[REPLAY] Ashby Monk – Investor Identity, Navigation, and Resilience (Capital Allocators, EP.312)

28:03But ultimately, going and meeting people and building these relationships, this is the culture part of investing that I think is going to be there forever, I hope. But the reality is art and technology, art and science are two sides of the spectrum. Like science is seeking to quantify, to codify, to take what is tacit and make explicit. There are tools to capture some tacit knowledge, like knowledge tools, but it's very difficult to do. So there is going to be a long, slow period, I think, where organizations that have built very strong cultures around alignment with their managers around, for example, risk-taking and direct investing.

28:48I feel like we could almost walk through what I would describe as the components of the Canadian model, where you really need talented people internally. You need to empower those people with strong delegation frameworks so that they can be credible in the marketplace. And you need to set up overseas offices so they can get the information they need. All these things don't feel all that technologized. Now, you might be able to automate some of what they do, but ultimately I would say that model of going out and building networks and originating deals, that feels like it is in tension with building the next great technologized investor because it requires such a big investment.

29:33And those organizations have thousands of people plus. They have overseas offices around the world. They're all operating in a very well-defined environment. Just to kind of swoop in and say, we're going to replace this and that with technology, I think will be a challenge, but we'll see. We're going to take a quick break in the action to tell you about private equity investing at Brookfield. With 100-plus years its owner-operators and a$1 trillion ecosystem, Brookfield focuses on essential industries and business services that help shape modern life, yet are often overlooked. It takes independent vision to see their potential, perspective to acquire with precision, and expertise to build lasting value.

30:17It takes industry. Learn more at brookfield.com slash ittakesindustry. And now, back to the show. So how do you think about something like Yale, which everyone likes to point to, with a new chief investment officer laying your framework for Yale's identity and how that applies to the enablers? If we take the Yale case, it's a fun one, obviously, because they invested very early and heavily in all the alternatives. Part of me thinks the technologized model is going to empower them to be even better at the Yale model. Why? Because you're just going to have much more confidence in how your GPs draw and return capital.

31:07So like right now, when we think about the traditional tools we use for predicting how a mid-market buyout fund in Europe draws capital and returns capital. A lot of that is putting the finger in the air and hoping for the best and looking at historical means or turning to the manager and asking them for guidance. But this can be much better. We can do this with data. We can go and pull custodial data and look at the 9 ,000 GPs that are sitting in some custody data set and start to say, okay, biotech in North America Series B and C fund. How did those organizations draw capital and return capital?

31:51And let's actually shock those assumptions with some past crises to see how they affect it. With that type of analysis, if you're a chief investment officer of an endowment like Yale, you're just going to be able to make bigger commitments to managers, hold less cash, and drive higher performance. That's the hope, right? That's the unlock that technology should deliver by helping you understand in more granular detail what you own. The people, the process, I think those things don't need to change that much given their strategy. You're going to empower those people to make bolder bets because they're going to have a stronger sense of what's coming in the future.

32:36I'd love to turn to talking about innovation a little bit. I know it's an area of great passion of yours. What have you seen from sitting in and around the Silicon Valley community of best practices of how innovation gets created as applied to the investment office of these pools of capital? I can't think of an R &D team that exists at a pension fund. So like we said in the beginning. This is the base of capitalism. These organizations put the capital in capitalism, $120 trillion, but they're pretty conservative. And by pretty, I mean outrageously conservative. So they have monopolies over their assets in most cases.

33:17The Australian super funds are a little different. They are actually fighting for survival, which is why I keep going down there because it's fascinating. But most of these organizations are going to be there. Stanford management company, CalPERS. The people in those seats might change, but the organizations will exist, which creates this weird incentive, I would say, to follow the herd. I often joke that the only way you get fired from a pension fund is you innovate, which means you've deviated from a peer group and somebody says, huh, what are you up to? And then all of a sudden you've got to justify it.

