Executive Q&A: Brian Langstraat, CEO, Parametric

As a 24-year employee of Parametric, Brian Langstraat has helped build a firm with $125 billion in assets under management on the iconoclastic notion that investment managers can do better for their clients by cutting the cost of investing in equities than by trying to ferret out the next great stock.

EARLY YEARS: My father was a banker for Seattle First National Bank. He moved from branch to branch, so I grew up in Arlington, Snohomish, Sedro-Woolley and Bellingham. I graduated from the University of Washington with a B.A. in economics in 1990, doing the least amount of quantitative work possible. There was a recession and my only two job offers were driving a truck for a uniform company or an entry-level job at Parametric. I went to Parametric because it was on the 34th floor of the Columbia Tower and I thought the view was cool. I didnt know a stock from a bond. It was a great place to start because there were only 11 employees and I got to see and do a lot of things. I became CEO in 2001.

OWNERSHIP: In 2003, [Boston-based] Eaton Vance bought a majority position in Parametric. We work very closely with them in sales and marketing, legal compliance and infrastructure IT. They help us research, market and position new products and provide capital for acquisitions, but we operate as an autonomous company with a very distinct style and operating culture.

THE MODEL: In 95 percent of the enterprises in the investment world, everything relies on your ability to pick stocks. But the track record of active managers is very spotty. At Parametric, there is nobody here who gets up in the morning and says, Is Boeing a good stock? or Is the Japanese market a good buy or sell? We rely on technology, engineering skills, math and model building to find ways to lower the risk and cost of investing in equities.

TAXES: In the 1990s, we realized that taxes are the highest costs investors face, yet few investment managers account for that. We engineered a rules-based process on when to realize capital gains, and when to realize losses that added significant value without having to predict the future.

PRODUCT DEVELOPMENT: To be successful, we had to have operations people, technology people and investment people in on the process from the ground floor. The operations people had to deal with millions of tax laws. The technology person was there because each of the 20,000 individual portfolios has to be separately managed to account for gains and losses. The invest team had to develop the rationale for how tax management works.

COORDINATION: We learned that many investors gave chunks of money to different money managers to invest in areas like growth or value. Since those activities werent coordinated, an investor might take a short-term gain in one portfolio, even though he could have taken a long-term gain in a different portfolio to save on taxes. So we created a centralized portfolio management offering, where each day all of an investors managers send us their list of which stocks to add or subtract and we coordinate the trades to improve the investors after-tax performance. This separates the artisan activity of picking the securities from the engineering activity of building the portfolio.

EMERGING MARKET: In 1994, we created Parametric Emerging Markets. Our goal was to build the best long-term, low-turnover portfolio for emerging markets. Its now about $22 billion in our business. Unlike other funds, we chose not to weight by capitalization. That forced greater diversification among companies, industries and securities. We avoid overpaying by looking at liquidity. We dont own more than half a percent in any one company, so you dont have boom and bust cycles. Our emerging market fund started with 23 countries; it now has 50. We improve outcome by systematically rebalancing so that, as securities move up, we end up trading against strength and adding the proceeds to countries and securities that are underweighted. That strategy has outperformed its cap-weighted index by about 3.5 to 4 percent a year for over 20 years now. Weve started to look at what other asset classes we could apply the same research to, including commodities, currencies and developed country equities.

GROWTH: We are growing in the retail channel and in the family office channel. A family office is a private client that is large enough to feel like an institution. If an entrepreneur sells his business for $500 million, hes got enough cash to set up a family office with a 35-person staff and a chief investment officer. Its like talking to the investment staff at the UW endowment. Family offices dont advertise because theyre prey to the investment management marketing folks. Our first family office client was a fifth-generation entity that built its wealth in natural resources.

SEATTLE ENVIRONMENT: It would be great if a financial cluster developed in Seattle we work closely with UWs program on computational finance but Seattle is not in the fast track of asset management. For us, Seattle is good because of all the tech talent. We build software to run these portfolios so we hire people in electrical engineering, physics, applied mathematics and financial modeling. And its good being off the beaten track of financial management because people tend to stay; it is not a steppingstone to the next job in a major financial center. Continuity is crucial. Investors choose investment management based on their trust in the people. Turnover, change and uncertainty put you in the penalty box. Investors can move their money anytime they want. Its tough on companies like Russell [Investments] that are undergoing sales or purchase.

CULTURE: If you dont have to get up every day asking whats going to happen next in the world, youre forced to think of other things to differentiate yourself. All of the investment products weve come out with were relatively new to the market, so we had to have a culture of experimentation and innovation. We dont have a hierarchy you move up in as you build a track record in stock forecasting. Ours is a team-based, engineering approach to investment management. There is no wall between the development of the systems, the prototyping, the testing and the running of the money.

INDUSTRY FUTURE: This industry is being barbelled. A lot of money is going to the aggressive, active hedge fund shops where the best compensated live and die by performance. At the other end are the index funds and the ETFs (exchange-traded funds) that offer performance by lowering costs. Thats valuable to the client, but its not very well received at cocktail parties.