Gary Sernovitz - Inside the CIO Seat (EP.357)

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2:32Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators.com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

3:11Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast. My guest on today's show is Gary Cernovitz, Managing Director at Lime Rock Partners, an oil and gas-focused private equity firm that manages$10 billion, where he runs the firm's investor relations and business development efforts. He's also the author of The Counting House, a fictional story about a CIO who oversees a$6 billion college endowment. After 20 years observing CIOs, Gary brings his pointed, witty writing with a nuanced understanding of someone sitting in the CIO seat. Our conversation discusses the perspective Gary brings to his latest book, the challenges of serving as a CIO, and insights from two decades of manager meetings.

4:04Sitting outside the CIO seat, Gary shares a side of the CIO role that many experience, but few are comfortable discussing on the podcast. Before we get going, we're hosting our fifth cohort of Capital Allocators University in New York City on February 22nd. CAU is designed for allocators with five to 15 years of experience to connect with each other and learn critical frameworks to help advance their careers. Rahul Moodgal and I will be joined by a few past guests on the show for a day filled with presentations about skills, Q &A, and small group discussions. For those who have attended one of the first four cohorts, we're now ready for you to return for a second semester too.

4:54Spots are limited, so hop on the website and register today. Thanks so much for spreading the word about Capital Allocators University. Please enjoy my conversation with Gary Cernovitz. Gary, thanks so much for doing this. Thanks for having me. Why don't you take me through your quick background that prepared you to write this book? Born in Milwaukee, Wisconsin, went to college, Cornell the whole time. I was very certain of my future, which was to be a PhD academic historian. Summer before the senior year of college. I was in London doing research on an undergraduate thesis. By the end of the summer, realized maybe I don't want to be an academic historian.

5:36And the historians of the British Library are like, we don't need a Jewish guy from Milwaukee adding to an already very well-covered history. I was fortunate to be born in 1973, the demographic lull in a post-war America. And so at that time, you can get a job with just a liberal arts education. I had no interest in finance particularly, and I had no experience. I had two job offers in front of me. One was to be a speechwriter for the Parks Commissioner here in the city, and the other was to be a junior equity research analyst at Goldman Sachs. And I took the junior equity research analyst at Goldman Sachs.

6:08I did that for a couple of years, assigned to the energy group. Eventually, I promoted to look at Latin American oils. After that promotion, I had a very big bout of insomnia and started writing what was my first novel. And I've always been a big reader of novels, always been interested in it. 25 years old, took the job in finance lightly because it was never something I'd really sought, announced like a real pretentious asshole that I was quitting to write a novel and finish the novel, sold to almost all my immediate family, had another novel that sold to maybe some second cousins, also bought it.

6:42And then in 2004, the founders of Lime Rock private equity firm, Energy Focus, private equity firm where I work, they were looking for someone to actually write their fun three PPM. I was like, I've never written a PPM. They're like, well, take the fun two PPM and upgrade it. We'll pay you by the week. Classic lobster in the pot or the frog in the pot. 20 years later, that role has gotten a lot bigger, but it's also been very fortunate where it was always this understanding between them that writing was always going to be an important part of my life. And they've been shockingly hands-off. So where did the idea come about for The Counting House?

7:15I wrote a book about seven, eight years ago on the shale revolution that was primer in my voice on the shale revolution. And I'd always thought a book like that around the age of alternatives, private equity hedge funds, et cetera, would be fun to write, but also never felt particularly compelled to write it. When you have a full-time job, you really have to be gripped by something to obviously write it. Especially the time I quit Goldman, I was a very pretentious and severe novels. The novel is the highest form of the written word. But then after writing two that got published, two didn't get published, I'd put it to the side.

7:51And my wife, after me moping around the house for a while, she's like, well, you haven't written a word of fiction in 11 years. Here's a story you always tell, write in a fictional format, take a Sunday and write something. So I did it. And then all of these private notes on this other nonfiction book just clicked into place into really what the format became of the novel. How it would go, how it would end, who would be the protagonist. It all clicked together in an intuitive way of just subterranean thoughts for many years. So what is the core thesis of this novel? There's a VS Nipole line that a novel is a sum of opinions that don't add up to a point of view.

