← Capital Allocators – Inside the Institutional Investment Industry
Capital Allocators – Inside the Institutional Investment Industry
Will England, Derek Drummond, and Tony Caruso – Disintermediating Pod Shops (EP.501)
00:53:21
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- [00:00]
Derek Drummond
Intra month volatility is a lot higher than you think. If you get one month snapshots and then you get to see the ride throughout the month, it can be a very different story.
- [00:10]
Tony Caruso
Derek and I have joked before you learn more about manager on three days on Dockside than three years. If you invested in a fund, you understand what they do, what their portfolio looks like, how it evolves.
- [00:21]
Derek Drummond
It's incredible when you see what they're buying and selling every day. We're in the business of buying serial good decision makers and sometimes I joke that my job is playing fantasy football. You're trying to find the best athlete, put them in the right position. Hopefully they all march down the field. Watching how they trade in a drawdown, you can see it. You can make much more informed decisions about the people that you're putting on the field.
- [00:51]
Ted Seides
I'm Ted Seides and this is Capital Allocators. Today's show discusses an innovative joint venture between asset owners and a multi manager hedge fund fund that seeks to deliver smooth equity like returns at a lower cost than available in the marketplace. My guests are Will England, Derek Drummond and Tony Caruso. Will is the CEO and CIO of $12 billion multi strategy hedge fund Walleye Capital, Derek is head of External Public Markets Investing at the State of Wisconsin Investment Board and Tony is Managing Director of Hedge funds at utimco. Together they co founded Dockside, a managed platform that gives institutional allocators direct access to portfolio managers using the infrastructure, risk systems and financing capabilities of a multi strat underneath. Our conversation traces Dockside's evolution from a barstool brainstorm to a platform with more than 60 managers and billions in assets. We discussed the accessibility of talent through managed accounts, differentiated manager sourcing, due diligence with trade level transparency, capital efficiency across portfolios, hedging, risk management and onboarding and exiting managers on the platform. All told, the combined heft of large asset owner capital and the sophisticated infrastructure of a multi manager hedge fund have created a win win for everyone involved. Before we get going, it's still travel season. Partner meetings and board meetings, the Capital Allocator, CIO Summit, Berkshire and Milken across planes, trains and automobiles. You're bound to into a few snacks when they're unavoidable. I try to remember Will Guidera's story of the pilot who lifted everyone's spirits by bringing families into the cockpit. But it's not always easy. Which leads to my most recent pet peeve. Speed limits. When I travel to certain places, everyone religiously follows the speed limit in Florida along A1A. If you go much over 35 mph, there's a good chance you'll get a ticket. In Sun Valley, I once got stopped for rolling through a blank blinking red light at a whopping 4 miles per hour. Once I adjust, I find it relaxing to drive slowly. It reminds me of the Pixar movie cars when the old timers off Route 66 drove low and slow. However, when I'm in Connecticut or New York, I'm a totally different driver. I need to get places and if I'm running late I'll end up on a single lane road for five miles behind someone driving annoyingly slow. That person is probably driving 35 miles per hour the speed limit, but it's common knowledge in those parts that the flow of traffic is well above the speed limit, with maybe 7 mph over as the whisper number statue. For the life of me, I can't reconcile the two. Either we should drive the speed limit or not, or maybe we need a lot more variability in what the safe speed limit should be. So my new pet peeve depends entirely on where I am. If I'm in Florida, get off my tail. I'm already going the speed limit. If I'm in the Northeast, you better hurry up if you're in front of me and you're only driving the speed limit. The only way I know to gain the benefit of such different perspectives is right here on Capital Allocators. Thanks so much for spreading the word. Capital Allocators is brought to you by AlphaSense. Expert calls have always been one of the most powerful ways to build conviction, but today investors are asked to cover more companies and move faster with leaner teams. With AlphaSense's AI LED expert calls, their Tigus call service team sources experts based on your research criteria and lets the AI interviewer get to work. Then they take it one step further. Your call transcripts flow natively into your AlphaSense experience and become searchable and comparable. So your primary insights plug directly into your earnings diligence and pitchbook workflows with no tool switching AI for coverage and efficiency, humans for complexity and conviction. Sounds like just the right mix to create a scalable institutional edge without growing headcount. For hedge funds, this means validating thesis assumptions before earnings across dozens of experts instead of a handful. For private equity, it means faster pre IOI scans and deeper commercial diligence. And for asset managers, it means pulling real operators perspectives straight into models without disconnected tools or manual handoffs. All of this lives inside the AlphaSense platform turning raw conversations into comparable auditable insight. The first to see wins. The rest follow Learn more at alpha-sense.com Capital Capital Allocators is also brought to you by Canoe Allocators. Exposure alternatives has never been higher and most of them will tell you the same thing. Their data hasn't kept up. Chasing documents, extracting performance and reconciling across dozens of funds is a real drag on the people doing serious investment work. Canoe intelligence purpose built AI to fix that problem. Over 500 institutional clients, including 40% of the top US endowments, trust Canoe to process more than a million documents a month across 44,000 funds. If your team is still doing this work manually, I strongly recommend you check out canoe@canoeintelligence.com please. Enjoy my conversation with Will England, Derek Drummond and Tony Caruso. Will Derek Toney, thanks so much for joining me.
- [06:51]
Tony Caruso
Thanks for having us.
- [06:51]
Derek Drummond
Thanks for having us.
- [06:52]
Will England
Thank you.
- [06:53]
Ted Seides
It probably makes sense to start with a little bit of a background on each of your seats and how the stock side platform fits into that. Derek, why don't you kick it off
- [07:05]
Derek Drummond
here at the state of Wisconsin we run about half of our assets internally and then half of our assets externally. I head up the team where we allocate the capital to external managers in the public space. We're trying to find managers where we can't manage those assets with either the team or the strategy or the region of the world internally, a lot more of the hedge fund strategies, a lot more of the emerging markets. How Dockside comes into the whole fray is your platform for us to be able to be a lot more dynamic about our allocations, to be able to target our risk a lot better, access managers that we might not have been able to access through a traditional GP relationship.
