E253: How Great CIOs Think w/Bill Brown

0:00Bill, you've had a prolific career working at the Stern family, which had roughly$10 billion. Today, you're CIO of a multi-billion dollar family office. Welcome to the How to Invest podcast. Thanks for having me, David. I'm really thrilled to be here. So you started working under Leonard Stern. Tell me about how Leonard Stern was as an investor. The one that I would take from Leonard, and I think I had mentioned it to you, is don't confuse activity with progress. And so that's, in a nutshell, what I learned from Leonard. The way Leonard operated was he didn't have a schedule. He kind of walked around the office day to day to day and just would stop by and ask you, what are you working on?

0:42And then he would, you know, he had this thing where he drank coffee all day and he would drink a third of a cup of coffee at a time. And he would keep asking his assistant, get me a third of a cup of coffee. And that was sort of a barometer of how you were doing in that conversation. His assistant probably brewed dozens and dozens of third a cup of coffees a day. If you got to sort of three one third cups, you actually probably spoke for, you know, 45 minutes an hour. And you were you were giving him what he wanted, which was the important part of the day, the important part of the task. If he didn't find it interesting, he just kind of moved on.

1:23So he was somebody who was very ruthlessly focused on what was important. And, you know, if he wasn't interested in what you were talking about, he would just sort of say, thank you very much and walk away. Like it was very cut and dried. And so if I had to learn something, you know, from Leonard, it was the way he scheduled himself and the way he just was maniacal about only spending time on things that matter. I'll add an adjacent one. If I had more time, I'd have written a shorter letter. That's another one of my favorites. And that's basically what Leonard was trying to make you do. He wanted you to focus, tell you what was important, and he just would move on.

2:06He wouldn't waste time on things that he didn't think were relevant or important, no matter how important you thought they were. He was very focused on that. And beyond being hyper-efficient, Leonard was looking to make indiosyncratic bets on the best ideas. What he was trying to do is get a pull to the organization. And one thing you learn, even in, say, investment banking, which is one of my other backgrounds, is some of the best ideas come from the lowest levels or across the organization. And you don't want to be one of those CEOs that sort of sits maybe in like an ivory tower and isn't in touch with what's going on.

2:50So if you were like in the military, the general walking the lines and talking to the troops and finding out what's going on and and hearing firsthand, we'll talk about the big short trade in a little bit. To get him convinced to do that was no easy task. But because he had all these little reps, multiple conversations and debates, he was put on the journey, so to speak. He wasn't just given it once at the end to make a decision. Daniel Ek has popularized this idea, the founder of Spotify, which is a lot of the alpha comes from people that have low hit straights, basically have a bunch of 10 crazy ideas and two of them end up being brilliant.

3:33Do you think there's friction between having a high hit rate of ideas and having some of the best ideas? Well, I think what you're talking about is, you know, in baseball terms, batting average versus slugging average. You know, some people, you know, like Ichiro from the Mariners had a really high batting average and on base, but he didn't hit for power. And some people are home run hitters and they hit 40 or 50 home runs, but they don't hit for average or get on base. not to overemphasize Michael Lewis, who wrote the big short, but he also wrote the book Moneyball. There's that scene with Brad Pitt where the quant guy is saying, you know, you're not buying players, you're buying runs.

4:13And in order to get runs, you need to get on base. I think you have to know who you are. You know, some people are Ichiro and some people are, you know, Aaron Judge. You can make money either way. You got to kind of know who you are. I do believe that there are these big hits, as you sort of mentioned, you know, maybe once in a lifetime, maybe it happens more than once in a lifetime, hopefully. You have to know who you are. But I do think you do need to be looking for those things. And, you know, we'll talk about, I've been lucky enough to have, you know, a handful of those things happen. And there's definitely an open mind that you have to have for those kinds of things.

