Clint Stone — Allocator Series — May 31st, 2023

[00:00:07] Clint

What’s luck? What’s skill? There are times where you can ride some waves and look like a complete genius. It’s a really difficult thing to pull apart all these risk factors. Am I just looking at something that was an artifact of the environment of that 5, 10-year period? I’ve got various quantitative tools to try to pull those apart, but it’s never black and white. It’s almost never black and white. It’s trying to assess and understand and pull apart luck versus skill. It’s not an easy thing to do.

[00:00:51] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions.

Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:46] Niels

For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary investors from all around the world. In this series, I have invited one of them, namely, Alan Dunne, to host a series of in-depth conversations on the topic of what it takes to be a world-class allocator.

In today’s world, portfolio construction is fast moving to the top of the agenda of many investors as they tried to analyze and understand the riskiness of their portfolios. With ever-increasing uncertainty around the globe, being well-diversified across many different strategies and themes in your portfolio can mean the difference between ruin and survival when the next crises emerge.

The aim of these conversations is to try and understand the experiences that have influenced these highly specialized allocators and the processes they follow to harness the best returns for their clients so that we can all become better-informed investors. With that, please welcome Alan Dunne.

[00:02:48] Alan

Thanks very much for the introduction, Niels. Today, I’m delighted to be joined by Clint Stone. Clint is SVP of Investments at the family office of the Larry H. Miller company in Salt Lake City. Clint has worked in the investment industry over a number of decades as an asset allocator, manager selector on both the sell side and buy side. Clint, great to have you talking to us today. How’s everything on your side?

[00:03:14] Clint

Thanks, Alan. Great to be here. A beautiful day in Salt Lake City.

[00:03:17] Alan

Good stuff. I’m sure it is nice and sunny. Well, maybe to set the stage for today, I did mention that you’ve transitioned through a number of different roles in the investment industry. So it’d be useful just to get a sense on your own journey in the investment world and what’s brought you to your current position.

[00:03:36] Clint

You bet. I started my career right here in Salt Lake City. I got a degree in finance at Southern Utah University and started at Fidelity Investments and Goldman Sachs in their private wealth management business here in Salt Lake City before going back east to get my MBA. That led to roles in investment research. I really wanted to make the transition to stock picking and investment research. So that’s what I did.

I worked for Bear Stearns Asset Management as an equity analyst when they were still around. They had a large-cap value fund. I studied during my two years, getting my MBA at Cornell. I was also part of a student-run hedge fund there where I did industry research and valuations and stock picking.

I surprised myself coming out of my MBA program and really wanted to look at the world from a broader perspective. So I joined the Cornell University Investment Office and instead of picking stocks, I was picking countries and picking strategies and doing asset allocation work and manager selection work and I just kind of fell in love with it. I really enjoyed it. It gave me a bigger view of the world and it just kind of fit with my goals.

I moved back home to Salt Lake City to join a large non-profit institutional investment firm called Ensign Peak Advisors, and then two years ago joined some friends here at the Larry H. Miller Company. They were going through a very big transition with two big liquidity events of selling the Utah Jazz and selling the car dealerships. It was just a really, really cool opportunity to be part of the team to help write the next chapters here at the Larry H. Miller Company.

[00:05:34] Alan

Good stuff. Obviously, it would be useful as well to get a bit of background on the Larry H. Miller Company in the sense that you’re involved on the investment side and on two distinct sides there, isn’t that correct? On the foundation or family office side as well as the investing of the holding company, I guess.

[00:05:57] Clint

That’s right. Really fun role for me, really meaningful role for me. I’ve been in the nonprofit space, nonprofit portfolio management space for the last call it 15 years. Having a foot on the foundation side with the Larry and Gail Miller Family Foundation is really meaningful to me. So the team I built and put together get to manage and oversee that foundation which is about $700 million today and getting bigger, and then also having a foot on the company side, the taxable side of the family office which has very, very different goals and investment approach.

So it’s just been a lot of fun to have fun on both sides of the house and be able to continue my work on endowment-style portfolio management with the foundation and being able to look at individual deals with companies on the Larry H. Miller Company side, which is really just in their DNA. Owning and operating businesses is really all we do, kind of our own private equity platform on the company side.

[00:07:08] Alan

Interesting. Well, maybe if we start off with the foundation side, and I’m sure we’ll talk about the other side as well. It’s mentioned at the outset, it’s a foundation. I guess it’s long-term money, $700 million. If you were to compare and contrast how you have to run this portfolio now, as a foundation family office, versus say how the likes of a Cornell University might run their endowment portfolio.

[00:07:37] Clint

We use a very classic endowment-style approach, but there are some differences. There are things that I’ve learned along the way that I want to implement here. You’ve got to look yourself in the mirror and say, what is my edge? How can I compete? Global markets are a very competitive space. What can I do to bring a competitive advantage and do something unique with the resources and the team that we have here, that we built here at LHM?

So we use eight buckets for asset classes, four publics, four privates. My four publics are fixed income, US equities, international equities and multi-asset. Multi-asset is just catch-all, most mostly hedge funds but could be anything in there from crypto to just anything that doesn’t fit in any of the other buckets. My four private asset classes are private equity, venture capital, we split those out and model those from a risk perspective and a return perspective differently; and then real estate and natural resources.

We use those eight building blocks for the foundation and really kind of the core of everything that we do here.

