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- [00:05]
Bill Kelly
Welcome to Educational Alpha. I'm Bill Kelly, your host, bringing you on the ground conversations with business leaders, educators and industry colleagues from around the globe. Educational Alpha is sponsored by iCapital, the financial technology company with a mission to power the world's alternative investment marketplace. Part innovator, part educator, and part navigator of the alternatives industry, iCapital offers intuitive, scalable digital solutions that have transformed how private market and hedge fund investments are bought and sold. With iCapital, financial advisors, wealth managers and asset managers around the world now have access to everything they need to deliver the return and diversification potential of alternatives to high net worth investors. To learn more, visit icapital.com in this.
- [01:01]
N/A
Episode, Bill welcomes Roger Vincent, founder of Summation Capital, to explore the evolving private equity landscape. Roger shares insights from his 30 year career, including his pivotal role at Cornell's Endowment and his motivation for creating Summation to deliver institutional quality private equity access to high net worth investors. They address private equity's shift from an exclusive asset class to a complex industry, the challenges of democratization, the critical role of manager selection, and the importance of fee structures. Roger also discusses the future impact of AI in investment strategies and portfolio construction.
- [01:38]
Bill Kelly
Roger Vincent, welcome to Educational Alpha.
- [01:41]
Roger Vincent
Hi Bill, thank you for having me.
- [01:43]
Bill Kelly
I'm looking forward to this discussion. I think you and I of like mind on many subjects, but not so much so we're not going to find some areas of healthy debate in the course of these next 35 to 40 minutes, which I'm looking forward to. One of the catalysts for us getting together was our common friend and former colleague in both cases, Steve Novakovich, who joined Kaya a couple years ago and he's just been an outstanding AD there and has done a great job advancing our curriculum. And I think having come from the Cornell Endowment where you once were, Steve understands the mindset of a very sophisticated allocator which has been a tremendous help to us because ultimately we have to be a resource to the investment community globally and has a great pedigree and been awesome for us. And I know the two of you did overlap as well, so if that doesn't get him a raise, I don't know what will.
- [02:35]
Roger Vincent
But I'm glad you mentioned Steve. It's wonderful to see what he's doing in developing his own thought leadership. I think one of the things that you find a lot inside Endowments is people who like the educational side of what we do. And Steve has really become, as I say, a great thought leader in the industry and I encourage anybody who's Listening. That's not following him online to do so. Hi Steve, Glad to see you're doing so well.
- [02:59]
Bill Kelly
I appreciate that. And I think you yourself continue to be a student of these markets and have evolved several times over. And maybe with that transition, Roger, maybe a little bit of your background and experience leading up to the founding of Summation, which I think was just less than a year ago.
- [03:15]
Roger Vincent
Just over a year ago. Now time is flying. I really have spent my whole career in the private equity space segment of the financial markets, but I've done quite a few different things and so I'll give a little bit of that background. Hard to believe, but this June will mark 30 years since the day I walked into DLJ, one of the great investment banks and investment firms of the 1990s, before and after that as well. But I was primarily there in the 90s and started my career. The beginnings were primarily on what I would call the GP side of the house and among other areas that DLJ was renowned in, it was renowned for its principal investing groups and there were primarily two of them, DLJ Merchant Banking and the Sprout Group which did their venture capital and growth equity investing. While the merchant banking was primarily buyouts and after a short stint getting trained up on the investment banking side of dlj, I was asked to join the Merchant banking group and really learned the private equity business from the ground up, how to do deals, working with some of the great people in the industry have gone on to run and build a number of very notable firms. So it was a wonderful place to start. I ended up spending a little over seven or eight years there just through the Credit Suisse acquisition of dlj. Got to see a tremendous amount. As I said, I was both on the buyout side as well as the venture and growth equity side which happened to coincide with the.com boom and the.com bust. So a lot of life and investment lessons were picked up very early in my career. I then had to find a new seat as it were after the Credit Suisse acquisition resulted in neither of those two investment groups raising subsequent funds. After a short stint getting my mba, I landed at a lower middle market buyout fund in New York called Founders Equity. Spent the better part of a decade there becoming a partner, leading deals, starting to build my personal track record as a private equity GP and investor. But I had an epiphany that I wanted to be a little bit wider than what I was doing in the GP side. I ended up coming up with this analogy that being a GP is a Little bit like spending the rest of your life in your microeconomics class. It's all about the theory of the firm. And I happen to love economics. When I was in school, I loved my micro class, but I also love my macro class. Being an LP is a little bit more like sitting in your macroeconomics