Bill Kelly
Episode 1:7

The following document is an approximate, but not exact, transcript of the Operational Leaders podcast conversation between host Terrance J. O’Malley and guest Bill Kelly.

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Narrator 0:05
Welcome to the Operational Leaders podcast featuring leaders and innovators in the investment management industry, where we discuss the business of running the business with host and top industry executive Terrance J. O’Malley.

Terrance O’Malley 0:19
This week’s guest is the chief executive officer of the Chartered Alternative Investment Analysts Association or CAIA. The Association was formed in 2002, and the charter has become the globally recognized credential for professionals managing, analyzing, distributing or regulating alternative investments. The Association has almost 12,000 members worldwide, 31 plus chapters, and sponsors over 250 events annually. Please welcome William J. “Bill” Kelly.

Bill. It’s great to have you here.

Bill Kelly 0:52
Great to be here, Tery. Thank you.

Terrance O’Malley 0:54
Bill. Can you introduce us to CAIA?

Bill Kelly
Yeah, I think that summary was pretty much spot on and maybe I could just add a few thoughts. So I travel around the world and it’s been a kind of just over six years myself and having come from the industry and being a level two CFA candidate – I took level one in the early 1990s and never moved on to level two. But having spent probably 35 years on the on the buy side of asset management, I didn’t know much about CAIA. So when I joined it, I was a bit of a newcomer as well. But then as I travel around the world, I have many people saying that they didn’t quite know what CAIA was. And the very simple way to describe it is most people in our industry know the CFA. And the CFA has been around since the 1960s, focused primarily back then on equities, fixed income for the portfolio manager, the analyst.

So as the story goes, AIMA – one of our founders – felt in the late 1990s that more and more of these alternatives, hedge funds primarily and commodities more the tradable strategies back then, were showing up in the portfolios of sophisticated institutional investors. And should there not be a credential that was a CFA like answer for the alternative investment professional? So out of that, CAIA was born with the Isenberg Business School at UMass Amherst, when you need the academic underpinnings for the exam and the curriculum. That first class had 40 some odd people in it now, which is 2002, we’re now almost 20 years old. So leaving our teen years and we have now about six, almost six to 7000 individuals sitting for the exam annually, and as you say, almost 12,000 members in approaching 100 different countries around the world.

So as we see more and more growth in the alternative investments, I think our numbers are going to be highly correlated to that. But my focus is on really not so much trying to grow the member base candidate-by-candidate, but being out there almost as an apostle for both the good and the bad of what alternatives are and how they fit into a portfolio. And I think there’s a lot of misconception there in terms of the right fit, which we’re going to cover I know in the course of our discussion today.

Terrance O’Malley 2:56
So what is the relationship between CAIA and the CFA?

Bill Kelly 3:00
It’s excellent. They’re very good friends of ours. They’re both at the society level. And I was just asked to speak at an event that you attended last night in New York, which was fantastic to get that kind of discussion. And then at the institute level as well, Margaret Franklin, the current CEO, I’ve met a couple times, I think she is terrific. I knew Paul Smith or predecessor quite well, too. And we look at this concept of trying to think and act like an allocator. And, and maybe to put a bold underscore on this point. The CFA exam is three parts. About two years ago, we did a mapping exercise of all three levels of the CFA into the level one of CAIA, and found the learning outcomes based in the PhDs’ analysis of this were reasonably high. So we put a pilot-based program in place to say to the CFA, the level one knowledge is already in your skull, move directly to level two, and complete your learning across that risk premia spectrum and think like an allocator. And that’s been a very successful move, ultimately, for the end investor, not for the CFA not for CAIA, but providing better solutions for the investor. And through the lens of our members, the group that we’re focused on first and foremost is the investing public.

Terrance O’Malley 4:06
I like to ask our guests how they got involved in their particular organization. How did you end up as the CEO of CAIA?

Bill Kelly 4:14
Well, it’s been a very interesting evolution. So I started out at Price Waterhouse early on and got my CPA and was never that jazzed about public accounting. And at that point, I think the rules have changed. It was two years to get your CPA in New York and I think I left after 26 months. So I went about two months longer than my game plan, and spent a little bit of time at Bear Stearns in New York, but then moved up to Boston and was with the Boston Company through several iterations of ownership. And then a founder of Boston Partners, which was an organization that seven of us started in somebody’s kitchen in Wellesley, Massachusetts, and that organization today has 100 billion dollars of assets under management. We sold a majority piece to Robeco in Rotterdam in 2002. And I became the CEO of the US based operation in ’04, left about 10 years ago under very good terms, and I’m chairing a board there as an independent director. So the relationship is excellent. And Robeco is an excellent partner.

