TIP343: How to Invest like the Best w/ Ted SeidesWe Study Billionaires - The Investor’s Podcast Network
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- 4 Apr 2021
In today’s episode, Trey sits down with Ted Seides to talk about how the world’s elite money managers lead and invest. Ted has had an incredible career as an allocator, having started under the tutelage of David Swensen of the Yale Endowment, before starting his own multi-billion dollar alternative investment firm. IN THIS EPISODE, YOU'LL LEARN:The playbook for Chief Investment Officers of hedge funds or institutionsWhere retail investors can have an edgeWhen to and when not to invest in a hedge fund Deeper dive into Ted's infamous bet with Warren BuffettWhat Ted has learned from his relationship with Warren over the yearsBOOKS AND RESOURCESCapital Allocators PodcastCapital Allocators BookListen to our previous interview with Ted SeidesPreston, Trey & Stig’s tool for picking stock winners and managing our portfolios: TIP Finance ToolBrowse through all our episodes (complete with transcripts) hereSupport our free podcast by supporting our sponsors
You're listening to TIP. On today's episode, I sit down with Ted Seides to talk about how the world's elite money managers lead and invest. Ted has had an incredible career as an allocator, having started under the tutelage of David Swensen of the Yale Endowment before starting his own multibillion dollar alternative investment firm. In this episode, we cover the playbook for chief investment officers of hedge funds or institutions, where retail investors can have an edge, when to and when not to invest in a hedge fund.
And we took a deeper dive into his infamous bet with Warren Buffett and what he has learned from his relationship with Warren over the years. It was a privilege to sit down with Ted, and I hope you learn as much as I did. So without further ado, please enjoy my discussion with Ted Saides.
You are listening to the investor's podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, everybody, I'm here with Ted Saidi's, very excited to have you on the show, Ted, thanks for coming on. Thanks, Trey. Great to be here with you. So a lot of people might know this, but you started out working for David Swensen at the Yale Endowment and obviously he's kind of a titan in the industry.
So I have to ask, how did that shape your investing style to date?
Well, I had the opportunity to learn a lot of good lessons before I learned bad ones. So I think a lot of investors that get passionate about the business start on their own and they read things and they learn from their mistakes. And that's great. It's even better if you can start without any prior knowledge working for someone who already has a lot of things figured out. And that was my formative education in investing. I worked for David for five years and learned everything I knew about that particular process of investing, which is different from picking stocks.
It's picking managers and asset allocation. And he's a remarkable investor and a remarkable teacher. And I was just fortunate to have that experience right out of college. And Gail, in general, I think you say in your book, there are only about 10 percent even allocated to something like US stocks, right. So it's it's a very broad portfolio. And is that something that kind of shaped your approach to date as well? The way I describe it is I learned what a hedge fund was the same day I learned what a stock was.
So if you don't have a bias, most people come into a seat like that. Even David did with a particular set of experiences, a particular set of beliefs about how either investing works or certain asset classes or or styles work and then they grow from there. I came at it with a clean slate and I was taught these first principles of equity, orientation and diversification and how just owning US equities is not a diversified equity portfolio. So those were just fundamental beliefs that I learned.
And so I did adopt a lot of that. As for me, just first principle, common knowledge. And that was before David wrote his book. By the time he wrote his seminal work in Two Thousand, I Had, I knew what was coming on the next page because I had lived it alongside of him for a long time. So you just touched on how his approach was very much based around finding managers underneath him, which I know it's kind of the same career path you've now taken.
So what was the key principle you took as far as approaching allocating to different managers? It starts with the seat, the particular seat or the particular pool of capital, so if you think about a seat like Yale or any other endowment or foundation or pension fund in the institutional market, there are large dollars at work, but they tend not to be very highly resourced teams. You don't have two hundred investment professionals even at Yale, which is one of the bigger ones, there might be 20 and they're trying to cover the world across asset classes.
So you could think about different ways you might want to pursue that. One is you could say, OK, we'll have one person focused on being the best US equity stock picker and let's have another person just focused on emerging market equities and another in venture capital and another in leveraged buyouts. Oh, by the way. And another in China. And then you have to say, are each of those people going to be able to compete with the entire rest of the world?
Or is the person sitting in New Haven picking stocks in China going to be able to compete with someone on the ground who has a full team of people in Asia? Probably not.
And so one of those first premises is rather than try to compete with the very best people in the world across disciplines, go try to find them, develop expertise in how you find them, how you partner with them, how you structure those partnerships. And that was a particular style of investing that David pursued and that I learned from an early age. It is very different. The science part of it, the art is probably more similar. The science of that, compared to the science of doing stock research is completely different.
But they're both viable. They're both disciplines that work.
It's just a question of how you want to pursue it. And for me personally, I thought when I left I wanted to pick stocks and I did that for a little while.
And what I found was I didn't enjoy the business analysis as much as I enjoyed the strategy and the assessment of people that went into picking managers. And so I went back to that after a few years. So having spent so much time around, David, what would you say his superpower is? All the great investors that lead the way, there are a lot that follow up and do their own thing, have this interesting hybrid of an independent streak and just intelligence and being able to see around corners.