class. And I wanted to scratch that itch as well. And in 2011, 2012, I had this idea that the experience I had being a GP at this point at three different firms doing three very different types of private equity investing would be very useful on the other side of the table with an lp. And so I set out to do that career pivot from the GP side to the LP side and was very fortunate to be connected with the Cornell Endowment as they were looking to restaff their organization and they particularly wanted to bring in some people with direct investing experience. So in 2012, I took over the private equity portfolio of Cornell's endowment and that really was the next meaningful chapter of my career. I spent the next 12 years running that program, designing and implementing the strategy that we executed in private equity. I had a great time doing it. It's a wonderful school, It's a wonderful endowment office. I got to watch the organization restructure and reprofessionalize itself today on a three year basis. It happens to have the number one return track record in its IV peer group. It's an exemplar well managed endowment across the board. But I was ready for a new challenge. With the support of the CIO and the support of the investment committee, I decided to hang out my own shingle. And that was a year ago. It ended up being what we call summation. It really wasn't born out of a desire to be my own boss or be an entrepreneur. It was born out of a desire to see the good work and the insights that we were employing at the Cornell Endowment and that my peers were employing at other endowments to see type of high quality private equity work being made available to other investors. And so I had this observation that it's probably never been easier to get exposure to private equity, but it's probably never been harder to do it. Well, that kind of brings me to where we are today.
- [07:49]
Bill Kelly
A couple thoughts, and I want to spend most of the time where you just left off, Roger, but just one fun observation. When you left Cornell, Leanna Orr, who I know a little bit, she wrote an article about your departure, which was an excellent article. And it showed the very amicable set of rules and comments and Support from both you and the endowment. But they describe you as the longest serving investment officer ever at Cornell's endowment. So is the shelf life 10 to 12 years, which you seem to have eclipsed. And I don't know if that's the normal time frame. It seemed like after 12 years a long time of service, but longest serving investment officer ever, I was a little surprised by.
- [08:30]
Roger Vincent
Yeah, well, Cornell had previously had a bit of a reputation for employee turnover and I think they've largely solved those issues. But if you go talk to any GP and you ask them about the turnover among their LPs, even those with high quality relationships and Ivy League LPs in their LP base will complain that those people turn over remarkably quickly. And they find it a little bit aggravating because the LPs tend to point fingers a lot when GPs have turnover. So the GPS find it a little bit inconsistent when the LPs allow for a similar level or higher level of turnover. And so having consistency in your investment team, I think everybody would acknowledge is incredibly important. And it's more important the longer term horizon that you are investing over. And so private equity, of all the asset classes in an endowment, really is the longest horizon one. And it's the place where you really need to have that consistency and longevity. And it doesn't always have to be the same person. If you build a lot of good frameworks and institutional knowledge into place, I think that that consistency can survive the departure of a person and that's my hope for what we built at Cornell. But you know, 12 years in the endowment world is actually a pretty long period of time to occupy opposition.
- [09:54]
Bill Kelly
There's always space for a next act. And congratulations on the one plus year of a very successful launch of Summation. I want to talk about some of the logic and the founding reasons behind this, Roger, which you just briefly alluded to. And I don't know the exact age and date of formation of so called private equity, but I would argue it once was an asset class and now has become a very complex industry. And I've referenced on this platform before a chart that prequent put out around the time I entered this industry in the early 1980s when there were 24 general partners in the private equity space in the entire world. So certainly if I drop a pin there, you could very much build the case that private equity was an awesome asset class today. And for some of the reasons we're going to talk about, it has become a very complex industry. And you said a moment ago that really almost today Anybody, including the average investor, very soon an ETF could get access to private equity. They can already in private credit. So it is widely available. But what are they getting in return for a substantial fee they're paying over and above what the public markets are offering. And if I think of just one entry point for this question, performance dispersion. The median returns are largely undifferentiated, especially if you bring it back to a PME type of quotient for the IRR ARR. And if I look at the median return from up to the top quartile, it's separated by thousands of basis points. So this brings up the fact that manager access, very, very important due diligence, very, very important. Thinking about not just private equity, but private equity in the buyout space, growth vc. A lot of variables in place. So somewhere in there there's a question. But maybe some of your observations about do you consider an asset class or is it my definition a much more complex industry?
