Hedging Risk, Accessing Opportunity with Dave Thomas

Greg Dowling (00:06): Welcome to the FEG Insight Bridge. This is Greg Dowling, Head of Research and CIO at FEG. This show spans global markets and institutional investments through conversations with some of the world's leading investment, economic and philanthropic minds to provide insight on how institutional investors can survive and even thrive in the world of markets and finance. To make a long story short, hedged equity has underperformed for a long time. Today, on the FEG Insight Bridge, we diagnose the cause of that underperformance and explain why all that may be changing. Helping us on this journey will be Dave Thomas of Atalan Capital. Dave spent the bulk of his career in long-short equity at several prominent jobs before founding his own firm. He will share what he learned along the way, what works and what doesn't, and how the current investment environment stacks up to the past. Do not get shortchanged. Listen now. Dave, welcome to the FEG Insight Bridge.

Dave Thomas (01:05): Thanks for having me, Greg.

Greg Dowling (01:07): All right. We're going to talk a lot about long short, and I'm going to use long short and hedged equity kind of interchangeably. So if I say one or the other, listeners, we are talking about the same thing. But I wanted to ask you to kick off by just introducing yourself and Atalan.

Dave Thomas (01:23): I'm Dave Thomas. I'm the Founder of Atalan Capital Partners. Atalan is an equity long-short fund. It's based in New York. It started in 2015, so we're in our 10th year, and the fund invests in equities globally, both long and short, across geographies, market caps and sectors where we have a broad opportunistic focus and do so in a concentrated manner.

Greg Dowling (01:46): All right. We'll explain all that jargon here in a second, but, Dave, personally, you grew up in North Carolina. How did you end up on Wall Street?

Dave Thomas (01:54): I had no background in this. My parents were in the medical industry. It was a small town in North Carolina. I went to public school there and made my way to Duke University, somewhat by luck.

Greg Dowling (02:050: It wasn't a basketball scholarship?

Dave Thomas (02:06): Unfortunately, no.

Greg Dowling (02:08): Okay.

Dave Thomas (02:09): That wasn't the focus. By luck, my college roommate was a French national, and his dad -- This is in the '90s. His dad was a very well-known macro fund manager, been very successful, and we used to get his letters via sort of snail mail at the time. I'm dating myself by saying email was just emerging when this was going on. I was always a current events junkie. I loved math, but it wasn't obvious to me getting to college how you would apply it. And reading these letters, kind of the light bulb went off, to me, at least, is that I can't believe people get paid to actually do this, to study the world, to get to look at it at this level, at the systemic level. And that just had an instant appeal for me, so I pointed myself in that direction, got my first job out of college in investment banking at JPMorgan, used that to get into private equity investing and, in the course of that, pretty quickly came to the conclusion that I wanted to be in the public side, primarily because I just love the investing side of what we were doing, the front end of the deals and a lot of the deal process, which I think you have to be good at, because that's where a lot of the alpha generation in private equity comes from. Just had fundamentally less appeal to me, and so that kind of put me in the direction of public markets. I went to Stanford Business School and began orienting my career in that direction and then came out, began the industry. That was the first decade of my 2-plus decades that I've been in it. From that point, after that journey into the industry, I started at Atalan Capital 9 1/2 years ago.

Greg Dowling (03:32): And so along the way, you worked at a lot of great jobs, a lot of well-known, long-short and multi-strategy jobs. What did you kind of take away from your journey along the way?

Dave Thomas (03:42): I was lucky to have had those seats. They were all scaled, successful firms. You knew them. That's where we met originally, Greg. In that process, all of them had different approaches. Fundamentally, when you get down to what our business is, it's an apprenticeship business. There's no right or wrong way to do this. It kind of ties into the whole concept of, what is a hedge fund? There's many different approaches to that. The DNA that you carry from those businesses and those mentors and what they do absolutely shapes you, and in the course of that decade, though, for me, a lot of it was just finding my own voice, learning a lot from these people, a lot of what they did that resonated with you, other aspects of the business that didn't, come together and find your own voice, position you if you wanted to go down this route of starting your own fund to be able to do that. But those experiences are always formative, and I was lucky to have those seats.

Greg Dowling (04:28): There were some great shops that you were at, so why launch your own?

