The Real Alpha – How Top Investors Find, Develop, and Keep Great Talent

This is a topic that is near and dear to my heart. There's two parts of the business that's identifying the managers, and then there's also construction the portfolios, preservation of wealth instead of maybe swinging for the fences, as some of my tiger cub lineage does. Now, this could also lead to outperforming in some of the tough markets, but also underperforming in some of the bull markets. I really enjoyed our chat about how you work with and mentor and coach merging managers that are not in your platform, but maybe at some point, you know, they're kind of on the bench, you don't follow a dogmatic mandate and that the only rule is that there are no rules. Hi there, this is Rich Bello. I want to welcome you to the Enrichment show by Aruta. We'll be bringing you some personal and professional inspiration. We hope you enjoy the show. All right, we've got a lot to cover. The objectives of the panel really are twofold. One is to identify talent and the other is to develop talent. And developing talent is both for the firms individually, internally as well as externally. So this is a topic that is near and dear to my heart. I'm fascinated because really what we're talking about here is the decision, the allocation, and written a couple of books on decisions. We have training on allocation to funds. So I'm really excited about this topic and we have a wonderful panel here. So let's dig in. Sam so how has the criteria in evaluating talent changed over the years? And I think there's some particular skills that we talked about that you guys look for, that you and your team look for.

Yeah, I think that all of us have universal components in our underwriting in terms of the people and the process and portfolio management. But when you're in an environment where you expect the market component of a manager's return to be more uncertain, you have to hone your skills on identifying the alpha component. And that has different nuances, whether you're an active hedge fund or more illiquid private strategies, underwriting trading orientation and flexibility in your hedge fund strategies. And then on the private side, focusing to ensure that the manager is leveraging more operational skills to create an operational capabilities to demonstrate a track record of growing a company or transforming a company. And in private credit, an example would be just ensuring that the manager has the turnaround capabilities and a track record of, you know, leaning into companies to help them turn around if they get into trouble. Another key area would be focusing on sourcing differentiation. Again, it's different depending on what, what market you're in. In liquid markets you want to focus you focusing to spending time analyzing whether their opportunity is very crowded because competition reduces makes efficiencies in markets. So you want less crowded managers with trades that are less crowded and also strategies assessing the barriers to entry. So focusing on if the strategy has a high barrier of entry or if new competitors can come into it. And so in aggregate I think you also need to develop your analytics skills to help identify the alpha component for all of the strategies, no matter where you are in public or private.

So Sona, let's go to you. Perhaps you could briefly describe how Cambridge's outsourced platform works and how you find best in class managers.

I serve as an outsourced CIO for my clients. Essentially I'm trying to replicate an in house investment office inside of Cambridge Associates, but really on behalf of an institution that's outsourced to us. So my team is composed of subject matter experts, I have specialists on alt assets, I have an actuary, I have someone who builds private portfolios and operational expertise, et cetera. So we're sort of what an in house office looks like. We leverage the large Cambridge research platform to identify the best in class managers. Obviously our research platform, which has more than 100 people, they're just working down that huge funnel that you've always seen, right? There's thousands of managers out there and they're doing a significant amount of due diligence, both qualitative and quantitative, to work their way down to the sort of the less than 5% of that that's investable for our clients. And then I as an outsourced CIO get to sort of cherry pick from that bottom of the funnel and I do a second layer of re underwriting for my portfolio fit for the institutions that I represent. The bottom line is that we're leveraging a sort of a global research platform of already vetted ideas and then picking the ones that go into our portfolio.

Mark, you know we discussed super tool that you use at the, at the Common Fund to tease out alpha. I believe you called it the flux capacitor that you developed with with Doc.

Actually the funny thing about the flux capacitor is when I talk about it with our summer interns or our first year associates, they're like flux capacitor back to the future. What? It just doesn't resonate with them the way it used to. So we may have to come up with a new name. But what is it? It's a quartile ranking system for hedge funds, if you live in the private equity world, if you invest in venture capital or private equity growth or buyout funds, everything's ranked by quartiles. Cambridge does quartile rankings pre Quinn Burgess, et cetera. There are a number of agencies out there that will quartile rank private equity and venture capital funds and other private capital funds. No one quartile ranks hedge funds. So about eight years ago at Common Fund we invented our own. And one of the great things about the flux capacitor is it's strategy agnostic. You may often hear this from a hedge fund of funds manager. Well, gosh, we filled up our equity hedge bucket. So we don't want to look at any more equity hedge managers. We now need to fill up our global macro bucket or our relative value bucket. We can be strategy neutral or agnostic. We really don't care whether the next best hedge fund manager we look at is equity hedge or event driven because that's all accounted for within the flux capacitor. We call this degrees of freedom. The flux capacitor gives us an additional degree of freedom because we're no longer constrained by strategy mix. And we try and build as many degrees of freedom into our portfolio construction process. And when you do that, you can build a more robust portfolio.