And David is all of that. He has incredible temperament and his investing, incredible ability to show up every day with a perpetual time horizon and act accordingly, which very few people can do. And he more than almost anyone else that I've I've ever met. The only other person that was close was his longtime number two, Dean Takahashi. They could just sit down with a money manager in any strategy, in any asset class and see right through them to the underlying assets they owned and have a view on whether that portfolio was likely to do well and fit in with the strategy.
They're just exceptionally talented people and investors. He's sort of the classic five to a player. He's clearly a great writer and a communicator. He's a great thinker and he's just is one of these people that can think through what the next important aspect of their investment program is. And maybe that's a strategy. Maybe it's a particular set of assets. Maybe it's something in structure, maybe it's something in style. But he always had the next thing to focus on that became important that would drive returns.
Well, one thing I learned out of your new book is that it seems that everyone has a boss, right? Even CEOs, they seem to be somewhat constrained by the boards that they report to. And even I'm sure David has even no exception. So I'm curious who is really at the top of the food chain? The CEO of an end owner of capital is probably as close as you can come to, the top of the food chain is always the person who owns the money.
So if it is a very wealthy individual and they don't really have to report to anybody, but on the institutional side, the CEOs are very close to the top. But invariably it's not their money. It may be the institution's money. So they'll be reporting to someone that is a committee or a board that will ultimately be responsible for the performance of the assets even more than the CEO. So in this case, just use that example. Yale has an investment committee, which is a subset of the Yale corporation.
And in fact, the investment committee makes every investment decision. David and his team make recommendations to that committee, but the committee is responsible for the decisions in that particular case. After thirty five years of the best performance in the world, it's highly likely that the committee would agree with all of David's recommendations. But he's earned that trust over a long period of time.
It's more common that a CIO will have a lot of say, but there'll be a fair amount of back and forth between them and the members of the committee in the process of getting to an investment decision, sometimes even at the manager level. The last question I'll ask about David is just around his coaching style, because I know you've also taken this role as a coach and leader and mentor. And I imagine when you're allocating to different managers, that's a big part of the job and the super power that comes with it.
So did you take anything away from his style and did it affect the way you operate today? I mean, I hope I took every little bit that I could in five years the way David operated, it was there wasn't training, it was all by osmosis. And it's a small team. So there were a couple of different things that would happen. One is you'd be in meetings with him, you'd see what questions you would ask, how he would ask them.
And then all the investment recommendations got written up in very long, very detailed memos. And he edited every word of every memo. And so I learned to write from David, not a college. And I probably wrote a thousand pages of memos and five years for the investment committee. So I think all of those disciplines go into an environment where you can't help but learn what he's teaching.
The other thing I would say about him that's different from others is he's very black and white and how he thinks he really does make the decisions of what gets recommended.
It's not a group decision process and he happens to be right almost all the time. So if he were someone that were the the fifty one percent. Right, it might be hard to figure out what's the process that's going into that decision. But you see this repeated pattern of great, great thought process and great ideas. And so it's just an incredible place to to learn because you can suck all that up before you really for me, before I really had any opinions of my own.
Will you recently interviewed my buddy Alex and Damian from Eiris, and Damian highlighted that Radio's Edge was only about fifty five to 60 percent and that probably Buffett was very similar. And I don't know about David. Sounds like he might even be better than that. But given that investing is all about having an edge and that these guys are obviously superstars in the best in the world, what chance do us as mere mortals, some retail investors have to compete?
Well, I don't think you want to compete on the same playing grounds, a big part of the Yael's edge, independent of David or what David built for Yale, it comes from a network of relationships that are very hard, if not impossible, to replicate. So you could think about investing with the best venture capitalists in the world, the benchmark capitals of the world, the Sequoia's of the world. I can't do that. You can't do that. Yale can do that.
And they'll do that as much as they can. And so I think what you can take away from it is not so much exactly how Yale does it, but what are the some of the inputs that are repeatable for any investment process. And those include being very rigorous about what you're trying to accomplish, what the purposes of your capital, understanding, what your own biases are that you bring to the table, and then being very disciplined and consistent in exercising that set of beliefs towards investing that can be very, very different for different people and individuals.
But the structure of how you go about it and the consistency that you stated, that structure ultimately is a lot more important sometimes than the individual decision of should I buy that stock or this other stock. And so there are lessons in how David invests at Yale that are very broadly applicable. Competing with them on their playing field is not one of them. Well, speaking of sticking with a certain style, you also highlight in the book that a traditional 60 40 portfolio of stocks and bonds is really unlikely to keep up with spending needs.
So should the retail investor reconsider that type of structure for their own portfolio? And is there something they can adopt from the CIO playbook? I think so I'm not big on making market predictions because I believe very, very deeply that nobody knows what will happen in markets, good or bad. But there are times where, generally speaking, you could look out and say, how are assets priced to deliver over a long period of time? And we happen to be at one of those times.
It's not hard to look at the 10 year now rising to the lofty rate of one and a half percent and say you have to be kidding yourself. If you think you're going to make more than one and a half percent over the next 10 years, it's possible rates could go down, they could go to zero and you could get capital appreciation, just like we've had for the last 30 years. But that doesn't seem likely. And stocks trading where they are, you can make all kinds of case for what you want about technology stocks and new paradigms.
