Top 5 of 2024: #4: Ricky Sandler - EP.414

Summary

Capital Allocators – Inside the Institutional Investment Industry
Episode: Top 5 of 2024: #4: Ricky Sandler - EP.414
Release Date: December 31, 2024

In this highly engaging episode of Capital Allocators, host Ted Seides sits down with Ricky Sandler, the CEO and Chief Investment Officer of Eminence Capital. With over three decades of experience in long and short equities investing, Ricky shares invaluable insights into his investment philosophy, the evolution of Eminence Capital, and his strategies for navigating the ever-changing financial landscape.

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Early Career and Foundations in Investing

Ricky Sandler begins by reflecting on his upbringing in a finance-oriented family, which laid the groundwork for his future in investment management. He shares, “As a kid, it was a mix. My dad was a cable and cellular analyst at Goldman Sachs before he went out on his own as a hedge fund manager...” (04:33).

Despite contemplating a career in law, Ricky's passion for investing ultimately led him to join Mark Asset Management, where he worked under the mentorship of Morris Mark. This experience was pivotal, providing him with direct access to industry leaders like John Malone and Frank Biondi, which ignited his enthusiasm for the investment world (06:24).

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Founding Eminence Capital

After several successful years at Mark Asset Management alongside Wayne Cooperman, Ricky decided to take the entrepreneurial plunge and co-founded Eminence Capital. He explains, “The more I thought about it, the more I knew this was a time in my life I could take a risk...” (07:23). Together, they pursued a long-biased value-oriented investment approach, emphasizing quality businesses trading at attractive valuations while incorporating a modest short-selling strategy.

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Investment Philosophy and Long-Short Equity Strategy

Ricky delves into Eminence Capital's core investment strategy: a long-biased value approach. Initially, the firm focused on buying undervalued companies and selectively shorting overvalued ones. Ricky notes, “We would short the bigger lookalike company that was more expensive than the smaller thing...” (08:37). This strategy proved effective for several years until market dynamics began to shift, particularly during the 1998 Russian debt crisis, which exposed vulnerabilities in their early short-selling tactics (10:06).

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Adapting to Market Changes

Recognizing the need for evolution, Ricky emphasizes the importance of adaptability in investment strategies. He reflects on the challenges posed by prolonged market dislocations and the necessity to understand investor perceptions deeply. “I think one of the things I've said since then is the stock isn't going to go from 12 times earnings to 18 times earnings because you think it's worth 18 times earnings. It's going to go from 12 to 18 because the next investor believes something different...” (16:42).

This realization led Ricky to implement a more proactive and rigorous short-selling approach, ensuring that Eminence Capital could effectively navigate and capitalize on changing market conditions.

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Integrating Quantitative and Data Science

A significant portion of the conversation revolves around the integration of quantitative analysis and data science into a fundamentally-driven investment process. Ricky explains how Eminence Capital hired experts like Adam Parker and Zafar Jafre to bridge the gap between traditional fundamental analysis and modern data-driven techniques (20:18).

He shares a notable example from late 2022: “In late 2022, we did a 50-year analysis on the premium for growth... Our 50-year analysis showed that growth was finally at a discount to its long-term premium...” (20:18). This blend of qualitative and quantitative insights has empowered the firm to make more informed investment decisions and maintain a competitive edge.

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Dedicated Short Selling Team

In response to the evolving market structure and the rise of phenomena like meme stocks, Ricky established a dedicated short-selling team. He recounts the challenges faced during the 2013 bull market: “In early 2014, I looked at the working list and it was like five longs and one short... So I did a number of things around that time... started to create a dedicated short team...” (28:23).

This strategic move ensured a more balanced and diversified short portfolio, mitigating risks associated with heightened individual stock volatility and coordinated trading behaviors.

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Evolution of Eminence Capital's Business Model

Throughout the conversation, Ricky outlines how Eminence Capital has diversified its offerings beyond the traditional hedge fund model. By 2011, recognizing the varied expectations of investors, he launched a long-only fund to provide more stable investment returns. Over time, the firm's asset allocation shifted, with long-oriented products comprising 70% of assets while the hedge fund segment focused on more aggressive strategies (42:17).

Ricky highlights the creation of the 150 by 50 fund, a product designed to deliver enhanced alpha by dynamically managing long and short exposures. “The thing is, long short equity investors, if they want to have real businesses, are going to have to play in this world...” (54:06).

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Leadership and Team Culture

Ricky attributes Eminence Capital's longevity and success to its strong organizational culture and emphasis on collaboration. He states, “Create a good culture... people want to come to work every day...” (49:46). By fostering an environment where senior talent feels valued and empowered, the firm has maintained low turnover rates and sustained high performance over the years.

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Personal Insights and Longevity

Beyond his professional achievements, Ricky shares personal insights that contribute to his longevity in the industry. Emphasizing the importance of work-life balance, he discusses adopting healthier habits such as prioritizing sleep and sunlight, which have enhanced his productivity and well-being (60:04).

Additionally, Ricky highlights the significance of allowing his children to forge their own paths, demonstrating his belief in independence and personal growth (56:30).

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Conclusion

Ricky Sandler's extensive experience and adaptive strategies have enabled Eminence Capital to thrive amidst market fluctuations and structural changes. His commitment to blending fundamental analysis with quantitative tools, fostering a collaborative team culture, and continuously evolving investment practices serve as a testament to his enduring success in the institutional investment industry.

Notable Quotes:

• “I think the one of the things I've said since then is the stock isn't going to go from 12 times earnings to 18 times earnings because you think it's worth 18 times earnings. It's going to go from 12 to 18 because the next investor believes something different.” – Ricky Sandler (16:42)
• “Create a good culture... people want to come to work every day.” – Ricky Sandler (49:46)
• “Only focus on the things you can control. The uncontrollables, you got to learn to live with them.” – Ricky Sandler (63:34)

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This comprehensive summary encapsulates Ricky Sandler's insights and experiences, providing valuable lessons for institutional investors and asset management professionals seeking to navigate the complexities of modern financial markets.

Transcript

[Ted Seides]

Tom, we're counting down the top five episodes of 2024 as measured from Thanksgiving to Thanksgiving by your engagement and downloads. Coming in at number four is episode 414 with Ricky Sandler from Eminence Capital. Ricky discusses his 30 years in the business of investing long and short equities and the adjustments he's had to make to his investment and business strategies to to continue to thrive in ever changing conditions. Please enjoy this replay of my conversation with Ricky Sandler.

