The Exchanges

Q So once you've given that stability to an individual PM, how do they go about creating that risk controlled alpha so that you then can port that in all kinds of different ways at the firm level?

A Well, it starts with good old-fashioned stock picking and long shorts, so you're trying to pick longs that go up more than your shorts, or in the down market shorts that go down more than your longs, and you're just trying to make the spread and trading around your positions actively to capture those spreads, and so you're typically in equities focused on earnings and multiples. Those are kind of the two main things that drive stock prices, so earnings. Can you get ahead of the street? Can you get ahead of other hedge funds in Estimating earnings inflections, where you're not one, two, or three percent differentiated, but you're 30% differentiated for the quarter, and you might be 60% differentiated for next year, because you figured out something that's going on with this business, which might be a combination of micro factors, where that company's coming out with new products, new processes, changes to their business model, and macro, where something is going on in the macro environment that's really gonna be a huge tailwind or a huge headwind to what that company's doing. And you're putting those things together to arrive in really variant earnings estimates. And that changes all the time, and as people catch on, and you're proven right or wrong, the stock prices will move, and your spread of variants will close, and you have to rotate to something else. So that's one. And t…

AI assessment note: “it starts with good old-fashioned stock picking and long shorts”

Q Which two people have had the biggest impact on your professional life?

A I'd say philosophically, I became a big fan of Ayn Rand in college. I read Hat to Shrug, which became my favorite book. I'd say it had a big influence because a lot of this game is really mental, and so you have to have your philosophy aligned with what you do for a living. If it's not, it's very hard to have sustainable success, and so if you have a lot of conflict and guilt around being successful, you wind up self-sabotaging yourself, and I've seen this a lot over time, and so She was very good at articulating a very cohesive, positive philosophy for being a successful, productive individual, and for capitalism in general, not just as a positive economically, but as a moral positive, which really helped not ever having those type of conflicts where you could basically be a positive influence On a larger level, on a society level, company level, et cetera, while being very individually successful, that it's not a trade-off between the two. So that was very impactful to me, and I've gone back and read it a number of times over the years, and I've gotten involved with the Imran Institute on the back of that. We actually started a scholarship program last couple years called Atlas Fellows, based on the title from that, and their funds are called Atlas Funds. We, uh, find really qualified, top tier, driven, but under resourced high school kids and help them with college scholarsh…

AI assessment note: “I'd say philosophically, I became a big fan of Ayn Rand... Steven Schoenfeld”

Q How'd you find yourself on a path from that to figuring some things out?

A I was very passionate about it, and I really enjoyed it. Always had good perseverance, not much natural talent, but good perseverance, and so I figured if it was something I was really committed to, passionate about, I got myself into a place where I could have some people to learn from that I'd be able to figure it out eventually. So after being a broker successfully for a few years where I was doing well on the sales side, but I was losing all my commissions trading for myself, I applied to a bunch of different trading firms. Hedge funds, and I was rejected from pretty much all of them. I didn't really have any relevant investing experience, and I was very young. I got lucky, and I answered a newspaper ad back in the days when you had newspaper ads, and it was the one time that Schoenfeld Securities ran a newspaper advertisement for traders in Chicago when they opened up a Chicago office, and they kind of came in with a few guys in an empty office that they wanted to fill. And they were looking for people that didn't have preconceived notions of what it took to be a successful trader, didn't have any bad habits and ingrained biases, and so I fit that really well. I was very clear that I didn't know what I was doing, but I really wanted to learn and was very committed to doing so, and so I was hired into their proprietary training program. So it was a great opportunity because…

AI assessment note: “I answered a newspaper ad... Schoenfeld Securities ran a newspaper advertisement for traders”

Q Before you brought in an analyst, were you focused at all on fundamentals?

A I was focused on the change in fundamentals and news flow, so I wasn't focused on fundamentals of trying to figure out what a company was going to earn next year, but we were focused on what is driving the stock for the next few days and few weeks. We weren't building models or running valuations, but we were very focused on what are investors anticipating going into this earnings print, or what are they anticipating going into this conference presentation? What are the one or two key things to be on the lookout for? And trading in anticipation of that, but also a lot of times in reaction to, how is the market reacting to the news flow? If you're getting positive news that was sort of as expected, but the stock is not acting well, like we were very focused on, you know, trading the other side of that and capturing the sentiment swings. So they're more like multi-day type swing trading, where fundamentals were input, but not fundamentals in terms of long-term valuations or models.