And we've seen all that before. But the pricing of stocks, particularly after the stimulus, is high. And so, generally speaking, you could invert the price of a stock to an earnings yield and think about what the growth of the economy is going to be on top of that. And and you get to a number that is not that high.
And so if you have just sort of common sense and you look at that and you say, well, particularly for institutions, institutions, a good proxy for individuals, that there is some rate of return that people need to meet their spending needs. That's more defined for institutions often than individuals in absence of a good financial planner and a whole path that brings them to where they need to go.
But no matter who you are, it's unlikely that investing so that you can make three or four percent is going to get people growth, the growth that they want in their portfolios. And so that lends itself to asking the question, what else should you do? And there are lots of opportunities, increasingly so, to diversify away from US stocks and US bonds that are reasonable and available to individuals that didn't used to be in the past. We have this proliferation of ETFs so people can make whatever submarket bet that they want to in a cost efficient way if they don't want to pick stocks.
We have the whole cryptocurrency ecosystem and that's kind of an interesting possibility of a way to hedge against fiat money debasement. Pardieu, to access the private markets for sure.
But even then, you have public companies like Blackstone and KKR and you can own a piece of the business in addition to what they're doing. You have hedge funds like Pershing Square and Third Point that have listed vehicles that are traded that traded discounts in Europe. So there are ways of getting access to high quality opportunities that are somewhat similar to what some of the institutions do and definitely diversify away from just owning the market.
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All right, back to the show. One thing I. That particularly lacks in retail investment is risk management. So talk to us a little bit why you think risk management is as much art as it is science. My favorite line about risk comes from the late Peter Bernstein, the brilliant economist, and Peter used to say risk means we don't know what will happen.
And if you really internalize that, it's pretty profound because he's not saying, hey, yeah, we don't know what's going to happen. But what he used to say on top of that is we don't know what will happen even if we think we do that. The probability distribution of outcomes is really wide. And so in any investment strategy, you could think about what could go wrong. And then you know that the thing that's likely to go wrong you haven't thought of yet.
And maybe it was knowable and you didn't get there, or maybe it just wasn't knowable. And so part of the idea of risk management is to have a deep understanding of how much can you lose and still stay in the game and not get shaken out of the position or the posturing that you have that's likely to reach your long term objectives. And that sounds super simple. I just went through this example two weeks ago, so I own a portfolio of sparks in the public market, and that's a whole thesis I could work through.
And it has a very finite known downside. These things have ten dollars of cash sitting in a trust. And yet when the portfolio smacks as a group traded off about 20 percent, I didn't have specs that were more than call it ten dollars and 60 cents. But when that 10, 60 went down to 10 across the board, I even felt myself with butterflies in my stomach saying maybe I was wrong. Maybe this is a bad investment. I shouldn't have done this.
Oh, by the way, I took more risk by owning some warrants while those things really got killed. And that was a tiny tremor after a long period in markets of muted volatility.
And everything seems great now. I know I read all the books about behavioral finance. I've talked to a lot of the experts. It still happens to me.
So that real question of how do you prepare for the time when risk plays out, why risk is not upside.
People call that performance upside volatility. It's hard and it's it's behavioral and emotionally based. And we're all wired to kind of get shaken out of the position. So you have to live through that a number of times to understand what is your quote unquote risk tolerance, which then determines how much risk you have in place in any given portfolio. And we can read all this. Howard Marks writes brilliantly about this, about cycles and we know this and greed and fear and all of that's true.
That's completely different from the moment when it affects you. And that's what every individual has to figure out for themself. So that why they're investing the purpose of that capital, what they're trying to grow that money to over time doesn't get affected by that one moment when they shouldn't be touching anything. Or as I like to say, that moment where you have to remind yourself, don't just do something, sit there. I love that quote, so on the flip side of that, obviously, these money managers are not immune to this bias either.
So as you just kind of highlight it there. So if I'm a retail investor and I say, you know what, I actually just want someone else to manage this but know that they're susceptible. What have you seen be put in place to kind of help manage that for or allocators? In the book I've just written, it's called Capital Allocators. There's a chapter on decision making processes that comes from some of the conversations I've had on my podcast with people like Annie Duke, the former professional poker player, and Michael Möbius and the great strategist.
And there's a bunch of tools knowing that our behavior will get in the way that you can try to put in place to make it a little bit less bad. And most of those have to do with being in a Decision-Making group where people hold each other accountable. So there are there are lots of things I walk through in that chapter about how do you structure that group? How does that group conduct themselves? How should they be thinking? All of those things go into setting up processes to try to mitigate the risk that you won't individually just react on your emotions at the wrong time.
So at what stage, maybe it's a certain amount of capital or what have you, should an individual consider investing in something like a hedge fund, which you know all about? You've written the book on it.
Well, I am now an individual investor for 20 years, I was not I was an institutional investor mostly overseeing nontaxable money. And with one exception that I'll describe, I do not invest in hedge funds because they are relatively tax inefficient. And I don't think that in most instances, hedge funds will let me get to what I'm trying to achieve with the capital. The exception to that are in retirement accounts. So I am on the cusp of making my first hedge fund investment in five years.