4:49Jeff Bezos uses this analogy as in baseball, you could hit a grand slam. In business one time you step up to play and you could score 10 000 runs this asymmetry and makes it very different than baseball yeah yeah there's no such thing as winning winning one at bat and winning the season so to speak or winning the world series or winning multiple seasons is what you're saying yeah no absolutely that would be very exciting very exciting game maybe you hit it you hit it far enough you you just become the world series champion well baseball has um got an attendance problem. So maybe that would be a good change.

5:23So you mentioned some of these big hits that you've had in your career. Let's start with the big short, arguably one of the most famous trades in finance history. How did that come about? Back in 2006, the peak of the real estate bubble might have been a year later. You know, 2007 started crashing in that period and really crashed in 08, 09. So this was early. And one of the hard things about investing is when you're early. Sometimes people say when you're early, you're wrong. So we were a little bit early, but Eddie had come to me and said, well, one of our managers wants to set up a contract to buy credit default swaps, which essentially would be shorting the subprime real estate market.

6:10And he handed me a newsletter that Jim Grant had written. It's called the Jim Grant interest rate observers. It's kind of a relatively arcane, boring type newsletter, but he's been doing it for decades and decades, considered an expert in the credit markets. And so that document outlined a particular security that was based on the subprime market. Some people on the call may not have lived through that as acutely as I did or others. You know, they were doing things like ninja loans. What ninja loan means is no income, no job, no assets, or they would have something called a liar loan where you could state your income or you could state your net worth and there was no actual fact checking.

6:56And so there was really bonkers stuff going on and people were borrowing money more than 100 % of their home. So, you know, when you buy a car, sometimes they give you cash back or you have a credit card cash back. They were giving cash back on homes. You would buy a home for a hundred cents and they'd give you three cents back. You'd borrow 103 % of the value of the home. So things were bonkers. But with a lot of things, things go on for longer than you think. And this newsletter basically outlined how crazy it was. And the crazy part was these subprime loans were then securitized. The U.S. market has a very sophisticated securitized market, and the conforming loans are, you know, Fannie and Freddie are traded quite deeply.

7:48But even the subprime loans were then getting securitized, and then they were rated by the rating agencies, S &P, Moody's, et cetera. And so this pile of loans would get rated, and they would rate them AAA, AA, BBB, BBB being the lowest investment grade. And the BBB was 92 % into the stack, so to speak. I don't want to get too detailed, but basically with only 8 % protection of the 100. And so that was the main point, that this didn't make sense. You know, that's what Jim Grant was saying. So then the second thing we did, and again, Eddie encouraged me to do this, and similar to his father, he kind of said to me, well, Bill, just go think about this for a few days.

8:32I don't want a quick answer. Investigate it. Investigate it. You know, like this seems like a really good idea, but like, I don't know. It seems kind of crazy too, right? What are credit default swaps is a new thing. All this stuff, the rating agencies, why shouldn't we trust the rating agencies? They know what they're doing, et cetera. And so the next person I met was Greg Littman. We had a relationship with Deutsche Bank and Greg Littman, as people may or may not know, was sort of the evangelist of this trade. And he had believed in this trade. He was the guy, I don't know if there's a scene in the movie or not, but the myth, the urban myth, was that he would be wearing a T-shirt, those white T-shirts with the black lettering that said, and his T-shirt said, I'm short your house.

9:13You know, and he believed, not so much that he wanted anything negative to happen to people, but he believed this was crazy. And so he bet his career, more or less, on it and had a proprietary position on the desk at Deutsche Bank. But in order to fund that position, because it had negative carry, he had to do these trades to sort of support the trade and keep it on. And so he was going around and around, meeting with all the hedge fund people and some sophisticated family offices like ourselves and explaining the trade. And so I met with him and he explained it. And basically what it came down to is that if housing prices didn't continue to go up, or if they went down by even the smallest amount, these securitizations would be wiped out.

