Andrew Beer on the Hedge Fund Industry (Podcast)

doing liquid alternatives. Really quite fascinating. Their goal is to roll out things that look like hedge funds, but with full transparency, liquidity, and none of the high fees it It's really a fascinating space, sort of bringing the philosophy of Jack Bogel to the hedge fund space. If you're at all interested in liquid alts or managed futures, or want to learn how these things work, I think you'll

find this to be a fascinating and wonky conversation. So, with no further ado, my conversation with Dynamic Beta's Andrew Beer. Vias is men Steers in Business with Barry Ridholts on Bloomberg Radio. My special guest this week is Andrew Beer. He is a managing member at Dynamic Beta Investments, one

of the older firms in the liquid ault space. Their goal is to deliver hedge fund like returns, but with reasonable fees and daily liquidly UH their long short hedge funny t F was up for the year in while their managed futures fund was flat. Andrew Beer, Welcome to Bloomberg. Thank you, Barry. It's a pleasure to be on the call today. So let's start with your background. How did you find your way to the investment management industry? So,

I it wasn't clear. I guess um. I started as an em and a banker in the early UH and back then, if you were an energetic young m and a banker, you wanted to go into the aldo business. That's where all the kind of same and glory was. And so I went back to business school. One of my second year of business school, I I got a job at one of the LBO firms, a very well respected firm in Boston run by guy named Tom Lee.

And in my so I was kind of in my second year of business school and thinking about where I was going to go in that industry, and I heard about the secretive investment firm bow Post that had been started by some Harvard Business School professors and was hiring. So I applied. And I don't think I knew what a hedge fund was but I really really like it. I'd get focusing on these weird niche investment opportunities. So instead of going into the LBO business or possibly doing

a PhD, I became a hedge fun guy. And you know, twenty six years later, I'm I'm stuck in that role. So let's stay with bout post for a minute. It's run by Seth Clarman, a legendary investor. His book Margin of Safety was published years ago and then went out of print. Copies go for some crazy two thousand dollars a copy on Amazon. What was it like working with a legend like Seth Clarman? So it was, I mean, it says it's extraordinary. I mean he is. He is

absolutely brilliant. And I think the interesting thing about Seth, which is uh, is that Seth was a value investor, probably from the day that he was born. It wasn't something it wasn't a study that he read about. It wasn't an academic paper that that resonated with him. Um. He just thought of things in terms of value. Uh. And but I think it's it's really important to note that this was in the early stages of the industry. The hedge fund industry was really a cottage industry back then.

Just to put it in perspective, bow Post had two percent of the assets then that it has today, and it was still considered one of the ten largest hedge funds. Um. So, so what you can do with six million versus one point eight million is very very different. And then you know, and then a lot of these markets that people invest in today were also in their infancy um so um. You know, so he really was. It was an extraordinary learning experience, and I think I think there are probably

three big things that I learned from Seth. And I think the first was you should try to get the area right um. In other words, it's much better to find a dirt cheap area and spend your time then then spend your time trying to find the best idea in an expensive one. Um. And then I think the second is that that things should be cheap for a reason. Uh.

And there's a certain humility in that. I think Seth never thought that he could look at some big, large cap stock that everybody else was looking at and think he had a meaningful advantage. But if he could see banks unloading real estate assets or UM, you know, because they had a certain regulatory requirement where they had to get rid of them. Well, that gave you a reason why something might be selling it a discount. And I think the third point is that risk isn't a statistic um.

That there are a lot of qualitative and other judgments that go into thinking about the riskiness of an asset. So the whole idea of margin of safety UM is really embedded in in this kind of complex, multidimensional thinking. And in part it was that UM, I think in in more recent years, as I've thought about those years, I think it's one of the reasons that concluded that value, the value factor per se was really missing something. But

that's part of a much larger discussion. I think, well, we're definitely gonna get to the value factor a little later, you know. Your your comment about bow Post having two of the assets in the hedge fund space reminds me of a comment that Jim Chano's famously made. He said thirty years ago when he was launching his funds, Uh, there were a hundred hedge funds, they all created Alpha.

Today there's over ten thousand hedge funds. But it seems like it's still those hundred hedge funds that are creating alpha. Is that an overstatement or is there some truth to that? So I think the hardest thing about hedge funds is um is we're always looking at who is doing well today, and people have a natural bias to assume that's going to continue. UM. And so if you go back in time,

it's a little bit like the mutual fund industry. I remember, back when I was at Bell Post, I was talking to Guide Fidelity and he said, you know, we started twelve new mutual funds every year, and we killed six of them by June, and by the end of the year, we've got three great performers. Um. The hedgehoan industry isn't quite like that, But when you do look at hedge funds today, people tend to focus on those hundreds that

have done well. What was interesting about was that as as much as you repressed about guys, you know, having historically good years, there are plenty of guys who had middling years and and and you know plenty of guys who at awful years and so um. You know. So the hedgewood industry as a whole, I think had a difficult but not nearly as bad as as it was portrayed in the press. So let's talk about that, because the reputation, especially since the Great Financial Crisis, was the

performance has been lacking. That the joke is come for the high fee, stay for the under performance. Do you think that's too hard or is that there for certainly the bottom half of the hedge fund community, if not more so. Here's an interesting it's interesting statistic that if you could pick the top quartile of hedge funds in advance, you'd be up thirty percent a year with no down years. No one would care about fees, right, It's it's a

little bit. It's a little bit like saying, I mean, the hedge fund industry is even probably more so than the mutual fund industry today, is replete with this idea that you know, we're going to find the guy who's going to go up. Um. In reality, people found find the guy who went up and so, but that issue aside um, uh. There. The disappointment about hedge funds in

the Tents comes from three areas. The first is that as that two thousand and eight was quite bad um, and it wasn't just that hedge funds went down more than expected, but that made off blew up large parts of the business, and there was widespread suspension of capital for investors who wanted to get out. Uh. So you know, this was a It was about as bad as it could have been from a pr perspective for hedge funds UM.

