CIO Greatest Hits: Single Family Offices – Steve Rattner (Willett Advisors)

25:55Secondly, it allows us to control our capital flows better. One of the problems in 08, as you well know, was the unfunded liability problem that many institutions had with these commitments to funds that were not going to be drawn for who knows when or could be drawn the next day. And so our unfunded liability ratio is very, which again, I don't want to get into specifics, is very low compared to what the typical endowment or foundation has. And so that was another advantage. And the Bloomberg name and relationship we felt would give us special access to deals. And that has worked out. We operate completely separately from the company or the people who give the money away, and even to a large degree from Mike himself.

26:33But there are many people out there who would like to have Mike Bloomberg's money. And if they're the right people, we're happy to give it to them. What are your thoughts on private equity, the area in general today? It's hard for me to have worked in an area for a decade, plus or minus, and not believe it has some reason for existence. I do think the return premium, which while it's smaller now, probably, certainly than it was, is still there. I think the way that private equity guys and ladies think about driving performance, not getting caught up in being a public company, being very commercial, very disciplined is good for corporate America in general.

27:15I think private equity does add value. Are there too many companies that pass from one private equity firm to another private equity firm to another private equity firm? Are there too many cases where it's all financial engineering and a lot of dividend recaps? Yeah. Is there too much money in the industry, in the sector at the moment, very possibly, probably. The amount of dry powder is vast. But the thing that often happens to people in my current business is you tend to be performance chasers. And so you look at what did well lately and you say, I'm going to go over there. And so private equity has done well lately.

27:48Venture has done even better. And so there's a lot of money going over there. If private equity hits a pothole, the money will then go somewhere else. and it's not the best part of how this all works, but it's unfortunately part of life. So having been on the inside and call it inside as a general partner and whether you call the outside as a limited partner, how do you think about the manager selection process in private equity? No, not that differently from any other area that we invest in, which is while we're certainly happy to be opportunistic, we also try to be methodical. So if somebody comes along with a private equity fund that's going to focus on industrials that looks interesting, we would landscape the whole area.

28:28We find out who else does something like this, whether the firm that has shown up or that we have found is really a top performer, whether other people who do it better, whether it's the right strategy. So we're always opportunistic, but we also try to be very, very methodical. And fortunately for people on my side of the table, the performance benchmarking, which didn't really exist when private equity for the first probably 10 or 20 years almost of private equity's lifetime has now gotten pretty methodical. And so the whole top quartile, second quartile, vintage year process does give you a fair amount of data to analyze.

29:02Now, the problem is that just like in other parts of money management, performance persistence is not that great. So a firm that was top quartile in its last fund could well end up being second, third, to fourth quartile in its next one and then back to first again. And so ultimately, as David Swenson has taught us all, it does come down a lot to the people and whether you just have that feeling that these people in the long run are going to turn out to be great investors and not get caught up in the returns of the last fund. We're going to take a quick break in the action to tell you about SRS Aquium.

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30:23Learn more at srsaquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. Are there things that you've seen from being on the general partner side that you have a particular keen eye towards that someone who maybe just spent their career looking at private equity funds might not pay as much attention to? Yeah, I think I do, having been in private equity and having done some things I'm happy about and some things that probably I regret in terms of investments and strategies and things like that, and managing a firm and hiring people and raising capital and dealing with investors, I think it does give you a benefit being on the other side of the table.

31:09It's a little bit like having been a journalist. If some journalist calls me and wants to talk about a story, I have a better idea of how to deal with that person or what they're really after than the average person might and so forth. How about hedge funds, which has been this area that a lot of people have thrown stones at for a while now. How are you thinking about the area and how has that changed? First, for better or worse, rightly or wrongly, I had views about hedge funds before I was in the business I'm in now. I think I wrote a piece for Business Week years ago in which I said that hedge funds are not an investment strategy, they're a fee structure.

31:44Because everything that falls under$2.20 is not a hedge fund, and there are many different flavors of it. I think the hedge fund model is, if you want to talk about long-short equity to start with, which is the core of it, as you well know, it is certainly under a lot of pressure at the moment. It's a bit like private equity, the excess returns have diminished. Some people say, well, the short selling opportunities, rebates, they've got lots of reasons. I think markets are certainly more efficient than they were when Julian Robertson got into business or some of the George Soros, some of the early pioneers.

