Brett Barakett - Digging for the Puck at Tremblant Capital (EP.386)

24:10Hey, do you have a long -only fund? And then we had one client, a guy named Matt Stefan. And he calls me. He says, hey, I just got this new job and they put me in charge of long -only. And I want to invest with hedge fund guys who have long -only funds. Do you have a long -only fund? I said, Matt, we're launching one tomorrow. Well, I didn't say I was investing in it. I was just saying, do you have one? I said, but no, Matt, we're going to launch it tomorrow. And so we did. In 2011, we launched a long -only strategy, and we went from there. So once you introduced the long strategy, I'm curious to get your thoughts now about the validity of long -short.

24:41Because they've been cutting rates since 9 -11 at a rate and to a level that none of us ever could have predicted, shorting became less and less attractive. The market just kept plowing ahead for a bunch of reasons. The debate now is, why would you want long -short? Well, now there's finally a real cost of capital again. And we think it's a phenomenal shorting environment. Why? Because there's a whole bunch of people that are carrying a ton of debt that was basically for free, which is not for free anymore. And so what we believe is there'll be a culling of the winners and losers. The strong will get stronger and the weak will get weaker.

25:15The strong balance sheets will get stronger and the weak balance sheets will get weaker. I do think there's a world, given what we see today, that makes a lot of sense for a long short. That might change again. If all of a sudden something happens, they blow up buildings and we start cutting rates to zero again. Now we've learned a lesson that long short might not be the most attractive place, but as it stands now, long short, I think is very attractive. What have you learned over the years about the types of short positions that work for you? I love smoking gun shorts. When you find that smoking gun in the accounting where you're like, wait a minute, they changed the appreciable life of their average asset from, I'm making it up 10 years to 20 years in the course of the year.

25:51Why would they do that? If they hadn't done that, what would earnings have been? So you look at that and you say, okay, that's a smoking gun. I got you. Or you told me you rented a car for, what'd you pay? $45 to rent your car for the day? I'm like, it was a really nice car. And I'm like, we're not working on, is there a short in the rental business? Because if that's the price, that's not normal. Just in your travels all the time, we come across stuff and you go, oh, that's interesting. That's different than what I thought. I should follow up on that. I'd love to circle back to the investing underneath what's going on in the business.

26:25How did you describe the investment strategy of Tremblant? I want to compound my own capital. That's been my North Star since we started, which is what would I want to do with my money? The process by which we invest falls into following four parts. Number one is an assessment of the business model. So it's basically if you brought McKinsey into a business and said, hey, is this a good or bad business? What would they do? And this is overly simplified, but basically they'd say, okay, what product or service does that business offer? what competitive advantage do they have relative to their competitive set, and is that competitive advantage sustainable over time?

26:59Michael Porter, buyer power, supplier power, these types of things. But basically, that's the idea. Is competitive advantage and why is it sustainable? Part two would be assessment of the financial model. And here, to make it a little more colorful, what I say is, hey, Ted, how about we give you the financial statements of a company? We'll white out the name of the company so you can't see what company it is or what industry is. We'll just give you the income statement, balance sheet, and cash flow. you have 15 minutes to tell us whether or not it's a good business or bad business just based off of the financials.

27:26Okay, that's a good exercise. So what would you look at? Well, I'd look at cash flow. How much is cash is being spit out of the business? What's being reinvested back into the business to have it grow? What's left over is free cash flow and then how are they allocating that free cash flow? Number two, I'd look at the returns on invested capital. So let's take two examples. General Motors has a lot of capex and so ROIC is lower than say Nike, which has almost no CapEx because they outsource all the production to somebody else. So we'd look at ROIC, and then we would look at what we call the ROIIC, the return on the incremental invested capital, so that the incremental dollar bill that's being reinvested into the business is at a higher or lower rate than the prior business.

28:07You'd look at what we call QOE, quality of earnings. GAAP accounting, G -A -A -P accounting, is assumption -based. Now, in the real world, we're cash people. Well, I bought that piece of equipment for, I don't know, $100 ,000, I paid $100 ,000. Well, in gap accounting, we then get to choose whether we depreciate that piece of equipment over five, 10 or 20 years. And depending on what you choose will impact your gap EPS. So if I choose 20 years, well, my earnings will be higher than if I chose five years. Well, as analysts, we just want to make sure we're understanding what assumptions were made and bringing everything back to cash accounting.

28:41And then finally would be valuation. Okay. What kind of cash do I think they're going to generate out into the future, bring it back, discount back today, and compare that to our stock. So business model assessment, financial model assessment. Third is we want to know what's changed. So what is changing in the world or what is changing this company or what is changing this company's industry set that will tell us why this is interesting now? This is an old example, but for those of us over the age of 30, might remember Blockbuster. When we started back in 01, I can't tell you how many deep value you guys, you got to own Blockbuster.

29:15It trades at five times free cashflow. It's just so cheap. Well, obviously things are changing and Blockbuster ceased to exist. I mean, Blockbuster traded three to five times free cashflow until it went to zero. And so you got to look at change and change comes in many ways. It could be something as simple as a new product launch, or it can be a competitor that launched a new product. It could be AT &T, Verizon, T -Mobile, and Sprint, which is a four -player oligopoly. All of a sudden Sprint and T -Mobile merge, and now it's a three -player oligopoly. So the competitive dynamic change, it could be a new CEO comes in, a new CEO has a new strategy.