[Tom]

Before we get going, I want to tell you about our year end raffle. To enter the raffle, you'll need to complete our annual Audience Engagement Survey. Your responses to this survey really do help shape some of the decisions we make at Capital Allocators and we thought we'd provide a little incentive. Completed surveys give you an entry into this giveaway. Duplicate entries are disqualified. So one per person and we're giving away one of three prizes. The first prize, some new Capital Allocator swag. Just placed a order of some of the softest hoodies you've ever worn and some Patagonia vests. The second prize? Ted's latest book, Private Equity Deals. In fact, let's make it a signed copy of Ted's latest book. And third, free admission to Capital Allocators University hosted in 2025. So if you're an LP, you'll gain free admission to Capital Allocators University for Allocators. If you're a manager, you'll gain free admission to Capital Allocators for investor Relations professionals. If you're not an investor relations professional, you can tap a peer or a colleague and you will be a great friend. You can find the survey in the show notes of this episode and episodes for the next few months or go to capitalallocators.com annual survey. That's capitalallocators.com annual survey. Thanks so much for spreading the word about Capital Allocators and our Audience Engagement Survey.

[Ricky Sandler]

Foreign.

[Ted Seides]

Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the Kingdom allocate their time and their capital. You can join our mailing list and access Premium [e-mail] All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital allocators or podcast guests may maintain positions in securities discussed on this podcast. My guest on today's show is Ricky Sandler, one of the OGs of fundamental long short equity investing. Ricky started managing a hedge fund 30 years ago and founded Eminence Capital a few years later. Today he's the CEO and chief investment officer at Eminence, where he oversees $7 billion across long, short, long only and long extension strategies. Our conversation covers Ricky's path to launching eminence in his 20s and the evolution of long short investing in the decades since. We dive into Eminence's culture, adaptation in the investment process and creation of invest products to meet the needs of allocators, each of which has been an essential part of the firm's ability to survive and thrive amid changing market dynamics. Please enjoy my conversation with Ricky Sandler.

[Ricky Sandler]

Ricky, great to be with you.

Great to be here Ted. Thank you.

What was the dinner conversation like growing up around finance?

As a kid, it was a mix. My dad was a cable and cellular analyst at Goldman Sachs before he went out on his own as a hedge fund manager and then was a manager that ran a very concentrated portfolio. Seven stocks all in the same factors and industries. I think a lot of it was around the opportunities in businesses. A guy named John Malone who was a legend, but he was the CEO of telecommunications, which was a big investment. So it was a little less around the market and a little more around the businesses that he was following and what the virtues of those monopoly oriented businesses were.

From that upbringing, what brought you to Wisconsin?

My older brother went to Wisconsin. I went to visit a bunch. I love the Midwest. I love the people there. Friendly and a little more gentle than New York, but still a lot of fun. I love the environment around big time sports and game day and tailgates and so going to the Midwest and something like that was on my radar. I thought maybe I wanted to go to Michigan and then Michigan deferred my admissions and then I went back up to visit my brother and had an incredible weekend. Madison's a really special place and I was like screw them, I'm coming here and never look back.

Did you know all the way through college that you wanted to get into investing?

No, I did not know I wanted to get into investing despite being around it. I thought maybe I would go to law school. I thought I'd get a broader education, maybe I would operate a business. So I took the LSATs, applied to law school, was going down that path and I began my research process on being A lawyer and talking to young lawyers and other folks. And I didn't like what I heard. Nobody was enjoying what they did. The things the document reading and writing began to make me question the direction I was going. And not that I thought I wanted to be a lawyer, but then there was a point at which I thought maybe it was a great education. And people would tell me, look, you're going to spend three years of your life and you're going to be competing with the same people. It's not as if you're going to get a leg up in another avenue. And so I put law school acceptances on hold and I did a bunch of interviews around finance. I was fortunate that my dad was in the business so at least he can get me some shots on goal. And interviewed at a bunch of places and ended up getting an opportunity to work for Morris Mark at Mark Asset Management, which, which really changed my life. And I wouldn't call it a last minute decision, but it's somewhat like a attack in the road that I didn't necessarily expect. And then once I got into the business, it was love at first sight.

Why did it change your life?

Because I got to work for a great investor. I got to work at a great platform to learn. It was a small firm. We had incredible access to companies and executives. So right from a very young age I was thrown into a research role that gave me huge stimulation, access to people like John Malone and Frank Biondi at Viacom and the management team at Time Warner. And I love the challenge of trying to figure things out. I'm a very competitive person. So I think I also began to realize that this was something where they put the scoreboard in the newspaper the next day and you could see how you were doing. And so it gave me a platform to learn a ton and ultimately to go out and start a fund at an incredibly young age when the hedge fund industry was a bit of a cottage industry.

What was that path in a relatively short period of time to getting the conviction to go start on your own at a young age?

I'd been working at Mark Asset Management for probably four and a half years. My then potential partner, Wayne Cooperman, he and I had worked together for two years. It was his idea, but I think he wanted a partner and he respected me. I don't think I was ready to do it or even thinking about it until he approached me. The more I thought about it, the more I knew this was a time in my life I could take a risk. I thought that there was Some strength in numbers. The fact that the two of us could work together, feed off each other. We both had backgrounds, we both grew up around investing. We both grew up in the same environment at Morris Marks. And I think we both had a slightly different tact on how Morris invested. Morris was a terrific investor, bought great companies, was a big believer in all the quality factors that we think about today. Cash flow, return on capital management teams. I think that Wayne and I probably felt like we both had a little more value in our blood and I think wanted to take a little bit of a different tact on what he was doing there. So there was a lot of alignment as well. That gave me confidence.

So in those early days, what was the hedge fund model you pursued?

