André Perold – Investing Through Exponential Change (EP.516)

25:09The inbox, whether it's stuff we didn't solicit or did, is big these days. We have built AI tools to help us do it. We work inside an AI sandbox that's secure, need to protect our data and everything. We have created an AI robot to imagine it's the investor. How would it evaluate each of these opportunities? It's an AI agent that takes the decks, gets industry information, gets information about the sponsor, gets information about the management team, gets information about the industry and the opportunity set. We'll build a little model. We'll create a scorecard. We've given it what the scorecard entries are.

25:55Client concentration would be an example. As a risk mid, you have a whole pile of things that you are scoring it on. And if it scores high, the team will look at it and say, wow, this looks incredible. Then we need to do the work to make sure that the AI did it correctly. We're running a back test to see if we had done this in the past, how well would it have done without any intervention on our product? It's an attempt to say, use AI to get you a long way without human intervention. Where can the humans spend the time where they are the best?

26:28André Perold:As you're able to put more money in the ground, the co-invests and the funds in that space, there's been this DPI problem across private equity. How do you think about what that looks like in smaller managers compared to the industry as a whole? The smaller managers doing small deals, small firms, they're at the bottom of the food chain. They are selling to the next layer up of PE that sells to the next layer up of PE, ultimately to the large cap PE. It's toughest at the large end where the entry multiples are the highest. The carry problem is the highest. We have found the DPI is much less of an issue in the lower middle market.

27:10It's still there, but it's nothing as bad as at the high end.

27:14André Perold:Let's move on to the next category, maybe venture. How have you thought about prosecuting that opportunity? Venture is a fantastic area. If you think about AI, there's non-AI venture, but most of venture today is basically AI. There's the AI side of how you invest, and there's the anti-AI. So if you think of small buyouts, roofing company, healthcare delivery services company, an engine testing company, it's not AI. It's the anti-AI. On the other side, venture is all about disruption. You want to be a disruptor. Exposure to venture and great VC firms is a fantastic way to be a disruptor. A balanced portfolio, you want both.

27:57Venture is a way of doing it. It's hard to time venture. The venture investments made in the 2010, 2012, when mobile applications were beginning, a few years after the iPhone came out. Incredible returns from that period. But would you have known at the time? I don't think so. Would you have known that crypto would have worked out as well as it has? You have to be in venture. You got to be thoughtful. Who are you partnering with? Do you partner with durable firms, the bigger firms that have a lot of money, have a lot of clout? We always love newer firms. Partners at the big firms leave and form a new firm.

28:38We do both. Then do you partner with highly specialized? Some of the VCs are super specialized in what they do. If you think AI will change the world profoundly down the road, which we do, how exactly? We don't. How much exactly? We don't. If you think there's a chance it's real, that five to 10 years from now, it's a world we don't really recognize, You need to be invested in things like VC. It's a critical piece of an AI strategy. A balanced portfolio will have that with other things. You'll have biotech, you'll have small biots and other things. The AI piece and venture is just a fantastic way.

29:18It's an arrow in that AI quiver.

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30:03André Perold:That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. When you think about those two opportunity sets in venture, the established brands and newer firms, most people think of venture as a pure access game. On that first side, how do you go about getting access to firms that already are well known as top players in the space? In our case, we're fortunate to have been doing VC for decades. We have longstanding relationships. We have access that we keep nurturing.

30:50That part is a continuation of what we have always done.

30:54André Perold:Outside of it, most of the firms that have been stars in the venture world have stayed that way. Occasionally, there's one that falls off. How have you thought about trying to be rigorous about, well, we think something might be wrong here. We should move on. But if we're wrong, we're done. it's nuanced because it's so relationship driven that not continuing is basically saying we're done this is how it works it's not like in a hedge fund you can take out half your position it's a critical piece of the value add to say we want to re-up in size with these in those we are going to pass knowing it may be a mistake for us on average these are good decisions you know that you're ending a relationship potentially.

31:47You've got to think it through.

31:48André Perold:How obvious is it to you when you decide to not continue with someone who has a longstanding pedigree? Some of it is easier. It's a version of what I was saying in the biotech stuff. You were the venture firm. They haven't added any partners. They're raising a ton of money. But the organization isn't adapting to the capital flowing in. Therefore, what they're doing is different from what they were doing in the past in an obvious way. Then you have to say, why all of a sudden are they doing bigger investments that they've never done before? The same people with no additional resources. Why is that still a good bet?

32:29Sometimes you can see maybe there's a path to that. Sometimes this is clear. Can't be.