But I found that I wanted to do something, again, more entrepreneurial and more externally facing. And if somebody said to me 10 years ago, that all eventually end up a CAIA, I wouldn’t have found that to be a possibility. But having done some independent board work, and one board I was on was very much involved in liquid alts, and I saw the advent of liquid alts. I thought that was an excellent concept to give greater access, but without the appropriate amount of education. And then by happenstance, CAIA came knocking and said, “Hey, we’re looking for a new CEO.” And it just synced into exactly what I wanted to do, even though I wasn’t hunting for it. And I would say this is the best job I’ve ever had. I feel like an evangelist. The mission is perpetual more than it is urgent. I travel around the world and preach the gospel of clarity, due diligence and hopefully greater education for the end investor.

Terrance O’Malley 5:58
Bill. A lot of people who listen to our program have a focus on the operational side of the business. What is your message to them?

Bill Kelly 6:07
I could probably sum it up in two words. And maybe it’s one hyphenated word “due diligence”. I think we’re entering a period in this market where a lot of these asset classes have morphed into industries. And it’s less about allocating to hedge funds or private equity or private debt. And it’s more trying to understand what is the investment process of the underlying manager. And if it’s a collateralized loan, as an example, understanding what’s behind that collateral, where the traps can be where that collateral could be moved – some of these agreements allow for collateral removed. Understanding the DDQ, the due diligence questionnaire what that means, and just overall transparency that no two products are created alike. And having a much more firm understanding behind the underpinnings if you’re in an operational role is critical for the for the end investor, but certainly for your employer for the regulator as well.

Terrance O’Malley 6:57
So in other words, it’s important to allocators and the due diligence process that when they talk to the operational team, the operations team has a good idea of not just for what they’re doing day to day, but how it fits into the bigger picture of the product that the managers offering.

Bill Kelly 7:12
Absolutely. And I think that I think what gets lost sometimes if you’re on the GP manager side, and you’re talking to an LP, who was an aspiring client or an existing client, where you’re looking for a larger allocation. From a portfolio management standpoint, it’s a zero-sum game. So in order for them to either come to you as a new client or to provide a larger allocation, they have to sell something else. And understanding how this all works into the broader ecosystem of portfolio management. We’re not trying to turn operations folks or anybody else into portfolio managers, but having a greater understanding of the moving parts where you can become more of a strategic partner, as part of the management team, as part of your IR team is part of the business development team. And if I’m a client coming in, and I’m sitting across from somebody in operation role – who usually shows up as part of the due diligence of managers – to know that they have an understanding of even the basic premise of portfolio allocation and understand the risk premia across the spectrum is a tremendous skill to have.

And I think most operations people aspire to either move up the rungs of operations or move on to the portfolio management role or some outward facing role as well. And these will be skills you never regret. And again, the skill not being the CAIA credential, although I would love that if that were the case, but greater understanding as to what it means from the investor standpoint.

Terrance O’Malley 8:32
A minute or two ago, you mentioned that you anticipate the alt space to grow. Can you explain that a little bit and maybe break down your idea of alts, it’s a broad category?

Bill Kelly 8:42
So I think there’s various definitions and from CAIA’s standpoint, we really think about institutional quality alternatives. So what you would find in the portfolio of a sovereign wealth fund, a public pension plan and an endowment foundation versus alternatives broadly speaking could include collectibles like wine, art, baseball cards. Life settlements we touch upon a little bit, but that’s more you see that in some of the family offices. So we do touch that a little bit, but not integral part of the portfolio. So for us, it covers things like private equity, private debt, venture, certainly hedge funds, commodities, real estate, farmland, timberland are a big part of it as well. Infrastructure. This is a lot of big growth in some of those non-tradable asset classes.

So, we think about it from the allocators’ standpoint. And if you think about what’s gone on, certainly in the last 10 years post the global financial crisis, you’ve got certainly in the fixed income side, net of inflation, your return is below zero. And that’s certainly true in the US where you get a 10-year Treasury at 150 basis points and 2% inflation, you can do the math, and it’s not a very attractive asset class for a long-term investor. And then in the public markets, by any definition, valuations have stretched. And if you look at the traditional 60/40 type of benchmark, I think most strategist you’ve talked to will say on a nominal basis, five-ish percent per annum and real three. And if you got to return assumption seven and a half, you could do the math there too. It simply doesn’t work. So I think more and more people are turning to alternatives to be maybe that alpha generator above what might be the norms in the public markets. I’m not saying that can’t be gotten. But to think it’s as easy as saying, “Well, I’m going to now allocate 40% to private equity and get 10% compounded return net of fees.” The dispersion of results in the private equity space have measured in thousands of basis points. And if you look at the average return for private equity, it looks no different than the public equity markets. And you put a fee quotient on top of that you’ve underperformed the asset class you’re diversifying away from. So it’s getting back to my earlier point, looking at this through the lens of due diligence and understand the investment process, how it’s going to add value. That all still is out there, but it’s a lot more difficult to find.

