An Interview with Orthogon Partners: Investing in Esoterics and Building Human Capital
“From a first course in microeconomics, you will learn the theory of competition: competition eliminates profits.” Orthogon Partners is founded from this simple premise. The firm seeks out larger risk-adjusted returns in “esoteric” assets, namely, those that do not face overwhelming competition, if any.
In this interview conducted by Business Today, Rishi Ganti and James Lavelle, partners at the firm, explain what differentiates Orthogon’s business from other funds and what students should keep in mind as they think about their career.
Business Today (Grace Hong): Can you speak about your background and how you eventually arrived at Orthogon Partners?
“The market will reward you for bringing assets into a market, even more than it will reward you for pricing that asset correctly in the market.”
Rishi Ganti: Back in undergrad, I fell in love with economics. The basis of economics is optimization and how to get the most from limited resources. For me, that was a great epiphany, and I realized this is what I want to study for the rest of my life. In graduate school, I came away with the understanding that once assets, ideas, or people are surfaced into a market, they might not be handled perfectly, but they’ll come close to their best uses. In markets, money, time, effort, and other resources flow to good ideas.
At the time, I thought to myself: What about the assets that do not make it into markets? What happens to those? Thinking about the fact that some assets never have the opportunity to find markets would eventually become what Orthogon is. Most importantly, the market will reward you for bringing assets into a market, even more than it will reward you for pricing that asset correctly in the market. In the same way, the markets reward you with money or fulfillment if you are able to create a company, rather than simply trading that company’s share in the stock market.
James Lavelle: I was also fascinated with the way economics can be applied to so many different disciplines, from the traditional being finance to less traditional being neuroscience, both of which were certificate programs I pursued at Princeton. Coming out from undergrad, I joined an investment bank. From there, I went on to focus on private equity at Two Sigma. I spent eight years there before joining Orthogon Partners to continue investing with the esoteric asset approach.
BT: How would you describe an esoteric asset?
RG: The word “esoteric” has not been used very well in the investment industry, but at Orthogon we’re trying to make it useful. Let me first describe what a niche asset is to distinguish it from an esoteric asset. Conventional assets include stocks, bonds, derivatives, private equity, private debt, or venture capital. As you go into the unusual, you may encounter less conventional assets, such as litigation claims, trademarks, music securitizations, or pharmaceutical royalties. These are niche assets. Investors are attracted towards niche assets’ potential for a higher return per unit of risk. But niche assets may still suffer competition. An esoteric asset, by contrast, explicitly defines itself as an asset that doesn't have a lot of competition. That’s different than niche. A niche asset might be an unconventional asset, but that doesn't mean that a lot of investors aren't looking at it and bidding on it. If an asset has very few people, or nobody, looking at it, that makes it an esoteric asset, whether or not it's unconventional.
“Imagine going to an art auction: a Picasso painting is being sold, but nobody shows up to the auction. You won’t have to pay a lot to get the painting. That describes Orthogon’s focus on esoteric assets.”
From a first course in microeconomics, you learn the theory of competition: competition eliminates profits. Perfect competition eliminates profits perfectly. If you’re a firm that is a monopoly, you'll make a lot of money. If you're a firm in an industry suffering from a lot of competition, you're not going to make a lot. The application of this theory to the investment industry is this: if you are trying to buy assets and there's a lot of competition for that asset, you have to beat all the other bidders on that asset by bidding high in order to own it. However, being the highest bidder is not a great way to make good returns. Instead, if you're trying to buy an asset, you should look for assets that don't have competition. Whatever the asset is worth, you might be able to buy it for a lot less because nobody’s trying to outbid you. Imagine going to an art auction: a Picasso painting is being sold, but nobody shows up to the auction. You won’t have to pay a lot to get the painting. That describes Orthogon’s focus on esoteric assets.
For some reason, when you enter the financial industry, people line themselves up for jobs in highly competed spaces — long-short funds, venture capital, real estate — places where every asset they're looking at, somebody else is looking at it too. The only way they can own that asset is to be the group that pays the most for it; that’s not a good formula.
