David Zorub - Navigating Hedge Fund Headwinds at Parsifal (EP.434)

David Zorub is the Founder and CIO of Parsifal Capital Management, a $1.5 billion hedge fund that invests in a concentrated portfolio of longs and shorts across geographies, sectors, and capital structures. David joined me on the show a few months before he launched Parsifal six years ago to discuss his plans. We got back together to talk about what's happened since. Our conversation covers the headwinds facing fundamental investing, Parsifal's approach to counter those challenges, and the investment and business processes that led the firm to reach this point. Along the way, David shares keen insights into research, portfolio construction, and partner relationships that have combined to take Parsifal from a start-up hedge fund to a thriving organization in a difficult environment to do so. Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com https://thepodcastconsultant.com/)

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Ted Seides?

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• 0:46Ted Seides?

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• 1:24Ted Seides?

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• 2:06Ted Seides?

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• 2:47Ted Seides?

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• 3:32Ted Seides?

  Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at capitalallocators.com.

• 3:59Speaker 01

  All opinions expressed by Ted and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.

• 4:18Ted Seides?

  My guest on today's show is David Zorub, founder and chief investment officer of Parsifal Capital Management, a billion and a half dollar hedge fund that invests in a concentrated portfolio of longs and shorts across geographies, sectors, and cap structures. David joined me on the show a few months before he launched Parsifal six years ago to discuss his plans. We got back together to talk about what's happened since. Our conversation covers the headwinds facing fundamental investing, Parsifal's approach to counter those challenges, and the investment and business processes that led the firm to reach this point. Along the way, David shares keen insights into research, portfolio construction, and partner relationships that have combined

• 5:02Ted Seides?

  to take Parsifal from a startup hedge fund to a thriving organization in a difficult environment to do so. Before we get going, I was always fond of Mark Twain's quote, "There are lies, damn lies, and statistics." So when I tell you that this week Capital Allocators grew by 25%, you might think of all kinds of things. Maybe we released an episode that shot the lights out, introduced a new offering, or Summit, or we're just plain crushing it. Now, while all those things have some semblance of truth, our growth this week came from the addition of Tamar Aribach to the team as our new head of business development. We were overwhelmed by the quality and quantity of interest for the role,

• 5:46Ted Seides?

  but in truth, we started talking to Tamar before we announced the position. She and I met a while back in her early years in the business, and we're fortunate that her timing, interests, and skillset match perfectly with our needs. In short order, prospective podcast guests, Summit and Capital Allocators University attendees, and sponsors will all get a chance to connect with Tamar. We're thrilled to have her and excited to see where we go next. Thanks so much for spreading the word about Capital Allocators' 25% weekly growth or about 10 million percent compounded annually. How about that for lies, damn lies, and statistics? Please enjoy my conversation with David Zorub.

• 6:31Ted Seides?

  Dave, great to see you.

• 6:33Speaker 02

  Ted, great to see you.

• 6:34Ted Seides?

  When you last came on the show, you were three months pre-launch and now you're still here, six years later. So why don't you give me just the highest level where you are today?

• 6:45Speaker 02

  I went back and looked at it. I think when we did the live talk at Columbia, it was the day after Valentine's Day 2019. So it's almost exactly six years to the day since we did that. I don't think any of us could have imagined what would transpire in the world during that time. But I'm happy to report that the things that we talked about at that time in terms of the vision and what we were hoping to do with launching Parsifal have played out really beyond our expectations. All the goals that we would have had for ourself, for the most part, we've met or exceeded. And as we sit today, we have a fantastic team that has executed really well and we've built a firm that manages about a billion and a half dollars of capital. It's been a really interesting, if not challenging and trying time to be in the public markets, but we've relished the opportunity and it's

• 7:31Speaker 02

  been a really fun ride.

• 7:32Ted Seides?

  That whole concept of how challenging it's been and the hedge fund strategy in particular, I'd love you to talk a little bit about how you think you've been able to make it work in an industry that's had so many headwinds these last six years?

• 7:47Speaker 02

  I think it goes to a few different things. It wasn't my first go around at trying to build and launch a strategy. And so there was a lot of lessons learned in prior lives to lean on. We anticipated that there would be challenges along the way in setting up the firm and how we built our capital base, defined our strategy, built the team and then ultimately deployed it. We didn't know what the future would hold, but we tried to at least make the firm anti-fragile and resilient, particularly in the early years to allow us to get through periods of adversity and hopefully thrive on the other end. But ultimately, I think it just comes down to we've been very blessed to have a stable of amazing partners who've allowed us to execute what we think is a unique strategy

• 8:31Speaker 02

  in a laboratory, which has been both rich with opportunity and challenges. So supporting us through those challenges while allowing us to go after those opportunities has been what's allowed us to succeed and thrive.

• 8:42Ted Seides?

  How has what you're hearing from clients changed from when you started?

• 8:47Speaker 02

  I don't know if their objectives have changed, candidly. Our whole industry exists to seek out and generate alpha, ideally alpha at scale in a replicable manner. But the truth is, is that most strategies that can generate alpha don't scale and aren't even necessarily replicable.

• 9:05Ted Seides?

  What do you think have been the most difficult aspects of achieving that objective, of that diversifying return stream, lower vol than equity markets?

• 9:16Speaker 02

  When you look back over the last 30 or 40 years, the central reality of investing has been that we've been in a world of structurally declining cost of capital, in a world where for most of that period, the volatility of macro indicators, particularly inflation, has been quite low. And that's been against a backdrop of relatively benign socio-political economic indicators globally. Up until 2020, everyone, public or private, has been investing in a world where their multiples have been expanding, and that has been a very forgiving environment to do that. Post 2020, we now have a higher cost of capital than we've had in some time.