8:30The purpose of it is trying in a classic novelistic way to combine ideas and feelings of really what it means to be an investor today. Finance in fiction today usually has two main formats. One is we want to write about rich people in New York City. They need to have a job. We'll ask our college buddy who works at a hedge fund to give us some notes and some trades. We'll have corny names for firms. We'll put in some prostitutes, probably a lot of cocaine. And then the other one is in the school of liar's poker, like the young person coming into New York and working in a job. But it's really classic building for a mom.

9:05But none of them really treated finance and investing. It's always the backdrop about the setting being more the fabric than the backdrop. So this one, I really wanted investing to be the fabric of the novel. The thesis of the novels, can I capture in a LA to New York plane read, funny, but also pretty serious novel, what it means to be an investor today? And that is a window to what it means to be alive today. How do you describe the book jacket summary of what it's about? It's about the chief investment officer who is unnamed through most of the novel, just referred to as the CIO. It is about a period in his life where he's coming off from being the recipient of the Times article of this is the CIO genius coming out of a very proud, going through a soft patch that gets very difficult in terms of performance.

9:57And as that happens, he is dealing with both trustees, the university president, his staff, and a lot of people coming into his office asking for money. as his life is tightening, his self-doubts are increasing until the novel ends. About a fifth of the novel is a scene where he meets this reclusive hedge fund manager, alumni of the university, very aloof from the university, in a scene where everything in his life and hopefully investing is brought into a very tense conversation. So you mentioned this as a fiction novel. The obvious question is, is this CIO based on a person? Are the individual stories based on actual managers?

10:39I'm trying to get away with everything. None of the main characters are based on anyone. I did that because there's some times in life where laziness and conscientiousness merge by not doing the research, by not sitting down in the office of a CIO and taking notes or a manager and asking them to see their pitch deck, but just saying this is going to be forged in my imagination. I also was a little more free to write a little more wit, less worried about the feelings of the person on the other side. The intention of all of it is to be true. This is not a satirical novel. There's some dramatic heightening, but it should make you wonder, as a reader, this has to be X, Y, Z.

11:20So the purpose is not to have fantasy figures, but there's a trusty or sir, Goldman Sachs. I didn't make up the name. He's working for Big Bank Inc. And so there are references to existing firms, but those are always rooting into the real language rather than this is an analysis of Goldman Sachs or this is a true, but I did want to not get too clever about that. So before we dive into some of the storylines or really your perspectives on it, the insights that you bring to bear, where did all of that come from? We're living, we're observing, we're reading, people are having lunch with CIOs, become friends with CIOs, and seeing pitches and read articles about VC.

11:58So it's just been forged from this direct experience. Most of the speaking roles in the novel are from money managers of various asset classes, but there was an intentional effort to say, hey, this is lower middle market credit fund. This is the golden age of VC. Quant. I'm not going to cover every single sub-asset class. It was trying not to be too focused on private equity or too focused on a specific thing that I know the best. So whenever you sit down to do something like this, you are the author. There's always a perspective that you're bringing to bear from your experience. How do you describe what perspective you're bringing as the author to this?

12:34I'm the IR guy for the 180th largest private equity firm in America. Not a particularly important job in finance. And I joke, I'm the stable hand in finance. And I'm writing a book where I'm imagining I'm a jockey. So a lot of the CIO's sensibility is another path of my life had gotten me there. That sensibility is how I think about the world, my sense of humor, or a lot of that. I'm also in other characters, and other people are in the CIO. A few friends who have read the book are like, Gary, you're a very good CIO, and you've imagined yourself as a CIO. Maybe you should just do the job instead of writing a book about it.

13:07And so I think he has a similar ironic remove and wore it lightly too, but found himself very good at it and very proud. And like a lot of novels, you want precipitating action or conflict or something. The self-doubt coming in after he thinks he's kind of figured it out is one where I have a tremendous amount of respect for people to do the CIO job because every day you're relearning things that you thought that you had figured out about a manager disappointing you, manager surprising you, things you missed. And so that drama is what I was trying to say, that he had a model and the novel's set in a time where the model doesn't really work.

13:45I'd love to dive into what you see as some of these challenges of the CIO. So clearly there's this performance pressure from the guy who was in the New York Times who's now not. What have you seen as how different CIOs respond to that performance pressure? It's a good question. It's hard because, as you know, a CIO doesn't make that many decisions a year. You're not running a pod for 0.72. The ability to move a highly illiquid portfolio is not easy. There's a lot of stages of grief when a portfolio is starting to move. And first is denial. The markets can always be different tomorrow. The markets are wrong now.

