Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: I'd love to rewind the clock a little bit. I mostly talk to investors on this show. I rarely have talked to some of the world's great traders through history. At a point in your career, you were probably the greatest active trader, or one of them, certainly the best in your market. I'd love you to describe what it takes to be truly excellent at that specific discipline. If you think back on the time when you were at – I’m curious, when you think it was that you were at the peak of your powers, I'd love you to take us behind the scenes a little bit of what it took for you personally to get to that stage, since I talk to so much fewer people that have done this.
· John Arnold
[00:00:00] S1: I might step back and think about my kids and what I want my kids to do. One of the big components is, do something that you're really passionate about, that you want to do, that it's not a job that you do for income. But if you can have a profession that you love, that you have this real, deep passion for. And that’s what I found with trading. I just loved the battle, the puzzle, the game of it. I would sit there from six in the morning to six at night, at the desk either staring at the computer screen or doing some analysis. Then go out with people from the industry that night and dream about the industry. In the shower in the morning, I'd be thinking about it. Just being so locked in. There were negatives associated with it. I'm not sure I was a great person, a great friend, a great partner for those times. But I think having that, dedicating your life to this craft, for a time period, was one of the things that separated me. I think there's also some downside. There are consequences to doing so. It's not the healthiest lifestyle. It's not healthy from a relationship standpoint, not healthy from a physical standpoint. It can be mentally exhausting. I think after doing that for 17 years, this one thing, and being so deeply intertwined with it, at some point, I just had to step back.
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: If you think about the second or third best natural gas trader that was active when you were active, I'm so curious about the difference between you and them. Another way of asking – if you turn it into advice for your kids, which I like that frame on it – what does it take to be number one in something versus number two and three? [00:00:00] S1: I don't know if I thought I was the best. I felt I was among the best. I had also managed to create probably the best seat in the industry. [00:00:00] S0: Say more about that.
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: Say more about that. [00:00:00] S1: My first job out of college was at Enron. I started there when I was 21 years old in 1995. It went bankrupt in late 2001. So then I'm coming out and I'm trying to figure out what to do. And I had a bunch of options. One is I could have stayed with the Enron trading floor, which ended up getting moved to UBS. I decided I wanted to do something that was a little bit more entrepreneurial and ended up deciding to start my own hedge fund. I had the classic hedge fund 2 and 20 structure. There wasn't an intermediary between me and the 20%. I was getting the 20%. I had the best, or as good as, economics as almost anybody in the business. Then we had very good financial returns early on. So that did two things. Number one, there was a lot of retained earnings and new investors came in. So we had a lot of risk capital. Second, we had a very good investor base that trusted the team I had built. Whenever we had a down month or a down time period, which we had, they weren't calling to redeem. They would call up and say, do you need more capital? Because we had earned their trust and we had done forced distributions along the way. I had set up this really powerful seat where I had good economics, so I could hire the best people in the business that I knew of. We had a lot of risk capital, and had a very solid and stable investor base.
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: I like this concept of developing the best seat in your industry. Are there any other interesting or useful components to that? If someone is listening and they're an investor, or even just a normal founder or business person, about setting up the best structural advantage in a seat, is it information flow? Is it other stuff? I love this concept. [00:00:00] S1: We started at 2 and 20. We did very well and had more demand to invest than we had capacity. We raised the fees over time and ended at 3 and 35 by the end. That allows investment in the business. You can build up a fundamentals team that's best in the business, because you can just pay them more. You can go do side projects, like trying to get proprietary data sources that give an advantage. You can pay the trading team, and the mid- and back office more money. Everything in the business starts to work and you have this sense of excellence around the firm, and that makes everybody better. We were able to develop a proprietary trade entry system and position management system. So, things that you don't necessarily think about, but are extraordinarily useful. Being able to buy any and all data, come up with proprietary data sources, have the best people trying to translate that raw data into something useful and build the best fundamental models in the business. I think it all becomes part of the flywheel. [00:00:00] S0: So really, scale. It's the redeployment of your scale that let you do all that and get into all these fine-grained ways that you could be better than your competitors.
· Patrick O'Shaughnessy, John Arnold
[00:00:00] S0: So really, scale. It's the redeployment of your scale that let you do all that and get into all these fine-grained ways that you could be better than your competitors. [00:00:00] S1: Yeah, I think that's right. [00:00:00] S0: Can you tell me about the baseball card business that you built in high school? I'm curious about it because I always wonder where the initial spark comes from. You mentioned the importance of passion and that you just fell in love with energy markets. I'm curious to trace why you were entrepreneurial in the first place, what the formative things were, maybe where a chip on your shoulder came from, to the extent there was one, in hearing about that business. But then also hear the story between that and the discovery of passion for the energy market specifically.