From Quant Investing to Venture Capital with Jim O'Shaughnessy

[00:00:00] Welcome to excess returns where we focus on what works over the long term in the markets.

[00:00:05] Join us as we talk about the strategies and tactics that can help you become a better

[00:00:09] long-term investor. Justin Carboneau and Jack Forehand are principals at Validia Capital

[00:00:13] Management. The opinions expressed in this podcast do not necessarily reflect the opinions of

[00:00:17] Validia Capital. No information on this podcast should be construed as investment advice.

[00:00:21] Securities discussed in the podcast may be holdings of clients of Validia Capital.

[00:00:24] Hey guys, this is Justin. In this episode just something I think Jack and I will always remember and appreciate. People like you that had pretty large followings that gave us a chance out of the gate, you know, we're still a relatively small podcast, but I don't know,

[00:01:40] over 250 episodes in, you know, we're committed to it.

[00:01:43] I think we've delivered a lot of great educational material largely because of that they can build up a fantastic body of knowledge that you could repurpose into a course, lots of things. And when you just look at the downloads, especially among younger people, they're not listening to music for the most part. They're listening to a podcast. They're listening to you guys. So you guys are the new rock stars.

[00:03:03] It's funny, without even knowing it, you were probably our biggest source of new guests

[00:03:05] at the beginning because you were kind enough to influence on what we do here at Validia with a lot of the models we run and sort of the way that we look at running money and managing models. And just, you know, where I guess we want to start is when you think

[00:04:21] about your career in investing and building O'Shaughnessy asset management over the multiple bought into, whenever it's not working, the urge to throw in the towel is going to be pretty enormous. And so I think that just letting the process work through very different market environments was one of our better lessons. I think people ask me, like, what are you essentially negate all of your previous track record because the track record was predicated on the fact that you had acknowledged, look, there's going to be drawdowns. There's going to be times when this particular model doesn't work. I mean, witness all the poor deep value guys and how hard it is to stick with that particular

[00:07:04] strategy. that process continual, trying to improve it, but you've got to learn how to get your emotions to calm down. Because generally speaking, I always joke fear, greed, hope, and ignorance are the four horsemen of the investment apocalypse. And fear, greed, and hope have wiped out more asset value, I think, than any bear market,

[00:08:24] for sure.

[00:08:26] I was reading an article earlier today, actually. it's you know factor investing has significantly gained in popularity and become prioritized over that period of time. Do you, what is your general outlook on factor-based investing going forward given how much assets are invested in these factor-based strategies? And so I think you know let's use the let's use a factor-based strategy called the S&P 500.

[00:10:48] zero return. I think factor-based strategies are far more an arbitrage on human nature. And what they allow is you can scream from the rooftops, right? This particular strategy

[00:10:54] worked over the last 85 years, 80% of of the efficacy of the strategy. And so I think, yeah, they're proliferating. A lot of them, the bone that I would have to pick with Bactor, the products that are either an ETF wrapper or mutual fund wrapper or separate account really doesn't matter. The ones that are designed by marketing people are kind of a no-go zone for me

[00:13:23] of the value that you created for that business. So I'm just wondering if you have any advice on that. How have you been able to pivot and be able to willing to change in your career?

[00:13:29] That's a great question. One of the things that we have found while looking at the softer side

[00:13:34] of investing is that agility is a really great characteristic for a company or a founder to have

[00:14:47] And so we had, over the course of about a 15-year period, built out all of the tech specific to the way we managed money,

[00:14:53] but it also was incredibly transferable to the way a registered advisor might manage money.

[00:15:00] And the tech really worked.