And it was also in in in stark contrast to the previous bear market, where hedge funds uh, you know, actually made money during the bear market, something quite extraordinary. UM. But the second issue in the two thousand tens is that easy things did better um in the two thousand tens. Sort that in the two thousands we had essentially a lost decade for US equities. You know, the SMP was down over the decade, NASAC was down something and in the two thousand tents, just by owning large cap us

and tech, I mean that pretty much destroyed everything else. Um. And then the last is that is that fees are too high. And this is something I've written a lot about, but basically, when somebody's earning three or four percent and they're taking half of every dollar that they make, um Uh, people get more frustrated with that over time. And so it's it's sort of it's sort of a combination of factors,

and they're of psychological reasons. Um why But I think actually the most interesting thing is that look a lot better. That discussion of fees kind of leads me to a different place, which is there have been some fairly innovative new concepts in fees, not just the compression, but but things like pivot fees where there's a participation to the upside only if the fund is beating its benchmark, and there's even a giveback if the fund is underperforming it's benchmark.

What what do you think that looks like in the future? Are we going to see some innovation around traditionally higher hedge fund fees? So? Um, I think it's going to be mixed. I think a lot of the industry. Um. You know, one of the one of the reasons there there are a couple of reasons that hedge fund fees have remained so high. Um. The the stark reality is that most people who allocate two hedge funds, it's not

their money, so they really don't care. At the end of the day, you know, they're they're investing in a hedge fund because I mean, if you read the Financial Times, or um or Bloombergs had some very good articles recently on hedge funds that have gone up a hundred percent. People will be lining up at the door and completely in different defeats because it's much easier for people to say, UM, you know, I don't care about fees as long as

my net returns are high. The problem is is when you've got twenty guys and you're paying away six out of every ten dollars that they make in fees, and you look back over three or five years and um uh and hedge funds have the hedge fund managers have made billions of dollars and clients really happened. And there was one article recently a better firm called Brevan Howard, which is by all accounts run by Kindaman Alan Howard, who's one of the greats of the hedge fund industry.

UM and those articles are talking about the fact that his funds had historically good year. What they don't mention is that when he had thirty billion dollars in assets, they went through a five year period of time where by my estimate, management made two to three billion dollars while clients lost money. UM so, so fees are are a real perpetual issue in terms of fulcrum fees and things like that. I doubt most hetch ones will do it.

I think you'll have a bifurcation of products where some will be expensive, um, some will be worth it, a lot won't be worth it, and then you'll have a suite of lower cost options for allocators to pick from. Quite quite fascinating, So let's talk about this area. It's quite fascinating. When did liquid alternatives begin to take off?

What does the space look like today? So it's a it's a great question, and I think I think the backdrop of liquid alts, You know, why do people care about liquid als in the first place, basically comes down to two things. The first is that the whole wealth management industry has evolved tour trying to push clients into model portfolios, and model portfolios by by definition, have diversification

between stocks, bonds, and hopefully other things. And so you know, when you're building a model portfolio and you can include a lot of different asset classes um in general, your risk goes down and you get a smoother return profile

if you add in things that have diversification benefits. And you know, the analog for this, or the precedent for this is in the institutional space, where a corporate pension plan forty years ago may have had one or two asset classes in it, and today it might have thirty

or forty. So you know what liquid also are really designed to do, or to bring hedge fund like strategies that have proven diversification benefits, but make them available to investors who can't meet the high minimums, don't have the ability to, aren't a credited investors, um uh, can't bear

the i liquidity of investing in these products. Um. The real liquid al market really took off in my mind around two thousan and twelve, and that was when Fidelity gave money to a hedge fund firm called Harden to create a multi manager mutual fund and a lot of people thought this was going to be the resurgence of the fund of hedge fund industry, which had gotten battered during the Great Financial Crisis, and um and it launched this whole wave of alternative multi manager funds that were

designed to give you index plus like exposure to the hedge fund space. So they have you know, a couple of equity long short guys, a couple of credit guys, a couple of macro guys, etcetera. And and what it really did is it turned the attention of asset managers to this area when they looked across the world and they said, look at all these target date funds out there, you know, look at all these e t F based

model portfolios. These things are are are in our minds, under diversified because they don't have exposure to the same kinds of strategies that a big pension plan might have. And so it really kicked off this arms race among fund nigment companies. And there were forty or fifty of these funds that were launched within the next couple of years and they were um and then and then since then, there's really been this wave of wave after wave of

new products that have been launched. And so now there are hundreds of products out there, but um, you know. But it's one of the things we've written about is is that we think actually the products are are uh, shouldn't be shouldn't have investors, product should be shut down because they don't do what they were originally designed to do. So let's talk a little bit about both of those things.

What are these products designed to do. Is it simply we're going to capture a premium that your stocks and bonds aren't and give you daily liquidly. Is that the concept behind hedge fund replication et s, so hedge fund replications. So I think one change is that people generally don't think of hedge funds as a single massive strategy um and just to go back to the definition of hedge funds, I mean hedge funds, there are dozens and dozens of

different kinds of substrategies of hedge funds um. The the the common theme in hedge funds, which which I think is very important but but can be lost in some of this, is that in general hedge funds are a lot more flexible than mutual funds or et f so they're equivalent. So a guy who was a you know, invested primarily in tech stocks at the end of two thousand nineteen might be heavily invested in emerging market stocks today and he doesn't have allocators, you know, wondering why

he burst out of his his strategy bucket. And the other thing of the hedge funds no style boxes. I mean, the institutions have tried to put style boxes on it, but which has actually been negative for the industry. But but it's nothing like what you see in the mutual fund space. And the other is that these guys generally have their own money on the line. So I don't know many mutual funds where you've got the mutual fund manager as a billion dollars his own capital sitting alongside you.

