The following document is an approximate, but not exact, transcript of the Operational Leaders podcast conversation between host Terrance J. O’Malley and guest Michael C. Neus.
Please support the production of this podcast by downloading the Michael C. Neus episode.
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
Our next guest has over 25 years of experience in the alternative fund business and has worked at some of the leading firms in the history of the industry. He’s a top practitioner, scholar, and thought leader. And he is the co-author/editor of the “Insider’s Guide to Hedge Funds,” described by some as one of the best books ever written about the operational side of the business. Please welcome Michael C. Neus.
Mike Neus 0:45
Hello, good to talk to you.
Terrance O’Malley 0:47
Hey, Mike, thanks for joining us today. It’s been a little bit since we had a chance to talk, so it’s always great to catch up. Can you tell us a little bit about how you got started in the business? Take us all the way back.
Mike Neus 0:58
I started way back as an outside lawyer doing fund work, and I did that both in New York, and then in Singapore. So after being in Singapore for about four and a half years with a U.S. international law firm, one of the firm’s clients, Soros Fund Management, was setting up a private equity fund. And they called and said, “Would you be interested in moving back to New York and working on our private equity in real estate?” And the rest is history.
Terrance O’Malley 1:28
So you walked back to New York and somebody handed you a pile of documents, and it said, “Make an offering document out of this?”
Mike Neus 1:34
They did. They gave me an offering document. I remember we were setting up a fund. This was April of 1994. And I came over with the contents of what was on my desk. And I remember that the first new purchase I had to make was a calculator because I only had an eight-decimal calculator. And the new private equity fund was $1.5 billion in subscriptions, and my calculator kept going into error mode. So that was when I realized I was no longer an outside lawyer.
Terrance O’Malley 2:05
So, Mike, you’ve been a lot of things in this business. In addition to General Counsel, you’ve been a chief operating officer, you’ve probably held chief compliance officer and several other titles. When you look back over your career, what are some of the key moments so far?
Mike Neus 2:19
You’re right. I have been CCO, COO, as well as general counsel. I think the one constant is the law, though. I’ve always been interested and always wanted to be the general counsel. I find that sort of the nerdy part of my career is that I’ve always been interested in the intersection between law and regulation and the pragmatic way in which businesses operate within that construct. And regardless of whether it’s compliance or operations, understanding the policy behind the law, what it’s designed to do, and then figure it out. How to do best for your investors. There’s one thing that’s actually excited me throughout my career.
Terrance O’Malley 3:06
So Mike, you’ve also co-authored and co-edited a book, The Insiders’ Guide to Hedge Funds. Can you give us a little background about the book and maybe some of the lessons that you learned from that?
Mike Neus 3:17
Absolutely. And in full disclosure, I had a brilliant co-author, co-writer. And for those of you who don’t know, this was Terry’s brainchild. When I was leaving Perry Capital after 12 years, he called me and said, “I got a strange proposition for you. Are you interested, or would you be interested, in working on a book on the hedge fund industry?” And at that point, I honestly didn’t know whether I would stay in the industry or move on. And the way you pitched it to me was, “Look, this is an opportunity to take whatever you’ve learned in your 20 odd years of experience, and put it into a way that other people can understand, can see, can track through what happens in the industry.” And it was really exciting.
Mike Neus 4:06
So we pretty much followed your playbook and that is to find people in the industry who are well regarded and well known, who have done the job at least once, if not twice, or three times at different leading hedge funds. Ask them to tell how they do their job. And then you and I tried to go through and standardize things and make sure that it worked as a cohesive whole. And to be honest, it was one of the highlights of my career – actually working on that book.
Terrance O’Malley 4:36
And to be clear, Mike, when it came to the heavy lifting of the recruiting people to help join, that was almost all in your court. I certainly am grateful for the opportunity to have met so many people in the process of writing that book through your contacts.
Terrance O’Malley 4:49
Mike, were there certain things that stood out for you that surprised you? You had been in the business at that point for a good 20 to 25 years. And when you’re writing that, did you say, “You know, I never . . . that’s a new one that I never thought about?”
