CIO Greatest Hits: Multi-Family Offices – Stan Miranda (Partners Capital)

27:44So number one is risk. You think about the result of an endowment model, you end up with, pick a number, 60, 200 managers, okay? And you think you understand from their exposure reports what you own, but you don't know what you own just from their exposure reports. So you have to go really deep in knowing what you own. We understand the underlying stocks that most of the portfolios have. We get all that data and then we run it through our factor models to know where we've got over and underweights. Because one manager may be doing the same thing as four other managers and all of a sudden we've got tons of exposure to clinical trials risk, okay?

28:22That's the single biggest change in the endowment model is the risk management. And that's what risk management means to us. We show our clients what we call the risk dashboard, which has over 16 different metrics, including the value and quality and momentum factors, as well as liquidity factors, currency. You have to understand all of this because odds are when you got an overweight that was unintentional, it goes against you. And when it goes for you, you call it alpha and you don't pay attention to it, but you should. You should pay huge attention to any source of alpha. It's probably beta.

28:59When you do that quantitative assessment to figure out what you own underneath, how does that then impact the way you construct your portfolios? The main impact is that we will counterbalance certain overweights that we don't want as intentional overweights. So we have to have enough liquidity in the portfolio where we can use ETFs or index funds or futures that we can offset those. That's the primary implication. But there's a positive implication of having so much data on what we own. You can actually then fine tune your allocation to different SKUs. So if you think structured credit at this point in time is cheap, we can do something with that.

29:40We'll find a manager and add to them or whatever it takes. How do you balance the notion of static risk with the concept that there may be something like structured credit that you think is an opportunity? So we break our tactical asset allocation model into three layers. We call layer one is just absolute risk. So we convert all those different betas and factors into one measure. We call it ENAB, equivalent net equity beta. It's equity-like risk. And we set the target, say, at 75 for a given endowment. and then when markets move it to 73, we rebalance up. Markets move to 77, we move it down. So we never time markets on level one.

30:21Level two, we have 13 asset classes or seven beaches, whichever way you want to look at it. And we've got targets for each one of those. Markets move those. Or we have valuation views on level two, say one of the 13 asset classes of emerging market equities. If we think that's gotten cheap, we'll do something there. That's also very difficult to do. So we don't do a lot of it. The third level is sub-asset class tactical moves. So those are where our managers are giving us some insights. So we do railways. That was one of our recent ones. We had, as an unsuccessful one, community banks going into 2023.

30:56Anyway, that's our level three tactical moves. And those tend to generate at least enough alpha to pay for our fees, if not a little more. So we're all paying fees to active managers. And sometimes you're buying the package that they're delivering. Once you start disaggregating this composition of returns and understanding what the alpha is, what the beta is, how do you then go about applying what you've learned to the implementation of your investments in a manager when it relates to fees or structure? If it's a manager with very constrained capacity, we have no influence over that manager. Over time, it's getting better, mainly just through relationships where we're working hard to actually add value to them, even though they've got limited capacity, we're competing with all their other LPs.

31:42And we will do things like educate them about the energy transition. We'll talk to them about the best incentive programs we've ever seen for hedge funds or how big an average compliance team is. So we're always trying to add value to those individual managers. But in the case of a lot of private equity, private debt managers, especially if they're fund two or three, we're allocating so much capital to them that we can talk about separately managed accounts. We can negotiate terms. We're always trying to make sure we're only paying performance fees on the alpha, not the beta. And so those sorts of negotiations do take place.

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33:08Learn more at srsaquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. What else have you done in the more modern version of what you've applied to the original endowment model. I mentioned too, so the risk management and then the tactical asset allocation. The third one is just focus on being a value-added LP is very intense. We have actually a best demonstrated practices book. It's about 70 pages on post-acquisition operating value-added that we share with private equity managers. So that's a very meaningful part of it. On top of that, I'd say this focus on beta as a risk measure, not volatility, is very important.

33:55A lot of people out there in our business think about the average endowment portfolio should have 10 % standard deviation around its annual returns, 10 % volatility budget, which makes no sense. Because what happens when markets go down, volatility goes up, all of a sudden your portfolio is over risked. What do you do to de-risk it? you sell right after the market got cheap. So you're selling into lower prices. And the opposite, when markets go up, vol goes down and you're buying at expensive prices. So that's another aspect of it. Those are the main changes. How have you thought about in the public markets, you said in the old days, you thought maybe Mr.