Terrance O’Malley 10:55
So some of the people listening to our program are trying to anticipate where they should invest their own personal capital and their own career. And we talked a little bit about growth. Where should they be looking in terms of skill sets? What asset classes if they have the flexibility to sort of transition?

Bill Kelly 11:15
Well, I think if you look at the private markets, I think there’s going to be a lot of interesting things happening there. The pace of the change remains to be seen, but if you look at where capital formation is happening more and more it is in the private markets. And one of the things that they’re thinking about at the Thinking Ahead Institute, which is part of Willis Towers Watson, and your listeners can go and see this is not behind a paywall. But they looked at the amount of capital raised in the private versus the public markets over the last 15 to 20 years. And I think on the one extreme off memory, they looked at Google, and how much Google raised in the private markets before they went public, I believe in 2004. And they had to raise 76 times more capital in the public markets than they did privately. So as an investor in the public markets, and if you owned Google for that period of time, you did quite well.

Then they compare to the other extreme of Uber that just more recently went public. And then Spotify, which is a brand that many young listeners know, they raised zero capital in the public markets because they rinsed out all of the juice and all the opportunity and came public in a much more mature level of the cycle. And the beneficiaries of that were really the private equity GPs and the LPs. But if you think about that, and overlay a backdrop where you’re looking where the retirement industry is going. So many of us probably you and I included despite our illustrious careers, nobody’s promised us a defined benefit asset at the end of our retirement. So we decided 62 or 65, we’re done and somebody’s going to pay us three quarters of our final salary until the day we dropped dead? Good luck with that. So we’re now saying to these individuals, “it’s up to you to save for retirement, and you’ve got to figure it out on your own.” If that is the value proposition which it is, we’ve got to find ways of getting and giving greater access to the private equity market for the retail investor.

And the SEC is looking at the accredited investor rules. Vanguard just announced last week that they’re thinking about getting into this space. And then the last piece in terms of why I think there’s gonna be some interesting things here is this whole concept of token-ization, and I’m not so much talking about a crypto asset. It’s probably more of a fee-based tokenization, where you could, in theory, go up and down the left side of the balance sheet and look at any asset on that balance sheet from a building to an intangible. And you could create a token-based market and turn a very illiquid asset into a liquid one. And if that sounds far-fetched, if you look at owning 100 shares of Tesla, 100 shares of IBM that’s effectively an illiquid security. You can’t go in and find your hundred shares of value in a Tesla factory. We created an infrastructure with specialists and trading platforms to do that. And I think with the concept of blockchain technology, tokenization that might not be too far off as well. So I think people think about where the future is, it’s probably going to be less opportunity for the traditional Portfolio Manager analyst role in the public equity space, but I think we’re going to see some interesting things and opportunities shaking out of the private space as well.

Terrance O’Malley 14:04
What’s going to happen in the public equity space?

Bill Kelly 14:07
I’ve been around not that long. But in the course of my career, the concept of Wilshire 5000 used to reflect 5000 names, and I think it ran up maybe in the 1990s to maybe 7500 names. Today it is 3500. Is that on its way to zero? Probably not. But I think we’ve got to find ways of giving investors access to risk premium in the equity space. And if the public market is just going to become a liquidity mechanism for mature companies, that’s not going to be a winning proposition for any investors. So I don’t know what the shakeout is, as I said, the assets in play publicly are probably 60 to 70 trillion in developed public markets and private equity is probably somewhere around 5 trillion and the amount of private companies dwarfed the number of public ones. So there’s a lot of change and opportunity there, and a lot of things are going to need to shake out and some of its unclear. But if you take a step back and look where the growth is gotta be and the participation’s got to be, we’ve got to find ways of getting greater access to the private markets.

Terrance O’Malley 15:08
Just switching topics a little bit, we’ve seen a constriction on fees in some of the alternative products. What is that going to do to the quality of the middle and back office, the operational side of the business?

