“Brent joined the team early in its formation as they brought the management of the assets in house. He was and is a strong leader on the credit team, helping to oversee the absolute return and real asset strategies. He is not afraid to be an independent skeptical voice for investment ideas, both pro and con, and is never afraid to challenge the status quo. He is highly regarded by both peers within the office and the industry.”
—Alex Ambroz, former CIO, Cleveland Clinic Investment Office
The CIO Editorial Team shared a dozen questions with all our NextGen nominees and asked them each to pick six to answer. Their answers informed our decision to include them as a NextGen. Below are the answers from Brent Mattis Jr.
CIO: What asset classes offer the best options for avoiding or mitigating drawdown risk in an institutional portfolio?
Mattis Jr: The first, yet least satisfying, answer is to take less risk: Reduce equity beta and own more fixed income, and an institutional investor reduces the single most significant risk contributor to its portfolio. That said, given the necessity of generating positive real returns and nominal returns expected by stakeholders, running a lower-beta portfolio is not always an option.
In that case, absolute return, especially strategies with structurally low or even negative correlation to equities, is one of the best options for mitigating drawdown risk. Examples include tail-risk funds, long volatility, dynamic convexity, trend-following and systematic global macro. The negative expected returns of systematic put buying and going long VIX futures render them non-starters in many institutional portfolios. The Cleveland Clinic has instead favored systematic global macro with a heavy trend component. Trend-following has the desirable feature of performing well during prolonged bear markets, which are the most damaging to institutional portfolios, as eventually, private markets experience actual losses from bankruptcies and foreclosures.
CIO: How can allocators address the growing global tailwinds of aging populations, geopolitical tensions and changing global trade?
Mattis Jr: I lean heavily on investors and researchers such as Ray Dalio, Peter Zeihan, Niall Ferguson, Byrne Hobart and Eric Peters. I agree with the idea that 2007 marked peak globalization and perhaps even America’s dominant position in the post-Bretton Woods world order. That said, significant changes to the world order or the dollar’s reserve status could take place over centuries, not the three- to 10-year cycles that most allocators of capital have their skill measured.
Given this mismatch, rather than trying to swing their portfolios based on current events, I believe allocators should instead focus on building robust portfolios that perform well enough during four very different regimes: booms, busts, stagflation and hyperinflation. Where I would expand upon Bridgewater’s “all-weather” concept is to layer in uncorrelated alphas, physical assets and, potentially, crypto assets.
CIO: What roles do AI and large language models have in the future of institutional investing?
Mattis Jr: Institutional investors are already using AI and large language models. Beginning with the launch of GPT-4, LLMs now perform at a high-enough level to automate tedious tasks. GPT-4 can be fed transcripts from speech recognition services like Vienna Scribe, and with suitable prompts, GPT-4 will output notes rivaling those of a human analyst. LLMs, especially when given the ability to access information online, make excellent research assistants when preparing memos and presentations. Basic facts and calculations can be handled directly in GPT-4, freeing investors to focus on bigger-picture questions. Finally, for drafting emails, a carefully written prompt usually gives an output that needs only minor tweaks to be perfect.
What I expect to see soon is fine-tuning LLMs based on the Cleveland Clinic Investment Office’s data so that the LLM serves as a doorway to access all our institutional knowledge. LLMs given natural language prompts such as, “How much exposure do we have to the equity of Class B offices in gateway cities?” could quickly answer questions about our portfolio.
CIO: What asset class or investment troubles you most right now, and why?
Mattis Jr: David Swenson’s critical insight was not that allocators should commit as much capital as possible to 10-year lockup drawdown funds. It was instead that investors could earn excess returns by committing capital to niches where capital is scarce. That is a critical distinction. The secular flow of capital from public to private markets is an excellent example of a “good idea taken too far.” While I agree that private equity firms can buy businesses, improve them operationally and then sell them for a profit, private equity also benefited from a 40-year tailwind of falling interest rates and rising EV/EBITDA multiples.
2022 saw a tremendous increase in interest rates and a decline in equity valuations, yet private marks barely budged. Will the catalyst for sharply lower marks be a decline in EBITDA during a recession? Take privates of similar companies at far lower multiples? Restructurings caused by unsustainably high debt levels combined with a SOFR base rate greater than 5%? Whatever the root cause is, I believe that, with perfect hindsight, institutional investors will see that, in aggregate, privates do not meaningfully outperform publics, net of fees, after controlling for leverage and factor exposures.
CIO: What investing decision have you made for your organization that you’re most proud of?
Mattis Jr: During the COVID crisis of March 2020, credit spreads moved sharply wider, causing mark-to-market losses on a structured credit fund in our portfolio. Our team and the PM agreed that credit was attractively priced and wanted the fund to purchase more, but the fund was long-only and subject to redemption pressure from other LPs who needed liquidity. I spent the next several months working with our team and the manager to re-underwrite the portfolio. I advocated for a restructuring that allowed us to perform a redemption in kind, created a fund-of-one with broader investment guidelines, the ability to use a modest amount of leverage and a basket to hold illiquid assets such as CLO equity.
The new structure allowed the manager to run fully invested, purchase assets from other forced sellers by tapping repo financing and hold assets inappropriate for a monthly-liquid fund. The new vehicle has outperformed our expectations and handily beaten its benchmark despite a generally challenging environment for securitized products in 2022. I want to thank Tim Compan, my managing director, for allowing me to spend so much time and energy on a project with many moving pieces.
CIO: Which asset manager (exclusive of their firm) has most influenced your growth as an institutional asset manager?
Mattis Jr: I first spoke with Robert “Jay” Kolyer in 2009. He was in the middle of his 23 years at Howard Hughes Medical Institute. He was one of the first institutional investors I spoke with after graduating from business school. His style of investing: deep due diligence, underwriting esoteric assets, misunderstood niches, contrarianism and willingness to get his hands dirty, always resonated with me. I started my career as a medicinal chemist, which required curiosity and numerous repetitions to develop skills. He showed me, more than anyone else, that my former and current careers surprisingly shared much in common.
After I joined a single-family office in the post-Global Financial Crisis period, we overlapped in legacy subprime residential mortgage-backed securities and bank trust preferred securitizations. These two niches exemplified Jay’s willingness to go down rabbit holes to find credit-like instruments with equity-like returns. Today, we share a few investments in common with HHMI, and I still enjoy chatting with Jay’s former colleagues who share his opportunistic mentality.
