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- [00:00]
A
I'm Curtis Peirce. For those that don't know me, I'm David's co founder and business partner. You're one of the most prolific interviewers of the world's top institutional investors. Today we're putting you in the hot seat to explore some of the most important lessons that you've learned over 300 interviews over the last two plus years. You recently made the comment to me that Alpha is not what people think it is. How do people traditionally think about Alpha and what do they get wrong?
- [00:24]
B
Experienced CIOs implicitly grasp this, but Alpha is in the hard and the boring. I recently had dinner with the chairman of Jeffries, who founded a firm called Leucadia. His name's Joseph Steinberg and he won't even jump on camera. He's, he doesn't believe in doing press. He's very much focused on his business. We spent three hours together. I asked him to like, like what determines what he's interested in. He said it has to be hard or boring and ideally both. Alpha, as portrayed in movies like the Big short or on TV or in YouTube shorts or TikToks, is this like stroke of genius. You're in the shower and you get this genius idea, let's short the mortgage crisis. Nothing could be further from the truth. Alpha is about doing the things that people don't want to do. There's this well known entrepreneurial meme which is if you want to get rich, you start a garbage disposal business. The same lessons apply to investing. It's focusing on the things that people don't want to do and focusing in the areas that people don't want to focus on.
- [01:37]
A
Would it be accurate to say, based on that description, that Alpha is more about avoiding these trades, these stroke of genius ideas, and more about finding the consistent compounding areas or factors that lead to true outperformance consistently over time.
- [01:56]
B
I interviewed Bill Brown, episode 253, who actually did the big short trade. He wasn't the main investor, but at the Stern family office they did a sizable trade. They knew all the parties, the guy who's portrayed and Big Shore from Deutsche bank and all these characters. And even that, even the most famous, most sexy trade of all time wasn't the stroke of genius. It was a lot of work. It was talking to a lot of people, talking to all the different banks, figuring out the unknown unknowns, like what are we missing in the trade? Building conviction. And then it was a lot of execution and trading and recalibrating. So even the most extreme Example of alpha being the stroke of genius was not actually a stroke of genius. That being said, 99% of investments are not the big short. 99.999%. If you take a 50,000 square foot view, Alpha is much more about portfolio construction than these structural genius trades. In fact, there's a famous pension Fund study that 90% of returns at pension funds could be predicted by their portfolio construction, not by their manager selection. So figuring out how to construct your portfolio, which sounds extremely boring and not sexy, is actually where alpha is more so than picking the trade or picking the manager that's just going to outperform.
- [03:10]
A
I really like that concept of manager. The dichotomy between manager selection and portfolio construction. I want to double click on that in a little bit. But first just to touch on the big short, because you took it there. There's an interesting thing I want to explore which is this concept of prestige. And it's actually interesting because in hindsight, it was a prestigious trade to have been a part of. It was this brilliant thing that only, you know, certain people saw in advance. But at the time, actually in real time, you were sort of crazy to short the housing market. It was something that, you know, had never gone down before. So I'm actually curious what your thought is on how much does prestige, or lack thereof and ability to maybe suffer low status or low prestige at a point in time play into this concept of being able to achieve alpha over time?
- [04:02]
B
That's such a good point. Which is prestige always follows returns, but it doesn't work in reverse. In other words, the highest returning trades are not prestigious. At time Bill Brown talked about this, he was left out of rooms. A lot of people thought that it was a silly trade, it would never work. Other people thought that even if it did work, they wouldn't get paid out. So there was a lot of naysayers, which is why there were such high returns on big short specifically. But this idea of being able to tolerate low status behavior for many years in every realm of business is one of the most underrated aspects of business. That is where the alpha is. If you're seen as doing something really smart, really capital C, contrarian and genius, a lot of people want to be seen as that. That doesn't differentiate you as investors. There's no alpha in that trade. But if you're doing things that people think are dumb, are not scalable, are not sexy, or as I mentioned before, just take a lot of work. One of the biggest sources of alpha in asset management is actually doing the work. And there's different derivations of that. But on the status thing, it's not just being able to deal with low status behavior for a month or a quarter or a year. Oftentimes the best trades require you to have steady hands for many years, which requires a lot of conviction and also a lot of paradoxically status within the organization to do that.
