The Exchanges

Q Adam, one of the tricky things you run into is this distinction between the stock selection opportunities and rigorous portfolio construction. So we know, like as Dan talked about on the platforms, you have this very rigorous risk management. How do you think about a manager who you think does a great job of finding individual stock inefficiencies, but also has to have this lens of sensible portfolio construction discipline?

A Yeah, you really need to thread the needle. A lot of long short equity managers actually run at too low of an exposure, both gross and net exposure, and you need such a tremendous amount of stock picking alpha to overcome that cash drag, to overcome the fees that they charge in order to generate something that net of fees is interesting, even if the stock picking alpha is excellent. Conversely, though, if you run at too high an exposure, you run into that risk of, boy, Now there's a mark to market event that's hurting my portfolio this month because I'm running at such a large exposure. Now I'm getting a call from my prime broker or for some reason I need to de-risk my portfolio and I'm turning what could have just been a annoying mark to market into a permanent loss of capital as I'm getting out of these bad prices. So there's kind of a sweet spot in the middle where there's enough exposure and let's call this a hundred long by 60 short as sort of a sweet spot, if you will. Depends a little on the volatility and dispersion of the area. You can probably go a little lower than that in higher volatility sectors, maybe a little higher and lower volatility sectors, but that's a sweet spot where the stock picking can be rewarded on a net of fee basis, but you're not taking so much risk that you face that margin call risk. And we generally like concentration in portfolios. I mean, we…

AI assessment note: “So there's kind of a sweet spot in the middle where there's enough exposure”

Q What opportunities are you most excited about in your purview?

A Some of them are boring, uh, like long, short equity. Um, you know, I just strongly feel that all this movement into passive, um, investing is a real boon for really great long, short equity managers. And I mean, I would caveat that with, you know, we think 90% of them probably add no value net of fees. And for that, 90% will probably have weaker investor bases. The fact that day in, day out, You know, stock prices move in a way that, that often have nothing to do with fundamentals is probably going to hurt that 90% of managers because they're going to get jittery. Their investor base is going to get jittery. For the 10% who are really good though, we just think that the distortions between individual stock prices and their fundamentals is just going to continue to grow because it's going to be influenced by ETF flows and index flows and things like that, and so fundamentally we think there's going to be Great opportunities. The cost for that is going to be higher volatility, though, because there's going to be noise in how stocks are priced. So, long way of saying we think long short equity has prospects for, for very high alpha going forward among the top managers, probably with higher volatility than it's had historically. Um, the other major area I would say right now is, you know, volatility across almost all markets is, is unbelievably Low. I think the realized volatility…

AI assessment note: “Some of them are boring, uh, like long, short equity.”

Q Let's circle back on portfolio construction. You mentioned that having a healthy amount of long-term equity is out of consensus. What do you think a consensus portfolio construction of a portfolio of hedge funds looks like at the strategy level?

A It's a good question, because it's different, different from different people, obviously. Yeah, I think maybe 30 to 40% long short equity. You know, there's certainly a, a performance chasing, you know, mentality in certain strategies, such as quantitative CTA. Strategies like that have certainly been in favor recently, and so I think those quantitative types of strategies would find a role in most hedge fund portfolios. We have very little of that, of that sort of exposure. Something like distressed debt, which is very on, on the investors, you know, tolerance for, for risk and that sort of directional exposure, but I think 30 to 40% for long, short equities. And then what fills the rest of the pie? Probably, uh, another thirty-ish percent, you know, event-driven. Call it maybe 15, 20% relative value, you know, and types of strategies in the remainder macro. And then that relative value of macro piece, I think, you know, a fair bit of that is more quantitatively driven types of strategies.

AI assessment note: “30 to 40% long short equity... another thirty-ish percent, you know, event-driven.”

Q Adam, I want to turn to something that Dan mentioned earlier, which is positioning your portfolio to have liquidity to take advantage of, whether you're seeing opportunities in the credit market, as you said, or these dislocation opportunities that Craig mentioned. How do you think about managing the portfolio as an LP in a lot of these funds from that liquidity perspective?

