Family Business Audiocast | Episode 7 | John Bailey | Lumenai Investments LLC
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About Our Guest:
John Bailey is the founder and CEO of Lumenai Investments LLC, a firm that leverages data science and artificial intelligence to create personalized and adaptive investment portfolios. Lumenai primarily serves family offices, advisors, and institutions, offering tools for constructing customized alpha investment portfolios efficiently and transparently. Lumenai's innovative approach aims to simplify portfolio management, saving clients valuable time. Recently, the firm earned recognition by being listed in the AI FinTech hundred and the WealthTech hundred, highlighting its position as a leader in using AI to tackle investment challenges.
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[Transcript]
R. Adam Smith:
Hi all, I am R. Adam Smith. The creator of this Audiocast series. I've been an entrepreneur, investment banker and board leader for about 25 years. Today we have 25 registrants for the event. Thank you all for joining. Family Business is a passion of mine, having grown up in family entrepreneurs and engaged in a wide range of dialogue in business with fascinating family enterprises around the globe for decades. I founded the family business audiocast provide a valuable platform for listeners to hear from veterans, academics and leaders and family-owned businesses, enterprises, and family offices. Whether you're a seasoned family business leader or building a family office, these conversations are sure to be enlightening. Today we have a special episode focusing on the wealth management side of the family office and the family business with particular emphasis on utilization and power, artificial intelligence with one of leading advisors family offices. Family Business is a subject close to my heart decide to dive into these topics with our guest. Today we welcome John Bailey, founder of Lumenai. It's great to have you here, my friend.
John Bailey:
Thank you for today. Thank you for having me. I appreciate it and I look forward to our conversation.
R. Adam Smith:
I'm going to brag about you for a bit and then we'll dive in.
John Bailey:
Feel free.
R. Adam Smith:
John is the founder managed partner of Lumenai Investments, and this business is at the forefront of revolutionizing hyper custom investing through data science and artificial intelligence. Lumenai caters to family offices and advisors and institutions, provides them with tools to construct highly tailored alpha investment portfolios transparently and efficiently. And typically, at lower overall cost from classic long-term portfolios to also complex hedge fund strategies. Lumenai aims to simplify portfolio management using data science and AI saving its clients valuable time. Lumenai was just recently named to the AI FinTech hundred and the WealthTech hundred list. Acknowledging the firm is one of the top global firms employing AI and technology to overcome investment challenges. I've known John for a long time before he was a founder of an outsourced investment office called Spruce and there emerge as an early pioneer and offered investments across the whole spectrum, and also was the CEO of investing for a private office prior to that. It's been around the community for a long time. So John, dive us in. thanks for joining us today.
John Bailey:
Thank you, Adam. I appreciate it.
R. Adam Smith:
So, we'll have about a half hour here. Let's start with your background a bit and what brought you to launch Lumenai and then we'll talk a bit about the different types of family offices as your client base.
John Bailey:
Sure. As you alluded to, I started Spruce back in 2000 and we spent a lot of time traveling around the world searching for and visiting the best hedge funds and private equity real estates managers that we find and we would do asset allocation and for public markets we would invest in low-cost ETFs, so passive investing. So it's kind of the passive plus they all together and that was a great process. Overall, we were very successful over the long run, but we noticed things were changing. What we noticed was a lot of the fundamental players really started to struggle much more, especially after 2008. When financial markets, government interventions we're changing the rules. But we noticed some of the best players that just continued to really succeed were quantitative managers. If you think of the hedge fund world, many of the largest and most successful hedge funds are quantitative. So, two Sigma, Renaissance technologies and firms like that. And so, we morphed from asset allocation manager selection process to adopting data science and AI, especially as computerized trading and cloud technology and AI technology have gotten better and better. So now we've morphed over into what we think is actually a much better, easier, simpler, more efficient, more scalable process to invest.
R. Adam Smith:
That's great. Now where are you guys today? I love the name about Lumenai, so tell us about the brand and your overall foundation.
John Bailey:
So, when you say where are we today, forgive me?
R. Adam Smith:
So are you based still in Connecticut or are you virtual in Stanford, Connecticut and the brand name and the mission. Tell us a bit about that before we dig into the market structure.
John Bailey:
Sure, yeah. Lumenai, it's a combination of lumen, the Latin word for light and AI and it really means lighting the way or showing the way using AI data science. And that's really our service and that's what we have a service fund, we're service for investors and use data science and AI build portfolios that people want like maximize or optimize that particular strategy. Great. So, it's a hybrid structure. We'll talk more about that later.
R. Adam Smith:
Alright, so back to the market. So, we know that with our friends and experts at Camden, our Richard Williams for Run Diamond, we know that the family office ecosystem has been exploding initially, quietly and now less quietly to hold 10,000 family offices across the asset management and quite mainstream, but still quite a mercurial animal at the same time.