32:19And also, if you believe that going forward, all this has not been true lately, we're in a lower return environment. If you've got a management fee of one and a half or two and gross performance of, I don't know, four and a 20 % carry, you can do the math and there's not a lot left for the limited partner. And I believe that it's a little bit of reverse engineering, that I'm willing to pay almost any level of fees if I believe the net performance is going to be superior. So we have people that we pay very high fees to because I really believe they're exceptional performers. And we have other people who would offer lower fees that we just won't invest with.

32:54But I do think there'll be a shakeout in hedge funds. I do think that it's going to be a tougher business going forward. I think a lot of folks in my side of the table are thinking hard about their hedge fund strategy and what really is additive versus simply money churning around, but not adding any return. And how do you think about approaching the traditional public markets? We have a very robust allocation to long equities. I believe, and Mike Bloomberg actually has pointed this out to me, and he believes that no matter how good you are at picking managers, no matter how good your managers are, in a normal world, the bulk of your return is going to come from beta, that alpha is always going to be a much smaller number than beta, that over a long period of time, markets go up.

33:38We started investing, as I said earlier, January 1 of 2008. I think from that point to today, even if you invested all your money on that date, I think the S &P is compounded at 7 % plus or minus. So the point is that even with the worst financial crisis, as we talked about since the depression, if you had just put your money under the mattress in the S &P, you would have done fine over these last 11 or 12 years. And that's how I think about it. And fortunately, we have very long-term capital. We have more capital that arrives than departs. We have a very understanding and tolerant client who gets the idea of long-term performance.

34:14And And so we want to take equity risk. The challenge is that in the US particularly, the market is highly, highly efficient. And even with lower fees than you pay to hedge funds, when the dust settles, really creating alpha in the US is hard. We have done it over time. I would say there have been times when we haven't done it, but it is hard. Europe is just generally a mess, and we can talk about Europe. The emerging markets, it's easier because they're a bit probably like the US was 40 or 50 years ago, they're much less efficient. People who know the way around them can add value, even net of fees.

34:50So we still are believers in active management. We still have virtually all of our equity exposure actively managed. But I can tell you, we don't think about it a lot and wonder whether that is the right way to go, especially in the US. Yeah. So let's go around the world with that. In the US, do you think about just simplifying and saying, look, this is really hard. We should either just index it or maybe index it with some factor overlays rather than picking active managers. Well, first, with respect to factor overlays, I'll make a broader point, which is that we're not good. I frankly don't think anybody is at market timing or even factor overlays.

35:26I think we're good at picking managers. I think we're good at making individual investments in private equity. But if you said to me, is the stock market going to be higher or lower a year from now than it is today, I think my view would be a coin flip. I mean, I don't know. And there's a 50-50 chance I'd be right or wrong in whatever I said. And so we don't make a lot of those kind of bets. Do we think about just indexing it? Yeah, we think about it. But we were born and bred to manage money. And so for the moment, we're going to keep trying to manage money. At some point, maybe we'll give up.

35:56But as I said, over the fullness of our existence, we have added alpha even in the US. And how about emerging markets? So in particular, emerging markets encompass a a big part of the world. How have you kind of approached picking managers in that part of the world? Yeah, the challenge in emerging markets for us is that putting aside China, India, we don't invest in Russia. I can't imagine we ever would. And maybe Brazil, they're relatively small markets. And so accessing them in a way that's consistent with our philosophy of finding people who really know the space is very hard. So we have tried with not great success, picking an emerging markets manager sitting in New York or sitting in London or anywhere else in the world.

36:38It's been okay, but it hasn't been great. And so the consequence of that is that our emerging market exposure has been narrowed to the couple of markets where we are both excited and where we feel there is investing talent. And so do you tend to find managers on the ground in those countries or parts of the world? Absolutely. That is our philosophy. Just the way I don't know how as a TMT guy, I could have invested in financial services. I don't know how a guy sitting in New York can be as effective in China as people who are on the ground there. And you mentioned Europe's a mess. We know that.

