The Exchanges

Q What were some of the either stories or things that really stood out to you of examples of Bob as a leader?

A The one that stands out above all others was the crash of 87. I'd started running the area in early 87. Bob had moved on co-running fixed income, but on his way to co-running the firm. And so by the time the crash hit in October, we had only been under my leadership for eight months. I was barely 30, not yet a partner there. And we managed to lose the largest amount of money Goldman's risk arb area had ever lost on that day. It was in percentage terms, not terrible. We were quite defensive and quite concerned actually going into the crash. Whereas I think a lot of firms were down 35, 40% that day. A number of firms closed shop literally that day. We came into about 70% cash. We were down four. We had a number of hedges in place. So Not unreasonable, but four percent of a billion dollars was 40,000,040 million to the partners was a very large loss. We were hearing stories of other areas getting shut down, risk getting cut in half in a number of cases. People that had been running the areas for 1015 years were effectively de-risked dramatically. So we were nervous the day after the crash, Talking amongst ourselves in terms of what do we do from here? What do you think the firm's going to do to us? How is this going to all play out? And as we were going through our positions, Bob Rubin came down to the floor and came up behind me and I saw the ashen looks on the people in the meet…

AI assessment note: “The one that stands out above all others was the crash of 87.”

Q And how did you grow into new businesses over time?

A The hurdle for us was always it had to be accretive to the returns. We ended up growing gradually into new businesses. Some of which worked, some of which didn't work. The business that we clearly were going to evolve into was credit. We did that in 2001, 2002. There was no question that that was going to be an ongoing business for us forever. The businesses that became a little more questionable, we went into the emerging market credit business with not great success, stayed in that business for a couple of years and decided to exit it. The businesses that worked better were the credit businesses under John Jackman. He runs our North American credit business. He developed an RMBS business for us in 2007, first from the short side, and then post the great financial crisis from the long side. The CMBS business for us in 2011, there was a big opportunity there, effectively a basis trade between senior CMBS pieces of paper and the CMBX indices. It evolved from there into real estate, In CMBS-related real estate in 2013, 14, when we identified an opportunity that was actually really unusual, where you could, by buying securities that had virtually no value in and of themselves, we paid virtually nothing for them, but they came with them rights to buy defaulting assets out of CMBS trusts. You would be the exclusive buyer of those assets. And so we ended up aggressively buying litera…

AI assessment note: “The hurdle for us was always it had to be accretive to the returns.”

Q So that Bob Rubin Riscarb desk became one of the first great training grounds for what formed the hedge fund industry over time. What was it like being there?

A It was small at the time. We had Bob Rubin, another partner there, Bob Freeman, Amy Stevens, and I on the research side. On the trading side, David Silfen, who over time became the head of the trading desk there, an older trader by the name of Bruce Mayers, who's since passed away. And then a junior trader by the name of Richard Perry. All the decisions got made on the research side. It was pretty intense in that most of the risk at the time at Goldman Sachs was taken in the arbitrage area. There was very little risk being taken elsewhere in the firm. Jay Aaron had not yet been bought. They really didn't take an awful lot of risk in the fixed income side. The lion's share of the risk actually was in risk arb. It was viewed as the single area where they took risk with partner capital.

AI assessment note: “It was pretty intense in that most of the risk at the time”

Q What was it about that group and that training under Bob and the desk and under you that allowed so many people to learn so much and become so successful in the hedge fund industry?

A I think there's a combination of two things. Bob's philosophy was one of uncertainty. He wrote a book on it where you couldn't know things for sure. You had to know what could go wrong. You had to estimate the probability of that thing going wrong and effectively being humble about your confidence level in ultimate outcomes. The second aspect of it, and I think this was really important and something that we tried to Bring to Taconic was the fact that at Goldman, it was the partner's capital. It wasn't other people's money. And that drove a very different philosophy with respect to the risk-taking mentality of that group than if we had been only paid on the upside.

AI assessment note: “I think there's a combination of two things. Bob's philosophy was one of uncertainty.”

Q What did that mean in terms of order of magnitude of risk compared to how you'd think about the balance sheet or the business as a whole back then?

