#64 - Katie Koch: Effective Leadership

26:35We just talked about something you learned from your mom. Your dad taught you to always do the right thing. What does doing the right thing mean in investment management? In the investment management business, the clients are the business. And so what that principle means here is you put the clients first. And how does this decision impact the clients? It's that simple. You can make this business really complicated, the investment decisions, as well as the decisions about products and distribution. But you can also make it super simple, which is the client is the business. What's in the best interest of the client?

27:11We will go do that thing. I mean, you just have to have that North Star because a lot of decisions come across your plate and you need to be able to have that framework. And so when I think about my dad giving me that advice growing up, we do the right thing. The way I apply it to this business is what is in the best interest of the client. It can be complicated because revenues are generated by assets under management. That's how the fee structure works. How it works. Yeah. And so you could see a spectrum that I've noticed in the industry where on one end, you have people who are really in the business of generating returns for their clients.

27:48And on the other end of the spectrum, you have businesses that are in the business of generating revenues for the business. And everybody says they're in the business of generating returns for clients rather than gathering assets and generating revenues. So I always look at what are you doing? What does the evidence suggest? Not just what you're saying. And so I think it goes a lot deeper than that. You're right. And it's multivariate, actually, what allows you to truly focus on investing and differentiated results versus asset gathering. So I'll give you my thoughts on that. It was a main motivation to come to this platform was somewhere with a strong investment culture that was focused on great investment results.

28:29And yes, of course, we're ambitious people. We'd like to grow the business. But the primacy is on the people, the philosophy, the process, and the performance. So, you know, how do I evidence that to you and how do we preserve that and why are we able to do that? I alluded to it earlier, being private helps a lot. We're just not under the pressure for quarterly results, which allows us to apply our philosophy and process over the long term. So that would be number one. Number two, it has to be real in the way that you talk and interact with people and lead the company. So we had a town hall earlier this morning.

29:02The first slide up, the first conversation we have is performance. It's not about what products we launched, how we grew the business. It's what is the performance across all the verticals because that is the business. And so I am very conscious in saying to our people all the time, we are in the business of investing in performance for our clients. Full stop, that's the business. The clients are the business. And so we really put that as center of everything that I message out to our people. And if you came to our corporate board meeting or a mutual fund board meeting, that's where we start the conversation too, is around this performance centricity.

29:36The final thing I'll point out is that incentives matter a lot. Culture's more important, but incentives matter, financial and otherwise. And so in many of our strategies, we do have the, you know, there is a compensation component. Well, first of all, across the whole firm, compensation is tied to client performance if you're an investor. But then we also have alternative products where there is a component of carry, which simply means that they will only earn the bulk of the fee if they outperform the benchmark that they agree to with the client, which fully incents them to focus on performance over just scaling a business.

30:15So those are some ways that we think about it and control for it. Hard to do if you're not a private company. And again, one of the reasons that I came to this platform and one of the reasons that I would, and what I continue to think is an extreme competitive advantage for us. Yeah. So it sounds like a big part of it is instilling that culture and then at the same time, aligning everything else along with that culture. Yes. And then thinking long term, right? I don't want to mislead anyone that we're not, that we aren't ambitious to grow the business. Our investors have earned the right to grow these businesses by the results that they put up and we want to deliver for them on that.

30:56But we're able to think about it over the long term. So as a leader, do you agree that the most important decisions are often the simplest once the North star is clear, while complexity may lie one level down? I do believe 100 % that the biggest decisions that you make, you spend a lot of time on them, you deliberate over them a lot, but they usually are very simple. And they're usually about some core operating principles that you've applied it as a leader over and over again that have worked out for you, or even these lessons from parents, like doing the right thing, putting the clients first.

31:32And when you look at it through that lens, it's a very simple decision. I would differentiate being simple from being easy, because actually sometimes you have to make really difficult decisions about exiting a business, about parting ways with a valued member of the team, because they might not be the right person to take you forward over the next 10 years. It is simple and you have this framework to help you figure out what to do, but it doesn't make it easy. And actually part of the job of a leader is to make many, many, many difficult decisions. What are some of the greatest mistakes you've observed leaders make, perhaps including yourself?

