Erik Serrano - Investing in Investment Firms - [Invest Like the Best, EP.358]

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0:25 Operate smarter and stay ahead of the curve. See what Ridgeline can unlock for your firm. Schedule a demo at ridgeline.ai. Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at joincolossis.com.

1:00 Mm. Patrick O'Shaughnessy is the CEO of Positive Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Some. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum may maintain positions in the securities discussed in this podcast.

1:23 To learn more, visit psum.vc. Mm. My guest today is Eric Serrano. Eric is the CEO of Stable Asset Management, which he started 14 years ago in his early twenties. and has scaled to over three billion dollars of assets under management.

1:40 Stable Strategy focuses on other investing firms. They look to back the blackstones of tomorrow and provide those founders with capital and support. So their time is spent doing what they do best, which is typically investing. We discussed the commonalities among promising founders in this sector. How stable serves as a full resource to their companies.

1:58 and some harsh truths learned from building an investing business. Please enjoy my conversation with Eric Serrano. So, Eric, what a fun opportunity this is to talk to someone that probably has looked at investing firms. as a class of founders, just like I would look at startups as a class of founders more than anybody else. You even use that word founder. What got you so interested in

2:23 Investing in investing firms. In the same way that I would think about investing in a technology business with lots of the same process. Like what was it about this that originally got your interest back when you were, I think, twenty three when you started doing this. I'm still amazed at how in the business of investing most of the focus is on

2:41 The investment strategy, how you make returns, but people don't think about what is the machine or the platform or the process. That enables you to Generate those returns. There's a Spanish saying which is the cobbler's son has no shoes. And I think

2:57 It's a really neat concept that The people that are dedicated to their craft often overlook that same craft when applied to themselves. And you find this in a lot of investment or professional services that you meet.

3:09 investors who spend their time maximizing their craft of returns, but when you ask them about What they do with their own money, or do they give advice to their friends? They just don't apply it to themselves. And so yeah, when I was that young I was working at Bain and I really wanted to set up my own private equity firm.

3:27 But for me it was I wanted to be a student of what's the best firm that I can set up. And because I wanted to start my own private equity firm, I went around asking people kind of how they got started. And that got me Thinking about

3:41 Uh seeding, acceleration and Investigating the history of how do people start Investment firms. And that's what got me thinking, okay, what are the frameworks that I can use to build An also investment firm.

3:53 Why aren't there more younger people that start investment firms?'Cause you mentioned tech, right? So If you want to start a tech firm, a healthcare company, there's all these VCs, but if you want to start An investment firm, there's no firms that start investment firms. And that's super weird, right? And so I was thinking, okay, why and it's probably this youthful arrogance of daring to ask questions. And I was thinking, hey I think I'm quite smart. I'm quite a good communicator. Let me try and start a private equity firm. And I start talking to people in my network.

4:21 Typically that have a lot of money'cause you're thinking, I've got capital first. And they all kind of laugh me out of the room. They're like, You're twenty three years old. You just started this job. You have no idea what you're doing. And there are actually good reasons for why you don't start an investment from young and now looking back

4:37 One of those is that when you're investing your product in a way is your Performance. But to generate performance, you need time to elapse. And to discern luck from skill.

4:49 Time has to elapse. And unless you have a time machine, it's gonna be difficult for you to prove like, no, this is gonna be great. Like we're gonna look back in ten years and it's gonna be Made lots of money. So there is a reason why there is that market failure Behind Trying to start a firm young.

5:03 And so I went into doing a bit of research on that and at the firm We do this thing called project legends. And project legends is figuring out, okay, who are the best investors. In public markets and private markets. And it's sort of defined as lifetime P L.

5:18 'Cause when I think of people It's often the case that they make a lot of money on small amounts and then as they scale they lose a ton. So there's ways to triangulate this. And it's hard to get the both data series. People tend to talk about returns, but not about AUM. But if you get both and multiply them together, you can get to this lifetime PNL. And on the public side.

5:36 The average age of launch is thirty three. On the private side it's about thirty seven, thirty eight. Although on the private side and we can talk about this, it's often a a duo. It's like the younger and older person, which is interesting in itself. But

5:51 Thirty three is still quite old, right? And I'm like ten years away from this at the time. Not that I had the data points. But I was thinking, okay, how can I convince People to trust me and then it became more about the mouse trap. So the the shape of the firm or what I was trying to do.

6:07 Because if you can say, Hey, here's the framework of how I'm going to invest People can underwrite that as opposed to Saying, Oh, I have this strategy that extracts alpha in this way or this arbitrage. Like it's more about this is how I'm gonna set up the mouse trap. And that's what started getting me interested in Can I actually back founders of investment firms in a way that I'm also a partner with them in their firm?

6:29 So the returns isn't gonna only be I give them a hundred million, they generate some returns. It's I'm gonna give them a hundred million, but I'm gonna be a partner in the G P And then to scale that GP and turn it into a great business. Is gonna be the objective of what I'm trying to do.

6:44 Do you think the reason that there isn't a V C industry for backing investors. It's just If I call it to mind, I can only name like a handful of great big asset managers that I would have loved to have been a seed investor in and Blackstone and Apollo and Firms like this.

6:59 And that Maybe there's just a limit to scale on these things and like they aren't that great a business th th they can be, of course, great businesses. But there just aren't that many in let's say the public markets that are Anything comparable to the

7:12 million software technology businesses that I can name that achieved a similar scale. Like is it just Is there just something structural about this? And that's the reason why there's fewer investors in investing firms? Yeah, there's a lot to unpack there. I think on the Investment firm It tends to have these oligobalistic tendencies.

7:29 So Scale begets more scale. And I think a lot of that is Almost to do with the asset owner side of the equation. This sort of no one got fired for investing in IBM where At some point the career risk of the

7:43 Allocator, investor, cab owner, asset owner. is an important decision factor. So once An investment firm has been de-risked, it just tends to scale. So when you look at asset raising, it tends to be quite concentrated in the larger firms. But another thing is that Bringing it back to people.

7:58 You're actually really investing in people. And I think people underestimate how the life cycle of a firm follows the life cycle of a human in investing in a way that in other industries like healthcare or tech The product is more the code or it's the molecule recipe for

8:16 the medicine, whereas in investing it's the intellectual capital of the humans. That are part of that team. And so they just have a shorter lifespan'cause we live less. And so I think the Building an investment firm is difficult because you're really dealing with humans. And so the focus

8:34 Of my work is Centering on what makes this person a great investor, like what makes them tick. There's this great saying which is Chips on the shoulders, put chips in pockets.

8:45 And so I'm always trying to discern Okay, here's a founder that wants to build an investment firm. What's really driving him or her What is their edge? And a lot of that tends to correlate with personality traits, but also your life journey.

8:59 And I think that's something that most investors under appreciate. Or have less access to in a way, I'm really privileged because when I'm meeting a founder I can actually get into the nitty gritty of who they are. I spend a ton of hours with them. But most

9:14 Limited partners, you know, most capital allocators will not have the opportunity to really get to know the person, so they tend to focus on the investment strategy. But for me it's really important to get to know the person because you're really underwriting this person's Decision making. Ten years into the future.

9:28 Like the markets will change a lot more than the person will change. And yet we focus a lot on the market and the Strategy, but less on the person. And so I have this really fun and privileged access to getting to know the person.

9:42 And the characteristics that show up repeatedly about what makes a good GP, what makes a good investment from founder is that they have attributes that create two things. One is Resilience.

9:54 And one is variant perception. So if you double click into each of those in turn. Resilience is never giving up. It's just Getting up when you're knocked down.

10:04 When you're feeling like you don't want to get out of bed in the morning. And being an entrepreneur has that. Everything goes wrong all the time. And the Bad news and difficulties actually

10:14 flow upwards. You know, people think it's great to be the boss and to be a founder, but actually All the hard problems go up to you. So a high percentage of your day is just dealing with problems and hard things. And so that's less fun. And so

10:29 Resilience needs to come from a place where You love what you do so much. that all this discouraging news and obstacles in the way and things going wrong and blowing up all the time are not gonna discourage you from remaining focused on

10:44 your investment strategy. There's many variables that bring this resilience. But there's a few fun ones maybe to talk about. I think

10:54 It's not particularly fun, but adversity at an early age. I always think that we are the product a bit of our childhood and our parents And a lot of How we interact with the world, our values, our chips on shoulders. I actually come from a relatively young age, so just exploring

11:08 How you got here is something that I spent a lot of time on. And The data is very consistent. We always try and start with data because you're also tempted to use heuristics of like who's successful and did they go to the right schools and are they good at Explaining things. But in a broad definition of success of being an expert in your field and contribution. When you look at the data

11:27 There's huge relevance, for instance, of Losing a parent young. Something crazy, like two thirds of British prime ministers until couple of decades ago had lost a parent before eighteen. About US presidents.