So we were pursuing what traditionally would be called long short equity, but I would call it long biased and dabbling on the short side. So we pursued a value investment style. We wanted to buy good businesses at value prices and we also wanted to short stocks and run with some amount of leverage to maximize returns. And I think the shorting that we did in those early days was I would call it dabbling. We would short the bigger lookalike company that was more expensive than the smaller thing that we were looking at. We would short some things that were obviously overvalued or obviously bad businesses, but didn't dig in on the short side like we did on the long side. And I think that worked for three and change years. Then came 1998, the Russian debt crisis and markets shuttered. And the mid cap and small cap stuff that we owned went down a bunch. And the bigger things that were represented by our short book didn't go down as much. And we weren't nearly as protected as I had hoped. And that feeling of not being able to be offensive when things are dislocated was something that caused me when I transitioned from fusion into eminence. Was a big part of what set my foundation for much more of a proactive and rigorous short selling approach. I would call that long biased value oriented investing.

What'd you learn about partnerships in those early years from your partnership with Wayne.

Co Equal partnerships in this business are really hard. I think that this business attracts very strong personalities, people that have strong opinions, willing to debate them, but probably not willing to compromise on them a lot. And so we battled a bunch on names and different strategies, the market. And you realize in this business that you have very strong headed people who have conviction. I think the co equal partnerships that I saw tended to take one or two forms either Two stock pickers like us who maybe didn't always see eye to eye on investments, or the kind that maybe lasted a little bit longer but ultimately broke up also, which was the business guy and the stock guy or gal in this case. And those also didn't end up working out because eventually the stock guy felt like he was driving more of the value. And so there's a lot of pitfalls in partnerships in this business because returns are not always generated equally or people are not always contributing or seeing eye to eye. And so I don't think I would be here today if I didn't actually start that business with Wayne. But I also realized after four years that I had my own view about what I wanted to build and I didn't want to have to fight every day to get there.

So when you went to set up eminence now at 25, 26 years ago, what was it that you wanted to.

Build as an investor? I wanted to build what I thought was a classic Jones model hedge fund approach. True long short, more moderate long short ratio, spending significant amounts of time on alpha, generating single stock shorts. That model of 120 long by 80 short, with the same long strategy that I had pursued with Wayne at Fusion, but with more time and more sophisticated approach to short selling. And then on the business side, I wanted to build what I thought was a high quality organization. I wanted to do something a little bit different than what had been happened in the hedge fund industry. I wanted to treat my people well. I wanted to have a good culture. I didn't want to have a lot of turnover. And I think the industry that I grew up in was one where I would say, for lack of a better term, shit flowed downhill. The boss felt a lot of pressure, so he put you under pressure and screamed and made you feel like we're all under a lot of pressure and you better feel this. And I remember thinking that was not going to get the best out of an investor. Ultimately, the thing we want to try to do is remove emotion from investing. And so if you put somebody under emotional stress for making a bad stock pick or for the way a stock is behaving, what's the likelihood that that person's going to be able to make an unemotional decision? Very low. And so I think that I wanted to build a culture that collaborated and worked together. Lead by example, we work hard, but we didn't treat people like commodities and degrade them and feel like that was okay because we paid them a lot of money and because we all Got degraded.

As young analysts, how did you organize the day to day effort to allow that kind of independent, unbiased thinking, but also get the best out of people?

I started with two analysts, a CFO and an administrative assistant. I wanted at least two people on every stock. I felt like there was good checks and balances and more collaboration. The other things that we did, we divided up the world a little bit by sectors, but with only three people, it wasn't as if we could really get deep. And then we built some processes around the short side, narrowing of the funnel very quickly. You needed a bunch of short ideas because you had to be diversified on the short side and with a small team, how are you going to find those? And this was still the early days, before people were ripping through 10Qs, before accounting services were out there, before CFRA. And I think that we identified an ability to screen for pressures in accounting that provided an early window into doing something others weren't doing and being able to generate a healthy number of our own ideas. We couldn't spend a month on every idea, so we had to build a mosaic approach. We're seeing these flags. This is the way the CEO is talking. This is what we see happening. This makes sense versus going out there and spending a month on every idea.

How long were you able to run that pure fundamental playbook before you felt like the markets were either catching up or changing?

Throughout my 25 or 26 year business at Eminence, there have been points in time where we ran a playbook that ultimately needed to be tweaked or changed. So I would say in a narrow sense that the short side eventually got more crowded. As more hedge funds launched. Posted.com, there was more competition. 10Qs would have nuggets in them that would get flagged much quicker. Accounting services came out and we had to morph and adapt and evolve that part of our process. But I would say broadly through the gfc, most of what we did was relatively consistent, which was on the long side, finding quality businesses that were trading at attractive valuations. And the rest took care of itself on the short side, looking for what we thought were companies that were going to miss earnings. We mostly did a lot of accounting driven shorts. The big changes that we started to see, 2010, 2011 caused us to pivot a bit on our strategy. What I noticed after the GFC was that stocks would trade at bigger disconnects to fundamental value for much longer than they used to. And we couldn't just count on the market to Correct things. Understanding why investors were perceiving things a certain way and what might change that became something that was a much more important element. Having what we thought was true differentiation relative to not just sell side consensus, but buy side consensus versus just believing this was a good business and it was too cheap where it was trading at. And I think one of the things I've said since then is the stock isn't going to go from 12 times earnings to 18 times earnings because you think it's worth 18 times earnings. It's going to go from 12 to 18 because the next investor believes something different. And how can we begin to at least bring that into our process?

As you look back, given everything that's happened, that was clearly an astute observation back then. At the time, how did you decide that you needed to change your process and compare that to being in the moment where, you know, it's not working great right now, but maybe it's just out of favor and will come back.

