Transcript
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Run one of the top endowments in the world,
Caltech.
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Your 4 and a half $1,000,000,000 endowment size
gives you an advantage in terms of investing.
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$4,000,000,000 or big enough where people pay
attention to it.
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Do you not have special access into venture
funds started by alumni?
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There are a handful of venture funds that have
either been founded by or are currently managed
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by Caltech alums.
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There's one particularly large and very well
known fund that has a Caltech alum at its head.
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You mentioned that you're a conservative
investor.
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I've been surprised by some of my peers having
30 or 35% of their portfolio in the riskiest
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asset class.
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It seems like a lot more risk than I'm willing
to take.
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I do not pretend to know what the market will
do.
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So, Scott, you run one of the top endowments in
the world, Caltech, which currently manages
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$4,500,000,000 Tell me about your portfolio
construction today.
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Well, thank you.
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First of all, let me say I'm not sure we're one
of the top endowments in the country.
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We're probably somewhere in the thirties in
terms of the absolute size of our endowment,
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but where we are top 10 interestingly is
endowment dollars per capita per student
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because we we have such a small student
population.
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Our undergraduates number under a1000.
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If you take that 1,000 and divide it into our
endowment, we're actually quite large in that
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respect.
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So the allocation, looks quite a bit like you
might imagine other large university endowments
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look like.
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We have about a third in global public
equities, about 25% in private equity, which
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should be split between buyouts, growth, and
venture capital, and then about 25% in
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alternative securities, which are generally non
correlated assets, things like aircraft
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leasing, insurance products, longevity
products, and then we have some distressed debt
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in there.
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We have about 12% real assets split between
energy and real estate, and then the rest is
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cash and and short term investments.
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How do you structure your team?
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Is is it asset by asset or do you have a more
generalist approach?
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I'd say it's split.
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We have a very small team.
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We have 6 investment professionals.
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They are nominally split between public
securities, private securities, and real
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estate.
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However, it's really quite fluid.
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We meet as a team twice a week.
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We review our portfolios, in detail on a
quarterly basis.
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On any particular transaction or any particular
manager, there could be people from the private
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team working on a public transaction and and
vice versa.
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So we we try and keep it pretty fluid and have
a lot of cross training so that people are
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familiar with the entire portfolio.
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When we last chatted, you mentioned that your
$4,500,000,000 endowment size gives you an
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advantage in terms of investing.
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What did you mean by that?
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Yeah.
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Let me clarify first.
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We have about 4,600,000,000 total under
management.
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The endowment is about 4,200,000,000 and then
we have another portfolio of taxable funds that
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we manage similarly to the endowment.
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But I think our size gives us an advantage in a
couple of ways.
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One, we can be quite nimble.
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We don't need or frankly, we can't write
$200,000,000 checks or $300,000,000 checks
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because and that requires a fund of a certain
size.
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So we can write a $25,000,000 check into a into
a smaller fund and have it be significant for
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us as well as significant for the fund.
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On the flip side, at $4,000,000,000 we're big
enough where people pay attention to us.
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So even though we're located in Pasadena, which
is a little bit off the beaten path, we're
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about half an hour northeast of downtown Los
Angeles, we still get plenty of visits and
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plenty of attention from fund managers and and,
don't have to beg and plead for for them to
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come visit
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us.
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And you mentioned you have a taxable pocket and
a non taxable pocket.
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How do you go about what's the optimal
portfolio for a taxable investor versus a non
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taxable?
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We don't really focus so much on the taxes as
much as the liquidity.
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The 2 portfolios serve very different
functions.
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The endowment is a portfolio that is intended
to last in perpetuity.
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Therefore, we take a very long horizon view of
that portfolio and are willing to tie up
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liquidity quite a bit more and do more private
assets than we would do in the taxable
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portfolio.
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And the taxable portfolio is, meant to be used
for capital expenditures and other, let's say,
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medium term needs of the Institute.
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And I would expect that portfolio to be spent
down over the next 15 to 20 years.
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So obviously, in that case, we can't have a lot
of private equity, which as you know, often,
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even though they're 10 year partnerships, they
often last 15 or 20 or even more years.
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So we can't, have a lot of illiquidity in in
that taxable portfolio.
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I just interviewed, Victor Mayer who runs the
Evergreen Fund at Pantheon, and they've been
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doing it for a decade or so.
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And his view is that most top GPs will have
evergreen structures in the next 5, 10 years.
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What are your thoughts on that?
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Yeah.
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We're definitely seeing a move in that
direction.
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We're already in a couple of funds that have
that structure, and and I think they make some
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sense.
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I mean, if you're honest, as I as I mentioned,
funds are no longer or maybe never were, 10
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year funds.
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And I I think it makes a lot more sense for us
to go in with our eyes open and understand what
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the ultimate liquidity is.
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And Evergreen Fund sort of helps us in in that
regard to understand what our true liquidity
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provisions are.
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As an institutional investor, why does it make
sense to ever invest in an evergreen fund?
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I think it helps both both sides.
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The manager knows that they have stable
capital, and therefore they can make decisions
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based on knowing that the capital will be there
for a reasonable amount of time.
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And secondarily, I think it gives a little more
choice to the LP, and, they can manage their
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own liquidity a little bit better.
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Tell me about your governance structure and how
does investment that come to you end up making
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it through the entire process?
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So we report to an investment committee, which
is a subcommittee of our board of trustees.
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We actually also have on our investment
committee what we call advisory participants,
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which are experts not on our board of trustees
that we invite to participate in all ways on on
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our investment committee.
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Currently, we have 14 people on that committee.
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Very generously, the committee early on
provided me with an enormous amount of
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discretion.
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So we actually have pretty high limits under
which we can invest without getting investment
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committee approval.
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However, I, the discretion is really more of a
negative consent type of structure.
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In other words, we treat a, an investment that
does not require approval by our investment
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committee exactly the same as one that requires
approval.
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And what that means is after we've done
sometimes years of getting to know a manager
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and then could be 6 months, maybe longer of
deep due diligence, then we will write a
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detailed memo on our views of the manager and
why we recommend an investment.