Dave Thomas (04:30): This is a mountain you either kind of want to climb or you don't, and there's a lot of reasons not to, but this is something that I had always had in the back of my mind as wanting to do, and that conviction along the journey just built. And I knew it was something, if I didn't do it, I would regret it, which makes the decision even easier, to go down that whole path to do this. But from my perspective, that first decade was really about learning and then also about really finding your own voice, finding your own philosophy, but then also accumulating enough personal capital that you really bring to this and owner-operator mentality, which to me was critical to sort of getting it right. The getting-it-right point was a big deal for me, and I spent a lot of time thinking about this and wanting to really prepare myself for it because you really get one shot. That's my perspective at this. You really get one pass at this. It's an incredibly competitive business. These aren't real businesses. They're very fragile investment partnerships that can come unglued really quickly. It's an intensely competitive business with a really high death rate. Industry-wide, I think it's 70 percent, and for what you call pedigreed funds, the ones that generally come out of firms that have been successful and had institutional presence, probably 40 to 50 percent within 3 years, right? That's the stats. So I spent a lot of time really saying, if you're going to climb this and do this, what's the way to do it and do it in the right way?

Greg Dowling (05:49): So what are those things? Because you're coming on 10 years. Ten years in dog years, hedge fund world, that's a lot.

Dave Thomas (05:56): It's true. I remember talking to you at this point when we were starting up. I spent -- probably had 20 plus conversations with friends, peers all through the industry who had gone down this route, some successful, some unscaled, others didn't have the same level of success, as well as just having a life of studying firms and investment track records that had been successful. Two takeaways of the kind of right-tail success stories from my perspective are two kind of consistent things I observed. The first was there was a really clear understanding of the people who were successful as to how they compete, the alpha pool they're going after, that sort of North Star. This is what we do. This is what we have conviction in to see this through the inevitable ups and the downs. And the second thing was, those success stories had been able to demonstrate longevity. And this became something I'm somewhat obsessed with. When I say "longevity," it was the ability over long periods of time to outperform in aggregate, survive the inevitable downturns. And the hardest part of our business, as we all know, in what's an intensely competitive business, is that nothing goes in a straight line. It's not linear. Every strategy and every investor from the hall of greats on down went through difficult periods. And this is where I had observed a lot of the partnerships really struggle, where you'd see peers where they would kind of go off the rails. And during those periods, it was not just about struggling, underperforming. It was also just avoiding very large, significant drawdowns or permanent losses of capital that would set back years and years of the work you had done on the compounding voyage up to that point. And I think that's just ultimately the hardest question in assessing an active manager, really, is this question of repeatability. I remember when you and I talked 10 years ago, when we were starting. I said, "We won't really have a track record until we get to a decade," because I think that's a real track record. Anything below that is sort of a good start or a good run. And you need to see it through different environments in different times. And one thing, looking back to the hall of greats that I always couldn't get out of my mind, thinking of the GOAT of our industry, Buffett, if you take him, you know, his alpha has been I think around 950 basis points, which unto itself doesn't sound that spectacular. You've probably got a lot of managers here at FEG who have outperformed that in trailing three or trailing five or whatever. But what was astounding about it was he did it for 60 years while avoiding big impairments. That's what made it special, right? It's not that there was plenty of times when Berkshire stock price fell 50 percent multiple times on a market-to-market basis. But there were no big mistakes or big losses to justify that move, and it didn't set them back. And when you can do that over a long period of time, really the longevity ends up being the big driver. So that was sort of a -- kind of the obsession I came to. Talking to those friends and looking at those success stories, the two common themes were that: knowing what you're good at and focus there, sort of like, "What is my alpha pool?" And then the second thing is like, "How do you avoid blowing yourself up?" Like, "How do you make yourself built to last?"

Greg Dowling (08:46): I've got to say that I was really impressed because when you said you were going out on your own, you kind of did this listening tour. I remember you came here, and you had gone to a lot of other places, and you were just saying, "What about this? Do you think these are fair terms?" Like, "What would you like to see as an investor? This is still the time where big hotshots would come out and be like, "You want in? Here are my terms." And, yeah, a lot of those aren't around anymore. That also doesn't build that GPLP alignment. You're kind of like, "All right. This is how you treat me on the front end." And when you have a down year or down 2 years, those people leave. I was really impressed by that. And how long did you do that? I feel like you went on this kind of listening tour for maybe a year or so.

