[REPLAY] André Perold – Academic Practitioner (EP.02)

27:16I would say it's pretty hard. It's pretty hard. After the fact, it's, of course, always easy. but there are a lot of folks who are on paper extraordinarily talented who end up not performing so well after the fact as we all know so you need to make judgments i think the ability to judge people is an essential skill that one needs and it's very hard yeah everything seems like it's hard today markets you talk to people everybody says markets are expensive asset classes are expensive. You are tasked with making money for your clients. Where are you seeing opportunities? So let's understand why it's hard.

27:55It's hard because the world's competitive. It's also hard because the world doesn't stand still. And so the industry is always evolving. If you have a good idea, the odds are high. Others have that same idea. So I think investing is always hard. It's harder than you think. It's the same as any other aspect of business. If you try and compete as a firm, it doesn't matter who you are, there's competition. It's seldom easy. And so I would just say this idea that there are times when it's easy and there are times that it's hard. No, I think it's hard all the time. I think in today's world, I think it is hard.

28:36It's hard to see anything obvious. Equity markets are high. It's hard to sort of have a belief that equity market returns will be fantastic over the next 10 years. I think we sort of think about it in sort of along two dimensions. One is there's a very dynamic aspect to the world. And it may be that there may not be great places to put money today, but there will be in the future and you need to prepare yourself for those instances. So we think of managers who have flexible mandates, for example, as being a prime candidate for folks we want to partner with, folks that are prepared for things. Being prepared takes work.

29:19Being prepared and not investing is very hard because it looks like you're not doing anything. But the fact is you need to be good enough to guess where the opportunities might be. And then the minute they occur, you have to jump and pounce on them. So finding firms that are good at that is one of the things that we're always looking for. On the basis that the world's very dynamic and it's the day you buy is when you make your money, not the day you sell. And being ready for those buying opportunities is sort of critical. That's one kind. The other kind is looking for niches where specialists can outperform and just thinking about very niche off-the-run areas.

30:01Example might be direct lending, for example. The lending space is interesting because banks have exited vast swaths of the lending space. and I think there's money to be made there. And there are other areas, niche areas that are a little off the run where you find a team that can do well and then you just have to keep reaffirming A, that it's the right team and B, that the opportunity set is still there.

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31:08André Perold:That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. And I think there are ways to make money there too. Are there any particular niches that you're excited about today? I think if you look at areas like biotech, there are a lot of smaller biotech companies that are not well understood at all. It's a, people love, it's sort of faddish and people chase things based on psychology. It's a particularly nice area to be able to try and play that game. I think smaller banks are an area as well where you see, they just not very glamorous kinds of things.

31:57And you just need to go from one to the next and try to understand what they're doing. but there's just a very broad range of these things. Small cap activism is another one where these are, again, off-the-run things. They're not buying the large caps and doing things like that, although the large caps themselves, not all of them are that expensive and there are opportunities, it seems, there as well. So you and your team spend all this time exploring these niches, trying to find these great opportunities. You're hunting where other people aren't. And at the same time, the studies all say that asset allocation drives returns.

32:39So if you step back from the biotech investing, the small cap banks, small cap activism, the banks, what does your overall asset allocation look like today? And does it jive with sort of how much time do you spend at that level as opposed to really looking at the underneath the corners to execute as well as you can? Look, so I think of it very differently. I would say, you know, people, I think there's a bit of a false dichotomy that people draw between what's more important, manager selection or asset allocation. So let me first say, if you're selecting managers who can't outperform, then it's a problem.

33:19You should just index and be done. And then it's all about asset allocation. If you can find managers who can add a lot of alpha, it changes the game completely. and then it's a function of how many of those do you have if you have all your money split between three managers who are very active in what they do but really good i think it's all about managers and i think so it's you know if you're highly diversified across managers it's a different story then most of what they do cancels out and you're left with beta risk which is about asset allocation. We sort of think about it as, look, finding alpha is scarce.

33:58Finding alpha is hard, and you need to find it where it is. You find alpha most of the time where there are dislocations, where there are capital shortages in the world. You don't find alpha all the time on the corner of Fifth Avenue and 47th. It just doesn't sit there all the time. You may occasionally, but it doesn't sit there all the time. So you need to go where it is and it may be it's there in Japan. It may be there. It's there in distressed investing. It may be it's in some place and you need to go there. So our view is alpha, the pursuit of alpha is always opportunistic and you must go where it is, not where you'd like it to be conveniently.

