Gavin Baker – Truth-Seeking and Crossover Investing at Atreides (EP.489)

A lot of being successful as an investor is finding an investment philosophy that fits your own emotional makeup such that you can be rational when you're wrong. I'm wrong a lot. This is a humbling business. When I am wrong and it's because of something I hadn't considered or a risk I was unaware of, that made it hard for me to be rational. But when the stock went down and it was a risk I had considered — stocks always go down more than you expect — it was much easier for me to be rational and make high quality decisions when I'm wrong, which I think is a lot of what being an investor comes down to. That's very important. As an investor, you have to either panic early or double down late. And you have to be one of the two. It's hard to be both. For me, I'm a double down late person. I'm always buying stocks on the 52-week low list. It makes me uncomfortable when a name is in the consensus. Sometimes consensus is right, but it's important to me to be contrarian.

Yeah, I'm likewise excited, Ted. I'm dying to know — what were you like as a kid? I was very competitive, but I was terrible at sports. Pick last for every team, always. I was very into Dungeons and Dragons. I remember a signature honor was being appointed the dungeon master by the outgoing dungeon master. He was going to his freshman year of high school and I was in fifth grade. I was just so proud to be the youngest dungeon master. I was always into history, the news, current events. I loved military history. Loved playing chess. Loved playing this game Stratego. I remember how bad I felt the first time I beat my dad at both Stratego and chess. I wasn't particularly social until I got to high school. Then I became very social. That served me well. When I got to college, people were going crazy because it was the first time they'd gone to a big party. And I was like, 'Wow, I was doing this stuff when I was a freshman in high school. Maybe I'll go crack open a book at a library.' Had a pretty free-range childhood. Was able to do what I wanted in the summers. I was very lucky. I grew up relatively privileged. My parents gave me an unlimited book budget. As a family, we'd go to bookstores every two weeks, so we'd spend hours there and I'd stack books up. Also, there wasn't a lot of structure to my summers. I spent most of the summers at my grandparents' house in the Texas Hill Country, which was an incredible experience growing up with all my cousins. If I was there for like seven or eight weeks, maybe my parents were there for in total 20 of those days. Some of the weekends it was a six-hour drive from where I lived. So, I grew up with all my cousins sleeping in a screened-in porch, going fishing, searching for arrowheads, running around. Tennis was very important to me. There happened to be a public swim club sports complex and I went there and there was a racket and a ball and I just started hitting against the wall. That was my first experience with athletic competition because I could practice my way into being good. I realized junior year of high school that there was no hope of me playing even Division 3 college tennis and I gave it up. But I think that was the first time other than something like chess or Stratego that competitiveness had an outlet.

Strangely enough, I got very into military technology. There's those black composition books. They're this big. They're black and white and they have papers. And I probably filled 50 of those. I was into the thrust-to-weight ratio of various planes. And I redesigned the F-15 with a canard, a different radar, and then these Rolls-Royce engines instead of Pratt and Whitney. Strange I didn't end up becoming an engineer given all of that. I read a tremendous amount about history. I read a vast amount of fantasy and science fiction, which I think shapes a lot of who I am today, and I still continue to do that. The conversations around the dinner table with my family were always about ideas, books, things that people had read. We would go on family vacations and we'd go skiing, you have a dinner, and then the last three hours of the night, we would sit in the living room as a family and read. The first time I went on vacation with someone else's family, I was like, 'Wow, people talk a lot and they're talking about different things than I was used to.' Arguments were a really big thing in my family. My parents were both lawyers. Arguing with them was always encouraged.