10:00And so just to put some numbers on it, you could buy these contracts, and the cost of insurance, so to speak, depending on which one you bought, you would make 70 to 200 times your money. So it's not 10 ,000 times your money, but it was a lot. and you could do it very easily. There was unlimited supply of these contracts. They were just issuing them. It was just a piece of paper, a contract between you and somebody else. And we started doing that. And then luckily, I think our first trade was in October of 2006. The market started to go our direction. So we had the benefit, like a lot of people didn't, we had the benefit of not being too early and we never really had major losses on the trade because what would happen is if the trade went the other way, you would have to post collateral and we never really had to post too much and then we started winning.

10:55And then we continued to do these things. We became very adept in understanding what the contracts were. We ended up doing CDS on Bear Stearns, Merrill Lynch, some of the other financial people. We also did what they called the pigs trade, which was shorting the sovereign debt of Portugal, Italy, Greece, and Spain. which it was a big debt crisis at that time as well. So it was a big trade and we probably made triple digit millions of profit over a course of two or three years. And the only shame of it was we probably should have done more. You know, we didn't do enough. Whether it's the big short, the pig's trade, all these trades in retrospect seem very easy.

11:34But talk about being in the heat of the moment where the market doesn't go with you right away. I mean, there were a few months where we were losing money and we had, because we weren't the most, the biggest person, we had what they call two-way collateral. So we had a post collateral, sorry, one-way collateral. We had a post and they didn't have to post. So we would have a trade where we were, you know, the broker would market. We might not have agreed with the mark, but they would market and they would say, send us the money, send us a million dollars, send us two million dollars, whatever it was.

12:06And that felt really bad. But we sized it in an amount. You know, we got a budget from Leonard that was an amount that he was willing to lose, which was actually quite a bit of money at the time. And so we had that sort of support. The second thing was the other way, actually, is sometimes when you're winning, my CFO at the time didn't believe in this trade, didn't understand. You know, it started to get these marks going the other way. And he was in disbelief. He says, well, we made$10 million or whatever we had made. So we actually started to get out of some of the trades early just to prove that it was real.

12:44You know, like, is it real? Is the money actually going to come in? And then the last thing, interestingly, on this trade was we were told up and down by people like Goldman Sachs and others, hey, you're never going to get paid on this. They'll come up with some reason not to pay you. These contracts are very complicated. You're not going to get paid. And so we probably also truncated some of our money because when we started making 70 to 1, we made 35 to 1 or 200 to 1. We stopped out at 100 to 1. We probably sold a little early because we just wanted to make sure that it was real. And it isn't always the case that you get paid in the end.

13:26You have to realize the money before you can count it. One of the complex things about these type of trades is that as a generalist, as a family office, how do you know that you're not the dumbest person in the room? And how do you know that you know the topic well enough to be able to make these kind of trades? i think that's a good question have this saying you know it's not the the fool who asks in that movie um tom hanks plays that character in the movie big and and he basically isn't there's a scene where you know there's there's something that doesn't make sense to him and he will he keeps saying i don't get it and then the guy sort of describes it and he says yeah yeah but i i don't get it.

14:11And so I think we're in that camp. And then I'll give you another favorite punchline of ours is, you know, victory moves from man to man. And so I wouldn't say that we're complete generalists. There's certainly areas that we don't travel in, but we really focused on being opportunistic and adaptable. And I think a lot of times when you talk to a hedge fund manager, they'll say something like, you know, I know this stock better than anybody else. Or, you know, I know the management team and, you know, I have the best model. And I actually think that can work against you because you have this sort of confirmation bias.

14:49You have this knowledge base that you have built up in the company and maybe the management team. And, you know, the switching costs are high. That's not our approach, you know. And one of the other things I talk to you about is that Seth Carman comment about, you know, it's not that he's so smart. It's that he's paying attention to the right areas. And I think that's what we try to do. We're not trying to be the smartest guy in the room. We're just trying to be in the right rooms.

