Hedge Fund Tools Applied to Long-Only Equities for Scarce Asset Identification
TL;DR
- Applying sophisticated hedge fund tools to long-only public equities allows for the identification of scarce, high-value assets that seldom go on sale, rather than common, tempting deals.
- Capital flowing into high-fee hedge funds has compressed gross returns, making lower-fee long-only structures with similar talent density a more attractive proposition for net returns.
- Developing a "right to win" in long-only investing involves building competitive advantages like duration, a long-term investment horizon, and a team compensated via salary, not bonuses.
- The shift from broad opportunistic mandates to specialized funds, coupled with increased market efficiency, necessitates a pragmatic specialization within a generalist framework to find outliers.
- The market's increasing inefficiency, driven by short-term capital flows to multi-managers and quant strategies, creates opportunities for patient investors to acquire quality businesses at attractive valuations.
- Focusing on a portfolio of diverse return streams with high expected IRRs, rather than solely on the highest IRRs, mitigates risk and ensures performance across various market outcomes.
- The creation of active ETFs allows firms to meet clients where they are, increasing firm duration and providing another avenue for clients to access unique investment strategies.
Deep Dive
Adrian Meli of Eagle Capital applies sophisticated hedge fund investing tools to a long-only public equity strategy, seeking to identify and exploit market inefficiencies. His approach centers on finding scarce, high-quality assets that become available at a discount, emphasizing a disciplined, long-term perspective and a deep understanding of business fundamentals. This strategy aims to generate consistent, above-average returns by focusing on asymmetric opportunities rather than chasing fleeting trends.
The core of Meli's investment philosophy is the pursuit of "arbitrage"--making money with minimal risk by identifying mispriced assets. This ethos, cultivated from a childhood steeped in deal-making and value-seeking, translates into a rigorous research process. Eagle Capital employs a generalizedist framework to spot outliers across various asset classes, but this is supported by pragmatic specialization. The firm's analysts are encouraged to dive deeply into specific areas where they identify promising opportunities, developing expertise to assess potential disruptions and long-term value. This deep dive approach is crucial, especially when evaluating companies in rapidly evolving sectors like technology and AI, where forecasting future profit pools is challenging. Meli acknowledges that many promising companies, particularly in areas like SaaS or AI infrastructure, are trading at high multiples, making it difficult to justify entry points based on traditional free cash flow analysis. Instead, Eagle Capital seeks opportunities in businesses where the current market sentiment is overly negative, leading to trough multiples on below-normalized earnings, believing that these companies will eventually recover and compound value over a five-to-seven-year horizon.
A significant implication of Eagle Capital's strategy is its differentiation from mainstream market trends, particularly the growing influence of passive investing and short-term oriented active managers. Meli observes that much of the capital in the market is now directed toward short-term opportunities and momentum-driven factors, leading to increased inefficiency in less popular or currently out-of-favor sectors. This dynamic creates an opportunity for Eagle Capital to acquire fundamentally sound businesses at attractive valuations, as other market participants are disincentivized from investing in assets with uncertain near-term paths. The firm's commitment to long-term holding periods--averaging over five years--and its focus on a concentrated portfolio of 25-35 securities allow for intense research and conviction building on each investment. This patient, contrarian approach is further supported by an organizational structure that eschews performance bonuses for analysts, instead offering salaries and the potential for partnership. This model is designed to foster a long-term investment horizon, aligning employee incentives with the firm's strategy and counteracting the short-term pressures prevalent in the industry.
Ultimately, Eagle Capital's success hinges on its ability to consistently identify and patiently hold high-quality assets that the broader market overlooks. The firm's "right to win" is built on a combination of deep research, long-term duration, a talented team, and alignment with patient capital. By focusing on the "and then what?" of market dynamics--how capital flows, how incentives shape behavior, and how market sentiment creates opportunities--Eagle Capital aims to deliver superior net returns for its clients, navigating an increasingly complex investment landscape by remaining disciplined and contrarian.
Action Items
- Audit investment team structure: Define 3-5 specialized research areas to enhance outlier identification and deep dive capabilities.
- Create analyst compensation framework: Implement salary-only structure for 8 analysts to promote long-term investment horizons and partnership potential.