I don't think I got very good grades in high school. The classes weren't meaningful to me. I found what I was doing, my own pursuits, much more interesting. I was lucky enough to be a good standardized test taker. So, that helped me get into college despite my grades. A big thing that changed my life — I went to Dartmouth College. I had no business going to Dartmouth given the grades I had. I'd been the captain of the tennis team and the president of Bay Club or whatever. There was a kid at my high school in my junior year. He was a little different. He was 6'7", 6'8", a big guy. He got relentlessly teased and bullied. I think this shaped a lot of my life because for sure I think I would have had a different path had I not gone to Dartmouth. One day there was a pickup area where you waited to be picked up. I was a junior so I was driving myself to and from high school and I saw this group of freshmen teasing this huge kid. I didn't think anything of it. I was just like, 'Hey, don't do that. That's not cool. Never do that again.' The next day, one of my best friends in high school was the captain of the basketball team, captain of the football team, and I invited this kid to come sit with us. Every month, come sit with us. And never thought anything about it. Senior fall, I get an alumni interview for Dartmouth, which I think was a little surprising to the guidance counselor. And a really big man sits down across from me, and I'm not thinking anything. He's like, 'Gavin, do you know who I am?' And I'm like, 'Sir, I don't. I'm so sorry they didn't give me your name beforehand.' He's like, 'Well, I'm the guy who's going to change your life because you changed my son's life.' It was the parent of that kid. And he's like, 'I'm the president of the Greater Texas Dartmouth Alumni Association. I've never asked for anything and you're going to Dartmouth.' And I was like, 'Okay.'

It was complete coincidence. In college, the most important thing to me by far was rock climbing. I became more serious about my grades. But rock climbing dominated my life. My plan was I'm going to go climb. The best seasons to climb are fall and spring because the rock's not too hot. If it's too cold, you can't grip it. If it's too hot, it's slippery. So spring and fall when you really want to climb. And I was going to climb full-time spring and fall. I was going to be a ski bum in the winter. I ski bummed at the Gold Miner's Daughter at Alta. I was such a screw-up. I went there with a bunch of kids from Dartmouth. Everybody else got rapidly promoted. I stayed at the most junior level of housekeeper the whole time. I was the guy who had to clean the toilets because I'm a little absent-minded. I was going to be ski bum in the winter, work on a river in the summer, climb, live out of the back of a pickup truck, try and write a novel, maybe write something about history, be a wildlife photographer — into photography at one point. You could save enough money working as a ski bum or on a river to support yourself in those shoulder seasons. A lot of people do it. My parents were like, 'This is an amazing plan. We've never asked you for anything, but just do one professional internship.' The only internship I could get was in finance here in Boston, working for Donaldson, Lufkin and Jenrette. I worked for the head broker, the number two producer of the office. Every day a bunch of research would be produced and we'd get these big stacks of nicely bound paper research reports. My job was to look at which clients owned them and then put them in an envelope and mail them to the client. As part of that, I started reading every report and I got so into it. It was everything I loved. It was competitiveness. It was history. It was current events. It was understanding risks. Risk is a big part of rock climbing, accurately calculating it. I have to think about things I learned about risk a lot in the context of investing. I started reading these. I loved it. I'll never forget I had to write a 20-page thing at the end. And I wrote up Cisco in 1996 and I presented it to everybody and everybody was like, 'Yeah, but it's already been such a good stock. How could it go up any further?' It was at 20x in the next four years. And being the arms dealer to the internet resonated with me and I knew how important the internet was because Dartmouth had email. They called it BlitzMail. I was very familiar with all of that. I came back to Dartmouth. I changed my major from history and English to history and economics. Started a hedge fund that traded options. Never looked back. Started reading the Wall Street Journal every day that fall that I spent at DJ. I lived in a one-bedroom apartment in the basement of a woman's house in Cambridge. Every day I'd take the Red Line home, get off at Harvard Square. There's the people who you can play chess for money. I'd love to beat one of them — no chance. I'd play one of them and then I'd go home, cook myself Kraft Mac and Cheese and read about investing. I read Buffett's letters to his shareholders. I read both Peter Lynch books. I found this great book that we still use here that helped me understand accounting. Taught myself how to build a model and that was how it worked. I remember I printed out the old Motley Fool message boards. There was this guy Dale Wettlaufer. He talked a lot about return on invested capital and incremental returns on incremental invested capital. That was so powerful for me. I never looked back. Then had a series of finance internships. I was interviewing with Soros and Tiger. I'd interviewed at Goldman Sachs for investment banking. They said, 'Hey, we see your SAT score. You're not dumb.' And they're like, 'We see you've gotten bad grades — I forget what, maybe geology. I don't know what it was.' And I'm like, 'Listen, if I'm not interested in something, I struggle to apply myself.' And they're like, 'Well, in investment banking, a lot of it is doing really boring, detailed work that has to be done well.' And I'm like, 'Well, it doesn't sound like it's for me.' But I'd gotten a job in Goldman Equity Research, and I was thinking about all these things. I didn't always go to class, so I relied on friends' notes before an economics test. And they're like, 'Hey man, we just heard this Fidelity pitch and it sounds incredible for you.' I interviewed them the next day, and this was the first time I learned about the buy side. I said, 'Well, I have these exploding offers from Goldman Sachs and Lehman Brothers. They explode like in two days.' And the Fidelity guy was like, 'Don't worry about them.' And I'm like, 'What do you mean?' And he's like, 'I'm going to tell you they're not going to explode.' I'm like, 'No, they've told me they're going to explode.' He's like, 'Listen, if at noon tomorrow you still believe they're going to explode, you give me a call, but we want you in Boston in two weeks and these offers aren't going to explode.' The guy's name was Steve Calhoun. He's a great guy. And then the next day, Goldman Sachs and Lehman Brothers call me and they say, 'You have as much time as you want. Your offers are no longer exploding.' And I was like, 'Oh.' I think had I gone to work anywhere other than Fidelity, I would not have had a successful career in finance. I profoundly believe that.

