The Exchanges

Q So what were the formative lessons that you learned from those early trading experiences?

A One of the first lessons you have to learn, and it's a painful lesson to watch, is gap risk, especially when you're an options trader. So I was down in the pits in 1994, and the way a lot of trading operations worked in O'Connor was one of them, you got paid each year at the end of the year, and December 1994, the peso devalued, and we went from having A spectacular year to having a horrendous year, and then one of the pits I was in, because you would cover more than just one pit, we traded a lot of Mexican ADRs, and that pit was, I was probably the only trader that was associated with an institutional platform. The rest were local, so they were primarily risking their own money, and watching them get devastated by the peso devaluation, Was, like, a really formative moment in my career, and also, by the way, watching the opportunity on the back end of that, when there weren't too many people left standing and able to take advantage of that. There were two sides to that, but it was a pretty awesome learning experience.

AI assessment note: “One of the first lessons you have to learn, and it's a painful lesson to watch, is gap risk”

Q See, you mentioned the risk of not knowing which domino was going to fall next on the banking side. Was O'Connor part of UBS at that point in time?

A We were. So we were wholly owned by UBS, and we actually had prime brokerage kind of assets exposed at that point in time, and actually one of the somewhat controversial decisions I made was I pulled from a number of different prime brokers, but UBS was one of them. You know, and again, that, from my perspective, I had a fiduciary responsibility to protect our clients, and I also felt an obligation to the team members. If something had happened to UBS during the financial crisis, we all had a lot of deferred that, depending on what legal opinion you believed, may or may not have been money good anymore. So I felt a real responsibility to both stakeholders. I knew that politically it could be dangerous, but I didn't think that should be part of my calculus.

AI assessment note: “We were. So we were wholly owned by UBS”

Q Well, why don't we just start in how in the world you go from a cross-country star to trading right out of college?

A So I had an interesting summer intern experience. It was 1990, and I was going to be an intern at Citibank. And if you remember 1990, it was in the midst of probably the biggest banking crisis since the Great Depression. So we show up for the first day of the intern program, and someone comes and asks for a volunteer to be an executive assistant And the other interns around me are looking at this person incredulously, wondering why anyone would raise their hand. But I figured there had to be a catch here. So I raised my hand. And long story short is they needed an executive assistant for John Reed's chief of staff's chief of staff. But the good thing was, back then, the city group was run by the policy committee, and they all sat at three 99 park on the second floor. And believe it or not, the chief of staff's chief of staff sat on that same floor. But better yet, because he was the lowest ranking executive on that floor, my desk that summer was right outside the men's room. So you had... You had a front row seat. You know, Citibank was the biggest bank in the country at that time to this crisis, and it was incredible, and right then and there, I decided that I wanted to be an investor and not an investee.

AI assessment note: “right then and there, I decided that I wanted to be an investor”

Q As a whole, your pool of capital is big enough so you could make big commitments and try to exert some of those desires on a general partner. The flip side is, well, maybe you don't want to be big when those practices are out there. So how do you kind of address that in practice in the market with the relationships you have?

A So I think it's just in conversations, and I think you pick your moments in time when you are going to be bigger and you ask to address them. I have talked to some of our peers that, you know, we're not the only ones who are, who are focused on these issues. Right now, private equity firms are able to dictate a lot of the terms because there is so much money chasing that opportunity set, but I think starting these conversations now is important and acknowledging that the issues exist. We just had a, uh, A firm that asked for an extension. The results of the, uh, so far have been poor. It's like a six percent IRR. They're asking for an extension where they want us to pay a management fee while they extend the call option of their performance fee. And it's funny, I was talking with our team, and they're like, ah, let's just consent. It's not worth it. And I'm like, wait a minute, let's have a conversation about why we will be happy to consent, but why they should not charge us a management fee since they're extending the duration of their call option. It's So I think it's having those conversations and not shying away from them, I think is pretty important.

AI assessment note: “you pick your moments in time when you are going to be bigger”

Q How much of that internal book is equities and credit?

