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of Capital Allocaters or podcast guests may

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maintain positions and securities discussed on this

3:00

podcast. My

3:02

guest on today's show is George

3:05

McElhockes, Chief Investment Officer of Gladstone

3:07

Management, a $2 billion long-shirt equity

3:09

hedge fund based in London. George

3:12

founded Gladstone in 2006 with

3:15

the capital from, well, maybe his

3:17

protege partners and six years later

3:19

bought back the stake when still managing less than

3:21

$100 million. In

3:24

the dozen years since, Gladstone has won awards

3:26

for European hedge fund of the year and

3:28

the top-performing five-year fund for three years in

3:30

a row. Long before

3:32

that, George became an international chess master

3:34

and took third in the 1992 World

3:38

Under 20 chess team. We

3:41

discussed George's path from chess to investing

3:43

alongside his college friend, Roloff Burta of

3:46

Sequoia, the challenges of the

3:48

fundamental long-shirt equity model, the culture required

3:50

to make it work and how he

3:52

does it at Gladstone. Before

3:55

We get going, 2024 is shaping

3:57

up to be a great betting

3:59

year. On the first

4:01

episode of the year I discussed about I

4:04

made with Morgan House or the same as

4:06

ever with sell more than one hundred thousand

4:08

copies organ let me know just last week

4:10

that his new book already a sort of

4:13

hundred and fifty thousand. Cells

4:15

are accelerating week over weeks and

4:17

it wouldn't surprise me if it

4:20

sells a million copies. Centimes are

4:22

over. Seconds: My

4:24

son Eric, How did his

4:26

focus going into our family

4:28

fantasy football leagues? Point. He

4:31

sounded persuasive or perhaps ready to take

4:33

over the show on the spread the

4:35

word, but I edged him out. And

4:37

to combs this used. To

4:40

best in two weeks with two

4:42

wins has me wondering if I

4:44

should go to Vegas. If you

4:46

want another winning best, I'll share

4:48

one here. I'll bet that if

4:50

you share your love of capital

4:52

allocators at the next opportunity, you'll

4:55

have good feel good. and leaguers.

4:57

Also bet that if you're listening

4:59

to this already, Agreed to go

5:01

ahead and spread the last. Thanks

5:04

for spreading the word about my

5:06

setting us. Once

5:08

as Isis. Please

5:10

enjoy. towards

5:13

lox. Stearns

5:16

Wonderful. safe, Sex addict. Or

5:19

take me back to. What?

5:21

You are most passionate about when you are to.

5:25

Problem. Solving problems. And.

5:29

Tests. Carried me

5:31

actually when I was young. And

5:36

you're. Some. You put

5:38

together a competition with where did you take

5:41

her. Became decisions have been.

5:43

That. Happened relatively quickly.

5:46

Came. Signal and twenty. Played.

5:48

internationally. Very. Reminiscent of

5:50

Queen's gambit. of course that Susan this

5:53

sucks but that took for me. To

5:55

the A at home to Mommy But. When.

5:57

I watch that doesn't load of reminiscing. That

6:00

was my misspent youth is the way I like it.

6:03

When you think back to those times, are

6:05

there any particular stories from your chest playing

6:07

years that stand out? It's

6:10

all about characters but like the series

6:12

on Netflix, it's not specific events but

6:14

I think the characters involved, they're

6:17

so unusual in many cases.

6:20

I just enjoyed the travel, going

6:22

to places. I went

6:24

to Armenia in 1996, found

6:27

myself in the middle of a coup d'etat,

6:29

was walking around with whatever hard cash and

6:31

my passport in my pocket for three days.

6:34

We had no idea what was going on and

6:36

I think the coup was repelled and then

6:38

the next thing we saw was the tanks,

6:41

the army marching in the square and I

6:43

go, it's over. What was

6:46

your path from going through university

6:48

into finance? I had somebody

6:50

in my university time that we

6:53

discussed a lot, what do we want to do with our lives, where

6:55

do we want to go. That person

6:57

is Rilof Boiter who runs the Koya

6:59

globally. He went on his path

7:01

and I went the London private

7:04

equity, long-term equity path.

7:07

I think we were motivating each other

7:09

or at least discussing what's interesting, what's

7:11

challenging, where's the opportunity set. Coming

7:14

full circle back to chess. At the time,

7:16

I was in my late teens, it

7:18

was obvious that there was some limit to how

7:21

far I could progress in the chess world. Maybe

7:23

you can get to the top 50 if you live

7:25

and breathe it but that's as good as

7:28

I would have been able to achieve whereas

7:30

I'd come to private equity in the

7:32

late 90s. There was a cottage in the streets, it's hard

7:34

to imagine today, 25 years later that private equity

7:38

was literally teams of 5 or

7:40

10 people doing handcraft deals

7:43

and the fun size role

7:46

1 to 5 and the firms were

7:48

nascent in terms of just where they

7:50

were in their development and I think

7:52

long-term equity, it's similar. At least in

7:54

Europe, it's still somewhat

7:57

unproven, fundamental long-term single man in

7:59

the world. I. Just know

8:01

many of us left away. And

8:03

I'm opportunities knocking. Obsessed. Best.

8:06

But rather excel and the

8:08

top. More. Was that

8:11

led you to go from private

8:13

equity to public equity? Private.

8:15

Equity. It's. A patient's game.

8:17

You do a lot of work three

8:20

months. potentially. I'm a single company. He

8:22

learned a lot. But. Often things don't

8:24

happen. To. Let us binary outcomes

8:26

at the end of three months of work.

8:29

As soon as I was in

8:31

public markets and intersected you can

8:34

multiple opportunities to use your knowledge

8:36

either long or short and steady

8:38

flow of opportunities at Incense and

8:41

your ability and money ties. You're

8:43

thinking both ways was extremely appealing.

