The Exchanges

Q This might be a tough one, but which two people have had the biggest impact on your professional life?

A It is a tough one. The first answer is real easy. That's David Swenson. I had the privilege of serving on David's investment committee for 17 years, and we were also, on a personal basis, good friends. But he is, without a doubt, the finest investment manager I believe any of us have ever seen. And it wasn't because he was such a terrific Investment producer, and he certainly got a wonderful rate of return, but it was because he did that with the discipline of minimizing risk all the time, and he created, he was more creative by a long shot than most of us are willing to recognize or able to recognize. I often think the best thing to say to get people in the right mindset with David Swenson is when he was not yet 30, And he was working at Salomon Brothers, where he had been sent by Jim Tobin, the Nobel Prize winner, who was his principal teacher at Yale. Because, David, you know all the theory, and you know all the concepts, and you're really good, but you do not know how the world, the market really works. And the market is not made up of nice people. It's made up of selfish, greedy, hungry, ambitious people doing what is in their own personal best interest. And until you understand that, So you got to go work at Salomon Brothers and Lehman Brothers, and he did a couple of years at both. While he was at Salomon Brothers, he came up with a cockamamie idea that nobody had ever h…

AI assessment note: “The first answer is real easy. That's David Swenson.”

Q What was Wellington's path during that decade when Vanguard went from very little to launching those index ETFs?

A Well, it's a completely separate but overlapping story, and it's a wonderful story. The culture of a partnership, and they were a publicly owned company in a terrible bear market, losing assets under management, so their profits were going down. And one day, Nick Thorndike and Bob Doran agreed, maybe the worst is behind us. Maybe what we should do is go private. They checked it out and figured out that going private would work out very, very well. If we had a partnership, we could go private and build a great organization. So They did that, and it was a time when it looked like it was a pretty dicey proposition, because the markets had been going, we had the longest bear market this country had ever had, and so there were all kinds of challenges along, hey, what's going to happen in the future, and asking people to put up the money to buy into the partnership. But the market did turn, and they got some substantial advantages that popped up. For an example, MIT endowment went looking for investment managers, and they picked out the two finalists would be Fidelity and the now Wellington, and Bob Doran led a team of people with a simple mandate. We have got to win this business, and they worked out and worked at it, and it over a period of a year or so showed to the people at MIT that there was a culture of value inside The Wellington organization that would be really worthwhile i…

AI assessment note: “Nick Thorndike and Bob Doran agreed, maybe the worst is behind us. Maybe what we should do is go private.”

Q So let's break down both sides of that. So the side of picking great money managers, what did you see in common patterns of those managers that David selected versus the many, many that you've known around the world that he didn't?

A Well, first of all, very few of the managers he's chose at any time were at all widely known. They just were never widely known until after they had been chosen. I would guess if you looked at his list of investment managers, you'd find over a hundred. And having spent most of my career in the investment management business, I probably would have known of. 25 or 30 would have known in detail, one or none. So they were all unusual Managers. And the characteristics of that unusualness would be first that they were Yale chosen when they were first getting started. And then Yale would be a major account for them. Usually their sole major account or their leading major account. And usually right from the very beginning, I will put you in business and I will put you in business with the following large account. And you got to that decision because you worked with David on how to design your firm in terms of your business strategy. And in terms of your investment organization and your investment process. And I can't tell you how important that was and how exceptional it made the relationship between Yale as a client and the managers as managers. David was really interested in helping very, very good people. And by that I mean obviously brilliantly talented, but also really strong character. And if you didn't have really strong character, David knew you can't get it. If you don't have …

AI assessment note: “characteristics of that unusualness would be first that they were Yale chosen when they were first getting started”

Q So Einstein quote, endeavor to keep things simple as possible, but no simpler. If we assume that indexing is the right strategy, Let's take it to the next level and walk through. Okay. How does someone pick the index?

A Depends how clever you think you are and what's your temperament or risk tolerance is. Easiest thing in the world is to buy a total market index. So you're now diversified across all economies, all markets worldwide, and virtually every major company is there. And That's one way of doing it. Second state now, I'm an American, and I want to stay within the United States. Fine. You can do the total US market, or you can do the S&P, or whatever generic broad base you want. And you say, actually, I've got a strong opinion. I've got enough time So that I can make a long-term policy decision. I believe that small cap companies long, long-term are a better place to be invested. Or I believe long, long-term emerging markets are more attractive than people think they are, because prices are dominated by short to intermediate term thinking. Over the long-term, I think they'll do better. And I've got the stamina, the nerve, the cool to be able to go through Turbulence ups and downs. But I know in the long run, that's going to work out. Or you can say, I do some of that, but not too much of that. So you might overweight the emerging markets by 10, 20, 30% of your portfolio, or overweight small cap stocks by 10, 20, 30% of your portfolio. But the main thing is fees are huge. And if you're talking about taxable funds, then taxes are really important, and costs are there and real, and sideste…

AI assessment note: “Depends how clever you think you are and what's your temperament or risk tolerance is.”