At Fidelity, you join out of college. You don't work for anyone. They give you a group of 30 stocks. They give you the phone number of the IR, the email address of the IR, how much Fidelity owns in percentage and dollar terms of each name. They give you three monitors and they say go. That's very different than anywhere else where you work for someone. I don't think I would have done that great working directly for someone. Can't tell you how incredible it is. There's a one-month training program and it's really good, but then you just get this list of stocks. The only thing you're judged on is results. Sometimes people there believe it's political but it is ultimately very meritocratic. Sometimes it takes three to five years for meritocracy to assert itself. But it was incredible. Your job is your buys need to outperform your sells. Ideally your buys outperform the market and they measured spread value added on each side relative to the market. Then they measured your impact, how you changed Fidelity's holdings. You can go do the job however you want. If you want to be one of these people who's always on the phone talking to other people on the buy side, okay, as long as it works. If you want to be the world's best modeler, live in a world of 10-Ks and 10-Qs, great. If you want to constantly be on the road, if you want to go to every relevant convention — and there was an unlimited travel budget in those days, which is wild — you can do that. If you want to do continuous channel checks, if you're the retail analyst and your process is you just want to drive around, go to every Best Buy you can, great. All you have to do is generate results. You have this incredible freedom and independence. And then it's combined with because Fidelity, they run money in every discipline — value, growth, core, income, small cap, mid cap, large cap. They have sector funds for each thing. And as an analyst, you have to service all of those PMs. You have to learn what will resonate with each PM and you begin to find the philosophy that resonates with you. I'll never forget Joel Tillinghast, great value investor. I went in and I covered these capacitor companies that were wildly overearning. Joel owned one and I was like, 'Listen, the earnings are about to crater. You don't want to own these names at a cyclical peak when they're really cheap because tech cyclicals are different than normal cyclicals. Normal cyclicals you get peak multiples, trough fundamentals. Tech, it's not quite the same.' Makes for a lot more nuance but even so everybody understood that capacitors were obviously wildly overearning. And I think Kemet was at four times earnings. I went into Joel and I was like, 'Man, you need to sell this. Their earnings are going to go down 80%.' And he's like, 'Well, let's do something. Let's look at their assets. Let's look at their equity. Let's look over the last 10 years, 15, and 20 years what their average ROA and ROE is. And then we'll generate those normalized earnings.' And I'm four months out of college and he's like, 'On those normalized earnings, I think it's pretty cheap.' And you're probably right. The stock is going to go down, but I've owned it for a really long time. I have a low cost basis and I'm going to live with this vol. You have experience after experience like that with different fund managers, which I think is really healthy because a lot of people come into investing they're steeped in Buffett and they're super convinced that that's the only way to do it. By the way, everything is downstream of Buffett. In the English language, 99% of good quotes are from Shakespeare, 1% are from Winston Churchill, and there's essentially nothing else. Overstatement of investing: Buffett is 95%, then there's Peter Lynch's 4%. Then a bunch of other people for the 1%. It's important to be exposed to all these things because you come in steeped in value and steeped in Buffett and steeped in Benjamin Graham. Everybody's read The Intelligent Investor. Everybody knows chapters 8 and 20 are the most important chapters. That's not the right philosophy for a lot of people. A lot of being successful as an investor is finding an investment philosophy that fits your own emotional makeup such that you can be rational when you're wrong.