8:46

And. Really of putting yourself against

8:48

other mine's some it's chest something

8:50

to something more like chess amounted

8:52

that appealed. Whereas. In private

8:55

equity credit which sign son's funeral

8:57

much process trevon but as lead

8:59

to a deal yeah. Well.

9:02

As your early training like in the public Marcus.

9:05

It was a nation industry back

9:07

in two thousand and three. so

9:09

most of Powers Learning was reading

9:11

books and talking to people who

9:13

were involved in the business. I'd

9:16

say the best training I

9:18

got at Lansdowne was. Which.

9:22

Is totally not what you

9:24

experience or see in private

9:27

equity. This. Was management in

9:29

underwriting securities in the diligence? the

9:31

if it's there but even think

9:33

of things in a portfolio sense

9:35

and you try and steer away

9:37

from macro debate. So macro risks

9:39

and trying to underwrite doll essence

9:42

predictable asks that should prove secure

9:44

over long periods of time. Going.

9:46

to three months and they the

9:48

most informative was really learning about

9:50

how to think about patrollers what

9:52

are the risks from a portfolio

9:54

construction point of view and water

9:57

the seems that the months slightly

10:00

top-down ideas and I'm actually grateful for

10:02

that because a lot of the emphasis

10:05

near private equity or age funds in the

10:07

initial five years of one's career is and

10:11

that's a bit commoditized. People now know

10:13

how to use a spreadsheet, people know

10:16

how to read 10Ks and you're

10:18

not going to make better assumptions

10:20

on a two-year view than most

10:22

other people. So you have

10:24

to differentiate in different ways and I think what we've done

10:26

well is combining top-down

10:28

thinking, thematic thinking, understanding

10:31

maybe an ambitious word

10:33

with that bottom-up analysis and

10:35

looking for where those two

10:37

coincide. Before we dive

10:39

into how you do that, I'd love to

10:42

chat about fundamental long-short equity which over

10:44

the last decade, maybe longer now, hasn't

10:46

really delivered en masse what investors have

10:49

expected, you've seen fund flows, index funds,

10:51

all this kind of stuff. What's

10:53

your sense of how

10:55

the long-short equity model should

10:57

work? I think there

10:59

are different models that can work and

11:01

that platforms have clearly exhibited success in

11:04

one type of model. I think

11:06

on the flip side, when you look

11:08

at the single manager construct, I

11:10

think there's been hidden flaws

11:13

in what most single managers

11:15

gravitate to that

11:17

isn't entirely obvious and

11:19

over time, the lack

11:21

of success there, it's being relatively

11:24

consistent. It comes down

11:26

to portfolio construction and short

11:28

alpha and I think a little bit the simple

11:30

way to do the math is if you're

11:33

running a 150 gross long-short

11:35

fund and you've got good

11:38

long alpha but no short alpha and

11:40

you end up with 150-50, I

11:43

mean as 150 gross 50 net exposure,

11:45

that means you're 100 long. So

11:48

you're a long manager on that side of the balance

11:50

sheet and on the short side, you're running a 50

11:52

short book which produces no alpha which means you're basically

11:54

short an index. So you're running A

11:57

150 gross product which is

11:59

effectively. A long product with

12:01

a short fifteen next. Over

12:04

time. Why? That was anything. And

12:06

that very elementary math is

12:09

a daughter. The bomb. To

12:11

little gross to little short Elsa

12:13

and you end up being diluted.

12:15

Good law manage. Again,

12:18

anyone market so healthy your

12:20

lungs are working. Product

12:22

seems okay. Have

12:25

some slight years the markets

12:27

and some challenging years for

12:29

you to shoot the index

12:31

and the price doesn't work

12:33

and sir over time that

12:35

construction some it was too

12:37

safe to begin with. And

12:39

it's probably a reflection of the

12:41

challenge of running Long Shot makes

12:43

people want to keep us safe

12:45

and simple in terms of the

12:47

put for the construction. but that's

12:49

like trying to build a formula

12:51

one racing team. And.

12:54

Not making the call fast, it

12:56

doesn't make sense because you really

12:58

have to be pushing the envelope

13:00

intellectually. Risk. Management Protection.

13:03

Sitting. Up else on the short

13:05

side in a very persistent methodical

13:07

way. You. Can't really

13:09

trust and Lieutenant Long

13:12

only protects. Council

13:14

Succession on the long. And.

13:17

Safe Shots make the product to look like

13:19

a lunch or products put the masses showing

13:21

it. Is that it's just

13:23

a diluted good imperfect? You.

13:25

Mentioned the challenges of running along

13:27

short fund suffered say stripping out

13:30

the timid as you say prefer

13:32

a concession. What? Are some of

13:34

those challenges? It's an

13:36

islamist industry, so you need to

13:38

set yourself up for that environment.

13:41

Than. Means people aligning

13:43

yourself with the organization,

13:46

sourcing talent. Incentivizing.

13:48

The Telling: Training the talent to let about

13:50

how do you find people that are aligned

13:52

with that performance culture? And

13:54

has a system. Search.

13:57

For incremental fonts

13:59

britain. into them. They don't think

14:01

that it's just going to happen because

14:03

it may have happened, doesn't mean it's

14:05

going to happen again. You have to

14:07

keep pushing as with every competitive industry,

14:10

you have to keep pushing for what's

14:12

the next idea, what's the next

14:14

improvement, etc. And ultimately, can

14:16

you create that culture of performance,

14:19

intellectual integrity, pursuit of

14:21

excellence and when

14:23

you canvas randomly people, is that

14:25

what you're going to do? Many

14:29

of them will say, yes. What it

14:31

takes to actually do it, that's a different

14:33

matter. Everybody wants to

14:35

be a world-class tennis player or a golf

14:38

player or something that's extremely competitive and difficult.