And that enforces a particular intellectual honesty in it that if they think, uh, if they've just made a killing on you know, having owned Apple and Amazon over the past five years and they're taking profits, it doesn't mean that they have to turn around and go into Maderna or Teslas they think those stocks are overpriced, Um, they can. They can go to different areas and find cheaper opportunities

and so um. So you know, I think when people are looking at these strategies and thinking about as a portfolio perspective in the wealth management space, you start with the idea that there are specific strategies equity long short, you know, managed futures, um, uh, certain other strategies that can be building blocks into portfolio, and you can look at the very very long term returns of these strategies put them into your asset allocation model and make a

determination as to how much diversification benefit they provide and whether they should be in your portfolios. And so I think I think when the liquid alternative space, their move being away from some of these broad strategies that that that cover the whole universe to strategy specific building blocks, and that's what we really focused our time. So who are the owners of these liquid alls? Who are the allocators? Is it foundations? Institutional investors are a s. Who are

the buyers of these It's a good question. I have to say, I don't know the granular data. I suspect most of it is is ori as and wealth management firms that institutions who particularly those who don't have liquidity constraints, tend to like hedge actual hedge funds more than they like liquid alternatives. I would say five years ago I saw some consulting firms building liquid alts efforts, and that seems to have somewhat died out. I guess there are

there are two big problems with liquid aults. The first is that a lot of hedge fund strategies. When you take a guy who's been earning eight percent per annum in his hedge fund and you ask him to do the same thing in a mutual and uh, you often end up with three, four or five. So so you lose a lot of performance on the top just based

on on the constraints. And that was the problem with Fidelity its original investments is and this is something I think we were one of the few people who realized it pretty early on, is that they were losing four to five basis points of pre few returns just by asking these guys to do what they were doing within a mutual fund constraint UM. So broadly across the industry, Liquid Alts and willsher has good data on this, but broadly across the industry, will Liquid also under performed by

twohundred basis points. And that doesn't mean hedge funds were doing ten and these guys were doing eight. It means hedge ones were doing five and these guys were doing three. UM. And the other issue with single manager risk and you know, the of the products are simply single manager funds that

have been poorted into into a mutual fund. And the problem with that from a diversification perspective is that hedge funds strategies like equity long short as a strategy can provide or miniatutures as a strategy can provide valuable diversication benefits, but x y Z manager within that space generally does not.

And and the analog that we use is that if you know, if you like, many people today are saying US markets has gotten very expensive relative to say, emerging markets, and we want to move to emerging We want to add exposure to emerging markets. You don't pick a stock

in emerging markets and call it a day. But that whole idea of saying we like equity long short and we're going to give it to Bob is a terrible, terrible idea because Bob, like every other guy in the space, no matter what kind of a terror he's been on, he is going to blow up on you in the next couple of years. Mean reversion is a cruel mistress to say the least you mention managed futures as a form of liquid alts. I have to confess I have

never seen the attraction to this. It feels like the and I tend to think of this as the commodity traders, even though that's not fair. The rock star commodity traders tend to trade their own portfolios and everybody else tries to raise outside capital. Convince me I'm completely wrong about that. Sure, so you're not, I would say, Um, you're not at all completely wrong. The there are two great benefits of

managed tutures in the context of a larger portfolio. And let's take a step back and talk about what manner tutures is, right, So manor tutres, it's called futures because these guys go along and short futures contracts, and it's

managed because they're not doing it in a passive way. Um. So, really, what it means if you walk onto uh, you know, walk into the office of a man of tutres hedge fund, You've got a bunch of guys with computers who are trying to identify in general, trying to identify trends and momentum among different markets. So if gold has been going up, is it is it likely to continue going up? If ten your treasury yields have been rising, should they be

shorting um the ten year treasury um? And then you know, and then and then the art and the science of it is figuring out which markets do you want to be long and short? When do you rebalance, etcetera. So that's where you get into the whole managed side of it. UM. Historically, manitutors have had two very very powerful benefits relative to UH for for a diverse fied portfolio, particularly of stocks

and bonds. The first is they tend to have zero correlation to both over time UM and although I will tell you that because they are long and short different things at different times, the correlations will go up and down over time. So it's not something like you're buying I don't know, like a private debt instrument that you don't mark to market. It does go up and down. And the second is that they've tended to do very

well in the worst equity markets. So they were up fifteen in two thousand and then continue to to do well in in um UH during that bear market, and then they were up in two thousand eight and then

did well in two thousand fourteen UM. So the and that's great, right because you know, even if you have a small FEP of two percent allocation to manage futures in in your standing with a client in the beginning of two thousand nine, and you have this you know, small beacon of green in the sea of red, you look like a hero. UM. The two issues with mannered futures, which are very very real, is that first, managed tuture's fees and expenses are still ridiculously high, and by that

I mean even in a big hitch fund product. But at time eight dollar gets back to clients, it's been after something like five basis points in fees and expenses.

And in the nineteen eighties and the early nineteen nineties, when you know, these strategies were completely esoteric and nobody knew how to do these things, this is one of the most expensive areas in the in the hedge fund space, I mean manager Bloomberg had an article that showed that one fund was charging about ten for an um UH and so fees have come down a lot, but not nearly as much as they should have UM and so as returns have come down as markets have become more efficient,

it means that basically, for the past five years, every dollar these guys have made has gone to them and their counterparties, not to clients UM. And then the second is single manager risk. Right, So now you have an area that's attractive but that on average has been earning zero and you want to add to its space because you believe in the long term diverstication benefits. What do you do. You find the one guy who killed it

over the past two years. Right, And the problem in the manage futures is the second problem is what we call single manager risk. When a guy outperforms everybody else I in our fifteen percent a year for two or three years. It's luck, not skills that they happen to be overweight treasuries in March, and they happen to be

long gold at the time the gold took off. And so what happens again and again in this space is that people say I want managed futures, I give it to this guy, and then he blows up on me. And you know, the poster child for this is a Qure, which did something phenomenally positive for the UH managed futures mutual fund space in two thousand ten when they launched what was a at that point a remarkably low cost product of a hundred and twenty one basis points um.