34:37Vanguard was the right solution. Then it was such an important part of your portfolio. You started looking for active managers. And now it's just increasingly hard with all these other factors to prove that you're adding value. What have you done about that? There's a portfolio construction solution. Turns out information ratio is probably the most important metric in liquid securities or asset classes. Okay. So how much alpha do you expect is the numerator? How much volatility, single standard deviation around that alpha do you expect in any one year? And if you think about that all the time and you're adding managers, theoretically what you do is you start with the highest information ratio manager, allocate as much as you think you can based on that volatility.

35:26Maybe it's 6 % of your total portfolio is a large allocation for us. And then you add the next highest information ratio. And then you look at what you own underneath that and you find, oh, we've got a lot of growth in there and you have to rebalance it. So that's the basic portfolio construction model for liquid securities. Credit's a little bit different because there's a lot of tactical asset allocation in there. So we're always taking a view on the different sub-asset classes of credit. Have you thought about internal capabilities compared to giving money to external managers? Well, we started life, no conflicts here.

35:59So there's a high bar on that. But we do have such strong relationships with liquid and illiquid managers. So we do a lot of co-investing, private equity and private debt and property. in the liquid asset classes, we've always done co-investing. It's been very successful. Our targets today are about 20 % in there. But about seven years ago, we started co-investing in public equities. So with our long hold closest manager relationships, we just talked to them about those positions and said, do you care if we double up on them? We're not going to pay you any fees. And most of them said, no, you're a big investor, probably be helpful.

36:39So that's the closest we've come to direct investing. The rule is that if we can't find it externally, we're allowed to do it internally. So we launched something on the back of COVID called the New World Equity Portfolio. The New World Post-COVID was one that was embracing technology, working from home. And you can imagine the sorts of things we invested in. They were both overcorrected companies like retail and airlines. We owned those and we owned the beneficiaries like Zoom. And so that was one that we just couldn't find anyone else doing. We did it. It worked. The logical lifespan came to an end and we stopped it.

37:17Right now, we're looking at one in the energy transition space. It's all about owning brown to green. We cannot find anyone else doing it. How have you structured your team? Initially, first 12 years, we had all client facing people were also research people. Back to the kitchen table with Paul Dimitrik, we wanted the person across the table from us to know what they were talking about, okay, about this hedge fund manager and so forth. And so we kept that model as long as we possibly could. But now with$50 billion of assets and 360 people, it's not possible. And so about six, seven years ago, we created the client CIO.

37:58There are about 130 team members under the client CIO. Each client has the primary point person, and they historically have probably worked on the research team doing asset manager research. But today, that's all they do is construct portfolios and manage the risk of client portfolios. Then there's roughly 64 people that are dedicated to the research team. There's a central research team, which does all the macro work under Cameron Mogadam. Then there are four groups of asset class teams. So equities, privates, private debt has its own team because the complexity is there. And then absolute return hedge funds and liquid credit.

38:36So those teams are roughly 12, 15 people each. We believe in specialization. We don't believe in the generalist model. And so that's all they do is live and breathe their asset classes. I'd love to dive through some of your thoughts and lessons learned across asset classes. And maybe start with private equity, where you started in the business. How do you see the landscape today? So private equity. Turns out it's one of the asset classes where you can actually pencil out the expected return. You just pull out an Excel spreadsheet. You put in what you paid for it in terms of multiples on earnings and what you're likely to get for it when you sell it.

39:15You've got the debt, the cost of the debt. You've got the two and 20 in terms of fees. Most important number of all, earnings growth. Put all those together, certain assumptions usually get you to about 15 % historically with nice growth of earnings and cheap interest rates. We just live around that model. We think about who can grow the earnings the most. What are they paying? What can they sell things for? And that has always pointed us in the direction of lower middle market buyouts and specialists, software specialists, for example. And so we've always been focused on that. And we had the data to prove that it's harder to grow earnings in a big company than it is in a small company.

39:55The private equity owner can be a more value-added owner than a huge Apollo Blackstone, even Bank Capital today and CBC. They're buying multi-billion dollar companies. It's just harder to grow earnings. But then you look at the performance, you realize, actually, they haven't done any worse than the lower middle market. But if you break out the attribution of that performance, the average private equity firm over the last 10 years earned 15 % net. 7.5 % of that was from multiple expansion, which is basically referencing the public equity markets, multiples, and those companies get valued in line with those.