A The majority is equities and credit, and we do have a macro book as well, but the majority is equities and credit. We also have been building in a fairly, um, focused way an internal private credit book, and in private credit, we've been very focused on going after, obviously, every day you see a story on, on the crowdedness of private credit, but a lot of the assets that have, this goes back to our competitive advantages, The assets that are being raised for private credit tend to be being raised in dedicated private credit funds. They usually have some kind of term lock, and they need to produce something like high single digits, low teens returns to keep their investors happy and to justify both their fees and their lockup. What we've done is we've gone after lower yielding private credit that has hard asset coverage that isn't sexy enough, For those private credit funds, but for us, it gives us a really attractive return. We can lever that return to get to a double digit, because we have this, this incredible set of assets on our balance sheet, so we can borrow against our public equities at Fed funds plus 20 basis points, lever up this safe but esoteric private credit, and it works really well. And the other thing is, when we're kind of underwriting that private credit, We don't want to be in a deal where there's 20 other people around the table, because, you know, invaria…

AI assessment note: “The majority is equities and credit, and we do have a macro book as well”

Q Were there seminal moments in that time that you remember? So it's one thing to look back and say, hey, we were able to do that. It's another thing to actually step in when everything's falling off a cliff.

A So a couple things, and again, this, I think, goes back to the culture that O'Connor has, is in the fall of 2008, when things obviously were going pretty badly for markets generally, the group of senior investors and myself, we literally hunkered down in a room and we looked across the opportunity set and we were, instead of people wanting to hoard capital or point fingers, we really were able to kind of Evaluate and pivot to where we saw the best opportunity, and that, at that point in time, one of the things that was really key is you didn't know the next firm or bank that was going to get tapped on the shoulder and liquidated, so you wanted to go to opportunities where there was a catalyst that might not be market-dependent, and you also wanted to make sure you weren't beholden to financing markets and leverage and And I think we did that well, and by, in doing that, we had to sell some things where we, we were basically crystallizing losses and pivoting to other areas, but it was, I think, the only way to execute on that is if you have a team that trusts each other and is communicating really well. The other thing I think we executed well in that moment in time is As markets started to recover post the first quarter, there was a ton of momentum, and we didn't settle into that momentum. If anything, we added into it, whereas I think a mistake some investors would make is tak…

AI assessment note: “in the fall of 2008... we literally hunkered down in a room”

Q And that strategy, so there's a lot of ways of thinking about a multi-strat across equity and credit. What was the kind of risk and return framework you were trying to create?

A We wanted to produce returns that weren't highly correlated with natural risk assets that clients would have in their portfolios. We were trying to keep a fairly high liquidity profile to give us the ability to be nimble. From a return perspective, we were looking at something in low, single, mid-teens type of returns. And I think we did a really good job for a period of time in the financial crisis I think we navigated as well as anyone, both in terms of truncating risk, but as importantly, taking advantage of the dislocation that was created. And we started to make money in November of 2008, just by kind of repositioning the portfolio and taking advantage of areas where kind of the rubber band had really stretched.

AI assessment note: “We wanted to produce returns that weren't highly correlated with natural risk assets”

Q 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. Let's start at the individual manager unit, whether internal or external. How do you decide if a manager's right for your portfolio?

A So, and I know this is one you hear all the time, alignment is a really big deal, and like that, without alignment, you don't get out of the box. So I think it's first about alignment, then I think it's about process and them being able to articulate and us being able to believe that they really do have edge and something persistent in terms of how they can extract that edge over time. Internally, it's really important. One of the things that we've been trying to do is really connect the dots. So when we think about the competitive advantages of this platform, and you think about kind of the asset management industry overall, or the hedge fund industry, allocators tend to allocate capital in very, very tightly defined ways and tightly defined boxes. And being able to kind of connect across asset classes and across geographies, There's not a lot of places that can, can do that with internal investment expertise, so when we think about allocating internally, we want to make sure that manager is going to make the other team members alongside them better at what they do, and by the way, that also makes the bar for an external allocation That much higher. Because if we can do it well internally and get that mind share, I'd rather do it internally.

AI assessment note: “I think it's first about alignment, then I think it's about process”

Q It always sounds great to say, hey, we have a group of senior people who were able to communicate together. What did it actually take? To get to that point in time, so when you were in the room where it was happening, that you already had that trust.

A So I think it's the actions leading up to that point in time, the moments in time when someone invariably loses money, but loses money for the right reason. We're in a, in a business where we make calculated bets, and sometimes they just go against you. So I think that trust in moments like that had been built up over a long period of time. I'm also a really, really big believer in, like, physical proximity. So spending time kind of shoulder to shoulder with people Over 20 years, it matters, and it's really helpful. I'm also, I'm a pretty candid person, you know, and I have an Irish temper, so people tend to know where they stand with me.

AI assessment note: “moments in time when someone invariably loses money, but loses money for the right reason.”

Q In the same way that you've kind of shifted the public equity more towards internal, do you try to do that on the private side to over time to address these structural problems?

