Our guest this week is Ted Seides. Ted hosts the popular "Capital Allocators" podcast, where each week he interviews leaders in the investing and finance fields, including hedge fund managers, endowment chiefs, and prominent academics. Prior to launching "Capital Allocators," Ted was a founding partner at Protégé Partners, a firm that invested in and seeded hedge funds. Ted began his career at the Yale University Investment Office before doing stints at Stonebridge Partners and J.H. Whitney & Company. Ted recently published a book reflecting on his conversations with investment leaders and experts entitled Capital Allocators: How the World's Elite Money Managers Lead and Invest. Ted earned his bachelor's degree from Yale University and his MBA from Harvard Business School. He is also a CFA charterholder.
Outsourcing and Complexity
"Drew Dickson—Blending Behaviors and Fundamentals at Albert Bridge Capital (First Meeting, Ep. 13)," Capitalallocatorspodcast.com, Nov. 24, 2019.
"The Surprising Cost of Volatility," by Ted Seides, Capitalallocatorspodcast.com, April 26, 2010.
"The Future of Long-Short Equity," by Ted Seides, cfainstitute.org, April 11, 2013.
Portfolios and Investment Committees
How I Invest My Money: Finance Experts Reveal How They Save, Spend, and Invest by Joshua Brown and Brian Portnoy
"Scott Malpass—The Fighting Irish's Twelfth Man (Ep. 25)," Capitalallocatorspodcast.com, Sept. 18, 2017.
"Michael Mauboussin—Consilient Observations in a Crisis (Ep. 127)," Capitalallocatorspodcast.com, March 22, 2020. 2020.
Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, chief ratings officer at Morningstar Research Services.
Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar.
Ptak: Our guest this week is Ted Seides. Ted hosts the popular "Capital Allocators" podcast where each week he interviews leaders in the investing and finance fields, including hedge fund managers, endowment chiefs, and prominent academics. Prior to launching "Capital Allocators," Ted was a founding partner at Protégé Partners, a firm that invested in and seeded hedge funds. Ted began his career at the Yale University Investment Office before doing stints at Stonebridge Partners and J.H. Whitney & Company. Ted recently published a book reflecting on his conversations with investment leaders and experts entitled Capital Allocators: How the World's Elite Money Managers Lead and Invest. Ted earned his bachelor's degree from Yale University and his MBA from Harvard Business School. He is also a CFA charterholder.
Ted, welcome to The Long View.
Ted Seides: Thanks, Jeff. Thanks, Christine.
Ptak: A lot of our listeners will be familiar with you but not all of them will be. Can you talk about your background and how it's led up to this conversation in which we'll talk about the book you recently authored Capital Allocators?
Seides: Sure. Well, I've spent, I guess, the early part of my career--earlier part of my career, 20 years--as an institutional investor, primarily investing in funds. The first five were right out of college, I worked for David Swensen at the Yale University Investments Office and really learned the business at his feet, that business of multi-asset class investing primarily through managers. And I left to go to business school. I came out thinking I wanted to be a direct investor, and did that for two years across public and private markets and found myself longing to be back picking managers and ended up forming a partnership that was a hedge fund of funds called Protégé Partners back in 2002, and stayed at Protégé for 14 years, had some great results for our clients.
And then I left in 2015, and wrote a book, which was a series of lessons and really case studies I had learned about the ecosystem for startup hedge fund managers, so fairly narrow. And that led to me appearing on a couple of podcasts. I was doing some consulting projects along the side and decided to start a podcast where I could mostly run around and talk to some of my old friends in the endowment world and see what they've been up to. And I had my head down, focusing on hedge funds for 14 or 15 years. So, that really just started as a productive extra use of my time. And about a year ago, some of the projects I've been working on sort of fell away, and that became the core of my activities. And so, now, we're kind of four years into this podcast. I've had just about 200 episodes and 5 million downloads. And somewhere along the way, really as my kind of COVID project, I could not keep track of what I was learning anymore. And I decided to start distilling the lessons, which turned into this book.
Benz: So, a lot of our listeners, our individual investors and financial advisors, they won't necessarily have the same chance that you've had, where they're sitting in front of investment managers, and taking stock of how good they are. So, what are the lessons that you think this book imparts that they can apply to their own practices or to their own investments?
Seides: Yeah, that's a great question. In fact, most of the book applies to just about anyone who is tasked with allocating a pool of capital. And the reason is that it's really broken into three sections. The first is a section that I call a tool kit. And there are a set of skills that aren't really taught in the investment world, but they're very well known outside of it. So, you think about things like interviewing, and decision-making, and leadership and management. And although those people may not be specifically interviewing money managers in the way that I have, it could be that the lessons that you learn about interviewing can equally be applied to how are you communicating with your clients? How do you learn to listen? How do you prepare for those meetings? So, that tool kit is very broadly applicable.
The next section is an investment section. It's really investment frameworks. So, that gets into how do people think about their strategy and process. And again, it's applicable to anyone who is trying to think through how to allocate capital. And then, the last section is a bunch of the best quotes from my guests that didn't really fit into one of the first two. So, there are a set of investment lessons and there are a set of life lessons that I think anyone would enjoy quite a lot and learn from.