11:39 But also when you double click into these Legends of the investment world. And again, I'm really privileged'cause often with Project Legends. My day job is forecasting forward which investment from founders are gonna be great.

11:52 But I'm really lucky to come across Already legend. investment from founders and if I get to get an hour with them. I run them through This questionnaire that we called past, present, future sort of an abridged version.

12:04 That we use with our founders in our day job. I run the legends. through it and I try to pattern recognize back. And you'd be shocked at how many of them say You know, is that financial insecurity in my childhood.

12:16 Or not seeing my dad succeed. And when you really get to the core of what drives them. It's this adversity that they channeled in a very positive way. To become what they are today. And

12:27 I think adversity at a young age is uh unfortunate and sad, but I th if you think about it as something that's giving you a superpower. That's really cool. So those are the kind of things we look for resilience wise. In terms of variant perception. That's really Seeing things other people don't see

12:44 believing Things. Other people don't believe. It's essentially being contrarian. 'Cause in investing.

12:50 If you're the average, you're beta in your market and you're you need to have a different view. And to be contrarian, you need a A point of view that's coming from a life experience or analysis. That's different from the herd. And again, that tends to come from

13:05 People who In childhood, younger years, they're just looking at things a bit differently. That can correlate to the household you grew up in, what your parents did. And we find that a lot of great founders just have different points of view.

13:18 And I think There's a point when Var and Perception converts into complete stubbornness and it's negative. So there's sort of diminishing returns to variance at some point, and then maybe it becomes negative where You believe something. outlandish or completely counter consensus, and maybe you were wrong.

13:35 And In my investing, I found that it's hard to tell where that point is. Some of the investments that have gone Less well have been where a founder just sticks to their guns.

13:47 In a way that Doesn't let them live to fight another day. I've kind of corrected a bit of my strategy there of like I used to look for extreme variant perception, but at some point it's actually negative. To be to Stubborn. I think

14:01 Just correcting your thoughts with new data is important. And that's one of the So not so secret secrets to the industry that I think managing evolution As an investment firm founder. Is

14:13 difficult because the audience interprets that as oh you're extending your mandate or this or that. Whereas in tech or the other industries we're comparing to that's a plus, like pivot is Like a good thing. Yeah. And uh and pivot is a euphemism for we got it wrong, we're trying a new thing. Yeah. Not acceptable in investing. Correct. And so I think the best founders find a way to do that within their strategy where they're testing and changing.

14:39 Without it being wholesale change of the strategy, and then they're good at evolving that. And more than anything, communicating that. And communication is something that is really underrated in investing. I think most GPs

14:52 Just want to focus on investing. And they see their LPs as this necessary evil. And I tell my founders You gotta change the paradigm. Your capital owners are

15:03 Allowing you to do what you love. Not only is it your passion And it makes you happy every day. It happens also to generate Huge amounts of wealth.

15:13 You should be grateful to these people. And if they have questions. Or things are not going so well, be proactively communicative. And if you do that well, I think that builds that trust for you to also evolve

15:25 your strategy because if someone has money for you for long periods of time, like the world changes, you can't stick to doing exactly what you do. So my advice for founders would be Be really good at one thing, do that. But also know that To keep your edge.

15:39 You'll have to evolve over time. But also be prudent and also be very transparent and communicative. to your investors about that because you almost have to earn that license and trust. To evolve.

15:51 And that's actually something very interesting about How that traditional GP L P relationship works. I love what I do because When my founders

16:00 Have an issue They come to me with the issue. So I'm like a special L P a special investor, you know, providing capital to them. And I think it's super healthy to be on the same team where It's encouraged.

16:14 to speak and communicate about how you can improve things. So one of the things I love about my job is that A limited partner is limited. I don't like limitations. I wanna be a full partner with you. If you think about the source of return for your style of investing, I'd love you to break it down for us because It's interesting in the sense that Yes, maybe there aren't as many blackstones that you can invest in early, but you're not just earning your return through the GP itself. You're earning it as an LP too.

16:39 So walk us through the like ranges, I guess. If I'm just like you and I earn a return in several different ways by partnering with these investing firms. how you make that work, because there are not a lot of seating businesses. There used to be more. I think in general, if you asked around and took a survey, people would say the seating business sucks. And

16:57 Yours does not suck and hasn't sucked, and so I'm curious what you've worked out that maybe others haven't. Like what is an investment? What are the sources of return in that investment? How do they range around? Like You're kind of a unique beast. So just describe how you earn your returns for your investors. Yeah, thank you. We're all unique snowflakes. No, um I think to look at the history of seeding or how investment firms came to be is quite

17:21 Illustrative. And this is something I did early on. setting up stable, I tried to find as many people as I could. who had been involved in That day one, that first'cause it someone gave

17:33 Steve Schwartzmann. His first dollar, and someone gave Bonnerman and Culture their first dollar, someone gave Ray Dalio their first dollar. The history is that it was typically Very wealthy individuals. families who knew an investor

17:48 Somewhere. Maybe was even an operator. On the private side. And they were impressed by their Capital allocation, essentially.

17:56 And this founder said, Oh, you know, well why don't I make it into a An asset management firm. Why don't I launch a private equity fund or a hedge fund? And so really the the history of seeding comes from these high trust relationships where A pool of capital knew the person. And I think the key aspect of that relationship is that there was

18:15 Less principle agent problem. The principal agent problem And Investing to me is that a lot of the decision makers who

18:24 write a check to an investment firm. Aren't the principal or the agent. And a lot of firms actually do a good job at alighting incentives and I think it's moving in the right direction. But generally speaking Probabilistically you can

18:37 Assert that In terms of L B types. It's typical that an individual or a family The Principle.

18:45 Is making the investment decision. And so historically they would be able to take that career risk. Because in a sense it's their own career, so they're taking their own career risk. On a new founder of an investment firm.

18:59 And some of them worked well and some of them didn't, but generally speaking, there wasn't a professionalized With Setting up your business. And then when I looked at the case studies, there were some firms that were starting to

19:13 think about this in a more systematic way. But often. the people that were seating tended to come From more of a allocator of fund of fund C Tware.

19:24 Again, they were very focused on the strategy. A bit less on the person. And critically I think We're not focused on the business side. So I was liking to spend a bit of time with

19:35 Gil Caffrey, who worked with Julian Robertson and Tiger, Julian became very famous for seeding On the Public side. And there I learned that distinction between the portfolio and the business. So investing's actually two very different things.

19:49 But everyone's just looking at the portfolio and they're not looking at the business. Which comes back to my surprise that there just aren't many people who are studying what makes a great investment firm in terms of how they're structure, their decision making, their process. And I think my realization That potentially drove

20:06 A bit better outcomes. was that We need to focus on the person. As well as their strategy, and we need to provide help. I focused a lot on helping founders initially think about

20:19 On the business side. What things can we do to set it up for success? So that your investment strategy maximizes It's returns. And a lot of it is minimizing distraction.

20:31 Because what's interesting in backing investment firms and backing emerging Talent is that When you're in a bigger firm A lot of the things are done for you. So you're maybe spending ninety percent of your time investing.

20:44 But then you're become an entrepreneur, you become a founder. And you might be down to forty percent investing and then thirty percent operations and thirty percent Asset raising. It's not that the founder has forgotten how they're investing. Is that they're spending a lot less time on it.

20:59 So that means that all the distractions are Creating that. Poor performance. So if you can be A true partner helping them with run the business. I think that's

21:09 one of the more powerful roles you can play to maximize those returns. So walk me through like if I had to build an attribution model that was customized for the style of investment that you're making. There's a bunch of different kinds of cash flow associated with this. So there's the literal returns you earn as the LP dollars go into the company, he they invest it for you.

21:30 And you earn your return. That's one. There's the excess fee income, the net income from fees that you own as part of the GP. And then in many cases there's carry. So you've got like all these different ways that you make money in your s what you call it full partner, not limited partner. And If I looked at your whole portfolio across your whole history. What percent would be in each of those buckets?

21:53 Yeah, great question. It depends a lot on the strategy in terms of what is the risk return profile. So we invest across asset classes. We started on the public side. And then now we invest across private markets as well. To recap your framework on income. Absolutely, there's return on the capital you're investing.