[00:08:59] Alan

It’s interesting, I read a paper recently around how a lot of institutional asset allocations may look diversified, in the sense of having allocations to different asset classes, but ultimately may have a lot of equity or economic risk in the portfolio, which I guess is probably fair to say about your portfolio. I guess the flip side in terms of managing that is your long-term time horizon. Is that it? Is that why you’re happy to be very concentrated in that equity economic risk type of factor?

[00:09:37] Clint

Yeah, absolutely. When you think about risk and how we define risk here, how I define risk, my single biggest risk for the foundation is not meeting its objectives and its goals. I could put the whole thing in T bills and have 100% liquidity. I would never have a year where I would have a negative return. I’d have a positive nominal return every single year. But yet, I still would not meet the goals that we’re trying to achieve in the foundation, which is cover the 5% spending, it spends 5% a year, and maintain its purchasing power in real terms, maintain that investment pool in real terms. So that’s been tough.

As you know, inflation has been very high and keeping up from a purchasing power perspective has been really tough, but that’s our goal. It’s ambitious, 5% plus inflation, and T bills are not going to get me there. So that’s how I view risk. Number one is, if I’m spending 5% per year, I’ve got 95% of my assets that I’m not spending per year that I can really think down the road and really think long term about. So you’re right, economic sense wise it’s very equity-heavy. Very, very little fixed income. I do need a little bit for rebalancing for covering spending. But for the most part, it is very equity-heavy.

Now, I try to think very, very carefully about diversification to macro scenarios within those various equity constructs. Owning equity in real estate, owning equity in oil and gas projects, owning equity in public markets, owning equity in venture where you’ve got this business formation and innovative companies that are being formed. I’m trying to think about geographic diversification and industry diversification.

So it’s not all chips; one big bet, all chips in one place. It’s really trying to think carefully about what can happen from illiquidity, interest rate, inflation, all of these various macro scenarios, but I do have the luxury of being able to look down the road 5 to 10 years because I’m only spending 5% per year.

[00:12:15] Alan

Obviously, we’ve lived in a very changed macro backdrop in the last few years. As you say, inflation has been high. I guess the growth-heavy equity-heavy approach certainly did very well over the last decade. When you look at last year and the year where we had higher inflation, equities down, bonds down, do you think that was an anomaly or would you be worried about the scenario of maybe a challenging decade for equities? Say if we had a period like, people talk about 1966 to ’82 where equity markets went up and down, but you look back after 15 years, it hadn’t really gone anywhere. I guess that type of scenario would be a big challenge in terms of hitting those longer-term goals.

[00:13:02] Clint

Yeah, I definitely view 2022 as an anomalous year. It makes sense what happened. When you looked at what the market was pricing in for interest rate hikes and then what the Fed actually delivered in 2022, it makes perfect sense what actually transpired and how that translated from Fed hikes to markets, particularly the public markets, stocks and bonds. That is kind of a 2%. If you look back the past 100 years in the United States and say, how many years do we get bonds down, stocks down, you could count on one hand the number of years that that happens. It’s a pretty low-probability event but one that made complete sense for what transpired in 2022.

Now, as I look at fixed income today, that’s the one area where you can model returns with a lot of specificity, with a lot of accuracy. Your yield to maturity at entry is going to be very, very close to your realized return. As I look at those yields, they are certainly more attractive but they’re still not in a place where I’m going to put 100% of the foundation assets. Public equities, private equities, I look at all my other asset classes, I look at carbon markets, I look at oil and gas, I look at pockets in real estate that are still very attractive today, very cash flowing from a supply-demand perspective, still very attractive.

I still think there’s a lot of opportunities outside of fixed income in all of these various equity pieces of the capital structure, whether that’s a public company, a private company, a piece of real estate, a natural resource project and still very much excited about the next 10 years. Although I think it’s very likely that the next 10 are not going to look like the last 10.

[00:15:06] Alan

Okay. When you say that, is that driven by the valuation? Obviously, I suppose the valuations in the equity space are clearly different than they were maybe back in 2010. Obviously, as you say, you can talk about returns for valuations and fixed income with a degree of certainty. But what would your perspective be on valuations in the public and private equity space?

[00:15:31] Clint

Yeah, I’m actually pretty constructive on valuations in both. Certainly, on a backward-looking basis in public equities in the US, you’ve had an incredible decade. I just looked at the numbers this morning, 12% annualized compound return for 10 years. These are extraordinary returns. International public equities 4% and emerging markets 2% annualized returns the last 10 years. So anybody that was doing their asset allocation work and doing their expected return models and saying, okay, I need to be overweight EM are international valuations 10 years ago were just completely wrong.

The world gave us something very, very different. There were a lot of tailwinds to the US equity market that I think are going to not be there or not be as strong going forward. Now. I still want some. I’ve still got a 20% strategic allocation to US equities. I’ve got a 10% allocation to international equities and so I still want exposure. There’s some incredible companies around the world in public markets. Despite the higher starting valuations today, especially in the US, I still want some exposure there.

On the private equity side, this is a tough one. A lot of people have talked about how valuations today appear or feel very high. I don’t feel it as much on the private side. Certainly, there has been a reset in valuations, especially in public markets, especially in late-stage venture. But when you look at early-stage venture right at the point where you’re giving capital to a business which is just getting started, what is valuation?

It’s either a very, very low multiple of future cash flows when you’re looking way out, 10 years out, or you’ve massively overpaid for it. It’s got to be binary when you’re at that early stage. In venture, we’re still seeing lots of innovation, lots of really interesting opportunities to deploy capital in companies around the world today. On the buy-out side, yeah, 12, 15 times EBITDA multiples, certainly kind of… I wouldn’t call it cheap, but not out of the realm of where it’s going to be difficult to make money.