Dave Thomas (09:27): It was a good several months where all I did was just go talk to everyone. My partner, Roger Smith, that's how we met. I went to go talk to him to sort of say through a friend, "What were your learnings of your experience down this?" I talked to everyone. I knew what I knew from my little vantage point in the coal mine chipping away I'd seen in my prior firms. But I really wanted to get this right because, again, back to the question of longevity, there's two parts to this, right? There's, how do you invest? How do you avoid the big losses? How do you do that in a way that's true to you and demonstrates competitive advantage and alpha pool that you're successfully harvesting? But then it was the construction of the partnership, and I felt like this is where I saw as many of my peers stumble as they did in the first. They were obviously good investors. They had a good track record in their prior construct. You're coming into this. It's a different role. You're not just an investor. You're a CEO. You're managing these external constituencies, and there's a lot of pressure. This is the adult world. There's a lot of pressure when you're underperforming. They have their underlying constituencies. Making sure you had that stable capital base where the duration of the capital base and the perspective of those investors match the duration we're taking to what we're investing. And you've got to earn that ultimately through performance and doing what you say. But I felt like there was a lot we could do, and I thought your insights in this were great. There was a lot we could do to build that trust into the partnership and create a repeated game, a win-win sort of mentality to it versus what I've observed is often the sort of zero-sum, like you described, transactional approach to it, which can work for other people but I think ultimately can create larger swings and insecurity in the capital base during difficult times, which, again, compromises longevity.

Greg Dowling (11:06): So then you launch Atalan, and what's with the name? Did you just misspell Atlanta?

Dave Thomas (11:13): Yeah, it's funny. Someone asked me this the other day, and I had almost forgotten. So when we started, we began by saying to ourselves, "Okay. We want to name this not about an individual or anything relating to them, because that sends a message to the partnership internally and externally about what a partnership is about, and really have it be about ideals, something we all strive for." All far from ideal, we're flawed, but we should set the mark as, "This is what we're striving for as a group." And when we thought about how to do that, we said, "Okay. Let's everyone write down three words, not sentences, not paragraphs, just three words, how you would describe something that's an enduring, successful investment process." And we came up with three words: strength, discipline, and unique. We then, of course, translated them into Greek and Latin because that makes it timeless and sound a little wiser than those three words and then scrambled them all up and came up with "Atalan." So that's how we did it. The other reality, too, is it's just, there's been so many funds, it's hard to find any good names anymore, so we had to come up with something.

Greg Dowling (12:06): That's right. All the mountains and Greek gods have been taken. We're going to talk about hedged equity, and it's been tough, right? The strategy has underperformed in kind of a melt-up situation. But before we get there, I wanted to, for those that aren't as familiar, kind of break out the strategy. And how does hedged equity work? There's more than just going long and short.

Dave Thomas (12:24): The broad rubric of hedge funds, it's such a broad term, it's almost, in my mind, meaningless. And within that are so many different stripes and flavors of risk taking, leverage levels, volatility expectations, returns expectations and approaches. So I really know the corner I've operated in of that world, which I'll classify as sort of moderate net. We really keep our net exposures in that 20 to 50 percent range. Historically, we've been in the 40s, and we don't move them around a lot.

Greg Dowling (12:54): How is that calculated?

Dave Thomas (12:55): That's calculated really as a long exposure, less our short exposure over our equities. So think of it this way. If someone invests $100 in Atalan, we'll buy $100 of stocks long, maybe 110, that kind of range. And we'll typically short 50 to 60, which is how you get that net exposure. So in theory, if our long and our short portfolio are not adding any value or alpha, meaning outperformance versus the market, the market return times, our net exposure would be the alpha return of the portfolio before fees, which obviously wouldn't be attractive if we were at zero alpha. But that's the way to begin the baseline value add for the strategy. And so our goal is to generate that long-short spread, have our longs outperform not just our shorts, but both of them do that relative to the market, which is how we think of value add. So to the extent that the strategy and our execution of it is doing that, then arguably better in terms of someone's portfolio than a passive, or at least let's say it adds value as part of the portfolio relative to the fee-free passive alternatives.

Greg Dowling (13:57): So you get some equity beta, right, in there. You hopefully get some alpha, both long and short. You get a little leverage, and then you also get a short rebate, so maybe explain what a short rebate is.