Mike Neus 5:01
Yeah, there were a number of things like that. I would say that one thing that stood out more than anything else is the rise of outsourcing. When I first started in the business, it was considered a huge red flag if you didn’t create your own duplicate books and records, for example, from administrators, or having your own independent IT and other facilities. And I think that that’s – in looking at the book – what I realize is how much that had changed. The idea of having a requirement to have shadow accounting is something that I grew up with. Every firm I’d had, had done shadow accounting, meaning that the management company would keep a duplicate set of all trading records that the outsource administrator did. And that’s something that actually changed over time to the point where I don’t think that’s necessarily standard anymore.
Terrance O’Malley 6:02
And when you go back through the book, is there an audience that you think or you say, “Wow, if there’s one set of people I really wish would read this?” Who might that be?
Mike Neus 6:09
Terrance O’Malley 6:11
And why do you say that?
Mike Neus 6:12
Well, I think that there’s a lot of books about the investment process, but not so much about how the business itself is run. And, you know, it’s often said that a poor back office won’t get you a mandate, but it will certainly lose you one. And I think that the purpose of the book is to glean best practices across the entire industry, across time, and across firms in a way that we tried to distill down so people can actually look at the operations (and by operations. I don’t mean trade operations, but more broadly full back in middle office), but in a way to really understand what are the commonalities across successful businesses. And I think investors, particularly those doing due diligence, could really benefit from that.
Mike Neus 7:05
I also teach a class, a class at Fordham Law School, in investment management and regulation. And so I assigned [the book to] the students who are both law students and masters in compliance. And what I find is that the compliance students benefit from understanding the legal underpinnings of what the rules are and where they come from. But the lawyers actually benefit from the practical implications of how rules are interpreted. And we assign the book and use that as a way of illustrating the practical implication.
Terrance O’Malley 7:41
So Mike, taking you back to the first part of your answer there. Do you find that investors take into account the quality of the operational side of the business? Or do they just assume more or less that it will get run properly? I mean, if we say that some managers are better than others, and are rewarded for that, is there a similar emphasis on the operational side of the business, or is it just too hard to generalize about investors and also about the operational side of the business?
Mike Neus 8:08
The industry is very, very diverse. So I literally have worked in a hedge fund complex where there was one portfolio manager and one analyst who managed well over a billion dollars in capital. And that was all on the investment side. On the other side of it, you can have quant trading funds that trade hundreds of thousands of shares a day or a week. And the operations that are required to settle 30 trades a week or to settle a million trades a week is so dramatically different that I don’t think there’s any way that from an outside you can say what is best practice for the broad operations. You have to understand the investment strategy, and then compare the infrastructure to the strategy to make sure that it’s well designed in that context. And that’s actually the exciting part.
Mike Neus 9:04
You know, people who do operational due diligence for a living, really understand that. And I find that when I do ODD – operational due diligence – meetings with sophisticated investors, I always learned something because they see more people in my shoes than I do. And to get that kind of feedback, what we’re doing versus what our closer peers might be doing with respect to certain areas, I actually think is really useful.
Terrance O’Malley 9:31
Let me ask a related question. What is the one thing you would like investors to understand about the operational side of the business?
Mike Neus 9:39
I think the important thing is to understand in practice how things work to make sure that there’s a separation of powers, that there’s a check and balance system, and that whether it’s highly complex, thousands of people firm or a 10 person firm, that there is a sense that the investor comes first. What I’ve always thought is, if I’m making a decision, a difficult legal or compliance decision, and sometimes there’s not a right answer, it’s the least wrong answer. And what I find is, if I put the investor first, what’s best for the investor, then what’s best for the firm, and then what’s best for the legal or compliance group or the operations group or whichever constituent is raising the issue. If your hierarchy is the investor comes first and then the firm and then the self-interest, you almost always are going to get it right and make fewer mistakes. And trying to understand when you’re coming into a firm, how that takes place in practice, and how people actually make decisions, I think is the critical aspect to it.
Mike Neus 10:52
It’s one thing that you had ask me years ago, that I wrote the foreword or the introduction to our book. And that is probably the single best interview question I ever got – was Dan Benton, who was the founder of Andor Capital Management. In my initial interview, he asked me, “Mike, how do you make decisions?” “So apropos of nothing, in the broad sense, how do you make decisions?” And nobody ever asked me anything like that. And I thought about it for a minute. And I basically said the Wall Street Journal test, which is, if my decisions were played out in the front page of The Wall Street Journal would I be happy for my mother to read the article. But then I refined it over time to really think through in terms of a hierarchy of needs, not just how it looks later, but how would it look to different constituents.