Ptak: There are some universalities, for instance, you recommend pulling in many different disciplines, including behavioral finance, and advisors have been adopting some of those same techniques in their practices. But isn't there a risk of overload? And to your credit, I think you allude to this in the book. I think one of your guests, Drew Dickson, I think he is at Albert Bridge Capital, called this the biased bias. So, if you're an advisor and you're trying to ensure that you're not biased by this constellation of biases, what would you do?
Seides: Drew said his favorite bias is the biased bias, because everyone understands behavioral bias, so they are biased to try to find a bias. So, I would take the opposite of that. I think that what we've learned about behavior and how it applies to investing in finance, I would call an unfortunate set of truths, or what Al Gore would call an inconvenient truth. There's a huge difference between labeling these behaviors that we have and learning about them and then implementing them. And the reason is that we are all hard-wired to make these mistakes, even if we know about them.
And so, while the labels of risk aversion and loss aversion and anchoring and overconfidence, confirmation bias, while all those help us with awareness, what that awareness allows us to do is build processes to try to get away from our natural instincts, which are to do the wrong thing. So, I don't even think it's possible to have an overload as it relates to the awareness and the attempted application of behavioral finance for advisors and for their clients, because it's deep-seated within us. And as Annie Duke says, the smarter we are and the more we recognize it, the more it afflicts us, because we can rationalize away all the reasons why we're not the ones who are subject to those biases.
Benz: Speaking of Annie Duke, she calls it "thinking in bets," this idea of approaching things probabilistically. If I'm a financial advisor or financial planner and I'm helping a client who is about to retire think about their financial future, what are a few things that I could do to systematize the forecast that I might incorporate into the client's plan?
Seides: Well, the most important part of any investment process is to understand what the objectives are of your client. Develop an understanding of their goals and I guess, most importantly, their tolerance in the short term for not meeting their goals or what looks like not meeting their goals. So, in a situation like that, you're talking about funding retirement. And to tell you the truth, I have incredible respect for financial advisors who really understand how to model out and focus on that part of the equation, because for their clients, that's all that matters. All of these strategies, some of these things I talk about in the book may not matter as long as they can meet those retirement objectives for their client. So, that's where it all starts.
And then, the question becomes, how do you discuss these sorts of mathematical constructs of probabilities in language that your client can relate to. And that's just not an easy thing to do. It's also not easy to do with institutions. So, you could think of an example of that where you might model out and have some model that tells the client that there's some statistical probability of a certain drawdown that's expected in the 10- or 20-year plan for the outcomes. But a client's eyes might glaze over. So, you could think about framing it differently and using more straightforward language.
So, one of the ones I've just talked to somebody about recently was, let's say you mapped out an asset allocation strategy that was 80% likely in your mathematical model to get the client what their retirement objectives are, they may or may not understand what that means. But you could talk to them and say, “Well, you have $1 million today, and we think, whatever it is 20 years from now, you're going to want a $1.5 million to retire, pick a number. Oh, by the way, flip a coin. And if we flip a coin once, and you call heads, and it comes up tails, it's possible that between now and then your million will look to you like it's dropped to $800,000. And just so you know, if we flip that coin 100 times, it's pretty likely we're going to get pretty close to your objectives. But at any point in time, it might look bad.” So, just to take some simple analogies and language so that you can put all of these mathematical constructs of risk and reward in a language that a client can understand. And when Annie talks about thinking in bets and probabilities and thinking in probabilities, you have to be able to communicate that in a language that's digestible for whoever your audience is.
Ptak: The book is a good framework for a lot of different types of tasks. One of them is choosing an asset manager. But maybe to step back, based on your experience, what's the best way to determine when to ask for help? Or I guess a more generic way of asking that is to self-assess and maybe determine when something sits outside of your circle of competence?
Seides: It starts with knowing yourself. And I know for me personally, and a lot of people in this field, sometimes asking for help isn't the easiest thing to do. One of the interesting aspects of that is hiring a money manager in and of itself is like the epitome of asking for help, because it's this humbling realization that you want to access something in the capital markets that for whatever reason you can't do it on your own. And so, that's kind of the crux of it.
There are a lot of tools to invest, access markets in really low cost-efficient ways. And those are incredibly valuable. So, when it comes to deciding what you can't do, if you lay out the things you can do and you know that you can get it generally right, so you could think of buying an index fund in large-cap U.S. equities, that's generally right. But there are a lot of other things that you might find that your clients need in order to meet their long-term objectives that are just outside of your own knowledge. It might be your knowledge of what the strategies are, or it might be your knowledge of who the players are that are likely to outperform. And any one of those times, it's probably a good time to try to partner with someone externally and pay them for their expertise rather than try to do it yourself.
Benz: What's your perspective on why institutions and high-net-worth investors have sought out more exotic strategies like you describe in the book like private equity, venture capital? And would some people be better off just keeping it simple?
