot of funds is not a virtue on the by side. That's indicative of some of the struggles I had along the way. I know people who would disagree because if you work in a lot of funds, it means you get a lot of garden time. And, you know, people love garden leave. The garden leave was

delightful. I do. There's nothing like a garden leave for sure. But thanks again for having me, Andrew, just to kind of tell my very quick story. You know, I had an improbable path to the by side. I grew up in a small town in Idaho, son of a steel worker, went to Arizona State. So not necessarily your typical hedge fund profile. Sounds more like you're running for Senate. then you're working at. Yeah, you didn't know. But I caught the investing bug in college, started investment banking and joined Maverick Capital in August of 2008. So I spent in total about 13 years on the by side, just about seven at Maverick, and then did a tour of duty in kind of the multi-manager space where I worked at D.E. Shaw for around two years as a healthcare longshore portfolio, worked at Citadel, the division of Aptagon under Citadel for a year, and then was

a consultant for two sigma for two years, a large quant fund where I helped them as a consultant to ideate and ultimately construct their fundamental investing business. And then the capstone was, I spent a year managing a portfolio for Schoenfeld advisors. And then in August of 2021, kind of reflected on my 13 year career, was on no one's Mount Rushmore. My kind of self-grading was I was a strong analyst, mediocre PM, and just felt like I was at the end of the the road, and so took some time to figure out what I wanted to do next. During that reflection period, I'd always kind of reflected on the silliness of the analyst training process on the by side, the fact that new fundamental analysts were generally just thrown into the mix,

and it was very much a learn through osmosis, synchrosim sort of approach. Not in a malignant way. It's really, to me, that's really more byproduct of the crushing. responsibilities of a portfolio manager on Wall Street to raise capital, manage the book, generate ideas. Too often, the training of the new analysts is the thing that gives. And so analysts more often than should be the case are left to learn on their own. As I kind of looked out at the environment of what was out there to train analysts, there There was some really good stuff on LBO modeling, accounting, basic Excel, but there's really nothing that tried to codify what bi-side analysts do on a day-to-day basis, right?

Trust me, I went through every training program, read every book by the time I started on the bi-side, I was still stuck when I was asked to look at my first idea, right? I didn't have a clear prescription of how to go from start to finish from a process perspective on an idea. So that's what we tried to do in Fundamental Edge. of business just about 18 months ago, a six-week, 60-hour analyst training program. That really is everything, every toolkit framework that I would like to teach an analyst if I were a PM, right?

Intentionally non-denominational, intentionally scraped of Brett's preferences and really meant to be a, you know, it's hubristic to say best practices, but we're seeking to codify what we think are best practices from an analyst perspective. and I could really kind of think about it as a salad bar of like we want to present everything out there and analysts whether they're a long-only or multi-manager will take what they want out of the program. But I view my job as one of exposure, exposing them to the framework, exposing them to the approaches. My, you know, I'm just a normal guy. I, you know, my track record was solid, not spectacular.

I think the benefit I bring is that I had the opportunity to work at the heels of some of the best investors in the world. And so I knew I didn't know anything when I started on the by side. And so I was taking copious notes for 13 years. And so those notes are really what have been codified into the program. So so far, so good. We've had almost 500 students through the program. The program continues to build momentum. And it's just fun.

I just love it, right? After, after, you know, decade plus on Wall Street, managing portfolios felt like a grind. This doesn't feel like a grind. This feels like work, feels like play. So, you know, we still think we're in the early innings of what we want to do in terms of becoming a bi-side learning platform. Awesome. Well, look, the reason we planned the podcast right now is actually two tweets of yours. So number one was a tweet around earnings season, right? So I planned, we specifically planned this January, what is it, it's 11th or 12th, January 11th because traditionally U.S. Steel would kick off earning season next week with the first report, earnings report of the season. I don't know if they're going to do that anymore because

U.S. deal is getting taken out. So it'll be like a change of earning season. But we planned it January 11th because A, earning season is kicking off. And B, based on one of your tweets that was about how individual investors can kind of compete with pod shops and smaller funds. Because like most of the people I have on this podcast are running smaller funds or individual investors. running substacks, right? And a lot of times, I think there's this, you know, it's a game selection issue, right? Are you playing your own game? Are you competing with the pod shops?

If you're competing with the pod shops, like, it's literally impossible because the pod shops have billions of dollars, the best research, the best models. So I just kind of wanted to kick off by talking about earning seasons, game selection and stuff. And I guess my first question would be this. All right, earning season. You know, there's this huge focus on earning season. Our individual invests, let's actually start with this.

What do pod shops look at when they're thinking about earning season? What frame are they viewing season as they're kind of doing their job? Yeah, I mean, so I would start at a high level, just like contextualize like the competing versus pods dynamic, right? Like the way I think about it is your timeframe is deterministic of your strategy. Your timeframe, you're leverage, you're deterministic, your strategy, right? Ultimately, the job of a stock price has to find a reasonable estimate of fair value. And so for long-term investors who have, you know, two, three, four-year duration, I would say

very little, right? Ultimately, stock prices, you know, the price for its value gap is what we're harvesting for as long-term investors, right? And so ultimately, the end point of any security should be, if you believe in somewhat efficient markets, should be a reason, less than a fair value, right? So for individual stock pickers, we're looking for ideas that are misvalued today and will be accurately valued in the future. And the closing of that gap is our alpha curve, right, our source of outperformance. And so that's kind of like first principles. Now, the path to get there is complex, right?

