The Exchanges

Q Well, I thought it would be fun. We don't have to go all the way back. I know that some people in this business got bar mitzvah money and started trading. I think you went even further back than that, but why don't you take me back to your early exposure in the hedge fund area?

A I didn't really think of it as hedge funds when I first got exposed, but so in what would have been, I took over the equity derivative business at JP Morgan. That was tiny at the time. It was 10 people and was losing a little bit of money and five million of revenue. I think we were trying to work out how we made money out of this thing. So we were a money center bank and we didn't really have equity clients and they were trying to build a cash equity business. And I was trying to make the equity derivative piece work. And what we realized was we needed to do some stuff that was basically prop trading. And we started doing various things that now we would think of as classic hedge fund strategies. We had convert ARB, we had cash futures ARB, we had event ARB, we had, those days there was a lot of things that were called ARB and you could make money out of them. And when I left, the first phone call I got was from Harlan Koremwes at HPK, who said, So I guess you're starting a competitor. And I was like, what do you mean? He said, well, I presume you're starting a big hedge fund. It's like, oh no, I hadn't really thought of it, but that was when I realized really what I'd been running embedded within JP Morgan, as well as a client business was something that looked like a big hedge fund.

AI assessment note: “started doing various things that now we would think of as classic hedge fund strategies”

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

A So that one is easy. I mentioned earlier that the boss I had at J.P. Morgan, who was called Ramon Olivera, Was the best boss I've ever had. And I learned an enormous amount from him about how to manage people. And he, the first day he said, look, it's very simple. My job, this is him talking. So his job, Ramon. Was to deal with all of the noise, all of the pressures, so that I could excel at my job. All I had to do in return was never surprise him. Good or bad, no surprises. It was amazing. It was all about him making me look good, as long as I didn't surprise him. And I've tried to manage everybody in my life ever since like that, as opposed to the thing that we've all seen managers do, where They want to look good, and they'll throw anybody underneath them under the bus to make themselves look good. So that would be the first thing. The second thing is my wife. So we've been together more than 30 years now, and there is no chance that I could have succeeded in this career without both her support in the, what one would take as the obvious things being the, the looking after the family, looking after me, but actually much more than that, She's the person that I talk problems through with. She tends to have a more aggressive answer than mine. One of the things when you end up running these sorts of places, people will always tell you it's a very lonely job. There is nobody insi…

AI assessment note: “the boss I had at J.P. Morgan... Ramon Olivera... The second thing is my wife.”

Q Before we turn to your next retirement and next re-engagement, either from that period of time or since, what did you find beyond the absence of hubris that were some of the indicators of someone's ability to be at that top echelon of generating alpha?

A It's a difficult thing to generalize. I think it's very easy to say the things that said there wasn't alpha. You have to have a repeatable process. It doesn't happen that one day you're a growth investor and the next day you're a value investor, that you're a bit of macro and then you're a bit of bottom up and you're, I don't believe in that. I don't think there's any one right way of running money. But I do think for individuals, personality, I guess are hard, their skills and their personality. There is a way that suits somebody. And there are ways that don't suit them. If you've got the personality to be a value investor, that is a particular type of personality. You've got to go against the crowd the whole time. And they tend to be fairly down in mindset and it takes a certain thing. And if you're that personality, there's no point trying to think you can Pick the next 50 multiple growth stock that's going to go to 60 because that's about cheating for the moon. So I always like people who understand what they're good at and don't try and do the stuff they're not good at. I like people or processes where their process is in tune with the market. They push hard. And when their process is out of tune with the market, They don't push hard, but they don't do something different. So you can think of it as if your average vol over time, it's supposed to be 10. When you're in tune …

AI assessment note: “You have to have a repeatable process.”

Q of what you're talking about, you started off on the fund of funds at fifty million. You sold your stake when it's 15. You're now overseeing a 130. There is this notion that size is the enemy of performance, that there's bandwidths on scale. So why don't you start there and talk about how you think about the constraints that you have because of the size of the asset base?

A This is a subtle thing because size is Absolutely the enemy of alpha at an individual strategy level at a firm level. Size is a benefit to an ability to generate alpha and an ability to generate profits for the business. And so what do I mean by that? So one of the things that I believe passionately, and it comes from my fund of funds days is in any individual strategy, any individual team. The size that they can run and generate alpha is a constrained thing. There is nothing that is size unconstrained, which is alpha. Mathematically, you would expect that as you increase the assets in a strategy, the alpha would drift down in some relatively linear fashion. Double the assets. Maybe you can get some extra alpha, but the alpha would go down by 50%. What I experienced in investing in funds Is alpha maintains much more than people expect for a certain period of time in a strategy, certain size growth in a strategy. But once it starts to drift off, it collapses and goes negative. And once you fall off the cliff, you can't get back up the cliff. And I spent lots of time trying to intellectualize why it was like that. And my conclusion in the end was at some point the market finds your footprint. We always used to joke it was medallion found the footprint and got in front of everything you wanted to do. And it's not really medallion, but it's, I'm sure they're part of it. The market …

AI assessment note: “size is Absolutely the enemy of alpha at an individual strategy level”

Q Under the sleeve of recruiting that you mentioned, and this probably gets in a little bit to where you're sitting in the ecosystem of the industry, with 300 different risk takers, how do you think about the need for and the process of recruiting the 301st?

