0:00

The Investment Manager Playbook,

0:02

What Allocators Don't See.

0:11

My last post, the Investment Office

0:13

Playbook, What Managers Don't See, discussed

0:15

part of what happens inside an investment

0:17

office that managers don't see, but

0:20

that significantly influences the cadence of

0:22

capital deployed to managers. Of

0:25

course, there's two sides to every coin, and

0:28

this post discusses what allocators don't

0:30

see when a manager chooses to

0:32

grow. It happens

0:34

hundreds of times a day. An

0:37

allocator awaits a meeting with a manager.

0:40

They've watched the manager post strong

0:42

returns implementing a strategy in a

0:44

small, less efficient market. It's

0:47

exactly what the manager articulated when spinning

0:49

out of a large firm a few

0:51

years before. The allocator

0:53

hopes the manager will stick to their

0:55

original plan just this once, but

0:58

they've seen this movie before. Sure

1:00

enough, the manager opens the meeting

1:02

with four dreaded words. We're

1:05

raising more capital. The

1:07

allocator shrugs and thinks to themselves, don't

1:10

managers know size is the enemy of

1:13

performance? Why are all

1:15

these managers so greedy? A

1:17

manager's business decisions are not as

1:19

one-dimensional as many allocators think. Allocators

1:23

often don't appreciate why so

1:25

many successful managers have grown

1:27

beyond their initial expectations. The

1:31

investment manager's playbook hinges on its

1:33

decision to stay the same or

1:35

grow. That choice

1:37

carries implications for the team, investment

1:39

opportunities, and risks the

1:41

manager will encounter in

1:43

maximizing its probability of

1:45

long-term outperformance. In

1:48

almost any rational assessment, the

1:50

playbook favors growth. Expanding

1:53

organizations can attract and

1:55

retain talent and capital,

1:57

which creates durability. In

2:00

the same may benefit from focus. But.

2:02

He carries significant business

2:04

risk. Allocators who

2:06

understand the drivers of these decisions

2:09

can better assess the prospects of

2:11

managers. I'll describe

2:13

the Investment Manager playbook across three

2:15

stages. The early stage

2:17

is all about performance and survival.

2:20

The. Second and third stages offer the choice to

2:22

stay the same or grow. Which. Carries

2:25

a set of opportunities and risks

2:27

that consider performance. Talent and

2:29

client stability. Early

2:32

stage. A startup

2:34

asset manager encounters the same challenges

2:36

as a start in any industry.

2:39

It's. A time of focus, intense

2:41

demands and heightened scrutiny. The.

2:44

Manager must build the team. Set.

2:46

Up Infrastructure. Implemented strategy.

2:48

And deliver on performance all at the

2:51

same time. A manager

2:53

reaches later stages of development only

2:55

when it gets everything right. Building.

2:58

A team is complex. Setting up

3:00

infrastructure takes time and money. And

3:02

generating For some, it's requires both

3:05

skill and luck. The.

3:07

Land mines that await could sell a

3:09

book. In fact, I.

3:11

Wrote one. It's. Called so you

3:13

want start a hedge fund. Lessons for

3:15

managers and allocators. When.

3:17

A manager succeeds. It earns the opportunity

3:20

to graduate to the next stage of

3:22

development. If. It doesn't It

3:24

can close the playbook right there. States.

3:27

To. With. Success! A

3:30

manager chooses the firm's future direction.

3:33

A fork in the road typically comes after

3:35

around five years For a public market strategy,

3:37

And. It fun two or three for a private

3:40

market from. With. The decision to

3:42

stick with what worked for my. Entre

3:45

paralled Sandra five us to strategies

3:47

and professor emeritus at Harvard Business

3:49

School. And Charlie Alice founder

3:51

of Greenwich Associates and renowned author.

3:54

Both. Have discussed the distinction between

3:56

the profession of investing. In.

3:58

The business of asset men. It. Though.

4:01

Is engaged in the profession seek

4:03

to maximize investment performance. Whereas.

4:06

Those in the business seek to

4:08

maximise profits for their enterprise. Harold

4:11

and L A straw clear distinction

4:13

between the two. However,

4:16

The profession and the business are

4:18

not mutually exclusive. A. Manager

4:21

that strives to be the consummate

4:23

professional must have a stable business

4:26

to optimise performance. A. Manager

4:28

and the business of Investing

4:30

must deliver outstanding performance to

4:32

grow assets and increase profits.

4:34

Whether. A manager remains a boutique or

4:37

gross. it must solve for issues

4:39

that come in the way of

4:41

both business and performance success. Option.

4:44

One. Stay. The same. When.

4:47

A manager chooses to continue down

4:49

the same pass. Strong performance in

4:51

the early stage may attract more

4:53

investors. But. It will slow down

4:55

or stop accepting capital. The

4:58

managers clients will applaud the decision.