This is a very delicate balance between sticking to your convictions, being disciplined, doing the same thing, and adapting and evolving. I subscribe to the view that pain is good. It tells you that something is wrong and it causes you to diagnose. I think one of the things that I learned through the investing process was in the immediacy of the pain. Your frame of reference is generally not the best that it's going to be. Often it's, let's not do that again, let's not stick our finger in the fire. But the right approach is how do we have to do things so that we don't do these things repeatedly? At the end of the year, everybody goes back and looks at their winners and losers and tries to learn from them. And what I started to do is look at the last three years, because oftentimes in the moment you bought a stock, it disappointed, it went down and you sold it. And you said, I was wrong. I thought the earnings would be X. They turned out to be 80% of X. And we got it wrong. And I'm going to sell it, I'm going to move on. But with 18 months more vision, you might be like, actually the mistake was selling it. Because that was a temporary problem. And so only with enough time could you really understand what the mistake you made. And then understanding that putting common mistakes together and saying, here's our bias, we tend to get too caught up in valuation and not enough in management quality or business quality or what are our blind spots and our biases? Are we getting sucked into too many things that are cheap, but they have leverage. And so I think in my first iteration of this, I was very cognizant that I believed in the basics of what we were doing. I believed in finding good businesses that were undervalued would be the right approach long term. And so I didn't want to change what we did at the core. And I think in that got us the beginnings of what I'll call more adapting, improving versus changing. The market wants growth and not necessarily cheapness. So let's just go chase growth that I knew would be a mistake. And so I think we saw really good success when we adapted and evolved in 2011. And I think that gave me a lot of confidence in continuing to do that as time went on in different ways, in bringing in quantum data science, in building out a dedicated short team, in recognizing in the last four or five years that market structure changes were meaningful. You had some pain, you sat back and reflected, looked at the commonality, the mistakes, what was happening, made some changes that worked and it fed on itself. Since then. There's a continuous improvement part and then there's an adapting and evolving part that you realize is critical to staying ahead in this game.

I'd love to walk through those three iterative changes that you made. Quant, short team, and market structure. So when you started introducing quant to what was a fundamental qualitative process, how did you figure out what worked?

When we first started to think about these tools, I knew that as a fundamental shop, we had to do things a little bit differently. And it's been a journey for us to get to the right place to get quant and data science as an important tool for the firm, not a separate silo and not leading things. And so one of the first things we did was hire people with outside expertise. So we hired in quant we hired Adam Parker from Morgan Stanley, and in data science, we hired Safar Jafre. Both of them, importantly, were fundamental analysts before they were quant or data science experts. Adam was a semiconductor analyst early days at Sanford Bernstein, then a strategist at Morgan Stanley. And Zafar was a software analyst before turning to data science. And so importantly, they understood what we did more than I think most people in that field do, I think. Secondly, you had to get buy in from the team. It took us a while. We also had to figure out how to precisely use this in a way that it didn't dominate things and it wasn't off to the side in a little science project that nobody was using. And through a little Bit of trial and error. We've come to a place of real good collaboration where on the quant side I, at the portfolio and market level, use the quant resource significantly. And so I am doing things such as analyzing our own historical data, our own price targets. We rate stocks in our sector meetings. Are stocks that are rated really highly, are those good stocks or the stocks that have tension, that get a little bifurcated rating, that are better, but you understand your own data really well. The other thing we do with quant is understand market opportunities with something I'll call analytical rigor. So we may look at things and say, gee, growth stocks are starting to look inexpensive. We're starting to get a number of interesting ideas and there's a number of things within that cohort of stocks which seem unusually cheap. Just how cheap are growth stocks? And we can answer that question with a lot of precision and a lot of history. So in late 2022, as an example, we did a 50 year analysis on the premium for growth. When analysts came to me in the middle of 2022 and said, hey, this stock is cheap, it's back at pre Covid multiples, I instinctively knew pre Covid wasn't cheap multiples for growth. But by late 2022, as you were looking at everybody selling from profitable growth, it looked more interesting. And so what our 50 year analysis showed was that growth was finally at a discount to its long term premium to the average company. A very simplistic conclusion, but with a lot of analytical rigor. And I think that takes an anecdotal perspective that somebody like me or Bottoms Up Investor has and adds real rigor and gives you added confidence that you're fishing in the right pond and heading in the right direction. So the quant side is really taking all of this reported available information, all historical, and running it through computers and being able to access it in a powerful tool. So if you take every number that every company reported, every data point of price, of earnings, of market, you can draw all sorts of relationships all back in history. Using the powerful tools of computer data. Science, on the other hand, is more for what we use it for, more at the individual stock level, More, I would say not as easy to get at information. It is information that you have to go source, whether that's web scraping or credit card data or people taking imagery of parking lots. And it is concurrent information about what is happening in that business at that given point in time. And so that may be telling you how the current quarter is progressing relative to how many email receipts a company is sending out. We also have the power of all historical data so we can do things in data science such as cohort analysis. So we may be looking at a software business or consumer business and trying to have more thesis impacting information. And so we may say, are the new cohorts really coming on at improved lifetime values? We could say in these 10 stores or these 10 regions there's been competition. How are these stores doing compared to these stores? And so that is where data science can be used for more thesis confirming or thesis denying information. We are also tracking the real time KPIs because that's what everybody's using. So I would call that today table stakes to know what the pods and the short term investors are seeing in the data. And so sometimes it's helpful to say, oh, they're going to miss the current quarter by 3%, that's why the stock is acting so poorly. I have a thesis about the next 18 months, so this doesn't scare me and doesn't concern me, but I understand why the stock is going down and why other people are selling it. And that's also helpful to the investment process and the bottoms of fundamental investor.

On the quantitative side, was there anything unexpected that you found in doing that work that really helped your investment process?

I think it helped us understand how quants think and how rigid and defined their systems are, which helped us also understand how mispricings could happen. So one of the good examples that I like to point to was also back in 2022 when we were in this moment where unprofitable growth stocks were really underperform. I remember there was a day where unprofitable growth was having a really bad day and my head of quants sent out a note and he listed seven stocks that were down 7%, the market was down 2. And one of those stocks was Zillow. And I corrected him and I said, no, no, Zillow's not unprofitable. They sold their home flipping business. That's what was creating losses. The core business is profitable. That's in the wrong bucket. He's like, no, on an LTM basis, this company is still unprofitable. And so it is in the right bucket. But you bring up a good point, which is what quants can't do is look forward and how things will change over time. And so you learn the power of it, but also the blind spots and so they can't see what next two, three quarters are going to be. And so that led me to A conclusion where Zillow and Uber, to a lesser degree, they would be profitable over the next 12 to 18 months that people were mischaracterizing it. And therefore in this new market structure environment, that was actually creating an opportunity.

And then on the data science, some of those historical data sets as you described, are what say a pod shop is going to look at.

[Ted Seides]

How do you think about using data.

[Ricky Sandler]

Science for your own process that's a little bit different from what the market knows.