Bill Kelly 15:20
Well, I think the fees clearly are under assault. And it’s interesting. You mentioned Vanguard they used to be, they set the low fees for an index provided. Now all of a sudden, they’re getting into private equity space. So they’re less about producing inexpensive beta and trying to give their fund shareholders access to expensive alpha. So I’m not sure how that’s going to shake out. But it’s no doubt that the fees are under stress. We even have ’40 Act mutual funds with zero basis point management fee. And then the concept in our space and alternatives: 2 and 20. It’s a great headline that very few people are paying these days and I think fees are under stress.

And I think organizations are thinking about a few things one, not the least of which is consolidation. But the concept of operational alpha, and how we can use some of these tools that are probably digital based tools and artificial intelligence, machine learning. That this can make back office operations more and more efficient, and less expenses, more bottom-line profit for the asset manager and less expenses, certainly more alpha for the LP. So I guess I think we’re going to see continued consolidation there and continued right-sizing of the operational side of the business. And I think we’re going to see more and more automation.

I saw a product recently that a provider was using automation to find out the highest risk touch points around mutual fund trade settlement. And that’s what you can focus on. And maybe it’s the 80/20 rule. 80% of it just kind of happens automatically and the 20% where the risk is, that’s where you want to put the expense. So I think any listener that is in any position in this industry, to think about automation and the advancement of machine learning and artificial intelligence tools that that these are real. They’re coming. They’re nascent in some parts of the investment process, nascent in some parts of the back office. But I see that as being both a cost savings opportunity, but more importantly for your listeners, an opportunity to upskill and reskill. Because the people that pay attention to this and become lifelong learners are going to future-proof their career in a time that we’re going to see a lot of change.

Terrance O’Malley 17:18
So it’s going to be skill set, it’s going to be understanding risk, it’s going to be judgment that is what is valued in the future of the alt space?

Bill Kelly 17:27
Yeah, and I think of those three you just mentioned, Tery, understanding risk – that is often mispriced – it’s going to be harder to determine it in the future because there is a lot of product out there. And the operational risk side should be paid great attention as well. And I think that certain area, we got to see more focus on it.

Terrance O’Malley 17:45
We had a guest on earlier, Mike Merrigan at Shadmoor Advisors who does ODD, and Mike said that every investment involves some degree of operational risk. It’s just where are you comfortable on the spectrum and he has had people come back and say “wait a second. I don’t want any operational risk.” And he says, “well, there is operational risk anywhere you go.”

Bill Kelly 18:04
I absolutely agree with that. But then you got to look at the risk mitigation. And certainly starting with the risk culture, the organization you’re partnering up with, and that sets the tone. But you’ve got to make sure that those operational risks are known and recognized. To think you can mitigate them to zero is a fallacy, but making sure that you got an organization that’s got that right risk culture

Terrance O’Malley 18:23
Bill, we’ve heard a lot in the marketplace about ESG. What are you seeing there?

Bill Kelly 18:28
It’s a very interesting part of the future and a very important one. And there’s a lot of a lot of avenues you could pursue there. But if you think about one, specifically around climate, the numbers are real. And if you pay attention to just what’s going on in the polar ice cap and the fact that in Boston in the month of January, we could have a 70 degree day and if you look at these heat charts that show the average temperature records being set over some period of time, temperatures are rising and the implications of that on our climate are very, very real. I think it is a very hard problem to solve. A very hard problem to size. And I think from an investor standpoint, I think if you’re an asset manager, you’re always thinking about risks and compensations for those risks and avoiding risks where you feel you’re not being fairly compensated for. And if you’ve got relatively short-term holding periods, and you’re thinking about climate risk that might not rear its head for 2, 3, 5, 15 years, you don’t pay any attention to it. But it’s got to be the incremental things we’re doing today, because the trend is moving against us. And we can’t mitigate the damage that’s already been done. We can just slow it or stop it. And that’s a big part of the challenge. And I think we recently did a survey with KPMG and created research that you can find on our website. And we polled the hedge fund managers and the hedge fund investors about ESG. And it seems like a lot of the burden is being put on the hedge fund investors themselves, where it’s up to them to get [ESG] fixed, get it as a priority. Yet, I think in the same survey, only 15% of the hedge fund managers integrated ESG principles across their product offering. So the cuts of the greenwashing comes into play as well.

Terrance O’Malley 20:04
Is there an inconsistency? On the one hand, you have people pushing ESG principles? On the other hand, there telling managers “I need this return, because that’s why I’m investing with you as an alts manager. So I just want you to get the return. I don’t care how you get it.” Or is there a caveat that says, “I want the return to the extent you can, while still pursuing ESG?”