37:10How are you approaching investing there, or are you investing there? We have a modest exposure to Europe. We're way underweight Europe. There are many days when I wake up and think we should just leave altogether. There's nothing attractive about the fundamentals. The only thing that gives us pause is that the valuations are more reasonable on a pure kind of PE basis. And so you worry that you might leave Europe just at the time where there's some kind of rebound. In the fullness of history, Europe has performed reasonably well. Maybe it will again. And so we're hesitant to just leave. But we're way underweighted, as I said.

37:44And every time I go there, I come back thinking, why are we invested here? When you roll up these exposures, how do you think about the total amount of equity market risk that might inform your asset allocation decisions? We do keep pretty close track of our beta. And we want to have a lot of beta because, as I said, I believe that beta is going to be the principal component of your return. But we obviously don't want to have a crazy amount of beta. And so, again, without getting too deeply into the specifics, we are well aware of the amount of beta that other endowments and foundations to the extent they report publicly have.

38:17So we manage our beta across the firm, and that means obviously keeping track of your beta in the public markets as well as in the private markets. And given the close nature of the relationship between you and the capital and Mike, does that allow you to take, say, more beta than some of those kind of endowment peers? I think so. I think Mike is the greatest boss, employer, client, whatever you want to call him, friend, I've ever had. once he believes you know what you're doing, and after 10 years, I think he finally, I think he was suspicious at the beginning, but I think he thinks now I kind of do, you get a lot of rope and a lot of leeway and a lot of tolerance.

38:58And so I feel comfortable taking a fair amount of risk because we do have this unusual capital position and an unusual relationship with him. And we don't have to report publicly to anybody. There is an investment committee at Bloomberg Philanthropies that we do report to, but they're also very professional and understand our business very well. And so it's about as good a situation as you could want. What's your manager level turnover been roughly on kind of an annual basis? Too high. I don't know the number, but one of the things that I force the team to do once a year is go back and look at our terminated managers, because it's easy to fire a manager.

39:37And in most firms, you fire a manager, nobody's ever going to ask you again, well, how did that manager do? Did you make the right decision or not? And I believe we have to live with those kinds of decisions. And so we very methodically go back and look at our terminated managers. And I would say it hasn't probably cost us a lot of money to terminate managers, but it hasn't made us a lot of money. In other words, if we had simply stuck with the group, because it gets back to this performance persistence thing. And there is a huge temptation that I try to resist, but I come to it like everybody else who's human, to fire a manager when you really feel like the bottom is falling out, but that may be the absolute worst moment to fire a manager.

40:14And so I think we are trying now to give our managers more rope, just the way we have a fair amount of rope, when we believe that fundamentally they are pointed in the right direction. And what is the decision process within Willett to hire a manager or fire a manager? We have a methodical process. I'm a great process guy. And Alice Ruth, who was our first CIO who did a great job, is a very process person as well. So we have a methodical process. We have Monday meetings. We have a process by which managers are introduced to the broader investment group, discussed, sometimes discussed a few times.

40:47Then there's an approval process that comes up from the bottom. The idea generation can happen anywhere. It can happen at the bottom of the totem pole. It can happen from me. But everything goes through the same machine to see whether it measures up to our standards. And you mentioned your own behavioral bias, and we all have them. How have you tried to kind of improve the quality of the decision-making over time? I think a little bit to be less quick to fire a manager, a little bit to be less quick to hire a manager. And also, which we haven't implemented as successfully as I would like to because it's contrary to human nature also, I would like us to be more concentrated.

41:26And again, without getting too deeply into our private business, there's a great temptation when you go to the supermarket. this is an analogy I use all the time with my colleagues, and you see eight kinds of P's on the shelf, and you don't really know which is the best, so you pick one of each. But I think we're getting paid to pick one or two of those kinds of P's, not all eight of them. And so I would like to see us over time become more concentrated. Because if you do the math, right, a firm has, let's just say, 100 managers. So each manager has 1 % of your capital on average. And each of those managers has 20 top positions.

