JUSTINE UNDERHILL: Welcome to How I Got My Start in Finance. In this episode, Hedgeye CEO Keith McCullough speaks with Real Vision co-founder and CEO Raoul Pal about using failure to find his calling.
KEITH MCCULLOUGH: So now I have a company called Hedgeye that's 10 years old. When I started as any other analyst on Wall Street, got a job as a hedge fund analyst. Didn't know what I was doing. Sort to figured that out a little bit. I worked with a guy named John Dawson as he was breaking up with a guy named Art Samberg, if-- you probably recall Pequot Capital.
RAOUL PAL: Yeah. Art's been on Real Vision.
KEITH MCCULLOUGH: Yeah, OK, cool. And so we were right there on Pequot Avenue. That's why it's called Pequot in Southport Connecticut. And I cut my chops as a buy side analyst. Then they gave me my own book, probably too early. Back then we didn't have factor exposures or limits--
RAOUL PAL: Which year was this?
KEITH MCCULLOUGH: This was back in-- well, I started as an analyst back in 2000.
RAOUL PAL: Right. OK.
KEITH MCCULLOUGH: I graduated from college in '99. As a Canadian, you're about 35 years old at that point. So then I rolled into your traditional Wall Street investment banking program. Couldn't stand that after a year and went to the buy side. And then eventually became a portfolio manager, had my own fund, and sold it--
RAOUL PAL: And you were running tech-- tech portfolio, or--
KEITH MCCULLOUGH: Consumer. Global consumer. With a big-- and that's how I got into global macro, was I got tired of modeling companies that couldn't tell me what the forward outlook was from a macro perspective. Because that's, of course, what they would always get wrong, so I would get wrong. And I didn't like being wrong. So I started to build a global macro overlay to actually analyzing companies from a bottom up perspective, which was easier with global companies like Nike, for example, or some of the big ones that I started to understand better earlier.
But it all started with just being an analyst. I started as an analyst. And now today, like, as-- I guess I moonlight as a macro strategist. But most of my-- all my macro calls are borne out of that same analytical process. That's 20 years-- we're almost 20 years later. But I've really just applied most of my fundamental learnings as a bottom up analyst to my top down view. And that's certainly not a qualitative one. That's how I quantify it. Like, this whole rate of change process that we've built and whatnot.
RAOUL PAL: So that process of bottoms up and top down was kind of the Tiger Management approach. People like that-- some people have done it really well, because there's a lot of top down information in the granular data, in the bottoms up stuff, if you know what I mean. And a lot of people don't look at it that way.
So is that what you did? You kind of tried to marry the two together?
KEITH MCCULLOUGH: Yeah, I mean, in the beginning, I-- again, you always start with you don't know what you're doing. And you're trying to refine a better path of getting it more accurate, more often. And I just fundamentally couldn't understand why people weren't applying a process, a repeatable process, from a macro perspective to signal, what is the dollar impact going to be-- again, to use an example-- what is the dollar impact going to be on Nike's quarter? What is the global growth rate decelerating going to do to Nike's European business?
So it was just a logical conclusion that you should get to having a rate of change macro processes and overlay to bottom up companies. Then I started working with many more bottom up analysts. I let them do that, because that's a full time job. I mean, there's plenty of hedge funds today that believe that's all you have to do. And it's been a great learning experience starting to see what everybody else does, like being in the other team's dressing room, so to speak. Because now I'm the sell side guy or whatever you want to call me.
And I get to learn what they're doing and try to help them augment their process with mine. And it's been a great voyage in that regard. You learn so much faster when you see what other people are doing and you can back test it, and-- because my goal, of course, is to be right. And I have no problem borrowing other people's best practices. There's plenty of them out there.
RAOUL PAL: Yeah. So one of the things I found that was my epiphany moment was back in the late '90s where I suddenly realized, if you look at the chart of GDP, it goes up and down. It's cyclical and when you look at every single analyst, they assume linear demand, let's call it. In which case they don't ever look at the macro, is how will the global demand situation driven by the business cycle change the performance of Nike or the dollar or interest rates that companies borrow at or anything?
And I had the same epiphany. It's like, really? I mean, this is really 80% of all returns come out of macro.
KEITH MCCULLOUGH: Particularly at the turns, I mean--
RAOUL PAL: Yeah, at the turns, especially.