- [07:47]
Tony Caruso
Tony I work for you. Timco. It's $88 billion endowment, manages money for 22 academic and health institutions. I manage the Zero beta hedge fund portfolio. It's roughly 11 billion in size but consists of the multi managers and a lot of equity market neutral and relative value strategies. The rate that we use Dockside is to access the single PM equity market neutral managers. While we invest in the multi PM models, we also want to access those talented single PM models that don't work for the pods. That's how we're using it. It's currently around 7 billion of GMV. It's the alpha pool that we use that tap into portable alpha as well.
- [08:26]
Will England
Well, I run Walleye CEO, cio, most people know in that context is running our Multi Strat business, which is a $12 billion full pass through. I hate the term pod shop, but I'll say it's pod shop for the purpose of this conversation. When most people think of Walleye, that's what we do. They're not the many scale multi strats. That's a core business. Dockside is a subsidiary of Walleye's parent company. Very separate business. Separate building ultimately does roll up into me. So think as a chairman, shareholder, chief cheerleader of Dockside. Dockside's a managed account platform that we started with Tony and Derek a few years ago. It provides enormous amount of value to everyone involved. It's one of those few businesses where everyone wins. It's been really fun to be a part of and to build out with these guys over the past couple years.
- [09:12]
Ted Seides
Where did this idea for Dockside come from?
- [09:15]
Will England
There's been this huge trend in the hedge funding community towards centralization of investment programs. The multi Strat model has been a big beneficiary of that. There's a lot of infrastructure alpha and putting together return streams on one balance sheet. Back in 2022, I was talking both with Derek and Tony around this concept. Maybe we could put together a product and service leveraging the capabilities that Walleye has built to run our business. We've been doing managed accounts through our Multi Strat fund going back to 2014. Could we make that available directly to Tony and Derek as the end owners of capital to start a managed account platform? It seemed like a great idea and a great way to add value to these guys. Let's go out and build a business together. Pretty fortunate that these guys were entrepreneurial in that respect. You don't always find that on the allocator side of the table.
- [10:01]
Derek Drummond
We were sitting around having a beer with each other and saying, hey, what if we did this together? Everyone says, yeah, yeah, that sounds amazing. Let's do it. The next day you follow through and you do the thing that you talked about. It's very, very rare, but that happened with us. We would sit around and we'd be talking, well, isn't that going to cannibalize your business, Will? Or Will would say something like, well, I know you big sophisticated allocators are going to figure this out somehow, some way. Why don't I provide that service to you all? It's going to naturally be different than his multi track pod business. It's not going to cannibalize that because he can do things that we can't. But also we can do things that he might not be able to capture assets from managers that want to face a state pension plan and maybe don't want to have a direct relationship with one of these shops. We had these initial worries, but they all faded away over time. It was a lot of trying by doing. There were very few potholes in the road along the way. We almost had to pinch yourself, does this really happen like this? It's this easy to do? And it really was.
- [11:01]
Tony Caruso
We didn't invent the SMA platform service provider model. There were other SMA platform service providers. When you go through their risk systems, you ask about their financing terms, you ask about everything that you would want in a multi strat. They didn't really have it. They didn't understand how the multi manager model worked. Here's this unique situation where we're partnering with Walleye who gets the game. We're leveraging everything that they built for the multimanager platform and were able to use it. That was completely unique and you couldn't find that with anybody else that was out there.
- [11:32]
Ted Seides
Tony, what's the core thesis of why this makes sense?
- [11:37]
Tony Caruso
There's cash efficiency, transparency, better control over the cash, more flexibility. So many different things. When investing in hedge funds, if you don't have extreme diversification, you're doing things that have cash inefficient way. What we're looking for is specialists that have an edge, putting it together into one portfolio, applying some leverage, getting this alpha engine, you could port it onto public equities and whatever asset class you want.
- [12:05]
Will England
Simply in a nutshell, what is a multi strat business model trying to do? You're putting together uncorrelated return streams which gives you dampening effect of volatility, gives you the confidence to use leverage. The real unlock. When you think of an overall plan like Utimco or Swib, you're implicitly borrowing money at fed funds plus like 20 basis points. Holy shit. You talk to the treasurers in these organizations, you're telling me that you can borrow money at fed funds plus 20. That's like the cheapest source of funding available. That is super cheap and super valuable in the context of an overall broad business. That's a real unlock. Things like that, that might sound nuanced or in the background really, really important to making the model work.
- [12:44]
Ted Seides
When you started discussing the next day after the initial beer, how did you think about who was going to do what?
- [12:53]
Will England
Initially was saying, how do we structure this in a way that's advantageous? Dockside is ultimately an advisor to a fund There's a fund that's set up for utimco. There's a fund that's set up for Swib. Dockside sets up the sandbox, then makes it really easy for someone like Tony or someone like Derek to select managers and then not have to do all the other work to make it work. Dockside, the name. I live in a lake. There's restaurants you can go to to get Dockside service. White glove type service. That was the idea. We built out a fully separate team to do this. Had a background in client service and operations and financing and accounting. To differentiate here, make it really easy understanding the nuances of how all these charges work under the hood at the primes. Pretty much the entire Dockside team to come from the sell side. That worked in private brokerage roles before.
- [13:40]
Derek Drummond
My core piece was how does the technology work? You have this fancy little front end. These PMs are going to plug in their order management system and then it all shows up. There are no trade breaks. At the end of the month. All the accounting's done. T plus one. You're getting your statements. Yeah, Derek, that's how it's going to go. And I was like, that doesn't really happen. It sounds great. Technology never works as seamlessly. And then you start plugging some people in. You do trade testing over a week and they're trading for you the next week. You're getting PMs up and running in a matter of days and weeks, not months. Numbers are flowing through. The risk is flowing through. The most surprising thing about this whole thing was how seamless the technology worked.