Q And what was the impetus for starting Grants Associates?

A One day, I was sitting there wondering, what am I going to do when a light bulb came out of the ceiling and straight gradually came down to my eye level and said, Charlie, blink, blink, Charlie, blink, blink. This is the opportunity of a lifetime. And that was everybody who's involved in financial services. I thought primarily through the stock brokerage business and the investment management business. Same thing's true of banking, investment banking, bond dealing, whatever. You don't know how you stand with your customers. You really don't, because they won't tell you, nor why should they, and you don't know how you're doing compared to your competitors, and you don't know who's getting better and who's fading, and you don't know who's doing a lot more of this or a lot more of that, and so you're basically blind man's buff, and I thought, you know, if anybody could figure out How to find out how each of the different firms is doing as the customers see it, that would be terrific. Well, take the institutional stock brokerage business. There are not a thousand major investing institutions. There might be 500. So could you get them to spend better part of an hour if you promised you would never reveal their name or individual identification, only groups of institutions? Could you get them to give you candid feedback By asking them some blunt, direct questions about all the firms …

AI assessment note: “if anybody could figure out How to find out how each of the different firms”

Q And what was it, so what was the lesson other than trust? Had you not done your homework after watching all of these incredible professionals doing all your homework?

A Such a boneheaded mistake. First of all, I know that you should do your homework. And really, do your homework. I didn't begin to do the homework I should have done. I didn't even check on the internet. I mean, you know, ridiculous. And I didn't ask people what your experience has been, and I could easily have done so. I just bought hook, line, and sinker, that this was a really smart guy with a very unusual personality, and that this would be a very interesting way for a modest Fraction. But to add some Tabasco sauce to what I was doing, indexing and all that sort of stuff was just getting to be my way of doing things. This was about 10 years ago, and just absolutely dumb, boneheaded mistake.

AI assessment note: “I didn't begin to do the homework I should have done.”

Q seventies, When relative to today, we can look back and say, boy, this was inefficient. It took two weeks to even get information. It wasn't the right information. Somebody should have been able to be smarter, move faster. How did you get the insight as early as 1975 when 90% of the trading was, was occurring through individuals that still that these professionals as a group couldn't beat the market?

A You have to understand what I was in this unbelievably lucky Situation. I was consulting and working with investment management firms on how they could build their business. So I really get to know people quite well when you're working to help them get better and better at what they want to do. And working very closely with not five or 25 or 50, but actually probably, fair to say, better part of a hundred different firms, you realize they're all Really smart guys, and they're all really working hard, and they all think they've got a competitive advantage, but they're all competing with each other. And the competition is also really smart and working very hard. They've got lots of interesting ideas on how they could do better. And they're all trying to do better and better and better. So that's the first step. And the second is, if you record over time, systematically, who are the best firms as judged by their clients, institutions like pension funds, if you're doing that, and you get to know the firms that are the 10 best, And you come back five years later, and half of the 10 best are no longer in the 10 best, and you come back five years later, and four of the five that were still there are not there now, you realize there's something really serious going on here. And now take a look. What is it? It's not that they're not hardworking. It's not that they are wonderfully talent…

AI assessment note: “I was consulting and working with investment management firms on how they could build their business.”

Q And what was it at Capital that was so strong in that area?

A Well, there's so many different ways of looking at it. One is John Lovelace, who for many years was the leader of that organization, had developed a frame of reference When he was working in personnel, it was that if you could find the right way for each individual to be doing what they're best at doing, and then aggregate that, that would be really important. If you could also keep work groups relatively small, so they really knew each other very well, and got used to really working closely together, and you know, Peter Drucker used to laugh and say, look, you have The largest team I've ever seen is 11. The next is nine. Probably seven would be better, and he wasn't kidding. That's in athletics, but most organizations, it doesn't help to get bigger if you want to get better. It helps to be relatively small and then get to know each other really well and play superbly well as a team. John Lovelace had a very strong interest in helping people learn how to be very good at listening. Not listening to hear what was said, but listening to hear what was meant this time a little differently from last time, and that's very helpful when you're interviewing companies, trying to learn about companies, but it's also great when you're in the kitchen working with the other folks that are trying to prepare the decision that's going to be made for the fund, and, ah, in the mutual fund business…

AI assessment note: “One is John Lovelace, who for many years was the leader of that organization”

Q What'd you, what do you learn in the Army? Haven't heard those stories.