And the path to get there becomes a function of catalyst path, right? It becomes a function of who owns the stock positioning, right? And so this is the complexity that I think has emerged in the marketplace, right? The emergence of the multi-manager strategy, which has really exploded in the last, decade is now still only probably 2% of assets, but probably 20 to 25% of daily trading volume, given the leverage, the inherent leverage in the portfolios and the aggressive, high turnover nature of the portfolios. And so I kind of think about, you know, when I was starting in the business in 08, I was taught that unlevered long only is the incremental price setter, right?

We have to get inside Fidelity's mind, hero's mind, right? Janice's mind. We want to buy the stock before they come come in. We're basically trying to identify something early, and they're the incremental buyer. We're selling our shares to fidelity up 30, 40, 50 percent. That I think has changed a lot, right? I think now the incremental price center is the levered multi-manager model, right? And just look at the number, it's 20 to 25 percent of value. And so I think it's important for all investors to understand that that ecosystem has probably permanently changed. I mean, market's always permanently changed. We're not going back to the 90s or early 2000s. And so understanding the incentives of those investors, I think is an important part of the toolkit of an investor,

knowing that they're levered, knowing that the time frame is shorter, right? And so now getting to your question of earnings, roughly, it depends on the portfolio, but anywhere from 25 to 65% of an average multi-manager portfolio is driven on the earnings season, right? And that can include the run-up, the 14 days before the print, the 14 days after the print. But that period is a catalyst-rich environment. If you look at quantitatively, earnings days are 2% of a year's day, trading days, about 20% of idiosyncratic volatility, right? So that volatility is what pods are trying to monetize. What drives big moves on earnings? I mean, fundamentally, revisions, right, beats and misses relative to guidance, relative to consensus, and probably

more so revisions to forward to forward to forward outlook right so more than anything right on the multi-manager world those analysts and PMs are looking for large divergences in in estimates revenue ebidda EPS I think on Twitter sometimes pods get a bad rap of like oh we're looking at the FX and you know the sequential SG&A I think that sometimes the the knock on pods is that they're getting a little bit too a ticky tack in revisions. What I would say generally is that pods are looking for situations where there's at least a three to five percent divergence, right? A good long is not a stock that's going to be by 1% on FX, right?

The stock is not likely to move on that. So pods are looking for business momentum shifts, right, where business was performing poorly as now is ticking up, was performing well, is now ticking down, right? those business momentum shifts, given the extrapolating nature of markets, tend to drive larger moves, and then associated with that, large changes in revisions. And then there's a big positioning overlay of, you know, is this position, you know, a consensus long, a consensus short, you know, the positioning, again, on a long-term basis, doesn't really math, right? But in a short-term basis, whether something has run up into the print is loaded with aggressive investors

on the share register, that can tell you a lot about the likely distribution of outcomes of the stock on the print. And so from a process perspective, it's really all the things that you might expect. It's intense P&L-driven modeling. It's conversations with management teams. The typical pod analyst is going to two, three, four conferences per quarter, going to non-deal road shows, talking to investor relations. And so there's kind of this continuous conversation with the management team to try to elicit information from the management team. There's an integration of alternative data. There is a large survey mechanism that is used to try and try and generate insights. There is use of the cell side trying to, you know, obviously reading

a lot of cell side research, gleaning insights from conversations with cell side. And in some degrees, of field research, going to industry conferences, talking to industry experts, doing reading TIGIS transcripts, doing GLG calls. And so there's a mosaic process of gathering information and insights around your coverage group looking for the tails that have the largest expectations gap heading into the print. Brett Coffron, founder and lead trainer of Fund Edge, barely remembers his first year as a hedge fund analyst. Most of the year was spending a blind panic. Was his research any good? Was he learning fast enough? What did his PM? really went from him. Training on the by side was non-existent 15 years ago when Brett was a new

analyst at Maverick Capital, and he actually got demoted. Then he worked harder, found mentors, and asked for uncomfortable feedback. Eventually, he turned it around, learning by osmosis from the talent of people around him, and rose to managing director. But is this the best way to develop talent? Brett doesn't think so, and that's why he founded Fundamental Edge. The Fundamental Edge Analyst Academy provides students with the tools, frameworks, and confidence to excel in any fundamental equity analyst seat in the industry. Lose the panic and fast-track your on the buy side. Find out more about their next cohort at fundamentedge.com. So let me, well, actually, I think I was so excited to you. I forgot to your disclosure. So Bobby, be sure to put the

disclosure at the end of this podcast for sure. Remind everyone, nothing on this podcast, investing advice, please do your own work. So we'll just do that. I guess there are a few things I wanted to get at. So I do hear you, like you mentioned how pause focused on it, but I just want to, there are two things you have to. Let's start with positioning overlay. You mentioned positioning overlay a few times there, right? And that to me, like there's this, One of my friends always treats out, he says the monkey pod shops and it's two monkeys fighting each other with a knife. And that's like the literal knife fight, right? It's like the game of games where you're like, oh, I think all the other pods are long.

