The Exchanges

Q How did you think about your tenure at Goldman?

A I think of it as three amazing years, then two years that were much less exciting. So, 2002, 2004 was phenomenal. I worked with an incredible group of people. It was a relatively target-rich environment. We were given pretty free reign to go after whatever made sense. And starting around two-thand-five, as markets got really frothy and some key people left, Goldman grew a lot. And Goldman has a habit of allowing different groups to play in the same areas. We started bumping into other groups within Goldman more and more, and possible investments I was working on, all of a sudden I would get a phone call that it was somebody else's area, or somebody's claiming it was their area, and so it became a lot less fun in oh five and oh six, and so I ended up leaving right at the end of oh six.

AI assessment note: “I think of it as three amazing years, then two years that were much less”

Q When you're sitting at Goldman, from the outside, a seemingly infinite amount of capital, all these resources, The concept of building that network is great, but it also requires you to have capital to have the incentive. So how did you go from that idea to forming a business with a pool of capital to pursue that?

A I was very fortunate that a friend from college, Graham Duncan, who was really a distinguished fund of funds investor, had created a relationship with the Miller family that controls Lenar, one of the largest home builders in the United States, and the family had had a couple of recent liquidity events, and Graham called me one day to say, there seems to be an opportunity to start an investment firm around capital provided by the Millers. We had been friends for a long time and had actually worked together on projects through the years and wanted to work together. It was also pretty clear that there was a compliment between Graham's skillset and my skillset and our way of thinking. Graham is an unusual thinker in terms of evaluating talent. He talked a lot about thinking of hedge funds, not as institutions, but as people. And was very focused on what made the best hedge fund people really good at what they did. And that was a natural compliment to my thinking, which was Goldman has this great model of external operating partners. How do we do it better? And so those two things came together to create the investing model we have today, which is to identify and really get to know The best people at larger firms, either before they leave or after they leave, and most of them eventually do leave, and many of them start new firms, and be in a position to back them in the early years…

AI assessment note: “there seems to be an opportunity to start an investment firm around capital provided by the Millers.”

Q When someone's coming out of a larger firm, there's always lots of resources around them. How do you determine whether their likely success when they're on their own doesn't get inhibited by the fact that they no longer have those resources around them?

A It's a great question. There's a professor at Harvard, Boris Kreuzberg, who has written a great book on portability of talent, which influenced my thinking on this. The irony is the stronger the firm, the harder that assessment is. So it's harder to assess people actually out of Goldman or Blackstone or some of the really great firms, because it's just harder to tell was it them or was it the firm. If somebody just did an extraordinary job at a firm that wasn't one of those places, that's actually an awfully good sign. In those really blue chip places, you do have to be really targeted towards figuring out what part of their body of work was them versus the institution. In any case, there's no substitute for a massive number of references done a certain way Ideally done, for example, in person, ideally done, not in 10 or 15 minute conversations, but in 60 plus minute conversations, and ideally off list, and even more ideally, knowing people in common. You almost can't stress that enough. One of the most important things in our business is to know people in common with the people we're assessing. There's just absolutely no substitute for it. If you know people in common, then you can reference them, you can get to know them, you can understand their body of work much better than you ever could if you're trying to create a set of references from scratch. And then digging into the…

AI assessment note: “there's no substitute for a massive number of references done a certain way”

Q So once you got started out of college, what was that first job where you saw that same dynamic?

A I went to work for an investment firm focused on private equity investing in Latin America, so essentially buying stakes in mostly family-owned companies in Mexico, Argentina, Brazil, Chile, and Latin America was a tough place to invest then. This was in the mid to late nineties, and these were early days for private equity in Latin America. There wasn't much of a culture built up yet about how you make these investments. And when I think about probabilities and one of the things I noticed early on is that when you invest in these companies, you're taking multiple risks. One risk plus another risk is not just the equivalent of two risks, but it compounds. And even though I love Latin America, Speak Spanish and Portuguese. My wife is from Mexico City. Spend tons of time in Latin America. I never invested there again after I left that job in early 2000. The tough part about investing in Latin American family owned companies and being a minority shareholder is first you have a macro backdrop that's pretty tough. It's an emerging market, but unlike the Asian emerging markets that were growing very fast, Latin America wasn't growing that fast. But unfortunately you did have a crisis of some sort every 10 years or so, where you'd have a currency devaluation, you have a debt crisis, you'd have some political crisis. And then you had sort of more micro risks, which was on the ground. Y…

AI assessment note: “I went to work for an investment firm focused on private equity investing in Latin America”

Q from portfolio accounting to reporting to reconciliation, trading, 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. Why don't we touch on how you've achieved alignment with managers?