- [14:21]
Will England
We ported over a number of our technology assets. Hard to justify building that technology through just starting a managed account platform from scratch. That was an advantage. The business is effectively setting up a fund of one for each client, providing a technology product and effectively an operating service for a bring your own managers type of a model. It's one of those businesses where the Dockside team, when they're talking to onboarding a new client relationship, new endowment, prevention, can legitimately go to them and say, we're going to charge you money, but you're going to pay less at the end of the day versus what you're doing right now. That's a great business. Going back to the notion of Dockside being a white glove service, a big portion of that was risk service. We have risk managers within Dockside that work with Tony and Derek and their teams because there's no right or wrong way to do this. When you have a new manager, what is Their marginal contribution to risk in various different dimensions. They are actively in dialogue with the dioxide risk folks of saying this is a live, living, breathing exercise. You step on one area, it goes in the other area. Having risk practitioners at the center I think was pretty helpful. Part of the model, the unknowns were the operational model. How's it actually going to work? Fortunately, we were able to go through the guinea pig period without a lot of hiccups, which was great. But there are other unknowns too. It's doing this as a subsidiary of a big hedge fund. People were asking, is that going to be a problem? How do you set up information barriers to respect the fact that this is IP that's being cleared onto these balance sheets? Fortunately, that has not been a problem. There's over 60 managers today. The IPPS we take extremely seriously. That's not just from a business practice standpoint. There's real compliance reasons for that. So you can't screw around with those info barrier rules. That was just an unknown. Those are some of the initial questions that we faced.
- [16:07]
Ted Seides
Derek, Tony, I want to turn to how you turn this into an investment strategy. You have to start with finding the managers to put on the platform. How'd you go about that process?
- [16:19]
Tony Caruso
That was one of the most difficult things because our typical sourcing prior to this was build relationships with the blue chip firms, fight for capacity. Think about the funds that everybody wants access to. They're already closed. You develop a relationship, you explain why Utenco is a great partner and you get that incremental capacity. These are the PMs that would likely join those firms. This is an alternative to joining a Bally Asni or 0.72, et cetera. They may not want to join for whatever reason. Maybe they want diversification in their capital base. Maybe they want complete independence. Maybe they don't want to be subject to stop losses. It was finding those PMs who are considering do I join the platform or create a single pm? SMA business? Pounding the pavement, talking to pbs, attending conferences, speaking with peers, finding out who's out there, mapping it all out, putting together a portfolio. What we're looking to do is find the best specialists in every sector, every region, and put it in this wrapper that's really cash efficient.
- [17:21]
Derek Drummond
This is a different business model. Use the swib edge to get access to a walleye or to some of these blue chip shops. Go make nice with the big shops. Get capacity. We're going to be price takers on fees and liquidity. There are three sharps so it's okay, that's a long term investment. I now have a person on my team, looks like a business development person. Their job is to know who's spinning out of where, what measures on the way up, down, beating the streets. We're long term investors with these PMs but we set the risk box. Part of the reason these businesses are successful is because they can hire 200 of these guys and they capture the upside. You have to have the transparency and liquidity in the wrist box to cut off your left tail. You get these high sharps because you can cut off the left tail very quickly. We're not going to go and hire 200 of these guys. We're going to hire 20 or 30 of them. Our risk box looks fairly similar to some of these other risk box. We want to be long term investors. Absolutely. If you go outside that box we can move quickly. We're trying to capture that right hand skew. That's a bit of a different change in our business model. As opposed to managers where you have a three year lockup, you have limited transparency and you're not 100% sure what's going on. So we had to change our team to accommodate sourcing the managers, getting them to like us enough to take the account, setting up the risk box and the infrastructure, managing that on a day to day basis. The diligence process is a little bit shorter. We have so much more transparency, much deeper and more thoughtful conversations with these guys. It happened this morning. We had somebody go outside the risk box. We had to have a tough conversation. Our business has evolved.
- [19:03]
Will England
This is the direction of travel overall within the industry, particularly for certain segments of called the hedge fund landscape which people would generally think of as the long short environment. It's not just long short, but let's sort of use that as an example. The rise of the managed account funding format is very much a real thing. We have this thesis that Tony and Derek are going to want to take some of the best practices from a structured standpoint, from risk management standpoint that we as the multistrads have utilized to build our businesses and do some of that themselves. That is going to happen. Let's participate in having that happen because of the question along the lines of sourcing good ideas in the same way in which sourcing in any investment industry is critical. As the platform reached scale, that ultimately could come back and be beneficial to wall arguing trends in the industry. Now that docsed really has reached scale. They said there's 60 managers on the platform, there's Billions and billions of assets. There's this notion also that's developing of the co invest that's becoming a real thing and helpful for all parties involved. That gets to the heart of historically why we're Managed accounts have a negative stigma. There definitely was some adverse election. What's happening now is given how easy it is for both the manager and the source of capital to have a managed account relationship, the availability of talent that is participating in running managed accounts, this whole notion of adverse selection has been dispelled and if anything it goes the other way. We're trying to think about how do we create positive selection.
- [20:27]
Derek Drummond
Ten years ago you would have a manager that would take a managed account. That was their last resort. You didn't want to go with a manager that was giving you a managed account because they really needed the assets. Now you have PMs that have worked at some of these shops for five, 10 years profitably. You have their track record and they want to go be entrepreneurs. It's a positive sign that they're rolling out. They didn't get fired from these shops. I want to go build this business now. I want to put my shingle on the door. They don't want 50 different clients if they can come to one place and they get Derek and Tony 3, 4, 500 million on day one with real end investors that are long term asset owners, that's huge for them. So everyone wins at the same time.
- [21:08]
Tony Caruso
This whole stigma of running a managed account, part of that was due to the fact that portfolio managers thought because you had this ability to pull the rip cord that you would choose to do so just get your money back. Our average hedge fund relationship is 10 plus years. We're sticking with these PMs even through difficult periods. If we need the cash, a hedge fund we'd have to put in for redemption and get the cash. With a managed account we have the unencumbered sitting there. We don't have to be disruptive at all. We sweep the unencumbered, we put that cash elsewhere. We don't need to disrupt anybody's business.