AI assessment note: “I was focused on the change in fundamentals and news flow”

Q describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. So at each of those levels, whether it's bottom up the PM, the opportunistic, the management looking at it, or the infrastructure required, when you see that pivot from 40% allocation to 60%, is there a bias in the firm that is momentum driven or mean reverting driven of what defines an opportunity set?

A It's usually a combination, and it depends a bit on the strategy. So in strategies that are more RV-oriented, so you could think about that as fixed income relative value, for example. Or merger arbitrage. Things that are very spread-oriented. There's a cost of capital, and there's a typical spread that you can earn if you're doing a good job in that strategy. And then once in a while, there's a dislocation. Some deals blow up. Some firm has a hard time. Something surprising happened. There's a bunch of stop-outs. And all of a sudden, the spreads are much fatter. And so those are more on a mean reversion basis, where those guys will pick up their hands and go, this is the time we need to step up. And the trick is you want to hopefully have navigated the drawdown period well enough to where you have the ammunition to step up. Because it's always easy to say, yeah, of course we should step up. Most of the time things come back. But if you don't have the room there and they don't come back for a while and they get worse, now you have a giant hole in the front. You have to navigate the balance of those risks. But if the teams have done a reasonable job and that business is doing fine overall, then you definitely want to play offense. When you're in a position to do so and capture that. Other strategies that are, I would say, a little bit more momentumy, like the growthy sectors in …

AI assessment note: “It's usually a combination, and it depends a bit on the strategy.”

Q over time. But as you're also defining the opportunity, you're talking about trying to bring in really talented PMs in each of those spaces you'd like exposure to. How do you balance that desire to have initial risk control to make sure that you're not making a big mistake with trying to bring in really talented people that probably want to put their pedal to the metal on day one?

A The two concepts that we think about with that are the capital allocation and the business plan has to be commensurate with the experience of the person. So if you're hiring somebody who hasn't run money previously, but you think they're a talented analyst who might be able to convert to a portfolio manager, we'll put them through a PM development program, and it's much more structured in terms of Here's the mandate. It's very well defined. It's relatively narrow. The team is small to start and you're building it over a few years. You're not running a lot of capital to start. And with the success, you're getting more resources for all of those. And then the guys that work out, we've had a couple of guys who've become partners now who started in the PM development program. But five years later, they're running very large teams and large allocations and our partners in the firm. But they didn't start with that. Now, on the other hand, if you go all the way to the other side of it, you're taking someone who has been very successful running a lot of capital at a similar firm where you think the risk limits and the resources they had, we could certainly replicate or do better. So their skills should be pretty transferable. And they've had really good track record managing both teams and capital. Their business plan and capital allocation are going to be much more ambitious to start.…

AI assessment note: “capital allocation and the business plan has to be commensurate with the experience”

Q How do you think about the war for talent? Maybe the right way to think about it is in kind of supply and demand. Are there a limited number of PMs that can succeed in that model? And if so, and the capital keeps coming in, what happens to that competition for that scarce resource?

A Yeah, I mean, I think there's a limited number of good PMs in general, so I don't think it's limited to this particular model. I think any type of high alpha content model where you really need to have a lot of skill, like by definition, there's few people that are going to have a lot of skill. How do you compete for that? It's a self-correcting mechanism to some extent. Like any market, at periods, it's going to become overheated, and at periods, it's going to become depressed. So if you have a strategy that's done well, and everybody's making money in that strategy, the talent in that strategy tends to get bid up. Then more people build teams in that area, more people overpay for the cost of building those teams, more capital gets deployed there, the returns come down, and the management of these firms got to be successful for a reason. We don't tend to keep doing the same dumb thing over and over again, so if you start Losing money on something, you'll pretty quickly adjust. And so then the cycle repeats and rinses the other way, and all of a sudden, talent in an area goes from overbid to nobid very quickly. And so you try to be a little bit contrarian. It's hard to be completely contrarian. Just like in the markets, I think there's a balance. I don't think you want to sit with your value stock for 10 years for the one year that it's going to bounce. So we're always bid for …

AI assessment note: “It's a self-correcting mechanism to some extent. Like any market, at periods, it's going”

Q As you look at the overall portfolio, let's just focus this on equity long short. The notion of volatility scaling, as it relates to both what you're doing, and then of course, the other types of capital, the vast amounts of capital in some of your peers. How do you think about navigating not just your own portfolio, but the broader equity market environment that your PMs are participating in?