29:45It could be a new CFO comes in and they have a new financial strategy and things that they want to focus on. It could just be, we saw very recently, both with Elon Musk and X and with Zuckerberg and Meta, two great examples of CEOs saying, yeah, we don't need to spend all this money. What did X go from 8 ,000 employees down to two? Right? And so I think so many companies were like, wait a minute. Yeah, we don't need all these people. So the cash flow that then spits out the other side. And then the last part, which is probably the most important, goes back to what I said about being fact -based decision makers is what independent research can we bring to bear that is outside of the financial statements, outside of normal financial analyst work that we can bring to bear that would help us make a decision here.

30:30And that's where we spend a lot of time. So within all of those lenses, a business model, financial model, consequential change, and the research you can bring to bear. What's the sweet spot of what you like to find in a long position? All of them. In a perfect world, you'd find a company where something changed. You would say, well, the moat around there can be advantage is just increased. I love when people say like, oh, back in the day, Amazon trades at 150 times earnings and they don't generate any cash. And like, what are you talking about? They're generating an insane amount of cash. They're just reinvesting it all back in the business.

31:03So we love finding things like that. there's some controversy. So we try to isolate. We try to figure out that one factor. Chris Shumway gave me great advice years ago. He's like, you're not going to outmodel the other guy. We're going to build models. Figure out the one driver that will dictate success or failure to your thesis, and then spend all your time on that one thing. And that's what we try to do. So in that last piece, that incremental research, I'd love to hear the evolution of what did that look like 20 years ago? And what does it look like today? So different. It's incredible, the power of technology and how it's changed that aspect of what we do.

31:40So you go way back, even before I started Tremblant, when I was working at another hedge fund, it wasn't like I had some big idea. To me, it was just like, well, I got to do this. So there was a company called Abercrombie & Fitch, the retailer. And I thought Mike Jeffries was a brilliant CEO. I thought his product was great. I thought he'd found a real niche for what he was doing. And so I did the model and I said, oh, these guys are going to bang out stores. So what we call the self -funded in retail investing, meaning that they're generating enough cash from the existing store base to open new stores.

32:10So the self -funded organic grower. So let's say that they're going to grow the store base 10 or 15 % a year, and then they're going to put another 10 or 15 % same store sale on top of that. So then you're going to get to a 25, 30 % top line, and then they're going to get leveraged. So that's really attractive because if you get a good retailer that can do that, that can grow for a long period of time. So I thought Abercrombie was going to be that. But part of my analysis was, okay, I got to go to stores. So I spent part of my day going out to Abercrombie's and asking certain questions. And then I realized maybe if I hire two or three high school college kids in different geographies of the country, it could lever my time.

32:47So pretty much every Thursday or Friday, I would call them and say, hey, listen, I need you to visit five stores over this weekend. And it's really simple. Here's what I want you to do. I want you to go find Abercrombie. I want you to walk in and I want you to find an associate on the floor and ask simple questions. Hey, are you getting more hours or less hours? Are you guys looking to hire more associates or are you firing associates? Hey, did you get the new line in? When did you get in? Two weeks ago? How's it selling? Oh, you've already sold out half the line? Or, hey, you got in two weeks ago and half the line's already 80 % marked down?

33:17These types of questions. Look around the store with the best guess, just eyeballing it, is 20 % of the store on 20 % markdown or it's 80 % of the store on 80 % markdown. And so it was that simplistic that we would just visit stores. And so Abercrombie at one point became somewhat controversial and the stock went up and then went down a lot. And I just maintained my conviction because I had enough data points from on the ground showing that Abercrombie was actually selling really well. And one of the small pieces that became controversial was people go in the stores and be like, hey, hey, half the store is empty.

33:51They've got an inventory issue. Well, what it became was, no, half the store is empty because they sold out everything at full price. And so that was independent research back then. And how has that changed over the years? So you can still do that. And we do do some of that. But now so much is sold online. The world has changed. We can scrape and create web bots that get so much information for us, which is rather than a small sample set, a big sample set. And so we can get so much more data from that kind of thing. And then you layer on top of that survey work. 23 years ago when we started the fund, you actually had to gather the people.

34:26Today, hey, I want this demographic, this income level, this age group, and this type of job. And you can get a database really quickly. And even now, yeah, I'm still a little suspect on this. AI can do that for you. You can say, tell me what 18 to 24 year olds would think about this brand or this product. And the AI will tell you, I'm still old school enough. I want to do the survey. I want to ask actual people as opposed to the AI telling me what it thinks. How did you sense over the years that the market was either incorporating or not incorporating this type of varying information? So it's boots on the ground 20 years ago, and now you're looking at your computer and web scraping and checking in on AI?

35:06You have to do both. So we have plenty of examples on investments over time where we just go out to the stores. You would survey a bunch of doctors. You could do a survey where somebody fills out a multiple choice questionnaire, but a lot of times more valuable surveys are, hey, can I ask you a few questions? And you just ask them, hey, what do you think of this? What do you think of that? But like all things in this world, there's shared learning, but there's also a lot of copycat. And so people talk and they're like, oh, how did you figure out how to do that? Oh, you visit stores, huh? We should visit stores too.

35:38And then things morph. And so what we used to call independent research or fact -based decision -making then morphed into this thing called data sciences. So you look at now the world of data sciences, I think you can get master's degrees in data sciences now. Obviously 10 years ago, you couldn't. Why? There's so much data now and everybody is trying to stay one step ahead of everybody else. So everybody knows you can buy credit card data. Everybody knows you can buy weather pattern data. Everybody knows you can buy satellites looking at parking lots. I mean, this stuff has been well -written about.

36:08Some of that is useless. Some of that is useful. A lot of it needs to be overlaid with each other. So looking at the parking lot today versus exactly one year ago may be completely useless depending on what the weather was like the prior year, whether it was raining or sunny, what the holiday was, was Easter earlier or later that month. So these things, they get complicated very quickly. The last piece I would say is I remember talking to somebody who has a very large organization and they talked about big data and we were talking about data lakes. They were going on about their ability to scrape their data.