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That will go through many drafts up and down
the chain within our office, and then
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ultimately be distributed to the investment
committee.
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And where the negative consent comes in is even
for a an investment that does not require
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investment committee approval after we have
sent out the memo, any committee member has the
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right to raise their hand and suggest that the
investment be discussed more broadly amongst
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the committee members.
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I can tell you in my 14 years that has happened
twice.
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So it's quite unusual that somebody would raise
their hand.
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And I think part of that is because we're
relatively conservative in our approach.
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Obviously, having worked with this investment
committee for 14 years, I know how they think.
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I know what they like and what they don't like.
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And so it's pretty infrequent that something
gets up to their level that I have any doubt
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will not be approved either formally or or
informally by the committee.
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When we last spoke, you mentioned that you're a
conservative investor.
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Is that a strength or weakness overall as an
institutional investor?
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In what ways?
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I think it depends what what your objectives
are.
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Right?
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I mean, if if your objectives are to maximize
return but potentially accept volatility, then
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being very conservative probably isn't a good
thing.
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In our case, the risk profile of our investment
committee is I'd say conservative, even though
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interestingly, they are primarily very seasoned
investment professionals, even the trustee
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members are seasoned investment professionals.
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But I think that also, a portfolio would
incurring a lot of volatility in our portfolio
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would potentially lead to actual cuts in our
budget if we were to have a steep and lengthy
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drawdown that would have an impact on our
actual operations at the institute.
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And so I tend to want to reduce volatility
within the portfolio.
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And sometimes that means that our returns won't
be quite as high as others.
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But on the other hand, when there is a drawdown
in the market, I think we're positioned to
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outperform.
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I mean, as an example, I think I referred to it
earlier.
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We have, we have 6% venture capital in the
portfolio.
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I've been surprised by some of my peers that
have let their venture capital portfolios run
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up into the twenties and sometimes even at the
thirties and high thirties.
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At least as far as I'm concerned, venture
capital remains the riskiest asset class or
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certainly one of the riskiest asset classes you
can invest in.
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And having 30 or 35% of your portfolio in the
risk is asset class seems, seems like a lot
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more risk than I'm willing to take.
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As the office of Caltech, do you not have
special access into venture funds, specifically
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venture funds started by alumni?
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Well, first of all, there are a handful of
venture funds that are have either been founded
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by or are currently managed by Caltech alums.
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I can think of there's one particularly large
and very well known fund that has a Caltech
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alum at its, at its head.
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And there have certainly been opportunities
from time to time where one of our alums has
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reached out to us and told us that they would
like to have us participate in the fund.
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While we certainly give those funds a really
hard look, We treat them similarly to any other
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in terms of our due diligence and and
ultimately investing in them.
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So I, you know, I think we get invited, but I
wouldn't say we have special access.
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And certainly we don't have special access to,
you know, some of the big brand name funds.
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On the flip side, I will say that once we do
have a relationship with some of the larger
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brand name funds, we invite them as a partner
to come in and spend time at the institute in
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our laboratories and with our A
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A famous study from University of Chicago has
persistence persistent in in private equity
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evidence from BIO and Venture Capital Funds
sites that more than 50% of top quartile have
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retained top quartile status over the last
several decades.
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What do you think about that?
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Is that not a reason to invest into venture
capital?
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Persistency, I don't think is a is a reason to
invest in an asset class.
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It may be a reason to select your managers very
carefully.
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I do believe there is some amount of
persistency, particularly in venture capital.
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Part of that is can be attributed to the fact
that, they tend to see the most deal flow, you
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know, success begets success.
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And so they tend to to see the most deal flow
and potentially the best deal flow.
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I also don't wanna take anything away from the
value that the top funds add.
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I mean, they have done deal after deal after
deal.
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They they have the experience to identify
issues within a company.
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They know when they need to make a management
change.
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They know how to, help the companies get good
product market fit.
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And so so just going back to your question, I
don't think it's a reason to invest in an asset
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class, but I do think it's a reason to think
carefully about the managers with with whom you
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invest.
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How much of your role as CIO of endowment
involves making macro forecasts or playing
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macro investor?
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In my case, very little.
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I I think that differs from endowment to new
endowment depending on the skills of the CIO
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and the rest of the team.
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I do not pretend to forecast or to know what
the market will do.
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I tend to set up a portfolio that I believe
will perform well in different environments.
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I want there are certain parts of the portfolio
that will perform well in a high growth
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environment.
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There are certain parts of the portfolio that
will protect us in a low growth environment or
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in a down environment.
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And so I tend we tend to be more of a set it
and forget it type portfolio.
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We're always trying to improve.
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We're always trying to add, better managers.
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We're trying to add new ideas, but we're
definitely not whipping the portfolio around
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trying to chase the economy.
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I mean, I'll just give you one example.
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Look look at what happened yesterday with with
the Fed cut.
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Often when we see Fed cuts, you you would
assume that the Fed is signaling a slowdown in
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the economy.
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00:17:24,809 --> 00:17:29,950
And what you might expect is for the market to
react negatively to that.
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00:17:30,170 --> 00:17:33,549
Instead, the, you know, the the market took
off.
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00:17:33,690 --> 00:17:38,085
I imagine there there might have been some
people who who predicted that, but if you just
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00:17:38,085 --> 00:17:43,524
think about classic economics and at least the
way, I learned economics, I wouldn't have
227
00:17:43,524 --> 00:17:45,065
necessarily predicted that.
228
00:17:45,204 --> 00:17:49,224
Does that signal that the market believes it's
more in the know than the Fed?
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00:17:49,444 --> 00:17:50,244
I doubt it.
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I I I just think there there is so much money
sloshing around in the markets these days that
231
00:17:56,390 --> 00:18:01,450
it's it's pretty hard to keep the market down,
it would seem.
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00:18:01,509 --> 00:18:03,929
I honestly not sure what the market is
thinking.
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00:18:04,630 --> 00:18:06,924
I think the Fed knows what it's doing.
234
00:18:06,924 --> 00:18:13,825
I think they've done a pretty incredible job,
if you think about it, of avoiding a recession.