41:59What is that? Five basis points of your capital is in some given position. Now, obviously, some managers duplicate, but all you're going to do is mean revert if that's your investment philosophy. And you might as well just buy index funds and go home and not work so hard. So I do believe you should be making bets. I do believe that you should concentrate with people who you think are really top performers. And as I said, we are trying to do more of that. it runs a bit against the grain of all of us, including me, but that is something I'm focused on. Without going into the specifics of the name, I want you to think in your head of either a recent decision of a manager or an example where you were looking at a space and there were eight different types of P's on the shelf.

42:38What were the things that differentiated the one or two in reaching out to those to make those allocations rather than buying one of each of the eight P's? Sure. Well, obviously, we look closely at track record and investment process and quality of thought, construction of the team, things like that. But at the end of the day, we like owner-operators. We want firms that are owned by the people who are actually managing the money, not part of some colossus. we want the lead person or lead couple people if that's what it is to just be so driven that you can feel that they taste this and they want this and our most successful managers have had those attributes and so you do all the math you do all the diligence you do all the landscaping but at the end of the day you look at the person and just say to yourself do i think this person has the drive, the determination to be great.

43:33And I think while that doesn't lead us to every right decision, I think many of our best decisions have come out of that conviction. So now that you've been running this for a dozen years or so, and you've built up the portfolio, as you look at your portfolio today, what are the areas that you're most excited about? And what are the areas that you feel like still need the most work? The thing that we're probably, I'm probably anyway, colleagues may differ, most excited about is still probably China, which is highly controversial, and we can talk about it. But I think as I look around the world, I think China is still the most exciting major market, probably in the abstract, let alone on a ratio to value or pricing.

44:16I think that the thing that has been probably most challenging for us, and it would be for any firm starting, is to build a quality venture portfolio. because, and again, this goes all the way back to the research we did back at Quadrangle. When you look at performance dispersion, as you go from fixed income on one end, the place you get to on the other end is venture. The median returns from venture are not, probably the last few years has been better. But when we were looking at this, they were not that great. They were not even as good as private equity. But the performance dispersion is vast.

44:49And so one of the early decisions that Alice and I made was that if we couldn't be in what we thought was a top quartile manager, we just wouldn't do it. And so the result was it has taken us 11 or 12 years now, and we still do not have as big of a venture portfolio as we'd like to have. And it also takes a long time for that to come to fruition. So that is a, when you ask, like, when I started, what were my disadvantages relative to Yale? That is one of them. Yale has a huge and a wonderful venture portfolio, which they treasure, I'm sure. Yeah. And so let's dive into China a little bit. High-level thoughts to start.

45:23High-level thoughts are, one, if you simply looked at the numbers, as I said, it is the cheapest major market in the world, especially relative to growth. Is that true in public and private markets? Yeah, I think so. It is certainly true in public markets where there's more data. There isn't really a true private equity market in China yet. It's more of a growth equity and venture market, and probably also cheaper than the US. If you simply sat in New York and read the newspapers, I'm not talking about Hong Kong specifically, generally, you'd probably be terrified about China and you'd probably think this just seems like the wild west and why would I go there or invest there?

45:58If you actually go to China, as I do a couple times a year, every time I go there, I come away unbelievably excited because I don't think everything about investing can be done on a spreadsheet. And when you go to China and you feel the energy, you feel the drive to succeed, you meet the entrepreneurs, you meet the CEOs, you meet the investors. They have a lot of challenges that are not economic. They have political challenges. But I do believe that their drive to succeed is enormous. I wrote a piece for the Times a few years ago after I'd been to India and China, basically saying that my view was in the great debate over whether India or China would do better, my money was on China.

46:38And I got a huge amount of blowback because people want to root for democracy. And they want to think a democracy would be the winner, not a totalitarian state. But it is what it is. And we like India. We have money in India. We may put more there. But it's not China. And I also think, well, I wouldn't say this as strongly as I would have said it a year or two ago. I am for democracy, and I'm a capitalist. But the Chinese model has some advantages over our model. And if you remember, a lot of this trade stuff started when China published something called Made in China 2025, which was their blueprint for world domination in the next six, seven years.

