The Exchanges

Q Louis, James, any additional thoughts to the framework that Marco just proposed?

A Look, we can talk all day about what's happening in the U.S. There's obviously a wider world. Yes, the end of U.S. exceptionalism has a lot mostly to do with the policy choices of the U.S., but also just the natural order of things. Trees don't grow to the sky. Valuations relative to the world were very stretched, et cetera. At the same time, we have to acknowledge that we're seeing very important policy shifts in both Europe and China. I spend a lot of time looking at China. I live in Hong Kong. We have an office in Beijing as well. The story of really the past six, seven years in China, first and foremost, where all the capital was being allocated to industry. The banks were told, don't lend to real estate anymore. Don't lend to the consumer. We have to build industrial resilience because the U.S. is trying to train our growth. It's not giving us access to tech, not giving us access to semiconductors. So we're going to have to build everything ourselves. This has now shifted massively in the past six to nine months. First reason is, industrially, China is much more confident and comfortable with where it stands relative to five, six years ago. At this stage, it basically dominates pretty much every single industrial supply chain. Number two, China's big fear over time became that the US would try to build an anti-China coalition. Now, funnily enough, having declared trade war…

AI assessment note: “we have to acknowledge that we're seeing very important policy shifts in both Europe and China.”

Q can't quite gloss over jumping into a firm that you think is going to be great, that's getting crushed by the markets. What happened in that period of time as you're trying to build out some of this infrastructure where your clients don't like you, you can't imagine what fundraising is going to be like, and the relationships may have soured a bit because of performance in the short term?

A You learn so much in those moments. I tell all of junior people that I work with, or people that I mentor, if shit goes wrong in an organization, start listening, and just hang on tight and write everything down. Because I look back at that moment in time, and so much of what I've learned about how to communicate well, how to respond to investors' needs, and how to Be resilient as an organization came from that time. We had to do what we called at the time a contrition tour, which was essentially David Bonderman and Jim Coulter traveling all around the world apologizing to our investors. We gave people an option to take their money out. We gave people an option to reduce their commitment. It was a twenty billion dollar fund, so we still had a lot to work with. But those were the types of motions that we had to undertake in order to start to turn around relationships. It was humbling for a lot of people around the organization. But I think it made the organization so much stronger at the end of the day, and I think when we look forward 10 years, we had very high NPS scores from the clients that we did retain and the client relationships that we built over time that came from The increased transparency, the increased humility, the personal connections that you needed to make during that time to build from the bottom.

AI assessment note: “We had to do what we called at the time a contrition tour”

Q I'd love to dive in a little bit on each of those three platforms and how you've thought about the role. So you're starting at Goldman, big investment bank, big operation. What did you see in terms of that capital formation role in that seat?

A I was very lucky in that it's a huge organization, but I was part of a very entrepreneurial group. We were building from the ground up. We were creating marketing materials from scratch. We were creating reporting and a fundraising function for an asset class that was new to most institutional investors and high net worth investors in the world. The exposure to Private equity and venture capital for most institutional investors when I started there was probably less than one percent on average, and by the time I left it was probably five or 10, so you can imagine the growth and the transformation that was happening. But I was doing it as part of a larger organization that had a very established sales function. We had distribution coverage all over the world. There was deep investor knowledge. The reach was very broad. It was organized by channel. Meaning type of investors, endowment and foundations, consultants, pensions, and I learned about the nuances between all of those different types of investors from those salespeople, and they knew how to run a campaign very distinctly. It is a machine, and you learn from being a part of a very well-oiled machine.

AI assessment note: “We were creating reporting and a fundraising function for an asset class that was new”

Q What was his business that led to the foundation at his passing?