14:30the markets are going to come or this manager's J curve is deeper, but still. So I think those stages of grief is what I see. These challenges, even defining success. I follow along probably like you do the P &I, the endowment tracker. The numbers are always surprising, but the five-year numbers, the 10-year numbers are pretty tight from very different sophistications, very different styles. One of the clear challenges that you describe is governance. And we just love your take on different types of challenges that you've seen CIOs face with their governance. I made some joke about the old days, Ivy Slip streaming and board of trustees.

15:14And we all know there's some legacy institutions that still operate where you have a big partner at a big private equity firm or a big bank to ones where they really keep them pretty removed. This novel purposely, I tried to put it somewhere in the middle where the CIO has a rubber stamp, I see, that generally lets him do, but talking to him a lot. And that soft pressure, this Goldman Sachs partner in there who's wonderfully foul-mouthed and everyone's favorite character in the book, feeling those soft pressures, those questions, and almost spousal, the relationship they have. It's like, I know you got to do your job, but what are you doing?

15:52So I think that the CIO is on the fortunate end of this governance. The university president is shockingly nice to him relative to his own self-doubts and how hard he is on it. What I was trying to capture, the toughest middle case where it's not clearly just an irresponsibly managed institution, but also feels these real pressures. There's a reason that it's the CIO of a college endowment, the real pressures of that money. If I did this about like a family off, no one would care. I think a lot of the CIOs I've met and their purpose of life on earth has become that scholarship, that research budget, and wanted a hero of the book who felt that deeply, which is something very nice about that seat.

16:35And you feel that a little bit on our side of the table in professional life, a little bit more at a remove, like you're proud, but it's so abstract. And one thing I actually did for my own amusement is put him on the campus. A lot are not even close anymore. And I find that interesting in my fictional university, have watched the students walk by every day as a reminder. So you go from managing up to the board, then you have managing a team of people. What are some of the key challenges that you've seen for CIOs in being able to manage their team while managing a pool of assets? I mean, I think that's one of the biggest dispersions of talents in CIOs that I've seen.

17:17Because as you imagine, managing people and managing investments are not the same side of your brain. There's no a priori reason that someone should be skilled at both. And maybe there's, in fact, the opposite. If you're an analytical, quiet person, you actually don't want to manage people. The CIO definitely is on the side of, in a perfect world, he would do everything himself. And I think there are other CIOs like that. This is a very simplified investment office. There's really two deputy CIOs, managing directors under him that represent the opposite of it. One is just like a very attracted to the bright, shiny thing.

17:55A real, you see how it calls like a pop in jail. Yale is doing must. We all know that this exists and he's just really into the horse race. And the other one's very diligent, but almost the flaw he sees in her or some of his own flaws of just feeling like you can master this as something that should be able to fit into the Excel formula, making these capital decisions, which obviously is not something that Excel had a formula, it would make everyone's life a lot easier. A lot of the book is framed around manager meetings. I'd love to talk about some of your perspectives with the different types of LPs that you encounter as a GP.

18:31I mean, I have a lot of time to observe it because remember in my role, I'm talking 5%, 10 % of the time. And a lot of time I'm staring out the window, looking at the people on the other side of the room. Occasionally they're like, why are you creeping on me, man? Like they're looking at me. So I have nothing to do. I've heard this pitch before. I wrote this pitch. I don't really have anything to do. So I'm going to study you as a human being. You can come out of meetings with the most enthusiastic, buddy, buddy. And then for years we thought they just loved us. Our spouses do not love us. as much as these.

19:04And then you realize that's just who they are. Every single person who walks into that meeting, they're just enthusiastic people who generally appreciate intelligent people coming to talk about investing. And that has nothing to do with their ability to invest. The opposite side, where in meetings, like, did they actually say anything during the meeting? Like statues. Sometimes it seems to be reflective of, they didn't want us to be in the room. Sometimes there's also just a different personality, like whether they're not interested in expressing their opinions, they're just studying. And then the one thing that we've always found super interesting is the questions that come up, sometimes very detailed 2025 EBITDA projections.

