Podcast Summary: Capstone’s Paul Britton on Running a Derivatives Hedge Fund

Podcast: Exchanges (Goldman Sachs)
Episode: Bigger markets, more alpha: Capstone’s Paul Britton on running a derivatives hedge fund
Date: February 28, 2025
Host: Tony Pascarello, Global Head of Hedge Fund Coverage, Goldman Sachs
Guest: Paul Britton, Founder & CEO, Capstone Investment Advisors

Overview

In this episode, Tony Pascarello interviews Paul Britton to discuss Capstone Investment Advisors’ journey over the past two decades, the evolution of derivatives markets, risk management, alpha generation, the impact of private assets, and navigating current market dynamics. Britton shares candid insights on building Capstone, lessons learned from crises, his investing philosophy, leadership approach, and the role of technology and AI in the financial sector.

Origins of Capstone: Strategic Vision and Early Challenges

Key Points:

• Britton’s background in options market-making and the transition from market making to building a global multi-asset derivatives firm in 2004.
• Shifting away from a "winner-takes-all" technology race in the liquidity business to seek opportunities across asset classes and geographies.

Quote:

"It always frustrated me of not knowing what was going on on the other side of the world and what was going on in other asset classes. So I said, you know what? I'd like to build a global business... that encompassed every asset class."
— Paul Britton (01:39)

Timestamps:

• [00:58-02:32] — Capstone’s origins and motivation for a multi-asset, global derivative focus.

Pivotal Moments: Growth, Setbacks, and Resilience

Key Points:

• "Aha" moment: MLK Day, January 2008—an initial realization of Capstone’s business model scalability, followed by cautionary lessons from Q4 2008.
• Britton recounts seeking solace at Trinity Church during the 2008 crisis as he grappled with overwhelming market turmoil and risk mismanagement.
• Reflection on 2020: Processing success not in P&L but in the robustness of frameworks, processes, and team discipline.

Quotes:

"January of 2008... we made a decent amount of money. And that was one of the moments where I'm like, oh, this is. I get this... this has to be a scalable business."
— Paul Britton (03:14)

"...it gave us, looking back at it, a real false confidence. And then it went spectacularly wrong in Q4 2008..."
— Paul Britton (04:18)

"That was a moment in time of extreme stress, but acknowledging that you're literally putting, you're putting one foot forward and learning from the process."
— Paul Britton (06:51)

Timestamps:

• [03:14-05:32] — Major inflection points (2008, 2020), stress, recovery, and framework-building.
• [05:46-07:07] — Personal toll and coping mechanisms during the financial crisis.

Evolution of the Derivatives Market

Key Points:

• Explosive growth in derivatives, particularly post-COVID, driven by increased participation from a broader range of market players.
• Expansion has been advantageous: increased liquidity and volume translate into more alpha opportunities, as different players use derivatives for diverse reasons.

Quotes:

"...as long as there is more volume going through those pipes, then that should translate into a higher alpha proposition for our investors."
— Paul Britton (08:25)

"The great thing about the derivatives markets is people use them for different reasons... we're after something different to the average participant."
— Paul Britton (09:29)

Timestamps:

• [07:39-10:20] — Growing breadth of the derivatives market; diversity of participants; implications for alpha.

Global Risk-Taking & Opportunity Set

Key Points:

• Capstone’s risk exposure historically tracks where derivative volumes are largest—mainly the US, with growing interest in China due to its deep equity market.
• The approach is to mine alpha from high-volume markets and expand into emerging areas.

Timestamps:

• [10:26–11:38] — Geographic diversification and rationale in portfolio construction.

Navigating Current Market Dynamics and Volatility

Key Points:

• The current market environment is influenced by unconventional policies, geopolitical flux, and technological disruption.
• Index volatility is low (VIX at 15), but Britton points to underlying dispersion—significant volatility at the sector and stock level rather than at the macro or index level.

Quotes:

"There's an enormous amount of dispersion... one day you have a stock or a sector that perhaps gets mentioned and that can cause terrific volatility. But it's stock or sector led and that is not necessarily at the macro level."
— Paul Britton (13:27)

Timestamps:

• [11:38-14:09] — Dispersion vs. systematic volatility; macro and micro trends shaping risk.