A Well, we can't do it on a program, but I can tell you one of the great uses of the English language I have ever seen. It was on a very foggy day. We were on the rifle range with the pop-up targets coming out of the woods, and we're supposed to see and fire, see and fire, see and fire, and one of the soldiers had jammed his rifle, so the sergeant in charge of our unit took the rifle and stood it on its butt and kicked the opening open, and it didn't work, so he kicked it again with a really strong downward thrust, and it didn't open. And he kicked it one more time. And then he delivered the greatest sentence I've ever heard, eff, the effing effers effed. But it was the musical tone of inflection that made it really memorable.

AI assessment note: “I can tell you one of the great uses of the English language”

Q How do committees go about helping managers be successful other than giving them money and keeping it there?

A Well, most committees don't do very much that's very helpful. So let's acknowledge that. But then if you look at those that are effective, then it's not, there are some very famous named endowments, for example, that don't have success in their investment committees. And there are some very large pension funds that don't have success in their investment committees. But if you do have success in the investment committee, the first and best thing that committees could do is figure out What is unique about their particular fund, and why is it different from all the other funds that would like to have very good investor results? That's not all that easy, but it's not all that hard either, and if you think about it, Yale, for example, has an integrated budget. All the different parts of Yale are Yale. Harvard, on the other hand, has every tub on its own bottom, so the Faculty of Arts and Sciences gets More than half of its income every year through the endowment, but the Divinity School does not, and the School of Education gets almost nothing from the endowment. So as you're managing the funds, you really need to know what is it about this particular client that makes them different, and there are differences if you've thought about it carefully enough. Some of them are institutional structure, some of them are scale, some of them are Proportion of the budget that's being covered b…

AI assessment note: “helping all the managers focus on solving the real problem that you're trying to deal with”

Q So what was it like inside those committee meetings? So everyone's done all of this homework. There are these memos, these recommendations. How did the process work in the boardroom?

A Well, we took each item one at a time, and the odds were exceedingly high that on each item that was being proposed, we would all fully agree before we got to the meeting that that was a good idea being recommended. Once, gee, once in 1516, 17 years, an item was withdrawn for further consideration, and of course it never came back. But that's a long, long stretch of years with lots of really consequential decisions being made left, right, and Sunday, and there was nothing that we weren't prepared to examine up close and really pay attention to. So, wide-ranging series of different possible questions, and never any real doubt about the rigor and specificity and the detailing of the homework. I've served on 14 different investment committees, and the usual due diligence is four or five references for any major manager decision. Ah, not at Yale. 15, maybe. 20, maybe. Might even get to 25. And the rigor and depth of it, when I went in the military, I was going to be top secret cryptographic analyst, so I had to get cleared by the FBI. And they did call and talk to all the neighbors. What was he like when he was growing up? Did he ever get in trouble? Most of my neighbors were intimidated, but it was a wonderful discipline on the integrity of granting status to seize government secrets. It's the same sort of a thing. The reason for doing the meetings in a way was to increase another…

AI assessment note: “we took each item one at a time”

Q And so what does the investor composition look like today?

A A hundred percent reversal, plus, plus, plus. Instead of 90% of trading is done by individuals. It's now nine, nine. That is, 99% of trading is done by computers in the cash market and derivatives markets added together. Derivatives markets a little bit bigger in the cash market, but 99% of trading. And that, of course, in my mind is the final bell ringer. So I want to explain some of the other things that go into it before you get to that, but 99%. Here's the final Slammer. So there you are, professional investor. You have noticed that you're getting better and better and better over the years because your skills keep getting better. You've got better tools to work with. Computers like you wouldn't have dreamed of five years ago. They're terrific. I've got more power in my cell phone in my pocket than an IBM three 60 computer would have had. Holy crow, that's amazing. Yeah, it's just the beginning of the story. You have gained and gained and gained. You have research services like you never had before. Want to have it right now? You've got it. Through the internet, it's there all the time. Everybody gets it. So you're looking at yourself, and you're saying, Ted, this is really terrific. I'm better than I used to be. I've got more sources of information than I ever had. I get it very, very quickly, and I can act anytime I want to. There's only one irony.

AI assessment note: “Instead of 90% of trading is done by individuals. It's now nine, nine.”