32:34André Perold:How about on the lesser known manager side, huge universe of those venture capital managers, however many people used to be at Google or Meta or wherever else they're coming out of now. How do you filter through to decide the ones that you think are more likely to be successful, even knowing they don't have that many at bats? A lot of the ones that we do are experienced people with great track records coming out of big firms. Sometimes it's someone out of firm A and someone out of firm B. They've done some investing together. They may sit on boards together. They know each other well. They decide to team up.

33:17We look at their track records. The track records take work to sort out. We do the work. You try and understand the firm's strategy and everything else. Usually other people see the same thing. It's often clear these are superstars. They're going places. Then it's a question of can we get access? You can get in more easily than you think. You have to ask why. It's the Groucho Marx problem. Why do you want to join a club that'll have you? That's called investing. Investing is all about you joining clubs that'll have you. How you do that well, that's our skill set.

33:53André Perold:Before private credit became the juggernaut that it has over the last couple of years, that was one of the first strategies that you had carved out. Would love to hear what's happened with your private credit investing. Private credit's a fantastic space. It's a space of many things. Credit's just a contract. Someone says, I'll pay you X under these conditions. There's direct lending, unsecured. If there's EBITDA, you get paid back. If there isn't, you don't. There's collateralized lending. Our credit strategy is always based on where can I find great borrowers where making a loan in size is what they need.

34:35And fashion alone that's highly collateralized, that meets our needs, takes a lot of work. For that work, we solve their problem, but we get paid an extra return. It's a return for the work we're putting in. to return for complexity. If you can do those well, it's great. There's a lot of hoopla today, a lot of concern about software and private credit. The software thing is not something we have done. It's out there. It's overblown. We think a lot of the software will be okay because the credits are short-term loans. They're not long dated. The software, you just need it to pay off within a few years and you're going to be okay.

35:16it's not like if you own a software firm where if you own the equity the terminal value of that software firm is critical terminal value at a time of disruption is one of the hardest things to sort out if you take salesforce a great crm its market cap peaked over 300 billion it's down by 40 percent in less than a year because of the fear of disruption its earnings growth is fantastic. The earnings growth continues high and expectations are for it to continue to be spectacular through something like 2028. Beyond that, we don't know. It's croaked in price. The multiples have come way down because the future value isn't known.

36:02The earnings are great. Could you lend to Salesforce and be okay all day? You want to be an equity owner of Salesforce, you need to understand terminal value at a time of enormous disruption. On the credit side, there's a lot of software that could be just fine. Even though software is suffering, it doesn't mean the loans are a problem.

36:21André Perold:The notion that the loans are short dated, you only need to get paid back, almost presumes that someone else is going to take you out. How do you think about when you're underwriting a private credit manager, they may make a short dated loan. If there's no one else take them out, they're the ones who need to roll to keep the company going. So the end game in credit, it's rolling. Where there's a risk of impairment, it's a negotiation. It's extension. Extension on what terms? If you're sufficiently collateralized, then the issue is you can take a fair hit and still get your money back. We do most of our loans with originators.

36:59We do one loan at a time. We'll do an energy loan. We'll do a transitional real estate loan. We'll do a housing loan. We'll do an equipment loan, each with a specialist in that area. Equipment lending needs a specialist. You wouldn't do it with a generalist. We have a detailed, very sharp pencil on what is the loan, what is the collateral, what would have to happen for it to be impaired in the way you're describing, where things get worse. Maybe you're in a negotiation, an extension. You have to handicap that risk. That's part of the math.

37:35André Perold:In the broad universe of types of loans you could make, where have you found the most exciting opportunities? It's in GP solutions. GPs have a need for money. GPs have to commit to their funds. They have to raise money for their funds. They have to show they can't always raise the money. If we can structure a solution through a form of a loan that helps them do that, It's an interesting part of the credit space is the GP solution space. What are some of the other ones you like? They come and go. Energy was fantastic. These days, everyone's back into energy. It's less interesting. Data centers are huge and massive.

38:17There's only so much that the end investors want to do in data centers. So you can get some fantastic loans in the data center space. Someone's building a data center. It's a construction loan. under certain conditions. It's highly collateralized. There are deposits people put up and you get the deposits the minute you cross thresholds. The collateral is directly or indirectly related to a hyperscaler often. You've got to think about their credit. What if it goes wrong? But it's become a fantastic space. Are there areas in private credit you're decidedly avoiding? We've always avoided direct lending.

