The Exchanges

Q So you have this big hole to climb out of. You've got these four forces you think of driving returns. How did you think about how to tackle this problem using the forces that you had in mind?

A I'd love to give you an elegant top-down story, but I'm going to give you a bottom-up story instead. I think probably with a public equity oriented portfolio, if markets are accommodating, I think maybe we can get eight. If markets aren't accommodating, we needed hedging. So I need two points of alpha. I guess alpha is all hope to some degree, but we need a real, real chance of two points of alpha per year. And that's not an easy thing to do. I mean, it's a pretty high target. What does the solution look like? I need two points of alpha. How am I going to get two points of alpha? Well, I'm going to go 30% privates. So I figure if we can go 30% privates, we can outperform Publix by four points on that. That's a 120 basis points at the overall plan level. That's part of it. In my mind, we saw this huge spending rate. If Delta does poorly, we've got a real challenge because of our spending rate. So that's about as illiquid as I thought we could be. Then portable alpha, second force. Let's go 40% market neutral hedge funds. If my 40% market neutral hedge funds can outperform my borrowing cost by three percent, that's another 120 basis points. So if I can get a 120 basis points out of the privates, if I can get a 120 basis points out of the hedge funds, that's going to give me 240 basis points. So that's 30% privates. That's 40% hedge funds. We got 10% cash. The other 20% of our cap…

AI assessment note: “if I can get a 120 basis points out of the privates”

Q How about turning to the private markets at 30%? How did you think about how you wanted to invest in that space?

A The private portfolio was very mature in 1999. By the time you get to 2014, it had become immature. And this is all professional credibility because I'm telling people leverage, derivatives, alpha, nine percent, 10%. We can do this. This is going to work. The last thing I want to do is show a bunch of negative time-weighted returns is we're firing up this private market portfolio. So private portfolio, It took a while to build into this. 15% private equity, nine percent private credit, six percent private real assets. Within that, for the private equity and the private real assets, 50% primaries, 30% secondaries, 20% co-invest. I want to put some wins on the board. I do not want J-curve. J-curve could derail my entire story, That was the blueprint for the private portfolios. And it's actually still where we are today. So it's been a decade and that structure served us well, but it's probably time to rethink some of those allocations.

AI assessment note: “15% private equity, nine percent private credit, six percent private real assets.”

Q How'd you think about some of the common levers of risk?

A It's all related to how much cash are you going to put behind the notional value of your portfolio? What is your derivative overlay look like? What is your net cash position look like? How much of a liquidity waterfall do you have? At some point you start cutting muscle as you go through that. That's really it. I mean, you've got investment risk and the liquidity risk and the liquidity risk really is what's your hedge portfolio look like and where are you going to go for cash if you can't get it from Delta and you've exhausted everything else. You've got to start looking at your risk parity portfolio, at your inflation hedging portfolio, at your emerging manager portfolio. You've got to start to look at where you're going to draw some of this.

AI assessment note: “you've got investment risk and the liquidity risk and the liquidity risk really is”

Q the market sells off, and as you said, you then tap that liquidity, you have to think about how do you reset it at some point in time? So you get through COVID, your portfolio looks totally different than it did three months ago. How did you think about recalibrating the program to where you started with this balance between the privates and the liquidity bucket and the hedge funds?

A The idea was from the outset, the 30% privates never changes. The 40% hedge funds never change. The only thing that changes is the nature of the derivative overlay and what we do with that other 20%. So we just reran all of the same calculations, and it's like, you know what, we don't need to reserve as much cash anymore. We don't really need equity hedges anymore. Our hedge ratio, 60%, 70%, something like that, so some exposure to a collapse in rates is still A good exposure for us. So we've been able to change some of what's in that other 20%. But that's it. It was designed that way from the outset. The derivative, the beta overlay, let that change. Let the hedge portfolio change. We don't do managed futures anymore. We don't do separate account macro, low cost, highly liquid stuff. We don't do that anymore. We just don't need to. We think we can get to a better overall risk adjusted return, liquidity adjusted return from there.