BT: When you view the future of the investment industry, do you imagine a space dominated by automation or one moving to esoteric assets?
RG: What we call automation has been going on forever. It might be because you're involving a computer; it might be because a law changes to make things more efficient. I remember when securities regulators allowed stocks to be quoted in pennies and not just an eighth of a dollar; suddenly the markets got more efficient. Being a stockbroker was aspirational, but as soon as regulators decimalized stocks, brokers were making a fraction of a penny, and suddenly nobody wants to grow up to be a stockbroker.
“Markets continually make things more efficient, and one thing we’re doing at Orthogon is acknowledging that instead of fighting that.”
This type of increased efficiency is natural. With the “invisible hand” of the market, if somebody is making too much money, there is an incentive for a market to bring more competition. Every year, techniques that used to make easy money will make less risk-adjusted return. Markets continually make things more efficient, and one thing we’re doing at Orthogon is acknowledging that instead of fighting that. If you go to a long-short shop or real estate firm, the activity of market competition will make the pricing of the assets you seek to buy more efficient, which is not good for you. Any investing technique that you employed successfully in the past will now return less per unit risk. You can fight that and stick it out. But even if you get good returns, now you don't know if it's luck or if it's skill. If it’s luck, you didn’t really “earn” anything at all. At Orthogon, the invisible hand is guiding us to where the market isn't acting and where we won't suffer competition and where we seek to be rewarded with higher return per unit risk.
JL: The set of esoteric asset opportunities is quite large relative to the set of refined asset opportunities. One analogy is that there’s much more water in the oceans than there is refined water to drink. Esoteric investment opportunities require substantial work and time to develop, much more so than traditional market assets, and that's what we specialize in here at Orthogon. The potential reward is much greater as well. We see that opportunity in esoteric assets to be around for many years to come.
BT: One of your investments is Charter School Capital. How are investments like those sourced, and how does human capital come into play?
RG: Going back to the kinds of jobs that graduates from Princeton enter, you'll notice that they automatically look at investment banking, sales & trading, real estate, etc. These verticals are areas where the ideas are already known. Let's say you're trading stocks. There are less than 4,000 public US equities out there — that's your universe. If you’re in real estate, you might be placed in commercial or residential, but you know what your ideas are — they’re buildings. So if you want to do something that is not competed, the very first thing you must do is not be part of an active market, because in all those cases, the assets are already known and somebody else will be looking at them as well. Again, the market will reward you for avoiding competition and surfacing an asset to a market rather than just competing in a saturated market. If you're trading stocks, you don’t have to “source” a stock. Even if you look at illiquid businesses like private equity or venture capital, you don’t have to source it; it will find you. Agents will pitch an idea to you, but they’re giving other private equity funds the same pitch. Orthogon does something that other investment funds don’t have to do, which is going into the field and looking for things before all kinds of investors find them.
JL: In the case of Charter School Capital, we had come across an esoteric asset opportunity –financing charter schools backed by state receivables. For us, it's not enough to find an esoteric asset; we then build an operating business to mechanize that opportunity so we can continue to invest for many years to come. We partnered with an operating team at Charter School Capital to do so. As a long-term capital partner, we can continue to provide financing in the charter school industry across a number of products. That model of partnering with operating businesses and helping them grow across product lines is consistent across our portfolio.
BT: Can you briefly define what it means to be a long-term capital partner?
JL: We call the operating companies with which we partner investment platforms. Unlike many others in private investments, we don't seek to sell our investment platforms after some defined period of time. That time is often related to the fund cycle for a private equity fund, for instance. We structure our investment platforms to last much longer than a traditional fund cycle, so we don't have an artificial incentive to realize after a given period of time. The underlying assets we invest in are often self-liquidating, not requiring a market exit of the investment platform, so there is significant cash flow for either reinvestment or return to our investors. This allows us to continue partnering with our investment platforms for the long-term.
BT: From how I view it, venture capital firms also would gain the highest returns if they’re the first ones to source a successful investment. Venture capitalists also support companies in their portfolio as well. Could you go more into detail differentiating venture capital from Orthogon?
