August 4, 2024 • 2hr 3min

RWH048: Betting Billions On Outlier Talent w/ Adam Shapiro

We Study Billionaires - The Investor’s Podcast Network

In this episode, William Green interviews Adam Shapiro, managing partner of East Rock Capital, a $4 billion investment firm that manages money for 8 ultra-wealthy families. Shapiro provides insights into how he identifies talented fund managers, builds a resilient portfolio, and thinks about preserving multi-generational wealth. The conversation covers Shapiro's investment philosophy, views on index funds vs alternatives, and lessons learned from working with billionaire families.

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Key Takeaways

Adam Shapiro manages about $4 billion in assets for 8 ultra-wealthy families through his firm East Rock Capital. The minimum investment is $100 million.
East Rock has outperformed major university endowments like Harvard, Yale, and Stanford over the last 15 years by focusing on identifying great fund managers early in their careers.
Shapiro believes smaller, newer hedge funds and private equity firms tend to outperform larger, more established ones. He looks to invest with talented managers who are launching their own firms after success at larger institutions.
Key qualities Shapiro looks for in fund managers include grit, resilience, an intrinsic desire to hustle, and the ability to make good decisions under pressure. He conducts extensive reference checks and builds a detailed picture of a manager's character and work history.
Shapiro is wary of index funds and ETFs, believing they expose investors to too much market risk during downturns. He favors alternative investments like hedge funds and private equity to reduce correlation to public markets.
For regular investors without access to sophisticated alternatives, Shapiro recommends reducing leverage and recurring expenses to increase resilience. He believes the investment industry needs better solutions to give individuals access to uncorrelated private market investments.
Shapiro warns about hidden leverage and risks in some large, well-known hedge funds. He cites examples of funds with 5-7x leverage that could be vulnerable in a crisis.
Key principles for building multi-generational wealth include avoiding over-diversification, focusing on truly uncorrelated investments, and being vigilant about removing "filler" from portfolios.

Introduction

In this episode, William Green interviews Adam Shapiro, managing partner of East Rock Capital, a $4 billion investment firm that manages money for 8 ultra-wealthy families. Shapiro provides insights into how he identifies talented fund managers, builds a resilient portfolio, and thinks about preserving multi-generational wealth. The conversation covers Shapiro's investment philosophy, views on index funds vs alternatives, and lessons learned from working with billionaire families.

Topics Discussed

Shapiro's Background and Early Career (3:34)

Adam Shapiro graduated from Yale in 1995 and initially worked in private equity in Latin America. This experience taught him valuable lessons about the challenges of investing in emerging markets:

Encountered issues like fraud, corruption, and difficulty operating businesses
Realized Latin American investments weren't compensating for higher risks through cheaper valuations or faster growth
Concluded the U.S. has extraordinary advantages as an investment environment

Shapiro states: "If there's one concentrated risk I'm willing to take in my investing, it's being overweight the United States, because the environment is so extraordinary."

Lessons from Goldman Sachs (20:03)

After business school, Shapiro spent 5 years in the Special Situations group at Goldman Sachs from 2002-2007. Key lessons included:

The power of sourcing investments through networks of people
Buying distressed/complex assets at deep discounts
Looking for investments where "all surprises are to the upside"
Wanting personal exposure to the investments he was making for clients

Shapiro explains: "What I sort of decided for my career was, I want to invest in things where I have the sense it's a privilege to invest in it, it's advantaged, it's favorable, and gosh, I want my own money in it."

East Rock's Investment Approach (36:38)

Shapiro co-founded East Rock Capital in 2006 with the goal of beating the Yale endowment's returns. Key aspects of their approach:

Focus on identifying great fund managers early in their careers, often as they're launching their own firms
Look for managers with 10-20 years experience at top firms who are now "betting on themselves"
Typically invest for 3-5 years as funds are in their early stages
Conduct extensive reference checks and due diligence on managers' character and work history
Own 15-20 hedge funds and 60-80 private equity investments across 30-40 sponsors

Shapiro states: "The key to identifying great investors is meeting them as early as you possibly can...and then building this whole picture of who they are and what their work product has been and what their style is and what their advantages are."