14:40

When you get down to what it takes

14:43

to actually get to that level of performance,

14:45

I think most people just have other things

14:48

in their mind, as simple as that and

14:50

differentiating between, can I build a culture where

14:52

people are aligned and motivated to win, to

14:55

perform? It's not easy actually. What's

14:58

an example of in

15:00

the investment realm, what it takes

15:03

to be able to excel in that way that

15:06

you feel sometimes people don't get to?

15:09

Changing your mind, being intellectually flexible. I

15:12

think a lot of people get into I'm

15:14

Right and the idea

15:17

that just toggling the potential

15:19

outcomes, possibilities, approaches,

15:22

there's an inertia, there's a stubbornness. I

15:25

think that's quite hard for people to

15:27

navigate. If you think about it,

15:29

in any professional sport, there are

15:32

times when the individual, the team are

15:34

not performing and they probably need to

15:36

change something and somebody needs to drive that change just

15:39

because they worked before doesn't mean they're going to work in

15:41

the future. So being able

15:43

to be dynamic enough and

15:46

open enough, intellectually open

15:48

enough, emotionally open enough,

15:51

maybe this has just changed. It's

15:53

just to look at the facts

15:55

anew. I think data is

15:58

something that people struggle with. embracing

16:00

data seems to be a challenge at

16:04

the end of the day. But

16:07

it's as simple as,

16:09

okay, you keep trying to short this sector and there's

16:11

no alpha doing that and you've been trying to do

16:13

that for three years. It just shows that, is this

16:16

a good idea? And it's like

16:18

money ball. And if you can actually

16:20

dissect performance into pieces and

16:22

really analyze not just your lungs and

16:24

your shorts but let's aggregate that down

16:26

into sectors, have you managed to prove

16:28

that you can generate alpha in this

16:30

sector repeatedly, in that sector? And

16:33

that's why I have the platforms

16:35

again, just the entire construct is

16:37

imposing that measurement discipline. I

16:39

find in the single manager construct, many

16:42

people are resisting that

16:44

measurement. So in

16:46

addition to the ability to be flexible

16:48

intellectually and that use and embracing of

16:50

data, what are some of the other

16:52

challenges you've seen in people that can't

16:55

get from maybe they're good to

16:57

being great? Again, let's compare

16:59

to professional sports. There's

17:01

10,000 guys with a great first serve, top

17:03

1% type of great serve. Of

17:06

those 10,000, what percent have a great

17:08

forehand? Maybe 20%. And

17:12

then of those 2000, how many have

17:14

a great backhand? Maybe 20%. And

17:16

then how many can play grass and clay? Maybe

17:19

20%. So one

17:21

of the challenges is that you're

17:24

having to keep adding new skills

17:26

and not only refresh the old

17:28

ones because things are

17:30

changing but having to actually add

17:32

new strengths. So

17:34

you have to keep getting better and that personal

17:37

drive to keep wanting to improve and

17:39

find areas that you can improve and then

17:41

working hard at them to improve. People

17:44

underestimate just how

17:46

many thousands of hours a tennis

17:49

player might spend just looking at

17:51

his backhand and the idea that

17:53

you're going to spend 50 hours getting

17:55

a bit better at your short side. People

17:58

under egg just are. hard it

18:00

is to get better unless

18:03

they're very determined. So I'd

18:05

love to circle back in time to your founding

18:08

of Gladstone as you come out of

18:10

Lansdown. If you look

18:12

back, what are the things that you've

18:14

learned both about building a

18:16

business and about the

18:18

investment process that you may

18:20

not have known even if you thought you did

18:23

when you launched Gladstone? On the

18:25

investing side, I think probably the

18:27

most valuable lesson I wish I knew back

18:29

then that took me for the first five

18:31

years to figure out is

18:33

have a very clear idea in

18:35

your mind how you're going to construct the portfolio

18:38

and somehow committing

18:41

to that structure really

18:44

informs how you build the team,

18:46

how many longs you need, how

18:48

many shorts you need. It sounds simple and most

18:50

people think they have the answers to those because

18:52

their presentation deck has an answer to that and

18:55

I wonder how many people it changes every

18:57

three or five years but really

19:00

committing to a portfolio

19:02

construction system ideology

19:05

that you thought through and

19:08

if you have something that works and

19:10

it might be 180 gross, 30 net

19:13

or whatever it is, stick

19:15

to it and really build from

19:17

there because that

19:20

will inform that you need 50 shorts

19:22

or you need 30 longs

19:24

or whatever the number is and how many people you need

19:27

to do that and how you're going to go about doing

19:29

that. I think managers

19:31

who haven't thought through those things, they're

19:33

often doing what their resources allow them

19:35

to do and they end up

19:38

with the product that their resources

19:40

allow them to have which

19:42

may again not be a product that actually works.