There’s still a lot of room there in private markets. Between private and public markets, I still think private markets are offering a little bit better valuation setup than publics.

[00:18:34] Alan

Do those valuation perspectives, estimates, etc., feed into your model? What is your approach to figuring out the strategic weights for those eight buckets that you mentioned?

[00:18:50] Clint

Yeah. Great question, Alan. It’s been a challenge in my career to build these expected return models and see what transpires over the next 5, 7, 10 years. It takes a long time but you get this report card of how well did you did on your forecasting. I’m classically trained in that MBO, mean variance optimization space where you input your returns, your expected returns, you input your correlations, you input your volatilities, and you get this output of various asset allocation depending where you want to be on that risk curve. I have come 180.

After doing that for a number of years, I’ve realized that’s almost a silly exercise. Instead of mean variance optimizations, it’s really error maximization. It’s really taking the error of your return inputs because the MBO process is so sensitive to your expected return inputs that you’re really just maximizing the error around your forecasts of those various returns and asset classes. So we use something different. We input volatilities, we input correlations, and we input our starting weights. Your actual weights, I think, are the best thing to use, but you can also use your strategic weights, your model weights, whatever you want to put in as your starting point.

We’ve got an implied return model. It’s quite simple. It could be run in an Excel spreadsheet that spits out the return that you have to believe for your weights to be optimal. So you give the portfolio a starting Sharpe ratio, let’s call it 0.5, and you input your asset class, volatility estimates, correlation matrix, weights. Your returns… You now have a set of returns that you can say, okay, I have to believe that these long-term returns are going to justify that this is what equates to an optimal portfolio from the weights that I’ve got here.

Now you can make decisions about okay, this is saying that I’ve got to believe international equities outperform US equities by 2% per year. Do I believe that? Yes or no? No, I don’t believe that. So I need to change my weights. It’s an iterative process. You go back and change your weights. So my allocation, my strategic allocation to these eight asset classes, four publics and for privates, are really this iterative process of going through what I believe in terms of risk correlations. Do I believe these implied returns?

We call it the implied return model because you’ve got to believe that those returns are what’s going to transpire in the future for your weights to be optimal. So kind of a dumbed-down black Letterman model that’s a little bit more easier to use in a spreadsheet. It meets the needs of our modeling. The last piece you’ve got to layer on top of that is liquidity. There’s no liquidity construct in just a sterile MBO process, which we’ve got to think very, very carefully about.

Even if we’re only spending 5% a year, you’ve got to cover the spend, you’ve got to cover rebalancing. I don’t want 95% of my portfolio in illiquid asset classes. So I’ve got a split where it comes out 55% publics to those four public asset classes, 45% to those four privates. That feels about right to me in terms of trying to maximize the returns that I can get from private markets but still having some flexibility to rebalance the portfolio.

[00:23:05] Alan

It’s interesting. Obviously, as part of that process, I guess you have to have inputs on, as you say, volatility, correlation, etc., for all the distinct asset classes. That, I guess, brings us to that interesting debate around how volatile it are in fact asset classes like private equity and VC. They tend to be marked less frequently than public markets so may present as being less volatile. But then some people will say, but ultimately, the underlying risk is as volatile. So what’s your perspective on that?

[00:23:41] Clint

I love this question probably because I’ve spent way too much of my life thinking about it and doing work around it. One of my last big research projects, before I joined LHM, was this exact question. How do we model the risk of a diversified private equity book that’s got PE, buy out, growth, venture, across vintages? You’re right. You’ve got to believe in those risk inputs because the implied returns, in that model, are going to be driven off of what you’re plugging in from a volatility and a correlation perspective. We could spend a whole hour on this and I’m sure that’s not the topic of the show.

Let me share just a few insights that I felt like were interesting to me as I went through this deep research project. We’re very familiar with public markets, S&P 500, 500 biggest companies in the US. You and I can pull out our phone, trade them anytime. Anytime the market is open, we can trade a basket of those 500 companies. Let’s say you’ve got a basket of 500 private companies; a mix of mature, mid-market, large, buy out, some growth in there, and some venture, both early stage and later stage venture.

So you’ve got this mix of 500 private companies, some super early stage, some very mature, and you can’t pull out your phone and buy this basket. You can’t trade it. You’ve got to get it either directly, go cut these deals yourselves or through external managers. So that’s the comparison I’m going to use: the S&P 500 is a liquid basket, and (let’s call it) the Private 500, this basket of 500 private companies. If you go back to how you calculate risk, you’ve got three main pieces of risk.

You’ve got your weights, how much money do you have in each asset, you got your volatilities, just the standalone volatility of each of those 500 companies, and then you’ve got the correlation matrix of that entire basket; how they correlate, how every single one of those correlate with each other. That correlation piece was really the insight for me. I’ve had different people say, well, wait a minute, you’re investing in venture capital, the volatility on these companies is huge. I’ll give you that. I’ll give you that.

The idiosyncratic standalone volatility on pick your early-stage venture company is enormous. Now, its weight, its dollar weight is also tiny, just tiny. It’s the smallest check size in that basket of, call it, the Private 500. Companies grow and through their operating performance, they grow cash flows. As those companies continue to grow and perform, they get follow-ons, they do more raises, they also grow from a capital base. So, the smallest check sizes are those ones where you’ve got the most question around at early stage.