15:18And how do you cultivate the right mindset to be just enough insider to see the opportunities and outsider enough to know that conventional thinking is wrong? We like to think that we're spending a lot of our time having the right friends or the right peers. One of my neighbors called the other day and asked for a recommendation on a Mason. I gave her the person that I use. And so the way I look at it is, you know, investing isn't, isn't, is more of a team game or can be a team game, particularly in the family office side. And so we're trying to cultivate knowledge. We're trying to, you know, we're trying to evaluate people and, and, and get ideas from, from, from our peers, from our friends.

16:01And so why do I, I don't need to come up with every idea, even in the big short example. That wasn't our idea. It was just that we knew enough people and we were open-minded enough to lean into the opportunity. I think of different communities as different herds of sheep, pun intended. And I'm one of the sheep that tries to go into different herds. I have the Silicon Valley herd. I have the family office herd. I have the institutional investor herd. and if you just do nothing else bring up new ideas between the different herds you could come up with some really good ideas that sound extremely first principle but really just taking common sense from one herd and bring it to another herd now i'll give you a little bit of you know an analog there which will fit your what you're saying are we were relatively early we weren't super early but we started investing in 2017 um and we invested with two people and And, you know, and this is a good pattern recognition, I think.

17:02So the two people we invested in, one was sort of like 26 years old. He had been like a real estate agent who got into crypto, not a financially trained person. You know, sort of somebody who was, you know, interested in the sector and was integrated, knew a lot about it, but wasn't classically trained, let's just say. And he was, as I mentioned, you know, mid-20s. The other guy we invested with was in his 50s. And he had been, he had kind of a consumer retail background. Then he had gone into venture capital in the consumer space and had been pretty successful in his own right. But then got the crypto bug himself, you know, early 2012, 2013.

17:42He was one of the earliest investors in Ethereum and other things. So he had made a lot of money, but he was a completely different guy, right? He was a veteran, maybe not a Wall Street veteran exactly, but sort of a veteran investor, decades of experience. We invested with both. But I kind of like the fact that we were getting confirmation of this pattern, this use case from two different people, you know, completely different people. And so that's a pattern we look for. So kind of what you're saying, we like when there's different people liking something. There's also people you probably have in your universe who are always pessimist.

18:20There's people who are always optimistic. And you also have to kind of calibrate everything like that. So, you know, it's one of your tech guys calls you up and say, oh, this is the next new thing. They're always saying that. Right. And again, I'm not saying they're wrong. Sometimes they're right. But a lot of times you have to discount those people. But when you're somebody who's in their 50s or 60s or 70s talks about something that's interesting from a tech point of view. You say, oh, that's interesting. Why? That guy never invests in tech. So when you had a crypto guy in his 50s telling you he was all in, that was pretty meaningful.

18:53On crypto, I had a similar experience where I went out and talked to fund managers and people. And a lot of people were talking about the trade. They're like, this was levered. And then you leverage this and you hedge this. And then you put out this token, you rug pull and all this stuff. And then I met a manager that explained it in very similar venture capital terms. I find the best founders early in the space and I build a portfolio of people that I believe have the distance to create enduring franchises. And I invested in that guy because it was a venture schema. Now, I might have been predisposed to think old school into the space, but it's a manager that did well versus sometimes you could get caught on to this hype that this new AskFest is completely different and unlike anything else.

19:33But usually there's some aspects of it that in some learnings you could bring from the past. yeah absolutely and i think one reason why we were able to um in both of those trades the big short or even the crypto is that the crypto trades were venture investments and people have a different mindset with venture they don't mind losing all their money because there could be a hundred to one thousand to one i mean one of the trades this guy did was truly a thousand to one I mean, he was buying Solana tokens at pennies, and that's over$200 a token right now. But it was money you were prepared to lose, and you don't mark to market.