But they went through a good period and they became the default allocation in everybody's portfolio. So you'd have guys who would have a diversified portfolio and then five with a q r UM for their managed Future sleeve, and that fund went to fourteen and a half billion in assets. And then like every managed sutures fund that's been on a hot streak, it underperformed by over the next year

two and now it's lost its assets. So so our approach to it was really, we've got to solve If we want the two first benefits, you've got to solve those two issues. And the best way that we found to solve it is you replicate. So you basically imitation is the greatest form of flattery. You replicate twenty of the largest managators hedge funds, but you replicate what they're doing the four fees, so if they're long gold, by will go along gold. And but we don't have a

hundred basis points of treating costs. We don't have three basis points and fees. So we get you back to what these strategies can do before fees and and and pass those diversification benefits back to clients. Last question on this space, when you reference these sort of esoteric areas the academics would have us eve they're really outperforming. Part

of it, as you mentioned, was luck. Part of it is just inefficiencies in these lesser thinner markets, lesser traded thinner markets that when everybody eventually piles into those inefficiencies, eventually get arbitraged away. What what are your thoughts on on some of the academic criticisms of this. So I think there's a huge problem with academic finance in general. Um. The first problem is that most academic finance guys are

also practitioners. So this whole notion that academic finances some objective assessment of these markets, um uh is often clouded by the fact that you know, these guys have another paper where they're trying to sell you something. Um the um. But but but this notion that markets get more efficient

over time is absolutely true. Um. And I think you know, my criticism of the value factor is that, you know, what Fauma identified in nineteen was that these cheap, beaten up stocks, we're cheap and they were built to stay that way. I mean, think think about what it was like for Warren Buffett in the nineteen sixties to find

a stock like Berkshire Hathaway. He had to pick up the phone, probably a rotary phone at that point, you know, call information wherever this company was located, have them mail annual reports to him. He gets them two months later, he's calculating by hand the market cap. You know, he may. I mean, it's just it's just the level of information of just trying to get information on these companies was was was incredibly difficult, and there was no glory in that.

You know, this wasn't uh An m and a banker being you know, kind of showing up on the cover of Forbes. These guys were poiling in basements, in his case, in an attic. And so you know, now today you can pull up carefully curate, curated financial information on every publicly traded stock UM, you can screen them, you can

run analytics on it. It is the world has changed and the world has become more efficient, and there are you know, I think one of the things that I've been asked to do was write a book on this UM and just to use examples of kinds of things that people are doing thirty years ago that if you could go back thirty years ago, you would say, by everything, it's like, forget about whether you're paying eight cents and and farallon you know is paying seventy eight and some

other guy in Soros is, you know, is willing to pay a D two just by everything because the world has become much more difficult for active managers. Venture capitalist Mark Andresen said something very similar. Go back and look at at all the original investments they made in these pre public companies. Would would it have mattered if they paid twice as much for Facebook? Although admittedly there's a touch of survivorship bias in that. Let's talk a little

bit about the approach dynamic beta takes. What is unique about it. How do you guys go about replicating all of those single manager firms. So what we do a thing called hedge fund replications, and replication is a terrible term because it's I think a lot of people here and they think of mediocrity. But let me frame it

in a slightly different way. If the only way that you today could invest in the five hundred stocks in the S and P was by investing with active managers who charged three hundred basis points, and someone came along and said, we can directly access four to five hundred of those stocks and we'll charge you a hundred basis points for it, it would be a pretty clear decision that the latter is not only likely to give you the benefits of investing in the SMP five, but it's

probably gonna do a lot better than those active managers. And so what hedge fund replication basically is is it's using models to try to understand how hedge funds are position today across equities, rates, currencies, commodities, and then copy their asset allocation in a low cost form. And so

on our side, we really pioneered this idea. And by the way that the whole concept of hedge fund replication has been around since the mid two thousand's and it's really the only area of the liquid old space that has worked consistently and reliably. And it's not just us.

I mean, the way you would analyze this is you would you would look at what we've done, but also look at at other firms who've been in the space, um and um, and it's it's But what sort of remarkable about about this whole concept is that you don't just do as well as hedge funds. You tend to do better. And the reason you do better is entirely

through cutting out fees. Before the crisis in this space, people generally thought if we can create something that does just as well as this leading hedge fund index, but offers daily liquidity and low fees. We're gonna be heroes, right, this is gonna be We're gonna be the John Bogels

of of the alternative investment industry. And remarkably, they did it right, and we did it and so but after the crisis, we said, maybe we can even do better, because when we're seeing this portfolio of hedge funds delivering six percent per anum, maybe they're really doing ten be four fees. And if we can replicate eight or nine or even ten of the ten and charge less, it won't just be like an index product, it will be

an index plus product and um. And so I think I think we're now known as the only firm at least that I'm aware of, that has been able to consistently outperform portfolios of hedge funds, so similar to what you would think of fund of funds would do, but with better draw down characteristics, low fees and daily liquidity.

And so in two thousand eighteen, UM, a fast growing French institutional investor called i AM Global Partner was doing this multi year analysis of the liquid dolt space and said, you know, we think these guys have the best mouse trap, but they don't have any products that are available to a broader range of investors. And that's when they partnered up with us and then launched these two ETFs around existing strategies. In two is the plan to eventually become

the vanguard of the alternative space. Are you guys going to roll out more products or are you going to stay focused on just a handful of products. We've been very, very focused on what we do, and I expect us to continue to be narrowly focused. Um, there are only certain strategies for which this works incredibly well. In the mannered future space. Uh, we've basically found a way to outperform la large hedge funds by four basis points brandom

with less risk. So if you're deciding how do you want to get exposure to manage features, this should be the obvious choice. We run into all sorts of agency and behavioral issues in that you know, for the same reason that that that allocators fought paths of investing for years, But that's that's changing and we'll we'll continue to change. But you know, in our case, I think actually and going back to think about seth uh. One of the best things you can do and asset management is decide

what not to do. And so when you ask the questions about the history of the liquid all space, every time there was a new wave of products, we try to look at it with an open mind and say, hey, maybe this does something better than what we're doing, Maybe we should do this instead. And every time we concluded that these were products that we're being you know, that look great on paper, that wouldn't work in practice. And I think we've been write six out or six times

on that. So it's possible that we would introduce new products, but I don't expect to do it broadly. Our goal right now is that for anybody who's managing a diversified portfolio who thinks that and we can help to make the argument who thinks that hedge fund type strategies and then in this mean I mean specifically equity long short and managed futures um has a role in their portfolios. The argument that we would make is that the way that we do it is more predictable, more reliable, has

tends to outperform over time. And therefore, if you're thinking in five or ten year increments in terms of how your clients you know, are going to end up viewing this portfolio and how you're going to be this portfolio. We should become the default allocation. So let's talk about one of the e t F in the space that you guys manage, the long shorthead strategy to dB H had a great year was up. Tell us how that sort of e t F is constructed, what goes into

that and who do you think that's appropriate for. So that's a strategy that we It's based on a strategy we originally developed in two thousand twelve, which is that we we look at forty of the largest equity long shortage funds and diversified across a lot of different strategies fundamental value, fundamental growth, UM, emerging markets, sector specialists, etcetera.