- [05:36]
A
And how practically should people think about overcoming this dynamic? One interesting parallel you could make is the startup entrepreneur. When they start, everyone is telling them they're crazy, they're going to fail. They have to suffer this low status for a long period of time, sometimes for many years, until they achieve that product market fit, until it becomes obvious they get that brand name VC and then they're a genius. Whether you're a startup entrepreneur or a mid career investor, how do you overcome these status games?
- [06:12]
B
It's the million dollar question. So I don't think you overcome the status games. I think you find other ways to gain meaning and joy from what you're doing outside of status. So taking down to neurobiological level, your neurons might not be firing on status like people looking up to you, people thinking you're smart, but it might be firing on, you're working with people you really want to work with. Yeah, you're focusing on things that really matter in the world. Oftentimes these low status trades are things that no one else is doing. Which is another way of saying you're actually changing the world. It's like the most trite thing, but if you were building nuclear reactors or nuclear startups three to five years ago, you were actually helping build the future of US energy policy. Low status, super high impact. Also, you just have to have, it's like the second marshmallow test. You have to have the capacity to avoid positive reinforcement for a long time. In fact, we've talked about this before at seven Billionaires now on the show. The one thing they all have in common, it's really only one thing that I've seen is they're able to do things for many years that are low status and they're able to go against the consensus, which is another way of saying low status. And not only are they going in an opposite direction of consensus, they're oftentimes running in the opposite direction. A couple examples of that, Lawrence Calano I Capital. He was a decade ahead of the retail trade and they were just running, they were just growing and they insulated them from the outside world and they, they didn't let naysayers and quote unquote Institutional investors tell them anything else Ryan her another great example to today, Ryan Sirhan is one of the highest status people, certainly on a show, but in society He's a top 10 on YouTube. He has his own Netflix show. In 2013, when he sold his first house on YouTube, people thought he was a joke. They thought he was literally ruining real estate. Real estate was a conservative industry, but he was a decade before that and he literally looked like a clown. He was jumping in pools and doing all these things. And yet that is why he has that advantage today because there's network effects when it comes to media. So he has this 10 year head start on everyone. So cultivating the ability to be contrarian, lower C. Contrarian, not seen as being contrarian. Right. But doing things that other people think are dumb or low status is one of the most important skill set that you could have in business, in all of business, including investing.
- [08:43]
A
I agree with that and I think it dovetails into something that we talk a lot about, which is structural alpha. Going below the surface and trying to find other ways to be consistently good or consistently find meaning if you want to stretch a little bit. So maybe for the audience. How do you define structural alpha and give me some specific examples.
- [09:05]
C
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- [10:32]
B
You look at what LPs are trying to do, you'll oftentimes hear Rahul McDowell on the show and he says it's not about the returns. And oftentimes people say it's not about the returns. I actually disagree. I think it is about the returns, but it's about sustainable returns. And LPs are always looking at okay, great returns. How do you sustain these in a risk adjusted manner? How do you continue to get these returns over and over? The implicit question there is are you lucky? Is it a time and place? Is there's not enough demand in in this industry in the sub strategy? But there's also a question of did you get lucky? This is the most pronounced in venture where you might have one one portfolio company driving a return. So it's also important to understand the quality of your returns, how diversified, how consistent. But structural alpha is one of those things that consistently delivers alpha. So much so that's literally in the structure of the investment. What does that mean? A couple examples at Professor Steve Kaplan, arguably the leading researcher in the private equity space, University of Chicago. And he created this Kaplan Shore index which found that the 2 and 20 that investors pay GPs translates to 600 basis points in fees per