A Well, when he came out of Princeton, his father was a serial entrepreneur and had most recently started a company called Dietrich Industries, not far from Pittsburgh. And as Bill described it, it was a horrible business model. His father had started this thing as a lumber and steel distribution center, trying to buy scrap steel cheap from the mills in Pittsburgh and then punch them into valuable small pieces. It was horrible. But Bill was trying to keep it afloat, eventually took over in the 19 seventies. Bill really landed on a product that he bet the farm on, which was non-load bearing steel studs. So really light metal, raw form steel that would hold drywall up. And Dietrich studs became wildly popular, and that business just compounded by the mid nineties. Had grown to over 2000 employees in production in 19 states and four or five hundred million a year in revenue. So he really had a success on his hands.

AI assessment note: “a company called Dietrich Industries... product that he bet the farm on, which was non-load bearing steel studs”

Q So 90% illiquid is a far extreme of what you hear about in a pool of capital like that. How did you come up with that number compared to a 50% number that is more common in some of the more aggressive endowment and foundation portfolios?

A Well, it was just trying to capture that additional return, and we didn't set out saying, hey, we should target 90. When I took over the portfolio from Bill in 2010, I think we were probably 50% illiquid, but the returns have been robust. We did not have in the last 10 years any U.S. public equity exposure except public positions in our private book, so that was the entirety of our U.S. beta. So the private actually continued to outperform the public in our book. So that stretched out. So we're taking the last five or seven years, we've been more careful and deliberate in terms of our fresh commitments to liquid strategies, trying to get that number down.

AI assessment note: “we didn't set out saying, hey, we should target 90”

Q How'd you get from the investment banking side over to investing?

A I joined PNC Capital Markets in Pittsburgh, and we did M&A advisory, mostly on sell side deals and lower middle market. And after doing a few of those, you sort of understand how the structure and the financing takes place. Being a little ambitious, I sat down with one of my colleagues and said, hey, how about if we go and raise a private equity fund and we can be a principal in these transactions? So we pulled in one of my high school buddies with a forensic accountant, And one of my MBA buddies who was an engineer ops guy, and we went out to raise a private equity fund in 2000. That's how I was introduced to Bill Dietrich as a potential LP.

AI assessment note: “we went out to raise a private equity fund in 2000.”

Q So how did he build the structure of the governance to allow you to invest in a different way?

A He first decided that everything had to be as well documented as possible. If you had a shot at persistence and sustainability of this, it had to be well articulated and rooted in thoughtfulness. And as he always said, clear writing reflects clear thinking. So when he crafted his charitable trust document, alongside of it, he wrote a 16 page statement of philosophy. Which was his explanation of why he wanted to pursue a high growth strategy for the benefit of the supported organizations, and how he wanted to go about doing that. And right after we formed the foundation, I expanded on that document and wrote a further overview of investment philosophy, which is even more detailed about what we're doing and why.

AI assessment note: “alongside of it, he wrote a 16 page statement of philosophy.”

Q How do you think about the use case for shorting now?

A I still think it's as compelling as ever. Maybe I'm a dinosaur in that regard, but what is the value of shorting? Well, first, it absolutely makes you a better investor. It forces you to be open-minded, forces you to be skeptical, not cynical. There's an important difference. It forces you to really question market narratives. So I just think it requires more objective process discipline and If we weren't shorting, I think we would be more prone to succumbing to not challenging key assumptions the way that we should. I think that is very valuable. Certainly within a portfolio like ours, I think in our first conversation at Columbia, I wished for a world that looked more like David Swenson's original formulation of long short, where he was putting a four to five percent short rebate into his target returns. Well, guess what? At least for right now, we're getting a four to five percent short rebate. So if we can then create alpha on top of that, that's quite powerful. And then of course, the ability to just help protect capital and fund our long book, particularly our concentrated long book in our model is very critical. And to be more explicit about that, we have our highest hit rates and our highest slugging ratios in our ideas that have been seven percent or more of capital at risk. And I have a cohort of roughly 38 of those ideas inception to date. Our ability to put those in…

AI assessment note: “I still think it's as compelling as ever. Maybe I'm a dinosaur in that regard”

Q What are some of your other favorite new frontiers?