So you’ve got a very, very small capital amount which in the risk model makes it very, very small. You’ve got a huge idiosyncratic volatility for each of those early-stage companies, and then you’ve got the correlation matrix. The correlations are where I think a lot of people are missing when they try to use public market information and model these private markets. I’m a big fan of Cliff Asness. He’s used this term “volatility laundering”. It’s a great term. I love it. I get it. I’m on the other side of that.

All of this work, when you do this and you assign weights, volatilities in a correlation matrix for this basket of 500 private companies, the bigger weights in there are not the early-stage companies. The bigger weights in there are mature, cash flowing, very stable businesses, and their volatility is lower. But really, to me, the biggest insight through all of this work was the correlation. The correlations should be lower when you’re dealing with private companies. Their correlations with each other should be lower. They can’t be traded together. There’s no future, there’s no index, there’s no ETF that can immediately move this basket.

Liquidity conditions are going to move prices so much faster in public markets than private markets. You don’t have banks. I don’t really have a single bank in my Private 500. From a sector perspective, there’s no banks in there. The correlations of a software company in Palo Alto versus a biotech company in Boston, almost zero, call it almost zero. So when you have that richness of really low correlations among these 500 private companies that, I think, gets really overlooked by people.

Well, let’s just use the Russell 2000. Let’s just use public market information. Well, it’s like you could do that, but it’s not reality of what you own in this Private 500. You end up with a lot of correlation offsets despite some really large idiosyncratic volatilities on the venture capital piece, which is still kind of a minority piece of this Private 500. A long way of saying like, what do I get to? I get to roughly a 12% to 15% volatility estimate that’s spot on the S&P 500.

My own personal belief, this is going to be heresy for a lot of people, but my own personal belief is that the volatility of that basket of Private 500, if it’s diversified across vintage, diversified across geography, is less than the volatility of the S&P 500. I’ve gone in circles thinking about this and trying to model it. I reserve the right to change my mind at some point, but right now, I really feel like my own personal opinion is a little bit less vol than the S&P 500.

If you’re modeling just venture capital, which we do, we break apart private equity and venture capital in our asset allocation construct and our risk allocation construct, I would assign a higher volatility. We’ve got like an 18% vol for just the venture piece. Again, a lot of that coming from the correlation offsets that are happening with these private companies.

[00:30:53] Alan

Yeah. Because I’ve seen some research on this that would say maybe if you regressed the performance of a VC index on say the S&P 500, you get a beta of maybe 1.4 or something like that. But not only that, you might have a negative convexity, that in the really extreme scenarios, downside for equities, it’s going to do even worse. You can imagine scenarios where that would be the case. But what you say does make sense as well from a correlation perspective.

So a couple of questions on that. One, in terms of your 12% to 15% vol estimate on the privates. Is that assuming that a chunk of it is in stable, cash flow generative more mature businesses, as you say? Is that what drives that? Is that right?

[00:31:44] Clint

It’s a little bit of both. Absolutely. The bigger weights… If you look at the S&P 500, today, it’s nowhere close to an equal weight index. If you look at Amazon, Apple, Microsoft, these are mega-cap massive weights. When I’ve done my work and looked at a mature private equity portfolio, you actually get something quite similar. You get these massive, massive weights. Those weights tend to be in the more mature cashflow stable companies and the smaller weights tend to be in the most volatile early-stage companies.

You get this richness… So that’s a piece of it, but then you get this richness of correlation. So why can’t you just take the volatilities of your 500 companies and just weight them and say, okay, I’ve got these weights, I’ve got these volatilities, my volatility of the package, why isn’t it just the weighted volatility? Well, it is if you assume a correlation of 1 across all 50 companies, then it’s just pure weighted volatilities. But this is where the insight to me is really powerful, which is you get such low correlations, zeros, point ones, point twos, point threes, that when you put that whole correlation matrix together, it really brings down the volatility of that private page.

Now, I’m talking about the intercorrelations of the companies within the Private 500. If you ask me, which is very important to do in my asset allocation work, well, what correlation are you using between private equity and public equity, I’m using a 0.6, 0.7, maybe 0.75 correlation, which is high. That’s moderately high. It’s not a 1. I still don’t think it’s a pure 1 correlation between privates and publics, but it’s high. But when I do the whole package of my implied return model, input my correlations, I’ve got that 0.6, 0.7 between publics and private; public equity, private equity, I’ve got my volatility estimates. You know what? You don’t have to believe me.

If you don’t like those volatility estimates or those correlations, put in what you think. Put in the model what you think is right and it will spit out an implied return that you can then debate with yourself to say do I believe that return or not.

[00:34:17] Alan

I think it’s a really interesting question. A couple of more questions on it just to get your thoughts on. Obviously, we all know about the scenario of correlation is going to 1 in public markets. Could you get that type of scenario in extreme economic downturns that more startups will tend to fail so those low correlations between the software and the biotech company might increase a bit. So that’s one question.

The second thing is the realizable value in these stakes could also take a hit in an economic downturn if investors are generally overleveraged and kind of in a liquidation type of mode. Now, you might say that doesn’t matter from the pure valuation inherent value perspective, but in terms of valuing those stakes, basically, is the left tail potentially fatter than what you might think based purely on the correlation?

[00:35:26] Clint

The short answer is absolutely, I’m going to recognize that there’s going to be some economic impact. At the end of the day, if you have exposure to companies and cash flows in a certain country, whether that’s a public company or a private company, there’s absolutely this base of correlation and sensitivity to economic outcomes, clearly. When I do my risk modeling, I do three cuts of risk. I do what I call average risk. These are my long-term average volatilities of taking the whole next 5,10 years, what do I expect on average, knowing that on a shorter term, there’s going to be periods of higher volatility, periods of lower volatility, it’s the averages. That’s the first cut.