It is in a portfolio of biotech related hedge funds, but it's in a retirement account, so I don't have to worry about the tax consequences. Interesting how available are hedge funds to retail investors, in your opinion? They're not particularly available and certainly not the ones you likely want access to. There are some alternative that call them liquid alternative products that are OK. And Blackstone has one. That's a fund of funds. What I would tell you from looking at that and knowing that organization, which is they're really quite good at investing in hedge funds, are the largest in the world.
What they're able to put in that liquid product is not the best stuff, the place where you can get around it. I had mentioned earlier there are certain hedge fund managers who have listed vehicles, mostly not in the US. But Bill Ackman at my largest holding is Pershing Square Holdings, which is Blackmun's fund with some leverage because he doesn't have to worry about liquidity trading at a discount and buying back shares. I mean, it's a very attractive, broad opportunity.
So there are some. But for every bill, there are 40 or 50 other incredibly talented hedge funds that, generally speaking, individual investors do not have access to. And that's OK. There's a large world of investment opportunities. They don't need to access everything. It's interesting, I noticed that Seth Klarman also holds a large position of Pershing Square, so even someone as established as he is, is investing in Bill. Very cool.
I just want to touch on the hedge fund fees involved. And I love this quote in your book by Rahul Mudgal that says if you pay peanuts, you get monkeys. What level of fees, though, do you consider to be appropriate? I don't think you can answer the question, I think that every investment in a fund is driven by net returns and some of the best performing vehicles in the world that we would all chomping at the bit to have access to if we could have the highest fees of anything.
So think about the Renaissance Medallion Fund. That seems like it's a money printing machine. The last time Renaissance had outside money, they charged five percent of assets in forty four percent of performance. Is that worth it? Absolutely right. They were they were still compounding in the high 20s net of those fees. You could say the same thing for Benchmark's venture capital firm. I'm not sure what their fees are, but it's probably two or two and a half and somewhere between 20 and 30.
But you pay it all day long if you could have access. And so, by the way, if we were able to give money to those organizations today, there's no guarantee that they'd to the way they have in the past. So we have a belief we are investing in a story based on the past that they'll continue to do what they did in the past. And that's what all of investing in managers is. You're trying to figure out an unknowable future.
And it's based on a story that you've made up, a narrative in Bob Shiller's words, an economic narrative of what you think will happen. And so it's very easy to say, oh, I know I'm paying those fees and those fees are too high. But if you can't access that opportunity any other way and you have a sense of what you think, that manager will deliver net of those fees, you may well be willing to pay it. And the market tells you right now for any particular manager because they're different, what the fees, that's a matching of supply and demand.
And so one of the funny things I found in my hedge fund years is that you'd have a lot of institutions that would give lip service to fees being too high and would go as far as to bring other institutions together to write papers like White Paper saying this is what we think the optimal fee structure should be. And then they would go around that group and go invest in the next new hot fund that had none of the terms that they had espoused, just the quote unquote, right thing to do.
So there is no consortium that could say we think fees are too high, they're lower. It really is a question of how much people are willing to pay to access certain talent. And so the market tells you what those rates are at any point in time and they can change. But by and large, hedge fund portfolios have delivered on expectations for the institutions that have invested them. We highlight another interesting quote from Michael Batek in your new book that says There are limits to value investing.
Ben Graham got crushed in the Depression. He just couldn't resist the values. He went in early and got destroyed. Is the takeaway here that an investor needs to be more dynamic in their approach? And if so, how do you know when you're evolving as opposed to just performance chasing? So I think the message in that is that the classic Chanes line, the market can stay irrational longer than you can stay solvent. Many people, including Dave Swensen, are dying in the wool value investors.
They have a belief and these days it's more well articulated based on behavior and why value stocks are systematically cheaper. And you can look past at history and say value outperforms.
What you find, though, is that except for the rare instances where you're dealing with the ultimate asset owner or someone like David who effectively speaks for the asset owner, almost everyone, including institutions, don't have an infinite time horizon to be in their own seat. And as Andy Golden said, who's who's the head of Princeton's endowment on my podcast to finish first, you first have to finish. So the lesson of what Michael was talking about with Ben Graham is that value can be out of favor for so long that even if you're right, over 20 years, if you only have 10, it doesn't matter.
And it's one of the big lessons that I took away from my own investing and what I did for my clients in my years, a protege that was different from Yale, which is I always preferred balance on style in any way that I felt like there was some belief that could go wrong, even if you were ultimately right for longer than was comfortable for your clients, because your risk tolerance, high risk tolerance isn't my own risk tolerance or not managing money for other people.
It's the shorter of mine and my clients. And so value investing may work over the long term. But you could look at what's happening right now to AQR as they're bleeding assets because they've been wrong or their style has been out of favor for too long for their clients to withstand it. And so that's my take away from that. Isn't so much about performance chasing. It's really more about understanding that investing isn't just what do you do with the money, it's what do you do with the money?
Who are you doing it for? And how are all of those people responding to results? You point out in your book this sort of Moneyball approach that shaped the industry, especially in recent years, and Buffett has been making this analogy for decades, referencing the Ted Williams book, The Science of Hitting. How can an independent investor determine their sweet spot? I think it comes from the experience of figuring out what works for any individual, and I could just give my example coming out of institutional investing, investing on my own.