22:10 Then there is excess management fees. as well as carry. And then there's monetizing the enterprise shards. Of those GPs, which is something that Fifteen, twenty years ago when I started People weren't even thinking about it. And then these amazing founders and business builders have taken

22:26 Their firm's public. Now when you look at these Integrated Alts managers like a Blackstone or an Apollo or a KKR. The amount of wealth created. In monetizing the EV is amazing.

22:38 You know, we do some like calculations, but when you look at the wealth of these founders We would argue the majority of their wealth was actually created Monetizing the EV. And a big chunk was created. with the excess management fees and not that much from Carrie.

22:51 And I think that misalignment is something that We love correcting. Because when asset managers were small, that two and twenty model made sense, but the management fee was always meant to just cover costs. You weren't meant to be getting rich on managing, you were meant to get rich on performing. And so that hasn't adjusted Surprisingly, as much as the industry has grown.

23:12 Like fifteen years ago the private markets industry was one trillion, now it's twelve. That's wild. And yet there hasn't been this evolution and

23:22 alignment improvement. to correct for that growth. And so Yeah, if I look back When you're looking at on the public side

23:31 It depends for how long you keep your money in the fund. But for us, our model is we give founders a three year runway. So you have three years You can hire people We're locked up, and that's a huge value of partnership with us is you can actually plan for the future, you can attract talent, you can get that lease.

23:48 On the office. For a few years. And Just assuming that at the end of the three years you're not invested just to create an example to answer your question.

23:58 It's about a third a third a third. So a third came from that performance, a third would come from the excess management fee and carry over the lifetime. And then on the back end monetizing that stake typically back to the founder. So we think it's important to have an aligned structure with the founder as well as with The asset owner and for the founder

24:19 I think it's an important attribute that from the beginning we say, as you succeed and We get rewarded for all the hard work and trust and risk we took. You can Buy back.

24:30 Or minority stake in your business. And then in private markets it's a bit different because there obviously your capital is locked up for the whole first fund. And they take longer to grow because Enterprise value is step functioned as opposed to open ended. So the maths is a bit different. There's probably

24:45 A bit more weighting to the L P side. Also'cause the multiples are probably higher, so you have to normalize for return. private markets you're expecting to have Somewhat of a premium on the return for the liquidity and value add and whatever you're ascribing that

25:00 Alpha from But yeah, I think a significant amount of return you can expect in an investment firm. Is the returns from building a fantastically

25:10 Run business. Not just from investing in. And I think when you look at the examples of these legends You'll probably see quite quickly that they became very successful, at least financially Not necessarily from being the best investors, but being the best business builders.

25:24 What was the most surprising finding For findings from Project Legends. So some of them are commonsensical and again heuristically the younger age on public's Made sense, but if you sort of double click a bit.

25:37 In public markets When you invest You don't necessarily need to know the other side of the transaction. You know, you can sit in front of your screen and with your Bloomberg. And just Transact.

25:49 In private markets the other side of the transaction needs to want to transact with you. And so I think there there's more returns to Experience network. And to some extent likability as well, which is something that

26:01 Would be interesting to talk about. So from Project Legends, in public it's a bit younger, but it also tends to be that On the public side, founders can get away with being Less likable.

26:14 Unless able to build relationships and Potentially lower EQ, lower empathy. In private markets the age is a bit higher'cause again you need network and you need to Find the

26:26 investment opportunities need to source the deal so return on age is higher. And what's interesting in private's actually that we discovered is that there tends to be this Dual. Act. So if you look at some of the

26:38 Legends here. With Blackstone you have Schwartzmann and Peterson. At T B G you have Bonderman and Culture. And the pattern is repeated with Rubenstein in all the Bigger private equity.

26:51 Firms Where I think you have one Person who is slightly older. They have the network, they're the door opener, they have a bit of grey hair. They're making sure that the

27:01 management team or a founder of the portfolio company you're buying Feel safe. And then there's the younger Hustler, hard worker See round corners person.

27:11 Yeah, this is something actually that I I learned from Schwartzmann. His insight into that was Actually quite revealing was People don't give money to the people they think are gonna Be the absolute

27:21 Best. Returners. They give money to people they like. And I thought that was super interesting because in our industry, everyone tends to focus on dollars and percentage returns. And again, we're not looking at the person, we're looking at the numbers. And it's all about money and it's quite transactional.

27:36 But actually when you look at The returns to likability are quite high. And I don't mean likability and you're super charming and you tell jokes and you're funny. I think likability is a proxy For something very monetizable in investing, which is that You're reliable.

27:51 You We'll probably act in a way that's not gonna be Offensive. You're gonna behave in five and ten years in the same way you do today.

28:01 Because disagreeable people are less predictable. They act in ways that might be contrary to a common goal. They tend to be people who at the negotiating table They just want to negotiate every single last dollar. For people who more likable, it's like let's

28:17 Think bigger pie. And split that as opposed to more zero sum. They're kind of more positive some people. And I think that

28:26 And private markets if you combine this Likability, network. That seems to be a reciпі for success. When we look at all

28:34 Project Legends. If you think about what I'll describe as the perfect GP. So somewhere out there there is a business that if you were to back it now would be your career definer, right? Like the thing that is just perfect in all the ways that you've conceptualized it. Can you describe that?

28:50 In Some detail like almost like the I'm sure that doesn't exist, but and never will, but uh in your mind, describe the perfect G P. Yeah, I think that's a good question to put a framework together. I will say that What I have discovered, and this is also with age. I think when you're younger, you say, like there's the best school and there's the best place to live and there's the best that, but

29:09 It's all contextual to some extent. So I think you have to match Your talents And your Compulsions.

29:18 Two a design of a firm that will make you be your best. And I just caveat that by saying If you're thinking of building your own investment firm I don't think there's

29:30 A recipe for success. Generically speaking, I think there's a recipe to success for you. And so the starting point if I had to design The perfect GP. Would be for the founder to think about themselves and think about

29:42 What do I love doing? What's my superpower? And somehow Design. a firm and an investment strategy that leverages that Talent, compulsion.

29:52 When I was younger I thought Talent was really Amazing and then hard work and hard effort was like anyone can do that. And now it's the opposite, because I think talent to some extent you sort of inherit, and I'm not sure you're deserving. So I actually admire people who work really hard and show up every day. So that's over time has changed. But I think Back to the perfect GP. I think it comes from

30:12 following your own path and following your own path means Design things that make you the best. Don't necessarily get normalized by society or by what people want on designing your firm. So if you start with that First find a Market

30:27 that you think there's some inefficiency or some way that you're gonna extract Alpha from We can use public or private examples, but I think one thing that is common to the perfect GP is that they're very good at identifying what the agenda of each stakeholder

30:42 in whatever their strategy might be. And understanding what each party wants and then they can design A structure to the deal, evaluation, compensation structure. something that extracts value from each stakeholder, but makes them feel like they're getting what they want.

31:01 And so a lot of the great investors we find have this Incredible ability to understand What does each stakeholder in this Want out of it. And how can I be

31:13 the solution for that. And sometimes we talk about Capital as a service. It's like what service am I providing? What am I getting paid for? And so I think designing the ideal GP would be someone who matches their skills compulsion to the platform they're building around them.

31:30 within that designs and investment strategy that extract that by understanding what the players at the table Want But then also make it long lasting.'Cause I think life's a bit of a repeat game, so I think People need to want to come to you for that.

31:46 And they wanna need to think, Oh, this is a problem that Only Patrick can solve, or he's the best place. Or we want him involved in the cap table. And in private markets it's easier to think about. I think publics has like a complexity of the speed of the game and The unknowable

32:02 Potentially participants in terms of scale. So it's easier to conceptualize in private markets, I think. But the same rules apply there. I think some of our Better founders. Display in public markets. very deep domain expertise. So there's interesting studies like in public markets to make that example come alive.

32:21 There's different return on specialization in different sectors. So in things that And again, it's sort of commensensical to some extent, but it's things that are highly complicated, highly technical, like healthcare. That has probably the highest alpha to specialization. Whereas things like consumer or other

32:36 energy utilities has less so. So I would also advise a founder to Again, find that narrow domain expertise, but tie that to your own talents and passions. Often great healthcare investors are doctors. my background. We have a founder's a a trained doctor and has become after that a fantastic investor.

32:56 And not only that, he's still The doctor at his hospital one week in a month. Just to stay in touch with his craft and see the front line. That's amazing, even during Covid. He's running super successful investment firm and he's just a doctor helping out on the ward once a month. And that's really inspiring.

33:12 And it doesn't have to be glamorous. A lot of financially successful people will go to university campus and they're like, Oh, follow your passion and this and that And then you ask them like Oh, how did you make your money? It's like iron smelting or something like super not glamorous. So But I think in investing, you need to have a passion for investing. And there's a really cool study where these academics map What car you drive.