That's where owning the data and then being able to slice it, dice it, and look at it in different ways gives you maybe an analytical conclusion that isn't, how is the current quarter progressing? I'll give you a good example. Dave and Buster is a company that we own and we have a thesis around new management, putting in place menu changes for the food and beverage, remodeling all the stores. And so they have 10 stores out of 200 that are remodeled. And the company is telling you the remodels are going well. But what does that mean? How well we know they're going to remodel all 200 stores over the next two or three years, but there's only 10 done now, and we can now take the data and look at the stores and or states where the remodels exist, slice and dice the data and say, how are those compared to the cohort? And then more precisely answer our own question about these remodels and what the consumer is doing. So it is in this way where we're taking big data sets and then breaking them down in ways that are a little bit less exact to this quarter and more relevant to a thesis that might be playing out over multi years.

What led you to create a dedicated short team?

2013, if you remember the year, I think the S and p was up 30% with no pullbacks, and it was the greatest Sharpe ratio ever. We have a process here where everybody creates a weekly working list. Call it three to five names in the next six weeks. These are the things that I'm spending my time on. And in early 2014, I looked at the working list and it was like five longs and one short, four longs, two shorts, four longs, no shorts. And I'm like, nobody's looking at shorts. I'm like, market was up a lot. So that makes sense. And everyone's doing what's working. And then I also realize that we are compensating people equally for long and short alpha, except short positions have to be half the size or less. So where are people going to spend their time? It's the old you show me the incentives and I'll show you people's behavior. We've been in business for 14 years and had a good track record. And I knew that when things were this good and this easy, you want to be a little bit more skeptical. And so I did a number of things around that time. One was began to create a dedicated short team. And at that time I took maybe my most skeptical contrarian analyst and made him a dedicated short person. I changed our compensation structure to add double weight for short alpha and preached to the team. I know that it's been tough in the past, but if we just look at the past, we're always gonna walk ourselves off a cliff. So let's get back to realizing we want to spend equal amounts of time on these two endeavors. And those changes change the volume of ideas to a more balanced perspective.

So in the last 10 years or so there's been at least this thinking of a big shift in market structure. What's happened with index funds that movement factors. How have you thought about that and addressed it in your investing?

Yeah, it was late 2019 that we began to notice something even more peculiar about how stocks were behaving. I mentioned the post gfc. Things got dislocated wider for longer, but eventually came back. What we began to notice in 2019 was stocks were behaving unpredictably. Even if you really knew the fundamentals, it was as if the things that we were doing in the short run didn't matter at all. And I had our quant team start working on some of these factors like who's trading in these stocks, what's happened to different elements. I want to get some data and some conviction that my anecdotal perspectives have some rigor to them. And so we began to put together the pieces of how the people trading in the market had changed and altered. And it was very eye opening to me. Things changed slowly. But then you look back over 10 years and you're like, wow, we just went from 25% passive. I think at that time it was probably 50. Now it's 60. And then when we looked at the active component and how much in the alternative asset space had moved from fundamental investors to quants to platformer pod shops, it was another big eye opener. We looked at the thematic share. So all these ETFs are beginning to be created and I didn't appreciate it till began to look at the amount of AUM that was being driven in thematic buckets through ETFs. And so then we began to put all these things together. And it was very illuminating that the people who were setting prices on a daily, weekly, monthly basis were very different than the world that I grew up in. Back in the 2000s through the GFC, most investors, I thought, were doing bottoms up work. And so when the weight of the buyers and sellers moved stock prices, it was bottoms up investors, more of them buying than selling. And that made the price go up and probably meant that something was changing. Now, the people that were doing things were doing them for totally different reasons, because a computer model spit them out in the top 20 percentile, because they're gonna say something positive at the analyst meeting in three weeks that will move the stock 8, 10%. And so this got me to take a step back in a big way. In some ways, my earlier iteration around investor perception led to this. Because if we need investor perception to change, if we need to understand where we're different, well, who are we different then? I hadn't even considered that the stock was driven by quant investors who were looking at the low margins and the low return on capital. But that was because of a bunch of accounting that put the stock in the wrong bucket. Maybe there was a gross revenue, net revenue, that made margins lower than they should be. They had done acquisitions. So the return on capital wasn't high on a stated basis, but when you looked at the business, it was. And I began to realize that we were playing a different game than the people setting prices. And that led me to take a step back more broadly and say, how do we want to approach this? What's different? We don't want to change what it is we do at our core. But can we execute a little bit differently? Can we adapt our mindset and adapt how we tactically execute as a way to both navigate and then ultimately take advantage of this?

What action steps did you take in your process to adjust the changes in behavior of the different participants?

So the first action step that we took was just a recognition. I started talking about this internally, externally. We had the data from the quant team about how much things changed, and I began to think about the implications. So implication number one was price action is much more meaningless than we used to think. Call that the one week to two, three month price action was stocks were acting weirdly and it meant nothing. In the old days, when a stock was acting poorly, you're like, somebody knows something. And there was a good amount of time where that company disappointed and you felt like at a disadvantage. The second thing was to begin to spend more time on the stock versus the business. We began, I think, to impart on our analysts who were attending idea dinners and lunches. What is the narrative around the stock? Who is driving and trading it? When we would speak to the sell side, instead of asking them their opinion about the company or going through the model, who's calling you? What questions are they asking? What's the tension point? And then our quant team could look at a holder's list and tell us, this is long onlys, this is hedge fund, this is quant. And we began to understand in what sandbox we were playing. So I think it was a combination of first mindset change and then adapting our research process to recognize that these were other people driving stock prices for different reasons than we understood. And so we wanted to understand them a bit, just to know why does the stock screen poorly to quants? If this is a short for the pods, is that because the data science is bad? So it looks like they're going to miss the quarter? And that again helped us understand positioning and sentiment a little bit better. And then ultimately all of this led to an increase in our portfolio turnover. What I noticed when I look back over the last four years is that our turnover since the end of 2019 is 40% higher on the long side and 70 or 80% higher on the short side. This isn't us turning into traders around the quarters. This is us trimming. When something is up by 30% for no reason, we can identify. Buying more. When it's down 30% for no reason, we can identify. And so I would say that was a natural change that we made almost without realizing that we should do it. And then as we began to study this, is us trying to take advantage of different lens, doing things for totally different reasons. We were fortunate to see this early. I think many more are talking about it today than when we first started to talk about it. And we're now adapted, adjusted. It's very much part of our process to be talking about the setup. We're still doing the deep research on the business, but we're probably spending 20, 30% of our time understanding that and hopefully taking advantage of it.