You know, we discussed a distinctive feature of UBS solutions was preservation of wealth. Instead of maybe swinging for the fences as some of my tiger cub lineage does now, this could also lead to outperforming in some of the tough markets, but also underperforming in some of the bull markets. Could you elaborate a little bit on that?

We have been managing hedge fund portfolios for 30 years and the beginning of our history is really managing money for private banking clients. And most of them have already accumulated quite a lot of wealth and is about preserving that wealth. And so our philosophy, our approach has migrated towards high ship ratio portfolios, relatively steady and you know, today in this kind of market environment where it's free being higher maybe 7,8% with a shop of 1 and a half to 2 is all is plenty is all the clients need. And so we sometimes define a bit boring in a way, but it has really served a purpose over the cycle and particularly in most recent times like 2022 where we performed quite well. But obviously in times like this one where everything is, is going up and there's no differentiation, every asset class is roaring, it's difficult to keep up. But I want to say something important. Being focused on sharp ratio and low volume doesn't mean that you're only buying funds with low volatility. Because if you do, a combination of low volatility and diversification will kind of eat the returns away. They'll kind of flatten out and barely make cash. So you have to mix different things and you have to be brave at some times, go where the opportunities are and potentially do things that are very risky. The outcome, if you do have good portfolio, robust portfolio construction is still I sharp. But in our experience, just buying funds that have low volume and putting them together, it really becomes becomes very difficult to meet your investment objectives.

You talked about operational alpha and why structuring is so important in generating alpha. Can you elaborate a little bit on that?

Because we sit within a broader asset management firm that has a very long track record of quantitative investing. We're able to leverage a lot of that technology and quant infrastructure and analytics in our underwriting. And we also have a managed account platform where we spend a lot of time around structuring. Many allocators would say, you know, I really focus on the strategy and the team and I don't focus so much on the structure. But we're at a point in time where you've got a lot of money looking for returns, you have only a limited amount of alpha in public markets and you have managers that might not be available to you and you have an interest rate environment that's higher. So to justify having the fees and complexity of a hedge fund allocation, the managers now need to make sofr plus, you know, that hurdle to justify their allocation. In this environment where there's, you know, competition for alpha, structuring becomes more important in the underwriting. So when you can assess the manager's track record and hone in on really what their skills and get rid of kind of the mediocre fat that they're not that great at and structure to get just that alpha source, then you have a better chance of meeting your benchmark and your objectives as an institution.

So obviously there's two parts of the business that's identifying the managers and then there's also construction of the portfolios. Can you talk a little bit about the construction of the portfolios and maybe some of the tools that you use for that?

The first and foremost is to get the the right manager in your portfolio, the best in class, someone who's aligned with your objectives and is going to do what we want them to do in a portfolio. But I think that there's a great deal of success that comes from getting the portfolio construction right. And so that Means getting, putting, not only putting the right manager in the portfolio, sizing them in the right way to make the right impact. Not too much, not too little, pairing them with the right existing lineup. Right. There are many, many investments in a portfolio. You want to understand how one is going to behave individually, but also in concert with other. And then also thinking a little bit about timing. Yes, we don't have a crystal ball and we don't know exactly when managers will bottom and top out. But there is some science to trying to get the timing right. So I spend a significant amount of time as an asset allocator to think through portfolio construction once I have the ideas on my plate. You know, we do, obviously I said I re underwrite the ideas to understand portfolio fit and how they might look next to something else. And then I have a lot of tools, a suite of analytical tools that I utilize to sort of understand more quantitatively how certain managers will behave vis a vis their peers in certain environments and what they look like as a complete whole. I use a lot of active risk analysis to understand how I should size an investment to have the right impact on a portfolio. Our toolkit essentially enables us to check some of the qualitative conversations we've had with managers. When certain funds say, right, well, we do well in this environment and we do poorly in that environment. And most of our returns come from stock selection. The tools that we have enable us to sort of check that. I'm able to sort of say over 10 years, this particular fund generated X amount of alpha. But most of it came came from getting the sector right and not the stock right, et cetera. So there's a lot of checks and balances that happens. And I think that that's the sort of second layer of alpha generation that is important for an asset allocator to get right to be successful.