34:37When you find it, invest in it unless there's some reason it doesn't make sense and that always leaves you with an idiosyncratic set of managers and an idiosyncratic exposure to the broad markets because each place you find, each pond you find has its own set of exposures to the broad market. So you can get pretty lopsided exposures if you follow money opportunistically, if you follow the opportunities where they are. And so our view is look for the opportunities where they are and then true up the exposures you get so that your overall exposures make sense. So how much U.S. equity exposure am I getting by virtue of these terrific opportunities?

35:19And if it's less than I would like, add to it, perhaps in a passive way. And if it's more than I really want, I can hedge it out. And that bounds, is that sort of, there's ranges that you're comfortable with? That's where the risk target really matters. So, you know, we are very risk conscious. And a portion of our capital is in a very low risk fund. and there the ranges are much lower for equity exposure than they would be in a higher risk version. So we set those based on a broad sense of risk and just depends on the risk target. You know, I found in my time at Protege that when you're looking for the great opportunities, you'd like your team who's out talking to people to also be looking at.

36:06But I also found there was a lot more art than science into being able to spot what is a great opportunity. And that takes a lot of experience, and you only have a limited bandwidth. How do you try to get the people on your team to be looking opportunistically around the world? Look, I think it's hard and it's easy. The easy part is it's amazing the inbound traffic that we get. Wait, when you have money, people want to talk to you? Is that what you're saying? It's shocking that when we have money, people want to talk to us. And so that's one of the things. So the issue is you are chasing down a whole range of things.

36:45Often there are opportunities you can't find the team. Often there are opportunities and you can find the team, but the terms don't work. It's too long a lockup or it's too expensive along some dimensions. Sometimes it's too expensive because of taxes. And so even though you might see something, you don't have a way to execute on it. And we work hard to try and find ways to execute. Sometimes there are ways to execute through derivatives or some other way of doing something or create a sort of an LP-friendly structure that sort of helps. But I think in each case, one just has to – this is where being an investor really helps.

37:22And having an investment mindset where you have to put yourself in the shoes of the folks making these investments and ask yourself, if you were doing these, would you see it the same way? and it's very much the same kind of work that someone would do is actually doing it and making those investment decisions. So we all learn from our mistakes. Can you talk about what you've learned in this period of time over the last decade that's different from what you thought investment firms did or had to do to execute well when you were teaching and studying firms? I think the biggest lesson has been that the world is extremely competitive.

38:05And that competitiveness is not something you see until later in a given area. So you think you found something, you think you're the first to see it or maybe the second or the third. And you realize later that you were just one of many and it's already competed away before you can actually take advantage of it. It is so surprising to see after the fact how things almost always don't work out nearly as well as you thought they did before the fact, you're always disappointed. It's a bit like golf. You're always disappointed. Hope springs eternal. You know, outside of the story, it goes both ways because I remember being involved in the subprime short and it was a perfect trade.

38:50And you looked at it and you mapped it out and you said, boy, if this goes as we think, and we're going to pay 8 % and we're going to make 10 times our money. And then it worked. And one of the things you saw afterwards with some of the people who were in that trade without pointing to any particular manager is that it almost changed the way they thought. They did something that was perfect. And then they proceeded to search for the next thing that was perfect. And if it wasn't the big grand slam home run, they couldn't do it the same way anymore. Look, I couldn't agree more. And what that says is that there's a huge amount of luck in our business.

39:30So subprime worked in two ways. One, it was just a good trade where if housing did badly, you could do well. What I don't think people understood at the time was it was also a huge macro trade. So if you got it right, it was a hedge on your overall portfolio. The benefits of being short subprime were extraordinary at the time. The other thing is I think timing really mattered. We did subprime and it really worked well for us. Our predecessors in the trade, meaning others in the industry who tried it earlier, did not do so well. And some got shut down because they were too early. Just read Michael Lewis's big short and it's all in there.

40:13And I think people don't understand the role of luck is huge. And I think we in the industry and society at large celebrate as skill what really is luck often, not always. And when you're lucky, you can be lucky and come across like a genius. And the mistake we make as investors is to assume it was skill and not luck. or not correctly or sufficiently adjusting for the fact that there's a lot of luck in this business and in investing. And that's really hard to sort out. So Subprime is a great example of trying to parse that out. I think a lot about the question of luck and skill. And when you're investing in managers, things change inside the organizations.