As you think through all these different ways that you've evolved, the short side has always been rife with risk from all these different changes. I'm curious what works today in your short approach.

So we have adapted and adjusted our short execution and process post the meme stock craze, another one of those pain Points that got me to take a step back. And I think in this understanding investor perception, all of a sudden we had to understand a retail investor and we had to understand in some ways coordinated bullying, something that for professional investors is illegal. But on Reddit posts and people banding together, the government's not really going after them. Single name shorting, where stock volatility is high is very dangerous. High stock volatility is good for the long investor. Stock goes down, you have less risk on the table, more upside, it's easy to buy. Stock goes up, you have less upside and a bigger position, it's easy to sell. The opposite happens in the short side. When it goes against you, it's already a bigger position, you already have more risk on the table. The best you could hope to do is ride through that. And so one thing I realized in this market structure change is we're getting greater individual stock volatility. The ratio of stock volume to index volume is at very high levels relative to history. And so that creates this challenge on the short side where these movements are not necessarily based on bottoms up fundamentals. If something goes up and becomes a bigger position and you have to risk manage it down, you are locking in negative alpha for non fundamental reasons. Same thing might happen, it may start to work and you may say let's press it back to its original size and you're capitalizing potential negative alpha again because that move was not based on what really made sense. So number one, we need diversity to be able to ride through the volume and not cause us to have to exercise risk management after things had already happened. Two is we needed independent balance on the short side. So we needed to find short ideas in every one of these buckets. Crazy meme stocks. The it's ridiculous, never going to get there. Earnings disappointment, losing market share, melting ice cubes, accounting fraud and have a diverse group. We also didn't try to reduce risk management by diversifying From GameStop into 20 other retail led stocks that all move together. So independent balance and then the last piece which we've done is pre mortem our position sizes and risk limits. We don't allow shorts to grow above 2% of capital. So I need to decide today if I love something, how big can I be so I don't trigger that risk. And if we're short a $40 billion stable business without a big short interest, that could be 150 basis points because I don't think it could squeeze much more than 20, 30%. But if I'm short a 3 or $4 billion market cap with a 15% short interest that is in the top 50 names in Reddit mentions. That's not going to be bigger than 85 basis points because I want to be able to ride through the 100% short squeeze. And so we are letting our position sizes float more. That is we made it 85. There was the squeeze, it went to 130 basis points. We're accepting a bigger position knowing that that was non fundamental and we're not going to trim it and let's say lock in negative alpha unless we think that the stock is up for fundamental reasons. That's a different iteration than the retail investors bullied some stock or flows into some AI basket or whatever is happening that we think is not truly fundamental on a bottoms up basis. So we're not pressing them when we're down because sometimes that's not a signal. So recognizing the market's not giving a signal, we shouldn't necessarily act in that way. So scale and diversified short portfolio, balance and short portfolio pre mortem position sizes and letting them float are all things that are new and prescriptive over the last three or four years to help us navigate this different market. This volatility does not make it easy on short sellers.

So alongside of these evolutions you've also done some pretty interesting things on the business itself. So we started talking about it started as the Jones model hedge fund. What happened with that structure from there to where we are today?

Today only 30% of our assets are in our hedge fund. 70% are in long oriented products, a long fund and a 150 by 50 fund which is a long replacement portable alpha alpha extension. But it's 100% net long, it's competing with the market. What happened along the way was that I think going back to the GFC I got a really good lesson in allocator behavior. So post the GFC we were down 19% in 2008 and we had not been down any year before that. And the market I think was down close to 40. So half my investors were thrilled. Congratulations. Thanks for saving us for only being down 19%. But the other half of my investors were furious and shocked that we could lose that much money. And I realized then that hedge fund investors want you to beat the market and they want you not to lose money and you cannot not structure a portfolio to do both of those things at the same time. You can structure a portfolio for absolute return, market neutral portfolio and not losing much money and you can structure a portfolio to outperform the market over the long run and lose less on the downside. The classic Jones model, a more risk adjusted way to own equities. And that got me thinking that I had these investors who had totally different expectations as much as we tried to condition them and they were very fragile. So our asset base got cut in half in 2008. We were down 20 and 25% of our investors wanted their money back.

From what to what?

That was from about 5 billion to 2.5 billion. We, starting in 2009, we began to raise that money back and we grew back to 5 billion. And then we had our worst year in 2010. We were I think down 1 when the market was up 15 and our assets got cut in half again in 2011. And I was like, man, these hedge fund investors, they are fickle. This is a fragile business. I would say having a $2 billion hedge fund could be a great business unless you started at six and then you got infrastructure for six and things feed on themselves. And so that got me to think about a different product where investors had very consistent expectations. In 2011, we launched a long fund. It also happened to coincide with a time where stocks were very cheap. I wanted a more stable business underneath. It was part of building business stability. And over the course of the next eight or nine years, our long fund grew and our hedge fund shrank. And I realized, and talking to allocators, that the classic long short equity hedge fund had not a really big place in allocators portfolios anymore, that allocators were barbelling their portfolio. Hedge funds were this thing in the middle. Better way to own equities with less volume. They could own full risk on one side and uncorrelated on the other side and get to the same place. And it was much easier for them to evaluate on the left side, the long only fund. Every year I'm measuring you against the market. How you doing on the uncorrelated side, it's absolute returns. And the thing in the middle where we were trying to explain when the market was up 20 and we were up 16, that we were doing well because we captured 80% of the upside, but 40% of the exposure. And people looking at you cross eyed like, no, no, you didn't outperform the market. And so doing that in 2011, 2012 really helped our business stability. We stayed in the 5, 6, $7 billion asset range even though there were outflows into long short equity. I realized after 2022, when we were up and the rest of the world was down that even doing well, much better than other people didn't matter. You were in an asset class that people were kind of divesting. And then ultimately about a year and a half ago, I looked at our asset base and said we've got 60% of our assets are long and 40% are hedge fund. Most of our investors don't have any benefit of our short selling. The only way we can beat the market for those investors is for a long stop form the market. We weren't getting any benefit of our short alpha, our long short spread. And that led to me believing that a 150 by 50 product could be a real powerful product to meet this need that I knew was huge. The 7030 model, 70%'s allocated to equities and they know they just want to generate alpha and that we could have a product that would have even a more powerful alpha story than our long fund. And that product has gotten great traction. We now have a billion four in it and a good amount of interest in the longer term. I think long short equity investors, if they want to have real businesses, are going to have to play in this world.