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00:18:14,125 --> 00:18:18,380
It looks like, we're gonna have a soft landing.
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00:18:18,440 --> 00:18:27,880
And and if you go back to March of 2020, when,
you know, the market fell dramatically as a
237
00:18:27,880 --> 00:18:33,575
result of COVID, it seems like we've, we've
recovered quite nicely from that.
238
00:18:33,575 --> 00:18:38,934
You mentioned that you don't like to play macro
investor, but you take advantage of macro
239
00:18:38,934 --> 00:18:40,234
trends and market opportunities.
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00:18:41,174 --> 00:18:46,069
In terms of private credit, private credit's
the hottest asset class right now, you know,
241
00:18:46,069 --> 00:18:49,509
are you bullish on private credit and how have
you played it with with the higher interest
242
00:18:49,509 --> 00:18:50,009
rates?
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00:18:50,149 --> 00:18:52,649
I have not been bullish on private credit.
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00:18:52,789 --> 00:19:02,875
We have one not insignificant partnership with
a private credit manager that we know quite
245
00:19:02,875 --> 00:19:07,455
well and we have been with for probably going
on 10 years now.
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00:19:08,154 --> 00:19:14,390
Otherwise, I've been quite concerned about
private credit because the it's a it's a very
247
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competitive market and all you can really
compete on is price and structure.
248
00:19:23,190 --> 00:19:28,710
So when you're competing, you're you're
potentially providing a lower price to the
249
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borrower and you're providing a looser
structure to the borrower.
250
00:19:34,044 --> 00:19:42,625
Where it's where it's not competitive, it tends
to be with borrowers who are having a hard time
251
00:19:43,964 --> 00:19:44,880
borrowing money.
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Right.
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And, and so in that case, the lender can
dictate the terms.
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00:19:50,799 --> 00:19:59,065
It's not clear to me that that's the loan that
I wanna be in where the borrower has been
255
00:19:59,065 --> 00:20:05,325
turned down by every other lender and they
finally found someone who who is willing to
256
00:20:05,944 --> 00:20:06,845
lend them money.
257
00:20:07,065 --> 00:20:14,099
The second issue, and and maybe having a little
bit of experience is a is a negative, but I
258
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started my career in asset based lending a very
long time ago, and, working at Citibank.
259
00:20:22,179 --> 00:20:30,195
And so I actually understand how hard it is to
make loans, to manage loans, and to work out
260
00:20:30,195 --> 00:20:30,695
loans.
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00:20:31,475 --> 00:20:37,555
And it wasn't as I've looked at private
lenders, it's not clear to me that, many of
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00:20:37,555 --> 00:20:45,700
them are prepared for the workout part of, of
the cycle, which I would suggest that we're
263
00:20:45,700 --> 00:20:46,840
moving into now.
264
00:20:47,220 --> 00:20:54,259
So they're they're either going to have to very
quickly learn how to do workouts, or hire
265
00:20:54,259 --> 00:20:57,345
people that know how to do workouts.
266
00:20:57,345 --> 00:21:05,105
Or I guess the 3rd option would be to sell
loans at at a discount when they, get into a a
267
00:21:05,105 --> 00:21:06,005
workout situation.
268
00:21:06,225 --> 00:21:08,805
You've worked through 6 major financial crises.
269
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And what lessons have you
270
00:21:11,369 --> 00:21:11,690
learned?
271
00:21:11,690 --> 00:21:11,929
Yeah.
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00:21:11,929 --> 00:21:17,289
I mean, I guess first, let's let's look at the
facts and and the the background to to that
273
00:21:17,289 --> 00:21:18,349
comment I made.
274
00:21:18,730 --> 00:21:27,544
If you go back to 87 when when I started my
career, we had actually a drawdown just as I
275
00:21:27,544 --> 00:21:31,484
was coming out of business school and joining
Citibank.
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00:21:32,105 --> 00:21:40,369
In that case, the market fell, or the market is
defined by the S and P 500, fell 36% over a 2
277
00:21:40,369 --> 00:21:46,630
month period, and it took 21 months to recover
back to the high.
278
00:21:47,650 --> 00:21:55,304
Another one that I lived through was, in 2,000,
of course, the dotcom and the telecom crash.
279
00:21:55,765 --> 00:22:05,500
In that case, we were down 51% over a 31 month
period, And it took almost 60 months to
280
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recover.
281
00:22:07,099 --> 00:22:10,619
The third one I'd mentioned was the 07.
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And I think there are a lot more people out
there in the workforce who did have to live
283
00:22:16,835 --> 00:22:17,575
through 07.
284
00:22:18,355 --> 00:22:25,815
But in that case, we were down 58% over a 17
month period and it took 49 months to recover
285
00:22:25,875 --> 00:22:26,934
back to the high.
286
00:22:27,154 --> 00:22:33,930
So in each of those situations, there was a
relatively long, drawn out grind down.
287
00:22:33,990 --> 00:22:37,670
Every day you'd come into the office and you'd
be down.
288
00:22:37,670 --> 00:22:41,190
And you can imagine how that gets to you after
a while.
289
00:22:41,190 --> 00:22:43,369
It took a very long time to recover.
290
00:22:43,670 --> 00:22:48,065
Now let's compare that to the 2020 drawdown.
291
00:22:48,525 --> 00:22:55,184
We were down 34% in 1 month and we were fully
recovered in 4 months.
292
00:22:57,404 --> 00:23:03,039
That provides you with a very different mindset
on how the market works.
293
00:23:03,900 --> 00:23:05,820
There was no grinding down.
294
00:23:05,820 --> 00:23:08,640
There was, you know, a quick drawdown.
295
00:23:08,779 --> 00:23:09,340
Oh, my gosh.
296
00:23:09,340 --> 00:23:09,900
Oh, my gosh.
297
00:23:09,900 --> 00:23:10,940
What's going to happen?
298
00:23:10,940 --> 00:23:15,115
And then before you knew it, you, everything
was okay and life was good.