47:15And then you realize when they focus what they can actually do, it's pretty scary. But as an investor, it's pretty exciting. How has it been trying to find the right managers to partner with in China? It's hard. I wouldn't tell you that transparency, rule of law, integrity is what it is here. So we've been very careful. We have now two, we had one, probably guess who, but I'm not going to say public equity manager in China for most of our time, we found more managers, again, not really PE managers, but growth and venture managers that we're comfortable with. And those partnerships have worked out well.

47:52I'll make one observation you didn't ask about, but it does. I found it fascinating, which is that we have more investment managers in China on the private side with a senior partner or the CEO of the firm as a woman than we have here, because here we have zero, approximately zero. It's interesting how well women have done in China in the investing world relative to here, and we need to do better. Why do you think this is the case? I have no idea. It may be that they simply didn't have a real investing business until fairly recently, and so women could ascend more rapidly. There wasn't a lot of men clogging it ahead of them.

48:26I don't know, but I just do know that we have a number of really impressive women managing money for us in China on the private side. I want to talk about a couple other things that come to mind. You know, I know you're on TV every now and then and have political views, particularly when you start talking about China and the trade war. How do you filter your own beliefs on the political side into kind of the investment decisions? I try not to, and I hope I succeed in not factoring in my political beliefs into the investment decision. But I think my political views or my insights, if you will, are really valuable to the investing.

49:03I think anybody's are. I don't think you can be an investor. I really enjoy my meetings with our managers because a lot of them have really interesting views on the political side, on the macroeconomic side, on things other than whether a stock is going to go up or down. I think you have to have a view on all that stuff to be an investor. And I do think it's something that I bring a bit of to the party. How does the journalist side that you still retained fit into kind of how you think about your day to day? It's my hobby. I do play a little bit of golf, but I'm not a passionate golfer. And this is my version of golf, which is to write for the Times once a month or so and to do my Morning Joe appearances once a week or so and still be able to be involved in the public policy discussion, which I enjoy.

49:49And also, frankly, to try to have some like really minimal impact on how people think about these issues, because there's a lot of crazy stuff going on out there. And I think anyone who's got a balanced approach to it should be involved in discussing it. The other topic that's increasingly changing, at least in this country, when you talk about sort of the difference in China and the centralized state is this notion of corporate stewardship after having gone through your career in private equity, how so much was tied to shareholder value, and now people are talking about broader constituents being important.

50:23Can you share some of your views on that? Yeah, I have strong views on this, which are not going to be popular, but I'm really scared about it, quite frankly. I think what's going on, to start at 30 ,000 feet and we can go down, what's going on really is that government has kind of ceased to be a problem solver. the gridlock in Washington, the lack of any real fiscal space on the state and local side. Government isn't building roads and infrastructure. Government isn't training workers. Government isn't solving the problem of people who have fallen behind. And so everybody's turning around and saying, okay, well, who's going to solve these problems?

50:56And more and more, they're pointing at companies and saying, you should solve these problems. And I'm almost with Milton Friedman, who wrote that famous New York Times Magazine piece in 1970, which said that The job of a company is to go out and make money ethically, legally, responsibly, but ultimately to serve the shareholders. And all these people who say that companies should be responsive to a whole set of other constituents, I'm not sure I understand what that even means. If I own a private business, I own a company. It's my company. I should be able to use it to benefit myself, again, legally, responsibly, and all that.

51:30Being a public company, I'm not sure why that changes anything. You still have a bunch of shareholders. I think you have a fiduciary duty to them. Now, if your customers say, I'm only going to buy products from a company that pays$15 an hour, or I'm only going to buy products from a company that sources it in an environmentally responsible way, absolutely. The public should vote with their feet and not buy products from companies that they don't think behave the way they want to behave. And that will drive some different behavior. But to say that a company should be forced to do X or Y or Z simply because we want to solve problems that government should be solving but isn't, I don't think is the right way to move ahead.

52:09So if you look in your perfect crystal ball 20 years out, do you think there is a road where the government can change to get back to solving some of the problems that, as you're saying, they're not getting solved today? Well, I hope so, but I can't say I'm optimistic about it because we're kind of going in the wrong direction. That just when you think it can't get worse in terms of the gridlock and the lack of action, it gets worse. If you look at a simple metric, which is crude, but I think useful, the number of bills that Congress passes has dropped steadily every year, and it's now at an all-time low.