So if the, even if the company beats, like unless they really knock it out of the park, the stock's probably going to go down just because everybody's over a lot. So there's like that game of games. If you're an individual investor or a small shop, should you even be thinking about that game of games or should you be thinking about some completely different game? Does that make sense? I would say no. I would say no. I think that if you reverse engineer P&L, even in a pod in a year, getting those like third order, you know, knife fight, questions, right, is really not what

it's about. I mean, even at a pod, the big winners are going to be identifying your fundamental stories, right? Okay. So fundamental stories was actually my next question. So let me just ask on fundamental stories. Like, you know, you hear and we'll go into the, you hear all the time. look at a pod if you're down 3% it's over right acts done like these guys they they lever up five times and they would monthly alpha and I I personally and a lot of people have trouble marrying that

with anything but what we talked about right hey we're trading on earnings beats the earnings beats the nearest term revision the near term momentum is the most important thing but you also mentioned what do pods do they're going to four conferences a year they're doing all these like deep dive expert interview calls they're reading transcripts like the pods I talk to generally have incredible incredible fundamental views of these stores. But it's really hard for me to marry like, hey, I think over the next 10 years company XYZ is the real winner in this. And I'm backing it for this long-term basis with, hey, I need to deliver Alpha now.

Not tomorrow, not next month, not next week, now. You know, like, how are you, how do they marry those two things? Because I think it's something I struggle with and something a lot of people outside the pod world struggle with. Yeah, I think, listen, I grew up in a tiger world. And so I think, you know, we, we, I always viewed when I was in that world that our research was better than the pod world. I got to the pod world.

I'm like, damn, this is pretty good research, right? And so I would be careful ascribing these investors, pod investors to monkeys who are just focused on short-term prints. The investors I know in that world are incredibly insightful, have incredible industry expertise. and marry much of the goodness of the tiger world of investing in quality and good business and longer-durned stores with the tactical overlay, right? And so what I would tell you generally you see in these portfolios is a combination of quick hitters, right?

There are going to be some quick hitters. Hey, this company is kind of guide down, talk negatively at this conference next week. Let's take that up. In general, what you will see, though, is you will see, hey, I have a. position i like in this stock okay i think we'll go up 30% this year but i'm going to trade actively around that right if it's up 10% i'll chop it down if it if it pulls back i'll increase it so much of the turnover actually comes from trading the tactical risk reward around core ideas that you that you like it's not necessarily i'm long amazon this week short amazon next week long amazon this week there's

very little, very little of that. That would create, on average, too much slippage too, right? Just getting in and out of these ideas that quickly is very, very, very hard to do. So I'd say in general, there is a, there is a call to generate consistent P&L, right? Many of the best PMs are generating positive P&L, nine or 10 out of 12 months, right? And so that's remarkable. How do you do that? You do that by having a portfolio, a diversified portfolio of ideas. And the hope is if I have 20 longs, right, at any point through the year, one or two of them is hitting and paying off. So there's a diversification of when my ideas are paying off that you don't necessarily know. Then you have the earnings cycle, what's

you're monetizing every quarter with the run up, the print. And so that creates some steadiness to P&L generation, right? Maybe your average team isn't making money every earnings, but they're making money three out of four earnings and they have one bad bad challenging earnings and then you are throwing in hey you know this this sell side analyst downgraded the stock gets down seven that's a very flimsy downgrade i'm going to take that position from five million to 35 million aggressively and by wednesday it's going to be back to flat and i and i picked up some trading p and l fading that sort of move and so i think there's a combination in the portfolio particularly as you start to get to the size portfolio is a billion, two billion, three billion, those portfolios don't move that quickly,

right? You're creating a lot of price action if you're if you're too spivy, if you are too data point driven. And so I think it's a common combination. I think the other element around it, Andrew, is that the the beta and the factor neutralization process in these portfolios does limit a lot of the volatility relative to a tiger style portfolio. So if I'm if I'm neutralizing long-term momentum, these other factors, right? That can distill down to the core core alpha generation of the portfolio. So one of the things pod shops thrive on is liquidity, right? They need five to, they need at least five, but generally more than 10 or 20 million of trading volume a day. And these stocks have liquidity to do everything we're talking about. So that raises two questions,

right? First question. I think a lot of people think, hey, if you're a small manager, you should be focusing on where the pod shops are, right? Like your average counterparty can only trade in the 5 million plus a day. And I don't think it's a coincidence that most of the people who come on here at all, but most are pitching, you know, smaller cap stocks probably in the 500 million to 1 billion range that might be just outside of the liquidity purview of a lot of the pod shops, a lot of the big hedge funds, all this sort of stuff. And I think the thesis would be because they're, you know, the pod shops of hedge funds can't invest in these things. There's just a dearth of coverage of them, right? There's fewer analysts because they don't get paid the trading revenues.

There's more alpha, right? Less people are doing the work, so there's more potential alpha. I guess my first question is, A, do you agree with that? Yes and no. You know, meta was up, what, 174% this year? When I was going back and seeing your tweets and seeing, you know, that's one I thought about, right? Meta was up 174%. It had almost nothing to do with earnings. earnings were pretty good, but it wasn't earnings. It was, hey, people got comfortable, Mark Zuckerberg wasn't going to like all of their money on fire at Meta Labs, right? And people got comfortable he was going to cut costs when he needed to cut costs.