Do you manage the 15050 portfolio differently from the traditional hedge fund or the long side? If you're long only the stocks are all the same.

It is mechanically managed drafting off of the hedge fund. So whatever our hedge fund exposure is, the longs get resized to 150 and the shorts get resized to 50 and we have more rebalances to stay at those levels. Our hedge fund is variable net. So if we're more bullish and we're buying more things and our net exposure drifts up, I may not touch that, but in the 15050 we'll stick to always 100%. And so it is mechanically managed tightly on exposures, but the stocks are all exactly the same.

In retrospect, a lot of these strategic decisions sound logical. I'm curious how you went about making those big decisions when at the outset of eminence you felt it was really important for you to be a sole decision maker on the portfolio.

I tend to come to ideas and decisions from surveying what's happening, whether it's pain or euphoria. How are investors behaving? These things are clues to me and then I socialize them with the people here. And one of the things about a collaborative organization is I feel like there are good checks and balances on me while I'm the ultimate decision maker. And sometimes we battle it out and I'm like, I'm the boss and I'm making a decision. But you've had your day in court, you and everybody else. I'm listening. And I feel like I need to convince some pretty invested people at eminence about these things that we're doing. I believe in the power of persuasion and in diversified groups coming together and hashing things out. Ultimately, many of these were things that I thought about. I reflected on issues, I looked at some data, I ultimately made a decision we should go in this direction. And then I had to sell my people on it. And while some people say, geez, who's going to say no to you? We've had senior people here have been here 18, 20 years, have their life invested here, work really hard. I think that having to convince the people here of these things along the way have been a good check and balance on making sure it's properly vetted. The good culture, having people collaborative, invested in the organization, has bred people who live and die for us and want us to succeed and maybe have different perspectives so are able to push back, but with the same long term goal in mind.

How have you led this team in such a way that you have such duration of senior talent who has stayed with you in an industry where notoriously people spin out? You've had some of that along the way as well.

There's a handful of things that I would point to, one we talked about before, which is kind of a good culture. People want to come to work every day. You get the right people, create a good culture is one. I think you have to compensate people, you have to err on the generous side. I don't think you have to dramatically overpay them, but you can't be cheap and you can't be greedy. You got to be long term greedy. Then for us, I think two of the things have been really helpful. One is the collaborative nature of what we do. I think that each of these senior people are very credible and strong and the people around them make them better and challenge them in productive ways that we get to a better answer. And then the person at the top has to be an integral player, has to make people better. They have to realize that they're good investors, but they could be great inside of this system. And therefore a solid piece of this pie is better than signing up to live and die by every of their own decision. Let's say if you went to a platform or having to build something on their own and dealing with everything, you have to be pulling your own weight because you're certainly pulling your share of the incentive pie. And I think that in certain environments that can become a disconnect for people below.

As you've looked at your peers in other organizations who do things a little bit differently, what are some of the things that you've either tried or thought about in working with your team and trying to improve that either haven't worked for you or you wish you could get to, but, you know, just wouldn't work here?

There's a lot of things that I've gotten from peers that we've implemented and have worked. So I would call them in the execution oriented, process oriented types of things. One of the things that I didn't do early on, but something that I know Viking does, is they make folks PMs at relatively inexperienced levels and a little bit of trial by fire. And I think for a long time I was of the mindset we have these investors entrusting us with their capital and I'm going to have to believe that you're great and experienced to have capital. And over time I've realized that that tool is a great tool to retain people. So they want to become PMs. It's a great accountability tool. It's a great communication tool. Their behavior speaks to what they want to do versus their words. And so that's something that I think through lunch with one of the senior people there, I heard about, I reflected on it, tried on for size, and then ultimately was something that we instituted and has been great for us. I think seeing peers invest in data science and quant were things that got me thinking about it. So I think where I come down is we're our own N of 1, we're a unique organization and there's lots of great ideas out there and you got to figure out what works for you. But it's a little bit of almost like picking from the supermarket. I tell young investors, find your own investing compass. Same idea. Don't invest just like person A or person B. Don't invest just like Buffett. Don't invest just like David Tepper. Invest like you. But that doesn't mean you can't take pieces from a bunch of different people and build your own compass. And I think I've done that. There's not many things that I sit and just dream up unbelievable ideas and then implement. And one of the things I know wouldn't work for us is independent silos where people were operating independently and we were aggregating that in terms of risk. So maybe how the multi Managers work or other firms where they let people do their own thing and it gets collected up into the book. For us, we have really good people with slightly different orientations and perspectives around the difference between a pretty good idea and a great idea. And bringing those together has made us stronger.

If you look back over the last 26 years, there are probably today only a few dozen investment firms where that long, short DNA is a core part of their existence. However that's getting expressed, what do you think have been the most important drivers of why you're still at it when so many of your peers over that period of time aren't anymore?

I think first and foremost is this adapting and evolving. There are times when people realize things have changed and their decision is, I'm not going to play because I was winning at this game and now we're in this game and I'm not winning, so I just won't play. I'm too competitive for that. I love this business. I love figuring things out. I'm too young. I'm also a big and believer in all this longevity stuff. And working is important. I often say if this doesn't work out, I'm not qualified to do anything else. So keeping this going, keeping this strong, building from 25 years to 40 years is what drives me going back to the culture. I work with great people. I don't have massive turnover, which also I think creates headaches and challenges for people in my seat. We all love investing, we all love meeting with CEOs and figuring out things. But there's a lot of other stuff that comes in this business. So you gotta love marketing if you want to keep a strong business. And that includes investors asking you about that stock that didn't work out and pushing you on why didn't you do this or why didn't you do that? And you have to have the humility to just engage with them and listen and tell your story. It includes dealing with people and people turnover. Now, we haven't had as much of that. So I think that's been another element of it for me is creating a culture where I love the people I work with and it keeps me motivated to come in. And I want to work hard because I want them to see great success and reap the rewards. I've been fortunate that this isn't about money for me anymore. This is about building something enduring. Maybe it is my own legacy that I built, something that lasted for 40 or 50 years. It is about the great people that I work with and having something and a Path for them to want to stay here, to want to work hard, and in some ways to make my life easier, which is to not have all this people turn over so that I'm not doing the thing as I love, which is focusing on the stocks and investing.