A So we are constantly looking for talent. I think that there are Two broad groups to it. So one is we try to bring in lots of young, smart people that we will try and train up and will be future risk takers and future salespeople and so on and so forth. But the other is about adding people, teams. We make a lot of new products organically, but we also hire A lot of new teams, or we buy businesses, or we do, there's quite a bit of things in the middle of those two. Somebody here came up with a horrible expression of the acquihire, where you find people that have got a small hedge fund that's running a hundred million, which is a non-economic thing. You're hiring them, but you're really absorbing the business and absorbing their fund and turbocharging it with our infrastructure. And this is where it really links back to what I was saying earlier about my funder funds experience. So we don't say we want one of those. We don't say we want a telecoms team or we want a U S equity team or whatever. We don't have a discretionary long only U S equity offering that we're out there pushing because we haven't found a team that we think does that in a way that has consistent Alpha over time. That's a massive market, right? It's the biggest asset management market out there. But if we can't find somebody with alpha, we don't want it. So we look at a lot of teams and businesses. I mean, hundre…

AI assessment note: “we are constantly looking for talent. I think that there are Two broad groups”

Q So how long was that first stint looking for what that next thing would be?

A It was about six months, and one of the people I started chatting to was my first boss, who Was telling me about this business he had started, which was called a fund of hedge funds or a fund of funds. And I never heard of a fund of funds at the time. Again, in a bank, you didn't really see those things in those days. And he was talking about it and he said, yeah, the problem is there's too much for me to do. I need somebody to help me get it going. And I said, look, I'll come in and spend a couple of days, see if I can give you some suggestions and some ideas. And I left 10 years later. It was like four years before we even had a contract on what I was doing. It was, I went in, but it was a great fun run. The fund of funds had, I think, fifty million under management. When I joined, it might've been a bit less. And it had fifteen billion and change when I left. That was the golden era of fund of funds. So it was good. And in a similar way to the earlier thing, Basically, it seemed to me pretty clear that the business had gone as far as it could do as an independent thing, and it would be better part of a bigger organization. And the valuations people were paying for fund of funds in the mid later, mid 2000 were really quite impressive. And I thought we should sell the business. We got to the level of offers and legal documents and dotted lines and My partner, whose baby it was…

AI assessment note: “It was about six months”

Q How do you create incentives at the individual portfolio manager level such that they are aligned in making that assessment of the trade-off between managing more capital with the slight deterioration of alpha and just maximizing the alpha potential?

A In the end, I don't think compensation is the way that you create behaviors. Compensation matters. People in this industry get paid a lot of money. One should never Not treat the process of how people get paid seriously, but I don't believe in using compensation as a management tool. And so we want portfolio managers who respect their clients, who put the client's interest first and think about how does me taking more money in affect my existing clients. And if it disadvantages your existing clients, So that you can make a bit of extra management fee. We want people whose natural reaction is to go, no, that's the wrong thing to do. That's a cultural thing and a management thing, and it's not very difficult, and it's not an incentive formula that creates that behavior.

AI assessment note: “I don't believe in using compensation as a management tool... That's a cultural thing”

Q Luke, take me back to oh eight, and how did this come about and why?

A So I think if we're all honest, the hedge fund industry did not cover itself in glory, and that's being overly polite in 2008. Performance was pretty rubbish across the average hedge fund, but also there was a lot of poor behavior, and regulators were worrying about it. But actually, even more than regulators worrying about it, participants were worrying that you had this situation where for the previous 10 years, there'd been a massive imbalance between The amount of managers there were available and the amount of capital that wanted to get in, and so managers had sort of been able to do almost anything they wanted. A lot of documentation was 1015, 20 years old, and it was somewhat chaotic, somewhat wild west, and a bunch of people behaved badly, did things which weren't in the interests of their shareholders or their investors during the course of that. And basically it started as a group of hedge fund managers trying to work out how to set some standards for better behavior. Very rapidly was a realization that it didn't work if it was just managers trying to agree good behavior, that actually you needed a balance between what worked for managers and what worked for investors. And so very quickly investors got involved. And you had a, just a place where people could sit down and go, okay, I'm faced with this situation. This is what I think we're supposed to do. Do people agre…

AI assessment note: “basically it started as a group of hedge fund managers trying to work out”

Q So with the standards Improving over the last decade. I think I'd be remiss in having both of you guys and not taking a step back and making sure we are covering both the forest and the trees. And just, well, Luke, just want to start with you. What's your sense of the state of the hedge fund industry generally right now?