A I'll talk about some of the things we've done recently. Industrial outdoor storage. It's become a little more institutional, but two years ago when we first did it, it wasn't an asset class that anybody would own. That's, I think, particularly interesting. Other stuff that we've done, oh, bourbon aging. First of all, one, it's certainly not an institutional asset class. Two, people think we only do it because Evan's from Kentucky and is a huge bourbon fan. But three, There's actually terrible technicals, because liquor consumption's going down, and Brown Forman's talking about volumes dropping, and so there's no capital going into that, and so the ability to be a structured lender to these small producers is incredibly interesting to us today, so that's one that we've done recently and are pretty excited about.

AI assessment note: “Industrial outdoor storage... Other stuff that we've done, oh, bourbon aging.”

Q Great to see you, Ted. Well, we're going to do a fun perspective on your 25 years here at BBR. I thought it might be good to start with the two bookends. What did BBR look like at the beginning, and what's BBR like today?

A In some ways, the bookend of the start is unrecognizable compared to what it's like today. There were five of us day one, and it was early 2000. If you picture the environment, you had dot-com bubble was raging, no end in sight there. You had five twenty-something-year-olds gathering to be part of that internet rage by creating a business that was nothing like the internet. The five of us had an alignment in terms of what we believed and what we wanted for a business, and so we took that idea and we made some tough career choices to leave the good jobs that we had and start from scratch. So day one was in Brett's apartment. That was where we spent our first few months surrounded by computer boxes and makeshift desks, and we got going. And where we are today is we have a 190 people at the firm. In three offices, New York, Chicago, and San Francisco, we manage money exclusively for wealthy families. There are about a 180 families where we're overseeing their wealth, and that's thirty two billion dollars, so the average family wealth is about a hundred and fifty million dollars.

AI assessment note: “There were five of us day one... And where we are today is we have a 190”

Q What were some of the other success factors that you found from your historical investing?

A We regressed earnings growth against returns. Unsurprisingly, it's very correlated. We were curious about whether organic versus inorganic growth would make a big difference. And startlingly, the R squared on total Earnings growth is almost as strong as organic growth only, and I think the reason for that is that when a company is approving acquisitions and we're obviously in control of that decision, we're typically doing it with a lot of strategic advantages. We're doing it carefully, and it's pretty rare that we've seen a systematic acquisition program with the proper discipline be dilutive, and so that was one surprising finding. Another one would be that we used to think that management stability would be very correlated with investment success, and we looked at changes in C-suite management, and there was really not a ton of correlation there, so I'd say that's been an insight that has caused us to be perhaps a little bit less fearful of making management changes when necessary or strengthening management teams. Another interesting one was looking at the correlation between entry multiple And investment success. And in our case, and we really had the data just to look at the hundred or so transactions in our history as a private equity firm, there was really no correlation. If there was one, it was a very weak negative correlation. So lower multiple investments tended to …

AI assessment note: “We regressed earnings growth against returns. Unsurprisingly, it's very correlated.”

Q miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. So as LPs see the trends and how you're describing the challenges of getting back to a distribution yield that might work for them on a longer-term basis, how do you recommend LPs go about thinking about their portfolios in this new environment?

A When we ask GPs, what is your vision and what is your right to win? We ask the same thing to the LP. What are you trying to accomplish in your private markets portfolio? What is its role? What is your right to win as an LP? One of the things we've been telling the LP community is you need to scale with alpha generators, not with capital aggregators. They're very different things. So do you have a process and a set of tools that allow you to identify alpha generation? If the answer is yes, are you aggregating your exposure with the managers That are producing that alpha. And over time, those managers should have scarcity. Access issues. We've been telling our limited partners, you have to be able to pitch those GPs on why you're the right partner for them. What are your unique capabilities that will allow a partnership together to not only help you succeed, but that GP succeed? If you can articulate that, that's a differentiator. That'll stand out. You also have to start to build real time active portfolio management capabilities. We think the asset class today is overvalued by about 10%. But that measurement moves a lot, and the liquidity of the asset class can come in and out rapidly. If you have a data-driven perspective on relative value and liquidity, And you have an information advantage on your own portfolio. You could be an active buyer and seller of your own book, wheth…

AI assessment note: “you need to scale with alpha generators, not with capital aggregators”

Q So you've got the sports business, you've got this working with practitioners in the space. How are you seeing these two collide?