There are a lot of things I thought would work so for many, many years. When I was managing outside capital, I couldn't pick stocks. We did not allow it because we were concerned about potential conflicts, even though we were picking portfolios of managers. So when I left for the first time I could in 15 years, I could pick stocks again. And I knew a lot of great managers and I knew some of their positions. I said, this is amazing.
I'd watch and if something sold off, I would buy it. But I never knew enough to know when to sell it. And what I learned quickly was as soon as there was a tremor, I would get nervous and I quickly changed that strategy. And over time for me got back to saying, you know what, my real comfort zone where I know I'm a good investor is when I'm investing in a fund and I know I am there and I know what the signposts are to make changes.
And that's my sweet spot for somebody else. It could be a value type situation. It could be a stock that they know people who own it and it get beaten up and they love buying it when it gets beaten up for other people. Could be momentum investing. It could be GameStop on Reddit that could work for for someone as long as they understand that that is the pitch that they're hitting. So in the analogy you used, Ted Williams had a particular spot.
He had he had mapped this out in the strike zone. I remember what it was about. I kind of feel like it was high in the strike zone. But somebody else might be a low ball hitter. Someone might be an inside ball hitter. Someone might like ball out over the plate. And so people just have to figure out for themselves it's a big investment universe. What is it that works for them and then have the discipline to stick to it?
And wait for that fat pitch, as Warren likes to say, right? So speaking of Moneyball, I love the quote from Ben writer in your book that says, We are taught to think that numbers are far superior to human intuition, but that humans can detect things that numbers can't describe. Try to get the best of both man and machine. So it's more of the machine part. I think I'm really interested in how we can incorporate more of that into our own investment processes.
We have seen a lot of investment managers go wrong is not so much in the stock selection and certainly not in the buying of positions, it's in the way they construct portfolios. And that is more of a science than an art. There's some element of art. And so there's only really two ways that that makes sense. One is that people believe their stock pickers and they don't necessarily believe in their own ability to take positions. And so they just equally weight their portfolios.
Maybe they rebalance every so often and they let things go. The other is people that weight their positions based on their conviction. And what I found over the years is when that's not measured and people haven't determined that they in fact do add value from weighting their positions based on their conviction, they often don't. They often would have been better off just equilibrating positions. And there's a lot of reasons why or hypotheses why you could make that case or people don't know positions equally.
Their attention drifts in different ways. Stock prices move around. And it's a multivariate equation to optimize what you think your price, target and downside would be as stocks are moving around. But when portfolio managers either from conviction weighting or equal weighting, kind of flutter back and forth, they end up losing a lot of money relative to their own idea generation because of the lack of rigor in their portfolio construction. And that's one of the ways you've seen kind of the science come into investing.
And you see it most pronounced in certain hedge funds, particularly the platform multi-manager, hedge funds, places like Citadel and seventy two in Millennium that are very rigorous about portfolio construction and risk management. And what they're trying to do is get the stock selection alpha or the ability of their portfolio managers to pick good stocks over what's available over the market to allow that to speak and not let portfolio construction get in the way. But certainly when you talk to individual investors, they don't often think nearly as deeply about their portfolio construction as they do about their individual positions.
Well, all these quotes I've been referencing so far are from your new book, Capital Allocators, and it's a great book. I highly recommend it. But I did also touch on the fact that you wrote the book on hedge funds as well. What has another great name called So you want to start a hedge fund? And I think a lot of our listeners probably have at least thought about starting a hedge fund, myself included. Right. So can you kind of distill down to us the premise of that book and what drove you to write it?
So my years of protege partners protegé was a hedge fund of funds that invested in early stage funds and also seeded new funds. So I spent 14 years regularly evaluating and investing in startup hedge funds. And what I found from doing that was that there was a series of mistakes that portfolio managers consistently make, but they never know they're making it because it's always the first time for them. And so I you know, I put that all in the book.
And I mean, if there are a couple of takeaways, I think it's that people just need to first understand what they're going into as it relates to a business and in an industry that they're entering.
And it always, particularly with with equity related managers, it always surprised me how rarely someone who says, oh, I want to go start a hedge fund. And in that hedge fund, they're going to analyze stocks and buy some time to go long and short. Others, they haven't really for second thought about what is the hedge fund industry? What is the structure of the industry? Is this a good business? What is my place and what is my competitive advantage?
What I go along my stock or what I go short my stock and some of what's happened over the years. And some of the people who read that book said, well, boy, this is pretty sobering. So some of what's happened over the years is that the industry matured. And in any industry that matures, there's much less of a demand for new products and you get more concentrated. So the bigger hedge funds get bigger and it gets harder and harder for a new product to come in because there isn't necessarily that much differentiation.
So it is a a difficult landscape to enter. And part of the reason I wrote the book was in spite of that, it's an incredible adventure for someone who is deeply passionate about investing and wants to give it a shot as long as they understand the base rate and the challenges and the difficult probability of success.
But to do it and to succeed, you don't really have a lot of degrees of freedom.