• 9:56Speaker 02

  We have much more macro volatility, and geopolitical tensions are in a bit of a different place than they've been for a long time. That's created a lot more volatility. And then, specific to our markets, the continued rise of passive, for sure, but also the rise of ETFs, the rise of the pod investing model. I would also add to that the rise of style factors, which our big business on Wall Street right now have all conspired to, I think, create more non-fundamental, short-term volatility, which has made the monetization mechanism of active security selection more challenging at times. I don't think it's impacted the actual underlying availability or dispersion of opportunity,

• 10:39Speaker 02

  or the ability to analyze these opportunities through a fundamental lens, but it has required more patience and the ability to arbitrage medium and long-term fundamental outcomes against much more short-term volatility.

• 10:52Ted Seides?

  So I'd love to start parsing through what strategy have you settled in on for how you're managing the capital?

• 10:59Speaker 02

  We know that based on very significant bodies of research that has been replicated over and over again, that there is a combination of strategies or factors, if you will, that do drive replicable, scalable alpha. And basically, strategies that do three things over time really outperform. And those three things are invest with high active share. So you don't, by definition, look like an index. Second, concentrate in your best ideas in recognition of the fact that actually markets are reasonably efficient most of the time, more so than most people like me want to admit, day in and day out. And therefore, when you find something that you can have a superior understanding of, you take risk to it.

• 11:40Speaker 02

  The third is being able to invest with appropriate duration and volatility tolerance that is consistent with your strategy. And the reason that the excess returns exist in that model is because it's very hard to create those three factors. It's basically business model alpha. As a manager, I can control my active share and my concentration. But if I can't find partners who are willing to align themselves with it through the cycle, good and bad, and stick with it, it's very hard to do. In competitive capital markets, the most sophisticated and thoughtful allocators have a lot of competition for their capital. It's hard to find those partners and build those relationships. And it's particularly true if you're a newer manager starting out, where the adverse selection can be substantial.

• 12:24Speaker 02

  I've tended to sometimes communicate it through what I call the scent of a woman challenge, which is, if you recall the movie Scent of a Woman, there's the famous scene at the end where Al Pacino's character, he gets the Oscar for this. He talks about how regularly in his life, he's gotten to the fork in the road. And without question, he's always known the right avenue to take, and he's always taken the wrong one. And the reason he's always taken the wrong one is because it's too damn hard. When I contemplate why the combination of high active share, concentration, and volatility tolerance yields alpha over time, it's simply because it's too damn hard for most people in our industry to actually Invest that way. It's too damn hard for managers to build that model.

• 13:07Speaker 02

  And it's too damn hard for allocators because of all the incentives that they're beholden to, to allocate to that model. But if you can break through that, it can be a really powerful way. But the nature of capital markets and public markets is they will always tempt you to take the path that you know is the wrong path, even when you know it's the wrong path.

• 13:25Ted Seides?

  What's the aspect of it that's so hard?

• 13:28Speaker 02

  It's better to fail conventionally than to win unconventionally. If I have a high active share portfolio, by definition, there are going to be periods when I underperform, maybe even quite severely. But the opportunity that comes with that is the opportunity to really outperform. But both I as a manager or an allocator may prefer to fail conventionally rather than to take the risk that leads to the excess return. It's that simple. And markets reinforce this. Thinking back to the film, the point that Pacino is making in his speeches, hey, you have two young men on the stage. One is trying to do the high integrity thing and the other is not. And you're going to reward the one who is not doing it at the expense of the one who is. And that's really what the market mechanism does. It tends to reward

• 14:11Speaker 02

  the expedient solution at the expense of those willing to take the path that will ultimately lead to alpha, but albeit one that might be much more challenging.

• 14:22Ted Seides?

  When you were initially even now going out and talk to clients, what is the strategy as you describe it?

• 14:28Speaker 02

  We deploy what we call a concentrated cross asset opportunistic mandate. Practically what that means is we want to take advantage of the inherent flexibility of the hedge fund model to allow us to go where we think opportunities are most compelling, take that risk, but not be forced to do things that we think are suboptimal because of artificial or institutional constraints. I think as alternative assets have institutionalized, managers have been asked to take on narrower and narrower strategies with very strong financial incentives. But the nature of investing is such that opportunity sets are transient. So what we do at Parsifal is you can think of three core functional areas that overlap. The first is event driven and

• 15:11Speaker 02

  Special situations or complex situations investing, areas where we think we get rewarded for taking a bottom up, deep research view on untangling complexity and extracting alpha. We cross over into what I think would be classically defined as fundamental long, short with a real emphasis on bottoms up work and a deep commitment to short selling. And then we work across the capital structure. So not just equity, but credit and volatility. And so if you think about a three circle Venn diagram and put your finger at the center of it, we don't think there are that many strategies that credibly deploy all three. Oftentimes you'll find maybe fundamental, long, short and event driven crossing over,

• 15:52Speaker 02

  or event driven and maybe credit, but those areas tend not to do much on the short side. So really deploying those skillsets across those three, we think not only yields differentiated portfolios. So the types of opportunities we're traversing in, but ultimately diversifying results for our partners.

• 16:09Ted Seides?

  When you take that combination of that concentrated approach with an opportunistic flavor, and you mentioned that the opportunities are transient. How do you go about identifying the opportunities that you want to pursue in this concentrated way?