32:15I would say avoiding the difficult conversations. Like I was just saying that you have to, you're constantly making difficult decisions and it often leads to difficult conversations. And as human beings, we just want to put that off. We don't want friction. We don't want to have to engage on a tough topic with another individual. And so we can delay them. And I will tell you, someone said to me before I took this job, and it's so true, like whenever you get to the end and you make that, like I said, it might be simple, but it's not easy to communicate it. everyone told me like, you're always going to wish that you had done it sooner.

32:53I don't know if you had that experience, Alex, of running a vote, but like that has turned out to be true to me. You figure out what you're going to do, but you prolong it because you may not want to deal with the friction of that situation. I think there's corollary to managing portfolios too, but in managing people, it's always the right thing. And I'm getting better at that, of doing it earlier, of engaging in difficult conversations for sure. The second thing related to that, because it can be a difficult conversation, is the willingness to give people feedback. And I'm very focused on building that at TCW, and everyone will use this word, we have a feedback culture.

33:29But giving people feedback real time on what's going well and what they can improve on, it just creates a much better culture. And it means that you don't have this one momentous, difficult conversation because people already know along the way your observations on what's working and what's not working. But that would be it, just like a reticence to engage in taking the tough decisions and having the difficult conversations. You asked a question before about empathy, and that is a superpower in being able to tackle those two things, because it is possible to take difficult decisions and to have difficult conversations and to do it in a highly empathetic way that is in line with what you want from the culture.

34:14Those things are all really related. One thing that I've learned is that you grow by pushing through those moments. And you talked about resiliency in the beginning, it's related. But the growth comes from learning from mistakes. And that is best done through somebody pointing it out to you. You have a conversation about it, and then you learn, and then you grow from that experience. 100 percent i mean that's been so really one of the reasons i've gotten the skill to do that to be empathetic to engage in difficult conversations to create a culture of feedback because that was done for me when i was growing up at goldman sachs like the most valuable thing that you can get is feedback so i would say that's something that leaders sometimes i've observed some leaders struggle to do writ large globally i would say from an employee perspective myself included that's an area that not everybody's skilled at either is accepting the feedback and the difficult conversation and to anyone listening to this that's growing you know early and building a career I would say that is like the most important thing to be able to do is first of all have a boss that's willing to engage in difficult conversations give you the feedback you need to hear and then your your ability to hear it is tough and I would say you you hire all these high performing people at TCW and elsewhere, and many of them haven't had tough feedback.

35:44They've excelled at everything ever in life, it would appear, through sports or academics at college. And you come somewhere and the reality is that this is going to be new and it's going to be hard and you're going to fail at things. And so it's really an advantage to be able to do one thing when people give you feedback. There's only one answer, which is thank you. And I would say very rarely is that the response that people get. So that would be my advice to people, to the employee too, is just to listen to it. And it doesn't even mean you need to agree to it, but you have to give it the space.

36:17You got to take it away. You have to reflect on it. And you'll really stand out when someone gives you difficult feedback. If you just say, thank you for that feedback. I really appreciate it. I'd like to ask you some questions about investing and your outlook. So a popular one is your thoughts about active versus passive investing, particularly in widely followed market segments like large cap stocks. I think there's a role for both. I know those groups of people like to fight with each other over what's better. And they're not very empathetic to the other side. Yeah, they're not very good. Good point, Alex.

36:51So I'm going to say answers to the high degree of empathy. I really do think there's room for both. And I think it's a great innovation that we have the ability for investors, individuals, and institutions to access market beta effectively for free. That's wonderful. It's great. I own some of it in my own portfolio. It can also be true, and it's true at TCW, that there is ways to extract excess return in those markets. And if you can find a manager that can do that repeatedly, net of fees, then it makes sense to add that exposure alongside passive exposure. And that's true in public markets. So I think there's room for both.

37:31You mentioned large cap. We have alpha statements in some of these large cap markets. It does require you to run a very concentrated portfolio. And so that creates volatility. And so I would recommend people thinking about owning passive alongside a highly concentrated portfolio in these large markets. The second type of active that we do, and I'm using public markets here, and then I'm going to end with something on alternatives, and I'm sticking with public equity markets, we do thematic investing. And so that's basically identifying a theme and saying, hey, this is going to disrupt and change the world a lot over the next decade.

