Podcast Summary: E166: $20 Billion CIO: Why Small Cap Stocks Have Underperformed (and why that’s unlikely to change) with Brad Conger

Released on May 23, 2025

Hosts and Guests:

• Host: David Weisburd
• Guest: Brad Conger, Chief Investment Officer (CIO) of Hurdle and Callahan

Introduction

In this episode of "How I Invest with David Weisburd," host David Weisburd engages in an insightful conversation with Brad Conger, the CIO of Hurdle and Callahan, an outsourced CIO firm managing approximately $20 billion in assets. The discussion delves into the underperformance of small-cap stocks, the evolving landscape of the small-cap index, and strategic investment approaches in a changing economic environment.

The Evolution and Underperformance of Small-Cap Stocks

Transcript Excerpt:

Brad Conger [00:59]: "The small cap index has fundamentally changed in its composition since those numbers, the numbers that were used in that study. And so, for example, the small cap index now I believe is much lower quality."

Brad Conger challenges the traditional view upheld by Eugene Fama's three-factor model, which historically showed small and value stocks outperforming the broader market. Conger argues that the small-cap index has transformed over time, now comprising a higher proportion of "zombie companies"—firms struggling with debt and limited growth prospects. This shift, he posits, is largely due to the private equity (PE) industry's influence, which prolongs the lifespan of underperforming companies and restricts the index's exposure to genuinely entrepreneurial and growth-oriented small caps.

Key Points:

• Changing Composition: The small-cap index now includes more "fallen angels" and "permanent residents"—companies stagnant in growth or declining.
• Private Equity Impact: PE firms keep companies under advisement longer, preventing their growth into larger, more dynamic firms.
• Increased Default Risk: There's a significant rise in bankruptcy risk among small-cap stocks, exacerbated by higher debt-to-equity ratios.

The Virtue of Illiquidity in Investment Portfolios

Transcript Excerpt:

Brad Conger [07:46]: "I think emotionally it's much more productive mentally to have your hands sort of tied."

Conger discusses the role of illiquidity in investment strategies, particularly within private markets. He acknowledges that while illiquidity can prevent emotional decision-making during market volatility, ensuring clients remain aligned with their long-term asset allocation goals is paramount. Hurdle and Callahan actively manage client portfolios to withstand market fluctuations, using illiquidity as a strategic advantage rather than solely relying on it as a protective mechanism.

Key Points:

• Emotional Discipline: Illiquidity helps prevent clients from making rash decisions during market downturns.
• Active Management: The firm actively rebalances portfolios to maintain optimal asset allocations, ensuring disciplined investment practices regardless of market conditions.

Critique of Traditional Asset Allocation Practices

Transcript Excerpt:

Brad Conger [09:28]: "There's a fetish with alpha. … it's like I hire Roger Federer and I put him in a ping pong tournament. … he's going to get killed."

Conger criticizes the institutional investment community's obsession with generating alpha—the excess returns above benchmark indices—often at the expense of strategic alignment and risk management. He highlights the pitfalls of chasing alpha without a coherent investment thesis, leading to subpar performance despite employing seemingly superior managers.

Key Points:

• Alpha Fetish: Overemphasis on achieving higher returns can lead to misaligned investment strategies.
• Opportunity Cost: Focusing on niche asset classes without considering their performance relative to broader markets can be costly.
• Dynamic Asset Classes: Asset classes like REITs and small caps can change in behavior and performance, necessitating adaptive allocation strategies.

Balancing Portfolios in a New Economic Paradigm

Transcript Excerpt:

Brad Conger [05:02]: "Our case for private equity is more alpha driven than a belief about sort of the market cap weight of small, of private versus public."

Conger outlines the firm's approach to portfolio diversification, emphasizing a blend of private equity and venture capital to capture alpha opportunities amid shifting market dynamics. He argues that private managers now have more tools and incentives to enhance company value, making private investments a compelling component of diversified portfolios.

Key Points:

• Diversified Universe: Expanding the investment universe beyond traditional public equities to include a broader range of private companies.
• Alpha Opportunities: Private equity offers potential for higher returns through active management and long-term value creation.
• Illiquidity as a Feature: Embracing illiquidity to access unique investment opportunities and mitigate common market mistakes.

A Contrarian Bet on Europe

Transcript Excerpt:

Brad Conger [16:38]: "We were overweight the US in about 2Q24... we shifted it into Europe. … this quarter they're up 20 points relative to the US so it's paid off."

Conger shares a strategic decision to overweight European equities based on valuation discrepancies and underlying economic fundamentals. Initially underweighting Europe due to geopolitical tensions and energy crises, the firm later recognized an attractive valuation gap compared to US markets. This contrarian move, despite initial discomfort during a period of declining valuations, ultimately yielded significant positive returns as European equities outperformed.

Key Points:

• Valuation Gap: Europe traded at a substantial discount to US stocks, presenting a buying opportunity.
• Long-Term Thesis: Despite short-term volatility, the European market's fundamentals justified the overweight position.
• Risk Management: Maintaining conviction in the investment thesis through turbulent periods led to substantial gains.

Navigating Market Turbulence and Utilizing Options Strategies

Transcript Excerpt:

Brad Conger [28:37]: "We started writing put contracts out in May, June, July at level something like 10%, 15% and 25% below the market…"

In response to market volatility triggered by unexpected tariffs, Conger explains the firm's tactical use of options to manage risk and capitalize on market conditions. By writing out-of-the-money put options, Hurdle and Callahan generated premium income while positioning themselves to potentially acquire equities at lower prices during market dips.

