Jack Coats, CIO, Equity Hedge Fund discussed on Capital Allocators

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Oh when he studied to be a rocket scientist before that our conversation covers marks path to ias and the principles of luck risk and uncertainty on that path we discussed the is portfolio when catered to achieve a low risk profile. And how we stayed the course when that structure hasn't been rewarded by markets. We talk about identifying managers that fit into his approach and different metrics of defining risk both the manager and portfolio levels. Please enjoy my conversation with Marc. Baumgartner park thanks for joining me. Pleasure be here. We always start talking about people's backgrounds. So why don't you just walk through kind of how you got to the CIO seat? It's a strange path. That's for sure. I grew up in Florida and watched a lot of rocket. Launches always close to Cape Canaveral and the space shuttle. I I remember drying pictures of the space shuttle. When I was thirteen fourteen years old I actually saw the first launch really need experience so always had that desire and so I pursued that in school I study aerospace engineering in Undergrad and then when I got out of Undergraduate Nineteen Ninety One. The country was in recession. And I said well you know. Why don't I just go for some more schooling and pursued graduate studies? The theme in my life has been luck. I think it was lucky that there was a recession in Nineteen ninety-one to push me to go get some more schooling. I went to Princeton Graduate School and at Princeton it was a very very different experience than Undergrad. Undergrad at University of Florida. And I always like an. I said when I was at Florida I had a calculator in my hand and I was always solving problems at Princeton through the calculator out in exchange for a piece of chalk and we did a lot of theory there and the other thing that Princeton had was it had a school political science and I had a great adviser there who encouraged me to branch out and so I took classes in the polly side department. They are got a minor in public policy and that shifted me off of Engineering and aerospace to public policy and application of quantitative methods to areas. That were more qualitative. More sociology psychology oriented and folks in qualitative disciplines are faced with no less uncertainty then folks in engineering disciplines. Perhaps some more uncertainty anti. That's where I found my home. It was a departure from engineering. But I enjoy that. Blend of addressing uncertainty quantitatively and qualitatively. What was the first step? Fu Academia so it was into management consulting. Yeah I was fortunate to find someone who's actually been a mentor to me my whole career. Hamilton Helmer so Hamilton was a a Bain consultant. Actually worked with Bill Bain in the early days and I had moved out to the West Coast. Start his practice there in Silicon Valley doing strategy work for firms on the West Coast and he saw some kind of potential in me and hired a kid. I always joke. I said when Hamilton hired me I didn't know the difference between revenue and profit just money but how Alton saw some potential there and brought me out to join his strategy firm and I learned about business in strategy with Bain level partner working closely with them. Incredibly luck incredibly. And how long did you stay? I was there for three years and we had fantastic case where this was silicon valley in the late nineties. So just amazing right if I knew then what I know now. I probably should have stayed there and should have been involved somehow in the venture industry. There was so much fun to. What do you know now that you didn't then how to create companies and all of the value creation potential that exists in that area? And how it's done right. I was a kid Twenty years ago now but I enjoyed consulting a lot and I said this has been so great here one. I take a look at one of the branded shops and I ended up going to. Abc G. Three years later and spent four years there being a generalist and just looking at all sorts of different industries airlines health care energy. Just a lot of fun consulting was wonderful and along the way I started to learn a little bit more about investing and seeing how value creation was rewarded by the markets and I ended up after four years. Going back to join Halston at his firm strategy capital this is in the early two thousands. We had a long. Short Equity Hedge Fund. The memory for me is being in the boardroom. At Net flicks before net flicks was Netflix. It was really so early. They had a red envelope company and having that experience and seeing that company being built from the inside and being able to interact with management. Was I opening for me? What was it like? In those years sitting inside a hedge fund very very different it didn't feel institutionalized at that point felt like I wasn't even a Hedge Fund. It was just an investment firm. And we were doing what we did. As Strategy Consultants which was to look at industries and look at companies and pick winners and losers is pretty clear to us that at some point net flicks was going to if not kill blockbuster seriously hurt blockbuster. So right there. You see a nice pair trade. And it wasn't clear at that point was Amazon. Had Not even entered. The business yet was were threatening to enter if I don't know if you remember they actually had a DVD delivery system before they were streaming and it was reed hastings who had the vision to stream content which you could see things converging. It's reality today but back in two thousand three you know it was pretty tough to see where broadband had to go and obviously mobile devices have changed all that as well. It was not as institutionalize. We were just picking winners and losers. And how