19:45And this is a case of a private equity decision. What is the purpose of these questions? Are you curious and you're in a room and you might as well ask any question you're curious about? Is there a specific model, a formula on this? But very random questions you get. How do you think about, from a CIO's perspective, or you as the CIO, what goes into the selection process for a manager? I talk about input, system, and hunger, which is if you think about hedge funds, you think about a private equity firm, you think about anything, what is the input into this investment system? Is it shop deals from Goldman Sachs?

20:22Is it data on stock price performance you get from Bloomberg, that they're just smart people that can figure it out. That's frankly, a lot of alternative assets is. If I were a CIO, that worse, is there a sector specialty? Is there some understanding of the data? Is there a data no one cares about? This input into whatever this model is, is hugely important. I think the second is the system of how they process it. Now, everyone pitches a very sophisticated system. We have this machine, and there's a scene in this about a guy who failed at private equity by calling bullshit on the machine. Because especially in private equity, you don't get that many at-bats in the course of a career.

21:00But there has to be some system other than we're smart guys who know a lot of people. And then hunger is the one that probably the Excel formula doesn't get right. And probably one of the hardest things to do for people in a CIO seat is these natural life of a money management firm. You want someone whose life depends on it, but you also want them to prove that their inputs and systems work. And you don't want them looking at their Hamptons real estate and spending for their seven-hour workday looking at art to hang on the wall and to try to find what is the optimal hunger and also when to get off a successful relationship because you can feel that hunger.

21:40And that's got to be extraordinarily difficult to do because usually that hunger dissipates after success. and you probably want to be off manager before that hunger dissipates. But it takes an incredible amount of fortitude to say to someone across the table, hey, I know you're getting rich, sloppy, and lazy. You're not there yet, but you're going to be there in nine months. I can predict that and I don't want to be there when that happens because usually you're there after it happens. Within that broad categorization of what you're looking for, you've been in a lot of meetings where there are a lot of little things that you pick up.

22:14I'd love to hear some of your favorite ones of things that managers might do in meetings that a CIO might see as negative. There's one chapter that a lot of people who have read it. It's the cringe chapter, but also the one that they enjoy. One of the pitch deck and just the absolute cliches of the pitch deck. And I have tremendous sympathy for that because as a writer and as someone pitching, there isn't a hundred ways to describe system input hunger. There are these things people talk about exactly the same. And so how to not cause that eye-rolling, proprietary deals, the funnel, the sheet of paper where somehow God has made it, you're the only uncompetitive sector in the entire history of finance capitalism, that these are put out.

23:04ChatGPT didn't need to be invented because people were doing it themselves. The bland, the formulaic nature of it. So I think that is one. And then a lot of the things I just had fun with, I do phone lock screens. I'm very fascinated by it. And there's a thing. We all know everyone brings their phone to the meeting, and they look at it, and they're very disappointed that they're going to have to be in this meeting and not look at their phone. But they leave it on the table. I'm going to be there for your buddy in an hour. Just hold on. But then when they're locking their phone, you can see their picture.

23:32And I'm always very fascinated. People have pictures of themselves. And they have children. Things like that. These human clues that a novelist is supposed to pick up, but a CIO is also supposed to pick up. the CIO not only talks about these clues, but also, again, there is no formula. The guy's a raging narcissist. He has three kids, but has a picture of him at the Super Bowl with Tom Brady or something, whatever it is, instead of his three kids. Maybe a raging narcissist is good as an investor. Maybe a raging narcissist is a sign of outperformance. And so it's like that second iteration that even if you have fun, interesting ways of picking up human clues, because so much of this as human clues, it doesn't necessarily give you the answer.

24:15What are some of your other favorite tricks for picking up human clues? A friend of mine always loves PGA Golf. You can go on the PGA website and see people's handicap. There are different views on golf as an important business, I think, and you have a lot of time on your hands. I talk about how polite folks are to assistants, cab drivers, and stuff like that. But again, is being a jerk to the assistant necessarily dispositive of being a bad investor or a good investor? So he's like human clues. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past?

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25:45And now, back to the show. What do you think, and what you've seen, are the most interesting questions that a CIO asks of managers? Great question. There's a philosophical one, which is repeated a lot in the book. Why are you doing this? I joke, all my friends got rich in private equity. Why not me? School of private equity. There's a lot of firms. That is the organizing thesis of that firm. All my friends got rich in private equity. Why not me? I think, first of all, what is the passion and differentiation bringing to this business? Why does this firm need to exist? A very philosophical one that I think is hugely important and I see interesting CIOs getting to.