You really have to do things the right way. And some of those lessons can be taught quite easily. And so I took twenty five or thirty of those stories from actual hedge funds, put them into a bunch of case studies and put it together in a book that's now, I guess, five years ago. Let's take a quick break and hear from his sponsor. So I have a text thread going with a group of friends where all we talk about is the stock market and investing.
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All right. Back to the show. Well, Ted, last time you were on our show, we talked about your infamous bet with Warren Buffett and you're never going to live this down. Right. But long story short is that you lost the bet. But it's interesting to note that you would have made the same decisions. Looking back, I've heard you say and essentially the bet was a basket of hedge funds versus the S&P. Five hundred over a decade.
And if you want to learn more about the bet and Ted's experience, you can definitely go back and check out Episode one 70 where he highlights it in detail. So we're not going to go through the whole story here. But what I'm curious about is that since the S&P performance was essentially tied to the Fed's intervention, I'm wondering why the hedge funds didn't benefit in the same way. And, of course, by definition, their hedge funds or their hedging if they're right.
But why didn't they also get a boost from that? Well, let's start with that premise. So if the premise is right, which I would agree with, that the Fed coming in in 2009 strongly boosted the market, flooded capital into the market. So the S&P had a big run. And the question is, why didn't hedge funds benefit as much? And I think you hit the nail on the head, which is by definition, hedge funds are hedged.
So the degree of risk, the degree of market exposure that they would have to those rising markets is much less than the S&P. So it's not that they didn't benefit. In fact, they did. And after a difficult 2008 for the market and certainly for hedge funds to a lesser extent, both recovered and that was part of it. There are a bunch of other interesting dynamics as well, which is you could make the case that it wasn't just the Fed, it was central banks around the world to some extent that lowered rates.
And so all equity markets went up. But it turned out that if the benchmark for the bet was the Morgan Stanley World Index instead of the S&P 500, the bet would have been pretty much a wash. And that's in spite of a pretty challenging performance for a bunch of reasons from hedge funds, definitely disappointing relative to expectations, including mine.
But the just the gap in the S&P from markets around the world was so wide during those, call it eight and a half years after midnight, that that in and of itself was a big determinant in the bet and the hedge funds invested globally.
So you did have exposure that underlying market exposure was much more global than the S&P 500.
Well, regardless, one of the biggest winnings, it seems, from this bet was that you've got to spend a lot of time with Warren. And I know that when I had dinner with Warren once, I had prepared one question in advance and I think I blew it. Looking back, it was something about the efficient market hypothesis and whether it's still, you know, value investing is still relevant. And it's something he's probably been asked a hundred times.
But I'm curious, when you walked into that room thinking about, you know, about to sit down with them, had you prepared a question of your own? The first time I sat down with them, I hadn't I had some ideas of things I wanted to talk about, most of which were non investing, and we got to those. But I will tell you a story that echoes yours. So a number of years ago, I brought Patrick O'Shaughnessy and Brent before out with me and we had dinner with Warren and Todd Combs.
I think Tracy Brett may have been there as well, Tracy Bakool.
And before we went to the dinner, Brent had a list of questions and he said, OK, we're going to have dinner. It's really your dinner. Let's let's make sure that I'm not going to monopolize this time. And Patrick had a few questions, and I said to Brent, you better pick one or two because you don't want to get frustrated and know we went into that dinner. And I. I remember going to the bathroom when I came back.
There was this full, long conversation about Notre Dame football and then it went into something else.
And you could see after about a half hour, Brent's ears were sort of smoking because he wasn't remotely close to being around the subject matter where he was going to ask us questions. He eventually did get to it and it was terrific. But I would agree with you. Warren is so he's such a polymath. He's so entertaining to be around. And, yeah, you can go in and ask the questions you want, but I always find conversations are much more enjoyable when they're somewhat free flowing and they go wherever they go.
I'm just curious, after all of those experiences, is there a longer lasting impression that he's made on you or something that you that you could really grab on to? I think there are a lot of little nuggets in so much of what he says is in the public domain, and so there are little stories and you pick up more anecdotes than lessons. I think privately, the biggest takeaway I had from when I first met him and then it's been consistent all the way through, is that he's the real deal.
And what I mean by that is we all know he's compounded capital and in an incredible way, but he really is a humble Midwestern guy and remarkably humble for what he's accomplished. And he's put himself out in public to to teach people. And over the years, we've all seen critics say, oh, he's hypocritical because he's investing in energy, but saying that the environment should be cleaner, whatever, whatever it is, there's always a litany of things where people come down on him.
And, you know, life isn't so clear cut ever. It's never so clean.
But I would say from having spent a fair amount of time with him, as he really is the person that he presents, he's just a wonderful, brilliant human being. Well, one reason I was especially excited to ask you that question was because you've made a career in allocating capital to money managers, right? So you are of anyone I know, very attuned to what makes a great manager. And you've interviewed hundreds, if not thousands of people to manage money.
You have probably picked up on the characteristics that make a good manager, I imagine. So did you see any of those same things in Warren or did Warren have anything else that you now apply to your hiring process? Farm or the former, when I first met him, I was so pissed off that I hadn't met him 20 or 30 years before because it was completely obvious to me after two hours. I've said this in the past, that from being in the business, there are a number of people I've met who have gone on to become billionaires.