Terrance O’Malley 11:42
It’s a little bit of a cliché, but tone at the top really matters
Mike Neus 11:46
Terrance O’Malley 11:48
So Mike, a couple of other areas to talk about. What are your thoughts or what advice would you give to somebody who is looking to start their own fund? One of the great attractions to this business is that it does afford the opportunity for people to put their name on the door. So if somebody wants to be a new manager, what advice would you give them?
Mike Neus 12:06
I think in the earlier days of the industry, what happened is that you would have a founder, who was the product. (He was almost always was a “he” in the early days, unfortunately.) But he would set up the fund, he would be the one that was managing the assets, then he would own the company, and he would supervise or manage everybody in the firm. And I think when you are at that stage, and you have to manage people, manage the process and raise the money, it’s at least one job too many. And I think that the critical aspect is if you start and don’t have a middle and back office that you can rely on, and the founder has got to spend tremendous amount of time doing that, it necessarily is going to eat into investment returns. And if you don’t have the investment returns, then you can’t grow the business. So putting that all together, I think it’s critical for founders to actually understand their limitations and concentrate on what they do best, what is their core competence, and be able to off-load those obligations to somebody else who’s better suited to do it, so that the founder can actually concentrate on that which will most likely lead to the business being a longer term success.
Terrance O’Malley 13:38
So if I flip that upside down, is there another piece of advice you would say, “This is something you want to avoid out of the gate?”
Mike Neus 13:45
I think that very often, it used to be that a founder would choose somebody they were very comfortable with on a personal loyalty basis. Sometimes a spouse, a sibling, a college roommate, a close friend to start the business with. And then at some point, sometimes those people may not have the core competence to be able to take business to the next level, and then it creates personal anxiety and strife in that relationship. And so one thing I would suggest, is to make sure that when a founder is looking for somebody who’s going to take on the administrative, non-investment side of the business, they go for not just personal loyalty, but also extreme competence. And I think you need both.
Terrance O’Malley 14:36
Mike, switching gears a little bit. You’ve hired a lot of vendors over the years, you’ve worked with a lot of vendors. Always interested to hear your thoughts on what makes a good vendor. What makes you interested in a sales pitch, what makes somebody a good long-term vendor that you want to maintain a relationship with?
Mike Neus 14:53
I think that you have to match the project with the vendor’s capabilities. So for example, if you are doing an HR payroll system, the industry leader may not be the best if you are a 10-person firm. Conversely, if you expect to grow dramatically, then somebody who can give you lots of personal attention may not be able to scale with the business. So I think that, on a broader vendor basis, I tend to try to match the expertise with the scale of the business. Whereas when I’m hiring law firms and lawyers, I try to hire the lawyer and not the law firm. So what I’ve always tried to do is find the expert in any specific area or fields. And so I’ll use dozens of law firms rather than a single firm as a gatekeeper for everything. But that’s because I can do it. If I were starting out, I’d need somebody else to be a gatekeeper and just to coordinate that. So it depends on your level of sophistication and what you can do.
Terrance O’Malley 16:03
On a similar topic. You’ve hired a lot of people over the years. What do you look for in a potential employee? And what have you seen that makes a potential employee successful?
Mike Neus 16:12
That actually has changed a bit over time. One of the things that I look for, and it’s probably counterintuitive, but I look to see if it’s the right job for the candidate. So I can have somebody who’s excellent at the job they’re doing, and I work at a good company that they want to work for. And in fact, they’re perfect for me because they can immediately slot in and take on the role. But they’re doing the same role that they’re trying to get out of. And a year from now, I would expect that they would be chomping at the bit to take on something else.
Mike Neus 16:49
Conversely, somebody who’s looking to take the next step in their career to go from a deputy to a department head or something like that, if they’ve got sufficient experience and got sufficient training, and they take that position, you may have them for much longer time. So I think that finding the right expertise is important. But finding the softer skills, somebody who works hard, wants to be there, is grateful for the job, and is likely to be there for a long enough time to continue to grow and to learn. I think, in the long run, that person probably provides you a better level of the time commitment to really train somebody if you know that they’re going to be around for the long haul.
Terrance O’Malley 17:38
Earlier in our conversation, we talked about outsourcing, and there’s a technology component as well. So some of the jobs and the roles in the business have changed a little bit. Where do you think the future opportunities are in the middle and back office?