Dave Thomas (14:07): Short rebate is basically the yield you're getting on the cash. So when you sell a stock, borrowed that stock, we've sold it. We hold the cash. Ultimately, we have a liability back to the counterparty who we borrowed the stock from, and there's a yield on the cash. We talk about my last 20-year journey in the hedged equity space. I would describe the first part of that as kind of the golden age of long short, where you had positive rates, a lot of dispersion in the market and relatively range-bound markets. The second half has had cyclical headwinds, and this has been one of the cyclical headwinds, the zero-interest-rate policy. When rates are zero, it's got two big implications. One, which was the most important we can talk about later, which is the fact that for our strategy, which is intensely bottom-up and based on the first principle that fundamentals are the laws of gravity and that bad businesses -- our job in the capitalist ecosystem is to allocate away from bad businesses toward good businesses, that's what we play as our little amoeba-like role in the overall ecosystem of capitalism. That becomes ungrounded when capital is free and there's no cost of capital, which has probably the most important negative implications for the strategy we've had to endure, particularly in the short side, during this period. But coming back full circle back to your original question on rebate, when rates are zero, which has been Atalan's 9 1/2 years of existence, close to 8 of them were this, we're actually having to write a check to maintain a short book. So we take that money, that cash we get when we short a stock. It goes and gets Fed funds, but then, of course, our prime brokers charge us a spread on that. The Fed funds rate is near zero. We're going negative. So for the first 8 1/2 years, we were actually having to consistently write checks to maintain a short book, which is brutal. So seeing the rates normalize has helped in that regard because at least now you're getting a positive yield on that cash, which is to the rebate argument, which we didn't have for that first sort of 8-plus years.

Greg Dowling (15:59): That's great. That's exactly what I was looking for. Let's talk about that. So we're talking about this environment. I should say, you've done well, right? You wouldn't be here if we weren't -- We wouldn't be like, "Gosh, you've been around for 10 years, and you've been terrible." You guys have done well, but your brethren haven't. On an average, it's been a tough environment because, like you said, you won. You're getting 0 percent on your rebate. In the golden days, it used to be like 2 percent. You could start the year with like 2 percent. That's pretty good. But what else? Why has it been so tough? That's not only true for hedged equity or long short, but it's true for just active management. It's been brutal the last handful of years. Why is that?