year. That's the bad news. The good news is that there's still roughly 3 to 400 basis points of alpha in private equity and still a lot of alpha in venture capital if you're in the right funds. But 600 basis points said another way, there's an issue if you're one of these large LPs in the network. Your Alaska permanent I think today is $70 billion. Your U TIMCO, University of Texas, your calipers, your calstrs. How do you sustain alpha deploying so much capital? It's a serious problem. And one of those answers is structural alpha. What does that mean in this case it means co invest. If you think half of your portfolio is going 2 and 20 and half of it is not that half, that's not. You're getting 300 basis points of alpha. Is that a thousand basis points is a 10%? No, but it's 3%. Predictably, both historically and forward looking it makes sense, it's intuitive. Why paying lower fees, that is a source of alpha. That's a form of structural alpha. In a high net worth space you now have tax loss harvesting. An entrepreneur has a hundred million dollar exit, puts it into a tax loss harvesting vehicle which right now there's two Major players, AQR and Quintino, you could wipe away that, that tax year one, you get a hundred million dollar tax loss harvesting that is the equivalent, if you're in New York, roughly 35% in capital gains. So that's the equivalent of 35% return in year one of structural alpha. That means the return, let's say that the investment does 8% or 12% or 10%. 35% is layered on top of that, that structural alpha. So together you might get a 40 plus plus percent return. As far as I'm concerned. I don't think those returns exist outside of structural alpha. I don't think anyone's consistently beating the market, at least anyone with open funds. So I think structural alpha is extremely underrated. Again, it's not very sexy. If you use the proverbial cocktail party test. You go to, you're sipping your cocktail and someone says, what's your best trade? And you say, I structured it in a tax efficient way. No one's going to be very impressed by that. And yet it is one of the most sustainable and most predictable sources of alpha in all of investing.
- [13:55]
A
Maybe that's a heuristic to think about. The investments you want to brag about at the country club or at the cocktail hour are maybe those that are more difficult by definition because of their sexiness, their prestige to actually achieve alpha consistently, and those that you would rather not talk about because it's going to be perceived as boring or uninteresting. Those are the places that alpha is more likely to be found and where you should really be spending your time. Is that the right takeaway?
- [14:21]
B
Yeah, let's call it the cocktail cringe test. If the other party will not cringe while you're talking about it, there's probably not structural alpha.
- [14:29]
C
By the way, the opposite is true too.
- [14:30]
B
You invested in OpenAI's latest round at a 500 billion valuation. Probably not going to get 10x on that at least before it goes public. And you also did it on three layers of SPVs. So to use the Kaplan Shore Index, you're paying 18% and year in management fees.
- [14:46]
A
One, eight, also known as negative alpha.
- [14:49]
B
Yeah, that is the definition of negative alpha. And yet it you go to a cocktail party and you could tell people legitimately without lying. I invested in the latest OpenAI round.
- [15:01]
A
If I would refine the cocktail cringe test, which I like, we should coin that phrase. If I would refine it, though slightly, I would say it applies at the point in time in which the investment was made. So if you were a seed investor in OpenAI, it wouldn't have been brag worthy at the time because no one had ever heard of OpenAI. ChatGPT had never been launched. So mentioning at a cocktail party would have been a shrug a so what? I've never heard of that. The relevant point is that it's the point in time the investment is made. Sure some investments that don't pass the test at the point in time of investment will in hindsight be be.
- [15:38]
B
You know, I'd also further refine it in that it depends what cocktail party you're at. As you know, we have a very specific archetype that we make the podcast for. We make it for CIOs of large institutions and family offices. We also make it for people that find structural alpha sexy that if you were to explain to them this tax loss harvesting or the co invest, they would be like oh that's actually really interesting. That's really sexy. So it's a very specific cocktail party. So it really depends also who's at the cocktail party. But a generalist audience and a generalist population should not find it sexy and should not find it interesting.
- [16:16]
A
Shifting gears lightly, what parts of the market have the greatest opportunity for alpha today?