A Alignment is one of the most tricky concepts that there is in investing. Alignment, when I was sort of first starting out in investing, the concept was so oversimplified. It was just, okay, does everybody have skin in the game, loosely defined, and everybody, if the investment makes money, does everybody make money? And if the investment loses money, does everybody lose money? And that is a massive oversimplification. Let me give you an example of why that is an oversimplification. We at East Rock have probably made 140 or so private investments, and a very small number of them, thankfully, have been poor investments, but a majority of those poor investments were cases where we broke our own rule, and our own rule is we must invest our money at the same time that the sponsor invests their money. So we need to go shoulder to shoulder from finding an opportunity to through diligence and to closing. And we have found that a majority of our mistakes occurred when the sponsor was already invested and convinced us to follow their lead into an investment at a later point. Now, the classic definition of alignment would say that was fine. That manager has skin in the game. If the investment is successful, they're going to make money. If it's unsuccessful, they'll lose money. And the reality is we were not aligned because by the time we were evaluating the investment and making our inves…

AI assessment note: “our own rule is we must invest our money at the same time”

Q What was the best advice you ever received, and what was the context that came to you?

A I'm gonna mention two. Strategically, the best advice I've gotten is that 95% of investing is sourcing, and we could argue what the right percentage is, and this goes back to Goldman days and the operating partner model. If you see hundreds and hundreds of things each year, you're gonna be able to pick a few that are just obviously good, and so there's no such thing as too much sourcing. You just want tons and tons and tons of ideas, and you want an engine for producing those ideas. The more the better, because the more you have, the less smart you need to be. One's tactical and has to do with the importance of competition in the context of something you're trying to achieve in investing. So we made an investment about 10 years ago where we took over a CDO. So we were able to control the CDO and liquidate it. And the primary asset of the CDO was a very unorthodox amortizing interest rate swap. And things were going well, except the counterparty to that swap. Once we got ahold of the assets of the CDO and we were liquidating them, The counterparty of that interest rate swap was a very large global investment bank, and our feeling was that that investment bank should liquidate the swap for fair value. Because the swap was so unusual, that investment bank made the calculation that they could liquidate it at a huge discount because it would be difficult for us to go somewhere else.…

AI assessment note: “Strategically, the best advice I've gotten is that 95% of investing is sourcing”

Q So when you have that breadth of experience of something that looks venture-like in emerging markets to hard asset lending and asset purchases, what did you most gravitate to?

A What I gravitated to was this moment where you would work on a possible investment, and the day you closed that investment, you knew you made money. And it didn't happen all the time, but I want to find a way to maximize the number of moments like that that I have in my career. At Goldman was the first time I saw this. My prior job, I felt like you close an investment And then you cross your fingers and you hope. And when I got to Goldman once in a while, we would make an investment and we'd celebrate as if we had already had a success. The money hadn't come back. We hadn't realized any profit, but we knew that what we had just invested in was worth more than we paid.

AI assessment note: “What I gravitated to was this moment where you would work on a possible investment”

Q Are there any other signs you like to look at?

A Being able to engage on a live investment. Now I want to be careful here because any one experience around a particular investment can be misleading. And we all have to be aware of that. And I think that's probably even more true on the public side. You can only learn so much about talking names with a manager. And talking names is helpful and you learn something, but there are limits. And I think the same is true in working on investment, but you do learn a fair amount. Based on the nature of my firm, we are in the backseat and the manager's in the front seat. But if we can watch them operate, see how they think, then you learn a lot and you look for certain signs. And of course the sign we're looking for Is that idea that the manager is creating edge, they're finding things that are special, they're holding the bar high, and the flip side of that is sometimes people feel an anxiousness to get something done early. We've worked closely with and have a very high opinion of EOS run by Jonathan Wang, and I'm not gonna remember the exact numbers, but I think in the first two and a half years he bought one hotel. Which is maybe not how you want to start a hotel-focused investment firm, but he had that informed confidence that the opportunities were going to come, and he was very patient about it.

AI assessment note: “Being able to engage on a live investment... the sign we're looking for”

Q Other than play to win, what are some of the other objectives that you espouse for the pools of capital?

A We want families to have a very clear window into our process. And what they'll see through that window is that they'll understand who these people are who are producing what we think are great investments. So on the public side, we have about 15 to 20 hedge funds we're invested in. The families will have some sense of who those managers are. And as the family pools develop, there'll be 60 to 80 private investments with 30 to 40 sponsors behind them, and the families will have some sense of who they are. It should feel Like I know who these great players are and I know what they're doing and some investing is tangible and some is not. So I mentioned the hotel strategy. Our families can go stay at some of the hotels we own and that feels tangible. We've invested in a few consumer products that the families recognize and that feels tangible. So we want it to be just the right mix of having our families feel completely comfortable and free. Again, that they can spend 95% of their time not thinking about us and not thinking about investing generally, but maybe in the five percent of their time, they get this incredibly efficient window into what we're doing, why it's safe, why it's special. I feel like this may be a reach, but you want your families to feel delight at being able to see this process that's being executed on their behalf. And the peace of mind it gives them, and just…

AI assessment note: “We want families to have a very clear window into our process.”

Q As you look out, what are you hoping Eastrock will become over the next five or 10 years?