- Develop portfolio construction dashboard: Track expected IRRs, risk-reward profiles, and earnings model divergences for 25-35 securities.
- Measure management access effectiveness: Quantify engagement with companies based on shareholder duration and long-term capital allocation strategy.
- Evaluate AI impact on portfolio: Identify 3-5 companies likely to benefit, be disrupted, or remain neutral from AI advancements.
Key Quotes
"The best deals aren't those unsellable teal crocodile loafers at the designer outlet on Black Friday that everybody is tempted to buy once or twice. It's those scarce few great assets that come on sale very seldomly that you got to jump at when you see."
Adrian Meli explains that true investment opportunities are rare and require decisive action, contrasting them with impulse purchases. Meli uses this analogy to highlight his approach to identifying and capitalizing on significant, infrequent market dislocations rather than chasing common sales.
"I'm always looking for an arbitrage, a way to make money without taking much risk. And given the house I grew up with, what was important to learn along the way is the best deals aren't those unsellable teal crocodile loafers at the designer outlet on Black Friday that everybody is tempted to buy once or twice. It's those scarce few great assets that come on sale very seldomly that you got to jump at when you see."
Meli emphasizes his core investment philosophy: seeking arbitrage opportunities that minimize risk. He reiterates his earlier analogy to underscore that exceptional deals are not about discounts on common items but about seizing rare chances to acquire undervalued assets.
"The best hedge fund returns in history were created from the late 90s to 2010, when that alpha pool was really big. It was just a really great time to learn, being in an unconstrained vehicle, working around smart people, and getting to go meet with company after company when you had that breadth of opportunity set."
Meli reflects on a past era in hedge fund investing, identifying a significant "alpha pool"--a market environment rich with opportunities for generating excess returns. He attributes this to unconstrained investment strategies, intelligent colleagues, and extensive access to company research during that period.
"Most of the great ideas in life are both non-consensus and right. Plenty of ideas are non-consensus; they're wrong. And so when I had the opportunity to get a senior role here and shift over, I thought, wouldn't it be interesting if I joined this world and I got to attack the swim lane of hedge funds that were higher fee and at the same time a lot of capital had left the long-only industry and a lot of the talent had left the long-only industry?"
Meli articulates his belief that truly impactful ideas are often unconventional and correct, contrasting them with those that are merely unconventional. He explains his strategic decision to move to a long-only firm, seeing an opportunity to apply hedge fund-like intensity to an under-resourced and potentially less competitive sector.
"The pitch to them is this: If you love doing what we do, you love deep research, long-term investing, we think we're a good home for you. You come in, you sit shoulder to shoulder with Alec and me in every research meeting, debating the entire portfolio, debating new names that you're pitching, and you can have an enormous impact on the future of Eagle."
Meli describes the recruitment strategy for attracting top talent to Eagle Capital. He highlights the firm's appeal to analysts who value deep research and long-term investing, emphasizing the opportunity for significant impact, collaborative debate, and a career path beyond the typical bonus structure.
"I feel like the market's becoming a little less efficient in certain areas. And I'll explain it: Let's just look at the last five years and say, was that look efficient to you, Ted? What happened in 2020? These all these fake companies with enormous multiples, SPAC bubbles, unicorns, it was a meme stock frenzy that didn't look so efficient in retrospect."
Meli challenges the notion of increasing market efficiency, citing recent phenomena like the SPAC bubble and meme stock frenzy as evidence of irrationality. He suggests that despite the prevalence of indexing and sophisticated trading, certain market segments have exhibited significant inefficiencies.
Resources
External Resources
Books
- "The Intelligent Investor" by Benjamin Graham - Mentioned as a foundational text for understanding investing principles.
Articles & Papers
- "How Hedge Funds Outperform Mutual Funds" - Mentioned as a paper written by Adrian Meli in college.
People
- Adrian Meli - Co-Chief Investment Officer of Eagle Capital Management, guest on the podcast.
- Ted Seides - Host of the Capital Allocators podcast.
- Alec Henry - Partner at Eagle Capital Management.
- Ravenel Curry - Founder of Eagle Capital.
- Jennifer - Adrian Meli's wife.
- Maisie - Adrian Meli's 10-year-old daughter.