Dave Thomas (16:37): Look: If you look over the past decade, there's been a mix of structural and cyclical headwinds for the industry. Structurally, you just nailed what it is, which has been the shift to passive over active. When I began the business, active was a single-digit percentage of assets under management, and now it's well over half. And that's been a headwind for all active strategies including ours. Within that, right, that's been a headwind. And I'll make up a number. I forget what it is, but probably the academics would tell you 3/4 of active managers don't add alpha in any repeatable way. And I think that's been somewhat unmasked. A lot of the index-hugging kind of active strategies that really weren't generating the alpha have been replaced by many investors with passive products, right? So that's been underway for a while, and that's impacted our industry unquestionably. And then within the pool of active that remains, there's been this mix shift toward a lot of these sort of factor-based strategies and things of that nature within hedged equity toward market-neutral, which has been a really intense trend the last 4 or 5 years. And sometimes they're called the pod ships, firms that run four by four, the Citadels, the Balyasnys. There's a whole Point72. There's a whole bunch of these that run market neutral. They're huge, right? They're huge pools of capital, particularly when you add the leverage levels that they run, the gross exposures, which can, of course vary. You'll know this better than me, 400 or 500 percent in terms of equity. And I believe those two big trends have created a change in market structure that has made it more difficult for a lot of strategies. Certainly a lot of the risk parameters that a lot of us grew up on have had to change. To try and put it in context, think of it this way. On a given day, when you're trading a stock, someone doing what we're doing, bottom-up fundamental-type investing around that stock is probably less than 10 percent of the daily volume. And that used to be 90 when I first got into the business. These are rough estimates, but the stocks just have a lot more volatility. You sort of look at the overall vol level of the market, things like the VIX, it looks pretty placid. Below the surface, the idiosyncratic volatility has gone up significantly. You can see this in looking at graphs of factor volatility over the last decade, and you just see them growing and growing and growing while the overall volatility levels in the market are relatively stable. And that's just showing you what's happening at the individual stock level in terms of the swings. And so you've had to think a little bit differently about how you size positions and also how you react to this volatility, because stocks will take much more random walks. There's a lot more noise than signal in some of these short-term movements, and these random walks are a lot less correlated with anything changing at the underlying fundamental level of the company than they ever were in the past. Now, again, our perspective is all of this with the right approach should be an opportunity for active managers, but it presents a lot of challenges on position sizing. It presents a lot of challenges around guardrails you need to avoid behavioral mistakes. And it's hard not letting a stock doing something that's unexplainable fundamentally get into your head and cause you to make a behavioral mistake where really there was no risk to the stock. The risk was my own action. I was the risk because I reacted to it when I knew nothing was fundamentally driving it that should have explained it. So that change in structure has been a big deal, and I think that's been a real challenge for the managers. The generation I originally worked for grew up with this sort of -- and you probably heard a lot of this. They listened to the market, and I think that was smart because there was a lot of signal in it. When 90 percent of the people in a given stock were making a fundamental call doing the same work I'm doing, I'm your -- Greg Dowling's well-intentioned 27-year-old analyst. And our company that we're long reports earnings, and I say, "Greg, this is really great. The stock is going to be up," and it opens down 6 percent. That's because all of the other people doing the same work are disagreeing with me, your well-intentioned 27-year-old analyst, and you knew that, and you would read into that, that the market is voting, and there was real signal in that. That signal was really faded because of this market structure change, and so that's presented challenges, certainly, I think, for the industry overall. And then the second thing, put aside the structural, is the cyclical. But there's really been two cyclical headwinds, which I think are incredibly material to keep in mind. The first is that -- we talked about this, which is the ZIRP policy, kind of since the GFC, which I think has really caused issues with capital allocation, challenges with the laws of gravity, meaning fundamentals, really rounding shorts and taking them where they need to go. But on top of it, since the GFC, we've been in an incredible sort of beta return market. The market's average return, I think it's CAGRed 15 percent. I was looking at this the other day over that period of time, and that's obviously well above normal. That's well in excess of underlying earnings growth. There's been a lot of multiple expansion, albeit coming off a very low level after the GFC. That's sort of the rabbit in the dog race that everyone is chasing, and when you've got a beta market going up 15 percent a year, the long-short spread we have to generate is almost linearly correlated with the underlying return in the market to be able to generate a net return equal to the market or better. So in other words, if the market's at 5 percent, the long-short spread you need is something near that or whatever. If it goes from 5 percent to 10 percent, then you almost need to see your long-short spread double to be able to keep up with the market. And so that's been a real cyclical headwind for the strategy. I'm hopeful now. We're bottom-up investors. We run steady nets. We don't make market calls, and who knows? That's my perspective on top-down views, having burnt my hand on the stove a number of times earlier in my career trying to make them. But I'm hoping that we're in an environment, prospectively, where you're in more range-bound markets, because those are the types of market environments where this strategy will thrive, particularly with a real cost of capital in the market that's going to drive dispersion between winners and losers where losing business models or struggling ones will not be able to get funded.

Greg Dowling (22:24): It seems to me, I always think about it this way, is that hedged equity does well in down markets, in sideways markets, and a little bit in oscillating markets, but not in melt-up markets when everything is going straight up, and especially a straight-up environment where the interest rate policy is zero. Boy, hedged equity is not going to do well.

Dave Thomas (22:44): You're right. It seems like that is changing, at least when we look at our capital market assumptions kind of going out. It shouldn't surprise anybody, after years of outstanding long-only equity performance above historical averages, you would kind of just think, right, common sense, that you're probably going to be in a period at some point in time where they're lower or at least average, right? And that should be a better environment for Atalan. That period I called the golden age of long-short, which was basically when the tech bubble burst, where the market was flat for 12 years, effectively from the 2000, 2001 period until 2012, it took to get back to that point, and we had a real cost of capital, real interest rates and real dispersion in the market, positive rebate, as you mentioned. That was the period of time when hedged equity really thrived. It was really kind of exiting that period into this long run of the beta market where I think it has been more challenging, in particular, speculative markets. Like you're saying, rising markets are fine to the extent we do maintain a moderate long exposure in acknowledgment of the fact that, statistically, 3 out of 4 years, markets go up over the last 100 years, and so odds are they will rise. Things do get better. Capital does accumulate. Earnings do grow in these companies. But in speculative markets, the short book becomes very difficult. Rising markets are fine to the extent that they're grounded in fundamentals. That doesn't scare us. The biggest challenges are those periods where things become very unhinged and speculative on the short book. Yeah, so look. We're hopeful, as well. But again, who knows? We could be back to ZIRP in a different market environment in 6 to 12 months. I'm not sure any of us know. But I would absolutely say the environment we've seen since rates have normalized in the last 18, 24 months has been one that's much more familiar to us.