299
00:23:15,115 --> 00:23:22,894
And that, has created the buy the dip
mentality, which may work in some circumstances
300
00:23:23,434 --> 00:23:24,254
and may not.
301
00:23:24,474 --> 00:23:27,694
So to answer your question, what have I
learned?
302
00:23:28,079 --> 00:23:31,940
One, markets can go down and stay down.
303
00:23:33,440 --> 00:23:37,539
They don't always recover in a month or 2.
304
00:23:37,839 --> 00:23:45,474
2, you can lose money when you have a and
sometimes you have to crystallize those losses.
305
00:23:45,774 --> 00:23:54,515
If you have a portfolio that has gone down 20
or 30 percent and it's down in in that range
306
00:23:54,815 --> 00:24:02,519
for 6 months, 12 months, 24 months, you may be
in a position where you need to generate
307
00:24:02,519 --> 00:24:09,580
liquidity and you're gonna sell some of your
assets at a loss that will make those permanent
308
00:24:09,640 --> 00:24:10,140
losses.
309
00:24:10,454 --> 00:24:16,634
The third thing is that you really need to
manage your emotions in this business.
310
00:24:17,255 --> 00:24:25,289
It's very easy to get anxious and worried about
the markets.
311
00:24:25,429 --> 00:24:30,869
But the fact of the matter is markets go up and
markets go down, and we have to remind
312
00:24:30,869 --> 00:24:32,549
ourselves of that every day.
313
00:24:32,549 --> 00:24:38,265
Is the key to surviving a downturn, having the
courage to keep your positions in place as
314
00:24:38,265 --> 00:24:38,984
they're going down?
315
00:24:38,984 --> 00:24:42,684
And talk to me, what are the best practices
when you're going through a downturn?
316
00:24:42,825 --> 00:24:46,924
I wouldn't say that the best practice is to
keep your positions.
317
00:24:47,065 --> 00:24:56,200
I think the best practice is to reunderwrite
your positions and make sure that they are
318
00:24:56,420 --> 00:24:59,160
appropriate in the current environment.
319
00:24:59,380 --> 00:25:10,204
You may have had a hypothesis or or a theory as
to why you acquired that investment 3, 4, 5
320
00:25:10,204 --> 00:25:14,865
years back, it may no longer be appropriate in
the new environment.
321
00:25:14,924 --> 00:25:21,740
And so I think there's a necessity to re
underwrite and determine whether or not the
322
00:25:22,519 --> 00:25:30,619
prospects for that investment are the same as
what you believed when you first underwrote it.
323
00:25:31,240 --> 00:25:35,494
On the other hand, you don't want to throw the
baby out with the bath water.
324
00:25:35,794 --> 00:25:42,054
It's human nature to do exactly the opposite of
what you're suggesting.
325
00:25:42,835 --> 00:25:48,509
That when, when you get panicked, when the
market goes down, it's human nature just to
326
00:25:48,750 --> 00:25:53,890
sell, to protect your assets or your downside.
327
00:25:54,589 --> 00:26:00,529
On the flip side, it's also human nature to buy
when prices are expensive.
328
00:26:00,829 --> 00:26:06,055
When the markets are going up, people tend to
get excited and buy.
329
00:26:06,674 --> 00:26:12,275
And, that often results in the opposite of what
you what you should be doing.
330
00:26:12,275 --> 00:26:14,835
It results in buying high and selling low.
331
00:26:14,835 --> 00:26:17,680
And we do try to avoid that, of course.
332
00:26:17,680 --> 00:26:22,400
Stanley Drunkenmiller famously said that
nothing looks as cheap as once it's risen by
333
00:26:22,400 --> 00:26:22,900
40%.
334
00:26:23,359 --> 00:26:24,340
It is amazing.
335
00:26:24,799 --> 00:26:35,244
And we try very hard to be disciplined and,
sort of, I wouldn't say contrarians, but at
336
00:26:35,244 --> 00:26:37,424
least believers in reversion to the mean.
337
00:26:37,884 --> 00:26:47,539
So we tend to actually trim from our winners
and add to our losers as as we look at the
338
00:26:47,539 --> 00:26:48,039
portfolio.
339
00:26:48,259 --> 00:26:50,259
That doesn't always work, by the way.
340
00:26:50,259 --> 00:26:57,160
I mean, sometimes losers really are losers,
and, we find ourselves adding to the losers,
341
00:26:58,099 --> 00:27:06,725
and we'll be patient with them, but sometimes,
particular strategies are out of favor for a
342
00:27:06,725 --> 00:27:08,005
really long time.
343
00:27:08,005 --> 00:27:16,410
And this current environment is an example of
one of those environments where anything that's
344
00:27:16,410 --> 00:27:25,210
small cap or value or basically not large cap
growth, has been out of favor for a really long
345
00:27:25,210 --> 00:27:25,710
time.
346
00:27:26,585 --> 00:27:32,924
And, that's caused a lot of portfolios to
underperform simple indices.
347
00:27:33,305 --> 00:27:39,400
And, of course, that that provides pressure or
causes pressure to come from investment
348
00:27:39,400 --> 00:27:46,380
committees and other people who can't
understand why your portfolio wasn't performing
349
00:27:46,680 --> 00:27:50,299
as well as, you know, a simple S and P 500
index.
350
00:27:50,855 --> 00:27:54,555
Do you see your role as an asset allocator or
as investor?
351
00:27:54,855 --> 00:28:00,295
Meaning, given that you have an underlying
institution behind the portfolio, your number
352
00:28:00,295 --> 00:28:07,720
one goal is to make sure that those liabilities
are paid for rather than, you know, generating
353
00:28:07,720 --> 00:28:09,400
alpha or generating the highest returns?
354
00:28:09,400 --> 00:28:14,299
How do you look at those 2 different roles of
maximizing returns versus preserving value?
355
00:28:14,359 --> 00:28:14,599
Yeah.
356
00:28:14,599 --> 00:28:24,795
I personally do both, and I think part of that
is attributable to my personal skill set and
357
00:28:24,934 --> 00:28:25,434
background.