The second cut is the downside. That’s really where I can start to think more clearly about exactly the point that you bring up, which is, well, what about downturns, economic downturns when correlations rise. This is where I put in like, okay, let’s consider this a three standard deviation event. What have I got here? I’ve got a recession. I’ve got higher volatilities. I’ve got correlations in certain asset classes that are increasing. I can input. I can input those numbers and see, okay, exactly what’s my difference between my average volatility and my downside volatility where I’m using a different correlation matrix, higher volatilities.

Then the third cut I do is relative to benchmark. So think tracking error. Instead of absolute volatilities and correlations, I’m using all relative to benchmark, which is the third way I use this risk model in helping me think through the risk in my portfolio.

[00:37:34] Alan

As you’re going through that process, do you have a number in mind in terms of max drawdown that you’re comfortable enduring or absolute worst case? What kind of parameters have you around that?

[00:37:45] Clint

Absolutely, 15% to 20%. If I’m building a portfolio for the foundation that can give me, in a worst-case scenario whatever you want to call it, 3, 4, or 5 standard deviation, just your worst peak to trough drawdown that you would expect over 30, 40, 50 years, I don’t want that to be worse than 15% to 20%. That’s just too much drawdown for the portfolio. At the end of the day, we say we’re all long-term investors and you’re long-term until you’re not. You get into these committee meetings and you’ve got human emotions.

When you’re looking at a number that’s 15% below your peak portfolio value and you’re having these discussions, there’s human behavior that creeps into that investment committee, in those discussions, in those decisions. It would be difficult for me to build a portfolio and offer that as the optimal portfolio if it could possibly have a drawdown worse than that 15% to 20% range.

[00:39:06] Alan

You mentioned as well, obviously, you have a 15% allocation to multi-asset or you have that multi-asset category, which is a bit of a catch-all but largely hedge funds. Curious to hear, how do you think about that? What types of strategies are in there? Are they there for absolute return or for downside protection or for diversification or for all of the above? What’s the thought process?

[00:39:30] Clint

All of the above. In our annual asset allocation review, we just increased multi-asset to 15%. Part of the thinking there, again, is the next 10 years probably aren’t going to be a repeat of the last 10 years. We like strategies that are going to benefit from dispersion, dispersion between securities, dispersion between sectors, dispersion between countries, currencies. One of the only places we can get that is in long-short space, arbitrage space where they can use both sides of the book and really put together more alpha, less beta, and benefit from dispersion among all the thousands of securities and opportunities in public markets around the world.

So we’ve got a few strategies that we like that are in call it systematic long-short, very tight risk management, very tight exposures to risk factors, not taking big bets, really trying to minimize those and just focus on the alpha signals. That’s a very tough game but we think to the extent we could find some managers who have an edge in that area called systematic long-short could be an attractive area for us over the next 10 years.

[00:41:12] Alan

Any reason for that preference for long-short in comparison to more directional? People talk about convergent versus divergent strategies within the hedge fund space. Obviously, if the world is going to look more different and more challenging over the next 10 years, we could make the case for more volatility, greater dislocations as well as dispersion, which might be beneficial for more directional strategies. What’s your perspective on that?

[00:41:46] Clint

I’m really sensitive to what I’m paying for. When I’m paying active fees, how much beta am I getting, how much exposure to risk premia am I getting, and how much true alpha after all of the exposure to various risk factors, risk premia, trying to adjust for skill versus luck. What is that skill-based return that I’m left with that I’m really paying for in terms of active fees?

I’m paying a lot. I’m paying a lot in private equity and venture capital. I’m paying a lot in hedge funds. I’m paying a lot for active management. I really want to make sure that I’m getting a return stream that is delivering something we’re paying for. If it’s got a lot of beta, it’s really hard for me. There are some strategies, think distressed credit, where it’s just going to come with beta. To get the alpha, you have to take the beta. But a lot of those strategies are really hard for me.

I’ve got plenty of market risk. I’ve got plenty of equity risk. I’ve got plenty of private equity in the portfolio. I’m really looking for something different. I also need that rebalancing capability in my multi-asset bucket. If markets are down like 2022, I really need an absolute return-ish independent return stream. That’s what I’m looking for. People have different asset allocations, and I could see how directional could fit into different constructs, but I’m really looking to build that multi-asset bucket from an independent return stream, less correlated.

I don’t view it as a tail hedge. I don’t really view it like all that side on the pendulum of being a pure tail hedge or crisis alpha. There are some strategies in there that might be down, might be up, but it needs to be liquid, it needs to be independent, it needs to be alpha worth paying for, and that’s what I’m looking for. I really don’t do a lot in directional long-short equity. That is a tough, tough game, trying to predict next quarter’s earnings when very diversified, across sectors.

I’ve got a couple of long-short equity managers, one in micro-cap banks, one in biotech, that are very, very narrow and specific and have tighter risk management between the long and the short puts. We can find some nice alpha in those strategies. That’s really the only place that I get into long-short equity.

[00:44:41] Alan

What about things like global macro or managed futures, trend following, that type of absolute return, but potentially crisis risk offset type profile?