Seides: So, this has really evolved. When I started my career in the early '90s, the hardest part of playing this game, which let's just broadly call them alternatives, was knowing that it existed. If you knew what a hedge fund was, if you understood what a venture capital fund was, and you could find your way to the very small, boutique industry of participants, generally everybody won. And so, at that point in time, the risk in those strategies was really the risk of being different, which is always a very challenging risk. These were not strategies that people were comfortable with, that knew a lot about, and they felt very opaque.
That was a long time ago, and now we're talking close to 30 years ago. And it's a lot less true now. So, the reasons are different. And the reasons today have a lot more to do with the perspective looking out on the pricing of traditional assets and capital markets and a realization that with bonds yielding zero and stocks at relatively rich valuations, if you just map out some version of 60-40, or 70-30, or 80-20, and you have a liability stream, if you're a pension fund and you need to make 7% or 8% nominal, or you're an endowment or a foundation and you need to make roughly 5% to 6% real, you're just not going to get there owning stocks and bonds. So, there's a necessity to develop expertise in some of these other areas that are diversifying and more likely to get you to the objectives that you have over time.
Ptak: Sticking on the topic of this tension between simplicity and complexity, one of the things that one could observe is the very act of creating an investment office or a family office that can spur complexity, because you have to hire a staff and there's this self-justifying tendency to prove it's worth it, which usually means diving headlong into alternative investments. So, based on your experience, what you've observed, is there a way to do this right so that you can confer the benefits of that infrastructure but without being overwhelmed by some of the complexity that attends to it?
Seides: There is always complexity, right? Families in and of themselves are complex, every family is. On the investment side, it really comes to this notion of how are you setting up the decision-making process, or in the institutional world we call it governance. And that starts with a very clear delineation of what the roles and responsibilities are of it might be the family, it might be the person they're hiring to make the investments, but understanding who is responsible for setting policy, who is responsible for the implementation of individual investments, under what circumstances is the family or the committee involved, under what circumstances can the investment team just go off and make decisions on their own.
And then, you go from that into the formation of whatever that decision-making body is, who is involved in that. And then, the last part of it, of course, is incentives. How is compensation aligned from the individuals that the family is hiring to their own desires and needs? And so, that basic structure of governance is what ends up determining over time if that investment office and operation is meeting the objectives of the family. And it starts with family. And it's not always easy with multiple family members figuring out what those objectives are. But when it goes awry, when they hire someone who just starts running around and making all kinds of investments that might not serve the family's interests, that's usually happening because they haven't had that initial period of time to get everybody on the same page about what those investment objectives are and how they want to create a policy to go try to achieve them.
Benz: So, it seems that the more there are intermediaries and helpers running around, the likelier it is that the investment approach will suffer from complexity or that conviction will end up getting diluted somehow. Have you found that there's a relationship between success and simpler, flatter organizations or governance structures?
Seides: What I've seen is there is a correlation between success and longevity of the investment team. So, if you think about David Swensen, who started at Yale in 1985, and is still there today, and two of the colleagues I worked with from '92 to '97 are still by his side today. You think about Scott Malpass at Notre Dame, who just retired after 30 years and had an incredibly loyal team. When you have a team that stays around for a long time and develops institutional knowledge of both the markets, their own tendencies and investment approach, and their relationship with the governance board, there's a high correlation between that and success.
In terms of the complexity of the structure, that actually, if you just picked a particular structure, I think you'd see results all over the map. So, I've seen it less in terms of the type of structures. So, just to give you an example, at Yale, the investment committee is ultimately responsible for making investment decisions. At other institutions, the committee might delegate those decisions to the investment office. And those are very, very different in terms of layers of complexity and who is making decisions. But I do think that when a team stays in place for a long time, that happens because there's a lot right in the way the governance structure is set up and the way incentives are aligned. And that does have a high correlation with long-term success.
Ptak: Given that it's in the news, and there's quite a bit of talk about hedge funds, I thought maybe we'd spend a second talking about GameStop and what you think--as a very learned observer of the hedge fund space, what do you think the longer-term repercussions of that episode could be? I know, there's a lot of talk about shorting that game having changed. What do you think? Do you think that's a bit overblown? Or do you think that this sort of episode that really could have an indelible impact on how hedge fund managers approach the job?
Seides: Well, there are a lot of lessons to take away from it that aren't really specific to this event. For example, I wrote a paper about how volatility in the markets causes pain back in 2011, and the crux of that paper was short-selling is really hard and how a portfolio manager of a long-short equity hedge fund, it's really a difficult balancing act. And so, on the hedge fund side, I would say a couple of things. The first is that leverage in investment strategies always has the potential for a left tail. And the managers that you read about in the news that suffered a difficult January all used a fair amount of leverage. By the way, the same managers have had great success in the couple of years leading up to that. The clients that suffered in January in those managers have had great runs for a couple of years and I think will have very, very strong hands to stay put.