AI assessment note: “The only thing that changes is the nature of the derivative overlay”

Q So once you had the idea that you wanted to be involved in owning businesses and private equity as you're coming out of business school, how did you grow into learning what aspect of private equity you wanted to play?

A Good question. Any aspect was probably my answer. And this comes back to and lessons learned in retrospect. I spent the better part of my first year at business school trying to get a job, literally sending out resumes. This is before email. So it's not just send an email. This is go to the research library, try to identify companies, find their names, figure out who the people are. And then you had to call them on the telephone. Got a okay summer job when I was in business school. Did not get an offer to return, and then spent my entire second year of business school interviewing, not exaggerating, probably had over a hundred phone interviews, 50 interviews, graduated from Harvard Business School without a job, and ultimately, in the late August of 1995, got a job in real estate private equity with a firm called Colony Capital in Los Angeles. It was a great opportunity. Hadn't been to Los Angeles once in my life. Said yes, took the job, and moved out to Los Angeles to begin my career. So yes, what private equity? Any private equity.

AI assessment note: “Any aspect was probably my answer.”

Q Then as you brought your experiences together, what did you crystallize as your strategy at Kinderhook?

A So when we raised the first fund, it was really buy value, back great managers, and grow. When the great financial recession hit in 2008, a lot of companies went through some very hard times. We had a portfolio of companies that also had some bumps in the road. We have never been big users of financial leverage. Our strategy has been to give our executive teams the flexibility to grow and invest. So as a result, you leverage that three times, you lose half of your EBITDA, you're at six times, and you can survive. If you leverage that six times and you lose half your EBITDA, you're at 12 and you're bankrupt. So we started taking advantage of those over leveraged situations to strengthen our portfolio and came through the great financial recession with some very strong companies, and that led to a focus on consolidations. But just as importantly, we learned that you really needed to be experts in industries to be able to add value and create value in a private equity portfolio. And so we Quickly honed in on where we had the most experience, the deepest bench of executives in relationships, and focus on three core industry groups, and that's healthcare services, where Chris leads the effort, automotive, aftermarket, and light manufacturing, where Tom leads the effort, and then environmental and industrial services, which is what I do.

AI assessment note: “Quickly honed in on where we had the most experience... focus on three core industry groups”

Q I'd love to dive in a little bit on your most recent acquisition, which has been one of the more colorful names in the headlines. Stuart, why don't you walk me through this opportunity and how it came to pass?

A Stuart Healthcare Was a company acquired by a private equity firm in 2010 or 12 called Cerberus. They acquired a group of struggling hospitals and through a series of acquisitions over a 10 or 12 year period, built up a multi-state hospital, private, for-profit hospital company. And while they were doing that, like many health systems, they also acquired the providers in those communities as part of their ownership. So they had both a hospital system, Florida, Arizona, Western PA, Massachusetts being the biggest, where they had hospitals and a network of providers. Over the course of the last several years, Cerberus sold the business through a leverage recap, and that leverage on the businesses with a lack of reimbursement ultimately led the business to file for bankruptcy. But in December of 23, Stewart, prior to bankruptcy, looked to sell their provider group. So they took all of their providers, put them under a basket of ownership called stewardship within Stewart and tried to sell it. We looked at that opportunity. We bid to acquire those assets. United Healthcare ultimately agreed to acquire those assets for eight hundred fifty million dollars, and in May, Stewart filed for bankruptcy. Everyone thought that United was going to proceed with the acquisition of the stewardship hospitals at this eight hundred fifty million dollars, and right around Memorial Day, it began to l…

AI assessment note: “We got called back in early June of 2024. If we were still interested”

Q So you have this early success, some great growth, economic performance is great. You've gotten through some of that initial pulling these two carve outs out of public companies. How do you think about the next couple of years under your ownership?