• 16:21Speaker 02

  We break our process day to day down into three functional areas, one of which you just named identifying. We have to be able to replicably and reliably identify opportunity. We then have to be able to analyze them and then in turn monetize them. And those are three very different skillsets and processes. But the lifeblood of what we do is a maniacal focus on the concept of inefficiency. Whereas I think most managers probably define their search strategy along either some sort of valuation axis. So I'm a value manager, I'm a growth manager, I'm a quality manager, or some sort of qualitative aspect. I want to invest in great management teams, or great capital allocators, or compounders, or something else. We care a lot about all those characteristics and many others,

• 17:06Speaker 02

  but that's not where we think about identifying new ideas. If our task is to generate alpha on some sort of replicable basis, then it seems pretty obvious to me that we have to first start by focusing in on places where there's a higher probability that a pool of alpha exists. So as a team, we spend our days asking ourselves, why do securities tend to get mispriced by the capital markets? Do these sources of mispricings recur? Can we identify them on an ex ante basis? Can we exploit them through our process? And when I reflect on my career to date, Ted, I think this has been one of the most impactful realizations of my career. When you tilt your lens away from asking, hey, is this business cheap or expensive? Is it good or bad?

• 17:52Speaker 02

  And instead ask, is it mispriced? If it is mispriced, why? And to what degree can I exploit it through my process? It becomes a very powerful algorithm for then filtering a global opportunity set because as it turns out, these inefficiencies do exist. They do recur and they recur across market cap, liquidity, geography, business model, sector and subsector. And you can very effectively identify them and begin to then triage them for suitability to your process.

• 18:24Ted Seides?

  What are some of the characteristics of those inefficiencies that you've found repeat over time?

• 18:31Speaker 02

  For us, our taxonomy, if you will, really breaks sources of inefficiency into three principal buckets. What we call structural sources of inefficiency, behavioral and then informational. And within each of those buckets, there's probably seven to 10 different fact patterns that we might consider. So for instance, structural sources of inefficiency are going to be quite tangible. Chances are you'll read about them in a research report or hear about them on a conference call or even see them in the newspaper. They're going to be things like corporate actions, spins, divestitures, restructuring, M and A, changes in management, judicial or regulatory decisions. But what they all have in common is that up till a certain point in time, the market was using a fact pattern to discount those securities.

• 19:16Speaker 02

  And now something has happened and it's rendered that fact pattern obsolete or inoperable. Maybe it's permanent, maybe it's temporary, but perhaps there's an entry there to create a new fact pattern through the research process. Informational sources of inefficiency will be Essentially asymmetric either availability or understanding of information. So think cross cap structure, credit versus equity, or it could be cross border. How do actors in one market view something versus actor in another market? It can overlap with maybe regulatory considerations as well, but it's going to be some sort of asymmetry in available information. And then, of course, the other bucket is behavioral. Now, here we're all familiar with behavioral finance and decision making.

• 20:00Speaker 02

  And to a degree, that's what we're talking about, but really what we're talking about is the classic noise trader model that Schiller and those guys got the Nobel Prize for. The idea that there are actors in markets who think they are making rational, fundamental based decisions, but in fact are not. And due to behavioral bias or constraints on their decision making, are making non fundamental based decisions. So here we think about things like asset class silos. Oftentimes, an opportunity may sit at the intersection of credit and equity or equity involved and lack logical sponsorship. We think about time horizon arbitrage and being able to extend our horizon when others can't. We think about generalist versus specialist or retail versus institutional.

• 20:43Speaker 02

  Or simply, pretty reliably each year, the market will spit out one to two opportunities that are so polarizing because people are simply afraid to lose their jobs or get fired if they even mention the name of that company. And our best ideas will typically exhibit characteristics of all three of those buckets and really be demonstrably inefficient in a way that we think we can exploit.

• 21:04Ted Seides?

  How different is the screening and availability of those types of ideas today compared to five years ago or 10 years ago?

• 21:14Speaker 02

  I actually don't think it's that different because we run a concentrated portfolio where we're deploying maybe 20 long securities. And ideally, the top 10 will be 65 to 80% of the risk. We have sort of the opposite challenge, which is we're trying to find one to three ideas that we can be very levered to. And then maybe another five to eight that can be quite impactful. So we're going to miss things all the time or not even be aware of them. But I don't Think the underlying base rate of opportunities is that different in terms of their availability? Now, what can be more transient is our ability to underwrite them. So for instance, in 2022, when there was just a tremendous amount of uncertainty about the business

• 21:59Speaker 02

  cycle, about all these different macro things that were happening, the interest rate cycle, it was definitely harder for us to forecast fundamentals of businesses in general. But the actual availability of ideas, I don't think it has been that cyclical, if you will.

• 22:15Ted Seides?

  What if you found the different decision points of when to dive in to decide whether you're going to spend your time analyzing something when you have such a broad canvas to look?

• 22:26Speaker 02

  Another key learning that I've experienced in my career is that when you think about the analyst's job, from identifying to breaking down a business to ultimately monetizing it, most spend far too much time analyzing and trying to monetize at the expense of really identifying effective setups. Ultimately, what we have found is that getting the setup right is really where you get the most leverage to a positive outcome. So once we find something that we think is inefficient, we have a battery of questions that we ask, what's the nature of the inefficiency? How tangible is it? What will it take the market to potentially realize it and remove that inefficiency?

• 23:08Speaker 02

  We're very focused on the credit mindset, which is to say, what is my downside risk? Return of capital before return on capital. We are really screening the idea upfront for suitability to our process, for potential asymmetry of return, for low risk of capital loss, and then asking ourselves, hey, if we spend a lot of time on this, what's the likelihood that we can actually differentiate ourselves through our research and then put it in a portfolio and make money from it?

• 23:35Ted Seides?

  Once you've found an opportunity you want to dive into, what does that analyzation of the opportunity look like at Parsifal?

• 23:42Speaker 02

  I don't think we can claim as a firm or a team to have any secret sauce when it comes to analyzing a company. But what we do have is a deep commitment across the team to doing our own work. We want to gather raw information ourselves. We want to analyze it, filter it, document it, debate it robustly internally, debate it in all likelihood externally, find who we think is the most informed person taking the other side of the position or the trade and have that debate with them. So doing your own work, building your own models, documenting it, I find is critical because clear writing is clear thinking. And if we can't articulate something clearly to ourselves,

• 24:26Speaker 02

  then we're probably not thinking about it in as clearly a way as that we think. Building thoughtful scenarios and then building those scenarios consistently across the team so that we can then compare positions and really minimizing process gaps where mistakes can get made. And basically just trying to kill everything at every step of the process. And if an idea can run the process gauntlet, chances are we have something that's interesting to work with.