A I feel pretty good about the state of the industry. The sort of hyper growth phase of the industry has clearly passed, and the industry went from being very small and very cottage to being quite big quite quickly, and with that came a whole lot of growing pains, and this was all about solving a lot of those growing pains. Fundamentally, the AUM of the industry has been going somewhere sideways, But that's okay. We run a significant amount of risk for our clients, and I don't think growth in an overall industry should be the goal. I think what you're seeing is a concentration of AUM and firepower and talent within the industry. You might say I would say that, given I'm one of the larger players, but it's a reality, I think, Hedge funds, whether you are discretionary or you're quant, technology plays an incredibly important part in collecting and processing all the information you need to be successful. And in any technology-impaired industry, you see a concentration of power because of the ability to invest and spend the big dollars it takes to keep ahead. The days of talking about 10,000 hedge funds are over. I don't know what the right number today is, but the reality is that probably there's a thousand credible hedge funds out there, and the top hundred have a significant proportion of the assets. But that's okay, because what's really it's all about is can we deliver a valua…

AI assessment note: “I feel pretty good about the state of the industry.”

Q You've just put a certain fear in the minds of your portfolio managers, but with that, how about you, Luke? Other occupation?

A Well, I have to say, money has never been the object for me. I think, assuming that you can afford to eat, money is a terribly bad reason to choose a career, and I love financial markets. And honestly, I would be doing something else in financial markets, because I was drawn to this. So I learned to play cards when I was two or three. And I learned to bet on the horses when I was four or five. And I observed with my grandfather who taught me about the horses. I mean, he made me do it properly, right? Form guides and couldn't bet on the name of the horse. It had to be a Properly informed decision. And I noticed in a three horse race that the odds meant we were going to lose whatever, and the bookies were going to win. I'm like, he said, yeah, well, the bookies always win. I'm like, okay, I want to be one of them. Well, okay, he said, go and work in finance. That's a more socially acceptable version. I would probably be doing something else in finance, but if not, maybe I should have been a bookie after all.

AI assessment note: “I would probably be doing something else in finance, but if not, maybe a bookie”

Q 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. Now that you've gone through this test period and fortunately haven't seen those types of articles, where do you go from here with the standards board?

A Onwards and upwards. We would like to continue to increase the footprint in terms of the number of managers and the number of investors who are signed up to the standards because it, it helps everybody. The more people signed up, the more that means the amount of time you spend on operational due diligence goes down, the confidence you have in the manager goes up and so on. We're definitely trying to increase our footprint, but also we are continually pushing around the boundaries of where we can add value. So we're not trying to cover all alternatives, and ILPA and other organizations do a great job in the private equity world, but we've taken on some of the alternative credit space because working out what's a hedge fund What's not a hedge fund is a very blurred line in there. We've looked at the insurance link market, because again, there are clearly hedge fund strategies and pseudo hedge fund strategies. So we're looking wherever we can also broaden our footprint by helping in more places.

AI assessment note: “We would like to continue to increase the footprint in terms of the number of managers”

Q So when you started out, was there a consensus of what bad behavior meant that you were trying to exclude?

A I think there were certain parts of bad behavior Remember, so this all started out in the window of a lot of funds gating, some of them gating for long periods of time. You had a bunch of managers who were paying themselves very well. Remember back then you had stories of people who were, who had bought a private jet using fund assets and were flying themselves around to go skiing every weekend on investors dime. I think when we all talked about it, you could see a series of behaviors that everybody hated. The managers in the room didn't like the fact other managers were doing that, and were things they would never have done. The investors absolutely hated some of those things. There were some easy things to say that's not the right way to behave, and there are some which take a lot of discussion to work out what is a sensible, balanced, Position. You get some investors who say, look, you should never have a management fee on a hedge fund. And I can understand why, from an investor's point of view, that might feel good, but actually it's not good from the long-term health of the business, because if you haven't got management fees, your business has actually become unstable, and that's dangerous for the investors. So that willingness to have open conversations, honest conversations, I think when you look back to the early meetings, it took a while till kimonos got fully opened.…

AI assessment note: “you could see a series of behaviors that everybody hated.”

Q So roll forward. Now you retire a second time, you come back to man and you've evolved to being the CEO. How do you define in that lens of investing in business? Clearly you're the head of the business. What is your role today?