A So we're very excited about the business. The rebranding and the positioning in the marketplace has garnered attention of the strategic buyer universe, as well as some of the infrastructure players in the market that are looking for assets of this scale. We have north of a hundred million dollars of EBITDA already on the combined platform. We like to drive that into the one 21 30 range organically over the next 12 to 18 months, we're gonna work on a couple of tuck-in acquisitions, and I'd imagine if someone doesn't knock on our door in the next 24 months, we will be going to market with the asset after that time. So I'd imagine this one will end up being a three-year hold as opposed to a five-year hold. And we're very bullish on the overall industrial demand cycle that we're in The federal government between the Inflation Reduction Act, the CHIPS Act, and some of the other energy transition spending is creating a tremendous amount of demand for the services that Ironclad provides. We don't think that's going to change the higher interest rate environment. While it makes our interest a little bit more expensive, it also dampens new entrants and new competition to the space. So we're really excited about the prospects of this business over the medium and even longer term as you think about some of the overall growth dynamics in the U.S. economy and where money's being spent.

AI assessment note: “I'd imagine if someone doesn't knock on our door in the next 24 months”

Q So as you've made these changes, bought these two businesses, how have the economics of the resulting business shaken out?

A So we've been driving double digit top line growth every month, month over month since our ownership. We're at 40% combined EBITDA on the business today. We're into our first budget cycle for the combined business going into 2024. And management is pretty confident we'll be able to continue with double digit organic revenue growth price and volume and drive our EBITDA into the low forties. It's a very strong cash generative business. It's also asset intensive. So you have to purchase new equipment over time. But again, given the utilization metrics that we were talking about, we have incremental assets that allow us to grow without a meaningful investment in new capital. So we are generating a lot of free cash flow in this business.

AI assessment note: “We're at 40% combined EBITDA on the business today.”

Q compliance, and more. In the AI era, asset and wealth management firms moving to Ridgeline gain a decided advantage. That's why 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. What action steps did you take in your process to adjust the changes in behavior of the different participants?

A So the first action step that we took was just a recognition. I started talking about this internally, externally. We had the data from the quant team about how much things changed, and I began to think about the implications. So implication number one was price action is much more meaningless than we used to think. Call that the one week to two, three month price action was stocks were Acting weirdly, and it meant nothing. In the old days, when a stock was acting poorly, you're like, somebody knows something, and there was a good amount of time where that company disappointed, and you felt like at a disadvantage. The second thing was to begin to spend more time on the stock versus the business. We began, I think, to impart on our analysts who were attending idea dinners and lunches What is the narrative around the stock? Who is driving it and trading it? When we would speak to the sell side, instead of asking them their opinion about the company or going through the model, who's calling you? What questions are they asking? What's the tension point? And then our quant team could look at a holder's list and tell us, this is long onlys, this is hedge fund, this is quant, and we began to Understand in what sandbox we were playing. So I think it was a combination of first mindset change, and then adapting our research process to recognize that these were other people driving stock …

AI assessment note: “The second thing was to begin to spend more time on the stock versus the business.”

Q Why don't you take me back to how you first got interested in investing?

A So that goes way back. When I was five years old, my dad lost his job. And you don't really realize what's going on at that age. But when your parents start fighting, and it's not very fun to be around them, you start to take notice of what's going on and how it's impacting your life. So that was the first moment that I began to understand how important finances were in a family's life. Roll forward a couple years, my dad ended up working as an investor, and then we never really got to watch much TV in our lives, but every Friday night, he'd turn on over dinner, Wall Street Week with Lewis Rukeyser, and so all four of us, in fact, watched that with the family, and all four of us are in investing, so thanks to Lewis, RIP, for getting me interested in investing back in the mid-eighties.

AI assessment note: “thanks to Lewis, RIP, for getting me interested in investing back in the mid-eighties.”

Q That was an early OCIO. What was the difference in doing that from what you saw at the endowment?