38:08And it's underrepresented currently in the market index. So let's overweight this theme. I don't think it makes sense to implement those tactically. I think you need to hold it for multi years, but there are vehicles that will allow you to implement that. So at TCW, for example, we launched an AI dedicated strategy almost a decade ago. So way before everyone was talking about it, before chat GPT, but we did identify that theme. And obviously people who went along with us on that thesis have done very well because it did end up being a dominant market theme. And we think it's still in early stages.

38:43And we have one focused on energy transformation too. We have a few of them, but that's another form of active. It's active both to identify the theme and the way that you implement it is active because the beneficiaries and the drivers of that theme will change over time as well. And so you want to have active exposure to it. And then finally, in the alternative markets, and for us, that's mostly alternative credit, there's not really currently a good passive substitution to that. And so I am a believer in alternative investments, and those are by definition active. We are in the active investing business.

39:18You know, people who have been successful and passive have scaled to 10, 12 trillion dollars. That's just not the business that we're in, but it doesn't make it a bad business. Like I said, there's a place for it in people's portfolios. And, you know, we're going to work with people who want excess return on top of the beta in equity or credit markets. Why are you so passionate about alternative investments? I believe that clients, institutions, and individuals need to have exposure to alternative of investments in their portfolio. And the most simple reason to give that to you is that ultimately buying risk assets, credit or equity, you're really trying to buy a piece of GDP basically of America over the long term.

40:01You're saying, I believe in growth. I believe in capitalism. I want to compound with this over time. And the reality of the way that markets have changed to continue to change is that a lot of that productive capacity sits in the private markets. And so just like I think you can have active and passive, I also think that you need to have public and private in your portfolio to fully capture the opportunity set. In public equity markets, there are 50 % less listed companies than there were 20 years ago. And so that is an example of why and why is that the case? Of course, there's mergers and acquisitions.

40:38But a big part of it is that there's more perpetual availability of private capital. companies can scale for longer in the private markets, and clients should have exposure to some of that. As it relates to the credit markets, we're in the much earlier stages of that. But I am seeing that CFOs, right, who are the borrowers, they're the ones that work with the CEO to issue this debt that can go public or private, they want more flexibility in financing. They want to be able to issue corporate credit debt. They want to be able to issue securitized debt, securitized against some assets. Even a high-yield company can issue IG debt if they securitize it against the right group of assets.

41:18CFOs just want that maximum flexibility. And so in order for us to stay relevant to that CFO, we need to be able to lend across public and private markets. And why do we have to be relevant to that borrower, to that CFO? Because we need to be relevant to the client. And so I'm a big believer in that asset class. I think clients need to fully capture the opportunity set. And I think fixed income's in the early stages of evolving to a more complex public-private market. And we want our clients to have exposure to that in their portfolios. TCW has been investing in private credit for over 25 years, so early in.

41:56But there's a lot of attention on private credit and its democratization. And there's been material asset flows into the sector. Should investors be concerned or do you see tremendous investment opportunities in this area? It's probably not going to surprise people to say we see tremendous investment opportunities in this area. I don't think there's going to be a bubble in private credit, which would by definition be this large mismatch between demand and supply. We don't have that in private credit, but there are going to be some accidents. And in the last decade and a half, Rates have been low to declining to zero to slightly rising, just in a very contained territory.

42:41And so the asset class, 98 % of people launched post-global financial crisis. As you pointed out, we're very fortunate to have done this for a quarter century. So it hasn't really been tested for the more challenging macro environment that we're in now. And as rates stay elevated longer than people expect, there is starting to be stress in this market. That is true. The other thing that is true is that we talked about at TCW, we're very focused on discipline over deployment. If you were very focused on it the other way around, you would have been lending in markets and doing some underwriting that's not very rigid because people were competing for these loans.

43:24And so they allowed covenants to weaken or disappear entirely. documentation became weaker leverage became higher and this stuff exists out there now um and so if the macro environment gets a little more challenging and i would argue you know we're kind of there i'm not calling for something catastrophic but the operating environment has become more challenging you're going to start to see some of these problems surface and it will be again for the first time in the in the history of the young asset class where it's under that type of stress. And so you'll see some differentiated outcomes. Now for us, we are a highly conservative lender.

