The Exchanges

Q And when you look at side by side, taxable investor, tax exempt investor, what are the big differences in the asset allocation or the investment strategies that you pursue for a tax exempt investor because of the tax inefficiency for a taxable investor?

A The biggest ones are not in illiquids, because if you look at endowments, this is where the issue is. They've actually been pretty tax efficient. The big Ivy League endowments haven't been huge private credit owners. They've done a lot of Growth equity in VC, it's actually pretty tax efficient, and they've done a lot of public equity that's not been high turnover. The places where you're going to see bigger hits are on the multi-manager pod hedge funds, which are incredibly tax inefficient, but have been a good source of risk-adjusted returns for some of the larger tax-exempt allocators. That's where I think the bigger difference is going to be if those allocators are in a foundation or an endowment where taxes are going to matter.

AI assessment note: “The places where you're going to see bigger hits are on the multi-manager pod hedge funds”

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 And what are the total number of managers that you'd consider core?

A We have about 50 public market managers that are core. Now, not everyone owns them all, but if you look from munis, after turning hedge funds, you know, active long only, passive managers, et cetera, you know, private equity tends to proliferate because a commitment you made 10 years ago is still in the portfolio. But that's a number about core. Um, we probably have an equal number of private managers we've committed to over the years, but probably half of whom are at most are sort of active re-ups today. But we have hundreds of managers, many hundreds of managers with whom we have one dollar on behalf of one client because of things we've inherited and things we've done, you know, My son's college roommate's hedge fund I'd like to invest in, et cetera, et cetera, and we're willing to be that customized.

AI assessment note: “We have about 50 public market managers that are core.”

Q Just to give a sense, what do those look like across strategies?

A Sure. So all else being equal in public equities, we want to be about fifty-fifty passive and active on the long side. Um, all else being equal, More aggressive strategies will own more private equity and more long-only equity and less long-short equity. You know, more conservative strategies or more conservative portfolios, all else being equal, should own more bonds and less absolute returning hedge funds as part of that stable returning lower risk mix. So as the person who oversees the investment management, investment research process here, I actually look at how all of our money is invested on a roll-up basis, and I'd say about Is in higher returning, higher risk strategies. But for us, that is still probably a modestly lower amount than most. So if you looked at your average high net worth portfolio, you know, 65% equities is probably about right. We're 65% higher risk strategies, but call it only roughly half of that in public equities.

AI assessment note: “More aggressive strategies will own more private equity and more long-only equity”

Q 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. As you go and look at how you're gonna fill out those strategy rows, the manager selection process, What have you found have been the most important factors to your team in your decision to work with a manager?

A There are several. They tend to be people. They tend to be incentives. They tend to be specialization. And I would say that partnership of those people. I talk about it as the shower thought. What do they think about in the shower in the morning when they get up? What's the first thing they think about in the day? If it's about their portfolio and about their area of expertise, that's someone I want to do business with. And if they've structured their business in a way where they're compensated and they will be successful, if they execute on that and we're aligned, then I'm not a client. I'm partners with them in doing that. Then our process is focused on regularly re-underwriting that and So that it's, has their approach changed? Has their passion changed? Have the key contributors to that process changed? Has the asset size gotten too big to execute on it? Has it gotten too small? Have they drifted? So that we can then make a fire decision in advance of the performance being negative. And if performance is mediocre for a quarter or two, but none of those things have changed, then we can be a buyer of those dips and not use One, two, quarter, or even one, two-year performance to drive decisions. At some point, if it's just performance after a couple years, maybe we've missed something on the underwriting, but it's to revisit the why did we hire you and what those key criteria …

AI assessment note: “They tend to be people. They tend to be incentives. They tend to be specialization.”

Q There are a couple of aspects of the industry that have changed a lot, and we talked a little bit earlier about this consolidation wave. Have you thought about the strengths and weaknesses of staying independent, not just for BBR, but then also as you look at managers who are selling steaks? The strengths and weaknesses of that entire consolidation activity in the industry.

A I think there are managers that fall into two buckets. They are managers who focus on their investment returns, and there are managers who focus on the enterprise value of their management company, and I think the decisions you make on people, hiring, process, how you spend your personal capital on building your enterprise are different if you're thinking about how do I generate returns versus how do I maximize The enterprise value of my company. That's not to say we not do business with investment firms that are public or investment firms that don't have minority stakes, but it's more the exception than the rule because we're focused on people who are waking up and thinking about their returns and their strategies. And I would say we wake up thinking about how do we deliver returns for our clients and service for our clients so that our firm will be here in doing that Decades from now, not because we ever want to sell it, and I'd expect the same of our money managers.