5:01

Allocators that's follow David Swenson

5:03

Gospel love boutiques with closely

5:05

aligned interests. However,

5:08

that view of the world ignores

5:10

the reality that a manager must

5:12

be in business for the long

5:14

term to deliver long term performance.

5:17

The. Same allocators who preach the importance

5:19

of aligning veer interest with the

5:21

manager often failed to consider a

5:24

mining the managers long term interest

5:26

with. There's. One.

5:28

Allocator who favors boutiques recently told me

5:30

she's fine having to turn over managers

5:32

if they don't survive. That

5:35

strategy may work well for the

5:37

allocator, but it's the antithesis of

5:39

the long term partnership mentality that

5:41

Allocator also preaches. A.

5:43

Manager that stays the same take

5:46

some substantial business risk from our

5:48

reliance on performance challenges with count

5:51

retention. And Clients stability.

5:54

One. Performance: history

5:56

suggests that even managers with the best

5:59

long term for suffer

6:01

periods of significant short-term

6:03

underperformance. At

6:05

these times, clients usually head for the

6:07

exits. A boutique may

6:10

be in jeopardy when a rough patch hits

6:12

too early in its life. There's

6:14

an elegance to a manager solely

6:16

focusing on performance, but an

6:19

investment manager's track record is almost

6:21

never linear and creates inevitable challenges

6:23

for a boutique. The

6:28

boutique tends to provide limited opportunities

6:30

for its talent to develop and

6:32

grow. A founder

6:34

hires young and hungry analysts at launch.

6:37

Five or ten years down the

6:40

line, those analysts become experienced and

6:42

get intrigued about what career options

6:44

are available. They may

6:46

get poached by a growing competitor or

6:48

yearn to have their name on the door. A

6:51

boutique can find it difficult to

6:53

sustain performance without retaining its best

6:55

talent. Three, client

6:58

stability. Staying the same

7:00

typically means focusing on a single

7:02

product with a concentrated client base.

7:05

Those business characteristics provide a shaky

7:08

foundation to serve client needs over

7:10

time. Diverse

7:12

interests. No two

7:15

allocators seek managers that perform identical

7:17

roles in their portfolios. Dave

7:19

Morehead, CIO at Baylor University,

7:22

uses a baseball analogy to describe

7:24

his preferred managers. Dave

7:27

hires a manager to play third base. He

7:30

doesn't want that third baseman to play the

7:32

outfield. However, he's

7:34

comfortable if his third baseman roams the left

7:36

side of the infield, where it

7:39

might charge the infield for a bunt, play

7:41

back to field a double play, or

7:43

shift to adapt to a hitter. In

7:46

non-baseball language, Dave prefers a

7:48

boutique and is comfortable with a modest

7:51

amount of latitude for adjacencies. Others

7:54

feel differently. Letitia Johnson,

7:56

the CIO at Amherst College, wants

7:58

her managers to be... best

8:00

athletes. Her portfolio seeks

8:02

those who can play all the positions

8:04

in the field and maybe even pitch

8:06

like Shohei Ohtani. Amherst

8:09

prefers managers with flexible

8:11

opportunistic mandates. Still

8:13

others might look for something in the middle, like

8:15

a utility infielder who can play any

8:18

infield position even if they're not a

8:20

strong hitter. A

8:22

manager's clients often have different expectations

8:24

for how the manager should behave.

8:27

A boutique with a concentrated client base

8:30

may find it hard to fulfill the

8:32

interests of all its clients simultaneously, especially

8:35

as client needs change over

8:37

time. Allocator

8:39

turnover. A boutique

8:41

often finds an ideal initial fit with

8:43

its investor base, but CIO

8:46

turnover can change the dynamic. As

8:49

discussed in the investment office playbook, the

8:52

duration of a CIO's tenure in the

8:54

investment office is finite. A subsequent

8:56

CIO at the same institution might

8:59

have a different investment approach. Staying

9:02

the same poses significant business risk

9:04

that leads a manager to consider

9:07

evolving. Let's take a look

9:09

through the same lens at what a manager

9:11

considers when choosing growth. Option

9:14

2. Grow. A

9:17

manager frequently looks to the future and

9:19

concludes that growth offers the best chance

9:21

to outperform. Asset growth

9:24

brings additional financial resources which can

9:26

be invested in talent and R&D.

9:29

A manager may choose to raise more

9:31

capital in its existing strategy or expand

9:34

the product offering into an adjacency that

9:36

leverages the team's skill set. Communication

9:39

of the manager's evolution is essential

9:41

to earning the confidence of allocators.

9:45

Allocators are likely to embrace change

9:47

that they believe will lead to

9:49

continued strong results. They're skeptical

9:51

when growth appears driven by greed.

9:54

Every manager has an incentive to give

9:57

reasons why growth is good for performance.