44:05We have strong covenants. We have extremely strong documentation. We say no most of the time. So we feel good about the loans that we've made. And if something goes wrong, which by the way, it will, because that's how life works and how investing works, we have the skillset to work out of it on behalf of our clients. So from a relative return perspective and a peer perspective, we're pretty excited about this environment for driving differentiated returns. But for the industry at large, we expect that there could be some accidents. So you talked about being a long-term investor and staying disciplined to your approach.

44:42But how do you balance the discipline versus being adaptable, particularly during those inevitable extended stretches of underperformance? Yeah, it's interesting. I think having been in the investing world for 23 years and managed a lot of investors, I've spent a lot of time thinking about what is the real competitive advantage in investing? and I think it's a question clients do and should ask of you, what is the advantage? One of the challenges is they want some magical, exciting, shiny answer, which I don't really think is the real reason. Like I don't think it's better systems or technology.

45:23I mean, there's a little bit of that that helps you around the edges or some miraculous model that other people don't have. There's a little bit of that, but actually the biggest competitive advantage is two things. and both are really tough to replicate, hence being good competitive advantages. The first one is just time and having been cycle tested, investing through different economic environments, different rate environments. And the reality is we've had a pretty one-way environment for the last 17 years. So by the way, that's something we worry about, think about a lot. It's a company because we look out on the trading floor.

45:59It's like how many of these people have actually invested through a protracted recession? How many of these people have invested through stagflation? How many of these people, it's not a lot. So we're lucky to have a good number of them, but it's not everybody. And that's something if I were a client, I would push on a lot because that experience gives you this pattern recognition that is hugely, hugely valuable in investing. And it allows you and gives you the stamina to push through to the other side, to have both the pattern recognition and the stamina. And the second thing is discipline, which doesn't sound exciting, but honestly, it's very rare.

46:36It's very rare that people will stick with their discipline process, to your point, even when you're coming in and for multiple days, maybe for months, maybe for quarters, maybe for an entire year, people will tell you that you're wrong. And so I'll tell you just being a value investor in parts of the fixed income market has been tough because we looked at the situation last year and we said credit spreads are at record tights. The market is pricing as if we're never going to need to cut rates. And that positioning persisted for a while, but the team stuck with their philosophy and process and discipline.

47:18And obviously this year is a different environment, but that is a tough thing to do, to have that discipline. And most, like I said, the people often capitulate out at the wrong time. And so if you can find someone who's willing to execute, first of all, has the environment, so has a company structure and a management team that's supportive of allowing them to persist with that discipline, and you can see them do it repeatedly, I think that's special. But how do you know whether the discipline is outdated or not? Meaning you may have an investment, what you thought was an investment truth, but it no longer is the case.

47:58So how do you differentiate between those two? To that, I would say, I think a value-oriented investing will always work, but it might take a while for it to work out. Why do I think that? It's just the center of gravity. Through the history of time, eventually prices matter again. It can dislocate widely for a while, but eventually cash flows, earnings, these things do matter. That's been true for a millennia and I think will continue to be true. But there are things that you can do to innovate around that. So, for example, take the securitized market. We've done securitized investing at DCW longer and deeper than most people in the marketplace.

48:38We have a lot of securitized assets in our portfolios, depending on our positioning, $70 to$90 billion of securitized assets. But there are new things happening in the securitized space. They're not all QSIP listed. Some of them are private. And so we need to be innovative to incorporate some of those ideas in our portfolios, which we do. So we can maintain a value position in saying cash flow, prices, solvency, like these things will matter over the long term. But then we can be more innovative in terms of the securities that we compete into the portfolio. And we can continue to push on our portfolio construction.

49:14So we had an underweight position in credit, probably the largest of any of our competitors in our core plus portfolio. That means that we would carry under the index. So we are we are pushing our portfolio construction to say, like, how do we compensate for that carrying under the index and what innovative security selection can we do on that? What sector positioning can we do to compensate for that? So I think there's you're right to say that, like the world evolves. We keep our value philosophy that has worked for a thousand years and will work for the next thousand years over the long term.