A Clearly the clients. So that was number one. We started with two clients at Morgan Creek. They are great families and they were interested in replicating what the endowment successes had been in the tech rec era. Many of the endowments were invested heavily in hedge funds that shorted the tech rec in 2001. And that was very successful for many of them. And so a lot of families took notice and they said, gee, the endowments are doing something right. They got 99 right through their VC portfolios. They got O two right through their hedge fund portfolios. Maybe there's an all weather way to do this for the family market. And so those two families were on board for that. Having just two clients and having the network that we'd built at UNC, it was pretty great. What changes is when you add many more clients and then all of a sudden your day goes from 80% investing, 20% clients to 20% investing, 80% clients. And now you're in the asset management business.

AI assessment note: “Clearly the clients. So that was number one.”

Q So as you've studied this ecosystem, looking for these little niche opportunities that look like great investments under the theme of something where you feel a lot of things are overcapitalized, where have you looked and found other opportunities?

A We think there's too much capital chasing renewables, and renewables are actually disrupting our grid system. They're causing intraday price volatility. They're causing electricity to be less reliable. That has actually, in a weird way, placed weight on the value of a dispatchable electron. The value of an electron that you can say, I want you on or off, because you can't really tell the wind to blow or tell the sun to shine. So in electrification, for example, we've been chasing weird problem. You'll start to get the theme that all of our problems tend to be a little weird, but the weird problem looks like there's upstream companies that are flaring natural gas. So why does this happen? A lot of times when an operator is drilling a well, that well is mainly for the oil economics. And if the gas is priced too cheaply, there's not enough money in the ecosystem to pay for a pipeline to get it out of there, or the pipeline's already filled. That causes this friction where operators flare natural gas and burn it off. That is a terrible thing. It's terrible for the environment. It's actually terrible for the upstream operators. It's terrible for the mineral owner. It's just one of these inefficiencies of life. So we have a firm, Conduit, that goes to these firms and says, hey, in lieu of you flaring methane, Which is very bad for the environment as well. Why don't we put that methan…

AI assessment note: “we have a firm, Conduit, that goes to these firms and says, hey”

Q Which two people have had the biggest impact on your professional life?

A I've been lucky to have many, but there are two, both of them from JP Morgan, Jamie Kramer and Ted Dimmick. Jamie hired me at JP Morgan, and she gave me A shot at leadership before I was probably ready for it because she saw potential and I'll be forever thankful to her for doing that. And she taught me how to build a business within JP Morgan as well. She's awesome. A force of nature. One of the smartest people I've ever worked with and ever met, frankly, and I owe her a lot. And Ted Dimmick was one of my bosses at JP Morgan as well. He taught me that you can be a ruthless competitor, but also not take yourself too seriously, have humility at the same time, and have a sense of humor, and I took that from him, and he's one of my best friends as well, so those two without doubt.

AI assessment note: “there are two, both of them from JP Morgan, Jamie Kramer and Ted Dimmick.”

Q What are some of the drawbacks of the structure?

A The drawbacks are asset liability management. So you have to manage The liquidity. That's not an easy task, so every quarter we will redeem or repurchase up to five percent of shares outstanding. Our flagship fund is over twenty billion dollars, so a billion dollars will offer repurchase. We have to have liquidity to meet that potential of a billion dollars, and so we don't want to hold cash, because cash is a drag, People are paying us to hold private assets, not cash or liquid credit. Having credit facilities in place where we can draw a billion on a few days notice, that's not an easy task, and you have an asset team, you gotta have a liability team that's first class.

AI assessment note: “The drawbacks are asset liability management. So you have to manage The liquidity.”

Q Why don't you take me back to what got you started in the investment consulting world?

A I was very lucky. I've had three jobs in my career. The first coming out of business school was with Wells Fargo Investment Advisors, and they were one of the first to do index funds, if not the first. And I got to work with some very smart people, in particular, Bill Sharp and Bill Faust. He taught the dividend discount model to me. I thought that was fascinating because he had a way to project expected returns on Equities, rather than just looking retrospectively at historical returns. And that was really important in the evolution of asset allocation. It allowed people to pivot from just looking in the rearview mirror to looking forward. I got involved in asset allocation along with index funds. Wilshire Associates hired me in 1980 because they thought I knew something about asset allocation and they wanted to start a consulting business. So I went there. And at that time, consulting was all about manager selection and Wilshire stood that on its head and said, no, manager selection is not important. It's asset allocation. I was a consultant there for over 20 years. I ran the consulting group for about 15 years. Success there was on the premise that we spend 90% of our time on manager selection, but really it's asset allocation that's going to determine returns.