[00:44:52] Clint

Short answer is I like it. We own some, we’re looking at some. We’re looking at doing more in that area. My caveat to that answer is that I’m looking for diversity of signal, not just a simple trend following strategy over a medium-term horizon. I’m really looking for an ensemble of models, a suite of signals and models where we don’t own anything that’s just pure trend following, but we have a couple of the sleeves inside of this broader macro strategy that are very much trend following. So I tend to skew to those.

Again, I’m trying to find something more independent return, but also consistent return. If I have a strategy that doesn’t work for seven years, and only gives me alpha in some big negative, to me, that’s not really what I’m looking for. That’s just not what I’m looking for. It’s hard to stay in those strategies quite honestly. So I need something that’s got a little bit more diversification, a little bit more absolute return nature where it can be clipping along and not some simple, naïve, trend following model that may work very, very well in a 2022 and then go 7 years without working. I’m looking for a little bit more diversity there.

[00:46:35] Alan

Interesting. That brings us to the topic of manager selection and how you think about that. You said something interesting at the start with you were very much a stock picker earlier in your career and then you went to Cornell University and you enjoyed the strategic asset allocation, manager selection, that side of things. Do you think it’s a different skill set evaluating managers versus doing fundamental security analysis?

[00:47:02] Clint

Absolutely. Now, does having experience with the underlying instruments of whatever they’re trading, public equities, futures, commodities, when you’re sitting across the table from a portfolio manager evaluating their strategy and what they’re doing, does having your own experience trading those instruments and those asset classes help? Absolutely as well. So I think the thing that I loved about it was that coming from a more narrow kind of value- I’m very much a value investor.

My finance textbook in undergrad was Graham and Dodd’s Security Analysis. I think I’m always going to have those valuation roots to my investing approach. But as I look at other strategies across asset classes, across the world, across different things that people are doing for both fundamental and systematic processes, I just realized there are a lot of ways to make money and there are markets and opportunities to isolate and capture the alpha in that area. It’s not just the simple fundamental intrinsic value approach.

There may be different tools and different strategies. So I loved being able to look and evaluate all these various people and processes and portfolios and different ways of doing things to say, is that worth paying for? Am I getting anything there? My default is always going into looking at a strategy, evaluating a manager is there’s no alpha here. That’s my default. I’ve got to be proved otherwise that there’s something worth paying for, there’s something special here, either the nature of the market, the nature of what they’re doing have to tie together.

I can look across my career and say there are times where I got so excited that I found something special and it just really gets me excited, but they’re hard to come by. It’s not easy.

[00:49:06] Alan

Yeah. What does that look like then, something special or something that you’re genuinely convinced is non-random and worth paying for?

[00:49:15] Clint

Capacity constrained, it’s almost always something that sounds hard to believe after having our discussion on global macro which were these enormous trillion dollar liquid markets around the world that can be easily traded. But honestly, those are the hardest for me to underwrite; the very hardest strategies for me to underwrite. As I go from macro and massive market down to smaller, and smaller, and smaller, and more niche capacity constrained opportunities where… Let’s go back to the micro-cap banks. This hedge fund that only invests in one thing and they do one thing really, really well.

I get excited about that, specialists that have dedicated their career to a specific asset class, to a specific area, to a specific niche. They’re more interested in alpha and delivering a track record that is independent, that is special, than growing their economic base. Clearly, there are times where if they just took in more AUM and there’s demand for that AUM, they could get richer if they just did that and it would dilute their returns. Sometimes that happens, and I see that as well.

But when I can find those people that are like I want returns over economics, I want to deliver something special over just getting rich, then that’s a unique formula for me when they’ve got the skill set, the people, the process, and it’s all aligned with this portfolio, and you can do the attribution and you can look at the biggest contributors, the biggest detractors through time and see like, how did you get into this position? What was your research? What was your insight that led you to take this position which led to this really nice P&L, this really nice return for this year or for this series of years?

As you go and tie that process and that group of people to their positions in that P&L, and you can see like, oh, wow, they had some unique insight here, they were ahead of the market, they had some research or a competitive advantage that I couldn’t find anywhere else, it’s hard to find. It’s really, really hard to find. But that’s what I’m looking for. Niche, capacity constrained, interesting people who are specialists in an area, their bigger focus is really to just deliver exceptional returns.

[00:52:03] Alan

What do you think is the most challenging bit then picking managers would you say?

[00:52:07] Clint

Yeah, attribution is tough, dirty work. I live and breathe attribution and for both my own portfolio and my own decision making, it helps me become better as a portfolio manager and as overseeing this foundation portfolio. I want to know what drives returns. I’m always surprised. When I do that, I’m always surprised that like, “Oh, I thought this was going to be my biggest contributor or detractor,” and every once in a while, it’s like that doesn’t line up with my own thinking.

Doing that work with a manager and going through okay, I want to understand your insights that led to your positions and doing that attribution work to me, it’s difficult. It’s very difficult to say, what’s luck, what’s skill? There are times where you can ride some waves and look like a complete genius. It’s a really difficult thing to pull apart, all these risk factors. Am I just looking at something that was an artifact of the environment of that of that 5, 10-year period?

I’ve got various quantitative tools to try to pull those apart, but it’s never black and white. It’s almost never black and white. It’s trying to assess and understand and pull apart luck versus skill. It’s not an easy thing to do.

[00:53:43] Alan

I’m curious. Obviously, you’re in a unique seat, as we said at the outset, in the sense that you’re running this foundation style portfolio, but you’re still dabbling in real businesses and looking at businesses that are involved commercially in the economy. Does that yield important insights for you as you go about sourcing opportunities?