A few things. Steve Wymer. Steve's approach was to always do the work himself, to not rely on the analyst, rather than expect the analyst to deliver ideas and alpha for you. To go understand the company really well, to go to every analyst day, to go to every relevant trade show, to do your own legwork, to read every relevant transcript. That was most formative for me because what helps me be rational when I am wrong is feeling like I have a high knowledge level on the company. I'm wrong a lot. This is a humbling business. When I am wrong and it's because of something I hadn't considered or a risk I was unaware of, that made it hard for me to be rational. But when the stock went down and it was a risk I had considered — stocks always go down more than you expect — it was much easier for me to be rational and make high quality decisions when I'm wrong, which I think is a lot of what being an investor comes down to. That's very important. And as a result of that, I didn't care whether the analysts at Fidelity got their stocks right or wrong. It was utterly immaterial to how I evaluated analysts. There's an analyst. He consistently had some of the worst stock-picking metrics in the department. But I made a vast amount of money with that guy because he always laid out all of the facts, even importantly the ones that suggested his rating might be wrong. And he would always lay out very clearly the bull and the bear arguments. Here are the three bullish lenses through which people view the stock. Here are the three bearish lenses. He would happen to pretty consistently pick the wrong one. It was incredible and I think that was the way a lot of my colleagues on the growth team who imbued Steve's philosophy of doing your own work. That was what was important to us. Be on top of the facts. Show us the second there is a new fact that's important because investing is a Bayesian endeavor. You have a Bayesian probability space of expected outcomes. The data points should fit within that. And then if there's a data point outside that, that's where you have to super focus. If a data point's inside your expected probability space, it's less urgent than if it's outside. The second thing, there's a woman named Jennifer URG, who's one of my closest friends, just like Steve. Her big thing, and it's so true — as an investor, you have to either panic early or double down late. And you have to be one of the two. It's hard to be both. For me, I'm a double down late person. I'm always buying stocks on the 52-week low list. It makes me uncomfortable when a name is in the consensus. Sometimes consensus is right, but it's important to me to be contrarian. And then the third one is Will North. A lot of people feel biased to be consistent. If you've been buying a stock every day for 100 days and the facts change, it's hard to turn around and type into the order management system 'sell all.' And Will was a true master of being totally dispassionate. He didn't care what he did yesterday. 'When the facts change, I change my mind.' That's John Maynard Keynes. But not many people can do it. Going back to that Bayesian probability space, when there's something that lands outside of that — it changes the thesis, you have to react. So in those three examples, there are threads of growth investing versus value. Joel Tillinghast is the value guy. You're pitching getting out of a value stock. There's threads of value wanting to double down late. Where did you see yourself on the stylistic spectrum in addition to wanting to know the companies really well? At the end of the day, everything is downstream of value. It's not this great value versus growth debate. This is something that's often misunderstood. When a growth investor owns something at 60 times earnings, it's not like they believe in the greater fool theory. Instead, what you think is that in three years or maybe five years, it's a high quality business. And on your numbers out that far, it's at eight times earnings and it should probably be valued at 25. So it's a triple. Growth investors tend to have more out-of-consensus estimates. Warren Buffett's famous statement is the price you pay determines your return. I would modify that and say the price you pay determines your return for a given business outcome. That's a very important modification. If you're paying 40 times earnings and the company is actually going to compound their earnings at a high rate over time, which is possible with a lot of these great growth stocks where they have low margins because they've been investing, and then you go into a period where the revenue growth maybe slows a little, but the operating margins explode. But I don't know a single growth investor with good numbers who isn't extremely sensitive to valuation. John Hampton's a famous value guy, short seller. He wrote this thing about an investment memo. It should be 8 to 10 pages. Valuation should be two sentences at the end. It's not that complicated. After you've been doing this long enough, you can do a DCF in your head really quick. If you've been doing this more than five years and you can't instantly do a DCF in your head, this is the wrong business for you. People are not confused about valuation. And I do think this is why a lot of fundamentally based value strategies have struggled for a long time because the alpha in those strategies was being willing to own these stocks that other people were embarrassed to own because they were so out of favor and you didn't have that different of an opinion on the future business outcome. You just were willing to tolerate six to nine months of pain owning something really out of favor and then it would mean revert. Problem is when algorithms and quantitative investors came in, they took all that alpha because they don't feel embarrassment. They don't feel shame. They don't feel emotion. And that's why a lot of human-driven fundamental value strategies really struggled — have struggled for a long time. And the alpha in the market as a fundamental investor comes from having earnings estimates or free cash flow estimates or whatever metric you choose that are materially different from consensus and being right.