33:50And so all that is to say, I spend a lot of my life looking for ways to bring innovation into these organizations. In fact, I would say I used to spend all this time focused on fees and costs, but the only reason I was really doing that was I realized that if you could reveal to the boards of directors and frankly, the broader community of stakeholders, how much these organizations were paying private equity and hedge funds and venture capital, it would ultimately create a conversation like, is that right? Should we be doing this on our own or should we be thinking about some novel way. And that's the opening to, in effect, change how that capital is being deployed at the base, which is, for me, the real motivation of everything I do.

34:37I'm trying to help that base level capital generate higher return while, if we can, deliver positive things for the world. More infrastructure investment, more jobs, less waste flowing into Wall Street, which is a tax on all those things. That is another way of saying, I'm trying to go into those organizations using data to reveal things about their portfolio that maybe they didn't appreciate, maybe was hidden, and then that's the opportunity to shift. But that actually means what we're doing is revealing little crises. And what I've also then learned is these crises, yes, they exist, but they are very powerful drivers of innovation in our industry.

35:23So in 2001, 2003, we had the perfect storm crisis. We got liability-driven investing. We got asset liability modeling. We got all this interesting stuff coming out of the perfect storm. In 2008 crisis, we got factor-based asset allocation. All the work that Andrew Ang done is now being implemented. Products correlate. You really need to go to the core factors that drive return and get diversification there. Now we've got our next crisis. What are we going to get out of this? Is it investments in technology to do better modeling? I hope so. For a moment, I thought this would be the big driver of ESG adoption, but now we're seeing this is a big rejection of ESG going on.

36:06So the punchline to answer your question is, we often need crises to drive change because these organizations are fairly conservative and slow moving and they are monopolistic. But interestingly, technology is going to reveal little mini crises inside these funds, which are opportunities to make change. When an organization does want to make change and innovate, how can they do that in an intentional way and not have to wait for a crisis for that impetus? You need to create organizational space. So the first thing to acknowledge is that innovation is very different from efficiency. So most public pension plans, sovereign funds, endowments, they want you to be efficient.

36:54The number of times I've been lectured, like truly me, lectured by pension employees to say, we can't just spend money on that. We're a fiduciary. And I just groan, Ted, because it's like, look, I get it. You are getting pressure to be efficient. But innovation is messy. I think you've noticed innovation and failure, they go together. That's the business. You can't run a just-in-time process in the Japan style and then make changes at the last second and expect things to arrive just in time. So you need to create organizational space, which means you need to create safe spaces for failure, recognizing that a lot of people went to work at pension plans wanting job security.

37:42They gave up the carry at the giant private equity fund because they liked the job security and maybe it was the nine to five, maybe it was the less travel. And that doesn't mean that their job isn't exciting. The job is, I find that the asset owner world is incredibly exciting. It was a trade. So as we go and we go to those same people and we say, let's get you doing innovative things, we need to acknowledge that we need to create new incentives. We need to create safe spaces for failure. And we need to pull these people that are working in monopolies to embrace that experimentation in a space where they know they aren't taking career risk.

38:21Because that career risk is a big motivator in the wrong way. What's an example of an organization that's done that effectively? I'm going to mention APG again, because they have this innovation engine where they pilot things, or maybe it was PGGM. It's either PGGM or APG, but these Dutch are very process driven. So they built process around experimenting with their technology and they would do pilots and then the good pilots would graduate into full projects. So that type of experimentation is really valuable. I can think of a sovereign fund in the Middle East. I'm not quite sure how much I was supposed to know, so I'm going to leave them as anonymous.

39:01But they have this whole business process automation focus where they're going in and looking at small tasks and seeing, can we automate them with technology? And they have a separate team that goes in and assesses them, builds the technology around it. And the core team is in effect facilitating innovation that's happening around them. So they can continue to do their day job. So this concept of business as usual tends to be very pervasive from Australia to Abu Dhabi to Sweden. You have this business as usual function. You need somebody to come in whose job it is to do the innovation. So that's what we saw a couple of times in that Middle Eastern fund.