• 24:53Ted Seides?

  How do you set up your team to be able to look around the world, equities and credit and any opportunity up and down the capital structure?

• 25:03Speaker 02

  There are a few different vectors to it. We need to be able to buy stocks and short them. And I think those are two quite different skillsets. We need to be able to work in complex situations, event-driven situations, situations where there could be legal, regulatory or other complexities that we need to disentangle. And then we need to be able to work across the cap structure. So not just equity, but credit and volatility. So broadly speaking, when you look across the team, we have those skillsets resident. Maybe not every person on the team has all those skillsets, but as a team, we can tactically deploy those skills in a very collaborative way. But then separately, we structure the team as a hybrid of a specialist and generalist approach.

• 25:46Speaker 02

  And of course, the debate between specialization and generalist is biblical. It's Old Testament, New Testament type stuff. There are real merits to both, but in general, our industry has gravitated towards one of specialization. Now, I'm someone who's been a generalist his whole career. Early on, that was a real problem because I didn't know anything about anything. It was neither wide nor deep. But now, almost 30 years into it, that's become a form of specialization in and of itself. There just aren't many types of business models or sectors and geographies, particularly in developed markets, where I haven't had credible experience. So at the team level, we want to bring the mindset of a generalist, but with some specialization around industry.

• 26:27Speaker 02

  So we organize as traditional definitions, tech, consumer, healthcare, et cetera. But within that, our partner, Matt Picarello, who focuses on consumer, I don't want Matt defining 50 companies in consumer and knowing everything he can about them, but we want him to take his ability to underwrite retailers and consumer finance and consumer internet and hospitality and gaming and airlines and apply that business model expertise to find just a handful of high conviction ideas.

• 26:57Ted Seides?

  How do you think about the ability to compete as a generalist? Where in any one of those sectors you're articulated, there's someone who knows the sector deeper, who probably has deeper relationships, maybe can get access to more information?

• 27:11Speaker 02

  It's a very practical reality. And the way I've thought about it and the way we've confronted it is, as a specialist, you're going to be able to react faster. You're going to identify situations and probably have access to data that maybe we don't even have. As a generalist, you're never going to be at the tip of that spear. But the advantage that you have is you can often see inflection points where those who are maybe deeper in the weeds are going to struggle to do that. You're going to be able to see changes in narrative, perhaps changes in risk. Unencumbered by the baggage of having had to follow something very closely for long periods of time. The flip side from the specialist perspective is you're under a lot of pressure, day in

• 27:55Speaker 02

  and day out, to always like and always hate something. But what if your sector or your subsector is simply out of favor? That can give rise to some perverse incentives that we try to avoid.

• 28:06Ted Seides?

  You mentioned at the onset that just the fundamentals aren't driving securities the way they used to. How do you think about how to monetize the fundamental work that you've done?

• 28:17Speaker 02

  When we think about monetization, there's the old saying that there's a big difference between finding a security that's mispriced and actually making money from it. And this is an area where I think we and just about everyone have really had to evolve your process over the last several years because markets have become increasingly efficient in many ways at defining expectations and calling quarters. A lot of that has to do with the rise of the platform model where these are very smart people with a lot of resources. So for us, what that's meant is first and foremost, placing an even higher emphasis on the concept of inefficiency. And in particular, doing it in places where we think we have less competition and where

• 28:57Speaker 02

  it's harder for the market mechanism to be as efficient around what those expectations are. So typically, what that means is situations where there aren't expectations to begin with that are well-defined, where we're not playing head-to-head against the platform or other participants. But it also has meant being able to tolerate more volatility, candidly, and knowing that our fundamental underwriting, our ability to define distributions of outcomes, good and bad, more accurately, and then sizing to those outcomes in an effective manner has become really important. Ultimately, in our process, concentration is our lifeblood. We have our highest hit rates and our highest slugging ratios and our highest conviction ideas.

• 29:41Speaker 02

  When you find something that you can have a superior understanding of, you want to take a lot of risks to it. But it's also a reflection of the fact that mediocre ideas tend to cancel each other out in the end, and they consume a lot of time and bandwidth. And so... Core to our process is I tell the team, don't spend any time on something that we don't think has the characteristics of becoming a large idea. Now, it may end up not being that as we move through the research process, but just by making that one simple mental adjustment of, hey, if I don't envision this having the characteristics of something that could be five to seven percent or more of the book, I'm not going to spend time on it. That behaviorally weeds out a lot of unsuitable ideas.

• 30:19Ted Seides?

  What are the types of things that have those characteristics?

• 30:23Speaker 02

  For us, it's the inefficiency. So maybe I can give you an example that will crystallize this. When you transition from analyst to portfolio manager, it's a big and often difficult transition. But one of the most important things that you learn is as an analyst, your job is to know everything there is about an idea. And when your idea is not playing out the way you want, the temptation is to say, I'm right and the market is wrong. What you learn as a portfolio manager is actually know the market is usually right and that you've got a problem and you need to go back and test. So that's usually the concept I'm trying to bring out.

• 30:56Ted Seides?

  And how do you balance those two? So something isn't going well. What do you do with that position?

• 31:02Speaker 02

  First, you lean on the value of the process. So the value of our process in documenting every step of it, what we thought we were signing up to, what we thought we were underwriting, the key assumptions, that now gives you a reference point to go back and say, hey, is what we thought would happen playing out or is something different playing out? If what we thought was playing out is playing out and we're still not getting rewarded in the way we thought, then we need to ask, well, does the market actually care about something else? Or not separately, if what we thought should be playing out is not playing out, then we need to go back and actually reexamine the root cause. But time and time again, I've seen in my career when you think that you're right and the market is wrong, the market is almost always right in the end.