Greg Dowling (24:25): So that's absolutely true, and it seems to me that a lot of the fundamental hedged equity managers are really good at parsing out change and companies turning around or recognizing some themes, predicting earnings and maybe even saying, "Well, okay. This stock should trade up to at least the average of its peers in terms of multiple." I don't find -- There's a couple, but I don't find many people that are good at, "Hey, this stock is trading at 70 times forward earnings, and I think it's going to trade it at 100." That's just pure aggressive momentum. That's certainly not what you guys do.

Dave Thomas (24:57): We call ourselves valuation-based. I've never really accepted the growth-value distinction to me because the two concepts are inseparable. I can't tell you if something is expensive or cheap if I look at a metric like price to earnings or price to book value without knowing what the growth rate is of the business and really what the ultimate terminal outlook/growth rate is going to be. I found the two of those inseparable, but we've always said we're valuation-based, meaning that we only invest in something that we understand the valuation of. We can think of a way to value it that's rational. We may have to look out further in the case of a growth company, but we can get to unit economics and ultimate profitability of the business on an absolute basis of free cash flow multiples, earnings multiples, real earnings, not fake earnings, not things like EBITDA, which are less-meaningful metrics, but actual returns to equity that we can justify the valuation. So we have that discipline. That's partially because we run concentrated, and we're obsessed with avoiding having big impairments. And the only way I've ever found that I have the ability to stay with something when it's selling off and not have it end up being an impairment is when I really have a good valuation grounding to it. That's the approach we take, partially out of rich management, as well. There's no right way to skin a cat in what we do. It's all about figuring out, what's the alpha pool you go after, and how have you built your process and your partnership in a way that gives you the platform to execute that consistently? And some people are great at that game and figuring out exactly when momentum in metrics like EPS beats and technicals and things like that have exhausted themselves. It's just not what we do. From our point of view, we want to find strong variant perception, but it always has to be valuation-grounded for us, at least.

Greg Dowling (26:35): All right. Well, let's talk a little bit about what excites you now. What are some themes in your current portfolio or just that you're investigating?

Dave Thomas (26:42): The term "theme" is loaded, right, because to many people, it implies a top-down view. I'm negative Europe. I'm positive the US consumer. I'm negative China. Those types of views, we don't take those types of views. So we really think of it more. We like to think of it as fundamental trends in the business because it really, for us, is bottom-up. Our general approach to the world, long and short, is that we're looking for -- The vast majority of time, the future for most companies rhymes with the past. There's always individual situations in any given time specific to that industry or company, but in general the basis of competition, competitive dynamics, how cycles look, organic growth returns and capital margins, et cetera. Earnings growth rhymes with the past. And that's consensus, and my view is that most things in the world, consensus is usually correct. However, there are the tails, left and right, where something is structurally changing, and the future is going to look very different. In the case of shorts, significantly worse, in the case of longs, the opposite. And what we do is we sort of are like heat-seeking missiles to those two tails with our capital, long and short. And we're looking for trying to find situations where we're observing these big structural changes. So for example, the last couple of years, the emergence of generative AI and the infrastructure build-out of that has been a big area in terms of a real important fundamental trend, which I think is going to be a decade-long trend, where we've been heavily invested, and our focus today is actually shifting. A lot of that has worked out, and we've monetized some of that and shifted really more toward now the application layer, right? So the big gains of this, which are going to ultimately show up, is productivity. Where are the business models that are best positioned to actually capture that, that have the pricing power, the market position, that the gains won't just be computed the way they'll actually be captured? So areas like information services I think are probably the best positions or some of the best-positioned companies to monetize as you think about their businesses with massive productivity benefits throughout their cost structure to be automated, whether it's low-level coding or data aggregation, cleansing, generation, populating, as well as an easy route to customer in terms of these sticky, recurring revenue relationships with pricing. So to the extent that they can create these tools off these big proprietary data sets they have to add value to customers, they'll be able to quickly add that in the price and raise it. I think about Bloomberg as probably the most rapacious supplier we use that raises price on me every single year, and I take it --

Greg Dowling (29:06): Every year, yes.