KEITH MCCULLOUGH: So I like to just think of it as one gigantic sine curve that can have the amplitude and longevity of anything. There's no fixed point.
RAOUL PAL: Correct.
KEITH MCCULLOUGH: But people who are modeling things bottom up don't quite like that. They want it to be linear. So that's the opportunity is really in understanding and having-- I'd like to think that if you have an apolitical and data driven view you can really be data dependent. The answer is staring you right there in the face.
And a lot of people, when they do macro, they do it one of-- well, there are one of many ways now, obviously. There are many different strategies. But the big difference I see is a lot of people say this is what the data should look like or could look like or the outlook could or should look like, whereas we built plenty of mathematical tools that are more modern than anything, you know, you might have seen before in terms of macro hedge fund managers and whatnot.
Predictive tracking algorithms, you can know day to day. It's not a guess anymore. You can now cast what the market is telling you about what is right there. So trade what's in front of you as opposed to what you might ordinarily want to see. And I think that was a great learning. I mean, as opposed to certainly trying to tell the macro market what to do, just listen to it.
RAOUL PAL: A lot of people do try and tell it what to do. It's like, it's not doing the right thing. Well, maybe either you're too early or wrong.
KEITH MCCULLOUGH: Yeah. Yeah, I mean, I've-- I think most of what I do is a function of all my mistakes. I mean, I've tried-- I tried a lot of--
RAOUL PAL: Anybody who says you can't approach this business without humility-- because I always say, every time you think your shit smells of roses, you're going to get your face rubbed in it. And it's true.
KEITH MCCULLOUGH: Yeah. Yeah, absolutely true.
RAOUL PAL: You know, it is all about failing. I mean, people-- anybody who doesn't understand that repeated failure, but losing less than you make in the upside, is the whole investing game. And learning from why you're failing is the icing on the cake. So once you started figuring this out, what made you leave kind of traditional Wall Street and set up your own shop? Talk me through that whole process.
KEITH MCCULLOUGH: Well, first I got fired. And that's the best way to start.
RAOUL PAL: OK, that's a good place.
KEITH MCCULLOUGH: So you start from the real safe place of not being able to go back and do your job.
RAOUL PAL: Yeah.
KEITH MCCULLOUGH: I was at Carlyle. So as I walked through briefly, I mean, I had my own hedge fund probably at too early of an age. I effectively went to Magnetar Capital and rolled that into a big book there and started to learn, well, what are these factor exposures? I mean, Magnetar had this proprietary system that was very early in its days. And I give them a lot of credit for that.
And I had no idea what it was that they were doing until I finally lived inside of that. Carlyle asked me to come basically run long short for them. That imploded within what was the fastest loss of capital certainly that I've ever seen. We completely blew up Carlyle's initial hedge fund. And it wasn't me. Our credit team lost a significant amount of capital in a short period of time. So effectively--
RAOUL PAL: Was that with Ralph Reynolds and Rick Goldsmith?
KEITH MCCULLOUGH: Yeah, that was. Yeah.
RAOUL PAL: Because they were my old bosses from years ago.
KEITH MCCULLOUGH: Oh, they were? Yeah, and so I was with them for a very brief period of time. It's kind of a classic, like you said, you think it smells like roses-- when I got hired by Carlyle, I thought, this is the best job possible. You're a young partner, managing whatever director title at one of the biggest private equity firms on earth that's going to fund their first hedge fund.
RAOUL PAL: It's a no brainer.
KEITH MCCULLOUGH: Yeah. And then six months later, I'm carrying a box with my notebooks. And my son's going to be born the week after that, my first son. So was a pretty jarring experience. The number one reason why I started my own firm is that I had a non-compete. So I couldn't go back. And the second reason is that after a couple of weeks, I was like, I kind of like not working for anybody but myself.
And that's when I started to think through, OK, what is it that I could do that could actually change the world a little bit more than me just having another big P&L?
RAOUL PAL: What year was this?
KEITH MCCULLOUGH: This was in 2000-- late 2007.
RAOUL PAL: Right.