33:34 to your performance. And they do this with publicly available sources. They sort of map okay w uh Car ownership. And then they Say, okay, cars that are flashy, they tend to be more expensive, maybe they have bigger engines, and they map that to the performance of the fund managers.

33:50 There's two really interesting conclusions. One is Fun managers who Drive faster, flashier cars. They return a bit better, but not commensurate to the increased risk. So

34:02 On a risk adjusted basis, they're worse investors. And that in our mind has all to do with sensation seeking with a psychological concept that Often people are talking that you're kind of born with it. But generally speaking

34:13 Higher sensation seeking, higher risk seeking. And you don't get Bang for your buck. But the second order inside, which I thought was really interesting to have a way to prove it data wise was that

34:24 Fund managers who had flashier cars. When in a drawdown. used to give up sooner. Which basically means if you do the sort of third derivative order. If you're in the business of investing because you love money

34:38 Which is probably correlated to you buying a flashy car'cause it's A material objective. Means that you probably love what you do less. So then when you're so far from the high water mark and the bonus is running away from you, you don't keep at it. And I thought that was so beautiful that someone had come up with a way to

34:55 Define a uh statistically significant and sort of academic. study around for what is probably A relatively commonsensical Heroism, which is like

35:04 If you're motivated by the wrong thing. You probably won't have the resilience to stick with it when it gets really hard. And that for me is really interesting. So when I talk to founders, I'm really trying to understand Are you in this for the money, or do you just love Investing.

35:18 And Money doesn't bring happiness, but it definitely is important to Make enough money that you don't worry about money. But A great answer there from a GP is that

35:29 They just want freedom from thinking about money. They have a great business. And They might want to Deliver amazing returns.

35:37 Build a great business on the way. Build a great culture. Those answers to me speak volumes as opposed to Hey, what's your five and ten year plan? And if the first answer out of your mouth is I wanna be five or ten billion

35:51 That just doesn't feel like the right answer. What about the other end of that spectrum, I'll call like the most dreadful GP or something like Obviously some of the part of this answer is just the opposite of everything you just said on the perfect side. But is there anything else that you see as common, like dark patterns amongst investing firms or

36:09 could call these red flags personality traits or business traits. Like things that you think are the most correlated with bad future outcomes either at inception when you're looking at a new founder Or if you were to go investigate a hundred existing GPs, like the things that would stand out to you is like this one's probably in trouble.

36:26 Yeah when I look at Mag Things that have gone wrong is We try to filter it out, but One

36:32 bad signal is Just wanting capital and not the advice and support that we Hope and believe comes with it if you work with us. It's a bit like getting married, you know, that old

36:46 Saying that as soon as you get married, people change. The kind of Got the commitment. And We were discussing earlier, I think the commitment to marriage is decreasing and the commitment to serving your capital

36:58 is also decreasing in some way. And by that I mean A GP that just wants To Get some capital and then forget about being open to feedback. Or being self aware.

37:10 That for me is Consistently What has driven bad outcomes for our investing? And we try and filter that out by Both asking you as the founder, but also referencing

37:23 Referencing is super important for us because There's less data. For us, you've often been in a firm where you had a boss, a risk manager, a big deal team, sourcing, structuring. So it's hard sometimes to allocate responsibility for Return to you.

37:38 On a quantitative basis, but qualitatively you can understand okay who sourced this investment, who Talk to the management team about it. Et cetera. And I think

37:49 The Referencing is also quite powerful around Is this someone who is open to advice? Is this someone who's open to feedback? Are they self aware? Like we ask people What is

38:01 A piece of feedback you've got that Surprised you. I think that's a really interesting question because It starts to dig into this Outside perception versus self perception.

38:13 And when referencing we're trying to determined that we're partnering with a founder who they might not always take your advice, but seeking advice. And being aware of The things you don't know is very important. I'm always reminded Probably apocryphal.

38:27 Attributed to Mark Twain, but it's this It's not What you don't know that gets you in trouble. But What you think you know.

38:36 For sure that just ain't so. And I think one big red flag for a bad GP. is one that thinks That they know everything.

38:45 And particularly in that framework sort of portfolio versus business. They think that just because they're very good at managing capital, that they're also going to be good at managing a business. And that's where they fall. So some symptoms of that when you're building your own investment firm or maybe thinking about building one A lot of it is

39:02 Team cohesion. So attracting good talent and retaining it. We see that a lot. Sometimes we see quite excessive churn at the beginning of a firm. Sometimes I call it organ rejection. When you start a new firm, everyone typically takes a pay cut, right? The asset base is smaller. m my advice to some of the founders that are having organ rejection from team is You're working really, really hard.

39:24 And in your prior incarnation, a lot of people were trading off that pain with money. Now you have to reset this pain. equation in your mind and you have to make sure that you're creating an environment where

39:37 Working a huge amount of hours. Getting calls at seven AM on a Sunday on a deal. І сортов ок. Acceptable. Or at least expectation set with the people you're hiring.

39:49 Just because they know that's what they're signing up for and they're trying to build something with you, not because you're gonna Pay them to take that pain. It's almost like a recruiting filter. And if you got that wrong. That's also something that goes wrong pretty quickly.

40:03 And another thing is also back to this managing expectations of the capital. One thing that I see GP's Doing wrong. Comes back to this

40:14 wanting to do different things Than what they say they would do. So I always tell my founders Losing money is inevitable. We all make mistakes. There's gonna be Good investments and bad investments.

40:25 But you need to lose money the way you said you would lose money. Don't lose money in new and wonderful ways. Because that gets penalized. Ironically If you start doing different Things. and investing in a new market, a new structure, something like that. And it goes well.

40:40 Then unfortunately like Most people won't penalize it'cause it went well. I think really good investors are like, Okay, this worked. But not for the right reasons and I Don't think this was a good idea.

40:50 But structurally in the industry there's this permission that if things are going well You got to do it. So I always say Even if things are going well, if they're not going well for the right reasons it's probably not a good outcome. And

41:03 They tend to deviate away from what they were doing and You invested in something that had a certain mandate And with things like crypto or something, that was quite rife.

41:14 People would be attracted by This blue light. I think it's ants or one of the cartoon movies that's awesome. There's like two mosquitoes. One must give a second.

41:23 No, no, whatever you do, stay away from the light. And the other mosquitoes like Oh, but it's so beautiful. And it gets like electrified on the light. Then I think about that a lot because there's like a lot of blue lights. Around And in investing. Because you also think very highly of yourself, it's a high confidence game.

41:39 People assume that just because they're good at doing one thing they're gonna be great at doing another thing. And I think that portability of skill and alpha is something you have to be very careful with. So I think when we are evaluating a founder If we get the sense that

41:53 They're gonna be all over the place. That would probably be another red flag. I'd love to talk about investment strategies as products. One of the I guess I would call it harshest truth that I learned in my investing career.

42:05 Was that Returns. Everyone thinks of the investing product is a Return stream. Which Obviously in some sense it is. Or in the major sense it is.

42:13 But what I learned the hard way was At one point in my career we had this our flagship strategy in the quantitative business that was an unbelievably good performer. It did exactly what you would want something to do over a long period of time. And we couldn't sell it. And the reason we couldn't sell it was that

42:28 Allocators felt that it was too simple. They would look at it and they'd say. Surely you must be doing more than what you're telling us. And It's only what you're telling us then we're not interested, even though it's worked really well.

42:40 And I that was a harsh but very useful lesson to me that In the investing world LPs are not just buying returns. And sometimes they're not buying returns at all. And they're buying something else, which leads you to believe there's some product thing going on here that a strategy as a product is more than a series of returns. And I would love you to just like riff on that as much as you could, because I feel like this is like one of the big secrets of the world of investing, and you're in the best position to talk about it. And I'd even love you don't have to name the names, but like favorite conceptual examples of like what a great investing product is beyond just its returns.

43:13 Yeah, I think you've hit on a The holy grail of Building investment firms and lasting strategies which is There is a lot more to investing than just the pure return.

43:24 And I love that example on your past business that you built successfully. I think there's almost a premium for hard work or complexity. Like people don't want to believe or pay for things that seem simple, and yet that's the most powerful Strategy of all. If you can come up with something that requires Pretty simple inputs and edges. That's just beautiful.

43:43 So yeah, I think a lot of Investing might be people dressing up really simple things. And often in founders, particularly in public markets, you find this is When you really dig into a founder's edge, they're kind of a one trick pony.