10:00

Allocators judge the authenticity of the

10:02

claim. The decision

10:04

to grow brings opportunities for the team, introduces

10:07

risks for performance, and

10:09

faces uncertainty over clients' response.

10:14

Talent. By providing the

10:16

team opportunities to increase compensation, engage

10:18

in new projects, and take on

10:21

decision-making roles, the manager fosters a

10:23

productive culture that offers a platform

10:25

for its top talent to develop

10:28

and maximize their potential within the

10:30

organization. Performance.

10:34

Asset management is ultimately a performance

10:37

business. Just because a

10:39

manager does well with a single strategy

10:41

doesn't mean it will outperform with newer

10:43

or larger ones. Growth

10:45

may compel the manager to move away from

10:47

the sweet spot that allowed it to generate

10:49

early success. Deploying

10:51

more capital in the same strategy requires

10:54

the manager to change what they do.

10:57

Expanding into an adjacency presumes the

10:59

team's skills are portable. If

11:02

either proves less successful than in the

11:04

early stage, the manager gives allocators a

11:06

reason to question the future. Client

11:11

stability. Growth may

11:13

bifurcate the investor base between early

11:15

adopters who favor boutiques and later

11:17

arrivals who embrace growth that allow

11:19

allocators to select the best one

11:21

suited for their playbook, the

11:24

manager aligns its offerings with its

11:26

client's interest. When

11:28

a CIO departure occurs, the growing

11:31

manager will have more options to

11:33

continue a productive working relationship with

11:35

the new CIO. Playing

11:38

the game. In the

11:40

ensuing years, the manager will outperform, underperform,

11:43

or fall somewhere in the middle. In

11:46

any case, the probability of business

11:48

continuity for those choosing the path

11:50

of growth strictly dominates those choosing

11:53

to stay the same. Outperformance.

11:57

When A manager outperforms, all is well,

11:59

irrespective. That path chosen. A

12:02

boutique with outstanding performance becomes

12:04

a stronger boutique. Historical.

12:06

Highest games for their confidence in the strategy.

12:09

And are more likely to stay around through tough

12:11

times in the future. At. The

12:13

same time, the more time that passes

12:16

with outgrowth, the more a boutique may

12:18

face challenges keeping the team together. Boutiques,

12:21

Are dependent on a few key players

12:23

and should any of those players move

12:26

on, the managers' culture and strengths can

12:28

get muddled. Allocators perceived

12:30

change as a negative. And

12:33

will heightened scrutiny. A new. A

12:36

growing manager that outperforms earned the right

12:38

to continue to grow. The. Manager

12:40

provides evidence that it's skill

12:42

not it's niche is driving

12:45

returns. It. Provides a pass

12:47

to grow assets in its course. Strategy. Or.

12:49

Expand to adjacent cease. Great.

12:51

Results are accelerants for culture

12:54

and team development. Muttering.

12:56

Analysts can take on decision making.

12:58

Ross. Senior. Professionals can

13:00

expand into new products. Lateral.

13:03

Hires can bring complimentary skills

13:05

and new strategies. When.

13:07

The economic pie grows. Team members

13:10

yeah past the increasing their compensation

13:12

without competing internally for a bigger

13:14

slice of a six pie. Professional.

13:18

See a path to a career at the From.

13:20

And. That excitement keeps everyone

13:23

engaged. Underperformance.

13:26

His performance suffer the consequences for

13:28

a boutique or more severe than

13:30

for a growing organization. When.

13:33

It boutiques performance suffers. It may

13:35

face existential risk to the business.

13:38

The manager has bet the farm honest

13:40

ability to perform. When. That premise

13:42

fall short. There's no backup plan. A.

13:45

Boutique is left trying to convince clients to

13:47

give it more time. Where. Additional

13:49

clients Once we did, an excuse to join

13:51

the soon and. The. Manager may find

13:53

the queue is empty. When. It

13:56

tries to open the doors for new capital. wow

13:58

what's confident enough to ability to perform and

14:01

keen to bet the farm on that outcome,

14:03

a manager at this point in

14:05

stage two often regrets the decision

14:08

to shun diversifying its client roster

14:10

or product lineup. The

14:12

allocators who want to plodded them for staying

14:14

focused no longer are as

14:16

loyal as they represented. A

14:19

manager who grows and falters in stage

14:21

two will also face challenges to the

14:23

business. Pressure increases as

14:25

the manager assesses the team, products,

14:28

and process to learn what went wrong.

14:31

Trust and communication become necessary

14:34

skills for survival. Managers

14:36

that clearly articulate the validity of

14:38

their strategy and diagnose the causes

14:40

of underperformance stand the best chance

14:43

of living to fight another day.