AI assessment note: “managers who focus on their investment returns, and there are managers who focus on the enterprise value”

Q Alongside of those strategies, you mentioned a couple of characteristics that are common, like people, incentives, partnership. So when you say you want to be partners with good people, what does that mean as a BBR investment?

A A few things. One, that we know what they own and they know what they own. So for instance, people ask about what reporting do we want to see? And I always turn the question back around to the manager and say, what do you look at? I want to see what's their dashboard, and that's what I want them to share with us, not what they think some consultant wants to see. I don't need positions. It doesn't need to be a separate account. We just need to be on the same page on a somewhat regular basis about that we're looking at the same things and we're looking at them the same way. That when there's bad news, they share it with us. That when someone leaves, we get that call and I don't find out about it from someone else. It's that level of trust that they can Give us bad news, and we appreciate that not everything always goes perfectly, and that, you know, when we're doing a portfolio review, here are the things that worked, and here are the things that didn't work, and so I think that level of honesty and integrity.

AI assessment note: “A few things. One, that we know what they own and they know what they own.”

Q So he calls one day and says, and why you?

A Uh, you know, we were very good friends. We, I had been in his wedding. I wasn't married yet, but he ultimately was my wedding. And we talked about a lot of different things. And I had had this background at Goldman where I had gotten to know some private equity firms. I had gotten to know the hedge funds. I had gotten to know emerging markets investors. And so it was really interesting from a sell side perspective. I had seen a lot of different types of buy side activity. And he wanted to start this business. I had spent seven years at Goldman. Goldman had just gone public. I would say of all the things I was good at at Goldman, politics was not one of them. And as you got more senior, who was responsible for what? Arguing about your compensation became a bigger part of the job. As I said, the firm had gone public and the culture had changed. And it was also late 1999 when people were starting internet companies and doing all kinds of entrepreneurial things. That's not me. I was always a finance and investment guy. But, you know, from his perspective, he knew about my frustration, given our personal relationship. He knew, he thought this was an interesting business opportunity. The way he explained it, I thought it was a really interesting opportunity. He thought I could be useful from an, as an asset allocator, manager selection perspective, given my background. And I just th…

AI assessment note: “He thought I could be useful from an, as an asset allocator, manager selection perspective”

Q tat. How am I going to get myself positioned to get what I want? So on that, even on the research team, how do you think about seven people independently forming their own view, as opposed to the natural tendency of groups to want to coalesce, treat each other well, their employees, some if not all are partners. So how do you How do you think about that decision-making unit?

A That's a great question, and it's actually something we've thought about a lot, and one of my partners, Todd Whiteneck, who manages the research team day to day, he and I have talked about that a lot. I think it's inherent in both structure and culture. First, from a structural perspective, all of the senior people are generalists, and so if you're a hammer, everything looks like a nail. If you're the private equity specialist, Every investment problem has a solution that looks like a private equity fund. From our perspective, all the senior people are generalists. Now, people know more about certain areas than others. I've got partners on the team who are, you know, more expert in structured products. I've got other people who know more about private equity or macro or whatever it happens to be, but anyone can work on anything, and all the senior people are expected to be generalists. And so, one, it's not, I'm fighting for allocations for my area. Everyone thinks the whole portfolio is their area. Two, from a cultural perspective, this is a tough crowd. There are a lot of very smart, very intellectually curious people who are not along for the ride, and so whenever we're discussing an investment idea, usually earlier stages, if they're skeptical, you've got to get them on board pretty early just to make sure that your time's allocated to that project long before you get to in…

AI assessment note: “I think it's inherent in both structure and culture. First, from a structural perspective”

Q So I'd love to turn from that over to the investment side. Once you have at least a sense of what you think, say, that asset allocation is going to be, why don't we start with the most important principles that you take in your investment approach?

A Sure. And I would say these are not revolutionary. They're core tenants. And I would hope that other thoughtful investment firms would have similar ones. But for us, it's long-term compounding. It's that diversification is the only free lunch I think we think about diversification a little bit differently. We've talked about mean reversion and rebalancing, but for us, that's also being comfortable being contrarian, and people talk about it, but I think you have to be very thoughtful about it ex ante so that you can do it in the moment, because it's really easy to talk about and really hard to do, and so you need to have the plan for it. And then a willingness to be, I call it tactical, but it's really opportunistic. We're not market timing, But what's interesting in the market today is different than what's interesting in the market two years ago, six years ago, eight years ago, and so as much as we've got this long-term strategic plan, we need to understand that sometimes things are really interesting in certain sectors, and other times they're really uninteresting and be flexible within that strategic plan, having those tactical shifts, but it's really more of taking advantage of opportunities.