- [16:23]
B
If you're asking for specific asset class or sub asset class, I think lower middle market Penn is one of the most interesting parts of the market for a couple of reasons. One is if you buy the thesis that large buyout has too much dry powder, which is empirical, you just raised too much capital and you think of just the second order effects. You don't have to go far. Where are they going to deploy this dry powder? They're going to deploy it into companies that get bigger lower mill market. It's this whole idea that companies get rebought over and over by private equity funds. It's absolutely a true idea. So second order effects. Going back to my definition of alpha, which is hard and boring, is lower middle market hard? Yes. There is no blackstone of lower middle market. It's a paradox. Lower middle market by definition is highly fragmented by definition. No one's really heard of these funds unless you're in the space. So you really have to do your diligence, you really have to do your team. It's a lot of work to get up to date on the lower mill market. Not to mention there's more PE funds today than there are McDonald's, so there's just so many due diligence. Similarly, in venture, almost no venture funded funds could talk to all 3,000 funds. It's just not a practical reality. So it is very hard, it's very time consuming, and to most people it's very boring. It passes the cocktail cringe dust. If I say I invested in ABC $200 million private equity fund, it's not going to be impressive, but the opposite will be impressive. I invested in Blackstone, I got access to ABC venture, you know, $10 billion manager, that sounds very impressive. Are the returns there? Probably. Is there alpha? Almost definitionally, no. On top of that, the incentives are completely misaligned in the institutional investing space between principals and agents. In terms of principles being these pools of capital, endowments, pension funds. There's a 2022 University of Pennsylvania paper that found that the average CIO at a pension fund, their tenure was six, 33 years. So six, six and a third years. And that doesn't sound great in general. But what makes it even worse is in most asset class, especially the liquid, from the very beginning that they make the investment. So I'm assuming that they make the investment on day one, the returns of that investment are unlikely to be materialized. Certainly not much DPI before they leave. In other words, their incentive from a purely dollars and cents and career aspect are not aligned with the investments that they're making and in fact are misaligned.
- [19:09]
A
You said a lot there. And I want to break it down into a few different points because I think they're all interrelated and they all tie back to a lot of the points we've already covered today. So in the lower middle market, you have a double layered or maybe even a triple layered brand friction, which is the companies themselves are not branded. They don't have general awareness. The funds investing in the unbranded companies have low brand on a relative basis to the largest players in the industry. And so you are overcoming the sort of Double Brand Friction versus if you invest in KKR's latest fund, they're probably buying a company you've heard of and everyone's heard of KKR in the space. So you have the opposite of that. The third layer, if there is one, is this brand friction between the individual making the investment decision and their governance structure. So they're trying to overcome this lack of brand in the companies and in the funds. And maybe they themselves may not have a strong brand within the organization, especially because there's this long lag time between the point at which the investment is made and the decision is made and when the returns will be realized or be able to be more easily assessed, which ties into your point around the principal agent conflicts that exist. So let's double click on that piece of it. How can institutional investors balance these factors when they need to make good investment decisions? But these conflicts exist and they're also trying to manage their careers, ensure that they're, you know, don't get fired in the worst case and in the best case have better, you know, career opportunities ahead of them. How do people think about and manage these, these conflicts?
- [20:49]
C
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- [21:44]
B
CIO is asking him or herself how do I balance the needs for returns in my organization with preserving my reputation and the longevity of my career? In the seat they've already lost, they're at the wrong institution. So the short answer to what you're saying is you've picked wrong. If the institution is not aligned with this because this is not something you could change just in time at an institution. What does that mean? That means first of all you need to even ahead of who the IC is, who really runs kind of like the board of directors of the institutions. Two different entities, but similar idea in that you need to know how they're chosen. In the majority of pension funds, you have non industry professionals on the IC on the board, which sounds great. You have police and firemen on the board and union members, all those things. There's nothing against them. It's just that they're not investors and they're going to make mistakes when it comes to investing not understanding the nuances. It's just like having an investor that on the board of a brain surgeon trying to do the best brain surgery. It doesn't mean that that investor's not best in class. You could put cliff Asness one of the greatest investors on brain surgery and they're not going to do a good job. They just don't have the experience. Same thing happens on the IC of certain institutions. There's also a principal agent aspect there where oftentimes it's not their money, oftentimes they don't even have a dollar. And there are underlying capital structures. So when you have a 12 person IC and one person's really being the table, like we need to invest in Blackstone, we need to invest in kkr, like I don't know what these funds are, the other 11 people on that committee, they may disagree, but ultimately it's not their money. So there's only so much they're going to fight. So you have these principal agent problems at every part of the organization and the most forward looking organizations, regardless of S class have solve this at the point of inception. At corporate governance, another thing that you won't bring up at a cocktail party, corporate governance is probably, if you think of portfolio construction as the main driver of returns, corporate governance is upstream of portfolio construction. And you'll see this, for example, AK permanent, the CIO can invest up to 1% of the entire capital discretionary. We had John Skirvin from URS same thing there. Giving the investor team the discretion to make investments doesn't mean that you take off all governance and doesn't mean that you allow them to put 50% of their money in Bitcoin, even though that might technically be a smart strategy. It's giving them discretion, at least at the margin to be able to move fast, to do the investments that they feel that they need to do that are not subject to political pressures on the board. Whether intended or not, it's one of the biggest forms of leverage and how institutional capital can actually outperform their peers.