long did you say so? That was a year and the story there is. We had a market neutral fund that had equity volatility and so no one was really ready for the downs. Came along with some of the ups so we shut that down and I went to work at another hedge. Fund called quantum L- A quantitative market neutral fund which one of the other partners had strategy capital was also the chairman of that and brought me over to be a PM and and help them grow that business very very different strategy then strategy capital was fundamental equity and quantum was stat. I really got my risk degree there. Quantum was first and foremost a risk management firm. So it was sort of a better barra was headed by the former head of finance at Stanford Paul Flutter and Terri Marsh. Who was former head of finance at Berkeley Great DNA? They're great finance knowledge there and so that was the risk model in the hedge fund was built around that which was really interesting. That was for me that fit right. This idea of uncertainty management which I had through my studies of turbulence in my PhD program and then business uncertainty in management through management consulting experience and now hedge funds and so it's always been about managing those uncertainties and the Stat Arb- shop. Cuanto gave me some more insight into how portfolios could be managed in a very risk risk controlled way. That's what you WANNA. You WANNA take risk. You don't want to avoid risk. Howard marks the risk avoidance strategies or return avoidance strategy. But you want to manage those risks. So that's been key for me in my learning about hedge funds and then how I manage hung portfolios after she. You have a setup where you've got two leading finance profs in the early years of Quantitative Hedge Fund investing but we don't really know about quantum today. Yeah so what happened. Cuanto is about the same as they were. Call it about a five hundred million dollar hedge fund not small not large but to grow you need to change and so we were already turning that portfolio over about seven times a year it happened to be a higher frequency trading back then was high frequency today. It's not very high frequency but we noticed that as we grew we had more slippage in the portfolio we're impacting markets and so was decreasing and so the happy medium was. They had kind of maxed out their size. I think there are a lot of funds like that. And you can make that trade off as a fund. Sometimes can I grow and still give the returns that I've had the pastor towards the next step after there so the next step was Morgan Stanley? I was fortunate again in the spirit of luck to find someone who actually understood my background. Jack Coats who was the CIO? At Morgan Stanley's Alternative Investment Partners Group in West Contract Jack was the CIO at warehouses and had come over with that. Lift out to Morgan Stanley. And he had an aerospace engineering background. Believe it or not and so I came to join him and help him build that business. It was the early stages of the O- cio expansion and so we were looking to help institutional clients do what Jack had done at Weyerhaeuser. Which was incredible. Jack started at the warehouse or Pension Fund in one thousand nine hundred five the same year. That Dave Swinson started at Yale to totally totally different strategies though where houser was a synthetic sixty forty portfolio using derivatives. Right in a pension plan. Mind you in one thousand nine hundred five so synthetic exposure plus Alpha from hedge funds and all sorts of inefficiencies that exist in the financial markets. Back in the day and it was highly risk. Control risk managed quantitative what you might think of an aerospace engineer. Putting in place at pension plan in Nineteen eighty-five and fast forward twenty years that portfolio which was levered two to one and used alternative investments which in the eighties nineties or something inconceivably risky to that portfolio outperformed. Yale on a an absolute Anna risk adjusted basis. But yet jack was very in the background you know. Jack was not recognized sort of unconventional but almost two unconventional a cowboy. Taking risk and sure succeeding. But that's the problem with being different in the world. The worst thing is to be different in failed but the next thing is to be different in succeed because then you are a cowboy risk. You're just lucky. But that's a story of how you can be different and that portfolio weathered the crash in eighty seven. It weathered the Mexican peso crisis whether long term capital management whether the DOT com boom and bust. But it's not widely adopted. There are few foundations out there that have that type of portfolio talk a little more about what that portfolio was in. Wyatt provided the ballast. That it did. It was just a collection of risks. But it was very very different so I think the origin of that portfolio as Jack said. Why would we want a seventy thirty or sixty forty equity fixed income mix because we're not going to get the type of returns that we could from having hedge funds or having other types of alternative investments in the portfolio? We don't need to take systematic risk or getting paid for it. But we're not getting paid as much as we could for idiosyncratic risk and was so they did that for a couple of years and the board I think at warehouses kind of gulped. But they said well you know Jack is really smart. Let's just go ahead with it so fast. Forward a couple years and possibly through the eighty seven crisis. I'm not sure. But the performance of that portfolio as you can imagine very very different than performance of a sixty forty. What did that portfolio look like? Call it a collection of Alpha generating managers portfolio largely on correlated with the market.

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