39:43I think the mergers that you're seeing in Australia are a natural driver of innovation. You're bringing these big teams together, smushing them and seeing what are the best practices that emerge. What's the low-hanging fruit that you've seen in a non-investment technology company, whether it's a Google or a startup, that you're just waiting for an asset owner organization to adopt? I mean, it is a separate research and development function, which is to say some team that is actually trying to spot the problems inside the organization that can be solved either with technology, with collaboration, with peers, things like that.

40:28I mean, right now, just to be clear, I think the way that many investment organizations get around this lack of innovation infrastructure is through collaboration. We partner with our peers. We go to Stanford and we sit around the table and we talk with each other about our problems. And then we pool our resources to try to develop solutions. And we do that because we don't have tons of resources at the ready to go and work on X problem. It also helps if you can go back to your board and you can say, yeah, look, we're doing this, but this famous Canadian pension plan is doing it with us. And this big Australian sovereign fund is also doing it with us.

41:08In a way that almost gets you to the prudent person rule because other prudent people are doing it with you. What are some of the specific examples you've seen of where collaboration works and where it breaks down? So collaboration is often incredibly effective where organizations don't feel like they're really competing to deliver out performance. It's like these middle back office functions or thinking through how do we design a legal function. Those are parts that I've seen collaboration really inform one another and drive change. Where there's a lot of value add, I think you get sharper elbows.

41:52People see collaboration as a way of leaking IP. If you're worried you're leaking IP, then you're going to lock it down and you're not going to share. I see a lot of that in the endowment space, very secretive organizations that are quite worried that whatever secrets they have are going to get out and be copied. And to give them credit, many other organizations have tried to copy the endowment model. So it's not like their fear of copying is baseless. Everybody has tried to copy the Swenson model so you can understand why they're so careful. But you need to find those areas where it isn't scary to share.

42:31I know you've been involved with Capital Constellations, one of the larger collaborative efforts. Within that trajectory, what are some of the things that have made that work more effectively than some of the other collaboration attempts you've seen? That's a super special one in that the capital that comes around the platform makes the platform more valuable. The bigger and the more sophisticated the LPs are around that table, the higher quality of the table. They're in the business of anchoring or incubating GPs and owning some of the GP. And they get fabulous GPs to work with them because the platform is big.

43:15The world's best investors, general partners, they still feel distressed when they are starting their business. They're not distressed because of anything to do with their investment strategy. They are distressed because it is hard to build businesses. And so Capital Constellation, with that amazing network of limited partners and asset owners that own that platform, can come together and in effect de-risk to remove that distress from some of those amazing GPs. So that's partly what's so effective. You can show up at Capital Constellation and you can really get enough capital to get to business and really start investing and building your own track record.

43:59So I think that's partly where that has been so effective. It's also hard to build that kind of unique capability around anchoring and owning and managing GP stakes. Kind of liken a little bit to what you see in development funds like NIIF in India. where there's been another really successful collaboration with certain Canadian pension plans, investing with NIIF that I raised my eyebrows a little bit like, wow, you're investing with a development fund. Well, part of that in the Indian case was it's hard to build that local knowledge of India and to really be able to go in and do deals. So by bringing all of these investors together in that Indian context, the value of the overall platform improves and increases.

44:46It gives them more leverage domestically to source the best deals. Just like Capital Constellation now has this, it's now probably the first port of call for most GPs that want to go and put themselves in business. I'd like to pivot a little bit to talking about ESG. So what are you seeing the asset owner community doing as it relates to ESG? Doesn't it feel like the whole industry has changed? Now when you talk about ESG, it's like You'd rather be swimming in shark-infested big waves or something because it's safer than talking about ESG. But I think the reality is this. If you're really interested in understanding your portfolio, I think there's still huge value in ESG.