Ricky, I want to ask you a couple closing questions. I have one question to come full circle before we get to that, which is we started with your growing up in an investment family. And I'm really curious, as you've raised kids in an investment family, what have you done similarly or differently than what you saw from your father?

I have kids who are 21, 23 and 25 now. One in college, two out of college, working. I think one of the most important things that I've realized, and this is probably more in watching other parents and people and how they've dealt with their kids, is it's their journey, it's not your journey. So while I provided guardrails, a good environment, I've let my kids figure out where they want to go. One of my kids has come into the investing business. He's an investment banker at Molis and on his own through his peers at school. He was driven and this is what he wanted to do. Now, I said, hey, I could help you maybe, maybe I could help you get interviews or whatever, but this is what you want to do. You're going to have to get it. I have another son who went into healthcare, growth, equity. That was what he wanted to do. And my daughter, I think, is somewhere between legal and not for profit. I don't quite know, but I've let them be their own people. I see so much of this in New York City, where it feels like the parents are living their own dream over again. What school the kid gets into, what sports he plays, and that's been an important part of it for me. And I think that's a little bit what I do at eminence, which is I don't oversteer. I think there's a lot that I could impart on them. But you want them to make their own mistakes, you want them to learn from their mistakes, and you don't want them to learn just because you told them something. So that's sort of one whole element. And then the other thing, which probably copied my dad, which was really having them know that the upbringing they had is incredibly unique and they need to be incredibly grateful for that. Not grateful to me, but it's very different than other people. And you maybe went through life and didn't have to worry about money and so you don't really think about it. But to everybody else in the world it may be the most important thing and you're in a different place and you need to know where other people are coming from. You need to know that people are going to expect you to be spoiled. Therefore you have to go out of your way to look people in the eye, say please and thank you. Be kind and knock on wood. And I give credit to my ex wife as well on this, but we've raised three, I think, well adjusted, good kids who are independently driven to do the things that they want to do.

That's great. All right, Ricky, a couple closing questions for you. What's your favorite hobby or activity outside of work and family?

Racquet sports. Was a big tennis player most of my life. I'm a big padel or paddle player now. I love it for everything from the workout to the competition to the mental aspect. Tennis I think is a great activity for investing because you only have yourself to rely on. It's not like the first baseman didn't catch the ball that I threw or the ref or this or that. It's me against you. And if I lost, one or two things happened. You beat me and you were just better than me or I beat me and I got to figure out how to beat you. So you may be better than me, but I've realized that if I hit the ball short to your backhand, you're not so confident coming in and I can expose something and how do I figure this out? So I love it for that. I'm competitive, I want to be active. And that's been probably a big part of my non work family life.

So this ties back to something you're saying earlier. There's a whole line of research about tennis being the greatest sport for longevity. So in your study of longevity, I'm curious, what are the two or three things you've most taken away and adopted so more recently.

So I think sleep is an obvious one that I think we grew up in a world where it was a sign of manlihood. The less you could. It was like I can name that tune in four hours. I only need three and a half hours of sleep guarding that and realizing that I used to have 7:30 breakfast meetings. I don't make breakfast meetings anymore. I want to wake up when I wake up and I don't sleep a day away, of course. But I think that's important. I think sunlight is incredible. Walking things that are so basic that I don't think until I began to read all the research, realized how important these things were. And so my whole morning routine is different now. I get up, I have water instead of coffee. First I try to get sunlight and walk a little bit, then I have my coffee. The energy and clarity it gets you is great.

What's one fact that most people don't know about you?

At the age of 14, I was about 80 pounds overweight. I was an obese child. My older friends know that, but people in the business world or otherwise don't. And I think in some ways the struggle overcoming that was a very defining event. Between the ages of 14 and 17, I lost 80 pounds and grew three inches. And by the time I graduated college, I was doing triathlons and kind of a fitness nut. And so it gave me this love of activity and doing things. And also overcoming something at a young age like that may be part of my competitive drive.

How did that affect you as a kid before you took that weight off?

I had some good friends, but I wasn't the most popular kid. I was a good tennis player, but at a certain age I could no longer compete at the tournament circuit level because of my weight. And so that was frustrating to me and I think ultimately got me to address it again. Probably another one of those things where the pain of something that's going on gets you to reflect and do something about it.

What's your biggest pet peeve?

I have a number across different vectors. So from pet peeves about the society we live in today, it is free speech and censorship and stuff along those things. Pet peeves around the world we live in, it is around the helicopter parenting that goes on and what it's going to do to the next generation and where that is.

How about on the investment side?

On the investment side, everything that was a pet peeve I've just accepted and dealt with. It is incredible how investors are backward looking at numbers and they create a narrative around what's existed versus actually being independent. But I've just come to accept that. So I think every one of them, whether it's the retail investors that are still buying GameStop or the pods that are doing things for the next three days, this is the world we live in. Just deal with it.

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

I'm going to say three people. My dad, Morris Mark and David Harrow, who runs Oakmark International, who I interned with when I was at school. He worked at the State of Wisconsin Investment Board. He's a deep value investor and he's somebody who I respect a lot in.

Terms of his global what's the best advice you've ever received?

Only focus on the things you can control. The uncontrollables. You got to learn to live with them. It's almost like it's a maturity thing. As you get older, you realize little things used to make me angry. You get to the airport and the flight's delayed and you're yelling, you just realize it's not helping. And through a series of things, people have said that to me and I've come to that place.

All right, Ricky, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

I don't think I appreciated at a young age how everything you hear from somebody is through their own perspective, their own lens, and their own motivations. Whether that's a CEO telling you something or a parent telling you something, or a teacher telling you something. I think I naively almost took things for fact or face value versus stepping back and understanding the context of the person. And I don't think at a young age I appreciated how different everybody was and therefore their frame of reference. What they're telling you is just their frame of reference.

Ricky, so much fun. Thanks for sharing these incredible insights from this last quarter century plus of your career.

Thanks, Ted. I appreciate it. This was a lot of fun.

[Ted Seides]

Thanks for listening to the show. To learn more, hop on our website@Capital Allocators.com where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one and see you next time.