Dec 18, 2017 · 1h 21m · capital-allocators
Deep Dive into Hedge Funds (Capital Allocators, EP.34)
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gold bands on the timeline = statements, start to end. Hover to read, click to jump. CC turns on captions
In this retrospective dialogue from Capital Allocators, host Ted Seides joins Patrick O'Shaughnessy to dissect hedge fund manager selection, fee alignment, and portfolio construction derived from his career at Yale Endowment and Protégé Partners. Alongside deep institutional investing insights, Ted shares personal reflections on mindfulness, leadership frameworks, and navigating major career transitions.
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 69.6% of the talking time here. How this is scored →
Ted as informed peer 7.2 Guest teaching 1.4 Guest disagreement 0.2 Ted pushing back 0.7
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 1:08:50 Challenging hedge fund allocations as growth stock traps
Patrick provocatively argues allocators should avoid hedge funds entirely, analogizing them to overpaid growth stocks that fail to justify their fees.
Hardest push from Ted ▶ 1:10:00 Reframing downside protection and market innovationTed counters Patrick's bearish view by emphasizing hedge funds' unique role in managing downside tail risk and capitalizing on market distortions.
Biggest teaching moment ▶ 8:00 Framing the monomyth and the threshold crossoverPatrick provides a deep structural breakdown of Joseph Campbell's monomyth and crossing the threshold into the unknown.
Ted holds their own ▶ 1:03:45 Firsthand account of structuring the Paulson subprime tradeTed demonstrates deep allocator mastery by walking through the exact quantitative risk-reward analysis behind backing John Paulson's subprime fund on day one.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Applying Joseph Campbell's Hero's Journey to Personal Transformation | 5 | 3 | 0 | 0 | Patrick opens by discussing Joseph Campbell's Hero's Journey and the monomyth concept. Ted shares personal reflections on his retreat experiences in West Virginia, creating an agreeable, philosophical exchange. | |
| Formative Lessons from David Swensen at Yale Endowment | 8 | 1 | 0 | 0 | Ted details foundational principles learned under David Swensen at Yale, including asset allocation, rebalancing discipline, and partner selection rules. Patrick acts as an engaged interviewer eliciting core insights. | |
| Independent Ownership and Structuring Nascent Fund Partnerships | 7 | 1 | 1 | 1 | Ted articulates how his perspective on fund ownership evolved away from Yale's rigid independent-ownership requirement to practical seeding models. Patrick asks targeted questions regarding the mechanics of nascent fund alignment. | |
| Cost of Capital Hurdles and Early Allocator Pricing Power | 8 | 1 | 0 | 1 | Ted explains historical cost-of-capital hurdles from the 1990s 5% interest rate environment and how early allocators act as price makers rather than price takers. | |
| Mechanics of Hedge Fund Seeding at Protégé Partners | 8 | 2 | 0 | 1 | Ted describes the business mechanics of seeding 40 hedge funds at Protégé Partners, explaining top-line revenue share percentages and portfolio risk-return objectives. | |
| Assessing Manager Skill and the Operational Realities of Hedge Funds | 8 | 1 | 0 | 1 | Ted demystifies operational failure statistics, comparing operations to a dentist visit where operational friction directly diverts portfolio managers from investing. | |
| Capital Raising Challenges in a Mature Hedge Fund Market | 8 | 1 | 0 | 0 | Ted analyzes the maturation of the hedge fund industry and the acute difficulty new managers face raising capital without ideal pedigree, short-term performance, and charisma. | |
| Analyzing Fee Dynamics, Alpha Unbundling, and Institutional Inertia | 8 | 1 | 1 | 1 | Ted breaks down the clearing price of fees, alpha unbundling driven by quantitative firms, and institutional inertia where legacy LPs tolerate outdated fee models. | |
| Designing Fair Fee Baselines and Talent Wage Inflation | 8 | 1 | 0 | 1 | Ted argues that hedge fund fees can be more justifiable than active long-only mutual fund fees on a true alpha-adjusted basis, despite talent wage inflation. | |
| Sponsor Message: Ridgeline Cloud-Native Investment Platform | 0 | 0 | 0 | 0 | Mid-roll sponsor advertisement break for Ridgeline Cloud-Native Investment Platform. No interactive interview dynamics. | |
| Innovative Fee Models, Investor Loyalty, and Structural Barriers | 8 | 3 | 0 | 1 | Patrick pitches a reverse-vesting side-pocket incentive concept, while Ted highlights his proposed frequent flyer fee discount model and the structural obstacles to fee reform. | |
| Structural Challenges of Short Selling and Asymmetric Market Opportunities | 8 | 1 | 0 | 1 | Ted analyzes the structural flaws of dedicated short funds, detailing the mathematical rebalancing dilemma during sharp equity market drawdowns. | |