So just for our listeners today, maybe walk us through the different types of family offices between the multifamily office, the single-family office, the hybrid, and then we'll move on to a bit of the wealth management side.
John Bailey:
Sure. There are many definitions. So, these are just some basic ones, family offices have really become very popular, very mainstream. It's both single family offices and multifamily offices, but we kind of think of the different types of family offices as follows, multi office or families source wealth management to a dedicated team and get economies of scale probably better for families below 200 million, pick your number, whatever it is, but let's say 200 million. There's this family office, dedicated office, but even there are different types. Many are administrative including philanthropy; others are investing-centric still. Others really operate around a family business or real estate. And then there's a comprehensive single-family office that really delivers all of the services to the family. An explosion in the virtual family office, and family office flight, which is really good for geographically diverse families or families that would use technology and third party services to deliver services to their family. And of course, there's a hybrid, which is a common in-house out outsource.
R. Adam Smith:
Now virtual, if we go back to my CFO, I think it sold to Harris Bank, but there was an additional phase of virtual outsourced family office platforms. What was that industry like let's say 10 years ago? Where does that stand out?
John Bailey:
I think the technology is just so much better and I think there are so many between cloud technologies and other services offered in things like a very common example for families for example is outsourcing, for example, for performance reporting. And with cloud technology and these kinds of services, I think it makes the virtual family a very effective option for families. I think it's the most cost-effective option or one of the most cost effective.
R. Adam Smith:
Okay. So, in terms of wealth creation, everybody likes, well there are different ways to accomplish it in terms of i liquid, and of course there's the risk profile and creating alpha in the wealth for the owners externally. So, walk us through your views of the broader allocation spectrum and in general, your views on the different asset classes and how you approach that moving into what does that mean for you in terms of using AI and how you decide to shift, pivot into being more of an early mover if you'll into AI for wellbeing.
John Bailey:
Yes. Well I think one of the reasons why we pivoted there, efficiency, scalability and so forth. We've witnessed personally attractive results is many families are still kind of an analog adopting or using analog kind of 1990s processes, doing things manually, spreadsheets, is what I used to do, the old-fashioned go, fly out and meet a manager and do your onsite due diligence and so forth. Those are good and effective and so forth. But what we're finding is adopting data science and artificial intelligence really enables families to be and advisor to much more efficient and control and what they want to create. So, if you look at the asset allocation spectrum, if you're trying to create high risk adjusted wealth creation, well there's things, of course there's stocks and bonds, but many families focus on hedge funds, private equity, private credit, private real estate, we really like private real estate. We also like private equity, although it can be very expensive and highly illiquid. We're a bit on private credit if you're a taxable investor, tax efficient and is also illiquid. And frankly from a person who a lot of investing, we've changed to the point where we don't really think need funds at all. The fees are too high, the tax efficiency too low, there's lockups gate side pockets, lack of transparency and plus there's the risk of a blow.
R. Adam Smith:
Not just as an asset class though, but also based on the dramatic expansion of the big institutional players and technology arbitrating.
John Bailey:
I think we used to, when we first started investing in hedge funds, we have very high output from it. We had a lot of access returns, very good high risk adjusted returns. We were super happy, very pleased. But over time we noticed a degradation and it just became more and more difficult over time. But at this point with data science and AI, you can actually create your own hedge fund strategy and you can completely customize, and you can have daily liquidity, hundred percent transparency at your custodian. You don't worry about made off; you control how much leverage. So we just think it's much easier, better, more efficient. So that's why we say you don't really need hedge funds. If you need a long or shorter market neutral exposure, you can create it yourself.
R. Adam Smith:
Now we talked a bit about also overlays for ESG currency, tax loss harvesting. Maybe talk through a bit of the more complex elements of the portfolio construction and then how did that lead you to create an AI platform to drive alphas?
John Bailey:
Sure. So, if you think of the base asset classes, stocks, loans, credit, commodities, cash, you do long short market neutral. You can add to your point, additional either overlays or services onto that. So, harvesting for example, I know that's a very common service or portfolio of aspects, but one of the things we really like is that somebody creates a long short portfolio. So it's custom, they design it, we design it together with them, but once you create it, tax service on a long short portfolio, fantastic, especially on the short side. So that's a wonderful overlay to add for a taxable investor. But you can also add things like options, options for creating income, for protecting downside, and then you can also do things like currency. So, with rising interest rates in different interest rate policies around the world, currencies are back and they're highly diversifying and complimentary and they're very balance sheet efficient.