AI assessment note: “Wilshire Associates hired me in 1980 because they thought I knew something about asset allocation”

Q So as you circle back, you're walking across the Charles River repeatedly with Josh Friedman. Who else was in your class that you've been alongside on this investment journey the last few decades?

A Yeah, it's really interesting to reflect on it. When I sat down on the first day of business school, right next to me or one seat over was a young guy that had already made a name for himself, but in sports named Steve Mandel. So I ended up studying with Steve first year of business school. The guy who sat right next to me in the investment management elective, which was my first serious exposure to investing, was a guy named Seth Klarman. So he was in our class. Jamie Dimon was in our class. Karen Firestone. Brian Rogers, who ended up running T. Rowe Price. It's a pretty long list. So apologies to people that I'm not remembering right on the spot, but I remembered there were exactly 90 seats in each classroom. When I walked in for the first day of the investment management elective, With Seth, with other people, a third of the seats were empty. Come back 20 years later, and that was oversubscribed. Everyone was clamoring to get into Mike Porter's strategy class because everybody wanted to go to work at Bain or BCG, or they wanted to take Bill Porvo's class in realty because they wanted to go to work for Heinz Interest or Trammell Crowell. And there were a few of us who said no. Those of us who entered the money management industry roughly when I did had essentially a forty-year tailwind of falling discount rates in the global economy generally. Which creates multiple expansion…

AI assessment note: “Steve Mandel... Seth Klarman. So he was in our class. Jamie Dimon was in our class.”

Q As you look back to your tenure at TIFF, what were some of the biggest investment lessons that you learned that you hadn't known when you started in the role?

A Not rank ordered. The immense value and utility, practical and psychological, of having cash in any portfolio you're managing. What you learned over the years is that it actually has a utility that goes way beyond its obvious help in meeting unexpected redemptions. Psychologically, it frees you up, and Buffett, more than any other actor in my lifetime, has proven the value because you can seize an opportunity that others may not be positioned to seize. Second major lesson, this would actually be number one on the list. As an outsider, you can never really know in a manner that really counts what's going on in an organization of which you're not a full-time employee. The germaneness of that to selecting and evaluating and managing external managers is rather obvious, but it goes beyond that to understanding, oh, I think I understand the pressures to which one of my key deputies is subject on the home front, but you don't really. Okay, that's fine, David. That's a rather obvious observation, but what have you done with it over the years? And what I've done with it in allocating, frankly, either human or financial capital is to just think about the broadest plausible range of outcomes that I can. You look at an organization, you look at GMO when I joined it, everything's firing on all cylinders. The returns are great. They're growing. The sun is shining. You get in there and after…

AI assessment note: “The immense value and utility, practical and psychological, of having cash in any portfolio”

Q There's a curious part of that where you're understanding how this is an insider's game as you're on the ground. I wouldn't think that would necessarily lend itself to, oh, we're going to invest in these companies as an outsider. What was that thought process as you became a sell-side analyst?

A I realized how markets were organized in Japan so you could figure out who the winners were going to be. Winners are chosen in Japan. The competition is managed. I had the good fortune of starting my career in the telecom sector. What made that sector different is at the time I started, There were really only four companies, an international company, KDD, a domestic company, NTT, their recently spun out cellular business, Docomo, and a third new market entrant that was introduced to finally mix up and create competition. And in this, the rules of competition were very familiar to me, and I understood how this market would be organized, and it made it very easy for me to model and be helpful to foreign investors thinking about allocating capital to Japan.