36:42We are the opposite. We talk about little data. We want to go find that one thing that's going to drive success or failure and bring a lot to bear on that one thing. And that is where we spend all of our time. How do you think about the importance and assessment of management teams in your companies? My wife, Megan, says all the time, how you do one thing is how you do all things. If you're polluting rivers behind your factory, I can only imagine what else you're doing. if you're cheating in other parts of your life. So yeah, this is critical. Look, not everybody's squeaky clean. One of my brothers, Peter, runs a business called DDC, Due Diligence Consulting.

37:17We hire him all the time to do background checks on management teams. There was one company we invested in a number of years ago where I just didn't feel good about the CEO. I mean, I know this is ridiculous, but I just had a bad feeling. And so we spent a fortune doing a background check on the CEO and CFO of this company, it was what I call a yellow flag. There was no red smoking gun, but there was enough there that we cut back the position. And it turned out that we were right. There was a problem and the stock was a fraud. We're lucky that we had cut back the position. So yeah, how you do one thing is how you do all things is a great way to assess not just management teams, but also investment managers.

37:53I don't know why you would ever put serious capital with an investment manager that you didn't do a deep dive on their background. Once you've eliminated certain management teams because of, say, yellow flags, maybe red flags, how do you assess the quality of a management team and the companies that you're interested in? You want to see talent. The same thing you would look for in an investment manager. You want to see grit. You want to see that they're driven. There's a track record of success. There's a lot of smart people. The prettiest guy in tryouts for the hockey team, that's one thing. But when the puck drops, you see who can actually put the puck in the net.

38:25And those are the guys you want. Some guys decompose when the game starts. And then obviously alignment of interest. How much stock do you own? I love sitting with management teams and we get in this conversation about how much stock do you own? What do you think your stock is worth? Why? Well, here's what I think. Sometimes I think I'm crazy and then it's like, okay, let's debate it over time. But now we're aligned. That's how I do it. Are there any things that you saw from your operating experience back in the Procter and Reebok days that give you some lens into deciding if the management team are better or worse than somebody else might think?

39:02I have to admit, I love CEOs or senior executives who know the granularity of their business because they love it. Jim Senegal, who used to be the CEO of Costco, you meet with that guy and you walk around at Costco with him. He is just locked in. He is taking notes. He's asking you questions. I can't remember what store it was. I shopped at, I think it was in Long Island. I shopped at a Costco and I mentioned to him that the carts, shopping carts, the wheels were busted on a bunch of them and that they didn't roll that well. I think a month later I was back at that Costco, all brand new shopping carts.

39:36Jim Senegal is so maniacal. Galanti, the CFO at Costco who just retired. I mean, that guy knew his business backwards and forwards. It's always concerning to me when you talk to someone senior at a company and they don't know some degree of granularity. How do you weigh the quality of management when you're looking at the business model, the financial model, the dislocation or change in the types of companies you like to buy? That's a very good question. It's a threshold. It has to be above something and then everything else is just benefit. And then we focus on the other things. because at the end of the day, whether it's the industry sector, the product, new product launches, there's some dynamic that we think is going to drive this forward.

40:19That's most important to us. Without naming names, you can look back over the last 10, 20 years, 30 years, companies that had a step on the competition and gave it up because they just didn't execute. We've made a few mistakes. BlackBerry. By the way, have you seen the movie? Movie's hysterical. A little too close to home because we made a bunch of money in BlackBerry and then we lost a bunch of money in BlackBerry. We were early, one of my partners was like, this mobility thing is going to scale much faster than people think. And the winners are going to be Apple and Google and BlackBerry. And the losers are going to be Nokia and Sony.

40:50So we had the longs and the shorts. And at first we did well on all of the pieces except BlackBerry. And you look back and it's like, yeah, they were skating a little too fast. So yeah, that comes down to management. How do you go from incorporating all those bits of research into making a decision about a stock? Well, there becomes judgment. As you know, thousands of people graduate from top schools every year and come into the money management industry, and there's very few who can generate alpha. So it's very, very difficult. And so there is a degree of judgment. There is a degree of, I'll call it artistry.

41:25There was one senior person at endowment who shared with me, you can play the notes on the instrument, but I don't hear music. And that's a great line. And I think that's the same thing with investing. You can have all the tools and everybody knows how to build an Excel spreadsheet and do a DCF and overlay a Michael Porter analysis. And okay, I'll get some data sciences work. But in the final analysis, it's the judgment. And it's not easy. It takes time to find out if you have it. How do you assimilate all that information to get to the point where you're ready to express your judgment about this is a buy, this is a sell, a certain position size?

41:58We use a phrase here. We say it should be obvious and compelling to all. So meaning that we're not interested in good ideas. Like, hey, I think if this, this, and this happens, we can make 15%. It's like, well, that's good. But we're long -term investors. And so we're looking for things that we think can double or more in three years or less. Okay. When you start saying, well, I need 20, 25%, it's like, okay, what do you see that is different than what anyone else sees? And is that realistic? And by the time the research is done, in our investment committees and the people I work with my partners, we've been together for a very long period of time.

42:35And so we create a culture where we can openly debate and guys get angry sometimes. It's like any family. By the time somebody expresses something and everyone's, well, did you think of this? And what about that? And what research did you do on this piece? By the time it's done, most of the people in the room are kind of nodding their head going, yeah, that sounds pretty good. I'd like to buy some of that too. That's usually what we come to. And then in terms of sizing, the second part of your question, There's many paths to the waterfall. Some people love having really concentrated portfolios.