| Allocator Dilemma: Pedigree, Short-Term Track Records, and Esoteric Strategies | 7 | 1 | 0 | 1 | Ted breaks down allocator trade-offs between selecting managers based on pedigree, short-term performance track records, or niche esoteric strategies. | |
| Institutional Halo Effects, Tiger Pedigrees, and Resilience After Stumbling | 8 | 1 | 0 | 0 | Ted reviews organizational training grounds, contrasting the divergent spin-out track records of firms like SAC Capital, Tiger Management, and smaller shops like Siegler Collery. | |
| Balancing Conviction, Concentration, and Volatility in Allocator Portfolios | 7 | 1 | 0 | 1 | Ted explains the mathematical and behavioral relationship between allocator conviction, portfolio concentration, and governance tolerance for drawdowns. | |
| Case Study: Backing John Paulson's Subprime Mortgage Trade | 9 | 1 | 0 | 0 | Ted shares a detailed historical case study of Protégé being the largest day-one backer of John Paulson's legendary subprime short trade. | |
| Realistic Expectations and Advice for Aspiring Hedge Fund Founders | 8 | 1 | 0 | 1 | Ted delivers realistic guidance to prospective hedge fund entrepreneurs, warning about elevated opportunity costs and modern institutional scale requirements. | |
| Hedge Funds as Growth Stocks and Downside Risk Protectors | 8 | 3 | 2 | 3 | Patrick challenges the asset class by likening hedge funds to overhyped growth stocks. Ted pushes back, explaining hedge funds' structural asymmetry and asymmetric downside protection. | |
| Recommended Reading: Timeless Classics and Data-Driven Insights | 7 | 2 | 0 | 0 | Ted recommends Dale Carnegie's classic and 'Big Data Baseball', sharing Seth Klarman's endorsement and discussing practical insights for asset managers. | |
| Cultivating Mindfulness: Morning Routines, Headspace, and Calibrated Responses | 6 | 2 | 0 | 0 | Ted outlines his morning routine combining Headspace meditation with physical exercise to calibrate emotional reactions, and reflects on his career transition. |
Statements from this episode (30)
Goldman Sachs hired only 18 global analysts in 1992, says Seides
“I remember interviewing at Wall Street and Goldman Sachs investment banking program had 18 global analysts.”
Early 1990s endowments lacked disciplined portfolio rebalancing
“And a very rigorous rebalancing methodology, which was something, you know, back in the early nineties that endowments and foundations around the world didn't have. Really, if there was an asset allocation, it was a sixty-forty mix. And what you would see was …”
Funds can succeed without the Yale Endowment's strict independent ownership model
“So the notion of independent ownership is as an investor, you want all of the money that you're paying to go to the management team of that fund. And they stick very rigorously to that. I've seen lots of notable exceptions that work fine without that.”
Seides: Very few allocators can replicate Yale's early-stage fund seeding model
“The problem is if that were the case and that were the only way to get into business and have a successful business, you'd probably only have 20 or 30 Investment funds in the world, because very few people have the alignment of, they have the capital, they hav…”
Yale's endowment never took equity stakes in hedge fund managers
“Yale did not ever take economics in businesses. However, they Often were very early. I'm not sure about first or very early and meaningful in the success of many of the funds that people know of today. And I think that's consistent with how David views the wor…”
Seides: Yale systematically required cost-of-capital hurdles from 1990s hedge funds
“In the early nineties, Yale systematically went out and imposed cost of capital hurdles on their managers, and managers who understood those economics, most of which did, they were the beneficiary of it would do something reasonable because the supply and dema…”
Early hedge fund allocators are price makers, late investors are price takers
“If you want to go invest in the Two, three, five, ten billion dollar hedge fund today and be the next marginal investor, you're always a price taker. But when you invest early on, you have the opportunity to be a price maker.”
Seides: Protégé Partners seeded about 40 hedge funds over 14 years
“In my 14 years at Protege, we seeded about 40 different hedge funds.”
Protégé's seeded hedge funds merely matched its non-seeded fund returns
“The funds that protege seeded, you know, my time there had roughly the same returns as the funds that protege invested in that weren't seeded, and then you sort of had acquired this optionality for free.”
Institutional hedge fund seeders typically take 15% to 25% of top-line revenue
“So in a broad range, I would say that it's probably 15 to 25% of the top line that a seeder takes in exchange for providing that initial capital.”