The more interesting dynamic, of course, is this question of is this another rise of the retail investor and mass, moving stocks in such a way that some people may think is speculative? And my take on it is, none of us know. We do know there was a lot of noise in Reddit and on WallStreetBets. But there are also a lot of quantitative models that drive markets and high frequency trading that exacerbate momentum trends and have been doing so for a number of years. So, I don't know, I don't know if anyone does what really drove these stocks up and then--at least, as we're recording this--back down somewhat.
But I think that the long-short equity hedge fund model has been a very challenged one for close to a decade, in large part because of the level of interest rates and the costs that that imposes on a long-short fund, and the second is just the nature of competition. There are so many more people participating in shorting stocks that you do have these dynamics that I never saw at the beginning of my career.
So, just to give you a sense, it was reported that GameStop had 140% of the float, which is not quite shares outstanding, but the float was shorted. A crowded short, when I started my career at Yale was 2% to 5% of the float. That was considered crowded. So, just to give you a sense of what's changed and how much more competitive it is. But I don't have any broad-brush conclusions as of yet of what this will mean. But there are some tried and true lessons like leverage is dangerous and going against the crowd on shorts is dangerous.
Benz: You recently shared your portfolio. You wrote about your investments and your investment process in the book How I Invest My Money. I contributed an essay there as well. Can you talk about why you decided to participate in that? And also, what you learned from the process about writing about your own investment portfolio?
Seides: Well, I first participated, because Brian and Josh asked me to, and I think they're wonderful people and great investors and so I was happy to. There's a small twist on how I've approached what I'm doing now from in the past. And I created a vision statement for my business right now, which is to learn, share, and implement the process of elite investors. And probably 60% or 70% of the way I spend my time is exactly the same as it's always been. I talk to money managers; I talk to other investors; I follow the markets.
What's different in that is that I'm sharing a lot more. And that started with the podcast. And I do it because I think it's a win-win-win across the board. I think it's a win for me, because other people can see what I'm doing. And I don't have a team around me now, so they can share their input and I can learn from their thoughts. I think it's a win for the way I invest and the people I invest with, because I can't be a value-added LP in the way I used to because I don't have--at Protégé, I think we got close to $4 billion in assets--I don't have that kind of money myself. But I can help managers that I invest with, with their brand to some extent, because I'm happy to let people know these are the ideas that are my best ideas.
And then, lastly, I think by just sharing my own journey, as I did in that book, which I think is probably quite different from what someone might understand, if they looked at my resume and they listened to the podcast, they might think I've got everything figured out and I always have, and that's just not the case. So, I think for everyone to be able to be introspective and learn from their own experience, it's just very helpful to share that with the world.
Ptak: What's the feedback been like and what have you learned from the feedback specifically?
Seides: It's been great. On the book, most of the feedback I got was from people who know me reasonably well, have known me professionally for a long time and said, "Wow, I had no idea that you'd gone through a tough period of time financially, that you had a reset that came out of a divorce." And they just appreciated the sharing and the thoughtfulness and willingness to do that. I think that's been most of it. It has been universally positive.
Benz: So, it looks like you own quite a few hedge funds and other nontraditional strategies, probably not surprising given your experience doing research and interacting with these firms. So, can you talk about how you chose the specific investments that ended up in your portfolio and how it upholds some of the principles that you describe in the book?
Seides: It's little bit different, right? I didn't say too much in the book for Brian and Josh, but I did decide a couple of weeks ago to just share my portfolio in social media. And again, just to get feedback. I want to take it through the way I think about investing, but to start with and I'll get to this, I actually don't own any hedge funds. And I wish it was appropriate for my own portfolio, but it's not, but I'll get there in a sec.
So, I start with my own goals and objectives. And the way I frame it out is to say if I'm cash flow positive in my life, so if I'm making more money than I'm spending in any given year, everything else I have, I can invest for the long term. There's some uncertainty in there. So, it's nice to have a little bit of a liquidity buffer. So, on a broad-brush structure, I'm heavily equity focused. So, you could probably think of me as an 80-20 or a 90-10 investor. And within that, the first default is to think about index funds, because I can probably meet objectives by just investing in the markets. But I've spent 25 years and had some quite good success being able to beat markets. And I prefer that for a bunch of reasons. One is, it's always nice to make more money. But more importantly, for me, I think what always goes lost in this question of active versus passive is the relationship component to it. So, when I have identified managers that I invest with, not only am I, hopefully, outperforming markets, but all kinds of interesting things come of that. You get to learn about what they're doing, sometimes you can help them, sometimes other opportunities arise. So, I have always found the relationship component of active management to be a huge source of value, both personally and financially.
So, then when it comes to structure, I think about what my competitive advantage is. And for me, it's relationships, it's a long history of judgment about managers and it's a network of peers that I've been around for a quarter century. And the podcast just keeps that going. It's this constant funnel of new ideas. And so, I start with core public equities. And you could say, you start with index funds in the U.S. especially, but I don't. I own Berkshire Hathaway, I have for a long, long time. I own Pershing Square holdings. So, I was one of the early investors in Pershing Square back in my Protégé days, but to own a talented manager with some controversy for sure, but a talented manager at a 20% discount, which more than pays for a net present value of the fees that you're paying to Bill Ackman and his team, is just an incredible value and likely way to beat the market over time.