A Yeah, so you always think about the positioning and the crowdiness in different areas. In general, the best environment is when there's a lot of generalist participation in a strategy, and there's a lot of money coming into a strategy. Because then your specialist participants, whether they're trading bonds, currencies, commodities, equities, like they should be able to do a better job of forecasting where the capital is going to go. Another side, the worst environment is when there is no generalist capital, and money's flowing out of the strategy, and the specialists in the strategy are all underwater. And so in that environment, you're trading against other specialists, and nobody has much risk tolerance, and so you have this cascading drawdown type of periods. So you want to know which type of period you're in, And adjust the capital allocation accordingly. And again, you're never going from all in or all out. But you're certainly changing it relatively aggressively depending on that period. Your risk in a particular sub-strategy could be up or down 50% very easily if you're in a good period versus poor period. So how we guide PMs when we have meetings and talk about kind of what's working in the market and what the environment is for a strategy, how much room you're willing to give things, how much Positioning becomes a factor, and how much you're looking to ride new winner…

AI assessment note: “So you want to know which type of period you're in, And adjust”

Q And as you look at one of these people when they join you, compared to someone who's running an independent fund on the outside, what is it that you think creates an edge for the individual PM underneath your umbrella?

A Well, first of all, specialization. I think in longshirt equity, it's very hard to run a standalone sector fund. I mean, it's hard to run any sort of fund. You have all the challenges from running an equity fund, but then on top of that, you have all the challenges from running a specialist equity fund. Sectors come in and out of favor. Think about energy. How many times has it gone through these multi-year cycles where it's fantastic and then it's really difficult to trade? Where generalist money is just flowing out and you're just have the specialist hedge funds fighting each other. That's a very tough environment to trade in. So if you're on a platform and you're running that type of strategy, it could be anything. It could be tech, it could be healthcare, it could be financials. Is there a great appetite to invest in a standalone financial fund? Probably not. But even in areas like tech or healthcare, it's very hard because for periods in time, there's just less to do. And what do you do during those periods? How patient are investors during those periods? Whereas if you're on a platform and there's 50 other teams in different sectors, and the money can flow up and down depending where there's opportunity to help pay for the various resources and to not distract you with explaining to investors why it's a tougher period all the time, rather than trying to innovate your proc…

AI assessment note: “Well, first of all, specialization. I think in longshirt equity, it's very hard”

Q In what's clearly a competitive world for talent, what is your pitch to the PM relative to your competitors to get them to join you?

A It starts with that philosophy that we try to be a really good partner for people in the best sense of the term. So if you think of the venture capital business, which is we're building a growth stage, venture capital business is another vertical. The best investors in that space, how do they get the best company founders to partner with them? Why does Mark Zuckerberg partner with one versus another when he's coming up the ranks? The best founders, and I think the best PMs, both look for a really value-added partner. You don't want somebody who's all over every decision that you're making where everything you're doing is micromanaged and it's very Vague, whether the subjective decisions are going to go your way or not. But by the same token, I don't think the best PMs want someone that's completely hands off because a lot of the experience that a firm has, having gone through it with hundreds of other PMs over time, you don't have to reinvent the wheel on everything. They want some guidance on how have other successful folks dealt with this problem? How have they built out their teams? What's worked? What hasn't? How have they developed their analysts? What's been the best practices in data monetization? How do they utilize tech? What's the best practices in portfolio construction? And so you want the benefits of that experience and that business building from a partner, as opp…

AI assessment note: “we try to be a really good partner for people in the best sense”

Q What's happened with the other side of the balance sheet and the types of investors and how you've gotten the capital that you've needed to grow in the ways you want to over time?

A Yeah, this is something I wish we would have done a better job of early on. Unfortunately, when we started off, we were coming from a prop background. Thankfully, there was enough interest, and we got initial capital, but it wound up being very volatile capital, because we didn't really have an institutional approach and institutional investors, and so it wound up with too much momentum, and sometimes the momentum was based on us, where I remember at first we, we went from 300 to 600, and then we had a drawdown, and we went back to 300. In the meantime, it hired a lot of people, and I was like, oh my gosh, you know, how are we going to deal with this? We made the money back, and it was fine, but it happened again in a way where it didn't have anything to do with us, but we went from two and a half billion to one and a quarter billion, and we made money in a way. People needed their capital, and we decided not to gate them, and we were liquid, and so people took their capital. Post that, and particularly the last five years, we really emphasized a more institutional approach, both first in the types of investors, and then in the terms. I mean, I think you need both, and now our success and consistency over time, we've had, knock on wood, 20 out of 21 positive years, and very consistent volatility, and drawdown management, and Zero correlation over that time. That's enabled us to…

AI assessment note: “we really emphasized a more institutional approach, both first in the types of investors”

Q How have you thought about that other divide between, say, equity and lowering the capital structure?