358
00:28:26,855 --> 00:28:33,930
Prior to becoming an allocator about halfway
through my career, I was a transactor.
359
00:28:34,150 --> 00:28:35,289
I was a banker.
360
00:28:36,549 --> 00:28:43,509
I was a treasurer of a fortune 500 financial
services company, and that was very
361
00:28:43,509 --> 00:28:44,009
transactional.
362
00:28:45,174 --> 00:28:55,434
I came to this allocator role with a skill set
in M and A, in treasury, in, lending.
363
00:28:55,974 --> 00:28:59,769
So I, my mindset is transactional.
364
00:29:00,710 --> 00:29:08,309
On the other hand, as an allocator, you're
picking managers, you know, you're choosing
365
00:29:08,309 --> 00:29:12,484
asset classes in which to invest and you're
choosing managers.
366
00:29:12,484 --> 00:29:21,704
So our portfolio actually has a sprinkling of
direct investments, primarily driven by me.
367
00:29:22,724 --> 00:29:28,669
The investment committee has kindly allocated
me a bucket, what we call the opportunistic
368
00:29:28,809 --> 00:29:35,869
bucket, where I can do direct investments,
private or public, if if I decide that there's
369
00:29:36,569 --> 00:29:44,005
a particular stock or a particular opportunity
or particular asset class, we should get into
370
00:29:44,705 --> 00:29:46,244
in and out of quickly.
371
00:29:46,785 --> 00:29:48,625
I have the capability of doing that.
372
00:29:48,625 --> 00:29:52,725
And also I have the ability to identify direct
private investments.
373
00:29:53,184 --> 00:29:59,579
And we have probably half a dozen of those in
the portfolio, but the vast majority of what
374
00:29:59,579 --> 00:30:03,039
the investment office does is asset allocation
to managers.
375
00:30:03,339 --> 00:30:11,005
When you're exploring a theme, say AI, data
source or services, you know, social mobile
376
00:30:11,005 --> 00:30:11,984
back in the day.
377
00:30:12,285 --> 00:30:16,945
Tell me about the process, how you get educated
on a theme, and how you get to consensus
378
00:30:17,085 --> 00:30:22,125
strategy between public or private investing,
direct funds, or any other way you could access
379
00:30:22,125 --> 00:30:22,785
the theme.
380
00:30:23,140 --> 00:30:34,259
We spend time looking at trends and and new
investment, areas, crypto being an example, AI
381
00:30:34,259 --> 00:30:35,240
being an example.
382
00:30:36,484 --> 00:30:46,725
But we spend more time as an allocator trying
to determine who understands it best or who we
383
00:30:46,725 --> 00:30:53,859
think understands it best or who has a
particularly interesting angle or who has the
384
00:30:53,859 --> 00:31:01,640
best access or who may have the the best ideas
in in that particular sector?
385
00:31:02,180 --> 00:31:12,134
So we don't necessarily, as an allocator, need
to become experts in AI or experts in crypto or
386
00:31:12,835 --> 00:31:16,055
blockchain or or whatever it is.
387
00:31:16,195 --> 00:31:24,210
But we do need to become experts in
understanding or evaluating a manager's
388
00:31:24,990 --> 00:31:32,910
approach to an asset class, whether or not we
believe in their thesis, whether or not we
389
00:31:32,910 --> 00:31:39,615
trust them to, stay on, on point with their
thesis.
390
00:31:39,914 --> 00:31:44,875
Of course, you know, as an allocator, and I
know I'm I'm I'm drifting off topic here, but
391
00:31:44,875 --> 00:31:53,809
as an allocator, one of your nightmares is to
hire a manager to, do a one particular thing
392
00:31:54,029 --> 00:32:03,464
only to realize, a couple years in, that
they've actually usually slowly migrated to a
393
00:32:03,464 --> 00:32:08,365
different strategy that you didn't expect, that
you didn't underwrite.
394
00:32:09,464 --> 00:32:15,944
And, you know, if if it if it turns out, really
well, then you got lucky.
395
00:32:15,944 --> 00:32:23,769
If it turns out poorly, then you made a bad
judgment in terms of understanding how that
396
00:32:23,769 --> 00:32:32,589
manager thinks, not knowing or or or not
understanding that, they were prone to strategy
397
00:32:32,650 --> 00:32:33,150
creep.
398
00:32:33,505 --> 00:32:38,244
On the flip side, when managers have returned
capital, how have you looked at that?
399
00:32:38,384 --> 00:32:39,444
Generally good.
400
00:32:39,505 --> 00:32:50,619
We have a couple of managers, well, well known
managers who hold very large cash positions in,
401
00:32:51,640 --> 00:32:58,380
in anticipation of opportunities that that may
come in the future.
402
00:32:59,480 --> 00:33:04,345
And, you know, while we invest in a couple of
those, it's frustrating.
403
00:33:04,404 --> 00:33:12,244
First of all, you're paying relatively big fees
for them to hold large, large portfolios of
404
00:33:12,244 --> 00:33:12,744
cash.
405
00:33:14,005 --> 00:33:21,919
And one would think that in this day and age,
if they saw an opportunity, they could very
406
00:33:21,919 --> 00:33:28,960
quickly issue a capital call or, you know,
within a matter of a couple of days, get as
407
00:33:28,960 --> 00:33:31,460
much money as as they need.
408
00:33:31,974 --> 00:33:37,654
So when managers return money, it's actually
somewhat comforting because they have
409
00:33:37,654 --> 00:33:46,569
recognized that the opportunity set is not
there and they want to maximize our returns.
410
00:33:46,710 --> 00:33:54,789
And and they believe that what what they are
doing at that moment with the amount of money
411
00:33:54,789 --> 00:33:57,494
they have will not maximize our returns.
412
00:33:57,494 --> 00:34:03,815
And so they're giving us an opportunity to find
a different area in which to invest our
413
00:34:03,815 --> 00:34:04,315
capital.
414
00:34:04,934 --> 00:34:09,275
So in in general, we we, we view it positively.
415
00:34:09,815 --> 00:34:12,750
Have you ever reinvested into a manager that's
given back money?