A We're always focused on having liquidity that's appropriate for the strategy that we're investing in. So if that's long, short equity, generally those are more liquid strategies. There are certain select cases where maybe a manager is of such a high quality or in so much demand that they can demand longer terms, but it would be unusual for us to want to invest in that. It's happened before. What would be unusual? Then you have strategies like many credit strategies where You don't want the manager to offer very liquid terms. If you're in a commingled fund and credit, and the manager is very liquid terms, but the underlying assets aren't very liquid, that can get you in trouble very quickly. If they put in a large redemption and start selling at bad prices, that negatively affects you as an investor who's sort of sticking with it for the long term. I think liquidity risks right now are underrated and underappreciated. There's a lot of optics of good liquidity in markets. But a lot of that liquidity, especially in equity markets, is just day trading back and forth, and if you need to get out of a fairly sizable position in a fairly short period of time, liquidity is just not great, and it even extends to things like bond markets. You saw in March of this year where you had a pretty violent move in the two-year bond, one of the most liquid assets in the world. Many macro managers …

AI assessment note: “We're always focused on having liquidity that's appropriate for the strategy that we're investing in.”

Q We all know, I need to talk about how hedge funds have struggled to generate those types of attractive returns the last bunch of years. Do you think those two things are tied together?

A Uh, that's probably true to some degree. I think the industry as a whole, and we, we've, we've always felt the industry as a whole does not really add much value, if any value, net of fees. So the average manager, um, isn't very interesting. And so, uh, as managers have probably underperformed, they've in many cases probably transitioned the story of why they should exist. And there's nothing invalid about, uh, risk mitigation in a portfolio, but you can mitigate risk through many different Mechanisms. You can just go to cash, for example, right? So hedge funds still need to provide some source of alpha or unexplained skill or edge on top of, you know, what you would get from just going to, uh, to cash. But I do think probably the disappointing returns have helped kind of shift the narrative more to that risk mitigation side.

AI assessment note: “disappointing returns have helped kind of shift the narrative more to that risk mitigation side.”

Q And do you have standing instructions with the prime brokers of that? We only want managers who have come out of a north of a billion dollar hedge fund.

A You know, we don't have standing instructions or hard and fast rules, but they generally know the types of managers that we would, we would tend to invest with day one, and they tend to be more what I call blue, blue chip launches. So whether or not they've garnered a lot of, uh, assets, you know, they tend to, you know, they, maybe they've run money as part of another team within a larger shop and they're coming out, they have a very good pedigree. Um, you know, they're going to check the boxes in terms of having good operations and infrastructure in the business side from, From day one, as opposed to the, the two people in the proverbial garage. So they, they, they tend to know that. Our view though has always been to take every meeting because, you know, almost in every meeting you're going to learn something about, even if you might know within the first minute, we're not going to invest in these people. You're going to learn something about the markets. You're going to get some idea. Maybe you wouldn't have heard otherwise. Maybe they have a view on a position that one of our current managers has in their That portfolio that might, you know, corroborate the view or might have a very, you know, different, different view that might inform us asking a question of our manager on that, on that position. And so, you know, we have a large enough investment team that, you know, it…

AI assessment note: “we don't have standing instructions or hard and fast rules, but they generally know”

Q What was the case for hedge funds in 2002? And in particular, how much of that still applies today, and, and, and what's changed?