49:47But we can avail ourselves of more tools and more creative security selection to be more successful within that framework. By the way, I just want to say you have to have the right partners, too. That's just true. Most of our clients really understand who we are and what we do when we're playing a very specific role in their portfolio. I talked about liquid fixed income, but also on private credit. I mean, there are going to be some clients that wouldn't have been happy that their manager deployed less than the market last year because they want to get their allocation up to a certain point, right?

50:18But if they hire you and they know that you're disciplined and you're covenant heavy and you're document heavy and you're diligent heavy and you're just not going to say yes to everything, then they're going to give you the patience and the time to allow that philosophy and process to work. So we have to be disciplined in sticking to it. We have to innovate along the way, which is the good question you asked, which is that, yes, value can work, but be creative and innovate within that framework. And we're doing that. But then we have to be with the right partners that understand who we are and what we do and will give us the timeframe for the philosophy and process to work out.

50:53And that mutual selection of manager to client, I think, is very important. And we're fortunate to have a lot of enduring, strong partners who have invested with us over multiple decades. And that's just the greatest gift that you can have in this industry. And that followership of those clients allows us is actually one of the reasons that we can execute with such discipline. As an AI and technology enthusiast, how do you see the most recent tech boom playing out? We've been focused on AI as an investing opportunity for the better part of a decade here. And I still think we are in the very early innings of it.

51:34I do think that there's going to continue to be an enormous amount of capital needed to invest in this, that the hyperscalers are going to be the biggest drivers of that CapEx. So these big tech platforms that we all know, and they're going to invest in that regardless of the economic environment, big picture in my view, because they need to maintain the formidable competitive advantage that is AI. So of course, these stocks are going to go up and down. We can talk more about who owns the stock market and why it might be vulnerable from a valuation perspective, which I think it is a little bit.

52:12But if you ask me out long-term, I think the CapEx for this part of the market is going to continue to be there because these trillion-dollar-plus platforms have to be at the leading edge of this. It's not an optional technology for them. And then when I think about AI in our business, we announced publicly we have a partnership with Microsoft, who's looking to gain more knowledge in asset management, and we're looking to apply more technology. We're a client of Azure that's our cloud provider, and we're doing a lot of work with them in incorporating AI, both on the investment side, to the point around innovation, using AI to go through.

52:49For example, if you do a CLO loan, the document can be 800 pages. So there is good use to take AI and even the basic, not even just basic machine learning, the early versions of AI can actually be pretty impactful in going through those documents and helping you focus on the key issues. We use it there and then we use it through business development as well. So we're pushing our teams to make sure that we're being as efficient as we can in every task that we do. And wherever possible, we're trying to incorporate more AI into how we run the portfolios and how we run the business. Katie, I appreciate your time.

53:27I'm just going to ask you one last question. What are your thoughts on the economic and market impact of the recent US election and the major risks over the next few years? So I think that what we've done, we may be at a regime shift here, I think. I'm not going to comment on politics on this podcast. You and I can do that over a drink sometime. But I will say that we have a new environment in the sense that we had a long period of time of, with one exception during COVID, but kind of like low rates, low volatility, very one-sided environment consolidating in the equity markets amongst a small group of companies and the credit markets manifesting itself in record tight yields.

54:19And I do think I'm not going to take out the crystal ball and predict for you where GDP is going to be at the end of the year. And by the way, I'm not even going to predict what the policies are because they probably changed during this podcast. As you know, they're moving around a lot. But what I will say for you is that volatility is back. That's just quantitatively true. We know that by looking at the VIX and other measures of it in the credit markets. And that should be a really fertile environment for active management. So actually volatility, the unknown dispersion, these things are all really good for public and the private markets that we invest in.

54:55So this should be an excellent investing backdrop for us. And so far it has been. And I would say that the number one thing, if you ask me what I'm concerned about and what we're positioning around, is that while the uncertainty has risen and the volatility has risen and whether or not we're going to go into a recession, we know growth is moderating and we know the consumer is weakening, even if it's at the margins. Very little of that has been imputed yet into asset prices. So we still are at record valuations for equity and for parts of the credit market. And so if you ask me, again, I don't have the crystal ball, but I would say that we don't have a large margin of safety and we have a lot of uncertainty.