416
00:34:13,150 --> 00:34:13,650
Yes.
417
00:34:14,829 --> 00:34:19,550
When we've had the opportunity, sometimes
there's, I can think of one manager in
418
00:34:19,550 --> 00:34:28,224
particular that has, on several occasions,
offered the opportunity to get liquidity or
419
00:34:29,485 --> 00:34:31,825
leave leave your money in the fund.
420
00:34:31,885 --> 00:34:37,585
And there's one manager in particular I can
think of where we almost always leave the money
421
00:34:37,644 --> 00:34:39,885
based, based upon their track record.
422
00:34:39,885 --> 00:34:47,039
But also frankly, in in one particular case I'm
thinking of, because we leave it there because
423
00:34:47,739 --> 00:34:53,519
the particular asset class that they're in
looks relatively inexpensive to us.
424
00:34:54,255 --> 00:35:02,434
And while the performance may not, have been
terrific over the last 12 or 18 or 24 months,
425
00:35:02,574 --> 00:35:04,275
you know, we're always looking forward.
426
00:35:04,335 --> 00:35:10,250
In that particular case, I'm thinking of we
wanted to leave the money there and wait for
427
00:35:10,390 --> 00:35:17,750
the opportunity to come up for the that
particular asset class, that particular sector
428
00:35:17,750 --> 00:35:18,409
to recover.
429
00:35:18,550 --> 00:35:23,030
Now Caltech is currently discussing adding
index exposure to your public equities
430
00:35:23,030 --> 00:35:23,510
portfolio.
431
00:35:23,510 --> 00:35:24,890
Tell me about your thought process.
432
00:35:25,135 --> 00:35:25,454
Yeah.
433
00:35:25,454 --> 00:35:32,114
It's been a really tough time in active
management over the last several years.
434
00:35:33,295 --> 00:35:41,199
It's primarily driven by, you know, what
everybody refers to as the magnificent 7, where
435
00:35:42,139 --> 00:35:52,159
if you didn't own those 7 stocks or 5 stocks,
you almost by definition underperformed the
436
00:35:52,299 --> 00:35:52,799
indices.
437
00:35:53,500 --> 00:36:00,114
And so at some point, when you're far enough
behind the indices, the the question comes up,
438
00:36:00,114 --> 00:36:02,434
well, why not just buy the index?
439
00:36:02,434 --> 00:36:06,295
And it's it's a little bit counter to what I
said previously.
440
00:36:06,434 --> 00:36:06,755
Right?
441
00:36:06,755 --> 00:36:13,949
Because right now, the the Mac 7 or the the
stocks that have performed very well are on a
442
00:36:13,949 --> 00:36:16,130
relative basis incredibly expensive.
443
00:36:17,230 --> 00:36:23,010
And so our tendency would be to look for less
expensive markets.
444
00:36:24,025 --> 00:36:31,644
But at some point, you look at it and you say,
well, would it hurt me to sprinkle some index
445
00:36:31,784 --> 00:36:33,405
funds into the portfolio?
446
00:36:34,184 --> 00:36:41,519
At least I would have some part of the
portfolio that would be matching the index,
447
00:36:41,980 --> 00:36:46,699
hopefully matching the index on the way up, but
it also will be matching the index on the way
448
00:36:46,699 --> 00:36:47,199
down.
449
00:36:47,659 --> 00:36:56,434
So we're we historically have been virtually a
100% active, but we're looking now at adding to
450
00:36:56,434 --> 00:37:06,195
our public portfolio, you know, maybe a 10 or
15% position in a relatively inexpensive index
451
00:37:06,195 --> 00:37:10,659
fund, so so that at least we have some part of
the portfolio matching our benchmark.
452
00:37:10,960 --> 00:37:15,679
Warren Buffett famously took the opposite side
of that trade and made a bet, with a hedge fund
453
00:37:15,679 --> 00:37:20,500
manager, Ted Cies, on whether hedge funds would
outperform index funds.
454
00:37:20,744 --> 00:37:24,764
Why does Caltech focus so much on active
investing in the public markets?
455
00:37:25,144 --> 00:37:33,304
We believe in general that if we're asked to
outperform the indices, which we are, I mean,
456
00:37:33,304 --> 00:37:39,609
we're we're benchmarked to various asset and
sector indices.
457
00:37:41,269 --> 00:37:49,525
The one thing I know for sure is that if I
invest only in indices, then due to fees, I
458
00:37:49,525 --> 00:37:51,545
will underperform the indices.
459
00:37:52,164 --> 00:37:58,025
It's we're pushed in that direction as a result
of attempting to outperform.
460
00:37:59,445 --> 00:38:10,050
Part of it is active management, but part of it
is investing in areas that aren't necessarily a
461
00:38:10,050 --> 00:38:10,949
right on benchmark.
462
00:38:11,010 --> 00:38:15,704
That's particularly true in our alternative
asset classes.
463
00:38:16,164 --> 00:38:23,304
As I mentioned, where we might be investing in
lesser correlated or completely uncorrelated
464
00:38:24,244 --> 00:38:31,170
asset classes, which particularly in a drawdown
situation where the where the equity markets
465
00:38:31,470 --> 00:38:37,890
have drawn down, those uncorrelated assets
should allow us to outperform.
466
00:38:38,670 --> 00:38:49,135
So in in general, we've tried to remain active,
tried to find really smart people who view the
467
00:38:49,135 --> 00:38:55,269
market similarly to us, are, you know,
relatively conservative, aren't super
468
00:38:55,269 --> 00:38:58,009
aggressive in their approach.
469
00:38:58,869 --> 00:39:03,849
And because at the end of the day, what we're
really trying to do is we're trying to generate
470
00:39:03,909 --> 00:39:10,255
a return consistent with our payout and not
lose a lot of money, as I mentioned earlier.
471
00:39:10,715 --> 00:39:15,454
So we, we look for active managers that can fit
that mold.
472
00:39:15,595 --> 00:39:20,235
You mentioned that you see hedge funds as
portfolio portfolio volatility reducing
473
00:39:20,235 --> 00:39:20,715
instruments.