He's one of the very, very few that I have a high degree of confidence that you could put him with next to no money alone in a room. And some time later might be 20 years, but sometime later he'd be a billionaire again.
He would do it in a completely different way. But he has this combination of an incredible mind and a drive that he probably hides from the public. But I was stunned when I first met him of how much everything he thinks about and cares about is that company and company capital set aside his family. Does he care about his family? Absolutely. Is he interested in talking about his family? Not at all. Is it because he's hiding them from the public?
Not at all. He just cares about the business. And so he has that deep, single minded passion. And you can just see it in his his mental acuity and flexibility that if he wasn't doing this, he would do something else.
And the stories he tells about his early business ventures, well, before he was an investor from a little little kid, like when he first they bought a gas station and he was pumping gas and he learned about pricing. And then he bought gumball machines when they were inside of barbershops and had the mob come after him and all these kind of crazy things, you could just see he was just a natural entrepreneur. And so, yeah, I mean, it's not easy to pick someone who you think will be a phenomenal money manager over time.
And most won't just buy the probabilities and end base rates. But he was one that one of a very few people I've met that you just you could tell that he would just figure it out. So, Ted, the last thing I want to talk about is coaching and leading, because you've made this career out of investing in people and these managers that you're allocating to. How much of your career have you found yourself being a coach or a mentor?
Increasingly so, I would say, in my time managing money, yes, you're managing money, you're investing in managers and you're partnering with those managers. So as you gain experience, oftentimes I would try to be helpful in different ways.
And sometimes you'd see that in portfolios, sometimes you'd see it in iterations of what happens inside businesses. And when I stepped away from that, you don't lose that experience.
And it's taken me a number of years to even explain to the people that I work with ahead of time, like what it is that I do until my wife, who's not in the business, said to me one day, I just heard you talk to them and like that didn't. And I say people well, I kind of understand how the business works. I understand how investing works. I understand how the two work together, and I think I can help.
She said, why don't you just tell people you're going help them make more money? And that became how I describe what I do.
And it's not money because everyone's greedy and they want to make more money. But it is kind of fun making more money. And I just have enough experience in around investment organizations that whether it's how people are thinking about just as simple as their marketing and business development, too, are they making mistakes on their portfolio or are they making mistakes with their team? I've just seen enough iterations of people making mistakes that I have a pretty good sense in real time if something doesn't seem right.
And so it's just fun to be able to share that. And and I do it from time to time. I don't really do it with startups anymore. Going back to what we were talking about with with people wanting to start hedge funds. And the reason is it's just too hard. I can't do anything about the fact that the industry as a whole doesn't have a large demand for new funds. I can't help people get through that that chicken and egg game.
So I do tend to work with a little bit more established funds. But not they're not mega funds, a couple hundred million dollars under management or more.
And it's a lot of fun. In a career that's defined by such quantitative outputs as investing is, how do you measure effort versus outcome? Well, I refer to his process over outcome effort is certainly part of the process, but sometimes the best inputs are not from the most effort. People say they get their best ideas in the shower or something like that. And it doesn't mean because they're working harder in that moment. So assessing process is incredibly important.
And it starts with an articulation, which, again, I have a whole chapter in the book about this, about what is that process? And it's not rocket science, what it is. How do people find their investment ideas? How does a CIO find their investment ideas? And if you talk to enough of them, you realize there's a pretty set way that they go about prioritizing what comes in the door. How do they go through that process before they're interviewing managers of what they're going to learn and what do they know?
What are they trying to find out? What kinds of questions to ask in those meetings? What kind of work do they do afterwards and how do they monitor the managers that are in their portfolios? And so I dedicated a whole chapter to how does that whole investment process work? All of that has to do with the process. There is a part of the process that comes from thinking about the outputs of the managers you invest in and the quantitative assessments that go into that and the qualitative assessments that go into that.
And what's important, and that's a big part of how I spent two decades investing. And so I tried to share some of that in the book. And it's not easy to distill in a quick answer. Well, you've definitely outlined an amazing playbook in your new book about hiring especially, and you list a few questions that I would like to ask you, and you can either answer them yourself or I would also be interested in hearing the best answer you've heard from managers you've hired.
So the first one is how do you position size? We touched on this earlier, I think that there's really only two ways, equal weight and conviction weight. And I just tell people, if you're going to conviction weight positions, make sure you're measuring your ability to add value relative to equally waiting positions.
Next up is how do you decide when to sell? So there have been studies recently that I've read that said that, generally speaking, active managers are quite good at buying that a lot of value in their buys, but they detract value in selling and there aren't a lot of people that articulate it. Well, one of those is a guy named Richard Lawrence, who I've had on my show twice. And Richard runs probably six or seven billion dollars in Asian equities, long only Asian equities, fairly concentrated portfolio.
And he has one of his many investment tools, a framework for thinking about selling that I think is sort of spot on. And so he describes as five different reasons to sell. One is you recognize you made a mistake, made a mistake in your process, in your investment thesis, and if that happens, sell immediately. The second is rebalancing. So within a portfolio, when stocks move up relative to each other, you can trim and there's a bit of a selling there and you can add value over time if those stocks relative to each other have some volatility.