45:30But I think the problem that we've all begun to recognize, which by the way, we were complaining. I was complaining about ESG well before Elon Musk complained that Tesla had the same rating as Exxon or something. And the reason we were complaining is because ESG ratings are difficult to understand. I joke with my students sometimes that the ESG ratings are like Big Macs. They're easy to get, they're cheap, they taste pretty good, but it's not clear they make you healthier and you definitely don't know everything that's inside. There's a lot of sugar, a lot of salt. There might be some yoga mats in there.

46:13I don't know. If you are trying to understand what's wrong with the ESG space, I think you can point to that product and say, look, there's bad data underneath this ESG rating world. We kind of borrowed that ESG rating logic from the credit rating logic. But with credit ratings, I can tell you that those credit ratings are associated with a probability of default on some instrument, some dead instrument. What is the equivalent for ESG ratings? What probability are they providing us? Another way of saying, let's go back to what we were talking about technology, like really good tech and data should empower you to change your portfolio.

46:56That's what we want. We want data so granular and useful, you can hold less cash, You can invest more in alternatives. In the case of ESG, you can pick one company over another. But if you are an equity analyst doing bottom-up analyses of companies, what does a Big Mac do for you? You can't chop it up and make meals out of it. You don't really know what's in it. So it's a very blunt way of communicating environmental performance, social performance, and governance performance. By the way, no fault to the ratings people that sought for a mechanism to deliver this stuff to the community in the absence of great data.

47:35We didn't have great data. We still don't have amazing data, but we need to go collect that data for this new trajectory of the ESG space. I often talk about needing facts instead of ratings. We need to go and look at the factors underpinning ESG. Environmental performance is a useful one. What's your environmental footprint? If there's a flood that wipes out a manufacturing facility, how resilient is that facility? Does it have a huge footprint and it's going to be a massive cost? Or is it a small footprint that can be agile and pivot? It's obvious as you start to talk through some of these things, workforces having loyalty to the company in times of trauma will allow those companies to be faster in their recoveries.

48:27So ultimately, you will move away from ratings that are really hard to unravel and really, frankly, hard to know what to do with. And we're going to move towards facts. Oh, this company has treated this many people in this country and we have a healthier workforce. In that movement from ratings to facts, are there any good analogs of how you get to what those common categories of facts will be in the future? Yeah. I mean, there's like the Nielsen ratings versus the data coming out of Netflix. So first off, maybe this is a useful aside, but you need to understand what data is. and data are signals and information are data in context.

49:21Knowledge is when you have enough information that you can begin to generalize about something. And then the tip of this little pyramid of insight is intelligence. You have enough knowledge that you can apply it in the context of your life, in your portfolio, whatever. So oftentimes in the absence of great data, we over-index on knowledge. And so this is what academics do. We go out and we collect some little sample of data. We clean it. We prepare it. We study it. And we publish about it. And then other people use our findings to actually avoid having to collect the data. So that's this focus on knowledge.

50:01And again, if you go back to the beginning of this conversation, it's like, this is why we pay people so much in finance. You have people who have track records and experience they have that knowledge, they've collected that data in their lives, and they are using it to make sense of very messy data sets in order to say, this company is performing well, this show on TV is performing well between 18 and 24-year-old men in Idaho. I don't know. That's the old Nielsen rating. Well, the minute you get this infrastructure of data, you can calibrate the information and the knowledge and obviously make better decisions with it.

50:38And so right now, we've got all these knowledge layers that are seemingly the focus. We've got these ratings frameworks. We've got, oh, you're a green on your climate physical risk score. That is jumping to that knowledge layer without truly giving people the tools to understand what's underneath it. And obviously, the tech revolution, from my perspective, is going to push us out of that knowledge focus, which is where we use process. We bring people into the data-driven decision-making, where you don't need Nielsen when you have view counts and you can see exactly how every single person has watched your television show.