“Venture capital isn’t any different than real estate, long-short, or other markets. It’s just a bunch of investors looking at the same deal and competing against each other to buy it. Only the highest price wins.”
RG: Let’s say you're a venture capital fund on Sand Hill Road. Let’s agree you are not creating any startup ideas. You’re just investing in them. Hypothetically, some group of people in their basement, around Stanford, or even Estonia, are coming up with an idea and want to raise capital. It won't be that long before a pitch deck works its way to hundreds of VC firms, including yours. Again, you did not create the idea; instead, you’re in competition with other VC firms to invest in that idea. To provide an example, let’s say you have an idea and are pitching to James and me. I can offer you one million dollars for 10% of the company. But James can offer the same one million dollars for 8% of the company. If I still want you to take my deal, I’ll reduce the 10% share of your company to 7%. James and I can continue outbidding against each other until you have your million dollars for the least amount of company that you could sell. In this way, we can see that venture capital isn’t any different than real estate, long-short, or other markets. It's just a bunch of investors looking at the same deal and competing against each other to buy it. Only the highest price wins.
Orthogon is totally different, and we can take Charter School Capital as an example. We didn’t create an entire superstructure like Tesla or SpaceX, but we did need to provide financing to charter schools. We helped build a business that originally was simply a financial company providing capital to charter schools. It’s a lot more today. Since we were the only group doing it, we have the potential to make a great risk-adjusted return. We’re not just the ones benefiting though; charter schools benefit too because they can now have the financing to buy books, hire teachers, and pull students off their waitlist. Since then, Charter School Capital has done two billion dollars of financing. All this is very different from venture capital, which is a zone where lots of people are trying to do exactly what you're doing — and generally the highest bidder wins. That's just not a great formula to make money.
BT: It takes a certain amount of capital to be investing in esoteric assets, or at least, there aren’t many firms doing what Orthogon’s doing. How can students who are interested in the field bring a competitive edge, especially as the options that are open after graduation tend to be those industry verticals like investment banking or private equity as you mentioned?
“Don’t confuse the kinds of things that a firm is doing with the skills that you are acquiring. There are some firms that might be doing really boring things, but that doesn’t mean that you’re not acquiring great skills.”
RG: Don't confuse the kinds of things that a firm is doing with the skills that you are acquiring. There are some firms that might be doing really boring things, but that doesn't mean that you're not acquiring great skills. You might use those skills later when you do your own thing or when you find an interesting firm. Whether you're joining an investment bank or joining the military or working for hospitals, you might say the institution that you’re joining is not that interesting but the skills you’re acquiring there are -- language skills, math skills, technical skills, people skills, increasing your social IQ. Knowing that difference is very helpful because it allows you to take on different roles or go to graduate school with a purpose in mind. I'm always worried that people might want to join a firm that’s interesting, but they don't have the skill to make an impact at that firm, and they may get orphaned at a low-level role.
“To be part of exciting new opportunities that may appear, you must have the skills and an open mind, rather than a mentality of mapping out the next ten years of job titles and worrying that every single job on your resume is with a brand-name firm because you’re too scared to have anything else as a building block.”
The world is always changing. People didn't know the internet would be a big deal or that artificial intelligence would garner so much traction. Consider that the firm or industry that you're joining now will likely not be part of whatever revolution might be next. You could say that we're in the age of automation and artificial intelligence, but that may become more institutionalized, but who knows what the next ten years will bring. To be part of exciting new opportunities that may appear, you must have the skills and an open mind, rather than a mentality of mapping out the next ten years of job titles and worrying that every single job on your resume is with a brand-name firm because you're too scared to have anything else as a building block.
JL: The development of skills shouldn't stop after graduation or the first few years of an entry-level job. A constant focus on self-improvement is important for graduates to stay relevant in a rapidly changing world. It’ll also help you find meaning in your career, and if you fail to do so, it’ll help you change your career until you do.
