Nov 23, 2020 · 1h 19m · capital-allocators
Joel Greenblatt – Common Sense for Value at Gotham Capital (Capital Allocators, EP.165)
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In this episode of Capital Allocators, host Ted Seides interviews legendary value investor Joel Greenblatt on his journey from founding Gotham Capital's hyper-concentrated fund to running systematic quantamental strategies. Greenblatt shares foundational insights on downside risk management, time horizon arbitrage, and applying capital allocation frameworks to reform public education and retirement savings.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 16.2% of the talking time here. How this is scored →
Ted as informed peer 5.1 Guest teaching 5.6 Guest disagreement 1.3 Ted pushing back 1.2
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 33:30 Rejecting factor models in favor of fundamental causation
Greenblatt firmly dismisses quant factor models like momentum and price-to-book as temporary statistical correlations that degrade, insisting that true value investing requires fundamental cash flow causation.
Hardest push from Ted ▶ 30:49 Challenging Gotham's quantitative and fundamental balanceTed presses Greenblatt on whether expanding to broad systematic portfolios makes their quant models simplistic compared to specialized quant shops and dilutes the depth of their fundamental research.
Biggest teaching moment ▶ 14:40 Masterclass on downside-driven position sizingGreenblatt articulates his core portfolio construction rule: sizing large positions based entirely on downside asset backing and survival under adverse conditions rather than estimated upside potential.
Ted holds their own ▶ 30:49 Ted's incisive breakdown of quantamental trade-offsTed demonstrates deep allocator expertise by dissecting Gotham's transition from high-conviction concentrated stock picking to systematic factor-adjusted investing.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Discovering Value Investing and Benjamin Graham | 4 | 5 | 1 | 1 | Ted prompts Greenblatt to recount his early path into value investing. Greenblatt explains how reading Benjamin Graham overturned the efficient market hypotheses he was taught at Wharton, establishing the foundational philosophy of finding mispriced assets. | |
| Leaving Law School for Wall Street Arbitrage | 4 | 4 | 1 | 1 | Ted asks how Greenblatt turned his student research into a career on Wall Street. Greenblatt describes leaving Stanford Law after a summer trading options at Bear Stearns and joining Alan Slifka's risk arbitrage desk. | |
| Launching Gotham Capital with Mike Milken's Seed | 5 | 4 | 2 | 1 | Greenblatt details how he realized standard risk arbitrage offered unfavorable asymmetric downside and pitched Michael Milken to seed Gotham Capital with five million dollars. He recounts negotiating directly with Milken and holding his ground. | |
| Concentrated Portfolio Construction and Downside Sizing | 6 | 7 | 1 | 2 | Ted probes how Gotham structured a highly concentrated portfolio of special situations. Greenblatt outlines his foundational philosophy of sizing positions by looking at downside protection and cash coverage rather than speculative upside. | |
| Market Shocks and Navigating Hidden Correlations | 5 | 6 | 1 | 1 | Ted asks about historical losses, prompting Greenblatt to recount the 1986 Ivan Boesky insider trading scandal where six seemingly independent merger bets broke simultaneously due to hidden financing correlations. He details how this painful drawdown shaped his conservative management through the 1987 crash. | |
| Managing Proprietary Capital and Long-Term Horizon Pressure | 5 | 5 | 1 | 1 | Ted inquires why Gotham returned outside capital despite stellar annualized returns. Greenblatt explains that the psychological toll of exposing external LPs to cyclical 20-30% drawdowns in a concentrated book led him to manage only proprietary capital. | |
| From the Magic Formula to Gotham Asset Management | 6 | 6 | 1 | 1 | Ted asks about the inception of Greenblatt's famous books and Gotham Asset Management's shift to systematic diversification. Greenblatt explains how testing return on capital combined with earnings yield proved that systematic diversification actually improves compounding in leveraged long/short portfolios. | |
| Fundamental Valuation vs. Factor-Based Quantitative Strategies | 7 | 7 | 3 | 3 | Ted asks a nuanced allocator question regarding whether Gotham's quantitative approach is 'quant light' and if its fundamental depth suffered. Greenblatt strongly distinguishes between factor quants chasing historic correlations and fundamental valuation grounded in cash flow causation. | |
| Research Process, Indexing Dynamics, and Institutional Allocators | 5 | 5 | 1 | 1 | Ted asks about the institutional research process and managing capacity at scale. Greenblatt describes their bottom-up private equity style accounting adjustments and offering tracking-error constrained mandates for large institutions. | |
| Sponsor Message: Ridgeline | 5 | 5 | 1 | 1 | Following a sponsor read, Ted asks about the inception of the Value Investors Club. Greenblatt recounts creating an exclusive online forum in 1999 that acts as a meritocratic crucible for vetted investment theses. | |