20:15And that's another thing I always tell people. It's like watching water boil. It doesn't boil any faster, and it can make you get upset or you can emotionally impact your investing if you watch it too closely. And so sometimes if you sort of set it aside and don't pay attention as much, I think you might do better. Talk to me about how you avoid the temptation to just be busy and focus on the things that really move the needle. We used to have this term fizzy, and what it stood for was fake busy. And people have this false sense that they have a busy schedule. You know, so I have a lot of people coming from Australia.

21:01I work, you know, for an Australian-based family. So a lot of the Australians will come through New York and they'll fill their schedule up. You know, they'll have all these meetings back to back to back to back. And they think that's productive. And maybe for a one-week trip, that is perfectly fine. You know, that does kind of make sense. But I ruthlessly try to avoid that myself. There's a bunch of things that, you know, and I'll mention a few people's names, but, you know, there's John Cleese, who is the comedian, Monty Python fame. You know, he has this lecture on creativity, and you can't be creative if you're running around, you know, juggling things, you know, meeting to meeting.

21:38It just doesn't work. You need to find this sort of quiet space. There's another guy that I like to read is a guy named Cal Newport. He's a computer science professor. I mean, he's a little extreme, but he talks about like not answering emails, you know, and not picking up the phone and, you know, being kind of turned off, you know, unplugged, people would say. And to some extent, I agree with that. So I think you have to be, you know, sort of like Leonard was not tied to a schedule. I don't want people intruding on my time. I want to be able to have blocks of time to do meaningful, deep work.

22:16And how do you do that? You got to turn your phone off. You got to schedule yourself in a certain way. You can't have little bits and pieces of time and expect to get things done. You need blocks of time. So I try, for example, not to have meetings on Friday. I try to have Friday end of the week to kind of get the things done that I haven't been doing all week and for the more immersive thinking type projects. This idea of conscious procrastinating. You're procrastinating not because you don't want to face the task, but because it's not the highest value thing you could be doing with your time.

22:54Yeah, absolutely. I mean, I don't know how your schedule is. How do you get yourself to be more productive? Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, manage staff, and keep everything running in one place. Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground. I was actually thinking about this the other day when I stopped by a local cafe here. They use Square and everything just works. Checkout is fast, receipts are instant, sometimes I even get loyalty rewards automatically.

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24:40I don't think time is actually the most scarce thing. I think energy is. So I try to schedule my day so that the most important tasks are early on. So I'm going after the most important, most creative, most energy consuming tasks early on. and then I focus all the admin stuff towards the end of the day, kind of responding to email and doing all these things. And I at least try to adjust my high energy with my high impact tasks because it's hard for me. If I stop answering my emails or responding to my mail, at some point, something's going to blow up. I try to batch that. I also have, I get my mail electronically.

25:16I use a service called Anytime Mailbox and I just check my mail once a week. So there's no reason to check your mail every day. I've never had an issue. I've been doing this for six, seven years. I've never had a single issue blow up in my face. Well, that's kind of directionally what I'm suggesting is that you've almost conditioned your network to know, you know, like it's not that you're not interested in the meeting or responding. You just respond on your own pace. And that makes a lot of sense to me. One of your other mentors, billionaire Seth Klarman, said, we're not that smart. We're just hanging out in the right places.

25:52we touched on it a little bit but what does it mean to hang out in the right places and how do you operationalize that as an investment strategy there's you know a couple of different things i mean the the punchline there might be you know the the old one location location location you'd rather own a the worst house on the best street than the the best house on the worst street and you know like i said earlier you know we don't want we're not gonna we're not staffed up to be better at some of the, you know, some of the people out there are amazing at analyzing specific companies or in this case, specific houses.

26:29But if you get the zip code right, you'll often do really well. Woody Allen would say, you know, 80 % of life is showing up. And so we just spend our time trying to figure out where the most interesting things are, hang out in the right areas. I'll give you a couple more sort of mantras that we have. this saying, don't let the great be the enemy of the good. And what that means is, you know, you start doing work on something, you get some patterns, it's in the right neighborhood, you don't overthink it. You know, and often what I've seen people do is they overthink something and they never buy it, right?