A Yeah, I think back in 2002, so you, at that point, a lot of the top endowment and foundation investors had begun to go into the, the hedge fund area. And I think really it was to seek an alternative source of return, but I would say back then, it doesn't feel like that long ago, but, ah, but back then it really was more, felt more return enhancing. You were trying to generate, you know, an absolute return that was very strong. And certainly some of the risk reducing characteristics were, were part of it, but it was really viewed as this is access to the very best and brightest investment minds in the world. It's a way to access their talent, um, in a way that's unfiltered and unconstrained by boundaries or guidelines or benchmarks or things like that. And I would say the industry has transitioned and morphed more into, it's become much more institutional, quote unquote, the focus on risk management, diversification, the risk mitigation aspect of it is probably, uh, usurp the return enhancement part of it. And that's not necessarily a bad thing, but I would say that it's definitely, uh, an evolution versus 50

AI assessment note: “risk mitigation aspect of it is probably, uh, usurp the return enhancement part”

Q And what is, what is that dynamic like? Because over time, boy, that's, you have to get the approval of eight other people. How do you not degrade to kind of a group think?

A Yes, that, that is a great question. And really, I think the most challenging part of my job and the most important part of my job in the CIO capacity is to make sure we're not just making safe, easy decisions or, you You know, one person raises their hand and has an issue, or one person didn't like the way some question was answered, but in the scheme of things, it doesn't necessarily really matter, and so the, ah, overused cliche here, but the sausage making part of our process is a weekly meeting of our, of our investment team, and that's where we'll, we'll bat around for an hour, often more, just about all the meetings in the week, all the managers we're seeing, you know, where are we in the various Stages of the process. And that's really where there's a, you know, pretty, pretty good debate among both existing managers and prospective managers where one person might say, you know, I'm concerned about X and another person might say, you know, I, you know, I hear you on X, but I don't think it's a big, I don't think it's a big issue. Dave Wagner, our founder, I think is a tremendous, uh, people person. And I think one of the things that he's taught us all is when you have that sort of conflict or, uh, Debate like that instead of trying to necessarily forcing yourself to reach a resolution in the span of that meeting, you know, walk away for the weekend, you know, come back …

AI assessment note: “make sure we're not just making safe, easy decisions”

Q Dave would have seen at Northwestern, there's the studies that tell you that asset allocation is what drives performance more than security selection. How do you think about that in the hedge fund space? Do you start with thinking about the areas of those just broad opportunity sets that might be attractive? Or do you start much more bottom up with individual managers and let the strategy buckets fall out?

A Much more bottom up. You know, we think the scarce resource are really great, great managers. And, you know, we've learned this the hard way, right? When you try to say, here's my view of the world, let's shove a mediocre manager in to fit that view of the world that we need to have more macro or whatever it might be. Uh, you end up making mistakes. Conversely, you might say, boy, I've already got two technology managers. You end up passing on a third one where you feel that the talent is outstanding and you live to regret that, that decision. So I would say we have much more confidence in our ability to select managers who have a real sustainable edge over the longterm than on our kind of tactical, you know, market sorts of moves. When it comes to the top down, we're really looking for more fat pitches, you know, to Overused cliche, but distress debt, for an example, we were very tactical on. So when defaults are high and spreads are wide, we'll tend to be much larger than in an environment like today where you have the opposite effect. But even today, if we found a great distress manager, we would still want to invest in them, but we might size them more, uh, more conservatively.

AI assessment note: “Much more bottom up. You know, we think the scarce resource are really great, great managers.”

Q So then as you continue to do your work, you have a bunch of meetings, usually face to face. Then you go offline, and you do homework with, you know, when you're not in front of them. What does that look like?

A Yeah, so part of that is, I would say, sort of clinical, clinical work. You know, whether it's done by the investment team or ops due diligence team, it would certainly be reference, you know, checks in terms of, you know, who is the manager work with, you know, what do they think of their success, you know, their character, all those sorts of things. Having done this for 15 years, you know, you look down those lists, and you say, you know, who's not on this list? Who should be on this list? And you try to find, try to find that, that person and try to, try to figure it out. On the ops due diligence side, there's certainly a clinical aspect to that, you know, in terms of, uh, background checks, just corroborating their education and making sure there's nothing, nothing in there that, that shouldn't, uh, shouldn't be in there. So those are kind of the clinical aspects. We'll certainly look at prior track record if there is a prior track record in a lot of depth. We'll look at old 13 F's and things like that, and just old positions, and just try to see if past performance, both the ups and downs, is consistent with what we think, um, you know, their strategy, you know, should have generated. And a lot of times in the past, you might have what appears to be an optically good track record, but it was done on a very low capital base, or there was some sort of issue that enabled them…

AI assessment note: “it would certainly be reference, you know, checks... background checks... look at old 13 F's”

Q It's hard to go through a full conversation of the hedge funds and not talk about how challenging it's been, and then maybe even, like, what's this gonna look like? So what do you think investing in hedge funds looks like five or 10 years from now?