A It's been a beautiful, like, emerging property of the last five years. If you look at the people who have purchased control of North American sports teams over the last decade, 80% of them come from tech or private markets. It's because they're business builders. They have a sophisticated institutional grade mentality on change and the value of change, but they also have lots of ordinary income and the sports properties create a huge tax shield. They are not correlated with healthcare or tech or finance. You're not allowed to use a lot of leverage. So if you are a titan of private markets, You have a lot of levered exposure to all kinds of equity, and you have a lot of ordinary income. There is a really unique benefit to being a direct sports owner if you are coming from the finance industry. And so from time to time, we have the opportunity to help leaders of private markets firms become owners of sports assets. There's actually a really unique overlap between our Keystone business and our sports business in that some of the leaders of both industries are the same. Look at Josh Harris, and David Blitzer, and Ostrover, and Eric Getty, and Rubenstein now. It's a pretty impressive list.

AI assessment note: “unique overlap between our Keystone business and our sports business”

Q What are some of the examples of those businesses that are a good fit that you can help grow and build with the audience?

A I'll give you a full life cycle of one of these businesses. So we started a business about two years ago now called Reflexivity Research. And in that business, we basically said, okay, there's tons of research that exists in the traditional world. They all have different shiny traps to them. Some of them are really, really smart on certain subjects. Some of them are really good on distribution. Some of them are really good in terms of a high price point and low volume. Some are high volume, low price point. Go and study all these different businesses. I had helped start a couple of businesses in the crypto space, specifically around research, but it was always more as an investor. And so when I looked at those businesses, I said, hey, each one of these has a niche to it. But the one niche that no one has gone after yet is providing free research for massive distribution. We're perfectly positioned to pull that off. We don't have to pay to go build all that distribution because we already have it. So why don't we take the right product and put it through that distribution? So that's what we did. We partnered up with a guy, Will Clemente. He was somebody I'd known for a long time. He had all the right values. He worked hard. He was curious and was into a lot of the data and research. And the way that that business basically worked is we put 500,000 dollars down on the balance she…

AI assessment note: “we started a business about two years ago now called Reflexivity Research.”

Q How does that translate to what you're trying to achieve in terms of the risk return profile relative to your peers?

A So we have always been very focused on DPI, and that just drives everything. I can't tell you why more people don't sell, frankly, and I think we had five or six companies direct list in the 20 and 21 just because that was a way to exit them very quickly. We want to make two to five X, three to seven years, slap it into a fund, make two to two and a half X net funds, and not lose freaking money. Our loss ratios are very strong. We've only lost all of our money on one of two companies ever. I'm sure we will again, but if you back companies that grow on average, 30% a year, don't have leverage, you own preferred stock in 70 or 80% of the time, and the vast majority recur, You may have overpaid, but then preferred stock helps you. And less than a third of companies, I think, have any debt on them. What gets the buyout fund in a lot of trouble is just leverage. The companies still survive. They just over lever the business.

AI assessment note: “We want to make two to five X, three to seven years... not lose freaking money.”

Q How did the idea of that forever hold dovetail with the initial expectations of this is probably going to be like any other deal you do with a five-year hold?

A It was around 2011. I think we really started talking about that more directly between ourselves and the management team. Before that, we hadn't really talked about exit much at all, but we had a successful investment going into 2011, and I just remember calling up the CEO of the business and just saying, most of the management teams really start thinking about exits around this point in time. You're four, five years in. At that point in time, we were Three to four X ROI on the investment. When you go into a deal with the management team, they're always worried that the private equity firm is going to sell the business out from under them at some point in time. The vast majority of the deals that we're in when we actually exit is because the management team wants to sell more so than us. And there's very logical reasons for that. Almost all of their net worth in a successful deal is involved there. They start to get really worried about concentration levels and the like. I think one big advantage that we had in this deal is that our management team was very successful before Crown Rock. They weren't looking for their next dollar to go on vacation or buy a new home. They were very well set up even before that. So they had the flexibility of taking a very long-term view. And when we opened the door to them that the private equity firm, Lime Rock, were not necessarily beholden to …

AI assessment note: “we opened the door to them that the private equity firm... were not necessarily beholden”

Q What were those other two extinction events that happened?