Mike Neus 17:53
I think technology is always the critical aspect, whether it’s a smaller firm that is using technology to outsource or whether it’s a tech-focus firm that technology really is the core element. I remember years ago, an analyst working on an investment in FedEx. And FedEx at the time, somebody in Investor Relations, said that Federal Express was a technology company, rather than a transportation company because so much of what drove its success was technology tracking, putting things together. And that always stuck with me, because I think technology is the backbone in so many industries. So having an adept technologist, I think is critical. The other thing I’ve heard, that I always think is interesting, is anybody over the age of 40 should have a mentor who’s under the age of 30. And if you think about it in those terms and being over 50, just the way social media has changed, the way I need my high school child to configure things that they can do in their sleep. That level of being adept at technology, I think is absolutely critical going forward.
Terrance O’Malley 19:16
Mike, can we switch gears a little bit? Talk about something you’ve talked about in the past. You’ve had the general counsel role and you’ve talked about organizational structures, organizational charts. What would be the optimal line of reporting for the general counsel, or in the absence of a general counsel, the chief compliance officer?
Mike Neus 19:34
I generally think that the general counsel should report to the CEO. I remember my first general counsel position, my predecessor had said, “The general counsel should report to the CEO because you want an independent judiciary. You want the ability to get unvarnished advice from your lawyer.” If the GC does not report to the CEO and they report to a COO or a CAO, there should at least be a direct line into the board of directors or CEO. You know, in the registered investment company space, the CCO has to meet with the board of directors of a fund independently. And that model is an interesting and useful model if you’re always looking at the investor first and fiduciary duty. I think that that’s critical that the GC and CCO have a direct line in to the top management of the firm.
Terrance O’Malley 20:28
So Mike, as we come to the end of our discussion today, looking forward, what are some of the things you see for the future this industry?
Mike Neus 20:36
One thing, as we’re seeing here, now, it’s been three months into a highly unexpected work from home. And I think that historically, I’ve been a firm believer, and I still believe that you need to be together for collaboration. And the one thing that may prove my dinosaur status is just how surprised I’ve been In the ability to be effective with the various tools that we have now for long distance collaboration. And I think that’s something that’s not going to go away. I think that the business generally has been formed by a counter-class who have not wanted to stay at big banks or broker dealers and wanted to go out on their own. And I think that that’s going to continue. So I suspect that will be a long-lasting reminder of the COVID pandemic of 2020 is how decentralized offices and firms will be.
Mike Neus 21:34
The flip side of that is, it’s much more difficult to exercise the level of control, check and balance, really understanding where things are. And so I think you’re going to see a lot more due diligence, really trying to figure out how in practice people can create that check and balance system in terms of audit, in terms of consultants, in terms of reports. So that I think will come out. For example, in ODD. There are a lot of things that you’ll show people in the office that you don’t want potentially leaking out that go to competitors, for example. If your investors are not coming into your office, how do you give them the same level of comfort without providing things? So I think that that whole concept of remote working, not just remote working for the employees of a firm, but remote working where you’re not necessarily going to conferences, hosting investors, meeting face to face in negotiations, I think that is too early to tell whether that is long lasting after a vaccine and herd immunity has been developed or whether that is something that will last for an extended period of time.
Mike Neus 22:53
Secondly, I would say technology, artificial intelligence is certainly up and coming and you keep hearing that. But whether that’s on the investment side with alt data, but also on the compliance side with surveillance and ways in which the compliance and legal side can harness artificial intelligence, I think it’s going to be really interesting. And thirdly is one of the recurring themes we’ve had in this talk is really outsourcing and how outsourcing of different modalities and areas within a firm butts up against fiduciary duty and the responsibility. And I think that’s something that is still being worked out. So those are sort of my big picture ideas for right now.
Terrance O’Malley 23:36
Well, Mike, it was great to have you here today. I appreciate you coming by. It was great to talk to you. I always enjoy our conversations. So thank you very much.
Mike Neus 23:44
Excellent. And I urge all of your listeners to go out and buy your book that I helped with.
Terrance O’Malley 23:50
Well, thank you very much. And we should note that our talented chapter contributors along with you and me, we have all agreed to donate the royalties from the book to Robin Hood, New York City’s largest poverty fighting organization.
Mike Neus 24:02
Which now more than ever is in dire need of assistance.
Terrance O’Malley 24:05
Well said. And thanks again – scholar, top practitioner, thought leader – Mike Neus.