Seides: Early hedge fund founders lacked portfolio management training
“When protege started You didn't really have a lot of people that had experience as hedge fund portfolio managers, so oftentimes you'd have someone spinning out of a big hedge fund in quotes, then big probably, the largest were probably one billion dollars in a…”
Seides: Hedge fund operations offer zero upside and severe downside
“I think operations are similar to going to the dentist. In that when you go to the dentist's office, you have expectations. And the very best a dentist will ever do is meet your expectations. But if they, you know, if the dental hygienist tweaks your gum or so…”
Seides: Fewer hedge funds gaining traction is a secular shift, not cyclical
“What you see is that fewer and fewer funds each year are able to get traction and grow. And the ones that do have everything right. So they have the right pedigree. They might have the right tracker. They might have the right initial investors. They might have…”
Fund-of-funds controlled up to 60% of pre-2008 hedge fund assets
“If you looked pre-crisis, the fund-to-fund investments in hedge funds constituted something like 50 or 60% of all the industry's investments in hedge funds.”
By 2027, hedge funds will only charge 20% on true alpha
“So I think what you're likely to see is 10 years from now, there'll be an active management fee on the long side. And the hedge funds that are charging a 20% incentive fee, they're really going to be charging a fee on what's truly value added.”
Seides: Hedge Fund Asset Growth Drove Massive Talent Wage Inflation
“One of the things that's happened in the last 15 years that I don't think anyone anticipated was as assets came into hedge funds and hedge funds were growing at a fixed management fee, the cost of acquiring talent went up because larger and larger hedge funds …”
Seides: Active Equity Mutual Funds Charge Egregious Fees Relative to Value
“The active equity world that people are still comfortable with charges egregiously high fees relative to true value add, and it makes the 20% hedge fund fee, if it's appropriately calculated, actually a fair deal.”
Seides: Hedge funds add gross value over long-only, but fees consume it
“And even if you look at the academic data that consistently maligns hedge funds, what you find is that for whatever reason, this universe of hedge funds on a gross basis adds value. And far more value than the traditional long only does on a manager by manager…”
Large pensions are now satisfied with a 2% return from hedge funds
“At the same time, the required rate of return that many institutions have for their hedge fund portfolio has just gone down and down and down and down and down. So that the large pension fund who is using hedge funds, not as an asset class, so they're not taki…”
Seides: Allocators choose investment managers on quality, not price
“What you find for reasons that are a little bit confusing is if you think of just normal business strategy, sort of one of Porter's models of price differentiation and product differentiation, investors really, for the most part, do not select their investment…”
Dedicated short-only portfolios suffer structural rebalancing decay in market crashes
“The other challenge is a little bit more subtle, which is managing a short-only portfolio has a real rebalancing issue. And if you just think about the fall of 2008 and early 2009, dedicated short sellers that might have been typically run, call it 80 or 90% s…”
Jim Chanos's dedicated short business failed multiple times in early 1990s
“Even Chanos had a dedicated short selling business in the early nineties that really failed once or twice.”
Dedicated short-only hedge funds are commercially unfit to survive, says Seides
“But as a dedicated short pool, I think Darwin has shown that that is not a species fit to survive.”
Seides: Return-focused seeders should avoid managers chosen only for short track records
“An allocator in the seat like protege was, where the investing was really driven by the investment returns on who the seed was, The middle manager who just had a good track record is the least useful. They may be the most useful in terms of short-term being ab…”
Seides: Esoteric strategies fail business-focused seeders due to capacity limits
“The esoteric strategy probably falls short because usually it's capacity constrained, and therefore you can't scale a business out of it.”
SAC Capital spinouts struggled independently, whereas Tiger Management alumni thrived
“The old SAC was a great example for many, many years SAC generated phenomenal returns on the capital, and yet, with somewhat, some great consistency, the people that spun out couldn't come anywhere near replicating it on its own, and back then, SAC was really …”
Seides: David Swensen's Yale disciples consistently outperformed peer endowments
“There is something to the structure of what Yale did and the discipline that has been proven that David has been able to teach other people. It could Seth Alexander, who I worked with, and Paul Valente at Bowdoin, and Andy Golden at Princeton, and Peter Ammon …”
Protégé Partners was the largest day-one investor in John Paulson's subprime fund
“The most obvious one that sticks out was protege was the largest day one investor in John Paulson's subprime fund.”
Seides: Launching a Hedge Fund Carries Higher Opportunity Cost Than Decades Ago
“The difference today with 20 or 30 years ago is the opportunity cost is much, much higher. So that, that talented person that might be able to get 20 or fifty million dollars and therefore get three or four or 500,000 dollars of management fee income can get a…”