Risk Management Philosophy

Key Points:

• During market stress (e.g., VIX spikes), Britton switches from CEO mindset to trader/risk manager, focusing on process discipline and knowing when to "play offense."
• Encourages teams to recognize when probabilities shift in their favor and to act with conviction, despite human instincts urging caution.

Quotes:

"Our business is a large casino... our odds are 51/49 on a regular day. When you get those types of events... the odds go to 55/45 or 57/43. And so I just encourage my teams to say we want to play more because the odds now are more in our favor."
— Paul Britton (14:42)

Timestamps:

• [14:09–15:54] — Britton’s framework for risk-taking in volatile markets.

The Rise of Private Assets: Opportunities and Challenges

Key Points:

• Growth in private equity, venture, and private credit has changed the asset allocation landscape for institutions—liquidity is a bigger consideration.
• Capstone’s role is increasingly about helping institutions manage liquidity risks, not just tail risk, especially given lower distributions from private assets.

Quotes:

"It's interesting that it's less about like a tail hedge, but it's more about of a liquidity function... we want to be able to think about ways where we can have a strategy that helps us deal with that liability..."
— Paul Britton (17:45)

Timestamps:

• [15:54–19:14] — Interaction between hedge funds and private markets; institutional portfolio construction trends.

Leadership and Building Culture

Key Points:

• Fast-paced, innovative culture at Capstone; constant drive and awareness that moving too slowly can be fatal.
• Britton emphasizes the importance of consistency in leadership and the value of showing vulnerability to build organizational trust.

Quotes:

"If it's not fast paced, that's a problem... evolution and innovation... goes at such a rate that if you aren't fast paced and you aren't moving, then you're dying."
— Paul Britton (19:24)

"I try to be as consistent as possible so that people always know what they're gonna get... And secondly is to, as a CEO, show some vulnerability."
— Paul Britton (26:00)

Timestamps:

• [19:14–20:16] — Organizational pace and culture.
• [26:00–27:03] — Leadership style, consistency, and humility.

Looking Ahead: Markets, Policy, and Alpha

Key Points:

• The central bank-heavy, low-volatility era post-GFC is seen as an anomaly; Britton expects less central bank intervention and, consequently, greater market elasticity and dispersion in the years ahead.
• These shifts favor active management and hedge fund strategies over passive 60:40 portfolios, given reduced "central bank put" effects.

Quotes:

"Central banks were critical in that early phase of stabilizing markets... But I think they just overstayed their welcome. And I think that they got enamored with this notion of getting into the growth game..."
— Paul Britton (21:17)

"If you have a repeatable task, I don't want you doing that because I want you doing tasks and work that are higher value. And that's good for me, that's good for you. And I think that's how humans stay ahead of the game with this first phase [of AI]."
— Paul Britton (29:59)

Timestamps:

• [20:45–25:25] — Forecasts for markets, policy, and active management.
• [29:03–31:32] — The role of AI in raising productivity and reshaping workflows.

Quickfire Closing: Investing and Leadership Wisdom

Notable Q&A:

• World-class investor skills: "Follow your process... and be curious." (25:30)
• CEO strengths: Consistency and openness about not knowing—building a culture where vulnerability is allowed. (26:00)
• Best advice received: "The importance of working hard... The greatest gift is seeing the world." (27:09)
• Investor admired most: Jim Simons, for curiosity and humility. (27:43)
• Time outside work: Tennis, though currently recovering from an Achilles injury. (28:40)
• Most excited about: The potential of AI to automate repetitive tasks and free talent for higher-value work. (29:03)

Memorable Quotes

• "Process will always get you out of trouble. And be curious."
  — Paul Britton (25:30)

• "Every day is a bit of a knife fight. You’re going to compete every single day."
  — Tony Pascarello (20:25)

• "I did a lot of math, I made a lot of money, and I gave most of it away."
  — Tony Pascarello, quoting Jim Simons (28:24)

Conclusion

Paul Britton offers an inside look at building and scaling a derivatives-focused hedge fund, the importance of learning from adversity, and the core attributes of disciplined risk management, adaptable leadership, and strategic curiosity. Capstone’s journey reflects broader shifts in markets and asset management—toward more dispersion, greater need for liquidity solutions, and the rapid adoption of transformative technologies like AI. Britton leaves listeners with a sense of excitement for the future of active investing, even amid unprecedented change and complexity.

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