51:22Here's where they paused. Here's where they hit play again. Here's what they fast-forward. Here's where they dropped off. It's so powerful now. We just need that type of data infrastructure out into companies. And frankly, we need to explain to companies why it's in their interest. Like right now, they're doing all this work and their data is flowing into some rating. Like you can understand why they're pissed. It's like, am I getting like a lower cost of capital because of all this work I'm doing? I hope we can point to a yes at some point. Then people will be like, okay, fine. It's worth the$2 million a year I'm spending on all these data services to collect and present, because it should drive lower cost of capital.

52:06And I think the reason it will drive lower cost of capital is because the ESG movement will be more effectively tied to long-term performance of these assets. And that's where I think if you want to talk about it, the whole notion of recoveries from crisis needs to be integrated into our theoretical logic. Why don't we go there? Because I know it's been a subject of your recent research. Just dive right in. We did this paper on submergences, which is basically when a drawdown starts, a submergence is the beginning of the drawdown, the downward trip underwater, all the way back to when it gets to the high watermark or the goal watermark.

52:48Because it doesn't have to necessarily be, oh, it's the high to the high. It's like you were tracking on your goals, you dipped beneath, you're underwater, and then you get back. And I liken this concept of submergence to the risk that every surfer faces when they're riding waves. It's not so much how deep you go when you fall off your board and get slammed, it's how long it takes you to get back to the surface and get air. And so weirdly, we don't have great tools in the investment an industry to think about the shape of recoveries. And so we have a lot of work through MPT on drawdowns, on value at risk.

53:26We do a lot of work on volatility and variance, but we don't think as much about the shape of recoveries. And because of that, we begin to think in our risk management terms around what I would say is more a robust framework of portfolio management, where we seek to immunize portfolios to shocks, all-weather portfolios. We're hedging this risk. We're managing that tail risk. That is really about trying to immunize a portfolio to shock. And so that's hard to do. It can be expensive. It can require huge investments in data and technology to really do it well, to avoid when the SVB crisis hits, you had all your hedges and derivatives in place.

54:13That's a robust portfolio. We don't build long-term things that way. We don't build buildings that way. We move to a parallel. We don't want ecosystems that way. We don't even want people that way. We want you to be resilient. We want you to absorb the shocks, bounce with them, and then recover. In fact, we press our armed forces. We push them all through these programs to teach them how to take hits and bounce back better. And that is kind of the philosophy we're trying to bring into our research on resilience, which is to say, well, if ecosystems and buildings and people have all of this work around resilience, why can't we bring that into the investment ecosystem through this concept of submergence?

55:03So then you begin to ask, well, what does change the shape of recoveries? If a certain asset recovers much faster than another asset, that's actually really valuable to know, given that drawdowns seem like it's a fact of life. These hundred-year crises are happening every six months at this point. So what we're learning, and the findings are still being developed on our team, is that it's these sustainability factors, these long-term factors, employee satisfaction, environmental footprint, things like that, that you would say, well, really good ESG tools would help you measure that. Those things are associated with recovery trajectories.

55:44It does feel strange to me that just as we're almost on the edge of showing exactly how ESG helps long-term investors drive out performance, this is also the moment when we have state treasurers around the country banning ESG from integration into tools. We'll just have to call it something else. We'll just call it long-term risk management or something. So as you looked at the research on drawdowns, recoveries, that sustainability lens is one that you found. What are some of the other discoveries that you've had in thinking about the concept? Well, that Sharpe ratios are largely wrong. There's a bunch of reasons why the Sharpe ratios kind of distort our understanding of the risk we're taking.

56:33And it's not wrong in the sense that it's not a useful tool to use just to look. But as long-term investors, Sharps don't work in negative return environments. The math actually doesn't work. And yet every single investor is communicating to us, and oh, here's my sharp ratio. Here's my information ratio. So I think finding new ways of thinking about longer horizon risk have been at the forefront of what we're focused on. And then moving us into this frame of portfolio navigation, which is actually once you start thinking about drawdowns and recoveries, you really start wanting to have much more sophisticated scenario tools.