A The private equity allocation that I inherited, and this goes back to our spend and what we're solving for being a little bit different than your typical foundation or endowment, we were over allocated to private equity generally with money in the ground and forward commitments, so we're in a situation right now where we're still making allocations, but we do want our portfolio to naturally roll down, so I don't want to build up a big internal Capability. And again, you know, I mentioned we have 90 external private equity allocations. Some of those firms are really spectacular at what they do. And one of the things that, that I constantly push myself and the team to be intellectually honest on is we should do internally what we're good at doing internally. And when there's people who are outstanding and have a niche, they deserve our capital and we should be allocating to it. And specifically in the private equity space, The people who I see doing the best job are the middle market type private equity firms who've really carved out a niche where they do add a lot of value to the companies they buy in their portfolio.

AI assessment note: “so I don't want to build up a big internal Capability.”

Q Yeah, so I'm really curious to ask how you get into there. So you're starting with a normalized or, you know, it's kind of a policy risk framework, and you want to grab all these attractive pieces of risk. How does that happen?

A Again, we have this top-down framework, but we also bottoms up, and we look externally and internally, and again, it goes to the amazing advantages I think this platform affords. So we allocate to 20 external hedge funds We allocate to over 90 external and private equity funds, and internally we have 28 portfolio managers and 17 kind of strategies or netting units, but we're thinking about building that portfolio. We're looking at those opportunities. We're thinking about when we look at a given external or internal strategy, we're thinking about what's the persistent beta of that strategy? What do we think the excess return looks like? And how does that excess return look relative to both the beta in our portfolio, but also the other excess returns that we have available to us?

AI assessment note: “we're thinking about what's the persistent beta of that strategy?”

Q And what did you learn in that time? About motivating and managing people in this space that you might not have been exposed to before when you're running a hedge fund.

A So I think a couple things. First of all, communication. I talked about the fact that I'd worked at O'Connor with people for such a long period of time. When I took over running investments at UBS, yeah, I had to earn credibility with people who I didn't know as well, and they didn't know me as well. And to do that, you really have to spend time. You have to communicate. So those skills actually were transferable when I came here, and I think that was really interesting. I also, It was good to understand the utility curve of the client who allocate traditional asset classes. I had a big passive business under me in that role, given the increasing dominance of passive players in markets. I think that was really, really helpful.

AI assessment note: “First of all, communication. I talked about the fact that I'd worked at O'Connor”

Q How do you calibrate the degree of concentration? So you talked about coming in and saying, wow, we're over diversified. Where are you trying to get to?

A We're trying to get to returns that are durably better than what you can get from a passive portfolio. And when I say we're over-diversified, one of the easy tells is that when you aggregated our external managers and you took out kind of beta, which isn't hard to kind of approximate, we were not getting an excess return. It was Zero. And that's, you're paying a lot of fees, and you're adding a lot of complexity, and not getting compensated for it. So I think that's an easy tell. The interesting thing is, I've been asked, like, what's the right number of managers? And if you can find really, really differentiated managers that Maybe there's not an answer to that question, but it's really hard to find those differentiated managers, and I think it's gotten harder over time. So we're at, as I mentioned, we have 17 or 16 internal strategies, 20 external. My guess is over time, internal grows a little bit, and external probably stays around here.

AI assessment note: “we have 17 or 16 internal strategies, 20 external. My guess is”

Q What rough percentage of the assets are internal versus external?

A So in public markets, we're about 75% internal and 25% external. And when I came in, we were about fifty-fifty. And one thing I'll say, Ted, is our internal managers, because we're trying to play to our advantages, which are, again, I think are pretty distinct relative to typical asset managers and hedge funds. They've persistently produced really, really attractive returns, and even when you look at kind of the hedge fund industry returns this year, or traditional asset management returns, they were pretty good going into May. It's been lackluster, might be kind, since then. Internally, our excess return, and we kind of measure it on a, you take out beta and then you normalize four or five volatility, they're up about six percent year to date, And it's been a pretty steady march.

AI assessment note: “we're about 75% internal and 25% external”

Q Okay. And how did that role shift from what you were doing, kind of stewarding a hedge fund?

A It's an interesting topic, and it's something that, that we talk about a lot here. I think in the asset management world, the difference between quote-unquote traditional asset managers and hedge funds, those worlds are blurring, and it's really all about what's the value you can deliver above and beyond what I can do for myself, and in that context, I think what we wanted to do with our products we offered clients at UBS was exactly What we had been doing at O'Connor, and it was about delivering valuable set of returns in the context of kind of opportunity set and risk. So it felt like a really natural progression. And I also think, from my perspective, it was a moment in time when the asset management industry overall was going through a lot of transition, and that usually creates a lot of opportunity.

AI assessment note: “So it felt like a really natural progression.”