38:54Lending to sponsors, uncollateralized, where you make a loan and you hope there's enough profits. That's the vast bulk of private credit is direct lending. So we've always avoided that. Why? Because we want to see the collateral. We want to get paid for complexity. It's a far more commodity space in the lending markets. It used to be you got very high returns. We're not sure you're getting paid enough for the risks. If things don't work, you're arm wrestling the PE sponsor as to how to renegotiate the loan to extend it if they can't exit their position in the firm that they own. We can't easily get an edge there.

39:35We think it's a pretty commoditized space. The bespoke loans where you're solving someone's problem one loan at a time, there's a lot of complexity, but a lot of value you can create.

39:47André Perold:In addition to these four, biotech, private equity, venture, and credit, I'm curious, Chris, what else you've dove into as a niche strategy? There's a lot of niche stuff you can do. It's not clear how long lasting it is. These others we've talked about, we're deep in the weeds. We see it as being pretty enduring. I'll give an example. Japan activism is a very interesting strategy, but we don't have to stay there. We'll go there opportunistically in a multi-asset mandate. Long short traded credits. Is it enduring? Not so clear. Is it a niche that has the moats that these other niches we've talked about have?

40:29No. Can others carton onto it and go and compete away? Yes. We expect that'll happen. Right now, they're very interesting. That's being opportunistic in the moment to take advantage of them. What are some of those other opportunities that you have your eye on today? There's interesting things going on in Europe. If you look at Europe compared to the U.S. and emerging markets, slower growth, it's messy. There are fantastic opportunities, for example, in restructuring. There are opportunities cross-jurisdictional. Every country is its own jurisdiction. A firm is doing business in two or three or four or five jurisdictions, or there are several firms involved.

41:10There's an issue to be resolved. If you can find a way to cut across those and solve a problem, you've got something real. In Europe, there are great franchises that people don't seem to care about. It's non-AI. Europe's an interesting place for less flashy things, but phenomenal stuff if you're set up for it.

41:31André Perold:If you take a step back with your flagship multi-asset portfolio, you have a couple of core prongs in these activities and then this series of tactical opportunities that come and go. How have you brought that all together into a single strategy? The compass has always been, where can we find alpha? In a multi-asset fund, where can we find interesting opportunities through a lens of alpha. What is scarce is alpha. Beta, you can get cheaply. The recipe is put your money where there's alpha. For each investment that has alpha comes with some exposure to a market, beta. You say, okay, I put my money in all these places where there's alpha.

42:18What is the beta I'm getting from each? You aggregate the beta. Then you ask, is the beta where I want it to be. There are two investment processes. The main one, what we do every day, come to work, bottom up, find alpha. Then we run a beta management process that adds it all up, and then we true it up to the beta we want. So if we're way underweight Europe because we didn't find much alpha in Europe, we'll add to Europe to get the beta right. If we like that beta, not always. There's a beta process and an alpha process. The firm is about alpha. The beta thing is important, but side process. How do you calibrate your desired beta selection?

42:59It's mostly broad market weights. We're going to have a strong bias to the U.S. We find a lot of alpha in the U.S. We'll find alpha in China. We'll find other stuff in Asia. We'll find stuff in Europe. It's not that different from the broad market beta weights.

43:17André Perold:Over the last bunch of years, you've gone from that one multi-asset strategy to a whole set of different things in different ways. There's the basic buy and build at different points in time. I would love you to take me through each step of how you did that, the decisions you made to buy or build along the way. The main thing was the realization, if we could find these inefficient markets, I call them beautifully inefficient markets. There are a lot of inefficient markets that are ugly. You can be right about some company in Africa will make money, wrong that you'll get your money back. Because when they make money, things go wrong.

44:00The government will tax them. Insiders will transfer price the money away. There are a lot of inefficient markets you don't want to touch. The beautifully inefficient ones are the ones where it's very clean. If you can figure it out, it'll work. It needs a moat from competition. What protects you is limited capacity and the need for deep specialization. Once we saw that recipe, we said, wow, where can we do this? We made some. We acquired others. So we made the biotech and the credit. We acquired the small buyouts and the venture capitalists in continuation vehicles we are making. We've added a team that is doing that.

44:40It's related to the small buyout thing that we have now. that we acquired a number of years ago.

44:46André Perold:What does that process look like internally when you know there's a strategy you're interested and you're trying to figure out how to go about building it or buying it? A lot of it is understand the opportunity. You say to yourself, there are opportunities. How would I source them? How would I underwrite them? What team would I require? How protected is it? Are they moats? A lot of it is the availability of the right people. Sourcing is the name of the game. Our firm is built on making connections. It's finding the right people. Some of that has all happened through COVID, which changed a lot in the way people were working.