A That's a good question. There were at the time, I think less than 50 partners, not an enormous amount of capital. I think we had a couple hundred million dollars worth of risk at the time when we started. It grew so that by the time I started running the area in early 87, we were running close to a billion dollars worth of capital. It was still a significant portion of the risk taking that we did at the firm. I can't remember when the private equity business started at Goldman, but it was right around that time, mid eighties. The real estate area was a couple of years later than that. So again, even as it grew, the lion's share of the risk was taken within the risk area. Jay Aaron started to grow and grow its currency risk so that by the late eighties, early nineties, it was dominant in terms of the amount of risk that got taken at the firm, but that wasn't the case in the early years.

AI assessment note: “I think we had a couple hundred million dollars worth of risk at the time”

Q What are some of the things that you put in place so that thought process could pervade the organization?

A It's developed over time. The most important concern we had at the time, because right as we were starting the firm, Goldman Sachs was preparing to go public. It occurred to us That much as we would want the firm to be in its private form like a Goldman Sachs forever, that the next generation may have a different view. We wanted to try and set up the firm in a way that it would remain a private partnership and remain effectively aligned with the limited partners the same way Goldman Sachs risk arb area was aligned with the Goldman Sachs partners. So we put in a clause which has been Referred to by one of our investors as the anti-Goldman clause, where if the firm ends up either going public or selling at some point down the road, 30% of the economics effectively gets carved out and goes to Ken's and my foundation. So the intent wasn't for us to get rich if it happened, but rather to have a deterrent to the remaining partners taking it in that direction.

AI assessment note: “we put in a clause which has been Referred to... as the anti-Goldman clause”

Q I'm curious what you found over the years with talent, attraction, and retention, when some of your competitors at least will take the star and pay them as if they're a soul star, that eat what you kill type model. How has that played through in that original concept of who you can have around Ken and you originally as partners over the last 20 something years?

A We haven't had trouble on the retention side paying people equitably. Equitability doesn't mean that you pay everybody the same. You clearly have stars within the organization that have become partners and become significant partners because neither Ken nor I really right from the start took as much as 20% of the economics. There was a large percentage of economics available for the people that really drove the profitability. In addition, they knew that when Ken and I eventually retired, our economic stakes would go to zero and they would effectively inherit the firm. The significant drivers of the economics have stayed. We have 14 partners today. The average tenure of the partners over 15 years at Taconic. The average experience over 20 years. We've been able to keep the stars that we had. We've also been able to attract stars with the same logic. If another firm goes out and tries to hire someone, they can offer them economics, but not partnership, or if it is partnership, it's a small Sliver of the economics that's left. In our case, we can talk to people about partnership and a significant partnership percentage if they end up driving a significant percentage of the economics. And so it's enabled us to go out and hire top talent as well.

AI assessment note: “We haven't had trouble on the retention side paying people equitably.”

Q How do you organize your team to be sufficiently proficient in lots of different areas so that you can spot those air pockets of opportunity and then nimble enough to take advantage of them?

A We started with more of a generalist model, which was more of the model we had at Goldman Sachs, frankly. The issue was more valuation of an enterprise, and that applied to credit just as easily as it did to merger arb. As time has gone on and we've gotten into more specialized We've gone to much more of a specialist model. CMBS is run by James Jordan, who has been in that business effectively his entire career. He now runs the CMBS and real estate operations. RMBS, same thing. We've got a specialist who's focused on that. So each area effectively is run by people that are constantly focused on their areas. What we do to end up getting the capital allocated to the best opportunities is effectively have them raise their hands when they see a big opportunity there. We're not effectively saying you did well last year. And so here's a lot more capital because frequently it's actually the opposite that happens. When an area is done very well, other competitors have also done well. Excess capital is typically being allocated to that area. And the expected returns tend to not be very good. It's usually the other way around. When someone's actually lost a fair bit of money, it's because an area has been quite dislocated. The expected returns end up being bigger, and so you're looking to allocate more. We think of capital effectively being pulled from us rather than pushed by us. The pe…

AI assessment note: “We've gone to much more of a specialist model.”

Q And what was Ken and your vision for Taconic having had that Goldman experience?