57:15So a lot of organizations use capital market assumptions to make projections. They'll use pretty blunt Monte Carlo style modeling tools. But what I think we're witnessing now as we explain some of this is the power of being able to model portfolios into the future with all kinds of different parameters, recovery being one of them, submergence, all these different components, then allows you to build a much more resilient portfolio. You can diversify your portfolio according to submergence. You don't just have to diversify according to risk factors and volatility and things like that. You can say, well, this type of asset has this submergence profile, and that asset has this submergence profile, and we should diversify according to that to allow ourselves not to have as much of a overall drawdown.

58:11So those are some of the things that we're working on. So in the future, if we look out to using some of these technology tools, aligning it with someone's investor identity, we may have more efficient use of cash. We may be able to weather drawdowns in a more intelligent way. You've always been involved as an advisor and an investor in some of the companies that are working on that future and would love to hear either updates on companies you're invested with or anything new that's come on your plate? I'm head of research at this company, Adapar. I'm splitting my time between Adapar and Stanford right now.

58:46And the reason I'm doing that is Adapar is investing in the GPS heavily. So for me, I admit that I almost have started thinking about this tech model of using less cash as like the endowment model is to Yale what the tech model is to Adapar. This could almost be the data par model. I am able to go into this company's data and begin to see that organizations that have really invested in their tech are using the navigation tools. And if you remember, one of the companies I started in 2017 timeframe was called RCI. We invented this software called Navigator. It's funny. It's not like any of this is new.

59:30Just nobody listens to me most of the time. So I've been working on this navigation concept for a long time, Ted. But what we're able to show is people on the core ad apart with the GPS and that navigator, it's very promising. We can see 1.5 % less cash holdings. And so I'm trying to write all that up right now as a kind of academic paper, just to be able to show how technology can enhance returns. So that's really the fun for me right now is how do I leverage all of the entrepreneurial and corporate opportunities that I've been presented at Stanford? How do I actually bring that back into the academic community and through podcasts like this to begin to explain in less commercial terms what I'm learning?

1:00:19Ultimately, all that commercial stuff is in the service of trying to solve that higher problem, which is helping pension sovereigns endowments foundations make more money. I think the world would be a better place. All right, Ash, I got one question. I probably asked you at this point in time almost all the closing questions I usually do, but there's one new one, which is what was the most challenging moment in your career or life? Is this the part of the show where we eat the super spicy wings? I was going to... I think so. No. So look, I think COVID was really hard. It was hard just with family, with all these little companies that you mentioned, it almost killed two of them.

1:01:00It was just really a lot of uncertainty and a lot of sleepless nights wondering how we were going to get through. I wasn't as worried about my health as I was about the health of the things I had been working on that I had dedicated my life to and brought my friends and family into. That was super scary. So in some of those instances, we really lucked out and we managed to land the ship or we managed to deliver on the project. And so looking back, I could say, wow, I learned a lot. And it was like a overall, a pretty constructive time from a professional standpoint, but it was so scary. And I think that type of fear, it's like not the first time I've had that level of uncertainty.

1:01:38I think I said this on the first time I was on, after the 9-11 events, my wife and I, we just picked up and we moved to Europe. And I can remember being like, oh my God, what am I going to do with my life? And so I felt that feeling again through COVID. I feel like we're in a good spot now. In fact, look at us. Here we are. You've got this amazing setup. We're doing this podcast. We're both in our own place. I feel like I've got eye contact with you, Ted. In a strange way, certain things have really improved, but it took a lot of suffering and navigating uncertainty to get to this moment right here.

1:02:14Well, Ash, it's always fun to hear what you're up to. Really excited to continue to follow the progress of all these tools you're working on to help a community. So thanks for sharing. Thank you, my friend. You're an inspiration. All right. Talk to you soon. Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators.com where you can access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time. 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.

1:02:50This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.