Qualities of Great Investors (45:56)

Shapiro looks for several key qualities when evaluating fund managers:

Intrinsic desire to hustle and find hidden opportunities
Grit and resilience in overcoming setbacks
Ability to make good decisions under pressure
Track record of finding creative ways to source deals
High integrity and trustworthiness

He emphasizes the importance of extensive reference checks, stating: "The answer is almost always in very extensive referencing where you know people in common and therefore, the views you're getting are from people who are actually motivated to tell you what's really going on."

The Power of Networking (51:53)

Shapiro has built a powerful network that helps him source investment opportunities and talented managers. Key points:

Views networking as mutually beneficial, not exploitative
Focuses on giving first and creating value for others
Sees investing as motivation to be a "learning machine" and connect with diverse people
Uses network to get detailed insights on potential managers from trusted sources

He explains: "What's wonderful about investing as a career is...all knowledge is relevant and all people are relevant."

Views on Index Funds and ETFs (1:13:21)

Shapiro is wary of index funds and ETFs for several reasons:

Expose investors to large drawdowns during market crashes (e.g. 55% drop in 2008-2009)
Most investors can't psychologically handle such volatility and sell at the wrong times
Difficult to choose the right indices - emerging markets have performed poorly
Spreading across multiple ETFs reduces returns vs more active strategies

He argues: "There is a very powerful argument for why people should not just kick out alternative investing and think about a publics-only strategy."

Updating the Yale Endowment Model (1:20:05)

Shapiro has updated David Swensen's Yale endowment model in several ways:

De-emphasizing rigid asset allocation buckets
Focusing more on market risk and liquidity budgets
Greater emphasis on smaller, newer managers
More vigilance about removing "filler" investments from the portfolio
Creative sourcing of alpha opportunities

He states: "I think there is room, significant room, to move the discipline forward."

Importance of Liquidity (1:21:31)

Shapiro emphasizes the critical importance of maintaining adequate liquidity:

Rule #1 is "never, ever, ever run out of liquidity"
Have a clear liquidity budget, but use illiquidity to your advantage
Balance between having enough liquidity for opportunities and not holding too much cash

He explains: "You budget for the liquidity you need, but not more than that. And you use illiquidity to your advantage."

Reducing Risk for Regular Investors (1:24:20)

For individual investors without access to sophisticated alternatives, Shapiro recommends:

Reducing leverage and recurring expenses to increase resilience
Living within your means
Being wary of commitments made during good times that are hard to maintain in downturns
Positioning yourself to survive market volatility without being forced to sell

However, he believes the investment industry needs better solutions to give individuals access to uncorrelated private market investments.

Hidden Risks in Large Hedge Funds (1:32:22)

Shapiro warns about hidden leverage and risks in some large, well-known hedge funds:

Cites examples of funds with 5-7x leverage that could be vulnerable in a crisis
Argues there is more "manager risk" with opaque strategies using high leverage
Recommends putting a premium on strategies that can generate good returns without leverage

He cautions: "The history of black boxes using a lot of leverage is not a great one."

Lessons from Ultra-Wealthy Families (1:43:16)

Key insights from working with billionaire families:

Importance of having purpose and engagement beyond just managing wealth
Desire to be responsible stewards and create opportunities for future generations
Need for "no surprises" in investment management
Challenge of maintaining family vitality and relevance over time

Shapiro explains: "What can suck vitality is this feeling of moving backwards. We were a relevant family in a lot of ways, and now we're moving backwards. And that's the key thing to avoid."

Conclusion

Adam Shapiro provides a fascinating glimpse into the world of ultra-high net worth investing through East Rock Capital. His approach of identifying talented fund managers early, focusing on uncorrelated alternative investments, and maintaining vigilance against portfolio "filler" has allowed East Rock to outperform major university endowments. While some of his strategies are not accessible to average investors, his emphasis on reducing leverage, maintaining adequate liquidity, and positioning for resilience provides valuable lessons for all. Shapiro's insights on networking, assessing investor talent, and balancing risk management with return generation offer a masterclass in sophisticated portfolio management.