43:02I'm going to own five stocks. I'm like, well, good for you. And that works when it works. But when it doesn't work, I don't want my brain melting down. Other people are like, you know, I want to own 50 or 75 or 100 stocks. I'm like, well, how much do you really know about 100 stocks? Or how much deep work are you doing on 100 stocks? So for me, 2025 names is probably about right. We can do a lot of research. so you say well we should have two to four percent positions we don't really outsize massively anything a big position for us might be five percent why because i want to make my money on my hit rate i know a lot of people talk about slugging and knowing when to take the really big bet but sometimes you're wrong and sometimes it's not that you're wrong on the fundamentals sometimes the stock just goes in the opposite direction i could give you lots of examples of that where we were right over time so what dictates whether something's two three four percent or maybe in of blue moon 5 % is one, obviously the liquidity of the stock.

43:58Two, what do we think the risk reward is? So the stock's at 20 and we think it can go to 40. And if we're wrong, we think it goes to 18 or we think it goes to two. So that ratio. And then lastly, what do we think we know relative to everybody else? What independent work have we done that we think gives us an edge on everybody else? So roughly about a third of the time we do independent research that we think is really impressive. It's like, man, we really know a lot more than other people. And we've had conversations, investors come in, they're like, we just left so -and -so shop and their biggest short is your biggest long.

44:33And I'd be like, okay. And we'd pull out our independent report and I'd say, do they have this information? And we'd go through page by page and they'd be like, wow. Okay. No, they didn't. So independent research, about a third of the time, we're like, wow, we've got some really good stuff. Another third time we're like, man, we got some stuff, might be good, better than nothing, but it's not heavy. And a third of times, like we have no freaking idea. Like we're making not a judgment call, but we really like the position. We think we've done good, normal, fundamental analytical work, but we really don't have anything extra.

45:04And an easy example on this one would be like, okay, Ted, we're going to get long Coca -Cola. All right, you and I can go to as many stores we want and count as many cans of Coca -Cola. It's not going to give us any advantage. There's no value in that. How do you think about in a market where, say, the tech sector, you've got the MAG7, some of the stocks that have some of the characteristics talked about, great business model, great financial metrics are doing well. It's very hard to know anything different from anyone else about a Google, for example. So you can have an analytical edge. You could also have a perspective edge.

45:36So a good example of this was back in the day, there was a perspective that Amazon was a good short because they didn't generate any cash. the PE ratio, which we think is useless, was infinite. But there was a shift in their business model that was so obvious to us. And we realized a well -known hedge fund investor wrote how it was a big short of his, Amazon. And I read the letter and I'm like, oh my God, we're not big enough on the long side in Amazon. Why? The individual is a very smart investor who I have massive respect for. They missed that Amazon was changing their business. So Amazon originally was basically, you would buy toothpaste from Amazon.

46:13Amazon had bought toothpaste from Procter & Gamble. They held it in their warehouse and they shipped you a tube of toothpaste. But what they had shifted was fulfilled by Amazon and third party. So meaning that Ted Seides would order toothpaste from Amazon. Amazon would route the order to Colgate. Colgate would ship you the toothpaste. We don't have any inventory. We don't have inventory risk, no shrinkage, no carrying cost. And then Colgate would pay us, I'm exaggerating, I don't think it was Colgate, but other suppliers, and they would just pay you a 15 % fee. Well, that's an infinite ROIC. They're just using your website.

46:46The other one that they had also done was fulfilled by Amazon. So meaning you would order the toothpaste and the toothpaste company kept their toothpaste in Amazon's warehouse and we would just send them the tube of toothpaste, but the inventory was not our problem. If it didn't sell, you're taking it back. And so when you look at the two additional ways they started selling to consumers, well, that just exploded the returns on capital in the business. And then the other factor, which we see now in a few businesses we're involved in is people are way underestimating the advertising potential of business.

47:19And we saw that in Amazon way back when, before Amazon was even really advertising or reporting it as a line item, we were like, oh my God, people are missing. Amazon is not going to be doing billions in advertiser revenue. They're going to be doing tens of billions and ultimately over a hundred billion a year in ad revenue. Why? And that's what I learned at Procter & Gamble. Targeted marketing is the most valuable information. Back in the day when we were kids, Ted, Nielsen would say, oh, the Citeys household, what are they watching on TV? What magazines are they getting at home? Okay, now we can figure out, we can create sort of a scatterplot of what they're going to buy.

47:53When you know exactly what someone's buying, you're Amazon, you have all the information. We know you buy Colgate, Ted. Well, now that information to an advertiser is infinitely more valuable than Scattershot because now they can target you. And as we all now know, the joke is, oh, my phone's listening to me because I talked about buying a new pair of HOKAs. And next thing you know, I go on Instagram and there's an ad for HOKA or whatever. It gets really complicated quickly, but you can still have a perspective insight into the investment. How do you think about sell decisions? Oh, very simple.

48:27You sell when it hits your price target and nothing else has changed. It feels good when it goes up. I think it's going to go higher. Really? Your opinion? or is that a fact -based decision? You gotta be fact -based. You gotta stay rigid. So you said the stock was at 20 and you thought it was going to 40 and now it's at 40 and nothing in your model's changed. We're selling the stock 100%. The other reason you sell a stock is something in your thesis changed. You said you thought it was going from 20 to 40 and here are the inputs to the model. We're quantitative people. One of those inputs just changed because something changed.