Dave Thomas (29:07): -- every year. And I just think about the potential for them in terms of all the productivity they can drive, almost creating junior-analyst-like outcomes with their data sets over the next decade, so --

Greg Dowling (29:19): But they're still not going to lower prices.

Dave Thomas (29:21): No. in fact, they'll raise them more rapidly, and we'll pay them to the extent we're getting the productivity. That's how I think about that side playing out. The Internet companies also, I think, are really well positioned. Software companies are trickier. We're having more trouble differentiating winners and losers in that space from this because this new technology cuts both ways for them. There's a lot of ways they can monetize it, but it is fundamentally deflationary, and it's fundamentally commoditizing to a lot of what they do. And the revenue model, seat-based licenses, butts in seats, which is how the industry has built itself the last 2 decades, technology whose fundamental value proposition is fewer butts and fewer people, and the organization is going to challenge that model, they're going to have to pivot to more consumption-based revenue models. We've been struggling to find ideas in the area. If you'd asked me 2 years ago, I'd have told you we've been able to find more to do. We haven't found anything yet. But in general, that's a big area we focused. Another area that's been active for us really the last 2 years has been the whole European defense situation. Europe is effectively for the last 30 years underinvested in defense since the end of the Cold War, and there's been growing pressure on them to do that but no real catalyst to force it. Obviously the situation with Russia and Ukraine on their Eastern border has created that. But more recently, the political change in the US, it's a step-change inflection point, and you see the European reaction to this, what Germany just did. These numbers are gigantic, going from 1.5 percent of GDP for the continent to 3 percent, the new NATO targets, maybe even 3.5 percent of military spend, which is necessary, losing the US security umbrella, is revolutionary in terms of what it means for the base of companies there that were built in the industrial base around a 1-percent-of-GDP kind of spend level. So that's something we've been very active in the last couple of years and continue to prospectively -- I feel like that's going to be one of these fundamental trends that's going to drive through the end of the decade or not longer.

Greg Dowling (31:18): Kind of talked about the journey along the way, and you've seen a lot of different markets. If a younger Dave Thomas came to you and asked for advice of starting a fund now, what would you tell them?

Dave Thomas (31:27): Just have a little more fun. Enjoy the game. It goes fast. And to take it a little less seriously. Maybe that's easy to say in retrospect, but sometimes I feel like I always had the nature to do that. In terms of younger people who are looking to get into hedge fund industry, before we talk about people who want to start funds, the advice I always give them, and I had the chance to do this in this class I lecture at in my alma mater, is to really go into this with a true intrinsic love of it. It's not a straight path to get rich that it was 20 years ago when the industry was in hyper growth mode, and I think that did attract a lot of people into the business at that time. But when you look at it today, it's still a great job. It's a job that you can be incredibly financially successful for, but you really have to love it and love the grind. And I'd say this across any walk of life. It's the people who really have a passion for something and find their way to it. If you do that, you love it. Every day, you learn. Every day, you get better. That compounds. When you go through the tough periods, you fight through it. And those people are the ones who are the most successful in any walk of life. In our industry, when someone doesn't feel that, you see that capitalism ends up canceling them out. As they stop learning, they stop growing earlier than you would typically reach in terms of the long term. So that's probably the number-one piece of advice I would give to people. And then in terms of anyone looking to actually start a fund and go into this role, I'd probably point them to two key questions. The first is really, what is your North Star? And do you really feel like you understand what that is? Knowing yourself, having made a lot of mistakes, had a lot of successes, knowing your temperament and having a process that you really believe in and you can execute when you eventually hit those tough times, to use Mike Tyson's famous quote, which I just love, given how profound it is coming from someone you would least suspect it to come from, of everyone having a plan until they get punched in the face. That really applies to this, and having that North Star is critical to being able to be a steady hand on the rudder and make it through those times and not lose yourself and start just chasing your tail. And the second thing is really asking yourself, do you really want to be in the role? I love the role. I found it incredibly rewarding, but it's challenging. It's not just investing and being a CIO. Most people who get to this opportunity have already done that and done that successfully, but it's also being a CEO and managing all kinds of other external and internal constituencies when everything you do becomes public. The results, the ups, the downs, the criticisms, the rejection, and you've got to accept and embrace that challenge. You've got to love that. When you come in and you're going through a tough period, you have to overcommunicate. That's when your investors and your partners need to hear from you the most. You have to talk intensely about mistakes you've made in the team, what you're doing to correct things over and over and over again across partners, and that can either be draining or can be something that you find energizing, the challenge of that. There's probably no book I would more recommend someone to read if you're thinking about this role than Ben Horowitz's book called "The Hard Thing About Hard Things." It's great. It's his story. In the 2000s, he was one of the early SaaS companies, Loudcloud, when they were starting that business, kind of the ups and downs in a period where he was capital-starved and was struggling to keep the company financially solvent until it ended up being a big success. There's this chapter that always just really stuck in my mind. I say it all the time to the team, and I think it's titled "Nobody Cares." And it's sort of his view of the hard reality of, when you're going through a tough time in that CEO role, the reality is nobody cares about what your excuses are, what the reasons are it's not working. They just really focus on the results, and they want you to figure out the solution. And we say this all the time in the team when we're going through a tough time internally, is just remind ourselves that it's on us to fight through that. And if you read that book and that chapter and you find that energizing, that's a really great indicator that this could be something that you'd love.