474
00:39:20,715 --> 00:39:21,840
What did you mean by that?
475
00:39:21,920 --> 00:39:22,000
As
476
00:39:22,000 --> 00:39:32,719
I mentioned the the before the the idea is to
have a portfolio of less correlated or non
477
00:39:32,719 --> 00:39:40,755
correlated assets that will smooth out the
return of the portfolio over time.
478
00:39:41,375 --> 00:39:47,554
So with, as I mentioned, about 25% of the
portfolio in in these lesser or uncorrelated
479
00:39:48,815 --> 00:39:58,010
assets, even when we have an equity drawdown,
I'm relatively comfortable that those assets
480
00:39:58,150 --> 00:40:01,610
will at least generate a positive return.
481
00:40:02,150 --> 00:40:08,694
They may not generate the return that we
expected, and and those assets generally, we
482
00:40:08,694 --> 00:40:13,674
look for something in the high single digits to
mid double digits.
483
00:40:15,014 --> 00:40:20,960
And we may not, you know, in in a tremendous
drawdown, you know, the old saying is all
484
00:40:20,960 --> 00:40:22,159
correlations go to 1.
485
00:40:22,159 --> 00:40:29,679
So even if you thought you had an uncorrelated
asset, you may see a temporary price
486
00:40:29,679 --> 00:40:30,179
correction.
487
00:40:30,880 --> 00:40:37,905
But those typically are temporary, they tend to
be liquidity driven, and so we can depend on
488
00:40:37,905 --> 00:40:46,260
those lesser correlated or low or uncorrelated
assets to deliver a different return stream
489
00:40:46,319 --> 00:40:49,139
from our equity exposed assets.
490
00:40:49,279 --> 00:40:53,380
And that and so that combination reduces
volatility within the portfolio.
491
00:40:53,760 --> 00:40:53,920
Yeah.
492
00:40:53,920 --> 00:40:58,284
It's sort of like having cash on the balance
sheet, having even a little bit could could
493
00:40:58,284 --> 00:40:59,585
basically smooth out return.
494
00:40:59,804 --> 00:41:03,744
Why are you so concerned with draw downs versus
expected value?
495
00:41:03,885 --> 00:41:04,125
Yeah.
496
00:41:04,125 --> 00:41:12,489
As I as I mentioned before, the the the
institute depends quite heavily on, a steady
497
00:41:12,869 --> 00:41:17,289
stream of income or or payout from the
portfolio.
498
00:41:18,630 --> 00:41:25,590
Secondarily, well, as I mentioned before, 22%
of of our operating budget is dependent upon
499
00:41:25,590 --> 00:41:26,085
the payout.
500
00:41:26,644 --> 00:41:31,784
The second issue with our particular particular
portfolio is that our payout is is relatively
501
00:41:31,844 --> 00:41:34,105
high compared to our peers.
502
00:41:34,644 --> 00:41:42,460
We are, depending on how you calculate it,
somewhere in the mid 5% range on payout,
503
00:41:43,159 --> 00:41:50,760
whereas I think you'd find the average among
many of our peers in the probably mid 4%, maybe
504
00:41:50,760 --> 00:41:52,859
high 4% range.
505
00:41:53,320 --> 00:42:00,275
And so the combination of those 2, causes us to
be a little more conservative.
506
00:42:00,735 --> 00:42:02,035
And dumb question.
507
00:42:02,655 --> 00:42:03,855
Why why does that matter?
508
00:42:03,855 --> 00:42:09,855
So in your most extreme of the 6 kind of
financial crisis is I think it took 5 years to
509
00:42:09,855 --> 00:42:10,515
get back.
510
00:42:10,929 --> 00:42:13,730
You know, clearly you have 5 years of budget.
511
00:42:13,730 --> 00:42:20,130
So talk me through the math about why draw
downs are are critical when you have a mid 5,
512
00:42:20,130 --> 00:42:22,150
high 5, distribution
513
00:42:22,835 --> 00:42:23,154
for some.
514
00:42:23,154 --> 00:42:29,094
Well, I'm not gonna walk you through the math,
but I can give you a real life example.
515
00:42:29,154 --> 00:42:29,474
Yeah.
516
00:42:29,474 --> 00:42:32,934
I joined Caltech in, September of 2010.
517
00:42:33,634 --> 00:42:46,289
The 07, 08 drawdown at that point was starting
to have a very meaningful impact on the payout
518
00:42:46,430 --> 00:42:53,994
based on the the calculation of of how we look
at the balance in the endowment and what
519
00:42:53,994 --> 00:42:55,535
percentage that gets paid out.
520
00:42:56,075 --> 00:43:07,130
We had quite dramatic budget cuts in 2009,
2010, uncomfortable layoff of of many people.
521
00:43:07,750 --> 00:43:10,170
And so it's it's real world stuff.
522
00:43:10,230 --> 00:43:14,969
I mean, we have on campus, we have 3,000
employees.
523
00:43:15,750 --> 00:43:26,335
And if we have a sustained drawdown in the
endowment, it's, unfortunate, but, we're gonna
524
00:43:26,335 --> 00:43:33,869
have to cut costs because we depend on that
payout in order to to keep our budget stable.
525
00:43:34,269 --> 00:43:34,769
Absolutely.
526
00:43:35,150 --> 00:43:39,550
You mentioned a big part of my job is to be an
acoustic wall to keep noise away from my team.
527
00:43:39,550 --> 00:43:40,670
What did you mean by that?
528
00:43:40,670 --> 00:43:48,214
As a CIO, there's a lot of managing up and
managing down.
529
00:43:48,514 --> 00:43:56,534
Part of my job is, of course, asset allocation,
managing the people in my office, reviewing
530
00:43:56,594 --> 00:43:59,335
investment ideas, approving investment ideas.
531
00:43:59,474 --> 00:44:07,150
But another part of my job is managing the
investment committee and managing, our
532
00:44:07,150 --> 00:44:12,510
president and and other and I don't mean that
in a pejorative way as if I'm managing him, but
533
00:44:12,510 --> 00:44:19,804
communicating with him, liaising with him,
liaising with other members of the senior
534
00:44:19,804 --> 00:44:28,125
management of Caltech, communicating our ideas
and what we're doing and the risks we're
535
00:44:28,125 --> 00:44:28,625
taking.