And that's not something you can really earnings track. And a lot of small investors hit it out of the park with that, right? I know a lot of investors who actually were long, like I posted an article, this could be, Facebook had the largest market cap drop in a day in the history. It could have the best market cap rise in a day in history if they just reverse what caused the drop. Now, unfortunately, I didn't really trade it, but some people did. So, yeah, I think it's like an interesting, it's an interesting philosophical debate to ask, like,

are markets more efficient or less efficient than they were 10 years ago? And like, I don't know that there's a, there's a clear answer to that. You know, I sympathize with both sides. You know, what's clear to me is that the markets are still not really efficient. The fact that it, that incredibly well-covered names like META can go up 174% in a year, I think does indicate to me that, you know, an investor who has the incredible gift of an open aperture should use that open aperture, right? I think the, you know, I certain list, I worked on a small cap team at a Tiger Cup for three years. I love small caps. I think in general, the discovery value of small caps is higher, the alpha loads are higher. I do think also the average business quality downcap

is lower, right? We're in an economy where there has been an emergence of oligopolis, right? right, emergence of really high quality businesses at the top of the market stack, right? And so if I'm a health care investor and I don't want to look at United Health or Humana, I'm probably doing myself a disservice even if I'm a go anywhere investor. And I would add the overlay that there are, there have been times where you get an incredible entry point on a meta or an Amazon or United Health or an HCA or other large, highly traffic names. Some of that, I think to your point, is because of the distortion of levered multi-strategy PMs, right? And so I think it's a really good time to be a Tiger Cup, a really good time

to be a long only. Because if you can understand the distortion in the price discovery mechanism, you can find these entry points that are incredibly attractive on a risk-adjusted basis. Right. So I kind of say like, you know, both sides of the market to me is still rich with opportunity. That opportunity can be episodic. But having a process to understand that, hey, the stock is down 30% because they missed the quarter and guidance looks too aggressive. So the whole pod crew is coming in and shorting it, right? Understanding that, okay, I don't care because I'm an IRA investor. Yes, everyone now understands that two or three quarters of earnings will be choppy, but we'll get back by Q4 and next year will be good. Having a little bit of patience

and time arbitrage to me is a huge, huge advantage in today's equity market. Let me just ask a question there. You mentioned taking advantage to the volatility of the pods, right? And I'd say at this point once a week, once a month, you know, five stocks will open down 2%, and five stocks will open up 2%. And people will say, oh, a pod somewhere must be blowing up, right? And I'm being a little facetious, but you hear it a lot more than it's even, there aren't enough pods to blow up for how often people say there's a pod blowing up. But you do hear that. And my first question is, you know, how often do you think these pod blowups or pod degrosings are actually happening? Like obviously, GameStop early 2021, that was a pod degrossing

event. Nobody's going to deny that. But how often are they actually happening where people can take advantage of them is it is it even close to as frequent is it as easy or would you is it really the days where you see oh my god avis is up 200% on a beat and every other car company is down 20% because avis is clearly getting short squeeze and everything else is blowing up it or is it a little bit more common to that i think it's um for probably every pod on wine that is that is called on twitter there you know there's probably for every 10 that are called on twitter maybe one actually happened, right? I think it's probably rare. It's like a recession. Economists have called seven of the last three recessions, except even less frequent. Okay. Yeah. I don't think it's

that. I mean, generally, when do unwinds happen of books? Like, when do broad degrossings happen? Broad degrossings at these firms happen in times of market curfuffle, right? So certainly during a game stop saga, certainly during like a COVID, you know, March 2020. and even not all funds degrossed during that period. Times where you have something, some sort of like fed surprise that everyone's, you know, upside down. And so the gross exposure at multi-manager firms tends to be pro-cyclical. What do I mean by that when performance is bad, gross will come off?

That is anathema to the Tiger Cub community that wants to gross up when prospective long short spreads expand, right? But that's just the way of the world in a levered ecosystem, right? Because if you're down 2%, that means you're down 10% on equity and you go into capital preservation mode at the CIO level of a firm, but also at the individual pod level, right? And so if you see an event where it seems clear that funds are licking wounds, those tend to be the add-on tends to be okay these those firms are going to degross into that right and so what what happens is i think in the tape is that many of these kerfuffles that might used to be

one or two-week experiences are now four to five-week experience or even even longer so i think the duration of kerfuffles has has expanded so i think look for broad kerfuffles but i look for sector-based kerfuffles like there's there's a big move in any energy price, right, that might catch some energy portfolios off sides, right? And so I think, you know, the tape has been very volatile the last, really last three years. So you probably have more of those than average. But on a random Tuesday, right, the CIOs of these places aren't walking around the training floor tapping people, like, take your book down, you know, take your book down.

Like something has to happen for these portfolios to really, really unlike. Now, what I would say is that five years ago, if there was, you know, a hundred billion of capital invested in the strategy, now there's a trillion dollars invested in that strategy. It doesn't take, it doesn't take a lot to create. So it's no surprise that these moves are more violent. There's just more crowding. There's more people at the poker table playing the game. Frequent question I'll get. You mentioned kerfuffle, right? And frequent question I'll get is, hey, these guys, you know, they're managing 200 billion in equity, but they've levered it up to a trillion times, right? And a frequent question I'll get is, hey, how does this not end in tears, right? Yes, these things have done well, but they're all kind of trading on similar strategies. And one day, one strategy doesn't work and you have a huge unwind and, you know, your 5x leverage and you're down 10%. So you're, as you said, that's down 50% of your 5x leverage. And it just all unwinds, right? This same way. long-term capital management. Now, that was, what, 40 to one leverage or something? But