- [21:44]
Ted Seides
There's a dichotomy that you talked about a model allowing you to cut off the left tail moving faster then Tony saying we have average life of 10 year relationships. How have you put those two things together?
- [21:58]
Derek Drummond
In Dockside we all set up the arrangement on day one. We all know exactly what the rules are. As long as we're all in the rule box, we're not nearly as tight as others out there. Some of the rumors that you hear you're down to and you're done. We just set up the rules of the road. You can't sell naked options. You're a healthcare trader, you shouldn't be in TMT names. But as long as we're all in the same group, we're looking to grow relationships with these PMs over long periods of time. We started this almost three years ago. Huge chunk of our managers are still with us. We maybe have turnover once or twice a year during higher sigma periods like we are having right now as a volatile period. In the first quarter you get to see the reaction function of some of these managers if they go outside of those risk targets. You sit down, you have a conversation with them, you come up with a plan. If they can't execute the plan, then it's time to move on. Part of the success of this model is having those risk controls to be able to capture the right side of the distribution. But the manager's coming in fully aware of exactly what the rules of the road are.
- [23:05]
Tony Caruso
The average length of our relationships, 10 plus years. We spent a lot of time on our diligence. Our hit rate's really high. For the Badge account platform. We're not looking for 350PMs, we're looking for 20 to 30. We're going to do a lot of work on them. Our drawdown guidelines are relatively loose compared to the likes of other platforms because we keep it manageable. At 20 to 30PMS, we can have the conversations with each PM, understand what is driving that drawdown. The other thing that cuts the tail is we have the ability to hedge. Docsad has a dynamic hedger like in Zap Factor risk. There's a position that's too big for a particular manager and we've been able to have a targeted hedge to bring that position lower so that it fits within our overall risk construct.
- [23:52]
Ted Seides
Tony, you mentioned you do a lot of work on these managers. Derek earlier said, well, in this platform you do a little less because you have to compete with people that are hiring lots of these PMs. How do you retain the confidence you can be long term when you're not doing as much work, we're doing as much work.
- [24:13]
Tony Caruso
We're doing different work though. We're doing a lot more reference work. Speaking with anybody who had access to their P and L, any analysts who have worked with the PM to see what the PM was like working for and if he was able to actually manage a team and train his analysts. Lots of conversations with the analysts and PMs to understand the investment strategy, we asked for daily returns and like portfolio snapshots, we put that through our system, the bar attributions. We do our work fast, but we do all the work that we would otherwise do. The only thing that requires less work on our part is the odd we control the cash. You can invest in younger firms that aren't as polished or super institutional. You cut off that operational risk with a managed account.
- [24:58]
Derek Drummond
We have this engine in this tool, this managed account platform. We have some overlap in some names but. But everyone's on their own. So are all the rest of the clients on dockside. Our process is faster for these PMs if I have a codified risk box that I'm putting around the manager. If I'm allocating smaller than maybe I would, it takes us a long time to write a four or $500 million check. If I'm writing a smaller check faster to a younger manager, I have full transparency and full control. We still do our work. Tony's right. The work you do is different. I'm getting full portfolios. If I can get to level of detail and put it into my systems to watch their trading over time and see how they made decisions through different periods, I can be a little bit faster and I know that they understand what the risk box is. My dollar size is a little bit smaller. Our typical write up is about 40 pages plus and probably takes us three months to get a deal done in our main hedge fund portfolio here. If we find somebody we really like, we could probably get three, four weeks, a 10 to 15 page write up. And it's much more looking at the decisions they've made over time. References are huge because you need to be in the network. It's uncanny the number of PMs in our portfolio where we got a reference from someone said hey, I know this guy wants to spin out of Citadel. I worked with him for seven years. He's a good risk taker. You should talk to him. We get more of our ideas that way.
- [26:28]
Ted Seides
What's different in what you've learned from having that level of transparency than what you see in your pre dockside hedge fund portfolio?
- [26:39]
Derek Drummond
Intra month volatility is a lot higher than you think. If you get one month snapshots and then you get to see the ride throughout the month, it can be a very different story.
- [26:49]
Tony Caruso
Derek and I have joked before, you learn more about manager a three days on dockside than three years. If you invested in a fund, you understand what they do what their portfolio looks like, how it evolves.
- [27:00]
Derek Drummond
It's incredible when you see what they're buying and selling every day. We're in the business of buying serial, good decision makers. And sometimes I joke that my job is playing fantasy football. You're trying to find the best athlete, put them in the right position. Hopefully they all march down the field watching how they trade in a drawdown. We gave an example to my CIO yesterday, but two different managers, similar drawdown. One got small, regrouped and started digging themselves out of a hole. Another one would add to losers. You can see it. You can make much more informed decisions about the people that you're putting on the field.
- [27:37]
Ted Seides
Once you have these several managers on the platform, how have you thought about capital allocation across the manager?
- [27:44]
Tony Caruso
It could be a bit clunky. Sometimes you want more exposure to the guys who won't accept more capital. Sometimes you don't want to be as big with some folks who required you to run a minimum amount. Ideally, how I would have it is equal risk allocations incorporating correlation matrix changes at the margins based on the conviction level that you have with each manager. We're trying to guess their Sharpe ratio going forward, triangulating it using their experienced Sharpe ratio, trying to understand what they need to do to deliver the returns that we expect.