AI assessment note: “I realized how markets were organized in Japan so you could figure out who the winners”

Q How does the regulatory body or regulatory bodies go about some type of enforcement of the stewardship code?

A Japan is different. They make domestic investors disclose how they're voting. They embarrass them. It takes Miti to embarrass the managers of these companies They have to threaten unsolicited takeover bids. It takes the TSE to literally publish a list of companies that are not publishing a cost of capital and proof that the management team is managing the business with a cost of capital mindset. So there is no immediate one center to this. It is a collaboration between various parts, and you'd think that it would be the investors that grab this bull and take it by the horns. But they wait until all the other institutional stakeholders and participants and regulators give them the green light before they take action.

AI assessment note: “They make domestic investors disclose how they're voting. They embarrass them.”

Q Why don't you take me back to what got you interested in Japan?

A Well, it was my grandfather. My grandfather, an industrialist in Cincinnati, was invited to Japan in the late sixties to help rebuild the Japanese glass and steel industries. He made high temperature industrial bricks, and there were only two companies in the world that could produce bricks that could go to a 1400 degrees. And with that, he made the four day trip to Japan in 1968. And after that, he would go almost every other year and pass through Washington, D.C., where I grew up. And tell me stories about the other side of the world. And being a white guy from the Midwest, he made Japan seem very interesting to me by making up interesting stories about how it was polite to burp at the dinner table. He was a gardener. He was a self-made engineer, and he found many levels at which he communicated with Japanese people well beyond the language. So that made a strong impression on me. Ultimately, it's been a lifelong constructive obsession. My entire professional career has been thinking about Japan.

AI assessment note: “Well, it was my grandfather. My grandfather, an industrialist in Cincinnati”

Q Which two people have had the biggest impact on your professional life?

A I first have to say my wife, and the answer there is coming home from a day at work, she looked at me and said, did you have one of those days? And I said, I had one of those days. And she said, do you really think it's time for you to do something on your own? I said, it's time. She said, you should do it, and I'm giving you 18 months to do it. If you're going to do this, I want you to give it your all. I want you to have an end point, and I don't want it to always be around the corner. So she put a time horizon on my ambition, and I had to show results. That's a really important partnership that helps bring great clarity to something as hard as starting your own company. I think the second is a mentor in Japan. Wakabara-san. Wakabara-san is a titan intellectually, an engineer. When I first got to Japan, almost as a stowaway, found my way into an investment bank. I was the only foreigner in the investment floor of the research group. And nobody thought a foreigner could bring any informational advantage in the Japanese equity market. And I was seated purposefully by the head of research next to Wakabara-san, who was the axe on Japanese semiconductor stocks, famous for three days of being awake and getting information. He was truly a titan of the brokerage industry, informationally, intellectually, That's when I realized, oh my God, that's my pace car. That's the person that if…

AI assessment note: “I first have to say my wife... I think the second is a mentor in Japan.”

Q So we can now roll forward. You've had a lot of successes in the business. What was your thought process that led to writing this book?

A I'm very interested in these startup frameworks, customer development, lean startups, business model canvas, all these types of things. And I would promote those to the companies I worked with, and companies would use them sometimes, sometimes they wouldn't. But I started to notice that I couldn't explain the success of the wins that we'd had with these best practices very well. So you look at Twitter, they couldn't decide who the CEO should be. The servers were down a lot with the fail whale. There were a lot of internal strife and difficulties. Lyft had started out as Zimride, and we had just launched an illegal service that had blown up in San Francisco. Twitch has started as justin.tv. And so I would find that. 80 to 85% of our exit profits had come from pivots. And conversely, there were a lot of founders who I would have put on the most likely to succeed list. And simultaneous to these big outcomes, I'd be helping these founders shut down their company after they'd been in the wilderness for many years, never finding product market fit, or even worse, just having these five year slogs where It wasn't an obvious success, but it wasn't an obvious failure either. It was just in this in between zone. And the founder felt like they were pursuing it more out of obligation than out of passion, but they had commitments. They had employees and investors felt like they had to keep …

AI assessment note: “That was the genesis of the book. I didn't even think I was going to”

Q This idea of repeat founders, as you described with Justin, there is an idea that if you have a founder that's success, they've learned a lot, there's a lot that they demonstrate, and yet, in this case, it was almost like the motivation was misaligned. How do you think about repeat founders?