So, you don't really need a lot of capital to add some currency exposure on it. And you can really have these building blocks, that's really what you feel comfortable. Maybe you want something super simple, that's fine. But you can also create a pretty sophisticated portfolio as well.
R. Adam Smith:
So you have really a concierge type of approach where you can customize the structure for the clients. Obviously, you've got some focus on the risk, also efficiency for the tax structure, and then there's the active management and driving towards alpha. So, what is your view on buying hold traditional strategy of the 60/40 and where is that? Where's it going to be going the next decade?
John Bailey:
Yeah, I mean it's always dangerous to forecast the future because nobody really knows. However, it would seem that the coming decade is going to be a little harder to generate the returns that people want. And I think buy and hold passive ETFs, things of that nature are fantastic old markets approaches and investments. But if we are going to be facing coming decade, possibly longer where it's going to be more difficult to generate returns, those are probably going to be disappointing. Those approaches will probably disappoint investors.
So our view is AI can help enhance this congested returns three different ways and I think this will be very important for the next decade. The first is through active management. So, we're an active firm, we're there to increase return, to reduce risk and through active management, whether it's through allocation or through security selection, you can add value and we would measure that through how much alpha is created or access return. So active management is one way to enhance risk adjusted returns over the coming decade. The other is active risk management in particular managing larger. So, if you're passive, you go up and down the market, market goes down, you're going to be some percentage of that downside. Well, that's not what we want to do. We want to be much more proactive in managing the downside. So, we'll be active and we'll reallocate the portfolio. So, reducing the larger drawdowns is a second way. And the third way is just creating portfolios that are very efficient from a risk versus return perspective or think of it as the consistency of the portfolio and let that compounding occur over the long. So if you can have a very efficient risk, return efficient portfolio, you can reduce larger drawdowns and through active management if you can create alpha rest return. You would say over the long term, that can add significantly to wealth creation.
R. Adam Smith:
There's still a hybrid model. I mean you've got your systems and I imagine that you've got a big barn and super computers in the back of the office, but then you as the CEO and the staff are still hands on as a hybrid model. So, it's really machine which kind of fascinating , like chatGPT is very useful but they have to use it manually. And our approach and our outline, walk us through that hybrid reality of the human judgment is still essential to be involved with machine.
John Bailey:
That's our view. Our viewpoint is man and machine are better together. I think most families and advisors are, they're on their own. So, it's kind of human team making all the decisions and the allocations and selecting the investments and so forth managers, but we believe that men and machine are better together as a combination. If you look at the people, what are people good at? Well people are really good at figuring out what are the goals and what kind of strategies do we want putting into context someone's goals and concerns and risk and becoming an architect. If you of building a, humans are the architect, but the machines are the con. And so once the architects design the portfolio, let say the people design what they want, we think it's much better to let the machine kind of figure out best way to do that because machines are better at crunching massive amounts of data, identifying market drivers and patterns, taking that to build efficient portfolios, manage risk, select securities, rebalance, and then monitoring every day 80,000 price points every day. Utilizing the best of man machine together.
R. Adam Smith:
Do you know how much data throughput and calculations are being done on your side every day?
John Bailey:
They're looking at pattern recognition across about 80,000 data points a day.
R. Adam Smith:
Amazing.
John Bailey:
And they're trying to identify what are the most important drivers and then once they figure out those drivers, they say, okay, what are the characteristics of the securities that can do the best over the next three to six months? And then they rank all the securities that we're looking at according to those characteristics and that's how we build a portfolio.
R. Adam Smith:
Let's talk a bit more about the benefits of AI and then we can finalize. Let's talk a bit about from a FinTech perspective and companies, what's going on in the market with the big players?
John Bailey:
Sure. There's actually a lot of benefits. I think there's so many benefits. It's really hard for a professional investor to not adopt or at least explore some measure of incorporate AI into their investment process. The first thing, so we talked about metal machine better together, AI offers a tremendous ability to personalize and customize your investments and it really offers the ability to very tightly control what you're building and the risks that you're taking, securities you're investing in. I think that's a tremendous plus. It's very efficient, automated, highly scalable self-learning, self-adapting process. Once it's built, the efficiency is quite significant. It's so significant in our experience, it'll save investors and professionals a significant amount of time. We're working with one chief investment officer of a very large family office, and we estimated that we would save approximately half of the CIO's work in terms of hours. He was doing everything himself manually and we built and improve his process and automated it for him. We'll save him about half his work.
R. Adam Smith:
You continue to build out the, or your firm as a boutique advisor, you continue to build out the AI backend and coding and algorithms and capacity, or are there increasing the common of scale as you build the AI that you don't need to continue to tweak it and fix it and enhance it because it might grow, you might reach the diminishing returns of change or it might learn itself in general in your coding? How does that work?