19:45

The comparison would be in Techland, if

19:47

what I need to do is build this type of AI

19:49

and have the size

19:51

R&D team and invest $20 million

19:53

to build it because that's the

19:56

only way to compete. I'm not going to be able to

19:58

do it with $5 million. insufficient

20:00

budget or you'd never start that

20:05

tax on the phone you have for a million dollars. I think

20:07

this business is the same. What you need is eight people,

20:09

you need to generate a short idea a week, you

20:12

need to generate one long idea every three

20:14

weeks that makes it into the portfolio. It

20:16

requires as many man-hours but

20:19

you need to start with a really clear idea

20:21

of what your portfolio actually is going to look

20:23

like. And it's a tough

20:25

exercise because when you're starting, you're not

20:28

quite clear enough about all

20:30

these variables. But spending

20:32

the time to work that out and then

20:35

ask yourself what resource that takes and how am

20:37

I going to set my team up to execute

20:39

on it is such a worthwhile

20:41

investment because all the ways that

20:43

can happen if you haven't done

20:45

that and I've seen managers on the

20:47

single manager side. One

20:49

day they're trying to be very long, whole team is working

20:51

on longs. The next moment they want to be neutral and

20:54

the whole team is working in shorts, that's

20:56

not possible. You can't manage

20:58

an organization to go

21:00

from serving Italian

21:02

food one week and Chinese food

21:04

the next week, it just doesn't

21:07

work. Being very clear in

21:09

your mind how to set yourself up

21:11

from a portfolio side I think is

21:13

probably the number one lesson I had

21:15

to learn pretty quickly. And then on

21:17

the business side and this is a recurring

21:19

theme that I've experienced with entrepreneurs that I've

21:22

engaged with. Is actually a board

21:24

in a cheap people's office or an angel

21:26

person? Very early on. This

21:28

business is about people and

21:30

having somebody full-time focused

21:33

on that feeling will be super

21:35

important. When it comes

21:37

to building the culture of the organization, there

21:39

are a couple of buzzwords you threw in.

21:42

Culture is one, alignment,

21:44

incentives. How do you

21:46

go about creating, let's just say, the

21:49

alignment and incentives in

21:52

the model that's worked? One

21:54

of the most important learnings is having

21:57

that contract with people at the front. that

22:00

I could share to do research and

22:05

so having that contract with your them

22:10

to do and how you're going to the

22:14

platforms, they got that right because

22:22

I think it's quite fluid and

22:24

people are just

22:26

expected to do more as they stay with

22:29

the firm and it's not always clear whether

22:32

they are doing more. The measurement of

22:34

what they are doing and what they're not

22:36

doing isn't clear. So a lot of effort

22:38

from our side to get better at that

22:41

contract with the investment team, the objectives,

22:43

how we measure sitting with them

22:45

on a biweekly basis to go through

22:48

what they are and aren't doing and really

22:50

helping develop them. Any

22:53

ambiguity in that relationship tends to not

22:55

work over time. As you

22:57

set up those contracts with the people on your team,

23:00

how do you bring that down into

23:02

practice of what the alignment

23:05

is? There's different compensation structures that people

23:07

use as one portfolio, as an individual

23:09

idea, as a contribution to the portfolio.

23:11

What have you actually done that's worked?

23:15

Alpha measurement, recognizing

23:17

when it's their idea versus somebody

23:19

else's idea, the firm's idea. Measuring,

23:22

just measure as much as you possibly can

23:25

and alpha being that North Star back to

23:27

all good and well. These

23:29

were money making ideas but

23:31

there was no alpha or it was

23:34

an okay short but not a great short or

23:36

it was a decent short but we actually added

23:38

at the wrong times and therefore there was no

23:40

alpha. It's a little bit getting

23:42

people to be more precise about how

23:44

much alpha they're measuring and really measure

23:46

themselves. Build the habits internally and also

23:48

with the team to want to

23:51

be measured, to enjoy being

23:53

measured, to check their own performance.

23:56

It's a performance industry. I'd

23:58

love to turn to how you take all

24:01

of these philosophies about people

24:03

and portfolio and put it

24:05

into practice at Gladstone. Let's walk through

24:07

some of that investment process. So first,

24:09

how did you decide what your investment

24:11

universe would be? My background

24:14

is financials and TMT. So

24:16

those tended to be the big areas where we focused on.

24:19

We've extended that to consumer which is touching

24:21

TMT. So those today are

24:23

the biggest three areas and then over time, you

24:26

can do match rings of things

24:28

as add-ons. Some industrial, some

24:30

healthcare. But really deciding what your

24:32

core areas of expertise are and

24:35

getting better at those and building

24:37

the organization around those, building

24:39

a culture of excellence around those. So

24:42

that takes an awareness of what am I going to

24:44

do and what am I not going to do? What

24:47

sectors, what market caps I'm willing to

24:49

invest in? My

24:51

background has always geographically been London. So

24:54

European equities has always been an obvious

24:56

investment place for us. The

24:58

US is such a big deep market and

25:01

we try and use what we see in

25:03

Europe or understanding of the world and apply

25:05

that to the US. And

25:07

then I grew up in South Africa so

25:09

that tends to be the market I play

25:11

in and I lived in Australia. So that

25:13

tends to be the country we do things.