A The other two, just before Thanksgiving in 2014, Saudi Arabia, and by extension OPEC, essentially declared war on shale. They set out to reclaim market share after tremendous amount of shale growth had really cut into the market share of OPEC from the 2010 to 2014 period. And 2015, which followed this announcement, was a complete wipeout. I mean, oil prices fell by 50% again. The rig count went from 2000 rigs to get as low as 304 hundred rigs. More bankruptcies than you had ever seen in the oil and gas business since the 19 eighties. I think in hindsight, we can look and say a lot of those 2000 rigs were very unproductive and were not focused on the best resources in the country. And that moment where Saudi said, we can put you out of business whenever we want. Really focused the industry to be much more high-graded overall in the most productive resources in the U.S. So there's entire plays that were, 405 hundred rigs were running that are completely wiped out and have barely re-emerged in the years since. It also really strengthened the focus on the Permian Basin, which is where fortuitously all of our investment was located within Crown Rock, and that proved to be by far the most resilient of the basins. You could Drill there at that point in time at oil prices below 30 dollars a barrel because service costs adjusted at the same time, too. And it also prompted an acceleratio…

AI assessment note: “just before Thanksgiving in 2014, Saudi Arabia, and by extension OPEC, essentially declared war”

Q customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. At that crucible internal moment to making that decision, how did that conversation compare to others that you've had in the past or since of similar successful investments that maybe you should continue and re-up for a while or exit?

A There's moments where the market collapses and you just have asymmetry in front of you and you layer in the bed and the challenge is don't overstay your welcome because whatever created that asymmetry is probably going to present itself again On the opposite end of the spectrum, we owned an oil sands company in Canada, first deal we did. We owned a shallow water jackup drilling company in the Gulf of Mexico, and our second fund outsized ROIs in both cases. In both cases, within five years of our exit, those companies were bankrupt. It just speaks to the fact that each year we were holding Crown Rock, the technology that was being really ubiquitously applied throughout the industry in horizontal drilling techniques, Lateral lengths for the fracks. Everything was getting better every year. I'm not sure there is an analog to the question you're asking. This was very unique insofar as prices were coming against us at moments in time, three that Jay mentioned, but there wasn't that extinction risk fear. The Crown Rock deal just never had aspects of that risk factor.

AI assessment note: “I'm not sure there is an analog to the question you're asking. This was very unique”

Q So when Jean was on the show a couple of weeks ago, she talked about Wellington getting into hedge funds, even predating Mark in the mid nineties. And I'd love you to take me back from the perspective of just the hedge fund group of how did this all start at Wellington?

A It wasn't necessarily a big strategic decision at the time. It was actually much more about retaining an incredibly talented investor at the firm. And so Nick Adams, Julian Robertson knew him well and had approached him to leave Wellington, join him and launch a hedge fund. And so Nick actually quit and was on his way out the door. And the CEO at the time, Bob Dorn, Said, Nick, come in to my office tomorrow. I want to see you and talk about this. And so Nick came in and saw him and he asked him, why are you leaving? You seem like a great fit for Wellington. We love you. And Nick said, well, yes, all that's true, but I really have a passion for pursuing hedge fund investing and Wellington doesn't do that. And Bob Dorn said, well, we do now, please stay. And Julian was part of the original capital that helped seed it. And that really started the business. Nick, to his great credit, continues to be one of our top hedge fund managers here at Wellington, but that really is what kicked it off.

AI assessment note: “It was actually much more about retaining an incredibly talented investor at the firm.”

Q How do you go about developing that conviction in an individual portfolio manager in their team?