- [24:48]
A
You mentioned John Skirvam. I think if I could summarize one of his primary points on public pension governance, I would say that it goes directly back to the point you made around people that actually have a vested interest in the pension fund, not necessarily being the ones driving the decisions which results in worse outcomes. So specifically a lot of the large public pensions, they have these open forums, these public meetings, these public hearings. But those that are coming and weighing in on those are not necessarily the pensioners, the teachers, the police officers, the firefighters whose money it actually is. These are random members of the public that it's not their money. Yet because of some governance processes, they do have a voice. So I think that would be his critique and I Think it does make a lot of sense. Your point, which is governance is sort of upstream of everything.
- [25:42]
B
When we chatted with John Skirvin, he has an even more absurd situation where it's not even a principal agent. When he was managing the Oregon State pension fund, he would have press people of the press in the audience, he would have people that were not even pensioners in the audience. He called him crackpots. And all these random characters would come in and challenge his portfolio construction. It's not even principal agent. So that's, that's the most extreme. But it happens on every part of the investment process. And if you play it out, why does it naturally evolve into this? It's, let's say that you're that one IC member that you really care about your alma mater, you're on the Ivy League endowment, you really care about it, maybe you got a scholarship to attend there, you want to provide that scholarship. You end up fighting over and over. At some point you're going to give up and you're going to say I'm not getting paid enough to fight, it's not my money. Some level you're going to give up that fight versus if it was truly your money and your family's money, you would fight for it more. And I'm sure people would disagree with that and say no, that's not the case. But it's human nature and human nature is consistent.
- [26:54]
A
And just to wrap up this part of the conversation, given all these things stated and all these things in mind, what advice, if any, would you have for a mid career allocator or trying to figure out how they should steer their career, where they should be, what advice would you have for that individual?
- [27:11]
B
I was a bit curt in my assessment, which is if you're asking the question, you're in the wrong organization, that's like 80% true. In truth, governance is not binary. There's really bad governance, there's really good governance and there's a lot of shades of gray. If you happen to be in a place where you might be 8 favorable out of 10 governance, the best thing that you could do this is the EQ part of the job is to continue building relationships both upstream. If you're mid level, if you're the cio, build with the board and build reputation. Bring build social capital that you could then spend in order to make contrarian bets. So you have to build over time. There's no shortcut on that. At some point you become the high status thing. Michael Burry, people followed him into this AI short just because he did the previous big short, which was at that point low status. But to your point, he ended up being extremely high status because he made that low status trade and people just blindly followed him into or people followed him into this AI trade. So that takes time. That's. That's your reputation. They say reputations take decades to build, but that's one of the hacks. But I do believe to double down on what I said earlier, if you're at a 2 out of 10 governance, the best thing you could do is to look for a place that has better governance because that's almost impossible to solve around.
- [28:35]
A
And one thing that I would add is the first step is being aware that these issues exist in the first place and knowing that you have to manage around them. So in many ways, advice number one is be aware of the issues and think through them. Whenever you're navigating a new investment, whether you're evaluating a new job opportunity. Beyond that, you make a really interesting point, which is things that lack status can be sort of made up for in the status of the individual making the decision. So maintaining a very high status or building your status as an individual will, with time, throughout your career, give you opportunities to help the organization make the right choices when the underlying things don't have enough status on their own and you can lend the status you've built to them.