40:58I remember leaving business school and going to work for a manager that Yale had money with. And so my prior training taught me that anybody Yale had money with was a superstar. And it was a great story. It was a small average buyout shop. And I went there the first day. I was the first associate they'd ever hired. And there were four or five partners. And the first week, one or two of the partners were in the office and the other guys weren't. And then the next week, there was a different guy in the office. And the third week, the other guys were in the office. And it took me until the fourth week to realize that that was happening because the guys hated each other.

41:31And then my big lesson was, wow, the people at Yale had no idea this was going on. And they had entrusted their money with them. How do you, over time, when you have a relationship with a manager, their life circumstances change. In this business, their wealth changes. How do you stay in touch with them enough to detect if what was, let's say, skill or luck turns into something else because the person changes or their temperament changes or their motivation changes? Again, a great question. I think the way we think about it is, firstly, investing with a manager is only the starting point for the relationship.

42:12It's really about partnership, that you want to give folks money that you can be in constant dialogue with and learn from. And hopefully, you can be of help to them as well. Those are the best. So when you have a real relationship with a firm where you're always talking about various things, They get to know you pretty well, but you get to know them pretty well. And I think when you have that kind of relationship, it's a lot easier to get a sense for what is the cadence of the firm? How is it changing? You can look at what they own. You can better interpret the things that you're seeing in their portfolios as to how they got into the portfolio in the first place and who might be driving decisions.

42:53And I think that's helpful. Nothing's perfect in this world. But I think that's sort of absolutely one way to think about it. There's a lot of talk today about fees across active management.

43:05André Perold:How have you thought about it differently in your relationships with your managers, if you have in the last couple of years than before that? And what, if anything, are you doing differently? So look, I think the first thing to say about fees is we always think of the returns we're getting from our managers net of fees. Very simply, if they can generate great returns net of fees, so be it. And if they can't, that's a problem. And so that's the starting point. All else equal, obviously, we would prefer lower fees if all else is equal. The question is, is all else equal? I think, and the answer often is no.

43:42For the kinds of skill we're looking for, you need talent. And talent is expensive. So the idea that you can generate high alpha for low fees, I think, is a complete misnomer. Very hard to do. I think I can see how there are certain firms where the fee levels are needed to be high or maybe are egregiously high, and it wipes out the value they can add, and you just don't need to invest with them. That's very easy. But when you find true talent, you've got to pay them. and I think you're kidding yourself if you think you can get the combination of extraordinary performance and talent for very low fees.

44:21I don't see how that works. What are you concerned most about in the capital markets today? It's crowded. I think it's crowded. There's a lot of money chasing. It seems like fewer opportunities. You need to go further and further afield to find things. So for example, as I said earlier, we're looking to give folks more specialized mandates in areas, but you have to go further afield to find those. When you do go further afield for those, do you find you tend to gravitate to smaller cap and less liquid necessarily? I think a lot of the time it is that because that's where it's harder to put money to work.

44:59But you also find there are smaller firms. They're not well known. You need to better understand the people. You're often one of a very small number of investors with that firm. and you just can't take, there's no such thing as safety in numbers where you can hope and rely on other people doing the work. You have to absolutely do your own work and have confidence that you can identify these things. So I think it's crowded. I do worry a lot about the political system today. I do worry about protectionism. I do worry about the freedom of the press. Things that go well beyond investing, but I think these things all hang together.

45:38The economy seems to be doing fine. but valuations are high. And so the question always is valuations are high. My sincere hope is that they're high because things are going to be great and that would be awesome. But you always have to worry they may be high because there's a little more exuberance in the markets today than is justified by the fundamentals. And so one has to be cautious and always be prepared for downturns. But part of being prepared for a downturn is thinking about where will there be opportunities and having dry powder to put to work on those days. You know, I guess we all hope that we're going to be able to make America great again.

46:15But at the same time, the political, the populism, everything you mentioned, it's hard not to wake up some days and sort of be worried that the world we're looking at for the next, I don't know, 10, 20 years is so different and a lot less comfortable than the world we've been living in. Or maybe that we in the financial markets were a little bit blind to what the rest of the country was really feeling all along. How do you take that awareness and apply it, certainly in your investment portfolios, but also in how you think about both the business and investing and then in life? Look, I think in life, the hardest question is we all know how this could evolve.