48:59Sell the stock. And the best part is we don't need to debate it. Just sell it. And if tomorrow you want to buy back the entire position because you rethought about it, fine. We're highly liquid. In what we do, everything's infinitely liquid. We're not in privates. How do you go about making decisions for the portfolio? This is so critical to how we've had success, but also how we've had success retaining talent is if you have somebody who you developed over time, ultimately they want to make the decision. What I found is people who are talented don't want to keep going to the quote head person and saying, Hey, I think we should buy da da da.

49:40And the person who spent 300 hours on it is saying, Hey, this is really compelling. And the head guy's like, nah, I don't feel like buying that day. The person is eventually going to get frustrated and leave. I mentioned earlier, Mark Bader, he was a Navy SEAL. He's a close friend and he's one of my heroes. He had this thing, always go with local Intel. Like, yes, always go with the person who's done all the work. Now you can disagree because you feel they missed something in the research or you want them to spend more time. So I have the ability to say, nah, can we hold off on that? Can we have another conversation about it?

50:07But I see everything we do. I'm a large investor in the fund. And so I want to know what we're doing with my money. But the people who are in the portfolio manager seats, they're managing positions for the entire portfolio. These are not carve outs. It's, hey, you're going to take a two to 4 % position for the firm and you're going to decide when to do that. And you're going to put the order in and then you're going to manage it. What we've always done is another procterical thing is you can't evaluate what you don't measure, therefore measure everything. And how we measure it is, it was your idea, air quotes, you were the trader.

50:41You were the one who decided us to buy it. It's one thing that you were the analyst on it, but someone else in the organization said, oh yeah, that's a great idea. We're going to buy it because you didn't want to buy it. You get partial credit for that. But where we put a lot of value is you did great analytical work and you executed the trade and ultimately exited the trade. I hate to say trade because these are investments, but you decide at some point to get out of it or not. We owned one stock, great company in Germany called Eventum. They're a ticketing company. So think Ticketmaster, but better run in Europe.

51:11And we own that stock, I think for 15 years contiguously. That was a phenomenal investment by one of our PMs. How do you think about risk and risk management? When we talk about managing risk, I want to make sure we're clear that we want to manage the risk of real capital loss, that we're going to lose real money as opposed to just managing the volatility. So the way I look at risk is it falls into five buckets. The first level is what I call the fundamental risk of the stock we're buying. So that does not include necessarily the beta of the stock. We'll look at the balance sheet. We'll look at insider ownership.

51:46We'll look at a bunch of factors that tells us how fundamentally risky is this. So for example, I think Credit Suisse, before it went bankrupt had a beta of one. And I think Silicon Valley Bank had a beta of 1 .2. So not that risky. They both went to zero. If you looked at the fundamental risk of Credit Suisse, if you didn't look at the beta and you just looked at the fundamental, it's going to be like, huh, a lot of leverage. You always said, that's a pretty risky business. Maybe Insider's owned a bit of stock. I don't know, but it's probably all options. Did anyone actually go out with their own money and buy stock?

52:17I don't know. When we first got involved in a company called Sketchers, Its beta was, I think, 1 .3 or 1 .4. But if you ignored the vol of the stock, you said, huh, 20 -25 % of the market cap is net cash on the balance sheet. That's pretty good. Huh, 20 -25 % of the stock is owned by insiders, by management. That's pretty good. Just those simple things. You'd say, that's not that risky. I feel pretty good about owning that. Maybe the stock might bounce around a lot, but point to point, it becomes this thing. I don't know a lot of people who measure the Sharpe ratio of their personal account. So level one is the fundamental risk.

52:51Level two is now you put together a bunch of individual stocks. That is important to look at the quantitative risk metrics. And I think that we have incredibly advanced risk engine that we developed over time. Started in 06, but it really accelerated. We had a big drawdown in the fall of 08. And so we developed this risk engine. We had a risk team. We ended up retaining a guy named Ken Grant, who used to be the head of risk at SAC, used to be the head of risk at Tudor Corp. And he's an advisor to us. He sits in on all our risk meetings. And so that's where you look at the risk factors, vol, var, beta, ivar, all these things.

53:23We think we have an excellent risk engine of how you're putting these pieces together, making sure there's correlation stuff. The other three are ones that people don't talk enough about. Number three is counterparty risk. We took our money away from Lehman Brothers in the summer of 07. We measure the risk of our counterparties. Very simple. We look at the CDS of anybody who holds our client's money. If the CDS goes above a certain level, we pull our money. There's no conversation. We do not get paid to take that risk. We need counterparties. It's part of our business, but I don't get paid to take counterparty risk.

53:55And so we will not take counterparty risk. We need to manage the operational risks of our business. Number four is what I call investor risk. Who you're taking on is your clients. There's people out there, they lever their money, they do certain things. So we need to make sure that we have a client base who deeply understands what we do and is deeply aligned with it. They'll understand that we will have drawdowns, that things will bounce around. We might not generate alpha for a period of time, years, but over time, we usually find our way there. We've never had gates on our strategies. We don't need them because we're super liquid.

54:29For the right partner, they like that idea. And then last and finally is what I call risk of ourselves. We run a business. We have a management company. We have employees. And so we need to make sure, just like we look at our investments, what cash do we hold on our balance sheet? How long can we pay the bills in a worst case scenario. What kind of leases do we sign? What kind of lease terms, counterparty terms, employee contracts? All these things are important, but that's a level of risk. So what we call the five levels of risk, that's how we think about risk. How do you organize the investment team?

55:01PM -based. So we think about industry sectors because there is expertise. We don't have a healthcare area. You would imagine if you want to look at healthcare companies, knowing the healthcare space would be pretty good. Obviously knowing the retail space, we have very broad brushes. So retail consumer, we have what I call TMTI, tech media, telecom internet. We have like software, industrials, these types of things. And I think it's really important to have really broad spaces. So for example, I suppose at a very large investment organization, you would get a job there, Ted, and they'd say, Ted, you're the US restaurant analyst.