- [28:17]
Derek Drummond
One thing that was difficult for us and it's still difficult to this day, is this a product or a line item in our portfolio or is it a tool within your broader hedge fund portfolio? Say we have 25 line items. Is this line item 26? All these PMs you're managing as a portfolio, Am I trying to optimize that P and L or is this a capital efficiency tool for my broader hedge fund business? We recently had a manager that was in our hedge fund business and they've moved on to the platform. They were throwing off the risk budget of everybody else and we were like, well, we had the same amount of money with them before, so what's different? Why are we trying to manage this PNL number? We came up with this heuristic. So we have 17pm and we're managing it like it's a portfolio. But if we get confidence in that manager enough, they can graduate and become their own line item in our hedge fund portfolio. As we get more and more confidence, we can give them more capital. They come out of our emerging manager POD program, They've graduated to a line item in the book.
- [29:20]
Ted Seides
Tony, how have you tackled that?
- [29:22]
Tony Caruso
We're not investing in single PM funds. Our allocations to the multi managers can be much larger. It's a very diversified portfolio. Much higher Sharpe ratio expectation. We can size them multiples higher than we would for a single pm. The goal of Dockside is to be able to create that same profile that a multi PM fund would have. Any individual PM is going to have a lower Sharpe at Citadel. From their experience I think they've said like a 0.7 to 0.8 gross Sharpe is what you should expect out of any pm. But the magic of it is if you can find these managers that run at very low correlations, highly idiosyncratic in nature, not clinging onto any factor risk, hopefully not too loading on crowding either. Across a number of lowish sharps you get a good net final Sharpe. The overall portfolio Sharpe can grow from any single PM is 0.9 but the overall portfolio is two and a half plus. That's what we're trying to do. Our allocation to Dockside is size about the same as any kind of multi manager fund.
- [30:23]
Ted Seides
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- [31:34]
Derek Drummond
We implement single name hedges. We have the full factor model, we have crowding models. Deleveraging risk is one of our bigger risk factors. We're trying to proactively allocate to PMs that are doing different things. Once you get everything together, we do have the tools and we have the team over at Dockside that can build the views. We used to have daily calls and that became a little bit too much. Now we have weekly calls with the risk team. Go through the risk budget. What we're seeing. How crowded are we, how liquid are we, how that hedging overlay we have is affecting the overall book. We try and do surveillance. Am I using the same factor model as Citadel and Citadel using the same stock to hedge that I am. And if this goes against us, how bad could that be? One of the benefits is that we have the same tools as everybody else. One of the detriments is we have the same tools as everybody else.
- [32:25]
Tony Caruso
Clearly, Dockside Edge isn't the fact that they have access to BARA models. Everybody has access to bara. One of the things that's been helpful is everything that the borrow factors don't explain. We try to figure out what that is. What factor is driving markets not being explained by momentum or quality or any standard risk factor. But maybe it is artificial intelligence, the war. Take that factor and see how much sensitivity your portfolio has to that being able to be creative and create custom factors. That's been very helpful. I've done a lot of work with that with the Dockside team. I don't know if any other platform service provider can dynamically hedge. Basically, I give them some factor constraints. Say I don't want any style factor to be north of X percent. The hedger will zap everything and construct a portfolio that has that target IDO and those factor constraints.
- [33:17]
Ted Seides
How do you think about exiting managers?
- [33:20]
Derek Drummond
Yesterday and today we had a manager. They were outside of their bounds. They continue to be outside their bounds. Over the last week, we developed a playbook. These are the catalysts you're playing for. These are the stocks you're looking for. If this happens, this will be my reaction function. And then we say, when would you fire yourself? They give us a level and they hit that level. In a weird way, it's a much easier conversation than sending a redemption form. And the marketing guy's gotta go talk to the CIO or something. We all knew exactly what was happening. They pick up the phone, they're like, yep, I can't hold it against it. Yes, you're exactly right. How would you like to liquidate the account? We're all still friends. We all knew exactly what happened. And there's no bad feelings. It was way more transparent. It's an easier process.
- [34:06]
Tony Caruso
That's why we set these risk guidelines. When we finalize the IMA before they start trading, what risk guidelines should be appropriate for your strategy? We don't want to change a thing. We want you to be able to do whatever you're going to do. But tell us, what are the bands? Net exposure, gmv concentration, risk. What is a crazy drawdown that you never expect to hit? We Monitor these and if they go out of bounds, it's an easy conversation. You said you were going to do one thing and this is what happened. Of course we'll have the conversation figure out how are you going to get back in bounds or what's the solution to this issue that we're dealing with.
- [34:42]
Derek Drummond
Typically speaking, there's a lot of group think. Tony and I have had positions where the managers had a drawdown and we've treated those drawdowns differently. He gets to choose how he interacts with that manager. We don't get them to do something different than their commingled fun. I'm not trying to get them to run some special account. Lower bait or higher Bayer, we want it to be parapassuan. In 99.9% of the cases, the PM doesn't want to do anything special. They want everyone to be on the same terms and the same strategy. How Tony reacts to a certain drawdown might be different than I react. Every once in a while we'll talk but we're not coordinated because everyone's risk tolerance are different.
- [35:19]
Will England
I run hundreds of managers over the years. A lot of different exit conversation. As there's the nature of business, the most adult conversations are when there's transparency. Everyone's an adult in the business, know what we're doing here. If things didn't work out, that's fine, no hard feelings and let's move on here. What people really hate in our industry is when they get surprised. The whole point of Dockside is to be able to provide the level of information, intelligence, situational awareness so that no one's surprised if everyone's reading off of the same playbook. Here's where the line is. You cross the line, no one's fault, no harm, no foul. Let's move on. Thanks for such an easy conversation. That's the exact mentality that I take in running our multi strap business is just be up front with people. The hard part is with the traditional redemption cycle that you get in culming vehicles. There's a lot of guesswork that's involved
- [36:07]
Ted Seides
when someone's thinking about engaging with Dockside to create their own account. How do you think about the differences between this and the multi manager pod shop?