40:34And so they went up by 7.5 % because of the last 10 years growth of the public equity markets on the back of the global financial crisis. The other 7.5 % is rather pedestrian average earnings growth combined with some inflation in there. So there's no real value added from the average private equity firm, even in the last 10 years, if you adjust for the public equity multiples and the debt aspects of it. So if you leverage small cap public equity, we think you could have done better. Okay, but here's dispersion. So there are big exceptions in the mega cap, large cap, all the way down to the middle market who would violate that observation.

41:16So if you've grown your asset base and grown your allocations to these managers, how have you tackled the sweet spot of this middle market? So we're now in the fund number two and number three space. That's our sweet spot. We have great relationships with certain names and we get big allocations with them. And they've gone up to$5 or$6 billion funds, but it's still working. We can call that middle market these days. But the best solution is just know the middle market firms that are most likely to create spinoffs and watch. And we have relationships with the search firms and others. So we get usually early heads up on firms that are leaving.

41:57We'll typically meet the management team the first time. We pass in most cases, not in all cases. We've done some fund ones. But generally, we say, we're going to watch you. Please hold some space for us for fund two. And we're in fund two. There's probably nothing that's changed more in these 20 years than hedge funds. And your next asset class you tackled way back when, how are you investing in hedge funds today? So first of all, we break them into two totally different groups. Hedged equities, anything with a beach of more than 0.2 to the equity markets, we call it an equity manager. And frankly, the learning is the same as in the long only equity space.

42:30But we do have more alpha from the hedged equity managers. They just tend to be deeper, more fundamental, and more specialists in a lot of cases. So our biotech managers are mostly equity long short. But in the absolute return space, first of all, more managers is better than few managers. There's a minimum where you debate whether it's 12 or 20, and you're all about diversifying your sources of alpha. So what we learned is you can create, say, with 20 managers with the right mix of strategy and a very consistent source of alpha, call it 3 % to 4%, not big numbers, with only 3 % or even 2 % alpha volatility.

43:14So information ratios of 1.2. And then what do you do with that information ratio? You leverage it. Okay. So that's how we invest in absolute return hedge funds. We create a very stable, solid stream of alpha, and then we leverage it. When you think about that area, the 12 to 20 managers, as you define a manager, can mean a lot of different things because so much of the assets have gone into these platform hedge funds that are effectively doing that aggregation diversification for you. So how have you balanced the ability to put capital in some of those strategies with, say, a millennium or a Citadel, an individual single strategy manager?

43:53We probably should have allocated to the Citadels and millennials. Okay. We should have. We just always look at the fees. We have an acronym for everything, as you've highlighted. EROC is our excess returns on costs. The EROC is terrible. And another way to think about it is of the total gross alpha, how much do they keep? It's about 80%. We get 20 % of the alpha. The alpha is huge, absolutely huge. But we could never get comfortable with only getting 20%. So what do we do? We allocate it to their spinoffs. and it's mostly Citadel spinoffs. They've done very well and they're closer to 220 and we get roughly 50 % of the gross alpha and we diversify.

44:37They'll be specialists in consumer or specialists in tech and we have to create a diversified portfolio of those. So beyond the equity long, short, low beta, absolute return, maybe some credit, there's this whole world of alternative alternatives. How have you thought about and participated in that? So we were early pioneers into that. You know what they say about pioneers. We started with insurance, including life settlements as well as catastrophe insurance. Quickly went into litigation financing, royalties, both music and drug royalties. And then one of our favorites is actually clinical trials and sports athlete financing.

45:14So that's the journey. Over about 10 years, we've been looking for this Holy Grail, which is high 12, 15 % type returns that are completely uncorrelated to financial markets. And all of those strategies I just mentioned are pretty much uncorrelated. The problem with them is that they have limited capacity. And as soon as I start talking about them on a podcast, then all of a sudden the alpha goes away. But in most of those categories, it has gone away unless they're in certain specialist areas. But it's been a good asset class. We can't take our allocation in client portfolios up above much more than 5 % 6 % today.

45:54How about real estate? Real estate, first of all, stay away from the double promote. You don't pay a private equity firm to pay a private equity firm. Okay. So we go with regional specialists generally and we build a national portfolio. Obviously, real estate has tax implications that make it hard to have a global portfolio. So our Europeans don't invest in US property. But frankly, the US property market is a lot more alpha rich than European and Asian property markets. So our US clients, a lot of them being taxpayers, benefit hugely from a diversified North American property portfolio. And then our European and Asian clients benefit from European and Asian diversified portfolios that are pulling together regional and sector specialists.