A So we have a credit investing business also relatively new that we started in the last couple years. We started with a couple credit portfolios. We're looking to build out more, but we trade converts, we trade high yield, we trade investment grade, we trade in the US, we trade in Europe, but still relatively small. It's just a couple percent of our AUM. Whenever we start new businesses, we start them small. We figure we're going to be the worst at them when we start. And as we build the expertise and the teams and the infrastructure and they're generating P&L, then we look to grow them. So now we're in the process of scaling those teams. Plus we're adding a few more teams with different geographic expertise, different types of trading style. And if we're successful with that, then you can look and go and say, okay, we have success at public credit. Should we look at private credit? You want to have success at each piece before you sort of go to the next piece. Same thing in commodities. If you had success in financial commodities, then you can look at physical and how do you leg into physical? So we're starting to work on that. So it's one step at a time.

AI assessment note: “we have a credit investing business also relatively new that we started”

Q What were some of the lessons you remember learning in those early training programs that helped you set your path?

A They did a good job about really kind of limiting the things that you could do. One of the challenges, like learning any new activities, at first it's kind of overwhelming, where there's like a lot of different things that you could do. So whether you're learning how to ski or how to swing a tennis racket or how to trade, it's like a lot of footwork, your balance, your hand, your eye, the ball, this and that. You're trying to just limit it, and so they did that with trading where you couldn't just come in and trade Whatever you wanted, however you wanted it. You had, like, very tight risk limits, very tight limits of what you were allowed to trade, when you were allowed to trade it, how much you were allowed to risk, what were the holding periods, and you just create, like, a very well-defined small box to start, where you just have, like, a few elements to worry about. Only had a small number of trades, a small number of potential trading instruments, small holding periods, You kind of define the types of trades that you were looking for. When you define that, then you try to build from it. And then once you had success within that small box, then you gradually were allowed to expand the box. And you could trade more things, different holding periods, different types of trades, more capital, etc. But at the beginning, it was very tight in all those aspects, which I think was h…

AI assessment note: “They did a good job about really kind of limiting the things that you could do.”

Q So as you look at this business today, you're one of, I don't know, four or five of the big players in these pod shops. What's been the driver of growth over the last couple of years?

A The term pod shops makes somebody visualize lots of very independent teams where the firm is a capital allocator and a back office provider, but doesn't do much else. And teams do their own thing within their risk limits. We've always tried to strike a balance between creating the benefits of that, which is lots of independent thought and creativity and Entrepreneurial drive from the heads of the teams. But we really try to help the teams build businesses on the platform, and we really try to create strategies and build businesses and then fill them with teams as well. So it's both bottom-up and top-down business building. And so to answer your question, in the last five years, that's really accelerated even more, where we have Ideas, and they're iterative with the teams, and they constantly evolve as you see what's working of how to build optimal investing strategies where you're really building a business. When we started out building commodities, for example, like we didn't really have any commodities, and so what's the best way to do that? And you try to outline what's a mature commodity business. Look like, and what's stage one of that, stage two of that, stage three of that? What do the teams look like? What's the infrastructure that you need? What kind of team leaders do you need? What kind of research and technology stacks do you need? So it's much more than just hiring…

AI assessment note: “So it's both bottom-up and top-down business building. And so to answer your question”

Q How do you think about the PMs leaving the firm?

A We basically guide people, number one, to be very thoughtful on the hiring. The more thoughtful and the more work you put into the hiring process, the better your odds are that you won't have to deal with making a change, or at least not quickly. And we see this all the time. The biggest gating factor to someone's success growing from a first-time PM to an experienced PM or a small PM to a large PM is their ability to build a team, to manage a team. And so defining that to start, like, what are the people you're looking for? What is your ideal number two look like? What is your ideal partner in your portfolio look like? What coverage model do you want? And what are the people look like that are covering those spaces? What's their experience level? And what are your expectations from them? And you want to really figure out how to avoid the expectation mismatches and just doing things that are unrealistic. So we see a lot of times you'll have a younger PM. And by definition, they'll then wind up almost always hiring really young analysts, and the expectation is this person's going to come in and help me make a lot of money. It's just not realistic. At the stage of development that they're in, they're going to take a couple years just to figure out how to be additive. So if you want somebody to come in and help you make money, and you're a first-time PM, you better find a partner …

AI assessment note: “better your odds are that you won't have to deal with making a change”