25:16

And beyond those, it's the minimum. So stick

25:18

geographically to what you understand and stick from

25:20

a sectoral perspective to what you understand. And

25:23

that's led to a risk framework

25:25

where we've much like the

25:27

platforms, we're measuring

25:29

exposures by country, aggregations

25:33

of certain countries by

25:35

sectors, by sub-sectors, by

25:37

sectors. So there's very much

25:39

a risk system framework that

25:42

we use that dovetails the

25:45

expertise. As you looked

25:47

across those geographies, South

25:49

Africa, Australia, Europe, US,

25:52

I would love to get your sense of where

25:55

you see relative inefficiencies and if

25:58

they exist at all. Everything's

26:00

an experiment and the experiment

26:05

of what that experiment means in

26:07

terms of the value of companies

26:10

traded on an exchange. The

26:12

fact that next year out of the S&P 500,

26:14

50 companies will be up X% and 200 companies

26:19

will be down Y%. That

26:21

estimation is potentially changing and it's not just

26:24

the company said X and therefore the

26:26

stock went up or down. It's

26:28

an estimation of how the macro is

26:30

affecting the company and what impactful AI

26:32

have on these companies. We're

26:35

always trying to cage future

26:37

prospects with current stock prices

26:40

that is inefficient. So the idea that

26:42

the market is efficient is true of

26:44

what is known but as regards

26:46

the future, it tends to

26:48

be a very inefficient mechanism. So I

26:50

think we're all trying to estimate where

26:52

is the future likely to be different

26:54

to what current information is telling you

26:57

is true. That could

26:59

be on this management team

27:01

is promotional obfuscating. So

27:03

the information looks better than Aurelia's and

27:06

that's going to unravel in the future. So that's a

27:08

short and human nature, human

27:11

condition. It's prevalent in everything

27:13

and how companies get built and how

27:16

communication happens with the stock market

27:19

in whether management wants to be promotional because

27:21

they want to feel like they're good guys

27:23

because the share price is strong or

27:25

you're a tech company and you have to

27:27

keep being promotional because so much of your comp

27:30

is in SBC. With

27:32

a lot of understanding incentives, there's

27:34

various areas where yes, there's a lot of information

27:36

in the kind of stock price, management

27:39

behavior incentives and it tends

27:41

to be very underestimated in

27:44

terms of the future prospects of a company. I

27:48

want to take a break in

27:50

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now, back to the show. How

29:01

do you go about creating a

29:03

process to assess those

29:05

people dynamics in companies and

29:07

in markets? We've got

29:09

a short framework. There's 10 boxes

29:11

in the short framework and divides

29:13

broad-linked internal dynamics to a company

29:16

and external environmental factors. We've

29:19

always been the most amount of time

29:21

talking about management because I do believe

29:23

that it's probably the

29:25

one dimension that people spend the

29:27

least amount of time thinking

29:30

about measuring understanding. We'll

29:33

have people come in who

29:35

do executive analysis. How

29:37

do they even think about understanding

29:39

executives? What do they look for in

29:42

the history and their buyers? And how do they assess them?

29:44

And that's more of the outside of this business, calculating

29:47

whether next quarter's earnings per share is going

29:49

to be at plus or minus 1%. It's

29:53

the science part. We should be

29:55

talking more about management strengths and whether that

29:57

behavior that we think the market will reward

29:59

or not. and actually creates for

30:01

the mental value. And last time talking

30:03

about whether the next earnings per share is up

30:05

or down 1%. What are some of

30:07

the tools or frameworks you use to assess

30:09

management? Looking to the background, we

30:13

look for alignment of the

30:15

skill set with the job that have been

30:17

hired to do and you'd

30:19

be surprised how many really good companies just

30:21

hire the wrong people to run them. You've

30:24

got to develop an eye for that. That's just the

30:26

wrong person. They're not going to be able to do

30:28

that job. It's coaching people

30:30

to develop a sense of what does

30:32

it take to run a business and is

30:34

that CV the right one? It's

30:36

rare to see lateral hires hiring

30:39

people from totally different industries

30:41

coming in to run businesses.

30:44

The idea that CEO was previously

30:46

at a chemicals company. That's

30:48

not a natural evolution. In my mind, he

30:51

was highly regarded in the chemicals industry. He

30:53

had no experience that we could tell in

30:55

the consumer industry. And some of

30:58

these things are happening more regularly and frequently

31:00

than we realize. Microsoft

31:03

3 goes to replace ballgates. They

31:06

got it right eventually. Getting

31:09

under the hood and observing whether somebody

31:11

is actually making the right decisions, capital

31:14

allocation decisions, M&A decisions

31:17

and tracking what they say

31:19

versus what actually happens and

31:21

disaggregating them. So you

31:23

could have a pretty sharp inquiring mind

31:25

to keep listening out

31:27

for groups in what people say

31:29

and then what they do. There's

31:32

often more turnover on the short side of a

31:34

book than alongside of a book. I'm

31:36

curious, how does that

31:38

assessment of management change over time?

31:41

Generally speaking, I think poor management tends to

31:43

persist. In our portfolio, the

31:46

longest standing positions are actually short positions. There's

31:48

more of a bell curve. Maybe things pay

31:50

off quickly. Maybe they just don't work and

31:53

you cut and you sell it because the

31:55

timing is not good. But the ones that

31:57

persistently underperformed, we tend to just stay

31:59

short. And it's often about

32:01

management and just their inability. Maybe

32:04

they just have the wrong skill set. Maybe

32:06

they have a little appointees. Maybe

32:08

there's a disconnect between shared incentives and

32:11

how they've been elected. There's

32:13

all kinds of stories. There's not just one

32:15

template out there. What are some

32:17

of the other parts of your framework on the short side?

32:20

As I alluded to, external environments are really

32:22

understanding where we are and allow us the

32:24

team to think and 10 your time frames.

32:27

If you look at the company, what environment

32:29

it's in today, how does that compare

32:31

versus the last 10 years? So

32:33

we'll give an example. As we speak,

32:36

regional banks in the US, if you look

32:38

at the environment they're operating in today versus

32:41

any point in the last 10 years, it's

32:43

the worst environment they've had. The

32:45

regulators obviously tightening up following SBB.

32:49

Rates have unstuck with low deposit

32:51

rate culture that's helped the banks

32:53

over the last at least 40

32:55

years. So now the interest

32:57

rates have moved up and customers actually expect

33:00

to get a return on their deposits. That's

33:02

meant the cost of funding has gone up. That

33:05

hasn't been present. Never mind the last 10 years, it hasn't been

33:07

present for the last 40 years. It's been

33:09

great that there's been such low loan

33:11

losses. There's been very little credit risk

33:13

in the US system over the last

33:15

decade but over the last 50 years,

33:18

that's not true. At some point,

33:20

you can't run a bank on the

33:22

basis that you're going to have 30 basis

33:24

points of loan loss provisions forever. It's

33:27

not true. When that changes

33:29

and how that changes, it's going to happen. It's

33:31

just a question of when. They've over invested

33:33

in the cost basis and they're behind on tech.