46:39So then in terms of office and industrial and residential and hospitality, that's where you can almost time markets. Not quite. When you're allocating for the next three to four years deployment, you may still want to be in all. So we do use generalists, in some cases, regional. But lately, last six, seven years, we have invested almost entirely in industrial. So a lot of logistics, and that's been a big success. How about real assets? We've moved away from them. Early on, we invested in oil and gas. It just seemed it was a great landscape for real specialists. People talk about reps. These are great opportunities for reps, but the commodity prices take you out.

47:24And all our due diligence had us being convinced by these managers saying that they hedge the commodity risk. They don't. The risk has just taken out too many resource companies. So not just oil and gas, but mining. It's a pretty difficult area to invest in unless you really take a 20-year timeframe and you live with this massive cyclicality. So we do not do anything in traditional resource areas. We are primarily focused on the energy transition. And those are effectively real assets in many cases. So with a lot of this idea of taking on a new asset class, having a clean sheet of paper, in the last couple of years, there have been some opportunities to do that.

48:07There's the crypto and blockchain world. There's certainly all the developments in AI. And we'd love to hear your thoughts as you've mapped out and looked at these areas, what you found. On AI, it's too early. First high level question is how is it going to affect institutional investing, asset allocation, the timing of various moves, but then how it's going to affect basic fundamental research at the asset manager level. So we don't have an answer to that. And frankly, it's too early to tell right now, but we will be in front of that when it happens. On crypto, we have studied it, and we have come to a decision not to invest other than in blockchain venture capital.

48:48The simple explanation is that it's like gold. It has no income. It has a market because people buy it. Okay. So quoting Jacob Rothschild, when the central banks are buying gold, you buy gold, ideally before they start buying. So crypto is the same. It has its pricing set by the scale of purchases. And that is driven by a lot of momentum and psychological factors. If you look at the value of Bitcoin, it bears no resemblance to any value proposition or utility that Bitcoin has. Bitcoin has utility, especially in just moving currencies across capital borders. There's a real value to that. I'm not sure it's legal in many cases, but there's a value to that.

49:37It's not$40 ,000 a coin. That's clearly speculation driven. And we'll invest in cryptocurrencies when they reflect their utility or their cheap relative to their utility. What's different today managing$50 billion at partners than at different stages along the way with smaller asset sizes? By far the biggest difference is our relationship with the asset managers. We're just always the top of their table. And so we get every question answered. We get more transparency than the average investor. And we can come up with creative new ideas with them. The managers are getting bigger, but some of them are getting bigger and developing their capabilities even faster, and we want to grow with those.

50:27And we're going to do that if we're close to them and we're contributing to their own capability improvements. I'd love to hear what you've learned about succession of asset management firms. You've certainly seen a lot of it in the managers in your portfolio. You've undertaken aspects of it with some retirements, as you mentioned. And it's difficult, but not as difficult as you think. We always assume there's so much more to that one individual that when they leave, it will be a disaster. It generally doesn't end up that way. Does succession work in all cases in terms of just the politics and no casualties in terms of the partner group?

51:08No. But asset management firms, if they're good ones, they've really embedded their capabilities so deep in the organization that no one or two people really are that important, especially in the bigger institutional portfolios. If it's a team of six, succession is vitally important. And so you've got to really focus on that. But it's extremely difficult. Have you gone about into partners? First of all, we were a partnership. So it wasn't a single person running the investment decision. So it's not Andreas Halverson at Viking. It was Stan Miranda who built a partnership and initially three partners and now 19 partners.

51:47And all the partners were involved in many different specific aspects of the investment process. So no one person really mattered that much. But when I gave up the CIO role, Colin Pan was already doing it. So I think succession in all companies, not just investment companies, is about giving the job to the individual before they take it on. And then it just happens more naturally. And you always expect as the founder or whatever, some big fanfare, but it's always just a little tiny applause when the transition actually takes place. Where do you think Partners goes from here? I do think we end up doing some more direct investing.