A For me, the starting point is the philosophy and process of the investment team. Why is it that you think you can beat the market, which is very, very hard to do in the process part, the three sub components of an investment process. So it's idea generation, capital allocation of those ideas, and then risk management of the collection of ideas that you're generating. If you do that at a granular level, it gives you Insight into the type of portfolio you should see from that team. If you go through that whole process and the conclusion is this a team that their strength is idiosyncratic risk-taking. Then when you look at the portfolio, you should see a portfolio where 80% give or take of the risk is idiosyncratic risk. And that is how you start to build conviction and differentiate between luck and skill.

AI assessment note: “And that is how you start to build conviction and differentiate between luck and skill.”

Q Have you made any more investments this year?

A My investment portfolio for context is really a best ideas. It's almost a total portfolio approach, much more than an endowment model. And it's fairly mature at this point, have a lot of great manager relationships that I love leaning into. So the new investments I made this year tended to be co-invest. I invested everything from a sports betting app to an AI company alongside a Gavin Baker at Atreides. To a European snacks business with Scott Spielvogel at One Rock Capital, to a blind pool with Chaz Cock at LB Partners, who just does an unbelievable job when he finds best ideas. And I made two investments in things related to the industry. So one, I'm an advisor at 10 East, which is a platform for alternative investments. They did a round for their operating company. And I also made an investment in Oldwell Labs run by Campbell Wilson, Which is the very best software I've seen to help allocators find and monitor managers. So that's most of where my activity is. Now, probably the most interesting one for next year, and it might sound crazy and certainly will sound contrarian, is a SPAC, a new SPAC. So I was involved in a SPAC in the heyday three years ago. We have a great team of people. Some of that team decided to do another one. When we did the first SPAC in 2021, there were something like 650 SPACs in the market that completely disappeared for a lot of good reasons. And in …

AI assessment note: “So the new investments I made this year tended to be co-invest.”

Q One of the things I'm always attuned to is folks in the institutional community care about what you're thinking, what you're hearing. And so when you think about the topics institutional community want to hear about next year, What are those topics?

A What's top of mind for allocators are first, let's call it the private equity cycle. So there's some discussion of what's going to happen with liquidity. When you talk to allocators, they're not actually worried about liquidity. This is nothing like 2008, but they are wondering when will distributions come back and how will they address continuing to invest in the private markets? The obvious big one now is this potential for a new economic regime in the US. Between the new president, Scott, alongside Kevin Hessard at the Economic Council, and Doge, there's some chance that you have a significant realignment of the U.S. both in the world and some rationalization of the budget in the U.S. economy. So what are the implications of that are important? And then AI is present of how is this going to change industries and investments. On the manager side, all of that always ties into performance, and that's first and foremost top of mind. I've yet to have a day in my career Where people thought it was just going to be easy to make money. Even when the opportunities in retrospect are easy, there are lots of reasons why it's hard in the moment. On the capital side, fundraising has been really hard. You've had this bottleneck in the private markets that's also affected public market fundraising. And so that capital on the margin, is it going to come from private wealth? Is it going to co…

AI assessment note: “What's top of mind for allocators are first, let's call it the private equity cycle.”

Q Well, I'd love to dive into this training ground story of Wellington going through your story as a classic homegrown talent. So why don't you take me back to those early steps in your recruiting and training as you worked your way up here?

A The recruiting is probably not as interesting as the training. So I found my way to Wellington, which was a very small company back in 1991 when I joined under 300 employees. I started as an administrative assistant. Very unusual. I only had two interviews, not the typical 30 that we have now. But the early couple of years was really about working in the research department and then 18 months in getting to work with Ed Owens. In Wellington, particularly on the investment platform, we talk about having an apprenticeship model, and I think I am the classic apprentice, particularly that first decade, but I would even say my second decade of learning to become an investor. So if I take a step back and think about that first decade and working with Ed Owens, it was really, one, getting to know companies. And working with him was pharmaceutical and biotechnology companies, getting the skills to do that. So that meant for me coming from an undergrad degree at Wellesley, going back to Harvard Extension School and getting accounting background, taking my CFA, and then taking biology courses, which was really necessary to understand what was happening in the subject matter that I was studying in the industry I was studying. What Ed taught me in those first few years, and it was really about observing him and being in every meeting with him, was really about how do you evaluate companies …

AI assessment note: “I started as an administrative assistant... and then 18 months in getting to work with Ed Owens.”