33:36

So it's just a bunch of environmental

33:38

factors that mean the entire regional bank

33:40

space is probably under the most pressure

33:42

it's been in for a decade and

33:45

we were short ahead of the market

33:47

recognizing that. The market just didn't want

33:49

to believe that things were actually not

33:51

good for the banks until SBB happened.

33:54

We're trying to score on a long duration

33:56

just what's happening in the sector. Is it

33:58

a good time for these businesses? or a

34:00

bad time? Management departures,

34:03

just underscoring what key management departures can

34:05

be the chief accounting officer, can be

34:08

the chief financial officer. Accounting

34:10

is a big driver, it's an obvious one

34:12

that people always talk about. If

34:14

I had to pick one leading indicator on

34:17

the short side, it's aggressive accounting tends to

34:19

be symbolic of a management team that's trying

34:21

to prove that it's better than it really

34:23

is or trying to office get something. So

34:26

that tends to be another item on the

34:29

list and then we have another eight items.

34:32

And how about on the long side? What are the targets

34:34

that you like to look for? Good

34:36

business models and that seems like

34:38

an obvious thing to say. But if

34:41

I just say something contrary to that, has

34:43

Amazon proven that it has a good business

34:45

model yet on the consumer side? 3%

34:48

margins, it's a good business position

34:50

for customers. That's very different to

34:53

it's a good business model

34:55

for shelves. So really being

34:57

focused on business models that

34:59

actually just great business

35:01

models. Certain businesses over

35:03

time have proven to just be

35:05

better businesses because the model is

35:07

better. That's like a super high

35:10

on my list of do I want to

35:12

be an investor in something? The

35:14

external environment, is this a good time

35:16

to be invested in this company? Or

35:18

I can wait and maybe this is

35:20

just the wrong environment for this business.

35:22

So identifying good businesses and then understanding

35:24

when it's time to actually own that

35:26

business. And then I could go through

35:28

the list of modes and good management but I boiled

35:30

it down to two most important

35:33

things in my mind. It's a good environment,

35:35

not a good business. As

35:37

you're looking across geographies and industries, how

35:40

did you settle on what you felt like

35:42

was the right number of names on both

35:44

the long and short side? On

35:47

the long side, we've always ended up with

35:49

20, 25 loans and then the concentration and

35:51

the private

35:53

equity philosophy comes from my background.

35:55

And if you're looking for businesses

35:58

that you can at night

36:00

and they buy quality and it's a good

36:02

time to own those businesses. Getting

36:05

those factors to come together doesn't produce

36:07

Android loans. It produces 28

36:09

to 25 at least of quality that we

36:12

like to invest in. So that's been very

36:14

consistent. And I could

36:16

make an investment case for another 50 stocks but

36:19

does it fit our framework? And

36:21

does it really tick enough boxes? Probably

36:24

not. So that's been very, very

36:26

consistent where we varied over

36:28

time and we've now settled on a pretty

36:30

consistent range on the short side. And

36:33

this is back to what I said right at the beginning. Manpower,

36:36

how large you want your short book to be, what size

36:39

shorts do you want, etc. Today

36:42

we're running 60 shorts. The

36:45

average size is just over 1% each

36:47

and that takes a lot of manpower especially when

36:50

you have a very detailed framework and

36:52

you're confirming every quarter a lot

36:55

of numbers from cash flows to earnings

36:58

to management turnover to incentive

37:00

plans. So that takes a lot

37:02

of organization. So I think of portfolios

37:05

on the long side concentrated,

37:08

private equity philosophy, longer

37:11

dated holding periods. We're not

37:13

interested in it's kind of a good quarter. And

37:15

on the short side, a very industrial process

37:18

with a lot of names but the

37:20

majority of the investment team organization time and

37:22

effort is on the short side. How

37:25

have you organized the investment team

37:28

to cover three main sectors, four

37:30

geographic regions, just a lot

37:32

of places, a lot of companies? What

37:35

have you found optimal for? We've

37:37

organized the team by industry. So

37:40

I work with three sub-teams as you

37:42

pointed out and we have three meetings

37:45

a week, one with each of those

37:47

teams that runs

37:49

through research and analysis, new

37:51

ideas, existing ideas once a week.

37:54

We're talking every day but as a

37:56

formal how we've organized ourselves and making

37:59

sure that people... have got a target day

38:01

to present work, Bermuda

38:35

versus I was looking at this tech

38:37

company in Palo Alto, great

38:39

forum for that and

38:41

always surprising how similar people's

38:43

experiences are. We're all somehow

38:46

on the same journey when it comes to public

38:48

market investing and getting people

38:50

to actually realize that and

38:52

be open about it and, oh, this wasn't unique

38:54

to me and what can we learn from that

38:56

and can I improve that? Oh,

38:59

you did that? I probably should have done that. Just

39:02

getting people to be open about what worked,

39:04

what didn't work. So example

39:06

that learning across different people on your

39:08

investment team that may be in different

39:10

sectors. Take the

39:12

financial sector, I think there's

39:15

naturally an underweight of management

39:17

assessment. The expertise lends itself

39:19

to a lot of field of acronyms and

39:22

lends itself to detail and numbers

39:24

and a lot of information and

39:26

people often just don't lift their heads and say,

39:28

who's running that company? Do they not

39:30

run this company? We were disclosed

39:32

on a short in Europe where the

39:34

CEO had no experience running anything

39:37

and that CEO subsequently got let

39:40

go overnight but getting the

39:42

team to focus on how's this person

39:44

ended up running this company? That

39:46

simple question as opposed to all the facts

39:48

and figures about how the business is doing

39:50

this quarter versus the next quarter etc. I

39:54

think it's important for different sectors to

39:56

hear how in TMT it all comes

39:58

down to the CEO. team and

40:00

TMT people naturally know that. But

40:05

TMT people tend to not spend a whole lot of time

40:07

on the balance sheet because that's just not the fun part

40:09

of being in TMT. Companies are companies and

40:12

good companies that are getting better

40:14

tend to embark on very similar journeys

40:16

for the time. And

40:18

I think bad companies are getting worse tend to

40:20

embark on the same types of fact patterns occurring.