| Seeding Emerging Managers vs. Internal Strategy Execution | 6 | 5 | 1 | 1 | Ted explores Greenblatt's experience seeding emerging managers discovered through the club. Greenblatt reflects on the friction of owning stakes in labor-intensive boutique firms versus simply allocating capital to their funds. | |
| Time Horizon Arbitrage for the Individual Investor | 6 | 6 | 2 | 1 | Ted discusses the reception of Greenblatt's book 'The Big Secret'. Greenblatt explains why retail investors hold an structural edge over institutions: institutional managers suffer agency constraints and three-year benchmark pressure, whereas small investors can practice genuine time-horizon arbitrage. | |
| 'Common Sense' and Rethinking Urban Public Education | 5 | 7 | 2 | 1 | Ted asks about applying investment frameworks to public policy. Greenblatt outlines urban education disparities and proposes alternative skill-based certification standards for major employers to bypass traditional college credentialing. | |
| Creating Corporate Demand Flywheels for Alternative Certification | 5 | 6 | 1 | 1 | Ted asks how to trigger corporate adoption for alternative certification. Greenblatt uses Christensen's disruptive innovation model and African telecom buildouts to demonstrate that securing corporate buyer commitments will self-fund the preparatory ecosystem. | |
| Open-Source Innovation Lessons from Cancer Research | 4 | 5 | 1 | 1 | Ted asks why translating the Value Investors Club crowdsourcing model to oncology research did not achieve similar success. Greenblatt candidly reflects on how extreme domain specialization and technical silos prevented open-source cross-pollination among researchers. | |
| The Invest 5 Initiative and the Mathematics of Compounding | 4 | 6 | 1 | 1 | Greenblatt explains his 'Invest 5' initiative aimed at low-income retirement savings. He walks through the striking mathematical contrast of compound returns starting at age 19 versus age 26 to emphasize early dollar-cost averaging. |
Statements from this episode (34)
Ordinary risk arbitrage historically yielded 60% to 100% returns in pedestrian years
“Cause I mean, a pedestrian year back then was you made 60 or a hundred percent doing risk arbitrage.”
Standard risk arbitrage offers an unfavorable asymmetric risk-reward profile
“Risk arbitrage, betting on whether a deal's going to go through, and if it breaks, you lose 15 dollars. If it goes through, you make a dollar or 75 cents, but you made it in two months, so it was a great annualized return. So lose 15 dollars, make a dollar. Se…”
Greenblatt: Milken agreed to seed Gotham Capital after a single phone call
“And three years into it, one day I called my friend who was working for Mike Milken. And I said to him, gee, if I could raise X dollars, I'd go out on my own and run a fund. And he called me back the next day and said, Mike said fine.”
Milken doubled Greenblatt's ask while keeping Ron Perelman waiting on Revlon
“So I kept him there for an hour and I actually literally had Ron Perlman waiting in the next room to do the Revlon deal. And I kept him waiting there and he finally gave up on me and walked out, sent his brother in. And I got the deal from his brother and then…”
Gotham Capital traditionally concentrated 80% of its portfolio in six ideas
“Well, the big picture, our portfolio six to eight ideas were traditionally 80 plus percent of our portfolio.”
Gotham Capital generated 50% annualized returns before fees over its first decade
“We made 50% a year for those 10 years before our fees.”
Position sizing must be determined strictly by downside risk, not upside potential
“And I think the key to sizing them, if you want to know my portfolio management philosophy, is look down, not up. Meaning, the largest positions were not the ones I thought were Absolutely the best or that I was going to make the most money in sizing all had t…”
Six broken deals in 1986 slashed Gotham's returns from 80% to 30%
“I had in my portfolio five or six merger deals that were going on, whether I had a piece of a security or I had some iteration of it, and I thought that was diversity. In my portfolio, but it turned out it was all the same bet. You know, is the financing going…”
Greenblatt: Investors can succeed without knowing market direction
“I think you can be successful without knowing which way the market's going.”
Greenblatt: Concentrated portfolios face 20% to 30% drawdowns every couple years
“When you run such a concentrated portfolio, every couple of years, there are a few days where you lose 20 or 30% of your assets because one or two of your ideas aren't going your way. And that's just part of the way it works.”
Concentrated investing is a great investing model but a terrible business model
“I don't think that's a business model. I think that's a great investing model. I don't think that's really a viable business model, except for the longest term investors.”
Simon & Schuster blocked Greenblatt's original book title to protect Motley Fool
“The original subtitle was even if you're not too smart was originally supposed to be any fool can be a stock market genius, but it turned out my editor at Simon and Schuster had the Motley fools and he wouldn't let me use the word fool.”