• 31:43Speaker 02

  And you need to go back and fundamentally revisit your entire thesis and the premise for what you were doing and not ignore that signal.

• 31:53Ted Seides?

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• 32:31Speaker 03

  This is not an offer to sell or investment advice. Investing involves risk, including the loss of capital.

• 32:36Ted Seides?

  And now, back to the show. How do you think about the risk management of individual positions moving away from fundamentals?

• 32:46Speaker 02

  I think there's a spectrum of how managers think about risk management. At one end, there are some managers who say, look, my research is my risk management, my understanding of this situation, my analysis of it. And then I'm just going to put that idea into a portfolio and that's the extent of my risk management. I think at the other end of the spectrum are those who put a lot of effort and telemetry around really understanding not just the idea, but how does that idea interact with a portfolio and what are the characteristics of that portfolio? And so when I think about Parsifal, we're very much at that latter end. We put a lot of time and effort into really asking one question, which is, is the risk that we think we're taking the risk that we're taking?

• 33:30Speaker 02

  Or are there risks in here that we are not aware of or that we don't want to be taking? We first embed that risk management for sure in the fundamental analysis. By definition, if we're identifying a pool of alpha that we think exists, it should be more variant, it should be less crowded. If we're applying that credit mindset, there should be strong fundamental support for the valuation. And then we have a process that we use to build the portfolio and to allocate capital objectively across different ideas. And then, once we have a portfolio of opportunities constructed, we just rigorously analyze it over and over again through different lenses. We use the Barra models, we have built our own scenario modeling and stress modeling,

• 34:15Speaker 02

  and we are constantly just measuring the risk and making sure it's behaving the way we think it should behave.

• 34:20Ted Seides?

  What you have in your portfolio is equities, long and short, credit, some event-driven situations. I'd love to go through each and talk about some of the challenges that the markets have brought up. We can start with equity longs. Have you navigated this strength of the MAG7?

• 34:37Speaker 02

  It's been tricky. We ply our trade in small to mid-cap parts of the market. We are global and we are looking for more complex situations. And the unusual nature of the current business cycle has been reasonably hostile, actually, to all of those. It's the job of any manager to adapt to that. But the kinds of things that we like to do have been more out of favor. And what we've seen is that the rise and dominance of MAG7 has led to a real bifurcation of markets and opportunity sets. The rise of MAG7 has really distorted bottoms-up investment outcomes and decision-making. It's distorted, I think, allocator and behaviors.

• 35:21Speaker 02

  For us, what that's meant is just staying true to our strategy, knowing that we can identify opportunities with conviction and not succumbing to being forced into the MAG7 trade. What's so insidious, I think, about what is potentially going on, and having lived through this in the late 90s with dot com, is the concentration of that kind of performance in so few securities. It really will ignite fear of missing out or fear of lagging, and eventually it will cause people to make bad decisions. The most important thing has been staying true to our process because we know it works really well over time, taking the opportunities as they're given to us, identifying opportunities that we think will thrive in that environment. And in general, we've adapted pretty well.

• 36:05Speaker 02

  But I do think that we're coming into an environment that will be even better and less averse as a result.

• 36:12Ted Seides?

  How have you managed your short book? It just seems like with all of the volatility, it's gotten harder and harder on individual stock shorts to be able to generate alpha, let alone make money.

• 36:24Speaker 02

  In the 22 or three years that I've been shorting stocks, every day that goes by is the hardest day that it's been to short. You are well aware of all the practical challenges of managing risk, of frictional costs, of things like that. And then I think what has also changed the last few years is, again, going back to something I mentioned a few minutes ago, obviously, the rise of the platform model, given how much it's grown, and then it's levered on top of that, has created a lot of incremental demand for a single name short capacity, as have the style baskets. The combination of that, plus the rise of the retail meme trader, have presented new challenges. Practically, what that's meant is, we remain as dedicated to single name short selling

• 37:07Speaker 02

  as ever, but we've had to diversify the portfolio. There was a time when I probably would have preferred to short with more concentration. Bigger positions really extract a lot of alpha through slugging, but the volatility, the short-term reaction function, when you get something wrong on the short side, can be so much more severe now. And then the rise of the retail meme type risk is not something that you can easily mitigate even through sizing. So for us, what that has principally meant is, we've grown our team. We've created more research bandwidth. That in turn has allowed us to create more inventory of actionable, single name, short ideas.

• 37:47Speaker 02

  And from that, we've been able to diversify the book more, but also trade at the extremes. Take the IWM, the Russell 2000, and just look at last year. That index probably went up or down 8% to 10%, six or seven times in one year. So that creates a lot of actionable trading in your short portfolio to cover at the lows, put those same ideas back out on recovery, identify new opportunities. And so I think that's been the single biggest adaptation. Maybe coming at it a slightly different way as well. In mid 23, I wrote a letter to our partners where we Actually looked at our short performance, the hard data inception to date. And at that time, I guess we had maybe north of 50 months of data.

• 38:30Speaker 02

  And what we saw was in the vast majority of those months, we had very, very good short performance. But there were four to six episodes when we ended up disgorging a fair amount of that short alpha, the biggest one being Jan 21 with Melvin and that whole meme meltdown. So what we concluded was that our process was very effective, but we just needed the ability to be more tactical in the extreme swings of volatility that we were experiencing.

• 38:54Ted Seides?

  How do you think about the use case for shorting now?