A I'm at a stage in life where I'm not sure I need new friends. But every now and again, I have to go to a dinner party and you sit next to somebody you don't know. And if I don't know them, I don't really want to sit there and talk about my job particularly. And so I, I learned this like defense mechanism, which when people say, what do you do? I say, well, pretty much I do HR and admin. And most people that stops them talking to you and they talk about other things and we could talk about what's going on in the world and whatever. And that's more interesting to me. I think the truth of the job. Of a CEO of a business like this. I mean, then the number one thing I do and the dominant thing I do is about helping people be the best they can be. And so it is, I joke as HR, but I mean, it is that thing of helping people excel, helping people be as good as they can do. That's about creating the right culture. It's about getting the right people in. It's, it's stopping the hubris in the people doing well. And boosting the confidence in the people where it's going badly. It's all of those sorts of things is we're a decent sized organization, right? We're 1500 people. Do I know every single one and every bit of their family history? Can I say hello to everyone and know something about them? Absolutely. And do I know everything about the 300 people That take the risk and drive the return…

AI assessment note: “the number one thing I do and the dominant thing I do is about helping people”

Q or five key drivers of how you could spend your cashflow, whatever's balance sheet. How do you think about there's this organic growth of hiring new talent? There's this acquisition of teams that kind of acquihire or whatever the phrase is. And then the different levers on the corporate balance sheet when you put on the cap of the CEO of a business and capital allocation for the business itself.

A One of the interesting things of asset management is that that problem is remarkably easier than it is in most businesses. There is a weird thing. If you rank all of the industries in the world from left to right, Based on the margin, typical profit margin in the industry. On the left hand end, you get things like retail and some of the like cleaning services, those sorts of things that if they're lucky are a zero percent margin and they think two percent is heroic. And at the other end, you get tobacco and social media that have the highest margins. And the incredible thing is asset management as an industry is way nearer the social media end than it is the outsourcing end. It's a sort of 30% margin industry and some parts are significantly better than that. And one of the things that's remarkable is all the things that are to the right that have higher margins than the industry are things which are addictive. No reason tobacco and alcohol and social media. I mean, they're basically addictive things that make money out of the addiction. And like there's asset management and you look at the industry and it on paper is super competitive with millions of players. And actually the margins are remarkably good. And so we don't have a scarce capital problem from the business point of view. We generate more capital than we can deploy and So the constraint is always our ability to exec…

AI assessment note: “we don't have a scarce capital problem... The constraint is always our ability to execute”

Q Where did you find resistance once the group of people involved had agreed to standards in the community of people that were less willing to sign on?

A One is about, we shouldn't say that all of the standards are easy to agree with the people who are signed on. Each set of standards applied to a particular area takes a lot of work. And it's basically volunteer work, so all the managers and the investors, or a group of the managers and investors who are interested in the problem, volunteer people to sit on a working group, and they have some pretty sort of stand-up shouting matches about to get to the right standard, because now people mostly come, because we've set standards on so much, people come at it, and they're in a pretty similar place, but 12 years ago, people were all over the place in terms of what's appropriate. Is it appropriate that you have a fund where your investors go in, and you have a fund alongside it, which is your own money, which is not pari passu, and isn't disclosed to investors? Today, I think people would have a clear understanding of what's right or wrong. I've got to tell you, you know, and there's a pretty famous example about it. You go back half a dozen years ago, and that was not something people agreed. There were managers who had a very strong view that was okay, and they could put the trades they wanted to into what they considered their own account, and there was a strong view from other people that part of the point of alignment of interest was The manager and the investor should be gettin…

AI assessment note: “we shouldn't say that all of the standards are easy to agree with”

Q Luke, where have you seen this pressure on fees playing out in the business?

A So I have a slightly quirky view on the thing on fees, because I'm not sure that it's really a pressure on fees. I think the proportion of alpha that clients are happy to leave with a manager Has not really changed over years. You know, you can debate, and maybe it's something to do with the quality of the returns, some number between 25 and 30% of alpha that clients are pretty happy to leave with a manager and to feel they're getting a fair proportion. And I think, to me, it's really important remembering the only people who take risk in all of this process. Are the end clients. It's really important they get more than 50% of the value add. What's changed over the years is two things. One, pre 2008, and maybe you have to go back a little bit further, but back, Mary and I first met over a reference I gave him on a hedge fund, which I happen to know today is the 20th anniversary of that hedge fund starting, so it's been Almost exactly 20 years, Mario and I have known each other. Back then, funds used to run typically at 10 to 15 vol, but it wasn't that hard to have a net sharp of one. If you've got a 10 to 15 vol and a net sharp of one, and you charge two and 20, actually, that works out that maybe the manager's getting a 30% and the client's getting 70% and That's fine. What happened was that the vol generally went down, and, you know, a lot of hedge funds stated that they were…

AI assessment note: “I'm not sure that it's really a pressure on fees.”