once the unwind starts and you're that levered, it goes. And here you've just got a hundred firms and like you have, I know, people who've said, hey, this leads to a down a, you know, a black Tuesday, October 1987. This leads to a black Tuesday or a long-term capital management taking the whole market down 15% in a few months. Like, this is going to happen at some point. I kind of push back and say, hey, these things have been stress tested. Like the GFC was a little bit before these things really came popular. But I think they would have broken in COVID if they were going to break. You think about a game stop. That was very idiosyncratic, very fun focused. You didn't see a single real pod blow up. Or you think about the banking crisis last

year. You think they would have kind of started exploding in that mini-sib crisis. You didn't really see explosion. So I kind of think they've been stress tested. But what would you say to people who think, hey, next 15 years, this all unwinds on some weird idiosyncratic event just given the leverage and how much everything's kind of copying each other? I personally, I mean, I don't have a crystal ball. I don't see this as an LTCM sort of situation. I say if you actually think about the structure of these firms, they are quite diversified. They're quite diversified. The larger firm is quite diversified by strategy. So even equities as a portion of capital might only be 20 to 30 percent. There are commodities, macro, quond, credit, other strategies that tend to

tend to have diversifying effects in bad tapes. I don't think there's any surprise that Citadel has had this more consistent level of performance. And the scuttle boat I hear without knowing anything is that in certain periods of time, they'll have a big return from a commodities team or a credit team or a macro team. And so the larger firms have this diversification by strategy that if you think about just a very simple math of sharp, P&L is additive, but risk is the sum of squares. And so that diversifying nature of the multi-strategy element of these firms, I think, I think

one creates a steadier, high-sharp approach, but two, makes it unlikely that all of those strategies will unwind at the same time. Now, listen, every day that more and more capital comes into this similar strategy, the risk cranks up a little bit, right? And there is a leverage is a double-edged swore because the higher leverage you run in these strategies, the higher your ROE and these funds, the GPs are incentivized on return on equity. If I run three terms leverage on three times gross, I'm only generating nine. If I run seven times leverage, I'm generating 20, 21. And so just, just rounding. And so there is a, there is a, there are incentives to run more leverage on these strategies, which does scare me. I don't necessarily think there's systemic risk at the large,

like the big four firms. What worries me a little bit more are some of the smaller startups. You know, I saw a Goldman report that cited 55 multi-strategy firms now. And so I think there are pockets. There's certainly stories I hear of levered LPs generating, you know, contributing capital to a highly leveraged strategy and there's this daisy chain of leverage. I'm like, that's not going to work well. I think those seem to be some of the smaller situations in the marketplace. But to your point, do at some point, do we see a risk reversal in a smaller fund, a blow up and that creates an avalanche of pressure at other funds? I definitely think it's possible. I mean, Ken Griffin had a high profile comment or last year

about the possibility of waking up and seeing a 15% hit to equity. So, you know, that doesn't seem that doesn't seem unrealistic to me as well. I just think it's a little bit more nuanced than looking like an LTCM or Lehman sort of sort of situation. Let me ask you just two things you said there that I want to pull on. The other most frequent question I'll hear people talk about is, hey, you know, again, most of the pods really skilled up post-GFC, right? So all the pods have grown up in a zero percent interest rate world for the most part, right? And I'll hear a lot of people say, look, maybe this model worked really well running five X leverage when you could literally borrow four zero, but when you're borrowing for five percent, right? That's basically the Fed funds rate,

five percent right now, and you're running five-x leverage, like that one percent alpha just doesn't cut it anymore and basically they're thinking interest rates will blow the model up. I actually disagree for a few reasons, but I'd love to, not to lead the witness here, but I'd love to get your opinion on just, you know, the interest rate environment and changes and how that affects the pod model. Yeah. Listen, I mean, it's, I've learned to, I've learned to give these firms the benefit of the doubt. and I would point you back to 20,

2023, right? 2020 was a year where bed funds rate went, what, from 50 bips to 550 bips? There was the emergence of kind of squeeze behavior. We had an emergence of some of the 2021 sort of bubble dynamics in some pockets of the market. We had kind of almost a one-way beta-driven market.

That's a tough market. Well, it was one-way beta-driven in November, December. I think from January to October, it was a lot choppier. That's generally a tough market for multi-manager pod market neutral funds. The big funds generated 10 to 15% returns. And that's without any beta exposure. So there's meaningful net alpha generation in that returns stream.

And so despite this environment changing, right, these still generated solid returns, specifically just a question of the higher interest rates, I do think on a first order basis, higher interest rates are a bad thing for a levered investment firm, right? You're paying more for your leverage. Now, you have to consider the short side of the book, right? That was one of my big points. Yeah. If you're long short, you're going to get a much bigger short rebate, so you cancel out a lot of that. Yeah. I'm not sure that it cancels. I'm not a prime broker. I'm not sure that it cancels out the entirety of it, but it does cancel out my understanding is the majority of the majority of the of the of the increase short rebates

and gone basically to zero in a low interest environment and so when you think about leverage you're long 100 you're short 100 and so if you're market market neutral you have you have that benefit on both sides now I'd say the other thing you have to consider in like a post zirp world was zirp good for pods or was zirp bad I think generally zirp created a lot of challenges Right? Bubble behavior of stocks doing well above fundamentals, zombie companies kept alive by cheap financing, made things a lot more difficult on the short side, right? The short side of the book, 2021, 2022 was phenomenally, parts of 2023 were phenomenally difficult, right? So if you get into more of a normal environment where winners win, strong business models are funded, weak business models are not funded, and we can identify that differentiation. via fundamental research, right, there should be an emergence of long short spread in these portfolios that goes back to normal, back to the, you know, the old world of winners versus losers in a long short portfolio. And so I think there's some kind of belief that a more

normalized interest rate environment is actually good for capital formation. So I sympathize with, I sympathize with that, with that view from a sure selling perspective. Last question, and this is a little deeper cut, but, right, if you think about the pods growing up since the GFC, right? And pods do, and this is more, as you mentioned, pods don't just have most people, I think what they think they think longshore, trading earnings, all this sort of stuff. They have other sleeves, right? They might be investing directly into commodities. Some of them do, a lot of them do private, credit, all this. So it is more than this.