And we analyze how those guys have been making money the four feets and our goal and what our research has basically shown is that UM that the way these guys primarily generate alpha over time is by getting is

through better asset allocation. And and this goes all the way back to you know what I mentioned about about Seth Klarman and this whole idea of get the area right if you look at you know, for instance, over the past twenty years in the equity long short space, they preserved capital and made money in two thousands through two thousand too, not because they picked a particular stock and short at a particular stock, but they were very long small cap value stocks and very short large cap

growth stocks at the time the markets fell apart, I mean. But then by the mid two thousands they had pivoted into emerging markets and they rode the brick wave and that was on the long side entirely. And interestingly in the two thousand tens, they did get the markets right. They were went into US quality stocks in two thousand twelve before those stocks took off, and then ultimately embraced

tech stocks towards the end of the decade. The problem with the Ladder two was that they don't have that much of an edge in terms of picking which tech stock is going to take off. So when you compare them to the NASDAC or or or particularly two, or to the SMB five fight or, they don't look as good. So what we try to do is basically figure out you know, if you if you if you could look through each of these guys portfolios today and see exactly how much they were long and short every single stock.

How much could we group into the s, how much can we group into small cap stocks, mid cap stocks, emerging markets, you know, non us developed into those major buckets. And if we get that right, then that ends up explaining their preview returns. So how do you that information? How could you tell what these private and not very transparent funds are doing in order to replicate what the

broad industry is doing. So the way that you can do it most reliably is actually by analyzing recent performance. So looking at thirteen filings doesn't doesn't give you much valuable information, believe it or not. Um Uh, you know, even reading prime brokers reports isn't terribly helpful. The way to do it most reliably is you simply run a what's called the multi factor regression against recent performance. And to be very clear, this does not work with a

particular hedge fund. Doesn't work terribly well with a particular hedge fund because they will change what they do faster than than than the models can pick up. But in the case of a pool of forty of these guys, um it's a little bit like do you ever read Jim Sirwicki's The Wisdom of Crowds? So it's basically that idea. It's that it's that you know, whether one guy is long or short, a particular stock or a particular area is much less important than than you know than these guys,

they're they're collective wisdom. You're looking more or less it quarterly returns for the group and reverse engineering what they're doing based on how broader asset classes are performing. What would have gotten them to their quarterly numbers? Is that ballpark exactly with the with the with the one correction that it's monthly not quarterly. So you look at you look at the past fourteen months of data. Is the

way that we do it. And so so if you take a year like last year, um, you know, the equity long short space overall was up seventeen and a half, let's say, so, really a remarkably good year for hedge funds in that equity long short guys were up as much as the SMP but with you know a half of the risk. But pre see they were up twenty three or twenty four. So so our goal is can we get all twenty three or twenty four only charge

basis points in an ETF and get all that x so. So, so hedge funds overall maybe did five hundred basis points of alpha. We get closer to a thousand. That's quite fascinating. You have previously written that we are on the cusp of a new golden age for hedge funds. Explain. So the first thing that I would say is that is that just in terms of my my my credibility in terms of writing that article. I've been a very well known critic of hedge funds in many circumstances. So this

is not somebody who is dogmatically pitching a party line. Uh. In fact, my friends used to say, if my car broke down in GreenEDGE or Mayfair, I should lock the doors and call hots to rescue. Um. So the the But but we saw something really interesting last year in that about mid year in our portfolios we started to see what ultimately became the value and E M pivot and hedge funds got a lot of things right last year.

So the first thing they did right, so they and by the way to understand positioning, they went in with the tech bias um into two thousand twenty. Overall, some some firms were you know, we're long airline stocks and got run over. But but overall the industry had had had somewhat of a tech bias, And it kind of blows up the academic notion that hedge funds are always long value, because in fact, what we've seen is that what hedge funds do as much more dynamic and changes

over time. But um, but then they didn't. They didn't cut risk in the draw down, and as we started coming back uh in the second quarter, they bought into the recovery. They bought into the availability of the vaccine at some point, and and and the depth and of the fiscal and monetary stimulus. So they were adding risk as the market came back. And then really interestingly, we

started to see a pivot where tech stocks um. Whereas they increased risk, they weren't adding more to tech stocks, they were taking it and adding it to emerging markets and small cap stocks and non US developed and so a lot of quant value investors have been waiting for this rotation into value to happen for years and and and we think it happens in a slightly different way, which is that if you're a hedge fund, you know, as I mentioned, that's had a tech stock that's tripled

over the past three years and has just gone up you know in the second quarter. A prudent investor will take profits on it, and then where do you put it. You don't have to go back into tech stocks. So

they started to look for cheaper areas. And so because of that, I think what you've seen is that hedge funds and this whole idea of asset allocation, the opportunity set for them in the looks great because back in two thousand sixteen or two and seventeen, people were starting to say the US looks expensive relative to emerging markets. And then the US took off and emerging markets didn't, and then it was you know that small cap stocks might look cheap, and you know, then you had more

years of of US large cap dominating. And so you know, this this evaluation rubber band has been stretching and stretching, and we've seen hedge funds pivoting into it. And so when if you're the reason this is really important is if you have a portfolio today, like most wealth managment portfolio that is heavily biased towards US large cap stocks and fixed income instruments, you have a really big problem.