BT: One topic you’ve mentioned is this traditional well-trodden 2 + 2 + 2 path of two years as an analyst out of college, two years in private equity or venture capital, and two years at a business school. How can students avoid commodification of themselves as they enter the market?
RG: To the extent that any part of that package will help you be flexible and have a meaningful life, that is fine. However, it's unlikely that 2 + 2 + 2 is actually about that, and that's the problem. The graduating senior has known only one thing her or his entire life, and that is having obvious stepping stones. If obvious stepping stones are what you need psychologically, then it can become easy to manipulate you. The industry puts forth something and packages it, like 2 + 2 + 2, to satisfy the neediness of graduating seniors to feel like they are moving ahead. Just because someone gives you a progressed path, it doesn’t mean you should be going down that path; it might be a waste of time. Be very careful what people offer you, and just because your peers are posting on social media that they're doing it, it doesn't make it the right decision. It just means a bunch of people your age are doing it. If you look at the people you admire, it is very unlikely that they took some package someone else offered them that really wasn't for their benefit. If you’re acquiring skills that will be helpful as the future unfolds, you'll understand when to exit that set path. But if you're doing it to feel safe, time is going to pass, you’re going to get older, and it may close off the kinds of opportunities that are not only meaningful but would have been great for if you started on them earlier.
With regards to commodification, the most important thing you should do is continue to increase your human capital — to gain skills. Don't worry that maybe in this job or that job you're being paid less. There are wonderful jobs in government, military, and education that don't pay that well but give you a platform for the future. Trying to win the whole game in the first year after school might lead you down the path that you don't want to be on.
JL: It is a very personal decision, and the key to that decision is whether that career path helps bring meaning to your life. That's not a one-time check; that’s something that you need to consistently evaluate. Find what you have a passion for and pursue it. For some, that may be a traditional finance career path, and for those individuals, 2 + 2 + 2 is a great way to develop skills that will help reach those career end-goals, but for many it will not.
“If you’re doing the obvious things in your career, seeking stepping stones and the “right nameplates” for firms, then you’re that child in Othello. You’re flipping pieces to white right after you graduate for short-run gain, and at the end, you’re going to see the kind of things you wish you had done. But by then, it’ll be too late. ”
RG: I want to talk about the board game Othello. That’s the game where there are two colors, black and white, and you flip your opponent’s colors to your own. Whoever has the most of his or her color at the end wins. Let’s say you’re playing against a child and the child is playing white and you’re playing black. The child will constantly flip your black pieces to white. They do that every chance they get. They are very focused on the short run, and they don't notice that you're putting pieces along the edge of the board which allow you to flip many pieces at once. At the end of the game, you capitalize on your “end of row” pieces, and suddenly entire columns and rows of white pieces turn black. The child realizes that despite “winning” throughout the game, they're now going to lose. If you’re doing the obvious things in your career, seeking stepping stones and the “right nameplates” for firms, then you’re that child in Othello. You’re flipping pieces to white right after you graduate for short-run gain, and at the end, you're going to see the kind of things you wish you had done. But by then, it’ll be too late. Othello is a great metaphor for strategy in life.
BT: What is one area that you seek to learn more about?
RG: I would say the philosophies that govern a meaningful life and the skills that are required to help bring the people around you with you in that endeavor. What I realized is that people spend a lot of time learning things, but they’re not learning how to live. At some point, learning how to live actually does matter because it teaches you the right way to conduct your life. Take that Othello example that I gave you. I would not have been capable of giving you that example ten or fifteen years ago. I didn’t quite understand it then. It matters because if you realize that analogy early on, you can change your whole life. There was a graduate from my alma mater, Emory University, named Jonathan Starr. He gave up a life in finance to open a school in Somalia, and the school prepares children to go to an American university. Imagine if you create this chain of graduates that become educated and go back — a critical mass of students — and they take over all the leadership positions in that region and bring it peace. This is a guy who is thinking about the long game. That's the kind of thinking that needs to be encouraged, and even speaking to you is part about how I can really make an impact and lead a meaningful life.