55:44And so I think those are two things that we really keep our eye on. The last comment I would make, at least something I think about a lot as it relates to the U.S. economy. So in order for us to have real protracted weakness in the U.S. economy or to have a recession, we need to have a weak consumer because the consumer is, I don't know, someone will Google it and get me a better answer, but let's call it 75 % of GDP. The low-end consumer is already in many cases in a recession. It's been under a lot of pressure. The high-end consumer has held up. And 50 % of consumption in this country is driven by the top 10 % of consumers.

56:24And that consumer, that top 10%, is pretty much the exact cohort and demographic that owns most of the equity market in the U.S. And one of them, we know that one of the wealthiest demographics out there is baby boomers, right? So my mom loves it when I talk about her publicly. So I'll talk about her here. She's a retired teacher. She has a pension. She has a portfolio, which does great because I manage it for her. Um, but, um, on a serious note in that portfolio, you know, she's the equity markets. I mean, you probably know this from your clients too. They go down 5%. They go down 10%. My mom feels, feels that she talks to me about it.

57:04She feels less wealthy, even though I can show her a chart of how much that's compounded wealth over time. It impacts the psyche of that consumer really quickly. And people listening to this probably realize that because now we can all look at our phones and see on a real time basis, how much money we have. And so my point of saying that to you is that we've had some weakness in equity markets. It hasn't been pronounced. We're still at record valuations in the event or close to them in the event that we get a real fracture in equity markets. I think the pull through of that to consumption could be quite severe and more so in the past because of the greater concentration of that equity market in this group of people and also the greatest greater concentration within the equity market.

57:47So that is something that we think about a lot. And it's a reason to just observe and be cautious and be aware around the consumer. They could roll over very quickly. And so we're looking a lot. We know the lower end consumer has been in stress. I wouldn't say it's broad based yet for the higher end consumer, but that's something that we're remaining hyper vigilant around. And I'll just end again by saying no one knows exactly where we're going to go from here. If anyone makes you a prediction at the end of the year, it's hard to do. So the idea is not take binary risks, have a lot of different things lined up in the portfolio that might work, but be taking enough risk for us at least to outperform markets and outperform peers.

58:30build a portfolio in a way where you can survive being wrong. And the way that you make money, for sure, the best way to make money, time-tested in big, big ways, is to step up and be a liquidity provider when other people can or won't. And that's what we're trying to do in all these portfolios, make sure that we have the liquidity and the conservative positioning, that we've had some breaks and some opportunities. My guess is the volatility will give us more ahead, regardless of where the exact GDP ends. And we want to have that liquidity to step up and provide that liquidity when others can't or won't as a way to deliver results for our clients.

59:06We've done an extraordinary job of that over the 50 years that TCW has been around. And that's something we think this environment is going to give us an exceptional opportunity to do. This was great, Katie. I appreciate you sharing your insights. Thank you for joining us. Thank you so much for having me on, Alex. And I want to say again that I thought these were great questions. very thoughtful. And your interest in leadership and your investment acumen in the markets is a real gift to your clients. So thank you. Thank you. Thanks for listening. We hope you enjoyed this episode. Please visit our website at insightfulinvestor.org to access past shows and learn more about our podcast.

59:51If you have questions, feel free to email us at info at insightfulinvestor.org. And if you enjoyed the discussion, please subscribe to this podcast to ensure you don't miss future episodes. And don't forget to forward today's conversation to others you think would enjoy listening. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of Evoke Advisors, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits.

1:00:35And listeners are reminded that securities trading, commodity trading, and alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

1:00:50Listeners should be aware that guests featured on The Insightful Investor may have current or past associations with Evoke Advisors or the host, including as an investment manager of a private fund opportunity by Evoke or access through an affiliated Evoke fund or as a client. Participation as a guest on the podcast should not be perceived as an endorsement or testimonial with respect to Evoke Advisors, the podcast host, or their services. Similarly, the inclusion of a guest on the podcast does not imply that Evoke Advisors or the host endorses the guest or any company with which they may be affiliated or employed.

1:01:29Evoke has neither paid nor received compensation from guests for their participation.