A So we had an interesting conversation in late, in deciding to start the firm. Where he said, you know, if we do this right and we create an entity that has some permanence to it, I think we could either sell or take the firm public and make ourselves a pot of gold in five or 10 years. And I came back to him the next day. I said, completely think that you're right and want to go in a totally different direction. And he looked at me bizarrely and said, why and what do you want to do? And I said, well, neither one of us has a huge lifestyle. We both have enough money that we could get by from here easily. We're not gonna be suffering. If we end up with a pot of gold in 10 years, what are we gonna do with it? We're not necessarily gonna live any differently. We could give it to our kids, probably ruin them. We could give the money away, so could our partners. It's not really gonna change our lifestyles one iota. So on the other hand, if we create a firm where we distribute the economics pretty broadly, Amongst all the partners, we'll be able to attract and retain a level of talent that we won't be able to do in a firm where we take most of the economics. We'll also walk in every day, not just with a quality of individual that's higher, but with a real feeling of a partnership, because it will be. It'll really be a true partnership in the sense of distributing the economics fairly. …

AI assessment note: “if we create a firm where we distribute the economics pretty broadly”

Q When you're going through the portfolio with the team portfolio managers, how do you implement that construct on the downside?

A The way we calculate the stress test loss is on a discrete basis. We've got statistics that model the portfolio that look at what standard deviations of loss are, et cetera. But in a big dislocation, the loss that you're going to suffer has nothing to do with the standard deviation of risk That the entire portfolio has. Your statistical analysis breaks down when you start to look at tails. I like Emmanuel Derman's quote. He used to work with me at Goldman and the equity derivative business who said that all models are wrong, but some are useful. Models are very good at predicting what will happen within one or two standard deviations of the current situation. Where models break down is at the tails, and it depends on the nature of the security. The nature of the risk that you're taking. And you've seen that time and time again, whether it's the Bear Stearns mortgage hedge funds that broke down in 2007 or long-term capital or date back to a number of situations, people will frequently talk about eight or 10 standard deviation events, which clearly could never happen. And it's a function of those models breaking down. So while we do look at the statistical analysis of the portfolio to try and understand what our effectively DVO one risks are, what our directional risks are, In the portfolio. To analyze our stress test loss, we assume that correlations will go to one, and we'll ha…

AI assessment note: “we'll have each of the managers go through their entire book... position by position.”

Q Inevitably organizations have some turnover, whether it's voluntary or let's call it involuntary. And when you have that type of meritocracy partnership feeling, How have you handled those situations where, for one reason or another, there was turnover?

A And it's been both, as you say, voluntary and involuntary. We had two partners, the only people that left to go to another business that just wanted their name on the door. We knew that was going to happen at some point. We've also had partners that in a couple of cases didn't work out, and we were pretty straight with them in terms of things not heading in a direction that was really going to work either for us or for them, probably leading to an area where at least for some period of time they would have Significantly less capital to work with until they effectively rebuilt their ability to demonstrate that their commercial instincts were still there and they could still deliver for the firm. In most of those cases, the partners decided to just move on and find something else. It's been relatively smooth even when we've had those difficult conversations. We've also had conversations where we took someone's percentage down Dramatically based on changes in contributions to the LPs and based on role. And a couple of those have led to people effectively saying, thank you. In one case specifically, they literally said, thank you for doing this. I've come in every day feeling like I was being overcompensated. It didn't feel good. I didn't feel like I had a future here. You found a way for me to continue to contribute at a level where I think it makes sense.

AI assessment note: “we were pretty straight with them in terms of things not heading in a direction”

Q What are some of the areas that you're excited about today?

A We're clearly heading in an area where, as I said before, excess liquidity is going to be much less prevalent. Financial conditions are going to be tight for quite some time, and that lends itself to a credit cycle that's going to be more normal. I think as financial conditions tighten, especially right now, over the next quarter or two, We're heading into a time where the likelihood is you're going to see corporate default rates substantially higher. That's particularly true in Europe, but Europe is more of a bank credit market, not a security credit market. But I think both in North American credit and in European credit, there's going to be a tremendous opportunity to own illiquid distressed assets, illiquid distressed credit for quite some time. Especially in Europe, since it's a bank credit market, having committed capital is really important, but in the US as well, liquidity of markets is getting more and more challenged, and to be able to optimally take advantage of the opportunities that I think we're going to see over the next couple of quarters, you really want to have committed capital ready and able to deploy.

AI assessment note: “tremendous opportunity to own illiquid distressed assets, illiquid distressed credit”