55:35Well, guess what? You're going to find five restaurants that you think are great investments. This is the way things go. Here, We don't want you to do that. We want to say, Ted, you're the global consumer and retail analyst. As I said earlier, we own 25, maybe 30 stocks, and our holding period is usually two to three years on a name. And so we need you to come up with one, maybe two great ideas a year. Okay, you got the entire world to look. That changes your lens. It changes what you're looking for in a really healthy way. How do you and the team think about that competition for capital to get at those 25, 30 names?

56:09because of how we compensate people, they're incented so that if you have a better idea than I do, you can have more capital. As I said earlier, our best ideas should be obvious and compelling to all. So if someone else at the table is like, yeah, you know, my stuff's good, but it's not great. But man, your stuff is really good. Everybody at the firm gets paid first on how we perform for our clients. And secondly, on the relative contribution to that performance. But the first part is so important because everybody's aligned to have the best outcome for the firm or for the clients first. Without that, you end up a mercenary type organization where people are trying to box out, oh no, I'm covering that stock or that's my name, or they don't want to share information.

56:53We don't want that. And that's not a culture I would want to work in anyway. So over the years with the senior team that's been with you for a long time for most of this run. Where did you come to in terms of the balance of the compensation that's based on how the firm's doing as a whole and the compensation based on the relative performance of the individual? I looked at other models. I looked at how other funds managed it and everybody's got their way. That works for them. But I just kept thinking for me, I wanted everyone focused on the main outcome, which is the client, the investor who entrusts us with their money.

57:28The outcome for that entity should be our number one focus. And so how do you align incentives around that? And two, that's just a culture I'd rather work in. And then three is I observed that a lot of funds had this thing where they'd have a partnership agreement and so -and -so would have this type of economics, a percentage of the profitability or something like that. But I was always like, but what if that person quits or what if they get fired? Or better yet, what if they don't quit or don't get fired, but they come in late, they leave early, they take a long lunch. Where's the incentive mechanism on that?

58:00And I realized explaining internally and debating it at length with people is that the people who perform, the people who are truly driven will do better economically over time if we don't have people having a click on the switch because somebody exits a firm and they were getting X percent of the economics. And then there's a bleed out for a number of years where, you know, three or five years where they get some portion of those economics. You have enough of that. And then the people who are staying, the ones who are the performers are like, okay, well, why should I hang around? I'm not going to get paid for three years.

58:30So we've eliminated that. In addition to that alignment with compensation, what have you done in managing this team of talent so that the senior people have stayed for so long? Because you're in this situation where you've had a long run, but you're not necessarily the biggest fund with the most economics to pay out. We're doing it the way that we enjoy. I mean, it depends what your goal is in life. but I think that we've created a culture. By culture, I don't mean like, oh, we're all like buddies and we sing songs on Tuesday nights. I mean like a culture where we don't lie, cheat, or steal. We think we do really good work, where we treat other people with respect.

59:08Another lesson I learned from Procter & Gamble, you're going to get judged here on two things. One, on your commercial performance and two, how you develop people. You cannot get promoted here unless you can show that you're developing people because we want to develop talent internally and that's worked out really well for us over time. And I think that people want to work in an organization like that. Ultimately, there's always somebody who can offer you more money. Anybody has a job anywhere in America, somebody can come along and offer you more than you're making now. But will you be happier?

59:39We want to make sure that once you find a place that you're happy at, yeah, I'm pretty happier and they pay me pretty well, so I'll stay. Now in the business, you started as a hedge fund, had this long -only strategy. I know recently you've launched this Toga, an active ETF. And would love to hear about that product. Why did you go into this new vehicle for you guys? My North Star since I started the business has always been, what do I want to do with my money? So the day I started on July 1st, 2001 is what I want to do with my money. What I've learned across all these decades is the markets are generally efficient.

1:00:17And every now and then, something happens either in the markets or on a stock -specific basis, and there's a dislocation. And at that moment, the thing that's guided me is what do I want to do with my money? So along the way, I've always had money in our different products, but to some degree, there's tax friction. Somebody subscribes, somebody redeems, a PM trims 50 basis points, another PM adds 50 basis points, so there's like a little friction. And you think about that compared to your personal account. A lot of people have PAs and they buy stocks there. And so we developed Toga because what I realized, and with the help of one of my partners, is that the ETF structure is massively tax efficient.

1:00:56So it's even better than your PA. Why? Let's say you bought Microsoft in your PA and over time it doubled. Well, you may want to sell it. Well, now you sell it, you owe capital gains tax. And I should have known this. I actually didn't fully understand it. The brilliance of the ETF structure led by Vanguard is create a structure that we can own Microsoft. we don't, but we can own Microsoft and Toga. It can double. We could sell Microsoft and the owners of Toga won't pay the capital gains tax until they sell their share of Toga. That's brilliant. So I was like, huh, well, that's better than my PA.

1:01:30I want to put my money in Toga. And so that's how the idea started. But then as I thought more about it, I was like, but why would anyone else be interested in it? Well, other people I'm sure like the tax efficiency of the ETF structure. But then, you know, I was thinking, well, it's perfectly liquid. So when you invest with a manager, you've got to fill out a sub -doc and you got to give 30 or 60 days notice when you want your money back. Here, it trades like a stock. ETFs trade 9 .30 to 4 every day, perfectly transparent. You got to post all the positions at night, ease of use, but you're also not waiting around for a K1.