I mean, US large cap stocks are historically expensive, and fixed income instruments the expected returns are close to zero, So so you know, how can you add something that does better? And I think what we're seeing is the opportunity set for hedge funds now because these valuation disparities are so wide and they have the flexibility to really take advantage of it. They have a clear role in investors portfolios over the next ten years. So that's a

really interesting observation. The US has certainly been much pricier than overseas and emerging markets for way over a decade, and you could say the same is truth for growth over value in large cap over small cap. What sort of persistency might hedge funds have in these spaces. Do you find generally they're willing to ride out that rotation for a long period of time or or does it

you mentioned a decade? The reputation is a little bit of the flavor of the month sort of thing, and whatever next shiny object comes along is going to draw their attention again. I I always have to say, is that an exaggeration or does it not apply to everybody. Is in an overstatement or is there some truth to that? So the core of what hedge funds do is to get these multi year trends right. The attention often is two short term shifts. So, for instance, hedge funds are

have been short the US dollar. You know, the general view among hedge funds is that um, other parts of the world are recovering faster than the US. The FED is likely to let the economy run on hot, which could be more inflationary for the U S and other parts of the world. But you know, what we've seen over the past five years is is that that you know, and that view leads them to want to own more

emerging markets over time. If something materially broke down that view, UM, if the FED announced tomorrow that they were going to hike rates, then you would then you would see a shift and a change, and that's what you want hedge

funds to do. But you know, again, I think that always the the the issue with looking at hedge funds is is it's the difference between you know, the individual data point, the anecdote that's being circulated versus what's happening more broadly in the industry, and so I wouldn't expect if hedge funds are long emerging mar because they're buying emerging markets today. I wouldn't guarantee you that they would be long in five years, but these tend to be

pretty stable and persistent. Um. But I think the other thing that's that's you know, so when you think about that, that grates with how a lot of people think about hedge funds and that they want to hear something special about this stock or that stock, or some particular trade that nobody's thought about. But the competitive advantage of hedge funds is that when they like a market and they

see an opportunity, they can go big. And so back to that example that I used in the mid two thousand's when I first started looking at this space and whether this idea would work, it showed that hedge funds on average had about a thirty five percent long position and emerging markets. But you would never see you would never walk into a wealth manager in the US who likes or even a pension fund who is very optimistic about emerging markets and see a thirty five percent emerging

markets position. You might see they if they love it, they go from four to six. And so that flexibility is very, very powerful over time, because you know, over the period that I've described in the mid two thousand's, emerging markets outperformed the SMP by thirty pc a year. So acid allocation was giving hedge funds a thousand basis points of alpha year. It didn't matter what you owned an emerging markets, it's that you you picked the right area.

And so I think what we have over the next decade again is, you know, is the easy money in the SMP has been made. The easy money in the nattack has been made and couldn't go on for two years. Of course it could, but looking back ten years from now, it is hard to see. I think it's statistically impossible to see the SMP putting up another decade with annual returns. It makes a lot of sense historically you should start to see some mean reversion. You have referenced the second

holy grail of hedge funds. I always think of the first holy grail as alpha. What's the second holy grail? So let me let me first start with it with the term alpha. So pete to use alpha in a lot of different ways. Um, The interesting thing about going back to the nines. Nobody talked in terms of alpha. I mean alpha was a concept that was applied to hedge funds by institutional allocators who are trying to justify

an allocation UM. And it is statistically problematic um because it all depends on what you're comparing one return stream to another UM. But but the basic idea of the first holy grail of hedge funds back in the mid

two thousand's was what I described. Can you find Seth Carman in two when he's just hired to build and run Bell Post, you know, can you find George Soros and Julian robertson the nineteen seventies, Can you find I don't know, you know, even today Christiam Way when when he launched Higher Global um but um but and and that's what the business lives in breathes on that that you know that if you if you try to identify a guy today, he's going to continue to put up

or he's not going to continue to put up spectacular numbers, or or he is, you know, so smart and so capable that that's exactly what he's going to do over the next ten years. The reality is that's nearly impossible. UM. And if you could do it, you know, you should give all your money to three guys, go home and come back in ten years. UM. So the second only grail was was we like the divers ocation benefits of the broad of the industry broadly, but god, it's frustrating

to pay these high fees. You know. It's it's difficult to invest in something that's a liquid where sometimes we don't get our money back at exactly the wrong time. UM. You know, these things blow up with frustrating frequency. So if you could deliver the performance of hedge funds broadly but with low fee's, daily liquidity, better downside characteristics, transparency, that this should have a role in every single hedge fund portfolio that you don't then necessarily have to just

pick ten or fifteen different liquid hedge funds. You could have of your assets in this liquid, low cost vehicle and and then pick and shoots how you how you invest UM. So it makes it makes all of hedge fund investing UM not just more efficient, but also it tends to um. It actually tends to improve returns and

improve performance over time. And so you know, if this had been embraced by institutional investors back in in in two thousand's uh, in the sorry or in the two thousand ten you know, they would have saved hundreds of billions of dollars in fees over the next decade. Um. But but the whole concept of it runs into the same issues that the active versus passive debate has has been dealing with in in you know, the rest of

the asset managed industry for thirty years. So you touch upon two things that I have to ask before we get to my favorite questions. One is that active passive debate. Again, going back to the academics, you would think that as more people become passive, that should create inefficiencies that make it easier for the stock pickers to make it easier for the active players. Do you think that is accurate? And why have we seen so many active managers fail

to adjust to the money flows into passive. It's a great question, right, does does passive make active more difficult? Um? And I will tell you that I honestly do not

do not know the answer to it. In theory, you are correct, right, I mean hedge funds should be out there saying here's this stock, it's undervalued because it's not included in this index, um, And all we have to do is by it is by it today and wait, and you know this big dumb elephant of an investor is going to come up and buy of the assets

in one day of the float in one day. UM. I think that you know, there are a lot of um uh, there are a lot of myths about hedge fund um that that have been perpetuated for a long time because there I would say they're convenient myths. UM. One that I've heard repeatedly that I've been asked about is is, oh, hedge funds aren't making money today because because the markets aren't volatile enough. Um. That I haven't seen any good data that actually supports the contention that

a normally more volatile market is necessarily good for hedge funds. UM. What I do think, though, you can say is that when when markets trend aggressively over some period of time, that hedge funds can be very good on at at at jumping in and capitalizing on those trends, whether it's managed futures or other areas. Um. So um you know. So, I think I think passive is has has been a little bit of a buggy man that people have put

up there. UM. But again, I, you know, I will admit that I don't have a strong conclusion on this, and maybe tomorrow somebody will show me something that that is dispositive, but I haven't seen it. And early in your career you were pretty heavily involved in the Comaliti space and the Greater China region. Do you still track China closely and do you have anything particular to say

about what's been going on over there lately? I don't, UM, I would say, my so, my experience with China was that around two thousand UM I had these these came

up with these two macro themes. One was that commodities would become much more important than they had been in years, and the other was that the Greater China region really specifically China was going to become an important areavaset management and so I you know, within a couple of years, I'd started to hedge funds in completely different businesses UM

with guys to to to capitalize on both of those. Um. I would say, the experience that we that that we had with China was that, uh, capitalism in China is done, or at least back then was done. With a different set of rules um. And that that you know, the idea of sporting UM, standards of of of conduct as it relates to two Chinese business activities often meant that the guy who had those standards was somehow the guy

who walked out of the room with no money. Um. And and clearly there's a lot more government intervention in the economy. I remember a guy at one of the private equity firms who had investments in China basically saying that you know, he was talking about how the government would let them have two out of one out of three or two out of three investments would make money, and if the third one is making money, then have

to somehow give it back. Um. So um. I've spoken to some people recently about China who have continued to do business there and and those those concerns, concerns are still out there, but at a granular level, I'm not I'm not close to it today. Quite interesting. I know I only have you for a limited amount of time, so so let's jump to our favorite questions that we ask all of our guests. Tell us what you're streaming these days, what's keeping you entertained during a Lockdown either Netflix,