40:23

And the underlying principles tend to be

40:25

the same. How

40:27

do you use the analytical

40:30

tools of risk assessment in

40:32

your day-to-day portfolio construction? So

40:35

as I mentioned, we have risk metrics and it's a

40:37

plethora of them from country limits

40:40

to sub-sector limits to sizing

40:42

limits on the short side

40:44

if stocks are extraordinarily volatile

40:47

to factor limits to limits

40:49

by analyst. So we've

40:51

got a wide range of hard

40:53

limits that are coded

40:55

into our portfolio management system. They're

40:58

based on our data. So this is

41:00

based on a long track record and

41:02

learnings from that track record. And they're

41:04

not intended to produce what

41:06

the platform is trying to produce, which is

41:09

no beta, no factor neutrality, no

41:11

risk to the house essentially. So

41:14

it's more how do we

41:16

optimize based on our dataset, what

41:19

exposures we're willing to take by

41:21

country sub-sector factor, sizing

41:23

individual positions, stock losses. We've

41:26

got this very colorful portfolio management

41:28

system that's color coded all these

41:31

triggers. It's very much based

41:34

on our long track record of me being

41:36

single trigger puller, which means the data is

41:38

very consistent because I've made every single buy

41:40

and sell decision in the portfolio. And

41:43

there's a DNA. It's the countries, it's

41:45

the sectors, it's the market caps. And

41:48

there's a tendency to have a

41:50

preference for some growth in the

41:52

company. Doesn't mean I'm a growth guy, but we're not

41:55

just looking for cheap, for cheap things. Etc,

41:57

etc, etc. So that

41:59

DNA is in code. coded in literally

42:01

30,000 individual trades. You

42:05

can analyze all of that and then it's

42:07

extracting what your risk framework is from it

42:09

and we've probably spent a good five years

42:11

doing that. Where are some of the

42:13

things you've learned from looking at all that data that you didn't

42:16

know ahead of time? It's as

42:18

simple as net decisions at the

42:20

fund level tend not to work,

42:22

you want to do mid-cap long

42:24

investing, any hair on that

42:27

asset tends to not produce outcomes that

42:29

are good. When shorts get

42:31

below a billion dollars and we probably had

42:33

15 stocks in our

42:35

history that have gone from large

42:37

to below billion dollars and when

42:39

they get to that type of

42:41

market cap, their behavior changes dramatically.

42:44

It's a survival call option. The

42:46

data can tell you all kinds of things. I

42:48

actually have a great expression for those small shorts.

42:51

We call them squirrels, they keep making these

42:53

noises and a lot of people, yes, you

42:55

can analyze companies and you can analyze what's

42:57

a good company or what's not a good

42:59

company. Can you create

43:01

a portfolio that actually works without information? And

43:04

in long short equity, I've seen a lot of people who the

43:06

good at the analysis, the same as the

43:08

good company and that's a bad one. Populating

43:11

a portfolio that actually produces outcomes, that's

43:14

a totally different skill set essentially

43:16

because that's about sizing and risk management

43:18

and exposures. And then if you

43:20

go all the way to the factor

43:22

neutral world, it seems that 3%

43:24

alpha works for everybody, that's

43:26

fine. We're shooting for

43:29

20% alpha, completely different

43:31

order of magnitude. If

43:33

you have the ability to generate

43:35

substantial amount of alpha over time,

43:37

I'm curious your thoughts about

43:40

extending your offerings to you've been this

43:42

one long short equity fund for nearly

43:44

20 years. Lots

43:46

of folks in your boat have said, oh,

43:48

we're going to scale by offering a long

43:50

only fund out of your

43:52

longs and curious why you have

43:54

not done that. I

43:56

worry about cultural dilution. I think long short

43:59

is a very specific

44:01

performance oriented business

44:06

What are the great things that I want to

44:08

be long and where's the trouble and what are

44:11

the bad things happening where I want to be short and you have to

44:13

be watching those two things

44:15

simultaneously, morphing into a

44:18

lonely business. At

44:20

times where that's worked very well for people

44:22

and I can really see how that's a

44:24

good business for the manager. But

44:26

right now I think we've still got runway in

44:28

terms of building the long

44:30

short business out and

44:33

retaining as the culture is making

44:36

as purest as possible. It's

44:38

important to me right now. If

44:40

somebody came along and said, can you replicate

44:42

your long book for us in some long

44:45

product, it's possible. There's

44:47

a time and place for things but it's

44:49

really not a priority. What have

44:51

you seen that you've done well that

44:54

you think other long short managers haven't?