Mark, you mentioned that you tend to stay away from some of the larger private equity firms. And I found your reasons compelling.

Could you share, definitely stay away from those private equity firms that are publicly traded. No offense to them. It just introduces a third constituent group called public shareholders. And we assume, we just assume invest, not invest with publicly owned private equity firms. The other flip side is we've done our own research on small versus large PE firms using data from Cambridge and Pre Quinn Virgins, et cetera. And what we have found in that data is small buyout firms in particular tend to produce very consistent outperformance compared to larger firms. And that outperformance can be 100 basis points or more. So the average size of the PE firms, private equity firms, and when I say private equity, I mean traditionally buyout or growth private capital firms we look to invest in the 700 million to 800 million range is sort of the average size we're looking for. We also like to invest with fund of ones. That is a partner that is spinning off from a large buyout firm no longer wants to get caught up in just endless fundraising and just wants to focus on investing. We like those individuals a lot. We also find smaller firms have better alignment. The management fee is no longer a profit center, which it is for the very large buyout firms. It actually is used. The management fee is used to just pay the operating expenses of the fund. And those smaller funds tend to be focused on getting most of their profit from the incentive fear of the carry. Again, that's better alignment for us. And then the third reason is smaller firms are investing in smaller companies, SMEs, small to medium enterprises. And we find that to be a much less efficient part of the market and a much better place where our private equity manager can come in and first buy the company at a cheap EV to EBITDA multiple and then bring a lot more operational experience, basically professionalize that company and extract much greater value. We find working with those smaller managers, most of the exits are then to bigger buyout firms. So financial buyers, which is just fine with us. But again we don't want to be with those bigger buyers buying the second leg of that company. We want to be with the smaller PE firms with that initial company getting that first leg of growth from their expertise.

Hey, thanks for listening to the show. At Aruta, we want to help you apply the knowledge. Did you know that we offer coaches to get you on track and to keep you on track. Head over to aruta.com to learn more. Now let's jump back in. Edo, let's go back to you. So you mentioned that as a large multi manager platform, top down approach can be very additive to alpha. And you also noted that you don't follow a dog shy away from a dogmatic mandate and that the I hope I'm getting this right. The only rule is that there are no roles.

There are no rules per se. There is an analytical framework, there is a process and there is the ability to evaluate opportunities as they come. Right. If I start saying to my team, oh, we're never gonna touch reinsurance ever again and you know, reinsurance had a great ride and then at Katrina and then you know, spreads compressed dramatically. A lot of hedge Funds came in. It's easy to say I'm not going to touch it ever again. Is it climate change? Guess what? It became one of the most profitable P and L generator for Citadel a year and a half ago. And so that's why you cannot be too dogmatic. You need to adapt. And if you get the strategies right and the managers right, that's your alpha. When we look at so probably the best hedge funds out there in terms of capital call it return on capital $P&L. The two biggest ones and best ones are Millennium and Citadel. Millennium has a very bottom up approach. It doesn't really move capital around strategies. Citadel is the other opposite. They're very dynamic. The move where the opportunities are. Of course they have great talent but when you combine a great talent and commodities more recently reinsurance back in the days and can really generate outsized returns and you don't always get it right. We don't always get it right. And when we do, we really provide a service to our clients.

Sam, let me ask you, how do you and your team at Man Group really look at helping your managers supporting these manager partnerships with focus on professional development and things like that?

It's universal for all allocators to want to engage with their managers and and the team because that gives you insight on what's going on in that household. So we're always wanting to connect and talk at various different junctures and many times those conversations are around things they're thinking about doing or ventures or changes and they we give our feedback and our thoughts on it. Sometimes it's more formal, sometimes it's more informal. Also just in terms of developing them, we provide a lot of feedback and recommendations in our ODD process. So best standards in hedge fund practices. Hedge funds because they're liquid, because they are very dynamic, because they can change their approach, they have a high degree of flexibility. There's complexity in those managers. And so people who assess hedge fund ODD have a very high bar of standards and they can often give young managers advice on what those best practices are. They've also more recently been helping more private managers who are thinking about offering more liquid structures as well because there's a big learning curve that will have to happen for not only the allocators of private markets in terms of their approach, but the managers and in terms of the operational requirements if they start offering more liquid offerings.

So Sona, let's go back to you. How do you think about talent development both internally for your own team? I believe you had 12 investment professionals on your team. And then I really enjoyed our chat about how you work with and mentor and coach merging managers that are not in your platform. But maybe at some point they're, they're, you know, they're kind of on the bench.