[00:54:05] Clint

Very much so. Why can’t people just copy let’s call it the Yale Endowment? They can. From an asset allocation perspective, they could pull up the annual report and just say those are my weights, those are my asset classes, those are my weights, but you’re going to get very, very different results than Yale most likely. To me, the magic is really within bucket, within asset class. Let’s take real estate for example, let’s take natural resources for example.

How do you go about building a real estate portfolio? If you had a book of office properties in New York and Chicago and San Francisco versus a book of real estate in multifamily and industrial and call it the Southwest growing economic areas, your returns in real estate could be night and day difference. Exact same asset allocation, but your exposures and your risks and your returns and the managers and implementation and the properties and the implementation of that book could be very, very different.

Natural resources, whether you’re in agriculture, timber, oil and gas, carbon markets, there’s so much creativity in terms of what is going to really drive the risk and return within each of those asset classes. I get to sit on a board of a company called Nano-Yield. Its headquarter is a mile from our office. We sourced it here, we invested in it here at LHM, not in the foundation, but in the company. It’s got a really cool technology in terms of nanoparticles. It increases plant absorption. The applications for fertilizer and crop inputs around the world are just enormous, global application, headquartered right here.

We’ve networked into it and the insights that I learned from looking at that specific business, sitting on the board, understanding the types of products and commercialization that’s happening there, understanding their go-to-market strategy, understanding what they’re doing in the US versus South America versus India, does that color my view in the foundation when I’m looking across these asset classes and how to implement?

Absolutely. It gives me point of view, it gives me insight. It helps me think about right now, boy, maybe within natural resources, I’m going to tilt toward oil and gas because I see this kind of medium-term, long-term supply-demand dynamic that is really interesting, where underinvestment today is going to lead to better pricing in the future. Having those whether it’s an individual property or an individual company on the Larry H. Miller Company side where we can have those insights to our own businesses.

We’re big into real estate, we’re big into senior living, we’ve got a number of home services, and fintech and ag tech, and a number of other themes and investments across the platform. Having those insights, when I’m sitting with managers and talking about what they’re doing, talking about our specific businesses, it just brings a lot of circular learning for me to be able to ask different questions and pick up on different things.

[00:57:55] Alan

Obviously in your role, you have to not only do all of the investing, but you’ve got to I guess leverage the skills of your whole team or the people that you put in place. So I’m curious to get your thoughts on what does a good investment process look like from, A, a decision-making perspective. Is it consensus? Is it the CIO calling the shots? What works best? Obviously, there’s pros and cons to different approaches. Second, I suppose, in terms of building an investment team, what does that involve? How do you go about hiring talent and putting a team together?

[00:58:36] Clint

Yeah. Alan, you can ask me in 10 years if we did this right. It’s going to take some time to see if the processes and the people and the frameworks that we’ve set up are effective. But we’ve built a small team here, we’ve got three senior people and three junior people, including myself, and then a rock star person on the legal side that does a lot of work for us as well. The three senior people, my function is overlooking the total foundation portfolio and then I’ve got a head of the for private asset classes and a head of the four public asset classes.

Basically, we each have an analyst to support our work. When you look at everything that we’re doing, across the foundation, across Larry H. Miller Company, that’s a pretty small team to try to cover everything that we’re looking at, everything that we’re trying to do across the world, across public-private markets. But we’ve got a great network. There’s a sister investment team just dedicated to the Larry H Miller company that’s looking at our businesses and our direct deals, that we work closely with. I want to empower my people. I try really, really hard to get input from my team.

At the end of the day, I feel like I have to sign off on everything. So coming back to your question about process and committees, I’ve got to sit in front of the foundation board, which is made up of the family members, and look them in the eye and say I believe in this portfolio, I believe in these investments. So I have to get to a comfort level, even if I’m not the analyst or the senior person doing the deep, deep, deep dive on every single strategy, every single manager, I’ve got to get deep enough on every single one where I can say, okay, I understand your work, I get it.

But I want everybody’s opinion. I want my public market’s opinion on a private market investment, and vice versa. I want the most junior person to be able to feel empowered to pipe up, share their opinion, and not feel like the bosses have spoken, I don’t want to look dumb. So I try to balance that. I’m a very opinionated person but I want to have that balance of empowering my team. So every investment that we put forward to the investment committee for the foundation I feel like has my blessing and has the team’s blessing.

If somebody has said, well, I’m not sure about that, let’s pause, let’s figure this out. I’ve learned in writing diligence memos for the last 15 years on various strategies, managers and companies, instead of trying to find all of the good information and present the strongest case, it’s much better to treat it as a discovery process. Here are the risks. Here’s what I like, here’s what I don’t like. Here are the risks that I see. Here’s what I think is really compelling and just treat it as a balanced discovery process and not a “I’ve got to convince everybody because I’ve done the work and I want to get this through and I want my name on it in the portfolio.”

So we’re trying hard. I don’t think we’ve got it nailed down. I don’t think we’ve got it perfected. But we’re trying hard in our memos and in our discussions to treat it more as a discovery process so that everybody can feel like, okay, I’m okay with asking a difficult question, and hey, if that leads to something that changes our mind, that’s good process. That’s good process. I don’t want to take it to the investment committee if we found something that changes our mind about an investment. I want that to happen with my team.

Our foundation investment committee has been very, very supportive. They’ll ask some questions. They’ll come back to us once in a while and say, what about this, but for the most part, as our team has done the work and done the diligence and presented something, they understand the framework, they understand the asset allocation structure, our strategic targets, what we’re trying to achieve over the next 5 to 10 years, and they’re very supportive on individual strategies and managers within the framework.