• 38:57Speaker 02

  I still think it's as compelling as ever. Maybe I'm a dinosaur in that regard, but what is the value of shorting? Well, first, it absolutely makes you a better investor. It forces you to be open minded, forces you to be skeptical, not cynical. There's an important difference. It forces you to really question market narratives. So I just think it requires more objective process discipline. And if we weren't shorting, I think we would be more prone to succumbing, to not challenging key assumptions the way that we should. I think that is very valuable, certainly within a portfolio like ours. I think in our first conversation at Columbia,

• 39:39Speaker 02

  I wished for a world that looked more like David Swensen's original formulation of long short, where he was putting a four to 5% short rebate into his target returns. Well, guess what? At least for right now, we're getting a four to 5% short rebate. So if we can then create alpha on top of that, that's quite powerful. And then, of course, the ability to just help protect capital and fund our long book, particularly our concentrated long book in our model is very critical. And to be more explicit about that, we have our highest hit rates and our highest slugging ratios in our ideas that have been 7% or more of capital at risk. And I have a cohort of roughly 38 of those ideas inception to date.

• 40:21Speaker 02

  Our ability to put those into a portfolio and manage them versus some short risk, I think, helps us to get to even better outcomes.

• 40:28Ted Seides?

  Why do you think that percentage of the hit rate of the slugging percentage has been that high?

• 40:34Speaker 02

  It goes back to really what we discussed earlier, which is we have a very specific rubric that we're looking to populate. So inefficiency that we can exploit, very asymmetric, low risk of permanent capital loss, high degree of research ability that we can build conviction, and then specific catalysts. And when that fact pattern comes together, our underlying portfolio construction algorithm says, be big in this now. So it's really just about being patient and waiting effectively for a fat pitch that we can elucidate very clearly, check all the boxes. Maybe another way of saying it, it's usually not the case that something comes into the book in like that smaller part of the sizing and then scales up over time. It happens.

• 41:19Speaker 02

  It's usually where we come across a fact pattern that is so compelling that we want to be big from the get go.

• 41:24Ted Seides?

  So Dave, what's an example of an idea that crosses these different areas of inefficiencies?

• 41:31Speaker 02

  I think a very prototypical bread and butter, parsifal opportunity is the investment that we've made, starting about 18 months ago, in a company called Shark Ninja. They're a designer and manufacturer of household appliances, vacuums, hair dryers, toaster ovens, et cetera. This company, which is an American company, it's based in Boston, but for most of the last decade has been owned by a Chinese corporate parent. And at the end of July 2023, that corporate parent just listed Shark Ninja in the US market with no fanfare. It was a spin out to existing shareholders. There was no IPO process, no existing research.

• 42:14Speaker 02

  There was just no institutional knowledge of this company. When you think about those structural, behavioral, and informational sources of inefficiency, it literally exhibited characteristics of all three. Structurally, you had a spin off. It was a change of corporate structure. There were class- Spinoff dynamics as existing shareholders got the shares and sold them and created a lot of technical selling pressure. Informationally, there was no market narrative whatsoever. There was no Wall Street coverage. There were no public filings as a foreign controlled issuer. They didn't have to make regular 10K, 10Q filings. There was just very limited disclosure of the business. On top of that, you had a Chinese foreign controlled entity. There were various

• 42:57Speaker 02

  related party dynamics that were potentially quite significant governance related issues. And then behaviorally, the business came out at a time when the world was very concerned about consumer risk and no one wanted to hear about what sounded like an undifferentiated designer and manufacturer of home goods. And so we had some knowledge of Shark Ninja as a competitor because we had followed iRobot from a research perspective for many years and we had seen what Shark had done in competing with iRobot. It was clear to see why it was inefficient and it came out at something like eight times current year EBITDA, so very cheaply.

• 43:38Speaker 02

  But when you opened the public filing, you saw was a very different situation. You saw business that had grown organically at very high rates for the better part of 15 years. It had 45 to 50% gross margins and high teens EBITDA margins, a very clean balance sheet. And when we purchased data from NPD that showed point of sale for all the different categories they were in, you saw a business that when it enters a new category, very regularly gets to 30 to 40% market share. So this was at the time of $4 billion business, growing very fast and had shown a proven ability to grow organically, to innovate and to disrupt.

• 44:20Speaker 02

  And when we put that through our process, we came up with something that we thought was very radically mispriced and extraordinarily asymmetric. So I think that's an example, again, where we and others are creating the market narrative where it didn't exist and that there were very specific, explicit and concrete inefficiencies that one could exploit if you were just willing to apply the proper process.

• 44:43Ted Seides?

  I'd love to take a step back and talk a little more about your journey over the last six years. There's a big difference from launching and then attracting capital to be where you are today. What were some of the success factors for you in being able to raise capital for the strategy?

• 44:59Speaker 02

  Much like every day that goes by is the hardest day to short that's ever been, I think probably every day that goes by is also probably the hardest day that it's ever been to raise a dollar of institutional capital. It is incredibly competitive to do so. Our mindset, really from the beginning, has not been one of raising capital. The mindset has been one, first and foremost, of defining what we want to do that we think we can be good at. And maybe that's a subtle distinction, but when I sit down to meet with a potential partner, our first meeting is basically an hour of me telling them probably why we're not a good fit for each other. We invest in a very specific way. We take a lot of single name concentration risk.

• 45:44Speaker 02

  We invest globally across different asset classes. We can kind of almost do anything we want with your money within reason. Our strategy will be volatile. We like to go into more complex situations or parts of the market. They may be hard for you to understand or articulate to your constituencies. And the nature of our strategy is that we know over time it will generate alpha if we execute it faithfully. There can be some real ups and downs along the way. So really, it's a process of trying to, more so than attract capital, find folks for whom it's a good match and let them opt into that conversation and then just build a relationship over time. So our approach has really been one of saying, look, this is who we are.