And with those managers and a few others, I tend to have a value bias. So, I don't want to value bias, I want to be balanced. And so, I kind of balance it out with growth stocks. And one of my favorite managers is WCM out in Laguna. I've gotten to know them very well and I'm just deeply impressed by their deep research mindset toward growth stocks. So, that's kind of my public equity portfolio.
And then, on the private side, it's really opportunistic. I come across some strategies that I think are incredibly interesting and are very well-positioned to outperform than I could do otherwise. Now, given the pricing of markets, I try to have a good chunk of my capital into things I call opportunistic, which are investments, I think make a lot of sense for the next couple of years, but they might not be a buy and hold forever. And so, you could think about things like the whole biotech sector and the potential for a great manager to add value in that sector. I recently have bought an entire portfolio of SPACs myself, and I have a whole thesis of why I think that's an incredibly attractive and asymmetric risk/reward as kind of a yieldy cash substitute. So, I'll do things like that over time. And it's just a lot of fun.
Benz: It sounds like a lot of these choices are driven by your relationships, your knowledge of these managers, your familiarity with their processes. So, how about when it comes to cutting them loose to deciding whether to sell? Is that difficult? How do you formulate your decision that something isn't right for your portfolio or is not working in the way that you expected it to?
Seides: That is the least-fun part of the investment process. In my years at Protégé, we were investing in early stage hedge funds. And so, a lot can change in a short period of time. And unfortunately, I've had more experience on that exit than I'd ever cared to. Most of my investments are things that I believe I'm going to own for a long, long time, that opportunistic bucket maybe a little bit less so. And so, the way I do it is I formulate an investment thesis. And that thesis is not based on performance. It might be based on the strategy; it might be based on the team. I write it down. And I've always said and did with my team at Protégé, it has to be qualitative and it has to be something you can disprove with facts. Because if you tell me that a manager is smart, unless you're testing their IQ score every year and you decide that if it goes down, you're going to redeem from that fund, it's not very applicable. So, I do that for myself. And it's a nice discipline to be in. And at times, things do change. These are people in organizations and individuals go through life changes. And sometimes those aren't conducive to future returns being as attractive as they once were. And so, when the time comes, you just make that assessment and move on. And I try to move on in as graceful way as I possibly can.
Ptak: Not to put you on the spot, what's an example of an investment thesis that you've applied for your current set of investments? Does one jump to mind?
Seides: Sure. I could talk about this SPACs thesis, which is sort of interesting. And it doesn't have to do with the manager, because I'm doing it myself. Without going into too much detail, people have heard a lot about SPACs. And within it, you have these situations where sponsors bring a blank check company into the public markets and there's cash sitting in trust. And so, to simplify it, let's just say, there's $10 of cash. Well, that $10 of cash might trade for between $10 and $10.50. And you know with near certainty that if nothing happens, you can get $10 back at the end of, say, two years. And so, if it's $10.50, you might lose 5%, but you're highly unlikely to lose more than that.
Now, if those sponsors go out and do a deal, oftentimes, the attractiveness of the deal is such and certainly, in these markets, where the stocks pop. And so, I've been doing this just for a couple months, and I've had three SPACs that I own do deals, and on the day of the launch, the stocks pop between 30% and 50%, which is just extraordinary. So, I'm actually doing this for the first time. I'm doing it on leverage. I don't usually use leverage for all the reasons I mentioned earlier. But you can borrow so cheaply that it is a very, very low cash drag, and you have the potential to make 20% or 30%, and then you just keep redoing it. So, it's an example of a strategy. I don't know how long it will last. It certainly looks attractive now. It was more attractive a couple months ago, because those stocks were closer to $10 and many of them are closer to $10.50, $11 today.
And I could think about having somebody else do that. But it's a relatively simple exercise for me, with some filter on who the sponsor is and what I think the likelihood of that particular sponsor getting a deal done over two years. There's certainly incentive to do so. And maybe it's tactical, maybe it will last for a long time, but a very interesting way for me to get that part of my portfolio that I'm trying to earn more of that kind of low correlated fixed-income-like return.
Benz: You recently said that most people are over-diversified to managers, they own too many managers, and you want to avoid that. So, why do institutional investors tend to overdo it, allocating to too many managers? And what does that say about their process and how they make decisions?
Seides: It's an interesting question, right? It starts bottom up. And if you go back to when David Swensen wrote Pioneering Portfolio Management back in 2000, that popularized some diversification through asset classes away from the traditional kind of stock and bond portfolio. So, if you have five or six asset classes, and most practitioners will then seek diversification within those asset classes by hiring managers, and maybe that means, five to 10 to 15 managers, depending on the space. Now, each of those managers, for the most part, their fund is their livelihood. So, they are diversified within that. And if you're not careful, before you know it, you have thousands of positions, and you're really owning markets and potentially owning markets expensively.