- [36:18]
Will England
There's probably a dozen scaled multi strats in the world, so there's relatively small numbers we're talking about. Those are premium products. There's businesses that we'd run that can't be run either as a managed account or as a standalone business. We have a large equity volume Business as part of what we do. That's not something that would be run by a single manager. Not something we've lend itself to a managed account. Same thing with a lot of quant strategies or things that are done fixed income. That's a big part of what multi strats do is strategies that benefit from true scale. The thesis originally was a lot of the businesses that Derek and Tony run, especially in long, short hedge funds, still want exposure to those type of strategies. Doing it in a structurally advantageous format. For all the reasons that we've talked about, I don't view it as replacing the allocations in terms of giving to managers like us. It's more saying there's a better way to run this business and a better way to get exposure to some of these traditional single manager funds in a way that everyone wins and everyone does win.
- [37:22]
Tony Caruso
We are large allocators to the multi managers. That's probably not going to change. We have great relationships with them. They're phenomenal. The best hedge funds in the world. Dockside is a way to gain access to certain PMs that don't want to join a multi manager platform. We know that there's talent out there. We want to be able to access that talent in a similar fashion as those multimasure platforms. By tapping into an SMA platform and having to be super cash efficient. This is our way to expand. We can't grow much more with these multi managers. A because they're closed. B because their liquidity terms are a three year or five year slow pay, there's a portion of the portfolio that needs to be liquid. This is our way of being able to have unencumbered cash, modulate the overall leverage of the platform and use that cash to fulfill our cash needs.
- [38:11]
Derek Drummond
Will has comparative advantages. He can pay for data for his quants that I just can't. I'm not saying Will does, but others might pay garden leave. I can't afford to pay for a guy to sit on a Beach for 12 months or something like that. But those are costs too. He can run a 2, 3 sharp. Some of these groups have 6 plus percent pass throughs. You have to run more leverage to be able to do that. All that math works. When you have 200PMs, you can turn them over and capture that right to the distribution. We're playing a slightly different game where maybe I only have 15 to 25PMs. I get to use a little bit less leverage. I don't have a 6% pass through. I'm taking the netting. My cost structure is a lot lower. Maybe my Sharpe ratio might be a little bit lower because I can't capture the quants that Will can because I'm not paying those fees. My Sharpe ratio is unlikely to get exactly where Will is. It gets closer and I have the liquidity and I get the target. My vault. The average hedge fund out there down the fairway hedge fund us dumb pensions did the wrong thing by incentivizing them to run lower volume and take in more assets and collect that management fee. If you're running a $10 billion book like I am and you have 30 line items and they're all 0.1 correlated, I can't get my volume high enough to beat my cost of capital without running a superstar sharp, knock on wood. We have been because Alpha's been pretty good the last couple years. Three sharps don't last forever. This solves an important problem for me where I can have this risk control transparent liquid pool where I can lever it to my volatility target and get my total portfolio of all where I need to be to be competitive out there. But I'm not giving up on quality of PMs anymore.
- [39:58]
Ted Seides
As you look at acquiring the talent you want, putting them on the dockside platform and dockside as a business, when you add it all up, what does the cost structure look like to the next investor compared to a pass through multi manager shopping?
- [40:15]
Will England
This war for talent is a real thing. It's become illogical in many cases the participants in it know it's illogical and they're just doing it for personal competitive reasons. The cool part about targeting people that are largely in a post economic phase of their life, they want to run their own business. And there's a personal motivation that extends beyond effectively someone pay them a large check for hazard pay. By definition, the managers that Tony and Derek and others are fishing into the dockside pool, it is a different conversation.
- [40:45]
Tony Caruso
They aren't.
- [40:46]
Will England
The single source of capital, by design is more structurally advantageous.
- [40:50]
Derek Drummond
It became apparent to me when we had one of our first managers. We set him up on day one. We walk into his office. His wife was at Costco getting the snacks to put in the snack room. He was like Derek, come over here, come over here. He had the name of the firm on the wall. We got the sign up. It's amazing. He's showing me every office and he's introducing me. These PMs take real pride in opening up their own business. They were inside some pod that didn't get to talk to other pods at some of these firms where there wasn't a level of communication and community and culture. For a large number of RPMs that's the case. They have a culture, they want to grow a business, they want to grow. They want to grow this next layer of talent below them and give them something to work towards. It's palpable.
- [41:34]
Will England
There's truth to some of these cost inflation things. Path models are necessary to be competitive. That's the reality of the world that we live in. The math does work. At the end of the day if you're good, it's hard to run these businesses. The investor is the one that loses when you make non economic decisions. I love the model because access the talent directly and you don't have to pay these fees in which you have no control over deciding what they should actually be. That's a good thing at the end of the day for the holders of capital.
- [42:00]
Ted Seides
Derek, Tony, when you're talking to your boards, how do you describe the expected fee savings of the dockside platform compared to one of your multi manager investments?
- [42:14]
Tony Caruso
It's so simple. We know what the fixed expenses are, the variable expenses every year. Put that in a spreadsheet. Then we could actually say here's dockside's fees. You were saving on this, that and the other thing. We're not paying the second layer of performance fees. Estimate the financing terms. Here's what leverage we'd run at. It's math. This is what we're going to do. And here's the expected cost savings. And it's meaningful, it's explicit.
- [42:37]
Derek Drummond
For every dollar that I borrow from the house because we were in full Porter Walph, we have to lever up the entire firm. We have a thing called the fleet rate. I'm the biggest consumer of the fleet rate at SWIB right now and I borrow 10, 11 billion dollars every month I get a bill for what my interest expense was. I can go to the board and say instead of borrowing 10 billion, I borrowed 9 billion. Now because I can be capital efficient, my returns are higher and everyone's better off, I calculate my interest expense savings from those managers. At one of our last board meetings we brought in one of our PMs and they talked about it, the board got to ask him questions. Why are you doing this? Oh, you set up your own business? Why did you want to set up your business? Why? And he's like, there's no way I could have gotten an account from the state of Wisconsin otherwise without being on this platform. Our board are huge availers of this program. They love it. They see the cost savings, how we're accessing younger, hungrier talent. The risk management, our risk manager loves us, gets up there and talks to the board. It's good for the board.