Q So how do these three components, the equity beta long vol and trend work together such that you took equity beta and as you looked at it historically, this outperforms?

A What we do is we take say a hundred dollars of equities. We replace that with futures contract. And we actually put in a 110 dollars of equity exposure. Explain that in a second. So that probably takes seven dollars of margin to do that. So now we've got 93 bucks left. And then we layer in the risk responders program, which is 23 dollars out of every hundred. And we put a hundred percent of that risk responders, which is dynamic convexity and trend falling in there. In a benign market, we call benign market that's drifting or trending upwards. We're going to expect in dynamic convexity to lose two to five percent a year. So having a 110% equity beta basically just looks at that strategy and says, well, if the market drifts up, there's going to be some drag because you're long this dynamic convexity, you're long your hedge essentially, and that hedge is going to cost you. So if you combine those two things, you should still end up with a hundred percent of the equity performance on the upside. And then you look at trend following and you go, okay, over the long haul, let's say trend is going to deliver a plus .2345 sharp, something like that. But for the purpose of this portfolio construction, just imagine it does nothing in a year. So now what happens in a strong S&P year? Well, your S&P goes up, let's say, 15%. You invested a hundred dollars, it's now worth a 115. What you can…

AI assessment note: “if you combine those two things, you should still end up with a hundred percent”

Q When you've traded across all different markets, why do you choose equities and not some mix of all different assets?

A The real use for dynamic convexity is to help our clients reliably lean something up against the biggest risk in their book. We work with pensions, endowments, sovereigns, If you look at the real risk in their portfolio, it's probably 90% driven by equities, and it comes in all sorts of different forms, private equity, public equity, credit. You end up with portfolios that there's just one risk factor, which is equities. So having a strategy that was highly convex to, let's say, a move in oil or gold or something like that, it might work for those investors, but it might not work at all. So that's biggest reason, but there are also liquidity reasons. The VIX market is an incredibly deep liquid market. So we can move through that market without having a footprint, and that's a great thing.

AI assessment note: “it's probably 90% driven by equities... So that's biggest reason, but there are also liquidity reasons.”

Q So both of you alluded to private equity owners and that maybe this isn't the last transaction in your careers. How do you think about the future of your businesses now knowing there will be some other events down the road?

A It's super important to define what that event is. I have no interest in working at a different place. I've had the great fortune of working at one place for a long time. I'm really excited to join Pastone, and I don't want to go and work somewhere else, and I think that is true with my partners. I absolutely expect that there will be more than one transaction at the private equity sponsor level. Somebody's going to come in and buy out the early private equity investors or just join as a third private equity sponsor of Pastone to continue that growth. I think that is the likely Next series of transactions, and that doesn't scare me at all. That's changing the capital base, hopefully adding strategic partners who believe in what we're doing and add value. Different story if Pathstone itself is bought by a different firm, becomes part of some gigantic investment management firm. I don't see that in the near future, if in the future at all.

AI assessment note: “I absolutely expect that there will be more than one transaction at the private equity sponsor level.”

Q When it comes to sitting down with a client and trying to understand their risk tolerance, how do you both define that and figure out what that is for that person?

A It's art, science, craft, all the above. I think institutions have four horsemen of risk. There's shortfall risk, which is the probability that over time you will just not meet your liability stream. So you need to have a portfolio that Gives you a fighting chance to get there over long periods of time, and that's just a candid conversation about what the purpose of the capital is. What are you trying to do with this? For endowments, it's pretty straightforward. There's typically a real growth element, and there's a stable supportive operating budget element, and you can model those out pretty clearly. There's also drawdown risk. So drawdown risk is about the path of returns. Can you live with the volatility that is endemic to markets? That has a practical element, which is you can't have too much volatility of the operating budget. And so you have to be able to control that to make sure that the CFO and the finance teams of these institutions can draw a stable amount of capital every year. And it also has a behavioral element, which is how much can the committee tolerate? Because everybody has a breaking point, and you have to know going in what that is for people. So we try and be very clear with folks what equity tolerance they have, because equity is going to be the primary driver of volatility in any of these portfolios, and what that may mean from a path of return standpo…