AI assessment note: “for us, it's long-term compounding. It's that diversification is the only free lunch”

Q And on the flip side, what are you worried about the most these days?

A I worry about how The unwind of the post-global financial crisis world is going to be. We have now have a generation of investors who think interest rates are only low, and that central banks are always there to bail them out. And I don't think that's always going to be the case. I think in general, as that changes, it's probably a buying opportunity. And generally speaking, I think any modest correction is a buying opportunity. We've actually done some really interesting work on that in the last month or so. Uh, in terms of when, when do you want to be overweight potentially, or when do you want to be underweight? But if people, people, i.e. folks on the buy side, you know, this is a young man's game younger than you and me these days, and they just haven't seen, you know, they weren't even in business in oh eight, uh, nine years ago now. What happens when interest rates are four or five, six percent? That's a pretty high hurdle to own, uh, A different, more aggressive strategy, where today people are willing to take some, I would argue, crazy risks to generate a six percent return in high yield and other places. That, that's going to be a regime change that could really scare a lot of folks.

AI assessment note: “I worry about how The unwind of the post-global financial crisis world is going to be.”

Q We think about a lot about where, where a market's efficient and inefficient. How different back then was what you saw in either the way the companies were run, how sophisticated they were about thinking about financing in Hong Kong versus what you'd seen in the U.S.?

A I think there was a very, very big difference when, back then, when you went country to country. There were places like Thailand and India where the companies were mostly family run. The families were very wealthy. The individuals were very well educated, often in the U S or in Europe and at places like Wharton. And so you go into the meetings, you'd speak English, you'd use lingo right out of business school and they totally got it. Now they may or may not have been friendly to minority shareholders. They may or may not have been good investments. But it wasn't a meeting that was materially different than a meeting you'd have in the United States. In the same vein, you'd be in mainland China talking to a state-owned enterprise, and there'd be no English. You'd have to explain what an equity offering was to the management team. I mean, it was the total end of the spectrum. So it really depended country by country.

AI assessment note: “I think there was a very, very big difference when, back then”

Q Value stocks have been killed for a long time. All of these long, only active managers alongside hedge funds have underperformed. Now we're talking like a decade. At what point in time do you start to question, maybe in the US this passive thing isn't so bad after all?

A I would take the other side of that. I don't think cyclical stocks are dead. Cyclical stocks are worth owning, but they're not worth owning all the time. It relates to our conversation about hedge funds. You want to own high quality companies for a long time, and given the nature of our clients, tax efficiently. None of those things equal hedge fund. But in strategies like cyclicals, where you don't want to be long all the time, you need to be somewhat macro informed Long short's actually a great way to have exposure because you don't want to own the banks and the commodity companies and the industrials forever. There are periods in the cycle you want to own and there are periods when you don't. The other place that that's totally true, emerging markets is not a good buy and hold marketplace, but between being macro informed, more alpha opportunity, more short opportunities, it's a good place to own hedge funds. I think those are places where active managers can add a lot of value. At the same time, this is one of the most confusing macro environments we've ever been in. I think it's more confusing than the middle of the pandemic. What is the Fed going to do? What is going to happen with inflation? What's going to happen with geopolitics? One of our huge investment themes is deglobalization. How's that going to play out? It makes it very hard to have a lot of confidence in gene…

AI assessment note: “I would take the other side of that. I don't think cyclical stocks are dead.”

Q That's great. So before we turn to Really the investing side of BBR and lots to talk about there. I, I'm always curious to ask, If you had to throw all this away today, start a completely new profession based on everything you know now and the coulda, woulda, shouldas, what would you be doing?

A I would have spent more time investing early. I think there's pros and cons to that. I think I learned a lot commercially from a lot of people I worked with at Goldman Sachs who are phenomenal mentors about how do you do business? How do you convince people to do business with you? Where, where should you spend your time? What's opportunistically interesting? But they didn't, I didn't do anything that was really investment oriented. You know, whatever I, whatever deal I had to sell, I wanted to convince people to own it, not should they or should they not actually own it. I, I think that would have been, you know, going quote to the buy side earlier, and it's different when you're actually making investment decisions, and so those first couple years when you're actually an investor, and you're actually managing other people's money, and you've got that Duty and that weight of responsibility, and by the way, that was oh, oh, oh, one, oh, two. It was not an easy time to be making those decisions. I think it would have been helpful to have a little experience earlier than that. You know, with all that said, the fact that we didn't start managing money till March one of 2000, like almost right on top of the NASDAQ high, really framed our investment approach for years to come, and I think it served us well, but I think I would have liked to have more buy side experience earlier.

AI assessment note: “I would have spent more time investing early.”