KEITH MCCULLOUGH: Yeah. And I had an explicit market view that was much different than Wall Street's. And that was the beginning of making an early and big bear market call to start. That's effectively what I started the firm with, was a call that people would be paying attention to, not for the sake of making the call. It was the same process I'd use for the first part of my career and what I was seeing at that point in my career. So I saw a big opportunity in being in print, or as I like to say, time stamped with accountability using modern technologies.
And don't forget, a lot of the things that came to be over that period of time were new. I used to call it YouTubing the street, or tweeting, obviously, was shortly thereafter. There were so many ways to communicate why things were happening a certain way, what other people were saying that's not happening. This can't be happening. This should not be happening. All the way down, obviously, to Warren Buffett in October of 2008.
RAOUL PAL: Yeah. One of the reason-- and we'll go into this a little bit later. But one of the reasons we started Real Vision was for exactly these reasons, that somewhere-- there is no such thing as the truth. But some are closer to the reality and somewhere that's non-reality. And we just looked at what was going on in the media business and what was going on on Wall Street and thought, this is not reality. And it's not fair.
You know, people forget, it's people's life savings. And the bullshit that they get fed, so often it's just not fair on people. So I think we were all driven by the same realization that we have to do something about it. I always felt like we had a bit of a moral obligation to do something about changing how the system was.
KEITH MCCULLOUGH: Yeah, I agree with that 100%.
RAOUL PAL: And even the part you walked into was in terms of the research business, the independent research business, yeah, there's a load of great independent researchers. But then there's this behemoth that makes a billion dollars a year-- which I won't mention their name-- out of newsletters built on sensationalism and tossing newsletters and burning them and all of this kind of stuff. And again, not really caring about the individuals.
And I saw what you guys done, and I thought, OK, this is good because someone's actually doing this properly, trying to build a proper business out of it, but using kind of modern techniques of doing it and not just the old way.
KEITH MCCULLOUGH: I mean, and back to your point on like, there are different ways that people express their edge in the market. There are different processes. But God forbid you have your own and you've built it and you refine it and you evolve it and you learn from its mistakes, its failures. It's always evolving and changing. So what I've realized pretty quickly, I'm very comfortable being transparent and accountable to what it is that I'm doing and what I thought something should have done and when it's right and when it's wrong. It was the perfect forum for me.
And not only was it fun, but you could change the world doing that, because a lot of people can learn from you. Don't forget that there are a lot of people-- like Hedgeye, the whole concept was to put an eye or put some transparency-- if you could look inside, like if we could look inside of this conversation, would I want to hear what we're talking about? Of course you would.
RAOUL PAL: And that's why we used Real Vision. That's exactly the same idea.
KEITH MCCULLOUGH: And people want it to be real.
RAOUL PAL: That's right.
KEITH MCCULLOUGH: If I could look inside of a world class hedge fund-- not in terms of its reputation, in terms of its process. Because I still think that there's a huge opportunity there. And looking at hedge fund returns, I'm more convinced today than ever before that that is the case. A lot of people have made a lot of excuses over the years of why they can't make money. And I've not had-- God willing I'm not going to have that problem at the point where I think it's a structural one.
If I'm wrong, I'm going to be wrong. But what the real opportunity is in showing people, look, here's our process. You tell me why this is wrong. I'll tell you why I'm doing this. I want to vet it at the highest level. 100% of our revenues in the beginning were with who I think are some of the most sophisticated hedge fund managers that had good numbers, that were willing and really having an open mind to listen to what it is that I was thinking and why. And then bringing it to the masses. Because if I can validate it with plenty of names that you've had conversations with out in the open, then I could surely do better than somebody like Jim Cramer.
I mean, this is almost like an insult, when you think about-- the bar is so low in a mass market relative to the institutional market. But both are very wide open nets in terms of the educational opportunity. I think that that's a big part of-- when I think of Hedgeye and its media presence, I think that that's the most important thing, how to try to educate both our audience and then get the feedback, where I get educated where I'm wrong.
If you tell me where I'm wrong and I validate that as a good reason, it's not my job to stay wrong. And that's a great thing to have that feedback, both from the mass market audience, rich people, people that want to be rich, people that do well on their own, or institutional money managers, which there are many of them.
JUSTINE UNDERHILL: So Keith McCullough is proof that true success grows out of learning from failures and applying those lessons to your process. For Real Vision, I'm Justine Underhill.