- [29:23]
B
This goes back to Alpha, which I characterize as doing the hard things on investing. It also applies to career Alpha. If you're doing 20 plus references on a manager that you're investing in, how many references are you doing in the organization that you're investing in? Me. And you had dinner with George Zhang from trs and before he joined trs, he did his own diligence and he found out that he was in the right organization that's going to bolster him and allow him to execute his his highest and best use as an investor. So I think the feedback there would be if somebody's unhappy in their position or complaining about governance is do your work, learn the lesson that you didn't do enough diligence and do diligence next time. It's absurd to do 20 reference calls on a GP and not to do at least 20 references on your own career.
- [30:18]
A
It's a great point. It's very good advice. Shifting gears to our next topic, I want to talk about this concept that you've told me about previously, which is LP capture. What is LP capture and why does it matter?
- [30:33]
B
Okay, how do you define LP capture. I've never really thought about defining it until this very moment. The way that I would define it is when your LP base leads your fawn to perform worse. What does that mean? A lot of people think that GPS are alone on island and they're either good GP or bad gp. But GPS could be highly influenced and captured by their LP base. A good example today is the sacred cow that you're not allowed to question dpi. DPI is one of those things where today everybody agrees, quote unquote, everybody agrees that it's the most important thing and questioning it could get you canceled in the industry. And yet some of the top long long term thinking LPs are aware of of the conflict between DPI and TVPI. So DPI is how much capital you get back today. TVPI is the overall capital return on the fund. Taken to extreme. If an LP wants DPI at all costs, you sell your most attractive asset and you sell it at a discount for venture. This could be disastrous. Let's assume going back to OpenAI, let's say you were in the seed round and you were pressured to sell at a hundred billion dollar valuation. Let's say it goes public at a trillion dollars which is what some people are expecting. If the $100 billion valuation returned the fund four times over simple math, the trillion would have returned to 40x. In that case LP capture and having the wrong LPs would have made the difference between a 4x fund and a 40x fund. That's how extreme in venture this is. Par for the course. Power laws are the thing. It's not some weird aspect that sometimes happens in a fund. It's what the fund is is designed to do. In private equity it's a little bit less pronounced but same thing. If you have LPs that are telling you a to capture DPI going back to status thing, they're saying why weren't you in this deal? That was all over the headlines. That was very sexy. Again, I would argue that's negatively correlated to status. Does that mean that it always doesn't work? No, it could work oftentimes but on average status is a contraindicator to returns. So going back to that, that's another form of LP capture. It's much more common than people think. It's par for the course. The average LP captures their average GP. Just like if you hired the 50th percentile in your organization, you're not going to have a great organization. It's obvious when it comes at the organizational level at the LP level, it becomes more novel.
- [33:13]
A
I think LPs should also want to avoid LP capture because worse returns is worse for the LPs as well. How do LPs and GPs avoid this dynamic of LP capture?
- [33:26]
B
There's actually an opposite to LP capture. So if you think LP capture is poor LP behavior and there's the middle lp, there's actually elite LP and I call it LP empowerment. What does that practically mean? It means when the market is down 20, 30% and everybody leaves the market, the top LPs will actually come in and support their top GPs in buying assets at discount. Think of the Warren Buffett Goldman Sachs trade during 2008 as one of these extreme cases. This is not theoretical. A lot of endowments and a lot of LPs will actually build relationships over a decade with GPs, assessing their skill, their right to win, their intuition around investing, and then will back them significantly in those times. Oftentimes there's a misconception that returns are always made in a linear manner. Sometimes fortunes are made on a downturn and happens once a decade.
- [34:27]
A
One term that I've heard a few LPs use, I'll shout out Hunter Somerville at Stepstone. They use this term unlimited partner. And I think that may be the way they're trying to capture this thought process of how do you position yourself as an LP that's going to do all the right things at all the right times and really not just be a limited, a limited partner, a passive partner, or worse, have this LP capture dynamic where you're actually detracting from the partnership, but you're truly being additive in good times and in bad times.