Bill Kelly 20:26
It’s a very interesting observation and just riddled with complexity at the same time. So if you talk about a public pension plan in the US that might be 70% funded and demographics are moving away from them, they’ve got a return assumption of seven or seven and a half percent, which they haven’t touched in 10 years and may have missed it by 150 basis points per annum, in a risk on trade that has gotten stretched. And then on top of that, you say, well, you gotta invest responsibly as well. When if you had an unvarnished discussion, what they really need is Alfa and they needed immediately. And the end investor – I’ve talked about some of this publicly and if you look at what’s going on in France now the rioting in the streets because Macron is just trying to address just the retirement age by two years from 62 to 64.

And if we said to a pensioner in State fill-in-the-blank that “Well, here’s your paycheck into perpetuity, and I’m going to give you 40 cents on the dollar and here’s a partial ownership of a windmill in Holland and, and here’s a rice farm and XYZ country and then if you round that up, here’s your hundred dollars.” These investors would go ballistic. So they want more responsible investing, but they want 100 cents on the dollar, and they want it as promised, where I just don’t think as individuals were inconvenienced enough. And for us to solve a massive, massive problem – we will talk about a trillion dollars of potentially stranded assets just in the climate space and energy – that we need to feel more inconvenienced and it cannot be not-in-my-backyard approach to life and I think we’re seeing more and more of that.

So I think getting back to your question, Tery, I think it’s we’ve put these allocators in a very, very difficult spot to think that it’s up to them to solve. I think we’ve got to take a step back and collectively and through probably policymakers have something with teeth attached to it to make this a priority, where we all feel inconvenienced, not just the allocate or the pensioner.

Terrance O’Malley 22:21
So it’s a broader issue.

Bill Kelly 22:22
Absolutely, it is. And we all have to have, we all have to have a part of ownership of this. And I just don’t see that deeply enough. And it’s something we’re committed to raising as much noise as possible about it, because it’s real, and it’s serious. But I think a lot of people can’t really see it and touch it, and there thinking somebody else can solve it further down the road. And this can is getting bigger and bigger and harder and harder to kick further down the road.

Terrance O’Malley 22:45
Bill, any thoughts about the future, big picture issues?

Bill Kelly 22:49
So I had an old mentor that would say the future is unknowable. And I think that’s largely true, but I think there’s a lot of growth left in the investment space and particularly alternatives. You’re talking about collective – depending on how you measure the AUM, the assets under management – 12 to 14 trillion and on a denominated, it’s probably over 100 trillion. So I think there’s still a tremendous amount of upside for alternatives. Not for the sake of growth in alternatives, but for the sake of investors to take a step back, and really try to get away from this mindset of traditional on the left side of my brain and alts on the right. We’ve got to think about this is one continuous set of risk premium tools that we can pull from, first and foremost, to have a more diversified portfolio. And also better risk adjusted returns, lower volatility, lower drawdown risk and stay fully invested for the long term.

And I think that that message seems so simple. I think many, many people act like market participants, as opposed to investors, and “acting like an investor” means understanding some of these basic concepts and investing for the long term. And until we get that right, people are going to probably be allocating to alts in many cases for the wrong reasons when they could be very, very powerful tools if deployed correctly. So our message is perpetual, more than it is urgent, but there’s certainly an urgency to it. And we look to get that out there every single day.

Terrance O’Malley 24:08
Where can people learn more about CAIA?

Bill Kelly 24:10
So it’s There’s a wealth of information on that website. We’re more and more trying to lead with interesting content. I write a blog called “What About Beta” that’s under “All about” So you can get some information there on the All About Alpha website.

And then we recently – we didn’t get a chance to touch this, and if you have me back, I’d love to talk more about it – this whole invasion of digital. We have a new credential focused on the analyst who’s now sitting next to the data scientist, and how does that analyst understand the potential over fitting that the data scientist is doing, the lack of ethics-based understanding of our industry that the analyst may have, but the data scientist doesn’t, and the analyst is programming away in Excel in the analysts and the data scientists working with Python. So this credential is meant to provide a solution to upskill and cross-skill an analyst. But there’s some basic programs as part of that. They cover Python and working with some data sets as well, which might be interesting to some people in the operational role. But upskill remaining completely in the educational space is very, very important. I came from a time and maybe you did too where one-and-done was good enough for a credential, a law degree, a CPA and pretty much good to go. It’s not so much credentials, you’ve got to be a lifelong learner if you’re going to survive in any industry, particularly in our space, and I would encourage anybody to continue to pursue more knowledge every single day.

Terrance O’Malley 25:32
Thanks, Bill. Really appreciate having you here today. Best of luck.

Bill Kelly 25:36
Thanks, Tery. Thank you.