[00:15:03] And things that are very non-trivial, for example, like I think Canvas is, is kind of really important if you want to succeed in business of any kind. And then the price to book that you mentioned, literally, I very rarely wrote anything that was a forecast, a specific forecast. And the only data that goes back to the mid-1920s, and we found that price to book did very, very low price to book, did very, very poorly during the depression. Not a big surprise. If the market is giving you a very low price to book, it's also signaling bankruptcy risk and saying, current value, but you probably had no idea that it would end up being in Canvas. And I just seem like that's occurred to me in a lot of different ways in my career that building that foundation without necessarily knowing what it's going kind of ideal in helping with this idea of custom indexing. I think that, you know, what I am very excited by is that the team at OSAM, like, was one of the the team selling was we wanted it to take over. And we were a little shop in Stanford, Connecticut, and Franklin Templeton managed a trillion and a half dollars. When you managed a trillion and a half dollars, you've got a lot of pipelines. And so that was our

[00:21:40] reasoning because we really thought if this is going to work and this is going to scale,

[00:22:46] It made sense to be prudent and diversify our investments. So we diversified into things like real estate, into specialty managers, some of which we

[00:22:55] still have to this day, but then also into direct private startup company investing. anything we've ever had access to in the past as humans. So things like AI, things like our exploration of space, we have investments in all of those areas. And then opportunities with these new platforms, like in education.

[00:24:20] So for example, we have a fairly significant position

[00:24:23] in synthesis school, which other. And that was whenever I want to learn about something, I just read about all of the people

[00:27:02] who were massively successful in that particular field.

[00:28:07] Hey, you know, week back you guys, if you, uh, if you fled Shockley and, and, uh, started your own gig.

[00:28:08] And so the first thing that really gets you, uh, uh, interested is venture capital

[00:28:16] as practice back then.

[00:28:19] And as we're trying to practice again today is a relatively new, uh, asset class, if

[00:28:27] you will.

[00:29:23] freedom in the way we operate than a traditional venture fund.

[00:29:31] Secondly, because we don't have any LPs, if we gain conviction, we can act very, very quickly.

[00:29:31] And as a matter of fact, I would say the last five deals that we did over the

[00:29:36] last, I don't know, 18 months, three of those we got simply because we could

[00:29:42] act quickly.

[00:30:44] into him being a wonderful guy and super smart is his timeframe.

[00:30:51] Like literally that gives him such a huge advantage over people who have to worry about, you know, what, what, what's the life of this fund?

[00:30:56] Uh, we got to make, we got to deploy all this money if we want, uh, to, uh, you

[00:31:01] know, draw the fees that, uh, that are the lifeblood of our business.

[00:32:03] One unique thing about you is your son and you have both started venture capital business, separate venture capital businesses around the same time.

[00:32:05] I'm wondering, do you guys compare notes?

[00:32:07] Do you learn together?

[00:32:08] How does that work?

[00:32:12] We of course always compare notes and we always talk.

[00:32:17] The interesting thing here is other than being an investor in a positive sum and Patrick being Well, it seems to me like you're the lunatic young BC and I feel like a private equity guy here And and yet like they're both, you know, who knows we'll see how it goes His his methodology is quite sound I I have a lot of money invested with him and the returns have been great

[00:33:41] Ours is really much more

[00:33:44] Exploratory and frankly again now we're back to your grandfather and the energy business and it just seems

[00:35:02] like some stuff is just in people's DNA and they're wired to be entrepreneurial

[00:36:07] And the studies that you look at show that a lot of the kind of risk seeking attitude is heritable. Now, it's heritable, but it also has to be switched on.

[00:36:11] And so one of the things that I think is that there is this huge lopsided to be risk-seeking, the amount of these opportunities and the payoff from these opportunities would be decidedly more muted. Obviously, I'm not a biologist or a geneticist, but I do understand evolutionary history somewhat,

[00:37:43] just enough to be said for America as that experiment in hypomania and, and I definitely think that there is a genetic component, but there's, you can also learn a lot of these things too.

[00:39:02] So I don't want anyone listening to think, Oh, you know, I, I don't think I have

[00:39:06] the genes for being a risk taker.

[00:40:02] think about the podcasting business as you look at it?

[00:40:09] I think it is going to be a massive industry.

[00:40:17] I think that as we build up the back catalog, so to speak, I think of, you know, my son Patrick with Invest Like the Best.

[00:40:20] If you look at all of his episodes and his guests and everything, is it not

[00:41:25] way that they fit into this ecosystem through podcasts, through YouTube, through sub stacks, et cetera, you're seeing this emerge and people who are really good at

[00:41:32] teaching or interviewing like Patrick with invest like the best, or David

[00:41:36] Senra with his reading of, uh, biographies and autobiographies like center is

[00:41:43] another great example that that that's a book.