- [35:02]
B
Perhaps the best example of this is episode 203 with John Felix, who worked under Scott Wilson, CIO at Washington University St. Louis, one of the top CIOs of our generation. And they would proactively go to GPS. Look at where they're weighted. So in venture or private equity they may have 20% of their weighting in a certain asset and they would try to get even more exposure to that with this very idea that their managers are actually underweight at their best ideas. So there's very practical ways you could be to use your to use Hunter Somerville's terms on unlimited lps is you could actually put more firepower behind great ideas and that this works in the public markets, the private markets.
- [35:45]
A
After the 300 plus interviews you've done, you mentioned 5 trillion in Guest Aum, what do you think is the most underrated thing about institutional investing and what is the most overrated thing?
- [36:00]
B
Great question. The most overrated thing is brand and prestige over time. It's the destruction of alpha. And some would say I'm fine investing in beta. If you're fine investing in beta, this probably isn't the show for you, but brand is highly overrated. The most underrated is is doing the hard work, specifically diligence. And the subset of that that's most underrated is reference calls. The top LPs in the world have all mastered reference calls and are very good at both conducting enough references, typically 20 plus for important investments, and also are uniquely good at getting the information they need on a reference call in order to build their thesis.
- [36:43]
A
I think the second part of that is really the underrated part, which is I think a lot of institutional investors have references as part of their process. But talking to someone and actually getting the right information are very different things, I think. And there's a big set of skills that go into one leading to the second. So maybe the question there is, when conducting references, how do you actually get the information that matters?
- [37:11]
B
There's one easy answer to that and then one tougher one. The easy answer is off list references. Obvious to most institutional investors, not obvious to a lot of people. Don't go off the references that someone gives you. Sure, you could call them just to check the box. They're not going to tell you anything interesting and anything unique. If they say something poor, then you could quickly discount the manager. It also shows a poor self awareness on the manager side. All the alphas on the off list references, meaning the references that the GP did not give you. That's the short answer. Longer answer is it's game theory. If I was to tell you here are the three questions you should ask tomorrow or over several months, Everyone would know these questions. They'd be prepared for them and they'd know how to respond. So it's like a terrorism, counterterrorism. What makes people great at references is reading between the lines, paying attention to things like how long does the person pause before they respond. In other words, how genuine or how contrived is their support of the gp? Paying attention to their tone, they might be saying all the right words, but they might be saying it in a very high tone or maybe in a low tone where they don't really mean it. Paying attention to what they don't say. Again, nothing that they say might be poor, but what didn't they say? Did they say it was like their top gp? Did they say they were so excited to have them in. Did they say that they took money from them twice? What they don't say is as important as what they do say. There's no shortcut to this. The best way to get good at references is do hundreds and hundreds of references and you could go up the learning curve quite quickly. But references are the most underrated thing in my opinion.
- [38:40]
A
And to summarize your position, I would say those that are best at references are getting at least as much, if not more from the reference beyond the words that are actually said correct.
- [38:57]
B
Two people can have a conversation with the same party with the same list of questions to have completely different quality of reference.
- [39:05]
A
If you could go back in time and talk to yourself as a recent grad, what's one piece of advice you'd give yourself to either accelerate your career or to avoid constant mistakes?
- [39:20]
B
Business is hard. Investing is hard. Spend your energy and your time. Focus only on things that could compound. You could spend years wasting on linear tasks that don't compound. Look for activities that compound. For us, it's media relationships. Those things compounds. A lot of things don't compound. And if there's no clear way that they compound, they probably don't compound. Focus all your time and all your energy, which is both scarce, on activities that compound over time. That's where the returns are in everything. And investing in relationships and all of life.
- [40:00]
A
Well, David, this has been a masterclass. I'm glad you let me put you in the hot seat for once and hopefully we can do this again.
- [40:07]
B
Thank you for being my partner and thank you for being with me for 300 episodes. A lot of people don't realize just how much work you put in, so I'm grateful to have you as my partner.
- [40:15]
A
Appreciate it.
- [40:17]
C
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