Q So there's a lot of very smart people, CIOs, teams in allocator seats, endowments, foundations, pension funds, sovereign wealth funds, but few. That have had both the duration and the success that David had at Yale. So what was it about how David went about it that allowed them to have such a high hit rate on these effectively lesser known early stage managers?

A Well, in a lot of different ways of coming at it, but have you ever read Ted Williams' book on hitting? He lays out the places where the ball might come across the plate, and he labels, I can hit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . At selecting and evaluating managers are really good at the mathematics, obviously. They're really good at the psychology of the individual leaders, and they're really good at the psychology of the team that's working with the real leaders. And if you know that's what you're looking for, you will look for it with considerable rigor, and because nobody else has done that, the other guy, the investment manager, Is not going to realize what you're doing until it's too late, and then he knows where you are, and you know where he is, and I think that's a key part of it. [...]

AI assessment note: “They're really good at the psychology of the individual leaders”

Q Well, Charlie, I have a few fun closing questions that I managed somehow to not have asked you previously. So I'm going to walk through those. First is, what is your favorite hobby or activity outside of work and family?

A That's a really tough one for me, because I love the work that I do, and I describe it to friends. I say, you know, I quit working at 32, and I haven't worked since then. But most people say, yeah, yeah, yeah, but you're still working all the time now. Well, that's the way it goes. I guess you'd have to say writing is my favorite hobby, because the opportunity to try to figure something out And that's where the title of the book, Figuring It Out, comes from. I've been trying for years and years and years to figure out what is it that we could be doing that we're not doing? What is it we are doing that we shouldn't be doing? What works and what doesn't work in the investment management world? And it, you know, it's just fascinating. And so I love doing that. I love the work that I'm doing so much that I'd have to call, that's my hobby.

AI assessment note: “I guess you'd have to say writing is my favorite hobby”

Q And what are the challenges of getting that message out so that people understand it and act on it?

A Nobody's paying attention to it. It's too late. It's the big problem. The second is Congress is not doing it because why? Well, they've got all the other things that they're dealing with, and those are politically urgent issues that they've got to be prepared to run on, and nobody's thinking about, hey, you know, be really good for America if we all agreed to move retirement age from 63 or four up to 70, then companies should have to adjust and individuals have to adjust, but that would make a huge Positive difference. And if we encourage people not to take their social security until they're 70 and a half, and if we encourage people to keep working, it's the best thing people could do. And I left, you know, I'm now just past 80 years of age, and I'm having a wonderful time working. I'm lucky. I'm in a line of work that I enjoy and love. I'm not a coal miner, and I'm not a ditch digger, and it's not Tedious and boring. It's interesting, but it does keep you alive and well to keep going.

AI assessment note: “Nobody's paying attention to it. It's too late. The second is Congress is not doing it”

Q Save it for later. Back then, how did price discovery work if 90% of the people were trading because of reasons exogenous to the market?

A They bought on the basis of what they had read in the local newspaper, or Business Week, or whatever place, or what had they heard? They might be pretty active. Maybe 10% of people were pretty active, sort of day traders. How do you do that? You call a broker, Pay 40 cents a share commission, and buy some good stocks. And if you want to do a little bit better, from time to time trade stocks, and try to do a little bit better than that. Or you might be, it's early days for that sort of thing, but you might be investing in mutual funds. You find a mutual fund that had really good investment results, and you'd buy in and hope that that good investment result would keep going.

AI assessment note: “They bought on the basis of what they had read in the local newspaper”

Q What's new in the eighth edition compared to the seventh?

A The biggest information for people who are interested in the profession and for people who are looking for a good manager is the data documenting the inability of active managers to outperform other brilliantly talented, fully informed, Fabulous equipment, active managers in very, very, very large numbers who have been making the market more and more and more efficient or close to perfect or accurate, whatever term you want to use. The privilege of having lots of opportunity has gone down and down and down and down. Then the reason is ironic because the quality of active management has gone up and up and up and up, and that's the reason the opportunity has gone down and down and down and down. So talk about a group of people who are their own worst enemies. And we're talking about some of the most marvelous human beings in terms of talent, character, personality, ambition, drive, skills, any dimension you want. These are the people that I admire most. It's just terrific. But trying to beat each other is really, really hard. It really bothers me when people call indexing passive because nobody wants to be passive. Imagine, Ted, if I introduce you, this is Ted Snyder. Ted Snyder is He's passive. People say, well, I think I'll go talk to somebody else, or how would your wife feel to find out that you're passive? If you think about it for a minute, wait a minute, wait a minute. Ind…

AI assessment note: “The biggest information... is the data documenting the inability of active managers to outperform”