• 46:29Speaker 02

  If it's interesting to you, please, let's talk about it, but let's build a relationship along the way. Let's give you complete transparency into what we do and see what happens. Just putting a lot of persistence around building that relationship.

• 46:42Ted Seides?

  So those relationships often take time to build. When you're starting, you actually need capital to manage, to be around for when those relationships may turn your way. How did that play out in the early years?

• 46:55Speaker 02

  Blackstone anchored our partnership from day one and they've been fantastic partners. And I think that played a critical role in allowing us to put that stake in the ground and say, this is who we're going to be from day one and not succumbing to what I think a lot of managers are forced to adapt or modify their strategy to do things they don't want to do early in their life in order to raise capital. We didn't have to do any of that because we had a very strong anchor. And then we were fortunate to be able to partner with some other very thoughtful, stable sources of capital who will partner early in the lifespan of a manager and who are able to allow us to do what we do. And then there's serendipity involved.

• 47:39Speaker 02

  There's a lot of luck that's involved, but you have to perform. And so we were fortunate enough not just to be able to perform, but to perform in a laboratory that was pretty rich for how we want to invest. The onset of the pandemic and its immediate aftermath, while challenging to navigate. And I think that gave us a lot of proof of concept to folks who we were building relationships with to then allow us to continue to scale in the ensuing years.

• 48:03Ted Seides?

  What have been some of the biggest challenges along the way?

• 48:06Speaker 02

  Gosh, where to begin? Building a team and a culture through a pandemic, not easy. There was a period of time where we weren't in the same room together or the same office and you're trying to forge your identity. And I give tremendous credit to the professionalism of the team. I think it would have been easy for a lot of newer firms to splinter and instead we came together and built our identity and our culture. That certainly was a challenge early on. I think continuing to build those partner relationships and giving transparency into our process through the ups and downs, because it hasn't been all up and to the right. We went through a period of underperformance in mid 22 where we had a drawdown and just

• 48:51Speaker 02

  managing through that, that's for sure been the most challenging aspect. The drawdown itself wasn't out of line with what you would consider maybe for a strategy like ours, but it still wasn't fun. Like many things in life, you think you have a plan and then it gets Tested and it's not what you think it is. And we had built our risk posture in the spring of 22 for probably four to 5% inflation, but not 10. To my point about concentration earlier, that was the one time when it worked against us. And so empirically, we had to navigate through that period and reset the portfolio and manage risk. And I think one of the things that came out of that in a very positive way is some of our best LP relationships today were born of that moment.

• 49:34Speaker 02

  They were folks with whom we had been building that relationship and that dialogue from inception. And then they came in and they said, effectively, we've been waiting for a moment like this. We were expecting it for a strategy like yours. You behaved in the way that we would have hoped you would have behaved. You explained it in a way that we would have hoped you would have explained. This is our time to partner with you. And from that moment, we've been able to build some of our best, most resilient relationships. That's been a positive at the other end of it.

• 50:01Ted Seides?

  What are some of the most important lessons and adaptations that you've made from how you thought about managing capital six years ago to today?

• 50:11Speaker 02

  I would say that the core strategy, the philosophy, has not changed. We are as committed as ever to high active share concentration, appropriate duration, working across the opportunistic mandate, the commitment to the short side. Where we've had to adapt is mostly around implementation of that. So a few examples would be what I talked about on diversifying the short side. Increasing our research velocity because volatility in the markets and the dispersion it's creating has meant that sometimes your window to access an opportunity is more fleeting and you've got to be prepared to move. We've worked hard to build more inventory of ideas, even if they're not actionable in the moment. When we see that price signal or that opening, that's consistent with what we have underwritten,

• 50:56Speaker 02

  being ready to move. Within the team process, most of our team interactions are geared around opportunity identification. And we've put more formal structure around how we communicate information to each other in the hopes of not just sharing insight by generating ideas.

• 51:15Ted Seides?

  What opportunities are you most excited about as you look forward?

• 51:19Speaker 02

  I'm as excited today about our opportunity sets as I have been probably since the early onset of the pandemic. We talked earlier about some of the distortions that the concentration of large cap tech, Mag7, were having. They've literally left very compelling situations lying in the middle of the street, the proverbial $20 lying on the sidewalk. Without making political statements, the change in leadership, the Republican sweep, is, we believe, a big deal for our opportunity sets. It is creating a lot of dispersion because of the uncertainty of the policy shifts, but the de-emphasis on regulation, the animal spirits that we believe are being unlocked, we think will ultimately be good for event-driven and special situations.

• 52:02Speaker 02

  We think there's a lot of pent-up corporate action demand that will come out here in the coming months and year. We think that regulation has been a real burden to small and medium-sized businesses who bear that regulation disproportionately. They employ something like 82% of people in this country. And all the real-time telemetry that we're getting, so data sets, business formation, conversations that we're having with corporate, suggest that the confidence that you're seeing broadly emerge is real. The animal spirits emerging are real. And ultimately, what needs to happen here is a broadening of earnings growth from the large-cap part of the market to this mid-cap. But we think that's happening,

• 52:45Speaker 02

  and we think it's happening at a time when it's been largely ignored in both passive and active flows. So I'm very excited about that. We're excited about the international opportunity, Ted. About a quarter of our risk today is outside the US. I think three of the last four long ideas that we put into this concentrated portfolio are international opportunities. We have risk in places like Korea, Japan, Southern Europe, the Nordics, Asia-Pac. So we're seeing it broadly. And that's because the large-cap AI trade, it's not just sucked capital out of mid-cap, it's sucked it out of pretty much every asset class and country globally. So we're pretty excited about the dispersion that we're seeing ex-US. And then, just long short, we're seeing

• 53:29Speaker 02

  Real dispersion, which was not the case really from like, I don't know, 2005, 2006 till maybe a few years ago. There was much less long, short dispersion. We're really excited about our underlying opportunity sets and that's being validated in our bottoms up work. Where our velocity of new ideas into the book and just the pace and different types of ideas that we're seeing long and short is quite robust as well.