[01:03:03] Alan

In terms of obviously, you mentioned analysts, are they tending to be generalists or specialists? I guess from your own perspective, you’ve done a bunch of different things over the years. Is that valuable? If somebody wants to be a CIO, is that something you would recommend having done different roles, if that was the ultimate kind of objective?

[01:03:30] Clint

I think so. I think there’s this balance between specialist in one area and generalist. There are times when you need both. There are times where you need deep industry-specific knowledge or even instrument-specific knowledge, doing work on various pieces of the structured credit markets and mortgage-backed securities. Having somebody with deep knowledge is going to be really valuable. At the same time, when you’re discussing what asset class should get the next dollar, the marginal dollar.

As we go through our annual strategic asset allocation exercise, you can’t just be a cheerleader for your asset classes that you cover. You’ve got to be able to think, what are my returns and risks here? What are my returns and risks here? We’re just trying to get to the very, very best answer we can and so we’re trying to strike the right balance. Again, I don’t think we’ve perfected it.

Right now, each junior person is connected to a senior person. So we’ve got a junior person on privates, a junior person on publics, and we’ve got a junior person in the middle that’s helping across both. But trying to still have that layer of being able to ask questions and poke and prod, whether it’s public or private, because at the end of the day, I want everybody thinking about the total portfolio and our long-term returns, coming back to that.

The biggest risk that we have is not meeting our objectives. We want to create something very special. We want to create a very special return stream 5, 10, 20 years, we look back, of course, we want to be in the top decile of foundation performance but that’s not our first goal. Our first goal is really to do something special with 5%, cover the 5% plus inflation, and do our very best around delivering on that within a nice, controlled risk when it comes to drawdown, liquidity, all those things. As the team grows, that’s harder and harder to do. It’s easier and easier to do the smaller you are.

I’ve realized as the team grows, I’m going to do my very best to keep that balance of having everybody still think of themselves as a generalist and having ownership in the total. I don’t want to get to the point, no matter how big my team grows, whether we’re the same six people in 20 years or whether we’ve doubled or tripled in size, I don’t want to get to the point where somebody is, “I’m just a real estate person, I’m just the international equities person.” I never ever want that to happen.

I want the entire team to feel ownership and to be able to kind of punk each other and help us get to the very, very best answer. You don’t get that by just saying okay, I don’t do that. I’ll just let them. It takes stretching and thinking and getting outside your comfort zone but I’m hoping we can continue to build and create that culture here.

[01:06:52] Alan

Good stuff. So maybe just to wrap up, and we always ask guests if you were to give some advice to people starting off in their careers or people who want to get into endowment investing or multi-asset or ultimately be a CIO, what things to read, things to do. What would your advice be?

[01:07:15] Clint

I did not reach out enough, when I was younger, and really seek mentors and really seek to network and create my own professional relationships and network with other people. I should have done more of that once I realized that it worked, that most people were really actually good human beings and interested. If you are genuine, if you are real in saying, hey, I have a passion for this, I’m interested in this, I have found you for these specific reasons because you’re in this role and you’re doing this thing and that looks really interesting to me and I just want to learn. Can we have a call? Can we go to lunch?

I’ve found that not always, but for the most part, it’s going to resonate with that person, if you are genuine, if you are authentic. I would recommend the earlier you can learn that and do that [the better]. I tell students, I am an adjunct professor at the University of Utah and I tell students, hey, you actually have superpowers, as a student, that you don’t realize you have. As long as you’ve got that .edu email and use that and are reaching out to people like, most people kind of have a natural soft spot, they’re willing to respond, especially knowing that you’re a student and in that role.

You kind of lose that superpower a little bit once you get out in the industry. If you’re working for a fund or something it’s like, you’re fine, you can figure it. But reach out, network, do your homework. Don’t spam people. I’m certainly not advocating a mass spam campaign, but be genuine, authentic, figure out what you’re interested in and learn from other. In terms of what to read, clearly, David Swensen’s Pioneering Portfolio Management book. That’s like basic reading, that’s like required reading for my team.

Beyond that, I wish I had something, but I don’t. I don’t have a book or one resource. I read as much as I can about different portfolio construction techniques. I want to learn the good and the bad. I see things that make a lot of sense but don’t speak to my edge or speak to my competitive advantage so I’ve got to do things my way. But that doesn’t mean I’m not willing to learn why other people are doing something in a portfolio. So I’m constantly reading, understanding, trying to build conviction. I do that through all kinds of stuff.

The Harvard Business Case studies on Yale and the Canadian Pension CPB are really good. I read a lot of industry research. I network and talk with people. I’ve obviously met a lot of people in my career in similar roles and constantly trading notes and comparing notes. I’m very open that way. I found that the more transparent that I can be with others all the way down to the details of what I’m doing, the more transparency I get from them and they realize that I’m not out to steal their ideas.

It becomes a much more mutual beneficial relationship of showing that transparency and just creating really good conversations over the years. So I’ve got a number of people that we just continue to talk and trade ideas and that’s incredibly valuable to me, the human element.

[01:11:02] Alan

Very good. Well, Clint, this has been a great conversation. Thanks very much for joining us today.

Make sure to follow Clint’s work, because obviously, he’s got a lot to say about asset allocation and it’s more important ever to understand that in the financial landscape that we are in today. So from all of us here at Top Traders Unplugged, thank you for joining in and we’ll be back again soon with more exciting content, so stay tuned.

[01:11:29] Ending

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