46:59We can all see the beginnings of authoritarianism, nationalism, economic nationalism, and we all know where that could lead. And there I worry about, you know, it may not be in my lifetime, but in my kids' lifetime, and I worry a lot about that. I think for investing, I think one has to take the view that good things can happen. There's certainly, I see a lot of good things that could happen. If society has, and today we have the extraordinary ability to make good things happen if we would just work together. And so there's upside and we may come to our senses and things could be fantastic. But I think the tail risks are high today.

47:41I think one has to think about tail risk. Small probability but big impact events. Including, I would say, I think whatever probability you put on having a major war in the world, I think it's always been small in recent years. But however small it is, it's probably double that small. Still small, but maybe a little bigger than it was before. It's a tail risk. It's something we need to think about and just be a little more conscious of as we make investment decisions. At the end of these podcasts, I always try to ask some fun closing questions. My first question, what was your favorite sports moment as a participant or an observer?

48:22I think you should know I love to play golf. I'm a golf nut. Apparently, you have a great short game. Is that right? I'll let others be the judge of that. But every now and then, I'm able to really score. A lot of the time, it's useless. But every now and then, I can really score. And I've had a couple of fantastic rounds. And those, you never forget. Those are very special and last forever in your mind. So one of those was at the Masters, and that was your favorite moment. One of those was at the Masters, and you can never forget playing Augusta and having a good time. How about recommending a recent book, TV show, or podcast that you've enjoyed?

49:00So I love Michael Lewis's writings. I think he's someone who thinks about the world in a way that is very unique. He has a way of seeing through what's really going on and developing a framework. So I like all his books. The one I think is most profound is Moneyball. I think it's not that recent, but it's an example of how he wrote about applying techniques of investing to talent management and finding great players on a team. And it extends to so many aspects of life. I just love the guy. What is your favorite thing to do that is a complete waste of time? Back to golf. I love, I'm always struggling.

49:40As any golfer knows, it's a struggle. And putting often just doesn't work. And I will go and research new putters, buy new putters, and find the problem is the six inches between the ears, not the putter. And talk about a waste of time. That's what it is. But it's great fun to always imagine. Wait, are you saying it's the magician and not the want? Exactly. Exactly. What do you know today that you wish you knew 10 years ago? You know, well, obviously, I'd like to know where markets have gone. That's always nice to know. In the 10 years. There's a movie. There's a Back to the Future 2 or 3 with the sports book.

50:13I think something like that. Exactly. Yeah. You know, I think in the last 10 years, if you think what's happened, we've had a terrible year and a bit during the financial crisis where extraordinary things happened far beyond anything we could imagine. And then, likewise, we've had a recovery in the markets that's been unbelievable. including U.S. equities in particular. I wish I'd known then how bad it could be, but also how resilient the world could be and how we've come back. So things like that, but that's always in hindsight. It's always easier to think back what you'd like to have known. You are now 110 years old.

50:53You are sitting in your rocking chair, which is your favorite passion at the time. What advice would you give yourself looking back at your life today? You mean what advice would I give myself for the next phase in my life starting now? Correct. And I would say, firstly, I think the beauty of life is there's no such thing as being too old. I think there's no such thing as retirement. I think you should never retire. There's no such thing as think small. You should always think big. You should always try and have an impact and think about what can you do to have an impact. have energy. I think basic things like the power of networking, it's critical to do anything in this world.

51:44You have to be able to network well. And you can never rest on an old network. You have to keep refreshing, replenishing. And that takes hard work. It's all about relationships. And I would say those things never get old. They never stop. And those are the things that make life interesting, work life interesting, and just keep doing them. You realize as you get older that life's about family, family, family. Never forget that. And I think we talked about luck. Luck really matters. So if you can make your luck, you're that much better off. And it's a version of you can't win the lottery if you don't buy a lottery ticket.

52:32You've got to find ways to make luck for yourself. Are you recommending buying lottery tickets? I'm just trying to clarify that. So I think you should always be taking risks. You want to manage your risks, but you want to take risks. Because good things happen when you take risks. Not crazy risks. I'm not saying not be prudent. But you want to take risks. If you don't take risks, taking risks is interesting. You learn. It's exciting. It works. if you're thoughtful about it and you always have a chance when you do that. Fantastic. Andre, this is so much fun. Thanks for doing this.

53:08André Perold:Thanks, Ted. I appreciate it. 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've liked what you've heard, please rate a review on iTunes or Google Play to help others find out about the show. Have a good one and see you next time.

53:30Thank you.