44:56

I think really being honest

44:58

about what the data is telling us, looking

45:00

in the mirror and measuring everything and being

45:03

brutally honest about what it's telling us. So

45:05

that's embracing data. It sounds

45:08

again subtle and most people think that

45:10

they're doing it but when it comes

45:12

to themselves, they're far more reticent

45:15

to embrace the data. I think

45:17

this is one of the learnings from chess is that you

45:19

want to get good at chess, you probably have to spend the

45:22

most amount of time looking at the

45:25

games you lost because there's something you

45:27

didn't understand about that game or

45:29

somebody understood better than you. Reflecting

45:31

on the games you won isn't

45:34

going to get you better. It's reflecting on the games

45:36

you've lost that gets you better and

45:38

take them personally. I think

45:40

one of Thalia's philosophies

45:43

that I very, very much like is mistakes,

45:46

errors, they're part of the business, part

45:48

of life but treat them like

45:50

opportunities and kind of embrace them.

45:53

Their message is to learn and

45:55

I just haven't seen people do that

45:57

and part of the growth is path

46:00

people that join us is

46:03

enjoy that aspect then take it

46:05

personally. No one's shy

46:07

to acknowledge their mistakes because if

46:09

you weren't making mistakes, you'd

46:11

be perfect and none of us are perfect.

46:14

In your conversations with your investors, what's

46:17

your sense of what the allocator's perspective

46:19

is on long-shred equity investing? I

46:21

think it seems to be all skepticism and I

46:23

think that's healthy because I don't think

46:25

it's possible to have a thousand

46:28

great long-shored managers. It's just

46:30

too hard and it's too specific

46:33

a skill set. So that

46:35

skepticism is probably healthy.

46:37

I sense disappointment in the community

46:39

with the overall returns from long-shored.

46:41

I think once they get

46:44

over that, they'll just realize it's

46:46

quite a bespoke business. How

46:48

many great venture firms are there? Maybe 10.

46:50

How many venture firms are around today

46:52

as a consequence of the last TMT

46:54

boom? Probably 300. So 300

46:56

is going to

46:59

peel back. It has to be and

47:02

it may be a decade long process. I

47:04

think long-shored is a bit the same that

47:06

just like venture is a very particular skill set and

47:10

it takes very strong world particular people

47:12

to get good at it. It's

47:15

not just throwing mining at interesting startups. That

47:18

realization that long-shored is the same

47:20

thing and it's actually quite

47:22

a critique bespoke business and

47:25

it probably shouldn't be that many proper long-shored

47:27

single managers out there when all

47:30

said and done. I'd love to ask

47:32

through your career to pick out a

47:34

couple of people that you've

47:36

learned valuable investment lessons from

47:38

and what those lessons are.

47:40

Look, Boysen, it's a choir. I

47:43

think he's very much a follow the

47:45

data and the fundamentals and understand data

47:48

and what the drivers of change are.

47:50

So that's been a super valuable learning for

47:53

me and he's in the business

47:55

of backing the right people who can grow companies.

47:57

So also learning about backing the right quality of

47:59

innovation. and creativity.

48:02

Frederick Stoller who is

48:05

a Warburpinkers partner and just a

48:10

business and really get to the bottom of

48:12

is this a good business? How does the

48:14

Flywheel work at each level of business? Was

48:17

this an analytical process and rigor that I

48:19

hadn't seen before and we try to apply

48:21

here. So I tell those

48:24

two probably the most influential. George

48:26

I want to ask you a couple of closing questions. What

48:28

is your favorite hobby or activity outside of

48:31

work and family? It would have

48:33

to be chess. So I'm still somehow entertained

48:35

by the game and I do

48:37

love to stay in touch with the community

48:39

globally. I'm still fascinated by the

48:42

sport actually. How have

48:44

you found chess when you're not

48:46

nearly as day-to-day engaged as you

48:48

were as a kid? Playing

48:50

the game is you're going to

48:52

not be as good. So but

48:55

I've accepted that. It's more who the characters

48:57

are, what the politics are and understanding

48:59

how the game is evolving. I'm taking the

49:01

team to have dinner with a 17-year-old who

49:04

recently was number 8 in the world

49:06

and just to hear from him what

49:08

methods and techniques are different from 10-20

49:10

years ago and getting my investment team

49:12

to engage with somebody who's on average

49:14

is half their age and he's 8th

49:16

in the world. So this is

49:18

what's achievable is what's possible. What's

49:21

one fact that most people don't know about

49:23

you? I was

49:25

multiple Yo-Yo champion. You

49:29

didn't know that? I actually forget that

49:31

for some reason but I think I

49:33

won every single Yo-Yo event I have

49:35

anticipated. I was really good. What's

49:37

your biggest pet name? Intellectual

49:40

dishonesty gets to me. People

49:42

confabulate and make stuff up

49:44

but sounds right. It's intellectually

49:46

just an invention. Which

49:48

two people have had the biggest impact on

49:50

your professional life? I would

49:53

say the same two as the biggest

49:55

differences on my investment career which is

49:57

World of Bortan, French dollar. advice

50:00

you ever received? On the

50:04

last one, what life lesson have you learned

50:06

that you wish you knew a lot

50:08

earlier in life? And

50:35

this is a very difficult one to put

50:37

in practice but really get the contract with

50:39

the people around you, that understanding

50:41

with people, what I'm bringing, what they're

50:43

bringing, what we expect from each other

50:45

and really flesh that out as much

50:47

as possible. It's a hard thing

50:49

to do in practice. I think people are good at

50:52

it, tend to get much further in life. As

50:54

human beings, I think we enjoy a bit of ambiguity.

50:56

Life is ambiguous but the more you

50:59

can create that clarity in your personal

51:01

relationships and business relation, any kind of

51:03

relationship really, the more you can do that,

51:05

the better you can do that, the more

51:07

effective your relationships are. George,

51:10

thanks so much for sharing your insights. My

51:12

pleasure. Thank you. Thanks

51:16

for listening to the show. To learn

51:18

more, hop on our website at

51:20

capitalallocators.com where you can join

51:22

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51:34

a good one and see you next time.