536
00:44:29,885 --> 00:44:35,400
However, I want my team to focus on investing.
537
00:44:36,739 --> 00:44:49,125
And so part of what I tried to do is make sure
that any, as I called it noise, but but any
538
00:44:49,125 --> 00:44:59,449
distractions that might be coming from campus
or from the investment committee or from any
539
00:44:59,449 --> 00:45:11,204
other area, that I'm able to absorb that and
allow my team to focus on on what they do best,
540
00:45:11,525 --> 00:45:19,925
which is finding great managers, monitoring
great managers, and investing in great
541
00:45:19,925 --> 00:45:20,425
managers.
542
00:45:21,125 --> 00:45:28,380
And so if I can keep them from having to worry
about, you know, what's going on around them.
543
00:45:28,380 --> 00:45:33,820
I think it allows them to perform in in a
better way.
544
00:45:33,820 --> 00:45:38,320
Do you believe in the principle of praise in
public, criticize in private?
545
00:45:38,539 --> 00:45:46,934
I believe definitely in the principle of praise
in public and mostly praise in private.
546
00:45:47,714 --> 00:45:59,050
I am the type of manager where I give the
credit for positive things to my team, and, I
547
00:45:59,050 --> 00:46:04,909
take the blame for negative things that happen
within my purview.
548
00:46:05,690 --> 00:46:07,369
I think my team appreciates that.
549
00:46:07,369 --> 00:46:08,505
I mean, they look.
550
00:46:09,065 --> 00:46:10,045
We're all adults.
551
00:46:10,184 --> 00:46:11,964
We we know when we've made a mistake.
552
00:46:12,184 --> 00:46:16,764
I don't have to tell my team member when
they've made a mistake.
553
00:46:16,824 --> 00:46:20,579
They they know, and there's no need for me to
pile on.
554
00:46:21,059 --> 00:46:25,800
What what I can do is make sure they learn from
it.
555
00:46:26,660 --> 00:46:30,840
I I can make sure that they understand what
went wrong.
556
00:46:31,380 --> 00:46:41,035
I can offer advice on how they might have
approached the issue or handled the the issue
557
00:46:41,035 --> 00:46:45,215
differently, but we all make mistakes.
558
00:46:45,355 --> 00:46:56,599
And and so I tend not to be particularly
critical, rather I, I tend to focus on what we
559
00:46:56,599 --> 00:47:05,385
can learn from an error, and most importantly,
what we can and will do in the future to avoid
560
00:47:05,385 --> 00:47:06,045
a repeat.
561
00:47:06,105 --> 00:47:08,905
What do you wish you knew before starting 14
years ago?
562
00:47:08,905 --> 00:47:10,764
What do you wish you knew before starting at
Caltech?
563
00:47:10,905 --> 00:47:23,940
I think I probably wish I understood the pace
of, higher ad versus being in the business
564
00:47:23,940 --> 00:47:24,440
world.
565
00:47:24,820 --> 00:47:25,960
I came from banking.
566
00:47:26,180 --> 00:47:28,280
I came from financial services.
567
00:47:28,875 --> 00:47:35,755
And as you can imagine, things move very
quickly in in those types of businesses.
568
00:47:35,755 --> 00:47:42,389
In particular, the firm I worked for for 12
years, a firm called Sun America, which was
569
00:47:42,630 --> 00:47:47,130
founded and run by a gentleman named Eli Broad.
570
00:47:47,989 --> 00:47:49,769
It's very aggressive.
571
00:47:49,909 --> 00:47:56,095
I mean, we were we were always pushing,
pushing, pushing to make things better and
572
00:47:56,095 --> 00:47:57,555
faster and less expensive.
573
00:47:57,695 --> 00:48:02,275
That was, that was what we understood our job
was to do.
574
00:48:02,655 --> 00:48:04,994
Academia runs at a slower pace.
575
00:48:05,535 --> 00:48:07,075
It just, it just does.
576
00:48:07,809 --> 00:48:17,250
And sometimes my personality and my drive for
constant improvement conflicts a little bit
577
00:48:17,250 --> 00:48:22,369
with, with the, culture of, of Higher Ed.
578
00:48:22,369 --> 00:48:28,505
So I, you know, I I I so would I have made a
different decision if I had known upfront that
579
00:48:28,505 --> 00:48:30,184
things run a little more slowly?
580
00:48:30,184 --> 00:48:32,264
Would I have decided not to go to Caltech?
581
00:48:32,264 --> 00:48:35,724
I don't I don't think so because it's been a
fantastic experience.
582
00:48:35,864 --> 00:48:41,670
As you know, I'm stepping down in in a few
months after a great 14 year run, and I've,
583
00:48:42,289 --> 00:48:44,210
enjoyed every minute of it.
584
00:48:44,210 --> 00:48:52,130
I've learned so much from the institution and
from the faculty and from my colleagues, and
585
00:48:52,130 --> 00:48:55,454
and it's been a a fantastic experience.
586
00:48:55,914 --> 00:49:02,474
But there have definitely been times when I've,
been, you know, banged my head against the wall
587
00:49:02,474 --> 00:49:09,909
because I wasn't able to accomplish something
that, I felt was was important to accomplish.
588
00:49:10,449 --> 00:49:13,670
Well, Scott, thank you for sharing your wisdom
from many decades.
589
00:49:14,130 --> 00:49:15,670
Thank you for jumping on the podcast.
590
00:49:15,809 --> 00:49:16,369
Thank you.
591
00:49:16,369 --> 00:49:17,349
It's been a pleasure.
592
00:49:17,489 --> 00:49:18,549
Thank you for listening.
593
00:49:18,746 --> 00:49:23,626
The 10x Capital podcast now receives more than
a 170,000 downloads per month.
594
00:49:23,626 --> 00:49:26,766
If you are interested in sponsoring, please
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