I did my first venture deal in 2001. I was on the floor of the Consumer Electronics Show and I met this company. They could do something called RF on CMOS. At that time, most Wi-Fi chips were made with very specialized, more expensive materials. They could do it on the standard silicon. This is going to be amazing. And I said, 'Man, when are you going to go public? I can't wait to invest.' Because I was at Fidelity. The CEO had heard that this Fidelity guy was at the booth asking about how to invest and a sales guy eventually comes out of whatever — at CES people are in these rooms — and he's like, 'Well, you can invest right now. We're looking to raise a round.' And I'm like, 'But you're private.' He's like, 'Well, you could still invest.' So, I call up Wymer and I'm like, 'Man, I think this is really exciting.' And he's like, 'Oh, yeah. RF on CMOS Wi-Fi. That's going to be amazing. It's going to change the world.' You have a lot of unusual experiences as a young person at Fidelity because sometimes you own 15% of a company, you're the most important shareholder and you're 22 or 23 and you're sitting down with a CEO. So anyways, I go to this room in New York and it was at a law firm's office and I was by myself and there's this giant team. It's the management team. They've hired a banker. It's their lawyer. We're there to negotiate the terms. They say, 'Hey, we think this is the price we want.' And I'm like, 'No, that's not the price. This is a fair price. I'm not going to pay an unfair price.' And they're like, 'Okay.' And I was like, 'I have to go meet with a big public company where we own $800 million worth of it. We need to wrap this up quick.' I wasn't even negotiating. That was just the truth. We were only going to put $30 million into this company or 50. And I was going to be late to see the CEO of a company where he owned a billion dollars worth of stock. I was like, 'Guys, I don't have a lot of time. Let's either do this or not.' And then they're like, 'Well, what kind of terms do you want?' And I'm like, 'The standard ones.' And they're like, 'Well, what kind of preferences do you want? What kind of liquidation preferences?' I had no idea what they were. And I was like, 'I just want the standard ones.' And then they sent over a term sheet. A Fidelity attorney got involved the next day and explained it all to me. And then I re-engaged with venture right around the time Allen and Company started bringing growth-stage equity opportunities to big mutual fund managers. It was just so important to own Facebook privately in 2010. From that point on, I became very involved in Fidelity's venture efforts. I was getting more into this and it was more exciting. It was becoming clear to me that doing public and private investing together was a big advantage. So, for instance, there's this company Roku. No VCs would fund it because every venture capitalist was worried about competition from Amazon, Google, and Apple. I was like, well, I'm really familiar with those companies competing with Roku. It is not on their top 50 list of priorities. It's not like the A team is being staffed on this. And I think there's a room for connected TV box. They had a great UI. The founder, Anthony Wood, was great. We led three rounds in a row at Roku. Made plenty of mistakes as well. Like I did invest in WeWork. They pushed the price and I did cut my order in half. Never did anymore to the best of my memory. But it's not like it was all roses or successes. But I really liked it. A venture fund, a hedge fund. I got excited about them. They felt like my calling. I became passionate about the products. So I told my boss it makes sense for me to leave.

When we started, I had a couple of ideas. I do think being at Fidelity for 18 years was an advantage because I saw a lot of different regimes for how you compensate analysts and PMs. Probably most big asset management firm changes the way they pay people every three to five years and it's really hard. You got to find a balance between accountability and incentivizing risk-taking. I had participated in the hiring decisions for hundreds of people and I'd seen how those people had worked out as analysts. Like anything, repetition and seeing a lot of film helps.