A I would say that the, ah, I hate to say this because it's not in one's control, but I do think the next performance node is a very, very important one. I think if markets struggle, hedge funds hang in there and do well, it kind of, ah, reminds people Why hedge funds are in portfolios. Even folks, most folks who are invested in hedge funds today are still at least mildly probably disappointed with results over the last five years. So it'd be nice to have some sort of reinforcement from real data that hedge funds can play an interesting role in portfolios. So I think if, if markets sort of stumble, hedge funds do well, I do think there's the potential for pent up demand into hedge funds that'll fuel some of these Startups that probably aren't getting started up because they can't raise money out of the gates, and I think, you know, the industry gets healthier again, especially for more boutique-y sorts of, sorts of managers. I do think, though, the next node is the other way, you know, and let's say, you know, markets stumble, hedge funds stumble, markets again do a V-shape recovery, hedge funds get, get whipsawed. It's just going to further kind of the negative momentum in the, um, you know, in the industry, probably more money will come out and go into, uh, More passive types of, uh, types of approaches, and that's where, from a, a business perspective, right, having a diverse …

AI assessment note: “strongly believe that over a five, 10 year period, The talented managers should”

Q Well, I guess time will tell. We'll have to, we'll have to see how this all plays out. Let's, let's turn to some customary closing questions. What advice would you give someone early in their career?

A Cliche, but certainly do what you love and try to surround yourself with, with, with great people. I mean, I can't tell you, uh, you know, like the AQR people as an example. I mean, they're great people, nice, you know, and, and, you know, when you're around people like that and smart people, no matter what your role is with that group of people, You just sort of put your head down, you know, work hard, listen to them, you know, you're going to learn an awful lot. And I think sometimes, you know, younger people get so caught up in exactly what their responsibility is in a first job or, you know, what their, you know, a small difference in income or something like that, which is not to say that's not important, but certainly surrounding yourself and getting yourself with the best group of people. Possible. And again, it's very cliche, but I think it's true. If you're not doing, you know, something that you enjoy doing, it's very hard to have staying power to be really good at it. And so obviously it's important.

AI assessment note: “Cliche, but certainly do what you love and try to surround yourself with, with, with great people.”

Q And where have you made mistakes, and what have you guys learned from them?

A Number one mistake gets back to that checking every box, uh, kind of mentality where the love and passion and risk-taking mentality just, just isn't. And so, you know, I would say, you know, we, we, we tended early on to invest more in lift outs from investment banks, you know, kind of teams that lifted out from those banks. And invariably those teams would say, oh no, you know, being part of the bank was a hindrance more than a benefit. You know, I had all these names that I was restricted in and, and so on and so forth. And, you know, being part of the bank and the Flow and all that was really not, not that important. Well, you know, it kind of turns out that, you know, probably was important. There was a lot of value to the seat and it's just a very different mentality from going from a large firm where everything is sort of figured out for you to ham. I'm running a business. My first three months haven't gone very well. You know, how am I going to get the gumption up to take, to take risk? And God, am I really enjoying any of this or is it like, what did I get myself? Into. So, um, we definitely made mistakes in, you know, in, in that regard, I'd say on the macro side, I feel we've definitely improved our process. Finding good macro managers is incredibly challenging because it's often hard to distinguish if someone's track record or history is, you know, a function of incr…

AI assessment note: “Number one mistake gets back to that checking every box”

Q How do people go about playing that? I mean, you're going out and identifying a manager, but are there simple ways if people want to express a regime shift in volatility that they can express that either in their own portfolios or through a manager? What do people do if you shared that view?