Greenblatt's early merger arbitrage failed after Cypress Gardens collapsed into a sinkhole
“One of the first deals I did in the first two months I was in business broke. I wrote about Florida Cypress Gardens was being bought by Harcourt Brace, and it was just a little theme park where they had alligators in the swamps and water skiing Santa Clauses, …”
Greenblatt: Buying Good Businesses Naturally Expands Margin of Safety Over Time
“Pretty quickly we realized that being involved in good businesses expands your margin of safety because you might buy in with some margin of safety, but the value of the business keeps going up. It expands your margin of safety. The value of the business is go…”
Leveraged long-short portfolios require broad diversification to prevent catastrophic negative compounding
“And we ran through the math of it and it turned out you made more money when you go long, short and put on leverage with more diversified portfolios than concentrated portfolios because those bad periods end up in negative compounding and negative compounding …”
Greenblatt: Private equity buys cash flows, not price-to-book factors
“I would argue that no private equity firm would buy a business because it's low price book or low price sales. They're looking at cash flows and how much they're going to grow and how secure those cash flows are, how certain they are of those cash flows. That'…”
Greenblatt: Momentum investing has worked globally for 30 to 40 years
“Over the last 3040 years, whether in this country and across the globe with one or two exceptions, momentum has worked. Over the long term.”
Gotham hires elite quant engineers for risk balancing but bars stock selection
“We have a tech guys who are very sophisticated, you know, one guy, one Google code jam, another one's MIT chess jam. And we need those guys to balance our portfolios, but they're not picking stocks. I picked those guys because they have no idea how to pick sto…”
Greenblatt: You Cannot Run $30 Billion in Six to Eight Concentrated Names
“You also can't run thirty billion dollars that way, and if you want to provide a service based on the way we value companies, That's the kind of things we're trying to do in a more systematic way.”
Value Investors Club has 500 members and a 3% acceptance rate
“And so we still to this day, I think there's probably about 500 investors. It's probably two or three percent of people who submit an idea get in, and it's very hard to get in”
Greenblatt: Value Investors Club became an 'American Idol' for seeding hedge fund managers
“It sort of turned into an American Idol for hedge fund managers, where we really discovered some really smart people that I've been able to put money with over time. I don't do that anymore, but when it first got started, that was an unintended consequence tha…”
Greenblatt: Staking small fundamental hedge funds is inefficient and overly labor-intensive
“I'm not wild about the idea of owning a piece of business where it's very labor intensive. These are usually very small shops with one, two or three managers who are working really hard to get a good return. And so while it's very helpful to get them started i…”
Greenblatt: Individual investors' main advantage is patience as institutional horizons shrink
“The big secret, just so you don't have to buy the book, was the advantage of the small investor has is patience. There's much more data available. Time horizons are shrinking. They're not growing.”
Greenblatt: Active management business will suffer, but stock picking opportunities will grow
“I think the world will continue to get harder for active managers as far as a business is concerned. But if you're a stock picker, if you're an active manager and you're an individual stock picker, the world's getting better for you because less people are doi…”
Greenblatt: Top 50 urban minority students face 1-in-11 college graduation rate
“If you live in a top urban center, top 50 urban center, and you are low income or a minority, your chance of graduating college are one out of 11. We know that college graduates earn 70% more than high school graduates and high school graduates earn 30% more t…”
Success Academy's 20,000 low-income students outperform wealthy suburbs on state standardized tests
“We now have 20,000 kids. The vast majority, close to 90% are minority low income kids. They're only in New York City. And if you look at the 20,000 kids as a group on the math and English state test, they outperform the wealthiest suburbs. So they outperformed…”
Greenblatt: Charter schools cannot scale enough to solve U.S. public education
“Charter schools are only seven percent of all the public schools, and they're in the best places that have the best charters, New York, Massachusetts, California. They're very challenged. It's going to be very hard to open even any more. So it's not going to e…”
Greenblatt: Alternative certifications will iterate to match college degrees
“And that's what I think would happen with alternative certification. That these standards that were developed over time, companies would figure out what works well in lieu of this college degree, what tests or courses or whatever you have to do. Some of the te…”
Greenblatt: College functions primarily as a signaling device
“Really most of college is a signaling device to say that, Hey, you pass through these hurdles. And you jump through these hoops, and you made it there.”
Crowdsourced research models fail in oncology due to extreme sub-specialization
“Yeah, so we tried to have along the same lines as the Value Investor Club, almost set up identically where cancer researchers were actually posting their ideas, their research on the site, and it turned out that it's a very technical field. Even if you're a ca…”
Greenblatt: 90% of bottom quintile Americans have zero retirement savings
“Nine out of 10 people in the bottom quintile don't have any retirement savings.”
Trailing five-year fund performance has near-zero correlation with future returns
“And we know that the last one, three, five years of performance correlate almost nothing with the next one, three, five. So the way to get the next one, three, five is looking at process and looking if it makes sense and looking if the manager is going to stic…”
Unprofitable billion-dollar companies from 2019 surged 75% in 2020
“If you bought every company that lost money in 2019, so this is pre-COVID, that had a market cap over a billion, there were 261 of them, you'd be up 75% this year.”
Greenblatt's biggest mistake was misunderstanding operating leverage in a trade show company
“Operating leverage, I invested in a company that was a trade show company, where you could get unlimited space in Las Vegas, so it only cost them two dollars a square foot for the space, and they could re-rent it out for the trade show at 62 dollars. So the mo…”