52:44They just do nothing. And that is because we are more and more polarized. the idea, which is not that far away, that the Senate in particular could come together and agree on stuff on a bipartisan basis, now doesn't exist. And so we are in a polarized country. The extreme from a Donald Trump to an Elizabeth Warren or Bernie Sanders is wider than we've had in my lifetime. And I think at the moment it's getting wider, not narrower. And I think that's terrible. Is there anything that we can do about it? I don't have great ideas. I mean, everybody always asks me this, and there have been various efforts along the way of people who are centrist moderates, which is what I think of myself as being, to kind of come together.

53:27but the structure of our political parties the way our constitution works the existence of an electoral college the senate the filibuster rules there's so many things that are structural that i almost think that what has to happen is it has to get worse before it gets better it has to get so bad that the public says to hell with all these people from the extremes of both parties let's have a sensible solution and somehow that happens we've had these problems before and this polarization existed in the late 19th century. It's existed at other times. Yeah. All right. From your lips. So we'll see what happens.

54:02Steve, I want to turn to a couple of closing questions. What's your favorite hobby or activity outside of work and family? Well, this was going to sound odd for a Jewish kid from suburban New York, but I ride horses on my weekends. What's your biggest pet peeve? Being left-handed in a right-handed world. That literally? Kind of. I grew up thinking to myself, I don't understand who designed scissors and why they are so awkward. And then some years later, if somebody invented left-handed, I don't know if this is my biggest peeve, but it's one of my peeves anyway. Well, I share that one with you.

54:33Okay. Well, you also know that it's kind of special to be left-handed. What's your biggest investment pet peeve? Probably managers who come in and just want to tell us how great they are, how great everything is, and they've never made a mistake and all that kind of stuff. And this gets back to what we're talking about before. I've been on both sides of that table and it's really not pleasant for us and probably not for them either, actually. And to what extent from when you were on the GP side, do you think there's this sort of game theoretic exercise where people are purposely saying what's good because by and large, that's what helps them sort of raise assets and grow?

55:06I think there's some of that. I think the interesting conundrum for a GP is when things aren't going perfectly, whether to basically own up to the fact that they're not going perfectly, say, I own this, or to say, no, no, it's really better than it looks and here's why. and we had one manager who we don't have anymore who in the public side who we used to go visit when their performance was really not good and they would always tell us it's all fine and you kind of want them to say look I get it you know I think I'm good in the long but anyway so that we all are in the business of sales to some degree we all want to present a positive story but I think having a high degree of honesty in that is probably well recommended on both sides What reading do you almost never miss?

55:50Five newspapers a day. Do you read them all? I do read them all. And my wife makes fun of me because I don't necessarily read them all the day they're published. I often carry them around for a week if I don't have time. But I just believe that if you read five newspapers a day thoroughly, eventually, you'll know most of, especially in the business I'm in now, you'll know most of what you need to know to operate. And what are the five papers? Well, I start with the Wall Street Journal, then the New York Times, then the Financial Times, then the Washington Post, and somewhere along the way, just for fun, I read the New York Post.

56:26What teaching from your parents has most stayed with you? From my mother, probably self-confidence. Some would probably say to a fault, but there you are. And from my father, had a great ability to get to the core of an issue, to kind of peel away the onion, not get distracted by irrelevant details, but focus on whatever the decision or issue was of the moment and decide it and move on. Great. All right. Last one. What life lesson have you learned that you wish you knew a lot earlier in your life? I think probably that your career and your life will be much better if you work for the best people you can work for, if you have partners or colleagues who are the best people.

57:10And I mean both skills, integrity, human qualities that you can find. And if you have the best people working for you. And I've made a few mistakes like that along the way, and I've learned from them. Great. Steve, thanks so much for taking the time. Thanks, Ted. Thanks for listening to this episode. I hope you found a nugget or two to take away and apply in your investing and your life. If you'd like what you heard, please tell a friend and maybe even write a review on iTunes. You'll help others discover the show, and I thank you for it. Have a good one and see you next time.