But, you know, in general, if you think of a pod as long short equity and thrott. and thriving on liquidity, well, the past 15 years have been the best in history for liquidity, right? In terms of the large have gotten larger, the magnificent sevens, the fangs, everything we talked about, right?

If you had a bias to invest more into liquid stuff and avoid the illiquid stuff, you had a huge tailwind over the past 15 years. And I kind of wonder, like, hey, this does come back to everybody playing the same game a little bit,

but I wonder if I told you the next 15 years, right, is the revenge of the small caps, which are less liquid in everything. Are we starting to talk about, hey, maybe the pod shops were actually riding a lot of beta in terms of liquidity and large cap beta. And if small caps really upperform, do you start seeing some of these pod chops? It wouldn't be a blow-up, but it just, they would not deliver the same out. Yeah, listen, it's an interesting question.

You know, I've been a small cap investor for a decade going back to when I was actually on the small cap team at a tiger cub and I caught the small cap bug. I just love it, right? When I was figuring out what I wanted to do next, I was going to small cap conferences looking for ideas in my portfolio. I'm not actively trading now, but at some point, I'll run a small cap portfolio again. I like the discovery value. I like the fact that you can find $0.50 in that universe. universe. What I have noticed is that the average quality of a small cap has degraded over, and that's just my perspective, has degraded over 10 years. And I think a lot of it comes to the

economic tailwinds, economic trends in the economy that, you know, big businesses are getting bigger, good businesses are getting better. Moats are deepening in many of the leading businesses. A lot of great businesses are staying private longer. And by the time they come public, they are large businesses. And so the history of being able to find a great business is a 300 million market cap company that goes to 30 billion. I think it's harder because the great businesses are getting more aggressive funding earlier in the private stage. And by the time they come public, you've already missed that market cap creation. So I think there are some structural challenges to being a small cap investor. Now, listen, there's, what, 4,000 small caps in the U.S.

alone. So that's a broad universe, and you can find some real gem, some real great businesses in that. But if I were, and again, this is my opinion, if I were to look at a rant, you know, a hundred small caps, you know, 85 are probably pretty four businesses. And so this whole argument of like the small cap index is going to rip. It's like, well, I don't know. Like, I'm not necessarily willing to make that bet that we're going to see an emergence of small cap driven, small cap driven where there tends to be kind of financials and there tends to be certain sector focuses. It's almost like the Europe versus U.S. debate where a big part of the reason that U.S. has outperformed other markets are these large tech firms or large, you know,

big, big winners at the top of the, top of the sleeve. So I would say selectively, do I believe in a world that we're going to wake up in 18 months in small caps. The small cap index is the new NASDAQ. Like I would take the under on that reality. And again, I kind of just go back to like, I'm going to believe in the pod model as long as they keep putting up numbers. And as long as I see the tape in large caps still alpha rich and back to the fact that you're seeing big dispersion in large cap stocks. You're seeing violent moves, big volatility. That is a good environment for firms that have fast turnover or paying close attention.

And so these large cap stocks that the scaled investors are trafficking in still seem to have a reasonable alpha pool. And you can kind of talk about risks and AI and competition and more gross. And I don't want to dismiss those risks. But my kind of bias is like, I'm going to believe in the alpha pool. a stream until I see, until I, until it diminishes. Like all the best investors, Fundamental Edge believes that the learning process never truly ends. That's why the Analyst Academy is just the beginning of their journey with you. Fundamental Edge alumni gain access to exclusive content, such as their guest speaker series.

It recently featured TEDCDs of capital allocators. Alumni can also look forward to frequent webinars, case studies, and content from industry partner. For job seekers, there's the talent hub, which helps both Academy graduates and other buy-side candidates connect with top funds looking to add new analysts. Alumni, including students enrolled in the upcoming January cohort, are also invited to the inaugural Analyst Spring Training Conference coming up this spring in Scottsdale, Arizona. Attendees will engage in numerous learning sessions while building their by-side networks, and then they'll enjoy some spring league baseball and the amazing Arizona weather. If you'd like access to all that Fundamental Edge has

to offer your career, visit Fundamentedge.com for more information about the next academy cohort. That's Fundamentedge.com. So I had another question, but I'll hop somewhere else. You mentioned AI. One thing I think people talk about, like, hey, if you're investing in a tech company, guess what's generally the best tech company to invest in? The largest tech companies, right? Like not always.

Obviously, you can get more explosive returns. But guess what? If you had gone back 12 years ago, the best company, now Microsoft's changed a lot. They fired Bomber. Like, I hated when people say, oh, should have just bought Microsoft 12 years ago. I'd love to see a world where Bomber had stayed on CEO for five more years and we could talk about buying Microsoft. But, you know, Apple over the past, like, it's generally been the returns of the scale.