The third is competition for capital. His portfolio is only twenty or twenty five names. If you find the twenty sixth name and it's better than what you have, that's a reason to sell something in your portfolio. The fourth is a change in outlook, so that could be an outlook for the company. Your investment thesis has changed. You don't think the prospects for that company or my case, that investment manager are as strong as they were when you made the investment, then you sell and the last, which I think and if pushed Richard on this, the most controversial, which he refers to as you get tomorrow's price today.
And the reason I think it's controversial is that in his investment style, which is long term compounding, sometimes it's OK to hold on to things that have gotten ahead of themselves because you might not be right, because it might run higher or because it might not go anywhere, but the company may compound into that valuation over a period of time. So it's a very subjective measure of when do you sell just because the stock feels expensive to you. And I know most value investors make the exact same mistake of selling too early.
And for years and years and years, I would push them and say, well, why? Why don't you hand off the decision to your trader and just tell them, don't sell less than this and make more money along the way. And generally speaking, people are value investors really, really struggle with that key component, which is what happens when a stock is running and gets to your price target. Yeah, I think I heard recently Charlie Munger say something to the effect of one of the biggest offenses by investing is disrupting the compounding involved.
It kind of speaks to that. Love that answer. All right. Next one is what is your favorite idea today? So my favorite idea, I own a portfolio of post IPO, preannounced merger, sparks trading around ten dollars these days, really right around ten dollars. And I love it because you can't really lose money if the way that sparks work, if the sponsor doesn't go out and conduct a deal, you get your ten dollars back. So, you know, your downside is ten dollars.
You know, your cost of capital is basically zero. Interest rates are close to zero. And you have all kinds of interesting optionality on the upside. They could go out and do a deal that you think is really attractive and you can continue to own a company. They could do a deal that you don't think is attractive, but other people do. And the stock pops and you can get paid that way. And sometimes the stock moves because of the sort of democratization of the IPO pop.
So this is a form of a private company going public. And sometimes just on the announcement, the stock will pop 10 or 15 percent because it's undervalued. And all of those ways you can sort of capture a little bit of value. And so I'm doing a whole bunch of rinse, lather, rinse, repeat on that portfolio as deals get announced. And it's a really fun area to watch. It's definitely an exciting area to watch, that's a very interesting perspective that I haven't heard yet.
So fascinating. The last one is how do you define risk? Is it simply that you just don't know what you're doing or do you define it some other way? I define risk not as you don't know what you're doing, but you don't know what will happen. And so risk is everything. Everything about risk goes into what will happen on the downside, how can we lose money and people can try to map out and think through all the different ways that they might.
But it usually is the thing that we don't know ahead of time that plays out. I don't know of anyone before, you know, last December for the forward thinking people that knew a pandemic was going to come and the markets would go down 20 percent. I don't view risk as the market popped back up. Therefore, that wasn't a risk. Lots of things can happen and do happen that we never anticipate. And the probability distribution of outcomes is much wider than the one outcome that we see.
And so that to me is is risk is really having a deep appreciation that we really don't know what's going to happen. And so we need to prepare accordingly. So, Ted, I love your podcast, Capital Allocators, and I, I suggest everyone go and follow and subscribe to that feed. You've interviewed some of the best names in the industry and captured a lot of value and wisdom and knowledge from them that you've put into your new book, Capital Allocators.
I am curious if you could recommend one episode from your podcast for a new listener. Which one would it be? It's very hard to choose among your two hundred children, but I'll name two, if I were picking a single episode that I think with great consistency people have learned a lot from, it would be the first one that I did with Annie Duke. So in and around when she released her book, Thinking and Bets, I've done four or five with Annie, but that first one was just amazing.
If there's a second one they should listen to, it will be the one that comes out on March twenty second. When I get a chance to describe my book, Patrick O'Shaughnessy agreed to interview me for my podcast. So that would be a. Love it. All right, well, the book is Capital Allocators How the World's Elite Money Managers Lead and Invest. And I really enjoyed the book. I found that there were a lot of applicable takeaways for not only CEOs but CEOs or anyone in business.
Really, it's a great lesson on people, on leadership, on management and investing. Ted, with that, I want to just give you a chance to hand off to the audience where they can find your books and any other endeavors you're working on. Well, thanks so much, Trey, and this has been really fun. It's fun to be on the other side of the mic. Well, my website is Capital Allocators podcast, dot com. Or if you forget that, I think capital allocators dot com goes right to it.
And that lays out pretty much everything that's going on the podcast, a bunch of activities around it. I also am on Twitter and LinkedIn and tend to post the episodes with some quotes on there.
And for people who are really interested, we have premium content available as well that they can access from the website. Well, Ted, I have to thank you again for coming on the show, really enjoyed it and I hope we get to do it again sometime soon. Sounds great. Thanks, Trey. All right, everybody, that's all we had for you this week. If you're loving the show, don't forget to subscribe to the feed and your app.
So you get these episodes automatically every week. And while you're at it, go check out the investors podcast Dotcom and be sure to look into our tip finance tool. This is the dream tool I've been looking for for years, and it's finally available on our website. Incredibly intuitive and a real game changer. And lastly, don't forget to follow me on Twitter at trade. Lockerby, give me a shout. Give me some feedback and let's be friends. All right.
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