1:02:02It's anonymous. A lot of personal friends and stuff, people in the industry have money in our strategies. But here, I won't know if they invest, but even better, I won't know when they redeem, right? So it makes it really good. And the last part, and this is really important, there's no discount to NAV. So unlike a closed -end fund where you go buy that closed -end fund, now you want to sell it. You got to find someone who wants to buy it. ETFs don't work that way. There's this creation redemption structure where if we own these 40 stocks and you buy a share of Toga, you're going to get prorata, these pieces of 40 stocks, and you can hold that for a year, 10 years, 50 years.

1:02:39And then when you go sell it, then they decompose it and hand you back your money. So it's brilliant. So we thought it was brilliant for my personal money and also brilliant for the underlying investor. It's different than our other strategies, but we thought it was a brilliant product. And so that's why we launched it. What have you heard from other peers or people you've talked to when you start discussing the active ETF structure? So it seems to be a fairly new thing, even though ETFs have been around for a long time. I think what happened was Vanguard was the brains behind creating this structure.

1:03:11I'm not an ETF expert, but my understanding is the government sued Vanguard saying, wait a minute, you're doing something wrong here. And Vanguard won the case, I think three or four years ago. In 2023, 600 billion, big number, flowed out of mutual funds and almost 600 billion float into ETFs, but there's not a lot of active ETFs. And so, yeah, now when I talk to people about it who are in the industry, they kind of squint at me. At first, they're glassy -eyed because they think I'm selling them something. And I'm like, look, I don't care whether you ever buy it or not. But number two is I'll never know.

1:03:44So it doesn't matter. When they finally focus in on it, really smart people, they go, huh, that's really smart. And I'm like, okay, great. And so I think there is a lot more conversation around active ETFs from people who look like us, start as long, short funds, this kind of stuff. I think you'll see a lot more. I don't know why you wouldn't because for your own money, it makes too much sense. I'd love to ask you about, of all these friends you've had, people in and around the industry, what are some of the key lessons you've learned from some others? There's different ways in today's world of learning, but one of the oldest ways of learning is just talking to your peers.

1:04:26Michael Porter has this statement that he made years ago where he says, people ask the question, why is it that most of the world's making up high -end leather handbags come from these three towns in the French Italian Alps? Well, he calls it circles of excellence. People talk. Well, how did you do that? Why that? And so I've just been very fortunate. I know a lot of friends who are just phenomenal investors. and so I've learned from them. But I've also been lucky that my mentor, I met this guy, Charlie Ellis, who I know you know because he's been on your podcast more than once and from your time at Yale Investment Office.

1:05:00Charlie is just unbelievable. I can't be more like Charlie because I'm not smart enough, but if I could be more like Charlie in life, that would be my goal. He's just so thoughtful, so smart, so articulate and just a nice guy. And I was fortunate to meet him because I received this fellowship when I was at the Harvard Business School that him and two other guys funded. is called the LME, the LeBaron MacArthur Ellis Fellowship. It was the largest pool of capital to people who needed money to go to school. But over time, I think over the last 30 or 40 years, it's been the number one contributor to helping people pay for the school.

1:05:34And so I met Charlie that way. And at first, I met him to thank him for the money. And then, I don't know, a year or two later, I said, hey, I reached out to him, hey, I can use some advice. I asked him a few questions and he was really nice about it and gave me really good advice. called him again another year or two later. And they said, well, why don't we meet for breakfast? Why don't we meet for a coffee? Bit by bit. I mean, he's just such an incredible human being. I've learned so much from Charlie about not just investing, but about life and how to conduct yourself, how to be a person of integrity and how to look out for other people.

1:06:06Phenomenal. If you circle back to where you started at business school, a lot of the people that you mentioned that we're in the business, Chris Shumway, your brother, are no longer still actively managing money for other people. I'd love to ask why through all these trials and tribulations over the last 23 years, you are still so deep in the game when some of your peers aren't or are doing it in a different way. Everybody gets to live their life. This is what I enjoy doing. Not in Maslow's hierarchy of needs, but like what makes me happy? Well, number one, spending time with my wife, Megan, makes me really happy.

1:06:43Spending time with my children makes me really happy. Whether it's coaching their hockey teams or something like that, or taking my son to the park, goes down the slide. That brings me joy. So spending time with my family is the thing I enjoy most. And then the next level would be looking at puzzles, like investments. I just enjoy that. For somebody else, they'd be like, God, what a boring guy. Well, that's your choice. Some people like going to new restaurants and they're like traveling the world to try new things. And they like going to rock concerts. They like going to black tie events. Hey, we all get to live our life as we want.

1:07:14And that's what you choose to do. That's your choice. So live your best life as you choose. This is how I choose. When you look structurally at just doing what you've liked for so long, and then again, some of your peers who I imagine have similar interests, why do you think you've had the duration that others chose not to continue on that path. It wasn't that they couldn't continue on that path. They just chose that there were other things that were interesting to them. I think though, the answer to the question you're asking is around balance. And I think that this applies not just to our industry, but to life and too many people overdo things.

1:07:53You just got to stay balanced and you got to decide what's important to you. And that's how I choose to live my life. A couple of years ago, you moved down to Florida and there's been a lot of movement of people who maybe used to be in the Northeast or down Florida. I would love to hear your thoughts on investing from down in Florida compared to where you were before. Well, it's not just about investing. It's about what's going on down here. It's been a massive upside surprise. Why, one, the dynamism that's down here. So in the financial services industry, I'm amazed at how many people that are in the industry are down here and you feed off each other.