So, it's a common challenge. I don't think it's necessarily the wrong one, because there are so many different strategies and there are so many different ways of participating in the markets that if someone chooses to go out and try to identify the very best practitioners across a range of asset classes or strategies, you can get diversification from that. But again, if you have too many managers and they have too many different investments, you can get to this over-diversification, or what we call the diworsification.
I would tell you that over the last five, 10 years, I've seen a lot of the leading CIOs, who knew that all along, act upon it. And so, you're starting to see portfolios that used to be 100 or 150 managers across the board work their way down toward, call it 50 to 70. And those numbers sound high. But when you get into the private markets and venture capital, a lot of those are very capacity constrained. And so, if you can invest with Benchmark Capital, you want as much money as you can there, but you're not necessarily going to say, Well, I'm not going to invest just because I can only have a suboptimal allocation to that particular manager.
Ptak: Shifting gears and turning to interviewing managers, which is another topic that you explore at some length in the book. In what ways do you think meetings with investment professionals are most overrated? And where are they underrated?
Seides: I love that. I think that the most overrated and potentially waste of time that is incredibly common in manager interviews is diving in on individual investment ideas. And I get it. I've sat in that seat and allocators want to talk about investment ideas so they can corroborate their thesis about a manager's process, and try to ensure that the depth of knowledge and the research process they go through on that particular idea is consistent with how they anticipate the manager behaves across the portfolio. The reason I think it's overrated is because there's massively asymmetric information. Much of the time the manager knows their whole portfolio, and that may or may not be fully transparent. But in the instances when it's not, the manager is typically choosing which securities they discuss. And they will always know more about those securities than the person on the other side of the table.
One of the things I found in my time at my former fund, we had a great deal of transparency, because we were investing in early stage funds, and in some instances, seeding new funds and had full transparency. And what you found far more often than not is that a team or an individual doesn't necessarily have the same amount of knowledge and information on every single idea in their portfolio. And there are some that they certainly know extremely well. But then, as you work your way down a portfolio, they may have great theses and those ideas may work really well but their process might not be exactly the same for every idea. So, the notion that you could sit across the table from someone and have them pick out an idea and then think that because of the beautiful way that they describe their process with one idea, it therefore is consistent across their portfolio, I think is a bit of an overrated discipline. I understand why people do it. It's entertaining, it's fun, you learn a lot. But in terms of really evaluating the manager, I think that that gets overstretched.
On the other side of that, what is harder to do more consistent and persistent is trying to assess someone's behavioral temperament. And I don't think I see as much--or certainly didn't--allocators, investors, asking questions that really can tease out how people are behaving. So, from the sidelines, we talked about GameStop. If I were an investor in some of these funds that were afflicted, the only thing I would care about is how are they behaving as a result, how is the mentality of their team, what's their mindset going forward, and questions like that, not so much like what happened, what did you miss. That was all in the past. So, that's a little bit of a subtle difference in overrated and underrated.
Benz: Can you give us an example of what the dialogue would be in that situation? What kinds of questions you would ask to tease out a substantive answer to those questions? Like, how do you gauge how someone's feeling about something? What sort of question gets you there?
Seides: Well, you have to start with a baseline. So, if I had money with a manager, this wouldn't be the first time I'm sitting down with him. So, I should have a sense of how they behave in, let's call it, a more normal environment. But if I were sitting down today with Gabe Plotkin at Melvin Capital, my first question would be, "Hey, how you doing? How are you feeling? What's going on? Are you sleeping at night? Your kids OK? Are you screaming at your wife? What's going on; it's super stressful time, right?" See how he responds. Have the same kind of meeting and conversation with other people on the team. "Boy, how are you doing? How's Gabe doing? What's the communication like right now?" And just be very, very empathetic, like understanding, irrespective of, if I think, "Oh, these guys really made a big mistake. I don't want to be here anymore." Just be empathetic and try to understand what they're going through, and then see how they're relating and responding. Because you can imagine in a situation like that where there's a massive short-term hit in the fund, lots of different potential outcomes. In this particular case, that fund has been incredibly successful for a long time, the individuals probably have very little to worry about in terms of their personal balance sheets, and they might be able to just say, this sucks, but we need to make money back for our clients. So, I've seen that kind of outcome.
Another might be just anger, like, if you hear them expressing anger and concern about the people who did this to them, then that's a much more concerning sign as an investor. So, there's just a lot of different ways you could think about in any given situation trying to tease out where are they at right now, how are they responding, and is that going to be conducive to calming down an extreme event, returning to some semblance of normalcy in their investment process, and how are they going forward from there.
Ptak: I think Morgan Housel observed on Twitter that you can learn a lot from people by observing them in an airport, and this is before pandemic, just how they react to situations. It's almost made me wonder if our true acid test for managers should be to of mock simulate their flight being canceled and see how they behave in a situation like that. But putting that aside, wanted to ask you about some of the best and worst experiences you've had interviewing managers. Maybe we'll start with the worst experience you had where it completely upended your expectations and shattered the confidence that you had going into the meeting and then, the opposite of that, where you went in with very low expectations and were just totally blown away and ended up allocating capital to that manager.