Point number one, when I started, I thought there was way too big of a bias for people who'd played college sports or been a fighter pilot in the Navy and I was like, hey, we need to have room for a violinist. In today's world, actually having played sports is an advantage or done anything where there's objective outcomes. For a lot of children, they've lived in a world of participation trophies and grade inflation. They haven't been confronted with losing, with an empirical reality where they're wrong. Having participated in a competitive endeavor is now more important to me than it was. Having a tremendous amount of passion and curiosity is important. And again, I think investing is interesting enough that you can take somebody who has a demonstrated history of competitive success, hard work, passion, curiosity, and a lot of those people will succeed in investing because it is so inherently interesting. I was a little less sensitive to experience, but then a lot of it is I would always ask people, tell me about sometimes when you were really wrong and how you made a decision. And then I would ask everyone, tell me what your favorite class was and the three most interesting things you learned in it. And if you didn't have a good answer to that, you probably weren't that passionate. And even though I was a different student, there were some classes that I was passionate about. I loved my class on the Iliad and the Odyssey. I loved my class on romantic poetry. I loved my class on behavioral finance. I loved my class on macro. You don't have to be interested in everything, but you have to be really interested in something. And then you have to be really curious. Tell me 10 things you've learned in the last three months. Because if you're a curious person, you should always be learning. So I look for curiosity, passion, and try to tease out this ability to be rational when wrong. That's I think the hardest thing to do.

I wanted it to be a place where I do think investing is a search for truth and truth — alpha generation is truth — comes out through discourse and discussion. You become friends with people you work with and you don't want to make an analyst look bad in front of the portfolio manager. So, I wanted it to be important for the analysts to argue with each other in a constructive, respectful way and to tell me I was wrong. Those were the most important things to me — is I wanted it to be a place where debate was really encouraged. People understood that I genuinely liked being told that I was wrong. So, I did a lot of that. Tried to lead by example. Anytime somebody tells me I'm wrong, 'Wow, thank you. Let's talk about that more.' I wanted to really incentivize people to not seek out confirmatory information. So instead of having an investment thesis, we have an investment hypothesis. Thesis being a literal statement of belief. And if you state a belief as a human, you become attached to it. Whereas a hypothesis is quantitatively falsifiable and you're attempting to falsify it all the time. And I think that's an important distinction because everyone here is always looking to falsify our hypothesis. A lot of being a successful investor — you have to find an investment philosophy that fits your own emotional makeup. And then you always have to find the right balance, to quote Michael Steinhardt, between the courage of your convictions and the flexibility to admit when you're wrong. I tried to set all of that up to make it safe for people to have high conviction and also make it safe for them to change their mind when the facts changed. In some investment organizations, it's not safe to change your mind. So, just tried to set up an organization where there was healthy, respectful discussion and dialogue about stocks. People felt comfortable debating each other and suggesting that other people were wrong. People felt safe telling me that I was wrong. And all of that, trying to find the right balance...

The way I think about it, and maybe it's not a perfect analogy: every position in the fund, I think of it as like an airplane. On some positions, I'm the pilot. On other positions, I'm the co-pilot. Some positions I'm in the plane, and the pilot and the co-pilot are people I've worked with for a long time and come to really, really trust. But I'm still in the plane—I'm going up to the cockpit regularly. A lot of that comes down to my knowledge level, where I feel the analyst's knowledge level is, but it's a balance. How do you get to the depth of research on a name that allows you to feel sufficiently comfortable to know when to buy and sell?

I think just doing primary research—you do want to know those bullish and bearish prisms. On any stock, there's like three to seven key analytical debates. You need to understand all those debates. Every once in a while you'll have an analytical angle that no one is thinking about, but that's rare. The analysts need to understand the analytical prisms for a given stock through which that are driving price action in the market. Where are we in consensus? Where are we out of consensus?