I think it's important and it's my job to develop the sort of next generation of CIOs. And some of those people are on my investment team right now. And obviously that is a multi faceted role. You have to know how to manage assets across asset classes and understand that sort of hard skill on the investment side. Risk management, you know, people management, process management, oversight of operations. There's a lot that has to happen that they have to learn. So I spend a lot of time trying to coach and mentor the younger people on my team and on other teams to sort of become sort of the next generation of CIOs. What's also very interesting is sort of the world outside of us, right? So a large part of our job at Cambridge Associates is to evaluate in diligence and identify the best in class managers. That's where the conversation began. And so a lot of emerging and newer managers are coming to us as well. And sometimes they come to us probably a little too early. What I like to do is I like to spend some time when I can, to mentor them. Now, this is not really a part of my job, but again, I feel like it's my way of giving back to the industry, particularly to, you know, I'm particularly interested in helping develop female investors because, let's face it, there aren't enough. But the idea is that when emerging managers come to us and we're not ready to give them capital because it's a little too early, what I feel could be even more valuable at that point in time is to give them advice, right? So they have questions that could range from, how do I tell my story? Are my fees and terms correct? How do I fundraise? When do I fundraise? There are a lot of things that, you know, I've gotten to see over the, over the last few decades that managers do well and they do less well. And so I try to help develop some of that emerging talent. And in doing so, sometimes you may find someone really, really interesting who's not quite ready for primetime yet, but will be in a few years, and then, you know, we can get access to them because, let's face it, the emerging managers of today, those who will do well, will be the sort of stable, you know, fantastic managers of five years from now.

So Mark, you mentioned that form of collaboration you do with some of your managers putting together this institutional product, an institutional product with a sweet spot. You coach them on how to get to that sweet spot.

So I used to manage the pension fund In California called CalPERS and after CalPERS I moved to London to take over the chief executive role. So I went from CIO to chief executive. So a new role managing the British Telecom pension scheme which is the largest pension fund in the uk. But BTPS as it's called also owns an asset management company called Hermes, Hermes Pensions Management. So it's a third party asset manager. So I was wearing two hats. So in a new country, wearing two hats, in a new role, chief executive. So I hired a coach for the first time and back to the soft skills, which sometimes can be the hard skills. So they are hard skills. My first meeting with this coach, we're sitting down and he looks me up and down and the first thing he says to me is, Mark, you need to change your shoes. I was like, what? Now granted my shoes today are very casual but I like to wear loafers, penny loafers or slip ons. And he says to me, you need to get a proper pair of British brogues. And I was like seriously? And he was like, seriously? You will not be taken seriously if you're going to come in to a business meeting wearing shoes like that. So indeed he took me to one of these arcades they have off of Bond street in central London to get a pair of black and brown handmade British brogues. Now those are the type of things that a good coach will pick up on. Yes, a good coach will help you work through a difficult employee issue or maybe you're going through a merger and acquisition. But it's these softer skills are really the nuances where people will either dismiss you or take you seriously. And a good coach will pay, pick up on that and point you in the right direction. You were talking about this Rich, asking some of your mentees, are you getting enough sleep? Critical question. Most coaches won't do that. So that's on the personal side. Let me give you one quick one. On the business side, we were working with one of the very well known venture firm on Sandhill Road, one of the top five venture capital firms in the world. They came to Comma Fund asked what we were doing on diversity, equity and clothes and we told them what we were doing and we explained it all out and they asked for a helping hand and what we said was, you know, maybe you might think about recruiting from different colleges and universities because you only seem to recruit from basically two and you're basically only hiring people that look kind of like you. And so they said, great, how do we do that? How do we contact an hbcu, a historically black college or university? So we said, well, we recruit from them. We're happy to introduce you to them. And so we did. So Morehouse College, we set up a meeting with the director of placement for Morehouse College. We set up the video meeting. We brought in this VC firm, we brought in the director of placement. We said, introduction to this group. Introduction to this group. Here's what they're trying to do. Please, you know, help them with what they're trying to accomplish. That's a softer skill. How does that actually translate into basis points of outperformance for this VC firm? I can't really tell. But again, it's one of these softer skills that these firms are trying to learn that you can lend a helping hand and you can become then an investor of choice or partner of choice for them.

So Edo, it's kind of a no brainer. Of course there should be talent development and you know, ideally coaching, executive coaching. But yet you often find that there's not the budget for it both internally and for your managers. Why do you think that is?