- Callie - Adrian Meli's 5-year-old daughter.
- Benjamin Graham - Author of "The Intelligent Investor."
- Joel Greenblatt - Mentioned in relation to spin-offs from large fund houses.
- Astro Teller - Head of Google X, mentioned in relation to discussions about self-driving cars.
Organizations & Institutions
- Eagle Capital Management - Firm where Adrian Meli is Co-Chief Investment Officer.
- Capital Allocators - Podcast hosted by Ted Seides.
- WCM Investment Management - Sponsor of the podcast, focused on moat trajectory and corporate culture.
- SRS Acquiom - Sponsor of the podcast, focused on M&A processes.
- The Podcast Consultant - Provided editing and post-production for the episode.
- Google X - Mentioned in relation to discussions about self-driving cars.
- PFF (Pro Football Focus) - Mentioned as a data source for player grading in a previous example.
- NFL (National Football League) - Mentioned as a subject of sports discussion in a previous example.
- New England Patriots - Mentioned as an example team for performance analysis in a previous example.
- Vanguard - Mentioned as a large shareholder.
- State Street - Mentioned as a large shareholder.
- BlackRock - Mentioned as a large shareholder.
- Citadel - Mentioned as an example of a top hedge fund.
- Millennium - Mentioned as an example of a top hedge fund.
- Union Square Ventures - Mentioned as an example of a top quartile VC firm.
- Benchmark - Mentioned as an example of a top quartile VC firm.
Websites & Online Resources
- capitalallocators.com - Website for the Capital Allocators podcast.
- twitter.com/tseides - Ted Seides' Twitter profile.
- linkedin.com/in/tedseides/ - Ted Seides' LinkedIn profile.
- thepodcastconsultant.com - Website for The Podcast Consultant.
- wcminvest.com - Website for WCM Investment Management.
- srsacquiom.com - Website for SRS Acquiom.
Other Resources
- Long Only Strategy - Investment strategy employed by Eagle Capital.
- Hedge Fund Investing - Investment strategy discussed in relation to Adrian Meli's career transition.
- Distressed Debt - Asset class Adrian Meli worked with early in his career.
- Domestic Equities - Asset class Adrian Meli worked with early in his career.
- International Equities - Asset class Adrian Meli worked with early in his career.
- 13Fs - Filings used to track investor holdings.
- Alpha Pool - Refers to the potential for generating excess returns.
- Compounders - Businesses that grow steadily over time.
- Active Management - Investment approach that seeks to outperform a benchmark.
- Indexing - Investment approach that seeks to replicate a benchmark.
- Systematic Strategies - Investment strategies based on predefined rules.
- Pod Shops - Refers to multi-manager hedge funds.
- AI (Artificial Intelligence) - Technology discussed in relation to its impact on businesses and markets.
- SAS (Software as a Service) - Business model discussed in relation to market valuations.
- Medicare Advantage - Segment of the healthcare industry discussed.
- Romcoms (Romantic Comedies) - Adrian Meli's preferred genre of movies.
- Cold Plunges - Activity mentioned in relation to Adrian Meli and Alec Henry.
- White Elephant Gift Exchange Party - Social event mentioned in relation to people's behavior.
- Line Dancing - Activity questioned by Adrian Meli.
- Word Finds - Activity questioned by Adrian Meli.
- Interval Funds - Financial instrument mentioned as a step towards market merging.
- Secondary Funds - Financial instrument mentioned as a step towards market merging.
- Private Equity - Asset class discussed in relation to capital flows and valuations.
- Private Credit - Asset class discussed in relation to capital flows and valuations.
- Venture Capital - Asset class discussed in relation to capital flows and valuations.
- Biotech - Industry mentioned as having no money currently.
- Active Equity Space - Investment area discussed in relation to fundraising challenges.
- Private Equity Space - Investment area discussed in relation to fundraising challenges.
- LBO (Leveraged Buyout) - Investment strategy discussed in relation to capital flows and valuations.
- Bitcoin - Cryptocurrency mentioned as a potential investment.
- Japan - Country mentioned as a potentially interesting investment area.
- Korea - Country mentioned as a potentially interesting investment area.
- Georgia Bulldogs - College football team mentioned.
- Cleveland Browns - Professional football team mentioned.