[00:42:46] The creativity of humans is astounding. And now we have this variance amplifier in the internet and AI, which can go through

[00:42:54] all of the hundreds of millions of data points and raise those that might be salient to

[00:43:02] you.

[00:43:03] It's going to be a very, very exciting time.

[00:43:06] And I think you're right on the money.

[00:43:08] You're trying a bunch of different... I've never met a guy, he came here and I have a library here. What does he do? I know him pretty well, but what does he do instead of, Hey, Jim, what's up? What's going on? And he just goes right to the library. And he's like, Oh, this one, did I borrow this one? I haven't seen this one. I just love his passion and his enthusiasm for learning.

[00:44:21] And then, and then his ability to break it down and make it highly educational.

[00:44:27] Wow.

[00:45:25] Just going back to that example of the custom education thing with AI, if you think about it, it's like custom indexing.

[00:45:28] But if there was some type of technology,

[00:45:31] because we all learn differently,

[00:45:33] we all digest content differently.

[00:45:35] I might be listening to a podcast,

[00:45:36] I might get a core of a way through,

[00:45:38] somebody might get all the way through,

[00:45:39] somebody's going to take different things.

[00:45:41] But if you had some type of technology that could learn and

[00:45:45] reinforce learning through the methods that work best for you, these things and that is going to make the educational experience actually come alive and be super fun because if you could imagine like maybe you're not a visual learner, your average human is a visual learner, but there's a big subsection of humans who are auditory learners.

[00:47:01] So in the old days when you were just designing your educational system to the fat middle to become more creative, to interact with information in ways that work for us, right? You know, everyone has their own kind of vibe and their own kind of way of looking in and learning and doing that. Now that it can be customized down to you as an individual, that is such an unlock that

[00:48:22] I think it's very difficult to imagine all of the benefits that are going to be driven So we will look at a variety of opportunities. We have a pretty good team in terms of doing the overall research on, does this look like it could become a new thing or could this be, is this an extension

[00:49:40] of something that's already happening?

[00:49:42] Is this something brand new

[00:49:44] that we think might end up becoming a norm?

[00:50:43] are the big brains designing this stuff. So the network becomes crucial.

[00:50:48] Your network essentially is your filter.

[00:50:51] I'm stealing that from Don Tapscott,

[00:50:54] but it's a great quote.

[00:50:55] Your network is your filter.

[00:50:58] And if you have a reasonably good-sized network

[00:51:03] with super high- power laws, uh, dominate, uh, most venture investing.

[00:52:21] Maybe there's so many there that we might want to just take a step back and wait.

[00:53:24] And then decide, yeah, they're probably worth funding or we'll wait a while.

[00:53:27] So process oriented to the degree

[00:53:32] that we want to have a general thesis

[00:53:35] about what we find interesting.

[00:53:38] And if you go to our website,

[00:53:40] you'll find things that we think are going to be good unlocks

[00:53:44] moving forward.

[00:53:46] We've already talked about a lot of them.

[00:54:45] in a venture fund called Anchorless Bangladesh,

[00:54:48] which is Dan McMurtry, Super Mugatu on Twitter.

[00:54:55] And again, love the thesis of this country

[00:54:58] that is super young, embracing technology for the first time.

[00:55:00] We think there's a ton of arbitrage available there,

[00:55:04] but we're certainly not experts, so we farm that out. a domain expert there as well. So you're telling me that painting behind you isn't a big mushroom? I thought you've promoted. It is not. I can't really see the button. I'm just yeah. Well, if you ever stop by, I have some some mushroom entrance in a bathroom wallpaper.

[00:56:23] Nice. OK.

[00:56:24] Yeah. We'll see.

[00:56:26] What a quiz.

[00:56:26] I'd be like, Justin, you, a variety of problems are like, if these were standard pharmaceutical things that the pharmaceutical companies could trademark, oh my God, they'd be trillion dollar drugs. And so with that new learning, I'm able to go very nice comment there is you should also watch for the novel mistakes that we make because we will make novel mistakes. And I think that people need to reframe the way they think about mistakes. Mistakes are the single, in my opinion, learning rich environment.

[00:59:02] That's how you learn, right?

[00:59:04] You learn by screwing up.