Greg Dowling (35:03): That's great advice. And also, I love your thoughts that you shared with your students, because I think that's true. And I think to your point earlier about current themes that you're looking at and AI, I don't think AI is going to get rid of our business. I just think that there'll be less jobs in this business. And it is an apprenticeship business. A lot of people started out doing grunt work. I don't know if that grunt work is going to be there, like their summer internship. It'll just be different, so you'd better be good, and you'd better love it and want to work hard, so I think that's great advice.

Dave Thomas (35:31): I heard a great quote about this, which is -- and I tell this to my kids, too. I've been obsessed with this, and I tell them they absolutely need to all understand this and be all over it because it's really going to be their generation's challenge and opportunity. But quote I heard was, "You are unlikely to lose your job to gen AI, but you're likely to lose your job to someone using gen AI." And I think it's incumbent on everyone to recognize that there's a big productivity boost over time from this. It's only going to get better. The potential addressable market for it is effectively all knowledge work, and right now we're on this scaling trajectory such that the more resources we throw at this, the closer and closer it comes to human reasoning. And we're just debating now the price of that relative to a human and the accuracy levels and things of that nature, but it's only going to get better. It's only going one direction, like most technological change. So I do think it's going to create a lot of productivity benefits, but I think we've just got to embrace them, and if you don't, you're going to begin to have those who are outcompete you.

Greg Dowling (36:25): So typically I ask about investment books or just favorite books. We're going to skip that because you already offered one up. So I'm just going to finish with, what's a fun fact that nobody knows about you?

Dave Thomas (36:35): I don't know if anyone doesn't know it or does know it, but I am a fiddle player. I enjoy that.

Greg Dowling (36:41): Well, see, this is the North Carolina coming out because, in New York, it's called a violin.

Dave Thomas (36:45): Exactly. To the sophisticated group up in New York, it's a violin. Down there, it's a fiddle. But it's great. I started off my life playing classical music kind of as a violin nerd as a kid, but I liked it, but I should have evolved it faster. It came to me later in life to bluegrass and to fiddle, which is so much more fun. Oh, yeah. No offense to the guy, great respect for classical music, but it's a lot more fun, and it's not something I do super regularly, given the needs of the Navy with the job and family, but it is something that's a lot of fun. I hope to do a lot more in the future years.

Greg Dowling (37:13): Well, we'll have to try to come up with some bluegrass music to fade out or something like that. But, Dave, thank you so much for being on --

Dave Thomas (37:19): Old Crow Medicine Show, that's my suggestion.

Greg Dowling (37:20): I'm going to go with Billy Strings. I think it's better, but his is a good suggestion, too.

Dave Thomas (37:23): Thanks, Greg. Appreciate it.

Greg Dowling (37:26): If you are interested in more information on FEG, check out our website at www.feg.com. And don't forget to subscribe to our communications so you don't miss the next episode. Please keep in mind that this information is intended to be general education that needs to be framed with the unique risk and return objectives of each client. Therefore, nobody should consider these to be FEG recommendations. This podcast was prepared by FEG. Neither the information or any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views and opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of their firm or of FEG.