43:57 But they're really scared about anyone finding out. So they often don't even tell you, which is self defeating,'cause then they don't have even a pony and then they don't get they don't get funded. But um that's so true. And that's really amazing if you can find that and repeatedly do it. When you look at some of the better investors, I think they just do very simple things time and time again and maybe they're good at product design.

44:19 To make it seem that it's really complicated. Product design. I think that's a really underappreciated aspect of building an investment firm, which is most founders don't think of themselves as a product. And I think that's almost an emotional thing because

44:34 Again, there's some mysticism that There's these Amazing stock pickers that see the future in a way that others don't. And this mysticism is beneficial. About 10, 15 years ago, we were looking in quant and It became a almost a marketing moat to say how many PhDs you had on staff. This was like really important.

44:53 It didn't matter if the numbers were good or the strong it was like, Well, how many PhDs do you want to do and stuff? How many PSDs did you have the stuff? Loads, right? So the big firmly had none. Right. Well this is even more genius. The big quant firms, I think, just started hiring PhDs so that they literally I mean I know this to be true as a fact. Like they I know one example where there's one hundred of them and they were just stuffed in a room and they did nothing and they did not affect the strategy. It was pure window dressing. Yeah, well, at least they were real, right? Some some investment firms they have like fake LinkedIn uh employees and things like that, which is University of Phoenix. In this day and age. So you need to be careful with that, D. But yeah, back in the days the the Wild West, when I started the business I'm our first

45:34 investments there wasn't even like a site visit. They would just wire money into an account. And that changed a lot post financial crisis, post Madoff and things like that. It's obviously a an improvement. It was sad that it was precipitated by people abusing trust and misbehaving, but I think the industry's come a long way in that regard. In terms of product design, so

45:52 There's some mysticism around it. Explaining something in life Almost makes it Less exciting. And I feel this way, like I love movies.

46:00 In another life I would have loved to be in a movie director. I find movie directors to be fascinating humans. And one of them told me That The one thing he hated about becoming a movie director and going to film school is that Every time he now watches a movie, he just analyses every scene and he doesn't enjoy the movie.

46:15 So there's things like movies or art or certain things that I love that I try not to learn too much about because it will I will go from like an appreciator to an analyzer, and a lot of that happiness and hedonism that I get. Even like food, just like understanding how it's done. You talk to a chef and they break down like the crunchiness. This is this. I don't want to know. I just want like please taste it. Don't ruin it for me. So there's a bit of that in product design, which I think is if you demystify something, it becomes So let's ruin it for everybody. Let's ruin it. I think the

46:45 product design aspect has to start With Again Identifying both stakeholders. So there's you as the founder and then there's the asset owner who are essentially the buyer of this product. And first I think you need to match this

46:57 Skill set, talent contextualize that with what platform and what do you need in terms of resources, access, whatever is gonna make your Interest, passion, superpower, compulsion. The best expression of that. And then when you're thinking about product design, you have to think about

47:12 The asset owner. And I think Too many founders again don't try and empathize with what is the Asset owner trying to get out of it. And the focus is purely on this very

47:24 unidimensional return metric. But I think over the last ten years Sophisticated large investors want to get more out of the relationship they have with the

47:35 investment firms they entrust with their capital. One very clear one. That we feel passionate about is knowledge transfer. So it's about I'm not only generating returns on your capital, but I'm explaining to you how things work.

47:48 I'm explaining to you how I do things and I'm trying to make you a better investment firm picker. And so a lot of the knowledge transfer we do it stable is We share how we think about.

47:59 picking founders. We share what processes we use in writing our memos. We share the importance of referencing. And LinkedIn, by the way, has been this amazing revolution in referencing. My thesis is that The younger you can go in the referencing, the more true

48:17 Assessment of a person's personality and motivations are'cause I think when you're younger you don't think about Repackaging yourself for the world. So one of the founders, he literally had blown up his dorm room with like an improvised bomb. I'm like, well, there's an omen, if I ever heard one, of blowing up your your

48:35 track record or capital. But I think Coming back to The Product design, I think.

48:41 You need to think about How am I Adding value with knowledge transfer. One example is for instance macro. insights. Good investment firms are really good at sharing that.

48:51 There's some firms that I think add more value through their newsletter or their conference than they do through their performance. But asset owners find that really helpful. And when I talk to CIOs of big asset owners that we're lucky to work with, I think they find it quite insightful kind of on the coal face developments that we're seeing because they can apply it elsewhere in their portfolios.

49:12 And if we also share We backed over thirty companies now. These are best practices that we see in terms of data collection, organizing the memo. These types of basic things like no one teaches you how to invest. That's back to this theme that everyone focus on the output, but what are the inputs? Another one is optionality. And sort of this is like a relationship optionality. So over the last ten, fifteen years there's been an explosion in co investing, for example.

49:37 And co investing has some really interesting attributes. I think Asset owners. Think about it. as a tool to actually achieve quite a few things. One thing it definitely achieves knowledge transfer.

49:48 Because in co investments, typically the GP is sharing more information about the deal. That's great for the asset owner because their team is learning a lot. Maybe over time I have this thesis and in twenty thirty years There's gonna be this harmonization, this sort of

50:05 meshing together of capital owners and capital managers. And it's happening because a lot of the very large Pools of capital now have direct teams as well. That was spearheaded. The Canadians did a great job of that.

50:18 the Norwegian model of in housing a lot of their Harvard do this originally like a long time ago. Yeah, Harvard's gone through cycles. You know, there's like pros and cons to this model. I feel like Harvard internalizes a lot and then some things don't work and they externalize and it kind of goes in cycles. But Collaborating with your investors in that regard, I think is an important

50:36 Part of the equation. So there's these layers. There's knowledge transfer, there's liquidity management. Then obviously there's fee management. Co investments tend to be lower fee than Coming old fund.

50:48 Commitments. And so often an asset owner will be in the coming old fund at a higher fee, but then the co investments are lower. So they're trying to average down their fee load. So things like that. in product design that allows for the relationship optionality between the asset owner and the Founder

51:03 The investment firm to be Tailored. I think is really important. And part of that is not only on a deal basis, but if you take a step back, think about the relationship over time. So an asset owner's dream to a certain extent is that. They're investing so much

51:17 Money, but also time. An effort in getting to know you. And they're entrusting you with their capital, right? Like this is a The biggest vote of confidence they can give you. And it's their job. And a lot of people at asset owners

51:29 Again, they're taking career risk by backing someone, particularly if they're emerging,'cause it's Easier if you give m money to a big brand and it goes wrong, it's like Oh, but it was brand X. Like, how could I The old IBM thing. Again. Ability for

51:43 you to have a relationship where they trust you with with your money is amazing. What about the emotional side? Like these are very rational sounding. Knowledge transfer is great. I'm a huge believer in this, obviously. Yeah. Optionality is great. It's like good for everybody. What about the a softer, more emotional side, like how you make somebody feel?

52:02 As part of the product design. Yeah, great question. Again, I think in finance we underestimate that. Because it seems fluffier or softer. But actually I found that the best investors

52:14 can build an emotional connection with their LPs in a way that's really around trust and reliability. So we spoke a bit earlier about likability. I think that creating a sense of security For the capital provider that you're gonna be

52:30 reliable. Trustworthy. And that you're gonna put their Interests ahead of yours. And act as a true fiduciary is absolutely key.

52:40 That might sound a bit emotional and Fluffy, but I actually think that It's not something that people talk about explicitly, and I'm not sure in investment memos We actually have in our investment memos things like Trustworthiness and

52:53 Expectation of being a good partner. I remember when At Bain when we were recruiting there was this question. Which was like how excited are you about having this person on your team? And when I was younger like what does that matter?

53:04 How smart are they? Where did they go to school? Did they ace their interview? But actually this level of excitement of who you want to spend your time with is really important. So underrated. So underrated. And actually I think the best Asset owners do think about this a fair bit and Although it's not explicit in our industry, I think

53:23 The way you're perceived. on that emotional plane and more human plane is really interesting. And I think we've seen that in the industry, right? Things are changing. I think Maybe

53:33 There was this allowance in the industry that Even if you were maybe not a great human being. But you were a great deliverer of returns that was more okay in the past. And I think it's a really good development that We are also holding people accountable about

53:51 How they treat their people and kind of what they stand for in a way. But there will always be that conflict or trade off between Okay, this is a person that maybe emotionally or values wise doesn't necessarily align with Me?

54:06 On a cultural or Yeah, values basis or emotional, as you say. But actually they're really, really good at making money. And I think that's a really difficult Decision. Personally, at least for us.

54:17 I always say to the team I'd rather we back. Uh eight nine investor who's a good person who we can see ourselves being partnered for a really long time. Cause for us, this is more like a marriage. Not only do we lock up our capital, but we're trying to build a business and building a business.