- [43:38]
Ted Seides
What does that add up to in terms of basis points?
- [43:41]
Derek Drummond
It's tens and tens of millions of dollars for us a year.
- [43:44]
Ted Seides
I'd love to hear, since you've rolled this out, what were some of the challenges that you didn't expect you'd face?
- [43:54]
Tony Caruso
Learning the lingo. Typically, allocators invest and they think about AUM as a concept, right? A $200 million AUM ticket. In the SMA world, it's an arbitrary concept. We're choosing the denominator. We allocate in terms of GMV long market value plus the absolute value, the short market value. Here's the GMV that you're going to run at. We choose the denominator to get to the risk profile that we want. That was a bit confusing, going to the investment committee and saying, hey, we're doing a 700 million GMV ticket. And everybody didn't understand what was going on.
- [44:28]
Derek Drummond
We don't typically have to deal with the financing side of things. Managing pbs, managing our excess cash. Do we take some risk with that excess cash? Do we do something cute with that cash? I don't want to take too much risk. Should we move balances from here to there? We are now a material client of one PB in particular. Who gets to use that goodwill with that pb? Is it State of Wisconsin? Is it Doc side? Oh, there's a new issue coming out. I want to talk to the UCM desk. Well, who's speaking for them? Is it dockside? Is it swift? That whole world of the stuff opens up to you. Because typically I don't get to talk to the pbs. They don't care about me. They care about Millennium and Citadel. Now I'm participating in the markets. I want all the stuff. I want the research, capital markets, access. I want to start doing some other things. You better know what you're talking about. The first time I walked in there, I was like, I want the things. They're like, that's not how that works there. Don't I get more things? And they're like, well, who gets to say that those are my flows or I paid you this much. Sometimes it's dockside, sometimes it's pm, sometimes it's swib. Learning all that was a new experience for us.
- [45:38]
Ted Seides
How did you reconcile the centralization of the potential benefits that you get on the platform when there are so many constituents within the platform.
- [45:47]
Derek Drummond
I don't think we've figured it out yet. I did a whole trip to New York and met with all of our PBS and I said, who owns these flows? Is it Tony? Is it me? Is it Dockside as a whole? It's a gray area. If you're the one directing that PM to go and trade at XYZ firm, you can kind of attribute it. Maybe those are your flows. If it's the PM that's saying, hey, no, I need this execution to be at this place because I've had a long standing relationship, maybe it's that guy's flows is not as clean cut as I thought it was. The state of Wisconsin has a large internal trading desk trying to combine all those flows with the Dockside flows. It gets messy, but it does get figured out.
- [46:27]
Tony Caruso
The partnership has been mutually beneficial. Out of the gates, we were able to get financing terms that were good. That wasn't because of our small account that we started with. It was because of Walleye's activity. We benefited from that. At this point, we're very large. We're giving back to Walleye in terms
- [46:44]
Will England
of the gmv, there's an economy of scale argument to this. The smoky back rooms of how things work on the sell side, as Derek was referring to, but was very clear, is that as Dockside gets bigger, everyone involved participates from larger heft to be able to conserve better rates and reduce the cost for everyone involved.
- [47:01]
Ted Seides
When you three came together to create this platform and now it's turned into a significant business with other clients, how did you think about who owns Dockside?
- [47:13]
Will England
We're all partners in doing this.
- [47:15]
Derek Drummond
They've become true partners of ours. We pick up the phone and talk to them multiple times a week. They're unbelievable. Faso and Michelle are just amazing. It's integral to our business. We want to see that business grow and thrive. Even if we don't bring in other clients. This is going to be core to our strategy for as far as I can see.
- [47:36]
Tony Caruso
This is the case with Walleye. I hate the notion of limited partners. We aren't limited partners. We are true partners.
- [47:44]
Will England
Feels good as a participant in the world to do stuff like that, that as a practical matter, all three of us participate in the cash flows generated by Dockside. That's a good thing too.
- [47:53]
Ted Seides
Where do you hope it goes from here?
- [47:54]
Will England
We want it to grow. This overall trend that's happening of managers wanting to put up their own Shingle and realizing that they can access pools of capital that Tony and Derek represent through this format. Dockside's a classic economy of scale type business. As it grows, as it grows in the right way, it gets better to everyone involved. Even from a cost sharing type structure, it's meant to grow with the right partners on both the client and the manager side.
- [48:21]
Ted Seides
Derek, Tony, you've lived in a world for a long time where the growth of a manager doesn't necessarily accrue to you as an investor, a client of that manager. Now you sit on both sides of that. I'm curious how you think about Dockside
- [48:36]
Tony Caruso
from that perspective when it comes to investing in hedge funds. Typically it's performance attracts assets. Assets ruin performance. This is not the case here. Obviously with any kind of PM that we invest in, as they grow, the Alpha is going to deteriorate. We try to find PMs that are going to be disciplined. We incentivize them too, to not live off the management fee. We're going to pay you less in terms of fix, but we're going to pay you more in terms of incentive. They eat what they kill. That's not going to change. We're going to find PMs who don't manage too much money, but we're going to be able to access it via this Dockside platform. And as it grows, we should reap the benefits as well.
- [49:13]
Derek Drummond
Tony, Will and myself, we're entrepreneurs. We like to build things. There's a number of things that we have on our docket to build on Dockside. We're in a commodity super cycle. I would like to have a multi PM commodity complex. I'm actively trying to find additional ways to keep growing the relationship. This space is getting more competitive now. The big platforms are allocating external managers. Getting access to that next talent coming out the door is getting a little bit harder. Getting a separate account for a hundred million dollars on day one, they're starting to get two, three, $400 million tickets. Could we cobble together $500 billion and get a PM to manage just our capital for the first couple years? Lock down that high end talent that's spinning out so we can keep that alpha stream higher for longer. There's something about that. There's some ability for us who as like minded, sophisticated allocators, if we all see someone we like, can we put up a big enough ticket to be able to lock down that alpha for a little bit? That's interesting. Our team's constantly trying to evolve and use this tool in new inventive ways. There's a lot of things that we have at SWIB as a big pension that might be able to be additive to platforms like this now that we have control over the assets and the trading and the P accounts. The example I use is I have a very large long only equity index account. I know a lot of guys that need stocks to short. Couldn't they borrow them from me? There are things that you can vertically integrate in your business that's beneficial to both sides. And maybe I'm lending out more stock at Swift. My PMs get to have certainty over their borrowers financing arrangements. There are a lot of things as big asset owners have as assets that we might not be utilizing nearly as much. But once you're in the mix and once you're in this whole world of financing and pipes and everything, you can start using them. It makes everyone better off.