A So first of all, I think repeat founders do have better odds. So a lot of people say very few people could do it again. That's true, but very few people could do it at all. Very few people ever have a breakthrough. And so why are some founders able to do it? I think it does come back to founder future fit. So for example, Elon Musk, he doesn't start any companies anymore that don't take on grand challenges that most people think are impossible. And because of that, he goes after a certain type of problem that most people won't go after, and he's able to attract certain types of people. Very often, he can even monopolize the expertise in a certain field because there's no other meaningful company trying to do something that meaningful in that field. And so I would say that Elon is an example of someone who does it multiple times, but partly because he pursues ideas for which he has great authenticity as a founder. And that was the mistake that Justin made as he Pursued an idea that would endow him with prestige as a founder more than it would represent the type of future that he was intrinsically motivated to pursue. So Elon is also unique in that a lot of founders, once they get rich having a breakthrough, do they really want to get on a plane to Germany to solve the problem for the angry customer? Well, when you're poor entrepreneur scraping by and you're desperate, that's one…

AI assessment note: “I think repeat founders do have better odds... it does come back to founder future fit.”

Q So we can now roll forward. You've had a lot of successes in the business. What was your thought process that led to writing this book?

A I'm very interested in these startup frameworks, customer development, lean startups, business model canvas, all these types of things. And I would promote those to the companies I worked with, and companies would use them sometimes, sometimes they wouldn't. But I started to notice that I couldn't explain the success of the wins that we'd had with these best practices very well. So you look at Twitter, they couldn't decide who the CEO should be. The servers were down a lot with the fail whale. There were a lot of internal strife and difficulties. Lyft had started out as Zimride, and we had just launched an illegal service that had blown up in San Francisco. Twitch has started as justin.tv. And so I would find that. 80 to 85% of our exit profits had come from pivots. And conversely, there were a lot of founders who I would have put on the most likely to succeed list. And simultaneous to these big outcomes, I'd be helping these founders shut down their company after they'd been in the wilderness for many years, never finding product market fit, or even worse, just having these five year slogs where It wasn't an obvious success, but it wasn't an obvious failure either. It was just in this in between zone. And the founder felt like they were pursuing it more out of obligation than out of passion, but they had commitments. They had employees and investors felt like they had to keep …

AI assessment note: “That was the genesis of the book. I didn't even think I was going”

Q As you watched it evolve through cycles, through the original boom and bust, and then recovery from that, what did you take away as how you thought about what worked in terms of investing in the area?

A Yeah, very good question. So first, I recognize that the market was surrounded by misperceptions. There was this belief that junk bonds, the vast majority of them defaulted and would end up as worthless securities. So that was the myth. I remember asking people, what do you think the annual default rate is for high yield bonds? And people would say, oh, 3040, 50% a year. And I said, what if I told you it was three or four percent a year? And they go, ah, that can't be. And I go, but that's what it is. And if you look at the yield premium that one gets at the time, it more than compensated for that risk. And then take it one step further. When a bond defaults, what do you think it's worth? And they said, well, zero. And I go, well, it really isn't because you have a claim against the assets of that company that The head of the shareholders. And if the assets have a value greater than zero, you are entitled to it. And in fact, the recovery rate is in the forties. So if you look at a default rate of three, four percent, and if you get close to half your money back afterwards, your loss is like two percent. And if you have a spread significantly higher than that, you're going to outperform other asset classes. So I spent probably the early part of my career just developing narratives to dispel the myths and to get people to actually focus on the facts. And even today that continues…

AI assessment note: “if you look at a default rate of three, four percent... your loss is like two percent.”

Q To get at this opportunity set of finding the higher yield securities that don't have as much of a risk of default, what are the characteristics you look for within that universe to find the most attractive bonds?