1:08:29And within that, I read an interesting statistic a few weeks ago that made sense to me, but I didn't think of it this way. Two -thirds of the people living in Florida are from somewhere else. The Floridians, in air quotes, are in the minority. Hence, the reason there's so much dynamism here. Number two is this place just works well. The airports, the trains, the highways, things definitely work down here. And my last one, I remember when I first started opening down here, I get a call. Hi, I'm Kelly Smallridge. I work at the Palm Beach Business Development Council, da, da, da. I'm like, okay, how can I help you?

1:09:06No, no, I'm here to help you. What do you need? I'm like, all right, what do you want? You want me to write a check to something? I don't understand. And she's like, no, no, no, no. I'm here to help you. I'm like, look, I don't need to pay you for that. She goes, no, no, I'm paid for by the government. I'm here to help you build your business. She says, if you need office space, you call me. If you need employees, you call me. If you need access to the universities, you call me. Whatever you need, I'm here for you. Here's my mobile number. Oh, and the mayor of West Palm Beach wants to meet you tomorrow for a cup of coffee.

1:09:36I mean, it was astounding. I am so impressed by how things run down here. Look, not everything's perfect. Sometimes the bridges go up. It gets hot in the summer. Florida has been a significant upside surprise. All right, Brad, I want to get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? I like spending time with my wife, Megan. I like spending time with my kids. I like solving investment puzzles, and I like playing in the odd game of hockey. What's one fact that you find interesting that most people don't know about you? Other than I'm bald?

1:10:10Look, I'm vegan. I'm like 99 % vegan. I might have an egg once in a while or a piece of fish once in a while. I just feel better that way. It's not for everybody. It works for me. And where'd that come from for you? I did a bunch of research. My brother, Tim, was one of the first people to mention it to me. And then I spent a lot of time studying a guy named Caldwell Esselstyn, Yale guy, doctor, Olympic gold medalist in rowing. He was the head of heart surgery at Cleveland Clinic. So there's been a bunch of stuff out there that he has said. And then there's other people who followed Dr. Michael Greger and others.

1:10:41For me, that's worked. That's how I got there. It's just, it was a health choice. What's your biggest pet peeve? I love everybody. And at this point, people do what they do. And I just smile. Somebody drives too slow. They cut me off at this stage of my life. I just smile. I'm like, okay, the guy's in a rush. Somebody gives me a finger for cutting me off. I'm like, okay, he doesn't know me. I think at this stage of my life, I look back at my own life and my pet peeve is probably my own thing, which is, you know, in my youth, I probably wasted too much time. Not that I was in a rush, but wasting time on things that didn't matter.

1:11:11Time and energy. If I had to pick one, it would probably be that. It's just, I don't want to spend time on things that don't matter. How about on the investment side? There are certain things that I'm like, that's just not relevant. We'll interview somebody and, well, what do you think of that? And at some point they'll say, and the chart looks really good. Or they'll say the peg ratio is X. And I'm like, peg ratio? Like, really? But that's okay. It doesn't drive me nuts. I'm just like, yeah, that's not that relevant to me. Or when someone says, well, we think they're going to beat the quarter by a penny.

1:11:41And I'm like, okay, it's just not that valuable to me. Which two people have had the biggest impact on your professional life? I think it would be impossible to say just two. So I'll give you sort of a hierarchy. Absolutely, number one is my wife, Megan. I am very fortunate that I met Megan. I look back, we may have talked about the movie Slumdog Millionaire. Certain things just happen in life and you're like, okay, why did that happen? And it's a whole other long story about how I met Megan and how she came into my life and my children's life. But I just am very fortunate. Number two is both my brothers, Peter and Tim.

1:12:18I mean, I had a gift that they were my siblings as opposed to somebody else. They're both just very smart, industrious, but they just have good judgment. They know how to put the puck in the net. And I was lucky. And then number three is Charlie Ellis. I can't even begin to explain how lucky I was. We could have a whole separate podcast just raving about Charlie. Number four, my partners that work here. I learn from them all the time. They challenge me. They get up in my grill. well, I'm better because of them. If they weren't here, I wouldn't be as good. And I hope, I hope they would say the same thing about me.

1:12:53The other bucket, which we've talked about as a string of guys that have had great success in the investment business who also happen to be good friends. The list is so long and I've just been so fortunate to, you know, I've had these people in my life. That's what I would say. What's the best advice you ever received? Who you pick as your life partner is really the most important decision you're ever going to make in your life. You pick poorly, man, that ain't fun. You pick well, and you and I probably have a lot of friends that we can see it. Did you pick well or did you get lucky? I know some people who met their wives when they were 19, 20 years old and they're still together and best decision they ever made.

1:13:31Were they smart in doing that? I don't know, but they got it right. All right, Brett, last one. What life lesson have you learned that you wish you knew a lot earlier in life? I would repeat the same thing, the life partner one. The one I'm going to say is way too easy. It's a marathon, not a sprint. And that applies in so many aspects. So when I was younger, I was always in a rush. The world did not move fast enough. And that's okay. I'm happy with how things turned out, but you got to have balance and just don't do things that are going to damage you. And I would say this about your life, your personal life, about your physical body, and about investing.

1:14:06You could take that one big bet. I can put all chips on red. Even I had great information that I'm going to be right, but you never know. We got invested in Apple in January of 04. It was our largest position for years. In October of 08, the stock fell 50 % and stayed there for six months. If you had had all your money in Apple, I don't know that you could have survived that. There was a great article written years ago about Amazon that if you had bought in day one, you would have made a ton of money, but you would have lost your mind in the process. And so just stay balanced. That to me is probably the best advice.

1:14:40Brett, thanks so much for taking the time, for sharing all this great experience and wisdom you have. Thank you, Ted. Thanks for your time. Thanks for listening to the show. To learn more, hop on our website at capitalallocators .com where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. have a good one and see you next time