54:35 Takes longer than an investment to play out. It's just a longer commitment. And so for us, we'd much rather have an eight nine investor who's a good partner than a number ten investor who's actually just not that pleasant as a human who's like a bit unpredictable.

54:50 who maybe has values not aligned with us, who's gonna create a culture that we don't think is a good environment for their team. Could you describe how you think investment firm GPs, the enterprise value prices, like at what multiples, what are the components of the multiple? You mentioned earlier that this is like an underrated part of the return that you earn that you can generate starting one of these things. And that's one of the special insights. How do these things price? Like what do they price on

55:17 Are they some of the parts are they Like you said, there's feed, there's carry, there's some are private with long lock ups, some are shorter with hedge funds with no lock quarterly lock ups or something. So how do these things price? Give us a little education lesson there. Yeah, so that's changed a lot. I think When we started the business

55:32 There was not this appreciation that GPs were also businesses. And so There was very little institutionalization around what these businesses are worth. And there's a few firms

55:46 over the last fifteen, twenty years they've done done amazing job at Almost developing this industry. So there's a few sort of eighty pound gorillas. The biggest one Is dial now blue owl.

55:58 was a new Burger Berman firm. And both Blackstone and Goldman have teams that do this. And they're Eighty percent of the market or something. In terms of capital raised to buy stakes in asset managers. So for us, we're builders.

56:11 Think of What we do as stable is building asset managers. There are a V C for investors, basically. Yeah, to some extent. The V C Nomenclature is a bit

56:21 scary in the sense that people might think like eight things out of ten go wrong. When things go wrong for us We don't lose a ton of money, you have sort of ways to In public will have risk parameters with maximum drawdowns on the private side we have ways in the L Pac to ensure that we're not gonna blow things up.

56:39 So it's V C like in the sense that The stage. Yeah. It's early. But also our day job is very much around Helping with product design, talent acquisition. the role that a V C partner would play for a tech firm is kind of very similar. And also

56:54 shoulder to cry on, cheerleader like so much of this is just helping the person'cause it's really tough. But anyway. Other than the V C downside is not the same. The upside is quite concentrated. There's a lot of power law outcomes. So that you know there there are some similarities. But back to your question was on how they're valued. Yeah. So These firms have educated the market that look, there is a huge amount of value as well in these businesses.

57:16 And so we think that for alignment it's fair for asset owners to participate in that. Because as firm grows, like one of the misalignments is When you're smaller Management fees aren't a source of profit. And

57:30 As you grow There's a misalignment where the GP wants to scale A U M, maybe keep volatility low and sort of You know, in public markets you can do that in some ways. In private markets there's like volatility dampening on how books are marked and things like that, which gives private GP's more stability and

57:48 There's great literature on whether Investors actually want that volatility dampening. There's this whole philosophical debate and a a few great academics that are shining a light on that. But that discussion aside, I think this misalignment between L P and G P gross

58:04 With scale. And a beautiful Mitigating that misalignment is for the LP to participate in that upside, as you mentioned. And so enterprise value is really a function of What are the revenues of the GP?

58:15 And uh parlance in the industry is FRE and PRE. So fe R F R E is fee related earnings, PRE is performance related earnings, which On the hedge fund side it's performance, on the private equity side tends to be called carry. And Those are valued on a multiple with a discounted cash flow like any other business.

58:34 And actually asset managers, investment firms are just amazing. businesses because they're capital light. They have huge margins. If you look at even publicly listed investment firms, they tend to have fifty percent margins.

58:47 And I think private investment firms are even higher. So just as a business, they tend to be beautiful businesses and some famous investors Have used things like insurance companies and float to really maximize their returns, obviously like the Buffets and Mongers of the world. I think the

59:05 understanding of the power of that capital light scalable model. Investment firms are almost like software. Like the incremental cost as you scale. It's a bit heavy on the private side, but on the public side, less than. So F R and P R you get multiples.

59:19 And The longer lock up capital gets higher. FRE multiples because obviously you're just discounting management fees over longer periods of time. And then on the carry side. Again, on the public side it's typically lower multiples on the private side.

59:34 But you're valuing it from a DCF. Like a normal cash flow business. And then I think an investment firms there's also huge value to brand and goodwill and trust because

59:46 Again, managing people's money is is a real trust based exercise. And coming back to your question on like the role of emotion or the role of likability. I think if you're someone giving your money or the money of the people you represent, like pension funds, their members It's a real responsibility, right? If you manage a huge pension fund

1:00:06 the retirement future well being of Thousands and thousands of people. Depends on what you do with their money. So in my experience the CIO of public plans in the US.

1:00:15 Are incredibly thoughtful. They're incredibly mission driven by serving those members. And so For me

1:00:24 It's very important. That The founder understands that. Better. If you think about the life cycle you mentioned earlier.

1:00:32 We haven't actually talked that much about your product, like literally what you do. We sort of assumed it in our conversation, but I'd love you to delineate it because I think a key insight you have is that you need to match your capital product, capital as a service, as you called it. to the circumstance of the customer. And you've alluded to this life cycle that like all investment firms go through. Can you delineate what the stages are of that? canonical life cycle and how your product, your capital product matches on

1:00:58 To that concept. Yeah, so I think the Let's separate The two stakeholders again, founders on one side and asset owners on the other. And that's maybe start with founders.

1:01:08 In terms of the audience. So the way we think about supporting founders is we have this founder cap stack, which is a concept that we came up with to distinguish it from a cap stock of a company's sort of equity and debt and growth and IPO. Think about the life cycle of a founder.

1:01:26 And so anyone who's listening who wants to start their own GP or is in the early stages of their GP, what they will be thinking about. And here's the what is The stable product to the founder. One is capital, and one is support. So on the capital side. When you're starting a your own investment firm

1:01:42 Probably what you want first is working capital. So We need to find a way to provide working capital to you. That might be a working capital line, or it might be we're gonna give you an LP check. So we're gonna invest in the fund. And just to make the numbers Easy maybe if we're giving you a hundred million and we're paying two percent. Again, two percent is a high number and probably not what people are getting paid, but we tend to pay

1:02:04 At the beginning high fees because you we want to make sure you have enough capital to cover your costs. And that's again one of these misalignments of the LPGP relationship. It tends to be quite adversarial in the sense that the founder says, Oh, I want high fees. And the capital says, Oh, I want lo fees. But actually That sort of

1:02:20 shooting yourself in the foot as an asset owner because you do want your founder to have enough money to attract good talent and pay for the right service providers and pay for deal fees and technology and whatever they need. So I try and turn it on its head and I say actually we're collaborating with you, we're happy to pay high fees at the beginning. But as our relationship grows, those fees are gonna come down and down and down. Maybe as a function of us

1:02:42 receiving part of the revenue from incremental management fees and enterprise value and all of that, but maybe also having capacity of discounted fees go forward or having co investment capacity that's much less. There's all these ways to reduce fee load. to be appropriately and justifiably rewarded for initially being very thoughtful about no, I'm coming to the table To tell the founder I'm happy to pay high fees. Like that's a eye opening.

1:03:06 discussion when I'm talking to founders, they're like, Oh I'm definitely gonna need high fees and I say, Yeah, absolutely. And they're like Flabbergas this topic, What, I don't have to argue with you about this? I'm like, No, that's the whole point of a partnership. I'm not paying you excess management fees to go and buy planes and boats. You're gonna be spending it on your business, which is what management fees should be for in the first place.

1:03:25 So it's a much shorter discussion with them and I think it's a good first meeting. In terms of back to the product design or the proposition design that we bring to founders. After working capital Then you need investment capital. So that's the LP check.

1:03:38 And In public markets again, you can kind of scale that in, you can start at a lower base. or lower size, but in private markets the minimum efficient scale of L P capital Is typically higher.