Seides: I love this question. So, I would start by saying, let's start with a baseline of expectations, because in both of these cases, there's some belief that I may have formed going into a meeting that then changed dramatically. So, I'll give you two examples on pretty poor experiences, one that comes right off of your airplane idea, Jeff, which is that many years ago, we had invested with a manager and I played golf with him one weekend. And I was so shocked at how abysmally he treated the caddy. One of the issues we had going in was this is one of these pre-Madonna-type managers that had had a lot of turnover on the team. But the results had been great, and we thought we understood why. But when I saw that behavior, I thought it was so abhorrent that I just couldn't, we just couldn't be there, he wasn't someone we wanted to be partners with. And in relatively short order, we exited.
Another one that's a little less behavioral, a little more in the weeds, but was something that really stood out for me. So, back in the early years of Protégé, in the early knots, we had invested with a manager relatively maybe in the first year or two of their life. And the process sounded great, and it was a stock-picking manager and the performance looked really good. And when he crossed $100 million in assets, for the first time, had to file a 13F filing with the SEC that disclosed the holdings of the long portfolio. And it turned out that within that there was a subset of securities that were really micro-cap stocks, not good or bad or otherwise, but just not something that had been part of the process and something that could easily, you could imagine, as money was coming into the fund, they could be buying more and almost manufacturing their own performance. And so, we had that set of facts. We went into a meeting with the manager and just asked him about it. And we were an early, large supporter of this manager. And I was stunned at the sort of visceral defensiveness in the response. And it was violent--violent isn't the right word. It was sort of this vehement denial that they had done anything wrong when we really hadn't accused them of doing anything wrong. We were just trying to understand what we hadn't understood about the portfolio. And that relationship, safe to say, ended shortly thereafter. So, that was one of the worst ones I ever remember.
I'll tell you one on the opposite side, which is relatively recent, one of my most recent investments. So, these days, sometimes I meet managers not necessarily in the context of evaluating them as an investment. People will introduce folks to me who they think might be good guests on the podcast. And one of those was a fund called the Arctos Sports Fund, which people may only know about, because very recently, Theo Epstein joined their team. It's a private equity fund that's taking stakes, minority stakes, in professional sports franchises. And I had been introduced to them as a potential podcast to Doc O'Connor who's one of the founding partners and was the former head of MSG, probably a year and a half ago, and they hadn't really done anything yet. I said, “Well, this could be a really interesting story. But you know, look, we should talk about this in a year or whatever it is, when you actually have the business.” And then, more recently, two other people said, “We know you love sports; you might want to do a podcast with us.”
And I got on the phone with one of the associates, a young guy named Peter Valhouli-Farb who's just brilliant. And the context was, “Hey, like, tell me what you guys are up to, maybe this would be a fun podcast. I'm going to be doing a whole bunch of stuff in private equity later this year.” And in the context of doing that he walked me through effectively an investment thesis for why owning minority sports franchises is attractive. And my alarm bells went off of just you have this whole dynamic of opaque assets that are undervalued that are difficult to buy with a team that had a competitive advantage in buying it and a COVID dynamic that was particularly attractive and I was blown away. So, an example of something I didn't even think was a conversation that really was going to be about an investment process. And after some due diligence thereafter, I made a big commitment to the fund.
Benz: Just wanted to follow up on that caddy example really quickly. So, it seems like they're sort of two questions where you're deciding who to align with. And it seems like the caddy question was informative. They're like, I don't necessarily want to invest with this person. But then, there's also the issue of, are they a good investor? And so, it seems like how do you disentangle whether someone might be a jerk, and you might not want to deal with them personally, and how good they are at being an investor? So, how do you how do you disentangle those two things?
Seides: It's a wonderful question. And I learned relatively early on that there isn't just one way to make money. And so, there are people and strategies that want to pursue the maximum return possible under any circumstances and don't really care about what that means. I'm just not one of those people. So, I much prefer to be aligned with people that I want to be partners with that I have deep respect for both who they are as a person, or the team is as people and their culture and their ability to perform. And so, that's a personal bias of mine. It goes back to part of the reason why I embrace active management so much because of the nature of the relationships, and the both economic and personal convexity that you can get in those types of relationships. But that's not going to happen if it's someone that I don't think very highly of and don't respect as a person and don't want to partner with. So, I don't think that there's anything wrong with someone investing with a manager who, say, doesn't treat people well, if they can perform and their objective is to find managers that can perform. It's just part of a criteria for me personally that I've never found conducive to long-term investment success in the various iterations of my career.
Ptak: I wanted to shift to investment committees. One of the guests you interviewed on your podcast, "Capital Allocators," was Scott Malpass, who you referenced earlier, is the retired CIO of Notre Dame's endowment. He seems humble and to strongly advocate for his team. So, my question is, do you think humility and self-effacement are so often in short supply among CIOs because that it simply doesn't sell well with investment committees? And I guess my related question is, can something be done to promote and reward such qualities so that they're more commonplace in the corridors of endowments and academia?