And there's a lot of reasons. There's regulatory. The cost to play is huge and only a few companies can afford this, all this sort of stuff. Is there something similar with pod shops is what I'm driving out, right? Like, it sounds nice, hey, I'm going to go work for this 500 million pod shop so we can take less liquidity. We can trade faster. We can move these positions. That sounds nice versus going to work for one of these multi, multi-billion ones.

But the multi-billion ones, they're going to have the best risk management systems. They're going to have the best access to management teams. They're going to have the best tack. They're going to have, like, is there scale benefits that kind of similar to what we saw with private equity firms, right? The large guys get largest stay there. Or do you think there's room for kind of the smaller startup pods to outperform? For sure.

I think in the early days of the hedge fund world, there was really no enterprise value built on the entity of the hedge fund, right? Many hedge funds where the CIO retired just disappeared, right? And so generally hedge funds as a business were not really a business. per se. I mean, there have been a few that have made the transition, but Tiger is the best example, right? When Tiger shut down, there was no Tiger again. And so no enterprise value to that entity. A firm like Citadel and Millennium, there's real enterprise values to those, to those entities, right? In a way, if you think about the evolution of finance, the prop trading

desks that used to exist pre-Volker were housing a lot of this risk. It's a lot of the risk that was housed at the large bulge bracket property trading desks is now housed at these multi-strategy firms, right? And there is alpha generated from those firms doing things like treasury basis trades, which has been a focus in the press, right? That does require scale. It requires capital. It requires relationships with prime brokers to get that financing. It requires the ability to pay large guarantees. It requires the ability to raise large checks from LPs. And so the barriers to entry in the hedge fund world have gone up over time, certainly. The ability to raise one of these new funds is very, very difficult. You know, the scale you need from a

capital base is very high. So, you know, the subscale startups, I think it is a harder game. One, because you don't have enough capital to have a diversity of strategies. Two, just the resourcing to do it is difficult. There's certainly been some real kind of success stories of smaller pod startups. But I think in general, the lookalikes are going to have a harder time of it over the next few years. I think for those scale reasons. But also risk management is not a joke. I think one thing I've heard from some of these larger funds is starting to think about

tail risk hedging to the strategy, like how can you use derivative to create a tail risk hedge around a large long short unwind, right? If you have the view that the tape is more volatile and you could have a, you know, an 07 quake sort of dynamic in the long short community, how can you protect against that from a, from a derivative strategy to protect, protect that. And so the larger fund just have the, the team, the resources, the ability to sit through and start to think about integrating some of those strategies into into the portfolio. So even if a long, short strategy is blowing up, maybe the tail risk hedge is offsetting that.

And my commodities team is offset, offsetting that during a market confuffle. You mentioned risk management. So that brings me maybe the last question. I'll ask, you know, I have a lot of friends. And most of the people I talk to run concentrated small capbooks, right? Like maybe it's three, maybe it's five, maybe it's 10, probably no more than 20 stocks. And when you hear people talk about, hey, in this pod shop model, you're down 3% you're out, right? You're fired, you're done, your capital's pulled, whatever.

I've had a lot of friends say something to me like, that sounds like absolutely no fun, right? Like my portfolio is down 3% or up 3% in a day once every other week. Right? Because we run concentrated and small caps can move and all this or stuff. But once every other week. During earnings season, it might not be crazy for my portfolio to be down 5% on a day if my company misses. And a lot of times I'll have a great year because I'm doing these long term things and I'm focused on more than their earnings. So I guess what I just wanted to ask, like, for people who haven't been inside of it or people who are thinking about, I mean, look, most of the people who are going to your training programs are thinking about joining a pod shop. For people who haven't been inside, is it fun? Or is it just like, is it crazy stressful? Because again, people, year down 3% you're out and I think you'll think oh my god I I'd never want to sign up for that that sounds terrifying and awful yeah one clarifying thing I mean I've been talking a lot about pods on Twitter because I think it's very intellectually interesting in general in general probably about 20% of students who come through fundamental edge are on the pod track um we actually surprising to me have more enterprise clients on the long only side than the pod world um so I think you know

what we're doing is not pod specific. I think I'm talking and researching and thinking about pods mostly due to their impact on market price discovery that I think even if you're a single manager or long-only. It's actually not surprising to me that you're getting so many long-goldly students because again, if the game is the knife fight and you're long-only and the pods are trying to like knife you to take advantage of you and sell to you, you need to understand what they're doing.

So it's like this meta game where you understand what they're doing so they can't take advantage of you. maybe you take a minute. Absolutely. And I think to your point of like unwinds, I, I often will talk to a long lonely investor who's like, oh, I don't want to own this because the narrative is bad. And I'm like, what? And I think sometimes people think about long lonely just like sleepy, buy stock and hold it for five years. Like, no, they care about entry points, right? If they think the narrative is bad and it's going to be squishy for six months because pods are short it, many of these long only funds are now getting into that game my general bias is like you have time arbitrage use your advantage like think about things on an irr basis and ignore the noise for the next three to six months like don't get too cute if you have duration don't overthink it if you have duration now my general my general recommendation to these firms is raise your bar so if your bar was 15% IRA if you think it's going to be messy for the next six months demand 25% of IRA like

demand a higher prospective return to deal with that brain damage near near term but to run away from that trade that trade is this is the fundamental source of your long long long long long term alpha like use that use that advantage is my general you know advice just back to the question like again everything's for different people right there are people who do jobs that i would i would never ever consider it a million years doing but i do have a lot of friends for like would a a lot of friends, people graduate and forgot, would have podshot be interesting, right? Because a lot of people worry about that 3% axe had cut off Mogi. And they say, it feels like it would just be too stressful.