Key Points:

• Options Utilization: Writing put options as a strategy to earn premiums and prepare for potential market downturns.
• Risk Harvesting: Leveraging existing portfolio positioning to mitigate losses and take advantage of volatility.
• Strategic Rebalancing: Continuously adjusting portfolio allocations to align with long-term investment objectives despite short-term market movements.

Private Equity Manager Selection and the Preference for Spin-Outs

Transcript Excerpt:

Brad Conger [44:28]: "They have become very adept at managing the movement of ownership to the right level of responsibility."

Conger emphasizes the importance of selecting private equity managers who demonstrate strong generational planning and seamless transitions in leadership. He expresses a preference for managers who emerge as spin-outs from established firms, citing their proven track records and the balance they maintain between experience and entrepreneurial drive.

Key Points:

• Spin-Out Preference: Favoring managers who have spun out from successful firms ensures continuity in investment philosophy and operational expertise.
• Generational Planning: Effective leadership transitions are crucial for maintaining fund performance and organizational stability.
• Manager Evaluation: In-depth due diligence, including understanding personal motivations and team dynamics, is essential for selecting reliable private equity partners.

The Importance of a Strong Investment Thesis and Conviction

Transcript Excerpt:

Brad Conger [20:55]: "When you leave college, you should have a punch card of 20 punches and that's all the investments you'll get to make."

Conger highlights the significance of having a well-defined investment thesis and the conviction to adhere to it, even in the face of market uncertainty. Drawing parallels to Warren Buffett's investment philosophy, he advocates for thoughtful, limited investment decisions that align with long-term objectives rather than reactive trading based on short-term market movements.

Key Points:

• Investment Discipline: Limiting the number of investment decisions fosters greater conviction and strategic alignment.
• Long-Term Focus: Maintaining a strong, coherent thesis helps investors navigate market volatility and capitalize on opportunities aligned with their strategy.
• Avoiding Herd Mentality: Resisting the urge to follow market trends ensures portfolios are built on solid, independent analysis rather than mimicking prevailing sentiment.

Corporate Governance and Its Impact on Returns

Transcript Excerpt:

Brad Conger [23:42]: "If you give people more degrees of freedom, they are able to make better decisions."

Conger touches upon the critical role of corporate governance in driving investment returns. He references studies that demonstrate how effective public board compositions can positively influence company performance. By empowering management teams with the autonomy to make strategic decisions, companies can enhance their operational efficiency and long-term value creation.

Key Points:

• Governance Impact: Strong corporate governance structures correlate with better financial performance and higher returns.
• Management Autonomy: Allowing managers the freedom to execute strategies fosters innovation and responsiveness to market changes.
• Accountability: Clear delineation of responsibilities between boards and management ensures alignment of interests and effective oversight.

Innovative Fixed Income Strategies

Transcript Excerpt:

Brad Conger [52:26]: "I took her to a 22 year duration in her fixed income portfolio. … that's an equity like return for a fixed income yield."

Conger discusses a unique fixed income strategy implemented for his personal portfolio, emphasizing the potential for higher returns through long-duration bonds. By investing in long-term treasuries, he aims to capitalize on real yield opportunities and hedge against economic uncertainties, drawing an analogy between the returns from this approach and those typically associated with equities.

Key Points:

• Long-Duration Bonds: Utilizing extended duration in fixed income portfolios to capture higher yields and mitigate interest rate risks.
• Real Yield Opportunities: Investing in treasuries with attractive real yields as a hedge against inflation and economic downturns.
• Strategic Risk-Taking: Applying unconventional fixed income strategies in personal portfolios to explore higher return potentials without necessarily adopting the same for client portfolios due to tracking error constraints.

Lessons Learned and Reflections

Transcript Excerpt:

Brad Conger [55:24]: "I wish that I had questioned more. They received wisdom… I wish that I had been more skeptical of the received wisdom."

Reflecting on his career, Conger underscores the importance of questioning established asset allocation norms and avoiding complacency. He shares an anecdote about challenging a traditional small-cap allocation, which initially lacked a fundamental financial rationale, illustrating the value of independent analysis and critical thinking in investment management.

Key Points:

• Critical Evaluation: Continually questioning and validating investment practices ensures strategies remain effective and aligned with current market dynamics.
• Independent Thinking: Moving away from herd mentality and conventional wisdom fosters more robust and resilient investment approaches.
• Adaptive Strategies: Being willing to adjust asset allocations based on evolving market conditions and empirical evidence enhances long-term portfolio performance.

Conclusion

Brad Conger's insights provide a compelling critique of traditional small-cap investment paradigms and asset allocation practices. By emphasizing the need for a strong investment thesis, disciplined portfolio management, and strategic flexibility, Conger advocates for a nuanced approach to navigating modern financial markets. His experiences and strategies offer valuable lessons for institutional investors seeking to optimize returns while mitigating risks in an increasingly complex economic landscape.

Notable Quotes:

1. Brad Conger [00:59]: "The small cap index has fundamentally changed in its composition… it's much lower quality."

2. Brad Conger [07:46]: "I think it's much more productive mentally to have your hands sort of tied."

3. Brad Conger [09:28]: "There's a fetish with alpha. … I hire Roger Federer and I put him in a ping pong tournament… he's going to get killed."

4. Brad Conger [20:55]: "When you leave college, you should have a punch card of 20 punches and that's all the investments you'll get to make."

5. Brad Conger [23:42]: "If you give people more degrees of freedom, they are able to make better decisions."

This episode offers a masterclass in advanced investment strategies, portfolio management, and critical analysis of prevailing market trends. Brad Conger's expertise and candid reflections provide listeners with actionable insights to refine their investment approaches and better understand the complexities of today's financial environment.