Amazon Prime podcast. What what are you keeping busy with? So this is going to be the most depressingly boring answer for you, I'm sure everyone, but um My dad is eighty six years old and he's a lifelong opera fan, and he lives in New York and last year, at this time, he was going to the opera three times a week and I was trying to join him there. He obviously can't go to the opera this year. UM, So I've been streaming operas on Amazon Prime to either

watch with him or or talk to him about. Um I do get another things as well, but it's not it hasn't been a priority for me. That's not boring. Opera is kind of interesting. Even if you're not an opera buff. It's still, you know, not running the television. The poor guy used to take me when I was young and and I would fall asleep. I'd have, you know,

a big lunch and then fall asleep every time. So I think in my in my fifties, i'm I'm, I've had sort of a renewed interest in it, and it's it's wonderful to be able to share it with him. Tell us about your early mentors who helped to shape your career. So I think the earliest one is uh is my late uncle Amo hotn Um. It's h o u g h t o n um he Uh. He was this really extraordinary guy who unfortunately passed away earlier

this year at age three. But he had run a company called Corning Glass, which was a business that his slash my family started back in the eighteen fifties. But then he went to Washington and my first job was working for him as he was a young congressman. And you know, I hope people listening to this will go read his obituary because if there was ever an example

of somebody that we need in Washington today, it's him. Uh. He went to Washington, he served as a congressman, He tried to be bi partisan, he was friends with people across the aisle. Um. He really I think set the standard um and and he I think just taught me ultimately just a level of decency in business. Um Uh. You know, ultimately you are responsible for for for conduct

and it's not always about just making money. Um. And I think you know, I think another guy is is Jim Wolfinson, who was when I was gave me my first job as an m and a investment banker, and then he later went on to run the World Bank. But he was just he was just an extraordinary guy. And in his you know, when I knew him back then, he just had this um, this energy in terms of wanting to learn. He picked up the cello when he was forty or something and was performing with Yo Yo

ma um within within ten years. Just just just extraordinary, And I think there was something about he had. He had almost a Warren Buffett like um enthusiasm for things. UM. I had the pleasure of actually visiting with Buffett in two thousand sixteen on on election day, believe it or not. We were talking about value investing and seth and and and all these things, and you know, and the guy, at whatever age he was, was just still bouncing off

his share with enthusiasm of talking about things. And I think there's something really inspiring about that. UM. And then I think, you know, I think the one who's who's not an early mentor, but I think one of the people I do admire at most in the industry today or you know, over the past couple of decades is

John Bogel, because he was right. You know, he was right, and he stuck to his guns in the face of withering criticism and gale force hat wins and um, you know, I think I was as I was thinking about this, I wanted to see if I could there are there are two quotes that I thought, I is it okay with you if I if I share two quotes, but I think are just sort of fascinating, really active in passivate.

So if you so. John Bogel, part of what he was influenced by was was Nobel lawyer at Paul Samuelson's whole idea of index funds and investing in the market. And what Paul Samuelson said about John Bogel in the first index fund was quote this Vogel invention along with the invention of the wheel, the alphabet Gudenberg printing right, And so it was basically, look how extraordinary this index

fund is. And I remember in the I think because the late nine nineties early two thousand's, one of the luminaries of the LBO industry was had this great quote which said, after the wheel, God's greatest invention was to carry and that to me, those two quotes summarized to be the whole active and passive debate. Is the role of asset managers to put their clients first and try to get as much money as they can reasonably get back to their investors, or is it to maximize the

profits of an asset management industry? And uh uh, you know I've gost fourty years, I've cast my lot with with Bogel. That's funny. You know you referenced the Financial Times earlier. They were the first ones who had the quote out that a hedge funds is a system by which a savvy manager transfers wealth from naive investors to himself. And I certainly think Bogel understood that, as did the person who was talking about the carry. Let's go to

everybody's favorite question. Tell us about what you're reading these days? Are what are some of your favorite books? So? Um? So, my my favorite books keep changing. UM. I go through phases where I got kind of obsessed with a particular

topic and then kind of move on. UM. The one one book that I keep going back to um and it has a lot to do with the hedge fund industry, although it has nothing to do with the hedge fund industry, which is a book that believe it or not was written in nineteen sixty two by again, I'm Thomas Kotten,

and it's called the Structure of Scientific Revolutions. And what he basically identified was that, um, that you know that that that progress, in his case, scientific progress doesn't just happen in the sort of gradual way that most people who have been you have an existing paradigm, and most people who have been been been brought up in that paradigm, They've been trained in it. They want to believe in

the paradigm. The self selected into the paradigm, and they will not abandon the paradigm until there was something new that has established that they can safely hop over to, and that's where they had fund industry is today. So I go back and I keep reading this because because every year that you know, I still face these these headwinds in the industry. Um uh. But but we see them abating and we see more and more people buying

into it. But I keep going back and reading it because I want to make sure that I'm not, you know, completely insane. Um. And then the other thing I did also, and I would encourage people to go back and read books they read twenty years ago, particularly about business, because you see what a different world it was. And I recently reread so I do have a copy of Staff's Margin of Safety that he gave me when I joined UM.