A It's challenging because probably the, the volatility index most people think of the most is the VIX, right? And, uh, Equity volatility, while it's low relative to history, can be very expensive to have a long position in, because the term structure of equity volatility, at least in the U.S., is still very steep, you know, upwardly sloping, which means that I might buy a futures contract on the VIX three months from now that's probably priced a couple points higher than the VIX is Price debt today. And if I just buy that futures contract and hold it, I'm probably going to lose a couple points and have strong negative carry. And so, you know, part of the reason probably people have, uh, you don't see as many people in those trades on the long side is precisely because of that negative carry. There's much easier ways to structure those sorts of trades outside of the equity market. So things like interest rate volatility, currency volatility have much more favorable Kind of carry characteristics as opposed to equity markets, but they're much more challenging to find ways to implement, you know, as kind of a, an everyday investor or not, not through a manager who's, you know, who's expert in the space. You know, I'd say one, I'd call it maybe an orange flag or red flag on the equity volatility side is you're seeing a lot of people today go, go explicitly short equity volatility, um…

AI assessment note: “things like interest rate volatility, currency volatility have much more favorable Kind of carry characteristics”

Q Yeah. So I, I'm having my head like the, the, the jury scene in 12 angry men. It's nine not so angry Chicagoans, nice people, but how does that work? So does someone raise their hand every now and then and just say, look, I, I'm not seeing this, and I'm going to, one person is going to turn down the minds of eight other investment team members.

A It happens more than, more than you would think, where we have people who just, who just don't, don't see it. And if everyone else sees it, it's not like we'll just necessarily just walk away and say, oh, okay, you know, eight to one, and we'll just move on and forget that. Um, We'll certainly try to convince that other person, um, but ultimately, if we can't kind of bring, bring that other person around, um, you know, we wouldn't, we wouldn't make that investment. Like you said, it's all, it's all very, very collegial, but when I, when I look at some of our best investments over the years, they often are the ones that have some hair on them, you know, in terms of, boy, that, that person was the number two person at some large hedge fund, and, you know, not every single thing that that person did or that that firm did was absolutely perfect. And so people who might have been in the larger hedge fund might not be investing in the spin out, you know, for those, for those reasons, and you might not get a good reference from them, right? And so, you know, there's definitely very, very few of our, you know, best investments have had every single box check absolutely perfectly, and in fact, some of our more mediocre initial investments have been the things that kind of check every box, but again, that spark wasn't necessarily there at the end of the, um, at the end of the day. It's n…

AI assessment note: “ultimately, if we can't kind of bring, bring that other person around, we wouldn't make that investment.”

Q So those are some of those filters in terms of some of that initial screening. And so what is it that comes in your door that you end up being attracted to?

A So the higher quality introductions, if you will, come from, you know, we'll certainly always ask our current group of managers, you know, who do you know that you like and respect? Or might be invested in personally. Um, and then we try to keep a small group of, you know, I call it kind of like-minded investors where we, we share ideas among, among that group. And it's small enough that I think we avoid the group think that, you know, we're not checking and corroborating with everyone else out there. But, you know, we feel that if you can interact with a family office or two, an endowment or two, you know, I'd personally love to interact with just What I think of as eccentric investors who have no institutional process whatsoever, but might have a good nose for it, might have good instinct, might have a way of asking questions that get at the person behind the, the fund a little bit, a little bit more. You know, those tend to be the best, you know, sources of, uh, you know, of introductions for us would be among, among that group. And certainly if we get wind that someone is, you know, leaving firm XYZ, And, you know, we think it's likely to be attractive. We might, you know, we might chase them if we think that capacity is, is likely to be challenged, but you very rarely see that in, in, in today's environment.

AI assessment note: “the higher quality introductions, if you will, come from”