14:47

Average performance. When

14:49

results in the second stage are average,

14:51

the manager's communication and ability to instill

14:53

confidence with allocators become the most important

14:56

driver of the next phase of the

14:58

business. Again, the outlook

15:01

for a growing manager is better

15:03

than a boutique. A

15:05

boutique will stall out without continued

15:07

outstanding performance. The manager

15:09

may keep its clients, but the queue

15:12

of interest from prospects will wane. A

15:15

boutique manager often eschews engaging

15:17

with prospects to focus solely

15:19

on investing. At times

15:21

like these, it will learn its

15:23

closed-door policy was a mistake. Team

15:26

members may find their heads on the

15:28

swivel as they consider what will happen

15:30

if performance does not improve. Departures

15:33

can undermine investors' confidence leading

15:35

to withdrawals. Similar

15:38

to a growing manager with poor results,

15:40

a growing manager with reasonable returns will

15:43

have opportunities to assess what's working and

15:45

what is not, make changes,

15:47

and improve. So long

15:49

as a growing manager does not

15:52

significantly underperform, it will continue to

15:54

have opportunities to expand. A

15:56

growing manager's team is more likely to stick

15:58

around and see what inspires. The

16:01

manager has expressed its intention to

16:03

grow and a pause in that

16:05

trajectory does not cause otherwise excited

16:07

talent to depart for greener pastures.

16:10

Making changes to put the firm's

16:12

best foot forward strengthens the culture

16:14

and re-energizes the team. Stage

16:18

3 and beyond. After

16:21

another stretch of years the manager will

16:23

have more opportunities to reconsider its business

16:25

strategy. Success begets more

16:28

success allowing a boutique to stick

16:30

to its knitting and a growing

16:32

manager to expand further. Failure

16:34

leads to business risk with the boutique

16:36

suffering sooner and more harshly than a

16:39

growing firm. Like

16:41

the compounding of capital the decision

16:43

to remain a boutique or grow

16:45

compounds over time. The

16:48

more success a growing manager finds

16:50

the stronger its business becomes and

16:52

the more resilient its organization is

16:54

to inevitable performance setbacks. A

16:57

growing manager builds a higher quality

17:00

business with diversified products and customers,

17:03

steadier income to support its team and a

17:05

reputation for excellence. In

17:08

contrast a boutique only modestly derives

17:10

the benefits of compounding. A

17:13

boutique manager is always one step away

17:15

from a bad stretch of performance that

17:17

creates an existential threat to the business.

17:21

Other factors public versus

17:24

private strategies. Public

17:26

market strategies compress the time between

17:29

decisions for both managers and allocators.

17:32

Fun flows are continuous for the manager.

17:34

Daily marks, monthly reporting and

17:37

frequent subscription and withdrawal dates

17:39

need allocators to draw conclusions

17:41

about a manager's skill far

17:43

more quickly than statistically significant

17:45

data would suggest. Private

17:48

market strategies can undergo two or three

17:51

fundraising cycles over five or more years

17:53

before allocators have any evidence of the

17:55

success of their initial commitment. Private

17:58

market managers have more time to to write

18:00

their playbook. Other

18:02

factors, duration and succession.

18:06

Boutiques are not designed to outlast their

18:08

founder. The investment offering

18:10

rarely passes on to the next generation.

18:13

As many hedge funds approach their

18:15

founder's retirement, only a few

18:18

have successfully passed the baton. Almost

18:21

every instance of a hedge fund

18:23

lasting beyond its first generation has

18:25

followed a business strategy that expanded

18:28

beyond the manager's initial product offering.

18:31

Growing managers pivot the investment DNA

18:34

from a single individual to the team,

18:37

including a process to develop the

18:39

next generation. Private equity

18:41

firms have employed an apprenticeship model from

18:43

the early days of the industry, and

18:45

many have succeeded their founders. The

18:48

large public alternative asset managers expanding

18:50

from private equity to credit, real

18:53

estate, and insurance are the best examples.

18:57

We're raising more capital. The

18:59

next time an allocator hears a manager

19:01

is moving away from its niche and

19:03

expanding, it may think twice about dismissing

19:05

the manager as another case study in

19:07

greed. Money managers

19:09

are in the business of assessing

19:11

businesses, and a boutique asset

19:13

manager is not a particularly good one. An

19:17

allocator idealizing a boutique may want

19:19

to consider how it feels about

19:21

a manager who makes a suboptimal

19:23

decision on such an important choice

19:25

in their life. It

19:28

also may want to consider how

19:30

alignment of interests works when considering

19:32

the manager's duration in business. Understanding

19:36

the playbook from the manager's perspective

19:38

can help allocators assess the motivation

19:40

behind a manager's decision and prospects

19:42

for its future returns. Thanks

19:45

for listening to the show. If you

19:48

like what you heard, hop on our

19:50

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sign up for premium content. Have

19:57

a good one, and see you next time. you