• 53:54Ted Seides?

  What are you most worried about?

• 53:56Speaker 02

  I'm by nature, someone prone to worrying. So obviously the flip side of what I just said is that we have a new administration. That can be quite volatile in terms of day to day decisions or unpredictability. And with that comes, I think, a heightened risk premium. I think you just have to underwrite a wider distributions of scenarios in everything that you're doing. From a macro perspective, it doesn't take much to destabilize markets. The market is not just all on one side of the boat. Everyone's in the bow of that boat and it will not take much to potentially tip it and create a major risk off event. So I think for us, it's about staying within our risk box parameters here from a gross net exposure.

• 54:41Speaker 02

  Balance of the kind of tilts that we're taking while still identifying those handful of high conviction ideas. That we think we can exploit in that environment. But I think it's still one where you need to be careful about the risk you're taking. As careful as you've ever been, careful about balance sheet risk, careful about operating leverage and the fundamentals. Of the companies that you're underwriting. In many respects, it's still credit 101. What are the things that can get you into a lot of trouble? Balance sheet, liquidity, operating leverage, customer concentration, crowding. And just making sure that you're not exposing yourself in excessive ways to those types of risk at this point in the cycle.

• 55:18Ted Seides?

  So if you look out six years from now and we sit down to do this again, what are you hoping Parsifal will become?

• 55:25Speaker 02

  We've always wanted to be in the IRR club. So my hope will have been that we've distinguished ourselves through very strong performance that's diversifying for our partners and has helped them reach and achieve their end objectives. Along the way, I hope that we've continued to build out and promote from within a very talented team and a team and culture that is self-perpetuating. In many respects, the Achilles heel of organizations like ours is the key man risks that sits with someone like myself. I've always been very open about that, both internally and externally, that for Parsifal to thrive and succeed means that I have to make myself redundant over time.

• 56:07Speaker 02

  I need to attract the best talent possible, groom that talent, put those individuals in positions of more success and responsibility over time, ensure that our process is not between the ears of just one or two people every day, but is really a self-perpetuating process of how we execute. So I think if in five or six years, we've been able to continue to perform in the way that we expect of ourselves to meet our partners' objectives, and I've been able to make myself much more redundant, I think we'll all be in a happy place as a result.

• 56:40Ted Seides?

  I have a whole new set of closing questions to ask you, so let's have at it. What's your favorite hobby or activity outside of work and family?

• 56:47Speaker 02

  I really enjoy just being outdoors in general. I think I mentioned last time, I grew up in a sporting family. I like to be in the woods. Maybe what I'd add to that is, as a child, I skied, and then for a long time, I didn't ski. And then as my children discovered it, I rediscovered as an adult, the joy of skiing. And that is truly something that I really look forward to once or twice a year.

• 57:08Ted Seides?

  What was your first paid job?

• 57:11Speaker 02

  So I spent a lot of my life growing up in Italy. My mother is from the north of Italy, and our family has a family apparel business there. In sort of the middle school and early high school years, my uncle put me to work as a translator. And even though he speaks pretty good English, we'd spend our summers there, and he'd have me translating copy or things that came over in a facsimile, which in those days was cutting-edge technology, or sometimes just getting on the phone with him and helping him translate when he was dealing with wholesale customers or things like that. So that's probably my earliest memory. And I got paid in clothes, by the way.

• 57:48Ted Seides?

  How's your life turned out differently from how you expected it to?

• 57:53Speaker 02

  I don't know that I ever had an expectation of how my life would turn out. I've been very fortunate to have won the life lottery in the sense that very loving family, loving parents. I won the wife lottery. My wife Katie is amazing. We're blessed with four children. I get along great with my in-laws. So I don't know that I ever had any expectation other than maybe of hoping to have that kind of life that I observed my parents and loved ones having. And so in that sense, it's turned out better than I ever could have imagined. But it may surprise you. I never thought I was going to work in finance or Wall Street. So in that sense, it's turned out quite differently. I think if you'd asked me in my formative years, what I would end up doing, I think I probably thought I would have been an academic, like a professor, a research role, maybe

• 58:36Speaker 02

  an editor, or maybe working in like the CIA or the FBI, like doing analysis, the same kinds of things, but things like that. I genuinely didn't think I would end up on Wall Street.

• 58:48Ted Seides?

  What's a mystery that you wonder about?

• 58:50Speaker 02

  My youngest child is 11, is obsessed with the planets, probably like many children her age, astronomy, looking through a telescope at night. So together, we've been on this journey of what is the universe? What are planets? Where do we come from? Are there other forms of intelligent life? And it really has caused me to go down this rabbit hole and contemplate the mystery of the universe, I guess. And when you go down that rabbit hole, it's extraordinarily humbling and provocative when you really get into what are the mysteries of our universe and questions of other forms of life or higher forms of life. So we've enjoyed that together and trying to communicate with an 11-year-old about these things is quite challenging and has been quite humbling in its own regard.

• 59:35Ted Seides?

  All right, Dave, last one. If the next five years are a chapter in your life, what's that chapter about?

• 59:40Speaker 02

  I hope for me, it's really just about service. Service to what we've tried to build and will continue to build here at Parsful and service to our partners, service to my team here in terms of helping them achieve their career, skills, development, aspirations, certainly service to my family as my children go off to college and into their own lives and beyond that, into my broader family and service to my community and to handful of things that Katie and I are really passionate and supporting.

• 1:00:11Ted Seides?

  Dave, thanks again for coming back on and giving us an update on what's happened over the last six years.

• 1:00:16Speaker 02

  Thanks, Ted. It's been a real pleasure.

• 1:00:20Ted Seides?

  Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one, and see you next time.