- [51:17]
Ted Seides
Well guys, I want to make sure I get a chance to ask you a couple fun closing questions before we wrap up. Before we get to the closing questions, I want to tell you about one of our strategic investments. We've made a few and each are working on a product or service we think will be valuable to our community. One is Oldwell Labs or owl. OWL is the very best software I've seen for allocators to find and track managers and I've seen a lot of them. Trust me, it'll be worth the look. There's a link in the show notes so you can learn more. And here are those closing questions. Tony, what was your first paid job and what'd you learn from it?
- [51:53]
Tony Caruso
I'm a son of an Italian immigrant who came to this country without any money. The value of the dollar was driven into my head at a young age. I didn't get an allowance for being cute or for existing. It was paint the fence or any kind of odd job around the house and I'd get money for it. It's kind of like a micro economy. I remember I was at my friend's house. They had a window washer do all the windows. The mom paid $300 for this professional window washer to do all the windows. I was like, oh man, that's a lot of money. I decided to become a window washer, created my own window washing business. I ended up recruiting some of my friends. We ended up washing all the windows in the neighborhood. We washed a hundred different houses in one summer. That gave me this sense of entrepreneurialism that I applied to when I was a proprietary prop trader in Chicago when I worked for Bridgewater, when I joined the allocator community, I always had that entrepreneurial spirit. It was that first job that lit
- [52:49]
Ted Seides
it will, how'd you spend your ideal workday? From wake up to bedtime.
- [52:54]
Will England
To the extent I have a superpower, I don't require variety. I'm happy doing the same thing every single day. I'm pretty boring too. I get up real early. I go and beat the hell out of myself in the gym. Like moving heavy objects, I go to work. What makes for a rewarding workday is not sitting at a computer looking at numbers all day. That's fun too. But running a business with hundreds and hundreds of people, there's leadership aspects, building things. That's why probably this group has worked together well is I like building stuff too. So if I could spend my day working with like minded people on how to move our business forward, that's really fun. Then I go home. I got three kids. We've been married for over a dozen years and we hang out as a family and do fun things. Go to bed and do it all over again.
- [53:33]
Ted Seides
Derek, what's the best advice you ever received?
- [53:36]
Derek Drummond
I learned this a little bit too late in life. Invest in those that invest in you. You have finite time. You want to invest in people where you're getting a return on that investment. As an allocator, you're not short on friends. Everyone likes you. But finding those real people. I've been doing this for 25 years now. I feel like I've gotten my core group of friends the way I trust them. I trust their opinions. If I reach out and put time into them, I'm getting something back from them. That's been a huge change in my life over the last five or six years. My friend group has gotten a little bit smaller, but the quality has gotten a lot better.
- [54:10]
Ted Seides
Tony, what's your biggest investment pet peeve?
- [54:14]
Tony Caruso
Overconfidence. People who think they can predict the unpredictable. If you've read any books by Nate Silver or Philip Tetlock, they call it the hedgehogs. Great storytellers. Not the ones who actually assign probabilities and understand that there's uncertainty with any prediction. They call them the foxes. I try to find foxes when I invest in PMs. They don't tell as great of a story. They understand that my hit rate is 53%. I'm wrong 47% of the time. I don't have a hundred percent confidence in anything. But if I can keep on hitting that 53% over time that's going to be a great business.
- [54:47]
Ted Seides
Derek, how's your life turned out differently than you expected it to?
- [54:51]
Derek Drummond
I wanted to be a hedge fund manager when I was 16 years old. My grandmother gave me the book Predator's Ball, the Michael Milken book. This sounds amazing. She's like, what's a bond? I'm like, I have no idea, but it sounds awesome. So I set up my life to be on this trajectory. I never thought I would spend 16 years at a pension plan. I thought I was going to do the New York hedge funding thing. I'm doing the pension fund hedge funding thing. It's been better than I ever could have imagined.
- [55:17]
Ted Seides
All right, well, last one. What life lesson have you learned that
- [55:20]
Will England
you wish you knew a lot earlier in life? Jim McCall came out with a book recently where he has this phrase of live life looking forward in the saddle. And I've used that concept a lot more recently, which is live your life moving forward, not backwards. I'm a mathematician academically. There's concepts in math which evolve around a memoryless process. The only thing that matters is the current state. A lot of people live life trying to fix the problems of the past. That's a natural human bias. What makes sense on a goal for it basis. And that's kind of the only thing that matters, which, by definition, it is. You can only control the future. I wish I had a little more
- [55:51]
Derek Drummond
clarity around that earlier on.
- [55:53]
Ted Seides
Well, Will, Derek, Tony, thanks so much for sharing this innovative new approach for how to access these assets and managers.
- [56:00]
Will England
Yeah, thank you.
- [56:01]
Derek Drummond
Thank you.
- [56:02]
Ted Seides
Thanks for listening to the show. If you like what you heard, hop on our website@capitalallocators.com where you can access past shows, join our mailing list and sign up for premium content. Have a good one and see you next time. All opinions expressed by TED and podcast guests are solely their own opinions and
- [56:21]
Tony Caruso
do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only
- [56:26]
Ted Seides
and should not be relied upon as
- [56:28]
Tony Caruso
a basis for investment decisions.
- [56:30]
Ted Seides
Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.