Seides: There's really a fine line between confidence and humility in the investment world. I think if someone is too humble, they won't be able to have the courage of their convictions, they won't be able to go against the crowd, which we know is just incredibly important for long-term success. So, the concern I would have is less about the degree of humility than potentially the disparity in an introvert and an extrovert. So, I don't know if being humble doesn't sell with committees. I think in some ways it probably sells very well. But what we know, both for CIOs and investment managers, is the charisma really matters in communicating a message. And so, that can be a bigger challenge for someone who's an equally or more talented introvert than someone who's an extrovert. So, I'm not quite sure what can be done to promote and reward introversion or maybe it's humility, as you mentioned it, other than I think over time, not results can speak, but processes can speak, and people can understand where someone's relative strengths are, and maybe it's not in their ability to be verbally effuse.
Benz: Can you talk about some of the things that tend to trip up investment committees in your experience and maybe things that we do well to avoid in the way that we collaborate and make decisions?
Seides: I think it starts with committees as a decision-making body. It starts with this, where we talked about a little bit on governance, this definition of roles and responsibilities. But really, whether it's a committee or anytime you have a group of people making decisions, there are a few things that can help get past some of these barriers that we talked about, these sort of behavioral barriers that are just compounded when you're with a group.
So, one is thinking about the structure of that committee or that decision-making unit. Research has shown, Michael Mauboussin shared on the podcast that the optimal size of decision-making teams are four to six people. I don't know why I haven't read that research. But I think that's right. And then, within that, the notion of cognitive diversity matters a lot. So, you don't want just four to six people; you want four to six people that think differently, that have different perspectives that process information differently--all the things that might allow them to come to different conclusions. Then, from that structure, when you’ve put the team together, there's a question of how they conduct themselves in the group.
And the most important principles within that--the first is cognitive safety. So, most of the time, if there's a group, maybe it's a little less-driven investment committee, but a decision-making group on a team, there tends to be a leader. And that leader needs to make sure that each team members' thoughts are valid independently, and that they're safe to express them if they differ from the leader. So, you could think about what are the implications of someone on an investment team speaking up if the head of the meeting determines their compensation at the end of the year and is vindictive and might fire them if they disagree with them? Those are all the things that are conducive to making poor decisions.
And probably the most interesting lesson that I've taken out of a decision-making theory, really from Annie Duke, is this notion of how easy it is to infect other people with our beliefs. And so, the way that beliefs get formed, it turns out that if I say something to you, you will immediately believe it's true and then you may or may not decide whether to think it through, do your own research, and come to your own opinion. And what that means is that in a decision-making unit, the person who speaks first has incredible importance in swaying how other people are thinking.
So, one of the ways you could work on that, and the process is that the leader of the meeting speaks last. You may have the introverts speak before the extroverts. You might make sure everybody has equal airtime when they're talking. But there's a lot of ways that you should think about how to conduct the meeting so that the best and most diverse ideas get brought to the fore, so that whoever is ultimately making the decision has the most information they can to go ahead and make that decision.
And then, the last little piece of that is their thought process. So, we talked about probabilistic thinking and base rates. But there's also this notion of risk assessments, which is, when you're at the finish line of making a decision, one of the best things you can do is take a pause and think about different ways that something might go wrong that you may not have thought about, and how do you get all those ways to the fore from all of the people in that decision-making group so that whoever is ultimately making the decision has as much information as possible at their behest to go ahead and make the best decision they can.
Ptak: Looking ahead, what have you got planned? You'll continue to do the podcast, "Capital Allocators," I'm sure, but what else is in store?
Seides: Well, the podcast has been a lot of fun. And that will continue as long as there's great people to talk to, and there's no shortage of that. And just within that, I think, when this comes out, I will have just released a miniseries on crypto investing for institutions--really interested in learning about that. I'll be doing something later in the year on private equity. So, some of that content is just really fun to continue to learn.
I've been doing a whole bunch of things to help mostly money managers tell their stories off the podcast. And I did that privately with some sort of private podcasts, and I continue to do that with a few managers, and probably will be diving into the webinar format. I'll be doing that in conjunction with the team at iConnections later this year. I am looking to launch something we're calling Capital Allocators University, which is going to be an early career training course for allocators that really don't have a place beyond, say, the CFA to learn some of the tools and disciplines of this trade.
And then, the last thing as I look out a year or two, I think there's a decent chance I'm certainly considering launching a fund again, because I'm just seeing so many interesting ideas and don't have all the capital I'd like to deploy it. So, I'm not going to try to grow anything like I did in the past, but a friends and family type fund might be a fun thing to do a year or two from now.
Ptak: Well, Ted, this has been a lot of fun. Thanks for taking the time to share your perspectives and insights with us, and congratulations again on the book.
Seides: Jeff, Christine, really enjoyed it. Thanks for having me on.
Benz: Thanks so much.
Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.
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Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.
Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
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