And I'd go in. I'd work there for six months. And, you know, I'd go in with a head of hair like I currently have and I'd come out with a head of hair like my dad, which is none, you know? So what would you say to people to that? Like, some people don't like it. Some people do like it, obviously. But on the whole, is it fine?

Like, how would people think about that? So I would say this. I'd say there's three different flavors of ice cream, right? vanilla chocolate strawberry, and on the by side, there's three different flavors of ice cream, long, only single manager and multi-manager, right? And so to me, fundamentally, it comes down to a matter of, matter of preferences, right? So let's dig into that. What do you get at the pod rule? You get a situation where if we'll talk about the good things first, right? You get a situation where if you're a talented young analyst and within the first year or two, you can demonstrate some

ability to pick stock successfully in that wrapper, right? There is almost unlimited capital at these funds, right? And so by year three or four, maybe four or five, you can be running a carve-out and having a direct payout on a $500 million portfolio. I know plenty of 26, 27, 28-year-old analysts who are running $4 to $600 million, certainly with oversight from the overlord PM, that's pretty awesome. You might still be in the training protocol at an instance. to Shillong, long, long, long, right? You're not touching a stock from a recommendation perspective until maybe years seven to ten. It's not the same thing. You're in the cell side. You're five years in, like, your name isn't published anywhere. You can go to analyst meeting.

But yeah, like, as you're saying, they are, this is a real like, if you can kill, you can kill is a strong word. But if you can generate alpha, they're going to let you generate alpha really damn fast. Certainly. And, you know, listen, the, Bloomberg is written in the past. about, you know, the war for talent in the world with some successful PMs in the multi-strategie world, getting 50 to $100 million guarantees. And so the beta, if you think about, you know, seats as beta, like the beta of the pot world is like by far the highest beta, right? The upside is almost uncapped. What I would say having worked in that model for a period of time is it is incredibly stressful, right? Three weeks feels like three months. Three months feels like three years. But

it will, I learned more in that year working at Citadel than any year, any year of my career. There's so much pressure, stress, intensity to perform that it pushes you to grow. The analogy I'll use often is like, no players liked working for Bill Belichick. Maybe it's a bad example because now he's on the downslide. Like, no one wanted to work for, No one wanted to play for Bill Belichick, right? But he created this level of excellence in the organization. And it was painful coming to, to painful playing for him. But you learned a lot.

You learned and grew. That's not necessarily saying anything about the managers of these organizations, but the rapper of the organization does require this level of skill paranoia to total commitment to generate P&L. that it does, there's no quiet quitting in a paw. Like you have to be totally locked in, totally dialed in. And that creates a, that pulls a level of like experience of execution out of you that is pretty awesome. Like I have huge respect for the people who are at these firms for five, 10, 15 years. I know I couldn't do it.

I have huge respect for their ability to continuously generate because it's damn hard. It is damn hard and it is damn stressful. Have you ever watched Billions? I'm sure, yes, or at least one. I stopped after the first, you kind of jumped the shark after the third season, the ice juice thing. But that was actually my favorite one where he's poisoning people for sure. That was my favorite. And it was really interesting.

But my wife and I used to watch Billions. We stopped a little bit after you. But I would always tell her it was really hard for me to watch it because, you know, Billions, it is a pot shop. It is a pot shop. I tell her it was really hard for me to watch it because there was no. no work getting done, right? These people like midday, every day, we're taking boozy lunches and like, yes, you can have the obsession with, oh, somebody's got a big like pot on pod boxing match. Like, yeah, you'll have obsessions. You'll have people. Be like, we're going to hire

you like Mike Tyson as your trainer for the next 10 weeks and something. That will happen. But there was just so little work getting done. I was like, I have trouble watching this when this little works getting done. Because I mean, I'm sure I'd work hard. I'm sure pod shop's work as hard, harder than me, maybe a little less hard. I don't know. But I guarantee you that there's no pod shop where they're going to four-hour dinners, five nights a week, like maybe an idea dinner once every other week where they're actually talking shop. But there was so little work. I was like, this is not the model.

And I understand dramatization. But that was just the, you walk through the trading floor of a pod shop. It's not good television. You have all the analysts on GLG calls, updating models, talking to IRs. I mean, that's not very exciting television. I mean, you know, 90% of the work is deep fundamental work. They're talking to companies, building models, doing research. reading cell side research going to conferences and so it's a very fundamental the process flow is

very fundamental well hey brett we're right up at an hour actually over an hour because i think you and i were chatting for five or ten minutes beforehand and i have to hop because torn peck and got a little physical therapy to run to but really enjoyed this look i i will say like as someone largely portfolio management analyst i mean i have a private equity consulting background but in terms of public stocks largely self-taught you know like when i was coming out of school, I would have, this would have been really nice if there had been a program like this. Even, you know, they teach you Excel at investment banks and stuff, but even the Excel skills and stuff is great. So, Brett, you're building an awesome product. People can check you out at

Fundamental Edge. This has been great. Thanks so much for coming on. Looking forward to the next one. Awesome. Thanks a lot for having me, Andrew. A quick disclaimer. Nothing on this podcast should be considered investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks. Thank you.