1:03:50 And when we think about the sizing of the LP check. Again, it's a bit of an art, not a science, but it's multivariate. And it's sort of falls into three categories. That you need to consider In our due diligence and proposition design, we think of investment issues, operational issues, and commercial issues. So if I talk about each of those in turn, the most important one is investing. So you think

1:04:10 Okay, I'm gonna build a portfolio. A portfolio of investments. Either on the public side or the private side. Each of those investments will have a minimum size and I need to have a portfolio construction. framework where I'm diversifying risk. So you kind of to make the things easy, I'm gonna invest in ten things are gonna be ten million each. And I'm super streamlining this. I'm sure a lot of people are gonna be like, Life is messy and this is

1:04:31 Nonsensical. From first principle. Yeah, bear with me. The you'll have a sense for what is the minimum size you need from an investment point of view. And also to be part of the conversation, what deal sizes are you doing in certain credit strategies, you need to be a certain size to be on the creditor committee. And maybe you're gonna be activist or whatever it might be. So there's a lot of nuanced drivers of what size you need to be from an investment point of view. The second one is more operational, so this is back to

1:04:56 What is it gonna cost to run the business? What are the management fees? Are they coming up front on committed? Are you gonna have to wait on investment? And then on the commercial side, that's more around. What is the perceived minimum efficient scale from the market? Or Are there concentration limits? And this again is empathize with the asset owner. Are there concentration limits in the asset owner's mind that they don't want to be more than X percent of the fund or something like that? And you need to get that right. In terms of

1:05:19 having a size that will actually allow you to raise assets from the LP base that you're targeting. And it also to some extent is also There's some levels us humans we like round numbers and we like these watershed type of pivot points, like is it fifty million? Is it a hundred? You know, everyone's always raising a round number. We joke at the office that whoever comes and says I'm raising three hundred and twenty seven million will definitely fund that founder.

1:05:44 But jugs aside, that's the way to think about A bit of that. to get size from an LP chuck. And then on your founder journey, the way I think about it, X axis is time. And y axis is cap stack as time progresses, you go on this curve as a

1:05:57 firm progresses and it's like first it's working capital, then it's LP check, then it's co-investment capital, then it's growth capital, and all the needs that you need To satisfy From a funding perspective to build an exceptional firm. And that's all to do really to like people, process, all the kind of firm building Frameworks.

1:06:16 And that's something that Founders don't think about enough, asset owners don't think about enough. It's not a linear sort of fee that's like where are the fees going? What are they paying for? Are they making you a better investor? Are they being spent 'Cause it's not only complication on the portfolio, it's complication on the business. So for instance, if you see a founder Spending tons of money on fancy offices. We always say red flag is like the water feature. And when the water feature shows up at these firms, it's like sell, sell, sell.

1:06:39 'Cause then there's too much excess management fee. But Where that capital is being invested in the Cop stock. varies life cycle wise. over time as the product.

1:06:49 And then We've talked about capital. But what is the proposition? On the support side. And this again goes back to V C like role which is

1:06:58 I think one of the differentiators of our approach has been We think founders need help more than they need money. Right, money's almost like table stakes. And it's a bit meta because in investing money is your product. The fact is you're gonna need

1:07:12 More things. So Those things are H R, it's operations, its distribution. We think about it in two Big.

1:07:21 Functions, operations, and distribution. And we try and support you. On each one. So there's a framework around pre-launch or pre-investment. You know, often we're seeding something from scratch, or we're coming into a firm that's been around for a year or two, it's still small and that's more of an acceleration investment. But

1:07:40 We wanna be sure that we're supporting you and building your operations to Top class standard. So this is hiring the right people, making sure the service providers are right, but it's also nuanced things like What is your evaluation policy? Have you thought about the asset liability matching

1:07:55 of your strategy in terms of redemptions and subscriptions. I can't tell you how many Firms. And not even emerging firms, but come across more mature firms where It's clear to us that the subscription and redemption or structure of the vehicles is just not aligned with the investment strategy.

1:08:12 That creates these huge risks that you're more liquid, people want their money back. There's tons of blow ups that have nothing to do with Performance. It has to do with A sort of emergency forcing decision.

1:08:24 That has to do with the duration of the capital. And often that's a real issue. L P do and need to be very careful about assessing What is the patient's

1:08:36 Down side. Appetite. Particularly in open ended or sort of public markets investment firms. What are the tolerances there of other investors? 'Cause other investors will

1:08:45 It's not only the investment strategy risk, but Other investors' behavior will become a risk for you as an investor. So those are the things that we're helping on Um pre investment then post investment. It's more about being a support function for

1:08:59 How do we do this new thing? We built A lot of businesses right now, so we understand on the life cycle. what is happening four, five, six years down the line. We call it future proofing,'cause you don't know what the demands are gonna be in the future. So you structure in a way that you future proof it so that You know that

1:09:16 Your product is life cycle insulated from the demands future on. But that's not like smart or common sense, no matter what a amazing business. Yeah, that's just like you've been there. It's like We've watched the whole box set. I know what happens in episode eight. Yeah. If what happens in episode eight is bad, let's not Go into that room, you know. So that's a sort of more ongoing forward looking help. A lot of it is

1:09:39 future proofing and a lot of it is firefighting because again going back to the travails of an entrepreneur. I think people forgot that founders of investment firms are also entrepreneurs and entrepreneurs There's just stuff blowing up all the time. And don't get me wrong, every year something that hasn't blown up, blows up in new and wonderful ways, and then we learn. But you have this institutional legacy. Knowledge about

1:10:01 What problems arise, how they go wrong, what are the best Ways to fix it. And so that's the proposition product, as you mentioned, on the founder side. It's the capital. And it's the support.

1:10:12 And then maybe moving over to the other side of the equation. On the asset owner side. I think that goes back to a bit of what are you actually providing your asset owner with? First and foremost returns. Risk adjusted returns, what do you need to hit?

1:10:25 What Tolerance do they have for losses? There's not only this basic Oh, I'm making this amount.

1:10:32 Of return. IRR or Moic or annualized or whatever your strategy is measured in. And this amount of risk, however that's measured. And that's sort of a big philosophical question. Is volatility really risk? In private, you get rid of that, but

1:10:45 Are you taking more it's often hard in our view to measure How much risk you actually took for the return? It's really hard to do. In addition to that, then it's also

1:10:55 Are you providing knowledge transfer? Are you providing for a way for them to allocate more capital as you grow? Because it's such a big investment to get to know a founder. that I think most asset owners would like those relationships to be pretty long term. And that essentially means are you providing capacity, discounted fees, access. All of these things other than performance are really important to asset owners to get more value out of the relationship.

1:11:20 I think the less collaborative the relationship is, the less the asset owner gets out of it. If all you get is a sort of administrator statement once a year and maybe there's an annual meeting for a few hours with a nice lunch. That to me feels leaving huge amounts of value on the table. Because that founder you've entrusted with your capital can get you ideas, insights, access, all sorts of other

1:11:42 Layers. Of value. Do you find it underrated? For investment firms especially started by young people

1:11:50 Like you did. To bootstrap. Through deal by deal. experience early on. I've noticed this with you and several others that you didn't just raise a fund to start, you actually went deal by deal.

1:12:01 Talk that experience and whether or not you recommend it for more would be young especially young investors out there. Yeah, absolutely. So I think The deal by deal on the public markets is start with a very small amount of capital and sort of try and scale that. It's a bit difficult there because one problem Is that investors would often not give credit for your performance on return if it's a really small amount.

1:12:22 And sometimes it's fair and sometimes it's unfair. So what I would tell GP w would be founders on the public side is Make sure it's externally validated. You have a law firm or an administrator or someone who's validating that you weren't changing with benefit of hindsight, but also make analysis of things like liquidity or pricing. to say, Hey, I could have but you know, I only had a hundred K or a million dollars of whatever you're able to scrape from your friends and family.

1:12:48 But actually here's all the data that shows I could be at a much larger size. And these are the externally Auditable. Emails where I said Or interactive brokers or something like that. On the private side, absolutely.

1:13:00 When I started I didn't even know the Name for it, but Often they're called funless sponsors now. And I think

1:13:08 Necessity is the mother of invention. And when I was starting, I didn't have a track record of doing this. Again, most people laughed me out of the room. I managed to Find a asset owner who believed in the mouse trap. And when I was putting together the first investment firm that I helped

1:13:24 Launch. It was really difficult because You're trying to build a plane At the same time as you're flying it. And you're actually

1:13:32 You need to be really on top of both sides of the equation. You need to be on top of the investment. So putting the team together, the founder, the talent, the business building there. And at the same time. You have to make sure that capital is there. But there's nothing really to

1:13:46 due diligence yet and it hasn't built yet, so you need to give the capital aware And I think there it's all about Candid communication to both sides. I think there's a potential risk that I see Sometimes assessing funless sponsors

1:13:59 Where There's a fine line between keeping the confidence in it coming together and then over promising or being disingenuous about is the capital really there? Is the team really going? I think Honesty and reputation is something that you'll Take a while to build and you'll lose really quickly. Doing it.

1:14:16 One at a time. It's a lot of sweat equity. I was the de facto sort of team member at a lot of these firms because we didn't have resources to build it. So each firm I was Playing a role. And for me the hardest part was the distribution side'cause I was coming and analyst at Bain, I felt like I had a good

1:14:32 Grasp of The investing side and also the operational side, but The distribution side is very complicated and raising money no one tells you how to do it. And I have huge respect for salespeople because it's a really tough job. It's super hard on the ego. You got so many nose. You often don't know why people say no.