52:34We see a thousand managers a year in any one asset class. We just know so much about each asset manager. most of us just sit there and perspire over all the opportunities we're seeing that aren't being exploited. So when I said the rule is we can only exploit those opportunities that haven't already been exploited by amazing people outside Partners Capital, there are a lot. And so I think we're going to cross that boundary at some time very delicately. We don't want to break the rule that created us of no conflicts, but I think there's some opportunities our clients should benefit from where they could see much lower fees and a lot more alpha if we integrate forward into asset management.

53:16And how about partners as a business three, five, 10 years down the road? Privately owned, management run, outsourced CIO, continuing to be one of the most highly respected in terms of thought leadership and investment management. Great. Well, Stan, I want to turn to a couple of closing questions before you let you go. What's your favorite hobby or activity outside of work and family? Okay. So outside family, family is definitely first port of call outside of work. Every moment of free time is spent in sports, basically. And I do triathlons. So mostly just the individual running, swimming, and cycling a lot.

53:52But I collect sports. You name the sport. The only one I don't do is golf because it would take too much time and it would take out all the other sports. But I do ice hockey, kayaking, every racket sport you can think of. I just love sports. It may be the competitor in me, but it can't be because I'm not that good at any of them. It turns out focus matters. I may be a good skier. That's about the closest one. But I am a master of none. What's your biggest investment pet peeve? Clearly, people who mistake alpha for beta. And we do it all the time. Oh, we just did fantastically well in those biotech firms.

54:29It's got to be beta. How about your biggest personal pet peeve? Okay, I have a lot of those. I was asking my wife, for example, she said, well, plastic bottles, brown shoes. Entitlement is probably the one because people that are entitled, you don't succeed with them. I think you succeed with people who have a basic philosophy that hard work earns you the right to whatever you have, whatever you experience. So I believe in hard work and focused efforts to get ahead. What investment mistake have you made that you'd never make again? I think invest in catastrophe insurance. You already said we're long global warming.

55:09That's what catastrophe insurance is. But global warming has always been ahead of pricing. So that was a painful experience. Which two people have had the biggest impact on your professional life? Number one, it was my second family. I was very close to Dr. Tom Eliason in Fresno, California where I grew up, and his wife, who was my den mother in Cub Scouts. And I spent so much time with them because their son was my best friend. Dr. Eliasson was a leading cardiologist, and he was my role model. The impact he had on me was to be calm and thoughtful. My family was full of drama. And so it must be the Portuguese DNA or whatever it is, but he gave me a sense of perspective and calm that compared to my siblings is distinctive.

56:03I think most of my work colleagues would say, really? I haven't noticed, but they have to understand what it could have been. And then secondly is a gentleman named Archie Norman. He's a serial CEO and chairman. He was the CEO of ASDA, Turnaround ASDA, Energis, ITV, and he's currently the chairman of Marks & Spencer. And I worked with him when I was a strategy consultant. And he has two unique characteristics as a leader. And one is that he just doesn't like doing anything ordinary, anything normal. He just strives to do things that surprise people out of the ordinary. And he taught me to always be brutally honest and face into the unvarnished truth.

56:49I'm the chairman of the board of Partners Capital. You don't go into the board meeting to convince them that our investment performance is great. You find the area that's not great. You spend all the time on that and you're honest about it and you focus them on it and you face into the unvarnished truth. That's what Archie taught me, which I think is incredibly valuable. What teaching from your parents has most stayed with you? Okay. So 1972, I'm thinking about university and there's the financial crash, the markets crash. my father happens to be a stockbroker. Okay, this was a bad period for him.

57:25He sat down with me, and he just said, well, first of all, that college fund, not so big anymore. But secondly, if you do anything in life or in university, have a skill that people will pay for, and you will land on your feet. And that just always stuck with me. And so my first degree was in business and accounting, so took care of it. I think that's wonderful advice for anyone early in life. Stan, last one. What life lesson have you learned that you wish you knew a lot earlier in life? Keep your loved ones close to you. That sounds so obvious. But in a global world where we have the ability to send our children anywhere, or they have the ability to go anywhere, and your friends have the same freedom, we all end up all over the world.

58:13And I'm at that stage where I'm try to gather them back into one place. And in some ways, wishing I didn't have the truly global experience I had because I'm just living on planes, going visiting children and family and friends. But so the advice I give to young parents in particular is don't let your kids go to university abroad. Keep them home. You'll never regret it. Stan, thanks so much for sharing your wisdom and experience. I've loved it, Ted. Thank you very much. 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.

59:00Have a good one, and see you next time.