John Bailey:
I think those are extremely important points. There are two things. The first thing is I really took this from my experience in traveling the world and meeting with many of the best hedge funds on the planet and I learned the importance of really investing with us. There's a tremendous difference between the top A players and the next few. And so, when I was creating Lumenai and I know we wanted to use data science and AI to create this efficient investment service, I had a very healthy respect for the difficult involved and the importance of track record. As we're building up the AI, we partnered with a team that's been around for 35 years in our opinion are one of the top quantitative and AI investing firms in the world.
And so, they've got 60 plus staff, mostly data scientists, PhDs, AI specialists and so forth. They're researching a very nice long-term track record. They've been through many market events, and we were building this. We did not want it far too risky to try to build something from scratch because the risk of failure is actually extremely high and we could reduce that risk tremendously, but just partnering with or utilizing group that's been proven through many crisis events over many decades. But to your point, innovation has to be continuous. So things do decay and there just has to be a continuous process of improvement and building out new techniques and technology. So that's a process that really should never end.
R. Adam Smith:
Okay. We've got five minutes left. So, let's talk about the market and who, for the listeners that may look at the market from a wealth managed investment management standpoint and AI really floating, it's a very amorphic market and very confusing or behind the scenes. So, I guess big picture, which of the big firms are using AI in interesting ways or who do you admire out there that are applying it in an effective professional fashion or who do you admire in your business?
John Bailey:
Yeah, I mean, well I think that the use of AI is in financial services is exploding. I've seen data from ENY and KPMG and Accenture and so forth, even CFA institute, where 75% of major firms have identified incorporating AI into their processes as one of their top priorities. And that's over the next three years. And so, it's banks, insurance companies, brokerage firms, they're moving very quickly to implement AI. However, overwhelmingly they're doing it in operations lending and compliance function, but there could be a massive upgrade of AI in those areas within the next one to three years. What you're not seeing a lot of is AI investing in the investment area. The reason is because the investment area is much more complex than operational. Global financial markets are so complicated, and things are changing so rapidly it's very difficult to create value through the investment process using AI.
There are actually very few players in the world that we see that are adept at utilizing it and have the experience in doing so.
R. Adam Smith:
Okay. I picked a quote to reference Peter Drucker. It's interesting, related innovation terms of how looking AI, he said basically there's a specific instrument of entrepreneurship that that endows resources with a new capacity to create wealth. Looking ahead at the AI, I think it's still intimidating for people to really either understand it or use it as both concerning and empowering at the same time. So how do you engage in that conversation with a wealthy client used to more hands-on human management of their wealth into something that is behind the scenes, albeit more efficient? What's that? What are those conversations like these days? How does that work?
John Bailey:
Yeah, I think there is a very broad acceptance of the value and importance of AI. It has really been a tremendous acceleration interest, like an explosion of interest and people see it. It's not just this kind of quirky kind of gimmicky kind of thing, but they see the real value to it. And so interest is significant real and growing and frankly the whole chatGPT thing kind of just exploded the interest even more, but people see the real value in it. We are getting a tremendous amount of acceptance. Look, there are still people that they really enjoy a fundamental hands-on more of an analog process or that works for them and that's fantastic, but there's a very significant growing segment of families and multi-line family offices and advisors that want to adopt it and we just see interest just continuing to grow.
R. Adam Smith:
That's great. Well, it's certainly very exciting time and it's a big deal to see the government step in and work with the major players in the market the last couple of months really get their arms around it because technology does tend to move much more quickly than we give it credit for. So I wish you great success in continuing to enhance the lives and the wealth and the efficiency for your clients and seeing Lumenai expand into a bigger business. I've really enjoyed observing the evolution of wealth management from a very more pedestrian, more traditional industry through the alternative asset explosion into where we are today. So, it would be great to see Lumenai and I change and grow and navigate these markets. Any less words for our audience in terms of AI and your views on your region of today?
John Bailey:
I'll give you a quote and then just a one-liner says ai, it says 96% of senior executives financial services say AI will redefine the financial services industry within the next years. We see a lot of data like 96%. So, we're interest as far as what we're doing at Lumenai and the impact on wealth management, we just think using data science and AI. We just think it's a much easier way to build better, more accustomed, lower overall portfolios that take less time to manage. That's really the benefits for families.
R. Adam Smith:
I know you serve a lot of clients, you're very busy and it's great to have your time today. That brings us to the end of today's episode. I would like to thank you our listeners and also extend. Thank you John for your time and expertise today.
John Bailey:
I really appreciate you having me and I really enjoy your podcast and I wish shoot the best with it as well. Thank you.
R. Adam Smith:
This is R. Adam Smith, signing off. Stay tuned for our next episode of Family and Business Podcast.
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