1:14:49 But that was the last piece for me that The inside there again is a bit what we've been talking about, which is I was focused all the time on the firm, the business, the founding team that I was putting together. And I failed to really focus on the asset owner side of the equation about

1:15:05 Who am I serving? What does the capital want? What are the risks they're facing in backing me? I mean it seems like most insightful things, they seem very insightful and hindsight, or once you're explaining they seem quite obvious, but I didn't I wasn't Quick enough or smart enough to figure this out.

1:15:19 On the asset owner side, you need to Make sure they can build a portfolio because all of these things won't succeed. And so I think of One advice for the funless sponsor phase for me is

1:15:31 Make sure you're taking bets that if they don't go well, you still have time to go back to the table. So it's almost this live to fight another day. Because you if you get lucky and your outcomes are good to the upside, then it might have seemed like the right answer. But what I see Funless sponsors. getting wrong often is that

1:15:49 They might take excessive risk because they want to get there faster, but if you're just patient and more long term and you are in investments that even if they start going wrong, there's ways to correct them so that the outcome it doesn't end up being bad. And that might be cutting your losses or pivoting or Exiting that investment and trying a new one. There's this like operations concept that I liked where It's like a quadratic equation of inventory of when you need to have more inventory. And I think of life a bit like that. You need to stay at this level where

1:16:17 It goes down, down, down, but you can't go over this Alert level because you're not gonna come back from that. The beauty after the Funless sponsor bootstrapping phase is it? Then you can take more risk. You don't have to rely on luck and path dependency to get there.

1:16:33 Taking risk is a huge privilege, which again is something I tell my founders. People who have very little, they can't afford to lose it. So being able to put chips on the table means you have enough chips to lose them. Because we're not always gonna get things right. And so actually one thing that's quite encouraging for that funless sponsored GP. listening is that it actually just gets easier in a way because you can afford to trip. Whereas early on

1:16:55 Those first eight, nine years of the business. For me, were incredibly stressful because I knew that I didn't really have that much margin of safety. There wasn't that much buffer. And when things started going wrong. Things just got incredibly close to that line on the inventory where We weren't coming back.

1:17:11 Any closing Secrets, patterns. things that you've noticed about what makes this world go, what makes people successful or fail that we haven't talked about yet? I know we've covered a lot of ground, but Any closing esoterica for us?

1:17:25 I like to think and I'm a bit of a optimist. delusional optimist somehow. We do these things called Seeds of Wisdom at the farm and we wrote a piece around do nice people finish last? And I think about that a lot because I think particularly in investing There seems to be some return to disagreeableness.

1:17:41 When you look at The people that succeed in our industry. And again, I'm giving success a pretty narrow definition of financial earn high returns. Earn high returns and Wealth and financial success will come. Through that too.

1:17:55 But I think at least Personally, my aspirations is I wanna be a good citizen, I wanna be a good husband, I wanna be a good dad. And so there's other definitions of success that I encourage people to Try and Make

1:18:07 Contiguous. To building a great investment firm and delivering great returns. And I think Our conclusion there was that it's not a consistent

1:18:18 game strategy. to necessarily always win and crush the opponent. And that Things like generosity being helping

1:18:28 People who are coming behind or Even just in a transactional relationship, making sure that the other party is also winning. Is something that compounds your own success. Did you learn anything about

1:18:40 Family stuff related to money managers. Whether that's like divorce or you know, the way they are as a dad, or the way they are as a mom or Just anything interesting here that

1:18:52 Pokes out as in the data. Worth mentioning. Yeah, so there is data on the impact on of divorce on performance. Yeah. As you can imagine and forecast it's not good. One of the things we do at Stable before we Fund a founder is to

1:19:07 Ideally if they have a partner, meet the partner, go for dinner. I think it's so important to have a support. network around you. And that can be provided by a few things. It it doesn't necessarily have to be a partner. It could be religion, or it could be sports, or it could be something that you feel you belong to, but when those darkest times when returns are really poor.

1:19:26 There's an old aphorism that you should always back a married founder. And that's something that I loved about getting married. I didn't realize this a priori. But after I got married I And I love these surprises'cause in life things that I didn't predict are huge. Teachers. And one thing I was like, wow, I had like twenty or thirty percent more mental bandwidth after I got married. And that was basically I was spending twenty or thirty percent of my time looking for a great life partner.

1:19:50 And I was so lucky to find them. And that was a huge bonus. I think that's something super underrated. about getting married is that people don't tell you What a better investor that probably makes you. If finding a life partner is something very important to you, which it was for me. Obviously some people might not think that's the case.

1:20:08 And then they'll have to find extra bandwidth on another development of their life. But I think I do think there's this harsh trade off That is not spoken about. It's a bit taboo because it's sad and harsh to some extent, which is Every hour there you're with your family or with your kids now as a dad is an hour you're not investing.

1:20:27 There's very little substitute for ours. Because all those hours compound be it your knowledge or your network or your analysis, whatever your edge is. in investing and here I'm sort of bringing it back to investing, but I think it applies to life and whatever your mission and Calling is But I think that's an important thing to think about, and for me a balance the

1:20:46 still retains a happy, stable life at home, but also a good relationship with your team. Is actually really important. And I don't Always find that consistently. I do think there is a price and a cost to pay.

1:20:59 And people don't talk about it a lot because it's a high cost. A lot of really successful People you see that it comes at the cost of not spending time with their wife or husband or not spending enough time with their kids. But I do encourage people to

1:21:13 try and find a balance through some structure. When I've seen founders struggling Not being judgy is really important. That's one thing that the market is bad at, as I mentioned. It doesn't encourage true feeling revelation. I tend to share my own life journey or issues or insecurity, you have to it's a two way street. You need to earn the right for someone to be truthful and show their vulnerabilities.

1:21:36 And in the investing world because it's all focused on money and returns, it's a bit difficult. But I think that's one of these learnings of talking to really successful people that Maybe if your returns to eighteen or your wealth goes from like seven billion to six billion, but it's not linear, like you spend a lot more time with people you loved. I think that

1:21:55 is probably quite powerful. Well, I don't want to inundate your inbox, but I do highly encourage anyone considering starting a firm to call you in stable. I've learned so much from all the nuance about like how these businesses work. And I've run two of them. So I've I've been in it, but even still There's just so much additional detail that you've taught me. that I think is so incredibly valuable and

1:22:17 It's so cool that you've carved out An investing niche that's so distinctive. And I think it's notable that you started at such a young age. I'm finding this a lot recently, that like the firms that look the most interesting were started By very young people. And that's maybe just compounding, right? Just staying in the game. It's like you're not smarter or anything, you'd like to have more years in a way. And that's why these big legends sometimes as well, you'll notice they all live quite long lives. Yeah, sure enough. Yeah. You have to be honest with yourself of attributing your success to like what factors. And I think just starting early you had more time to get it right. It wasn't like you were this sort of a genius.

1:22:49 Well, I'm forced to go to my traditional closing question. What is the kindest thing that anyone's ever done for you? So I gave this a lot of thought. I love that it's predictable. As opposed to all your other questions, which make you think really hard. And it's not super original, I think I find most people or many people go here, but I think it has to be my parents and

1:23:09 One thing that was really meaningful in my life. Unfortunately my dad passed when I was eighteen. And While he was sick, he died of cancer. The only time I'd seen him cry was when I'd gotten into Oxford for University where I went to undergrad. And then the second time I saw him cry was

1:23:24 when I came back home and found out that he was sick and I was like Dad, don't cry, you know, you'll be fine and he's like, No, I'm not crying for me, I'm crying for you'cause you know, I might not be here. And becoming a dad has been A really amazing experience'cause for me Kindness has this element of self sacrifice, but also willingness to be

1:23:41 Uncomfortable? So like tell people the truth or uncomfortable things I think is quite kind. Like when you forecast something or predict something, being kind actually means being willing to say something tricky.

1:23:53 Between both of you. And then my mom After my dad had passed and I was a University at the time, she was like Whatever happens, I'm gonna be okay. I'm an only child, my mom's an only child, so she doesn't have a lot of help. She's like You need to go live your life. And now as a parent, I'm like, wow, that's amazing. I want my children to be with me forever. Like I don't want them to leave home.

1:24:11 And so that for me is probably the kindest thing to put Others first in that way. It is true, kindness. Eric, thanks so much for your time. Thank you, great to be here.

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