A Essentially, we're looking for higher growth, lower CapEx businesses, so businesses that are throwing off a healthy amount of cash flow, but really what we're trying to do is avoid secularly challenged businesses. What Amazon has done to traditional brick and mortar retailers, and then that translates into Shopping malls and so forth, where you go through a traditional shopping mall that was vibrant 10, 20 years ago, and today it's a ghost town. So we want to avoid those secularly challenged businesses where there's often a fertile ground for high yield investing, and what we do is the private equity transactions, where the PE firms identify businesses that, in their opinion, are High growth, throwing off free cash flow, relatively low CapEx, and can handle a significant amount of debt and grow into their balance sheet. If they're exhibiting high single digit, low double digit growth rates, if they levered that business six or seven times debt to EBITDA with a mere passage of time, a year or two into it with that kind of growth rate, And the growth in EBITDA, all of a sudden, the leverage can come down one or two points, and that's significant. And that free cash flow can be used to pay down debt as well. So what started out as six or seven times leverage in a couple of years is four or five times, and then it's eligible for an upgrade. But if a company has six times leverage, …

AI assessment note: “Essentially, we're looking for higher growth, lower CapEx businesses”

Q When you think about tackling that type of lens of looking at the pool, you have to think about measuring the risks and then deciding what choices you're going to make. When you got there, what were you looking at measuring to roll up and understand before you could even decide, are we taking the right types of risks?

A The first one is obvious. It's vol. So arrived there and figured out how to calculate vol. And as so often happens in a quantitative world, there was a rudimentary risk system up and running, but everyone said there's no data for private markets. So we're going to solve out the risk of public markets to the penny, but for private markets, ah, we're just going to wing that one. That might've been valid at the very beginning when private markets was four or Over time, Texas teachers, at our height, we were 42% private versus a 35% neutral, or down to about 38% private versus, still versus a 35% neutral now, and it really became tail wagging the dog, because there's more risk in private markets than there is in public markets, and if you're kind of winging the private part and solving the public to the penny, so we really had to think a lot about how to proxy risk and think very intelligently about how we were modeling that risk.

AI assessment note: “The first one is obvious. It's vol. So arrived there and figured out how”

Q How do you measure the success of those returns with that many different strategies?

A It really is just using the same benchmarks as what our larger portfolio uses. So private equity, it's got to beat the SSBEI for us. State Street Private Equity Index and real estate's got to beat the Odyssey and public equity, public benchmarks. So we can just measure the alpha, the regular old ways. Something else is we have identified what we think does not work. So for example, we don't allocate to venture capital in our emerging manager program. And there are a lot of emerging managers in venture capital. But we've not had success there. And if we want this program to be sustainable, we have to acknowledge where we can have edge and where we don't. And so we've just been very clear about that. And we've gotten larger in the asset classes where we've had more success. We've had more success in PE and real estate, and we've gotten actually smaller in areas where we have less success. So long only is smaller than when we started, for example, and hedge funds have been pretty steady.

AI assessment note: “It really is just using the same benchmarks as what our larger portfolio uses.”

Q Roz, how do you think about going directly onto the committee compared to leaving a year gap before coming back onto the committee?

A First of all, I wasn't given a choice, but second of all, I think ideally that would be the best way to do it because it gives the successor the opportunity to get his or her sea legs under them without necessarily the scrutiny of sitting there in front of your boss. One of the things I was concerned about is that the team would be reticent to bring forward a recommendation that they think I personally wouldn't like. And I had to come to grips with the fact that I wasn't the CIO anymore. My job wasn't to approve or disapprove. My job was to ensure that all the policies and the procedures that Helmsley had were adhered to, test conviction, and ensure that due diligence was appropriately undertaken. The team is compensated through an incentive comp pan, and they had to live or die By their own decision making, and I had to respect that. So we all had to be disciplined in our new roles, and that's what it meant.

AI assessment note: “ideally that would be the best way to do it because it gives the successor”