45:27André Perold:How has the culture of the organization evolved over the years? There's many aspects to culture. One is, what is hardcore will never waver from it. rigorous thinking, honest communication, being very frank, having debate about an investment, we'll always do that. Increasingly, you need to source further afield. There's not a lot of investment opportunities sitting here in the Boston Common. There's more opportunities walking down Fifth Avenue. Even there, there are a lot of people chasing them. How you source is the single biggest thing. Where and how? You've got to locate yourself in those places.

46:07Increasingly, we find we need to go further afield. Everyone comes to work every day. How do you build a culture where you can have that rigor? People know each other, yet more of it is done remotely. It's a constant tension because you're trying to get the best of both worlds. You want to be remote, but you want the culture to be intact.

46:29André Perold:What are some of the small things you've found that have been effective in making that work? Four times a year at a minimum, maybe five, maybe six. Everyone comes to the office. We do a lot of sessions. We do town halls. We'll have company outings. We'll have deep dive investment sessions, meetings with a senior leadership about a question such as data. What do we do about data? How important is data? Critical. Where can we do better? What skill sets do we need? Who do we need to hire? We had a phenomenal session on each team. We talk about if they had to build a robot, what would it be? In the presentation, they came out and said, oh yeah, I've already built it.

47:14Don't worry. Here it is. It was fantastic. Things like that where people talk about what they're doing. The rate of adoption of AI in each team has been amazing. As they talk about it, everyone learns. The value of being together and sharing these ideas, it's profoundly valuable. You do that enough, the place keeps humming, but you got to do it enough and you have to do it well. What's next over the next 5, 10 or 20 years for HyVista? We love the recipe of beautifully inefficient markets. It's looking for new opportunities to do those. We have a bunch we're looking at as we speak. as you talk about the next five or 10 years, we just have to understand AI is big.

47:58It's going to be a different world. The nature of investing, the nature of competition, it's all going to change. How do we do well for our clients, put up great numbers in a world of dramatic change? That's what we need to do. To have a compass that keeps you balanced, have an edge, it's exciting. You got to keep at it. You can't relax. The next five years, the next 10 years is going to be doing these beautifully inefficient markets at a time of dramatic change.

48:32André Perold:What will it take for both you and your team, the partners that you're working with, to be able to stay on the ball in a time where there is such rapid change? It's a version of what I said about the AI robots and the adoption It's incredible to see how people naturally are drawn to AI If I say, hey, Ted, I don't have to tell you it's cold outside, take a sweater You know if you take a sweater, you're better off The team naturally is adopting AI, not because you're pushing them into it Because they're finding it helpful, they get much more done If we are that kind of firm where we give people the ability to do that, make available the resources that they can innovate in what they do.

49:22André Perold:All right, Andre, I want to make sure I ask you a couple of additional closing questions from the last time we talked. What's the most rewarding thing you do outside of work? My wife and I are blessed with a small, young grandson, our first, Remy. we watch him play and learn. It's fantastic to watch. What is so interesting is you see how much you learn by playing as a kid. Then you draw the parallel with AI. The way to learn AI is to play. You prompt, you try, you learn. If you can't play, improvise and be comfortable just being a kid in AI, you can. So we watch Remy. I say, hey, that's what everyone should do as an adult.

50:07It's fantastic.

50:09André Perold:What are you unusually good at that most people don't know about? I love making things, fixing things. I'm a good carpenter, plumber, electrician. I used to do it as a kid. I still love doing it. It's therapeutic. What have you changed your mind about the last few years? The single biggest thing is coming to believe that exponential change is real on many dimensions. War is never going away. It's too easy to make a drone and shoot at someone. I don't see deficits going away for a long time. I don't see AI suddenly withering. I don't see innovations in healthcare disappearing. It's a different mindset.

50:53It's a very big change. Andre, last one.

50:56André Perold:If the next five years are a chapter in your life, what's that chapter about? I go back to one of my first chapters, which is I was a pretty hardcore programmer back in the day. You play with Claude Code, Claude Cowork, Vibe Code. It's amazing. I want to program my calendar. I want to program my email. I want to program a lot of this. And only I can do it because it's me. It's my life. It's my tastes. I'm now playing with it and doing it. It's exciting. Andre, always so much fun to catch up. Thanks for taking the time. Thanks, Ted. Thanks for listening all the way to the end. If you made it this far, how about one ask from me?

51:38André Perold:Tell one friend about the show. It's the best way to keep growing this incredible community. Thanks so much. And until the next one, stay curious and keep compounding knowledge, relationships, and capital a little bit at a time. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions and securities discussed on this podcast.