First of all, obviously we only hire external managers. We don't have portfolio managers in house even though we're part of asset management. My group, the fund of funds is only investing in external managers and we can provide advice. Opted is a great example, business management, the right structure. But we don't have the experience and the credibility to really develop investment talent per se. And so they would have to find it either from resources inside the bank, which I think would be very smart thing to do especially for a business of our scale. But like I said, resources sometimes are limited and they tend to be focused on internal employees. But that would be a very smart sort of add on in addition to perhaps open up to the network of the bank in different divisions. So we're a bit limited in that respect, but we do see a lot of value in talent coaching. There are many cases of investments we make where we see for example, a lot of turnover and turnover can be very disruptive. You can lose your number two and number three. It can be a destruction for people internally. It's just sometimes a sign that something is not wrong and you lose assets because of it. Consultants are very focused on those data points and just coaching the top one or two sort of PMs. The CIO, the CEOs, in terms of communicating well, managing the team in a constructive way, try to get the best out of the team in a constructive way, can provide that stability ultimately leads to better performance. So even though it's not always easy to measure, you know, outcomes in terms of alpha or risk and return, there are some quantifiable elements. Again, there are some multi PM platforms that are more focused on internal talent development than others. Others tend to just buy it out, right, and pay for it when it's nice, seasoned, kind of safe bet. But obviously it's expensive for us as LPs, as allocators. If you can develop it internally, take a young analyst and make it grow to a 1 billion allocation in the fund is a fraction of the cost to me as an allocator than going and poach a 1 billion sort of allocation PM from a different shop, from a competitor. So that's very quantifiable. That's actually, if you, if you want is alpha in, in, in. When you look at the net, the growth versus the net return to us.

It'S really tough to find the leadership skills and the kind of the, the correlation for leadership skills on communication, on delegation, all the things that, that, you know, that, that we teach. It's tough to find that correlation. So the one thing I have found that pro. Probably more important than even talent development, and I can get this across probably better in a story, is acquiring talent. Talent acquisition is even more important. There's a coach that told the story about. He was at a banquet, I forget, at the Hyatt Hotel, and the service was amazing. Like, the service was amazing. He called over Mr. Hyatt. He's like, Mr. Hyatt, Mr. Hyatt, come here, come over here, come here. I just want to tell you the service here is impeccable. It's the best service that I've ever had. It's like, can you tell me about your training and development program? Mr. Hyatt said, we don't have a training and development program. We just hire the right people. I was like, ooh. Light went off in my head when I did that. I was like, we're starting a talent acquisition business now, not even for an outside business, which we do have, but I wanted to have it for my own firm. I wanted to be an expert in acquiring talent. So we're writing a book on how to acquire talent. I've had a lot of experience. We were writing a book on it. We, we're developing software and then we're gonna sell It. If you wanna be an expert in something, you teach it, write a book on it. You teach it, and then you sell it. So we've done that. So any thoughts on acquiring talent? Because the worst thing that you can do in anybody's career is having to terminate somebody. There's nothing more painful than that. You really wanna get that right. And the problem is, if you have pretty good people, you hire pretty good people, then you're left with a pretty good firm. You don't want to be left with it. It's really hard to terminate pretty good people.

It's great to hire great people, but then you got to keep them. And great people will come to an organization for three reasons. First, they want to be well compensated. I think we all agree with that. But then they want to work on interesting projects and they want to have an opportunity for advancement. You can offer those three things. Finding great people is the first part, but that's the way you keep them, I think.

Also just talent training. I mean, you can have talent, but you can then help with training around some of these softer Managing people, having difficult conversations, bringing in outsource outside resources, or building internal teams to help with coaching.

Yeah, I mean, maybe I'm stating the obvious, but I would say that we're in the investment business, but we're really in the people business because, you know, alpha comes from skill and skill comes from people. So, you know, I think that we should focus really hard on getting the right talent, keeping the talent, letting them thrive and develop, so that they can sort of give rise to a new talent. And I ultimately think this is the talent game. The alpha game is actually the talent game.

I'll just leave you with this. You know, when I talk to portfolio managers, I let them know you're managing two portfolios, Portfolio of investments and your portfolio of people. And as you grow, that portfolio of people becomes a much more important portfolio to manage. Let's thank the panel. Thank you. Hey, thanks for listening to the Enrichment show via Route Talk. Please subscribe and leave us a review and check out our YouTube channel. Remember, knowledge does not apply itself. You must make the application.