And and you know, when you hear what he was writing about UM and the kinds of things, the kind of opportunities that he uses examples, it is so clear that no hedge fund with any meaningful assets could do any of those things today. And if an opportunity like that came about, you know, it would be seventy sophisticated hedge funds competing for for for each trade opportunity, each investment opportunity. UM. So I do think that that. You know,

there's another quote that I love. Um My, my great grandfather was very good friends with this guy named George Santayana who famously said those who forget history are doomed to repeat it. And and you know, I think, in the case of people who are in the asset management industry, five years ago is not history. Three years ago is not history. If you want to understand why quant based investment strategies are disappointing you today, you've got to go

back and look at the nine nineties. You know and even better. Yet look at what they were saying in the nineties about the nineteen of these and um, and there's not enough of that the industry. Yeah, Ray Dalio has been a big His new book is all about that. Unprecedented doesn't mean it's never occurred. It's just never occurred in your lifetime. And if you go back through history, most of the things that seem to surprise us have happened time and time again after everybody forgets about the

previous time. Absolutely, I mean, you know, because Mark Twain said history doesn't repeat itself. It at rhymes. Um. I think you can often find examples and sometimes and sometimes they're alarming examples. And if you look at the political situation today, you can point to very alarming, deserving examples where you had, you not established democracies, but democracies that were under threat in some way. And you can see the same kinds of you know, politicized debate around it.

And um uh you know, I think it would do us a lot of good too, uh, focus on on on historical precedents and think about what they mean to do. Let's talk about the sort of advice you might give to a recent college grad who was interested in either hedge funds or liquid alts. What what sort of career advice would you give them? So I think the the I guess I would start with, um uh, the statement that you want to find an area of broadly that's likely to grow over the next twenty years. UM. And

that probably has something to do with technology. UM. So. I mean, you know, one of the things I think is so incredibly sad about the coronavirus crisis is that you've had people whose lives were built around retail businesses that were built around um, movie theater chains that were built around things that are probably never coming back in the same way that they were twenty or thirty years ago when they made that decision. So maybe this is kind of a shadow of you know, Seth's original thing

that find the right area. So if you're going to the active management this street, have conversations with people about what do they expect to be big and new, and maybe that's crypto. You know, I don't I'm not a I don't know an awful lot about crypto, but but I think you can point to it and say, crypto in twenty years or ten years is going to be

bigger in some way, shape or form. Interestingly, the and I said, the only way you're gonna be able to figure that out is by doing a day to day One of the most interesting pieces of business advice I got was was ironically from from Mark Cuban in twenty two thousand one or two thousand two, UM, when I met with him and we're talking about the future of UH what. I said, what you know, how are you

investing your money today? And he said that he was gonna willing to spend the hundred million dollars is money to invest in high definition television. And I asked him what that meant, and he said, I have no idea, I said. He said. It could be producing, it could be better pipes into the homes, it could be all the different things that But what I can tell you with certainty is that ten years from now, people are gonna want much better quality than the grainy TV that

they have today. And and the only way that I'm going to know where the real opportunities are is by by doing it every day. It's not an academic exercise, and so I think when people are going into it, they should have that that that view of trying to think about what's going on around them and how it's changing, because if they're entrepreneurial, that's where they're going to see the opportunities. If not by writing a business plan, you know,

by pulling down Wikipedia. And I think that you don't. Alongside that, I would stay flexible. You know, it's not it's it's um, it's not clear at at age twenty five or twenty seven or however old you are. UM, it's not clear where the opportunities are going to be. We know that things will look very different in five or ten years, and so you know, keep financial flexibility, keep yourself on your balls, balls of your feet so you can pivot as necessary. Quite interesting, and our final question,

what do you know about the world investing today? You wish you knew twenty five years or so ago when you were first starting out. So I wish that I had understood how institutionalization of the alternatives business would play out. UM. So you know, we started this by talking about whether I was going to go into the LBO business or

go into the hedge fund business. And my in one of in a shockingly bad conclusion, I thought the LBO business had probably seen its best days because the things that had made LBOs these profit generating machines, was a function of the nine eighties. It was a junk bond market. You could buy things with you know, five percent equity down and you go buy a reasonable company with it.

Because of distortions in the junk bond market. You had terribly won companies with inactive boards that you could take over and clean up and and double their cash flow. And you had um uh, you know, companies had gone through conglomerization phases in the seventies and eighties, and we're selling off subsidiaries because you know x y Z hedge fund. Baron, I mean LBO Baron had dinner with the CEO and convinced them to sell it at six times cash flow. I mean, it was all of these things were you

know that made LBOs in the ninet eighties. It's really really these great investments, um huge, huge, huge access returns what I didn't see. And by the way, when I was looking at this, you know KKR had bought r j R Nibisco and that it turned into kind of a fiasco and people thought, no one's ever gonna be able to raise a five billion dollar fund again. Today What I didn't understand was that institutions and consultants around institutions UM once that they had their own reasons for

having these new asset class categories. So once they labeled LBO slash Private Equity and Asset Allocation UM, it was the first movers into that ended up getting new clients because they could say, we have special access, we know how they invest in this area, and their business would grow and then somebody else would look at them and say, oh my god, look at that. They just won that new client. And it seems to be in part because they know how to get invested in l b O

s and we don't have that capabilities. Let's hire some people to do it. And this whole process builds on itself. And so now you have you know and and so you know, now this is why you have thirty billion dollar hedge funds, which people would have said was for posterous years ago, or people routinely raising ten or twenty billion dollar private equity funds and so UM. So I think if I'd known, if I'd understood that, I think there would have been different ways that I would have

managed some of my businesses. But you know, next life Thank you Andrew for being so generous with your time. We have been speaking with Andrew Beer, managing member at Dynamic Beta Investments. If you enjoy this conversation, well be sure and check out any of our previous I don't know three nine such prior conversations. You can find those at iTunes, Spotify, wherever you feed your podcast fix. We love your comments, feedback and suggestions right to us at

m IB podcast at Bloomberg dot net. Give us a review on Apple iTunes. You can sign up from my daily reads at Rid Halts dot com. Check out my weekly column at Bloomberg dot com slash Opinion. Follow me on Twitter at rit Halts. I would be remiss if I did not thank the crack staff that helps put these conversations together each week. Reggie Brazil is my audio engineer, Michael Boyle is my producer. Tracy Walsh is our project manager. Michael Batnick is my head of research. I'm Barry Ridults.

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