None of this is to compare myself to Michael Jordan. But if you watch The Last Dance or you read any histories of the Bulls, Jerry Krause, who was the GM after their second-to-last championship, said, 'Listen, players don't win championships. Organizations do.' He went on to say, 'It's not just Michael and Scottie and Dennis Rodman. It's the way we scout players. It's the way we draft players. It's the way we evaluate players and trade for them. It's the training facilities we have. It's the offense we have—Tex Winter's Triangle offense. It's a system. We have an organizational edge.' Well, after Michael Jordan left, they never won another championship. That is a truth that a lot of allocators struggle with, because it feels safe and good to say, 'Oh, wow, there's a process and it's repeatable.' And by the way, you have to have a process and you have to have the process that works for you. But any process that's repeatable that generates significant alpha—in a very competitive world, it's going to quickly be arbed away. In fundamental investing, any process-driven advantage just isn't going to last. So where does the repeatable performance come from? I would just submit that any investment organization, no matter how big, they're somewhere between two and ten people. And if you took those people out and the organization had the exact same process, the results would be very different. I always think of idea generation as a very funny concept, because particularly as a crossover investor, there should be no new ideas if I'm doing my job well. You should have a defined universe where we have a very high knowledge level. You should be aware of the fundamentals, and then the fundamentals drive the valuation. The places where you have the biggest gaps to consensus—and ideally the stock's cheap on both consensus numbers and dramatically cheaper on your numbers—that's where you hunt, and vice versa for shorts. I think of the most important edge as recruiting, training, and retaining a great team. And then going back to that pilot co-pilot, having an internal process such that we get the most out of our combined insights. For me, execution is the gap between our performance and the performance we could have had based on the quality of our insights. I make an effort to measure that every year and every year get better. That's incumbent on me as the portfolio manager, and it's incumbent on the analyst. We're a team on each stock, and it's our job to deliver the best outcome on that stock given what we know, and then the rest of the team is there to be additive to that discussion and debate. Kaizen is a word that we often use here, and my goal is to get a little bit better at execution every year.

The only thing everybody who ran a hedge fund said to me—and these are hedge fund luminaries—is, 'Listen, Gavin, you are going to hear from every allocator that shorting stocks is very different from a long-only, and you should be cautious and learn to short.' Said is super important: that you ignore them. There's no difference except for the risk, but the same principles apply. If you're good at buying stocks, you're going to be good at shorting stocks. Now you have to understand the risk differently—that was the second thing. I've had such a lucky career. I was so lucky to be assigned small and mid-cap semis in the year 2000. Another really lucky thing that happened to me: I took over my first fund. I think I was 25 years old. I went down 700 basis points relative in my first month. It's a lot. I'm like, 'Oh my god, I clearly have no idea what I am doing.' Fidelity had just hired a team of quantitative researchers. There was a lot of skepticism back then about the quants. They asked to schedule a meeting with me, and these are like people with PhDs, and they say all this stuff to me about how to think about risk and construct a portfolio and size decisions and selection for sizing. And I was like, 'Oh my god, this is awesome.' And I was like, 'Well, when is the next time I can meet with you guys?' They're like, 'Well, to be honest, not many people want to meet with us, so we're excited to meet with you as much as you want.' So I met with this team of quants for one or two hours a day every day for more than a year. I read the Barra book on factor risks. I got used to thinking in terms of vol-adjusting position sizes. But after a rough start, that background and thinking about risk and portfolio construction from a quantitative lens helped me make this transition, because it's not the dynamics of shorting that are different in terms of what makes stocks go up or down—it's the risk, because they can go up infinitely. You have to manage short squeezes, crowding. One of our clients had this great phrase: there's three risks for a hedge fund—LLC: liquidity, leverage, concentration. I now say LLCC: liquidity, leverage, concentration, crowding. Understanding all of those was maybe a little easier for me because of that incredible education I got from those quants who I'm so grateful to.

If you are going to run a high-growth, the most essential thing that you have to manage is basis risk. Basis risk is when your longs and your shorts are not correlated. So quantitatively, if you're a hedge fund and you run a levered long book and a net exposure over zero, the most important factor for your returns is long-short spread. You can generate an immense amount of long-short spread by being long names that are uncorrelated. You can't be long a stock like GM and be short Tesla—from a quantitative perspective, that makes no sense. If you're long growth and short value, that's equally painful. If you're long value and short growth, that means you're just levered value. If you're long growth and short value, you're just levered growth. So if we were going to run with a high-growth, it was important to me to try and generate long-short spread in stocks that were quantitatively and fundamentally similar. If you do that, you can lever that up, and then that's how you get a Sharpe ratio that's ahead of the index. That's a hedge fund.