A Objective one is to be the best, I'll call it post-breeding ground of talent. So the breeding ground, of course, is the place where all these folks trained. We want to be the best post breeding ground. So when it's time to leave those breeding grounds, we want to look back and know that we partnered with these exceptional folks at these key moments in their careers. And we both benefited tremendously. They made some incredible investments with our capital. And so we succeeded and we were The springboard to what they ultimately wanted to achieve. And so in a lot of cases, people will come out of blue chip investment firm, and it's really not clear who owns the track record. And in those first few years, when they're on their own and we're putting up the capital for whatever they're doing, that's when they're building the track record that'll propel them to what they ultimately want to achieve. And I want to look back and see a mosaic of These folks who were able to do that and achieve that. And then along the way, I want to build an absolutely phenomenal long-term track record. And so the nice thing about what we do with such a small number of families is that it's not like we have 30 track records or 50 track records or a hundred track records. We really have one longest track record and then several other families have a very similar ones. And I want to be able to look back An…

AI assessment note: “Objective one is to be the best, I'll call it post-breeding ground of talent.”

Q As you're doing all that work, what are some of the signs of things that you found that make someone more likely to succeed on their own as they go through that process?

A The best positive signal there is, is that somebody leaves the larger place without something already set up. When somebody does that, they are sending a signal. I know I can do this on my own. And I would say the majority of people we back, they leave their prior employer without having something already set up. I do counsel people to the extent they have the personal circumstances and the personality that they can do that. It's a very valuable move to make because the conversations that they can have with potential investors, once they've left their prior employer, Are just so much more open that they're really doing themselves a service by opening up the world that way. So that's a tremendous positive signal. Probably the other general category of positive signal is this sort of informed confidence. When we get concerned is when that manager we're going to back is too worried about things like getting taken seriously by sellers or bankers or whether they can hire people successfully. How they're perceived in the market, if they, let's say, accept a seed deal, or if they set things up a certain way. So it really boils down to this informed confidence that I'm going to leave where I was, I'm going to start something new, and I'm confident that I can attract capital, I can attract employees, I can engage with sellers, or if it's a hedge fund with prime brokers. And when I say i…

AI assessment note: “The best positive signal there is, is that somebody leaves the larger place”

Q How do you think about managing liquidity within the construct of your portfolio?

A It's one of the hardest things we do. We have models with many sensitivity scenarios around them. Because we have a small number of clients, the dialogue with families is very important. And so we have some sense of what liquidity they may need or want and how to sensitize around that. So if you look at the portfolios we manage for our families, they are comprised of cash. Hedge funds, some of which offer liquidity in the near term, and then some private investments, some of which are illiquid for the very long term, some of which have already matured and there may actually be public stock at that point or some other way to get liquidity off of them. And so we are constantly updating our assessment of different liquidity scenarios based on the outflows. Obviously it can be new investments we make. It could be a family requirement. And then of course the inflows could come from families, could come from selling privates, could come from redeeming from hedge funds. We've never used leverage. So obviously very important to get that right with a cushion.

AI assessment note: “We have models with many sensitivity scenarios around them.”

Q What are some other examples of alignment that don't follow the traditional money flow definition?

A One is that's really underappreciated in terms of alignment is actually the alignment that comes from having a long, close relationship over many years or decades. So if there's a manager who I've known for a very long time, who is a very close personal friend, Who has proven through the years that not only are they a really good investor, but they care about alignment. Everything they do after you make the investment is about maintaining that alignment. And so there's a personal element to alignment that has to do with your relationship with the person, the character of that person, them caring about alignment. And that in many cases is much more important than just the financial flows of what do they put in and what do you put in. It's because I know this person, because I know they care about alignment. I know that they're going to be incredibly focused on not making a mistake up front and then optimizing the outcome over the course of the investment through all the twists and turns it may take.

AI assessment note: “alignment that comes from having a long, close relationship over many years or decades”

Q When you're going through a live idea with a prospective manager, there's a degree to which you may never know as much as they are, right, about that idea. You're in the backseat, they're in the front seat. What are you trying to learn?

A It's quite different. Mainly our investing on the public side is investing in smaller, newer hedge funds, and then invest in privates, and mainly those are more bespoke partnerships. So it's much easier on the private side. We end up with nearly as much information as the manager, hiring vendors and getting third-party reports, and so we get to see Quality of earnings. We get to see an environmental report. We get to see a whole bunch of things. So there's not quite the information asymmetry. I guess this is ironic because in the public markets, we ought to have the same amount of information, but it's much harder to replicate a public manager's knowledge base. When they see edge in a public name, they're talking about the primary research they did. And I think we learned this the hard way in some of the early years is that Some managers were really good storytellers. And so convincing that when they pitched a stock, it just sounded great. And some of the elements of the pitch, you wouldn't even think necessarily to go try to verify. Where we've really evolved is how we deal with your question on the public side. On the public side, you have to be very focused on what sort of pitches sound smart. And of course the classic is the short pitch. Everybody knows that if there are 20 hedge fund managers around the table and you want to sound the smartest, you do a really colorful sho…

AI assessment note: “Where we've really evolved is how we deal with your question on the public side.”