AI assessment note: “I think institutions have four horsemen of risk. There's shortfall risk”

Q So the end of that enterprise assessment, you can imagine some type of a spectrum of, you could say, risk tolerance or what they're trying to accomplish. You then have to put that into action. How do you think about what to do now that you've made that enterprise assessment?

A The nice thing about it is each of those risk factors that we talked about, shortfall risk, drawdown risk, illiquidity risk, variance risk, maps pretty cleanly to a form of risk exposure that you might have in the portfolio. You know, as a endowment investor, that your nominal return goal is going to be high enough that you need a very healthy dose of equity in there. It's going to have to be at least half of the portfolio, probably a little bit more than that. And then the question is, what forms of diversification away from that do you need to incorporate? The first thing for us is always deflation hedge in the form of interest rate risk. There are also periods of unanticipated inflation beyond that. You use things like commodities and real estate to hedge those particular periods. And you can run all of these factors through your model and figure out what is the optimal mix that gets the client to its goal within the constraints of its risk budget. You overlay obviously the alpha that you think you can generate in each of the opportunity sets that you'll ultimately leverage. How much can you get from private assets? How much can you get from public assets, et cetera, and bolt that on top of what the beta is providing you from a return perspective. But it's a fairly straightforward model. I don't believe that we're trying to win in terms of portfolio construction in the way t…

AI assessment note: “each of those risk factors that we talked about... maps pretty cleanly”

Q As you're investing today and you look out over the next couple of years, what are the different ways you're thinking about the process of manager selection compared to what you've done in the past?

A There's always an arms race in terms of the execution here. And so our team is laser focused on how do you continue to scout and access talent effectively? I think there are a couple of things that are going to continue to be very important. Number one, Is relying on the causes that our clients serve. We are blessed to have this handful of clients who have discrete missions, things they support, programmatic objectives, and it is very rare for us to be unable to find a cause that really resonates with a GP within our client base. The universities have been using this for decades, and we effectively have 40 some odd Different missions that we can point to, which is really, really powerful. A lot of these firms have decided they really only want to serve LPs that are doing social good in some way. And so whether it's scholarships or medical research or social equity or whatever it might be, there's someone in our client base that's really pursuing that objective. Number two is just burning shoe leather. We live on airplanes doing residencies and In Europe, in the Bay Area, we have a colleague now who's in Singapore full time covering Asia for us. There's just a lot of intensity that goes into the consistent need to top grade the portfolio. The sourcing construct is something that Jay brought over from his private equity days, which was this view that if your deal people are doing…

AI assessment note: “our team is laser focused on how do you continue to scout and access talent”

Q Why don't you tell a little bit more about the history of Gem until you showed up?

A Jem was founded in 2007 by the CIO at Duke University's endowment, Dumac, Thrus Morton, his head of privates, and Stephanie, who at the time was the CIO of the Duke Endowment, which is the family foundation in Charlotte. The premise was to deliver the governance model that the leading universities were utilizing, which appeared to be at that time an extraordinary advantage relative to consultant-led or committee-led institutional pools of capital. And also the portfolio sophistication and access that came from having a dedicated team working in these markets all the time. That was a well-trodden path. There were some other firms that had done similar things. Alice Handy at Uvimco spinning out earlier in the decade to found Investor. Mike McCaffrey and the team at Stanford founding McKenna and Palo Alto. There were a couple others as well, but we were the Duke team. The model was really to just bring to bear all of what we'd learned from that experience and that form of engagement with a single client and spread it across a select group of smaller institutions that lacked the institutional scale to do it themselves.

AI assessment note: “Jem was founded in 2007 by the CIO at Duke University's endowment”