- [11:52]
Roger Vincent
Now we certainly call it an asset class. But I think one of the big shifts over the last 10 or 15 years was to stop thinking about private equity as part of alternatives group together with private real estate and private credit and hedge funds, and start taking each one of those segments of that alternatives bucket and aligning it with a traditional asset class and just saying, hey, it's the illiquid version of an existing asset asset class. In the case of private equity, obviously, equities, we came up with some nomenclature which we said, look, that's now called total equities. Total equities is comprised of liquid equities and private equities. You could say you have total credit comprised of liquid credit and illiquid credit. Same thing on real estate hedge funds. We can have a longer debate on where hedge funds should go. I want to come back to your data point on 24 GPS globally in the 1980s. I tried to get to that number when I started my career in the mid-90s and I think it was a couple of hundred. So already by that time there had been some nice expansion and access was almost impossible. I mean, very few people were able to access private equity. So the access to where we are today has gotten very simple to get at least a little bit of exposure. But now there's probably 10,000 GPS in the market. And so knowing which ones to go with has become a lot harder. If they're only 24, they probably all did pretty well. And if you had to, you probably could differentiate among 24 vehicles. But what do you do when there's 10,000 of them. And so that's where I say, while access has gotten easier, quality has gotten harder, manager selection or access is really critical. There's, as you say, thousands of basis points of differentiation between quartiles within private equity. Being able to get somewhat reliably into the first, if not the first or second quartiles is incredibly important. One of the reasons we founded Summation is we just don't think everybody in the world who wants or should have some private equity in their portfolio should try their hand at manager selection. If you get it wrong, and lots of very sophisticated people get it wrong, and you end up in a fourth quartile manager, you live with that mistake for an extraordinarily long period of time. We think that intermediation level, what I call the allocator level, where you have a professional team that is designing a portfolio, that is underwriting managers, that is applying selection know how, is very valuable if it's not overpriced. One of the things I got to do at Cornell, which is really unique, is I got to underwrite something like 175 funds over the 12 years I was there. You learn a lot. It's like a surgeon gets better at their surgeries when they have more reps. If you ever have to go in for something, you want to pick the surgeon who's done it. A lot of times you get better at this and you gain insights. And so I'm not trying to say that people shouldn't pick managers if they want to. I'm just trying to say for a lot of people, I don't think it's the right way to spend their time. They will not know whether they have the skills to do it until it's too late.
- [15:09]
Bill Kelly
So you said something very important at the beginning of your answer or observations here, Roger, which I want to come back to because I think it gets into the heart of maybe what you're trying to accomplish in summation and how an asset owner should think, from a Cornell endowment down to maybe the average person on the street, which is equity exposure, is equity exposure. And if I think about most investors, they're either an owner of the business, that is an equity owner, or a lender to a business, a debtor. And depending on the risk appetite, it could be one or the other. But when it comes to thinking about approaching equities, it's not so much. Well, your 6040 is dead to me. And now you got to be 30, 30, 40, which I think is a lot of the refrain I'm hearing versus thinking about inequity exposure and how much of that do you want to be more liquid in the public markets, less liquid private, if you want to free up some cash, maybe use options to get exposure. So is this 60, 40? Is your grandparents or your parents investment model is now dead? Is that the right conversation to be having or should be more in line with what you describe, which I think is the preferred method.
- [16:21]
Roger Vincent
I got to say that how much liquidity and how much risk you want to take, I mean that's just completely personal to every single asset owner. I really have no perspective on what's right for somebody I don't even know. What I can say is, you know, the endowments are a nice sort of stake in the ground. The endowments are interesting vehicles to look at because you can know a lot about them, they publish a lot of their information and you know a lot about their duration and their long term nature and their liabilities. And if you have greater liabilities or shorter duration, you can know which way to adjust the portfolio. And conversely, if you have a longer duration or time horizon or higher risk appetite, you can know which way to adjust the portfolio. But there's a lot of very smart people around these endowments, both in the staff and in the investment committees, as well as external advisors. And so the fact that they are all ending up with very similar portfolios and very similar strategies gives you some indication that these are smart portfolio construction choices and smart strategies. And so among the ivies where I tend to track the data, or at least I did while at Cornell, what you'll find is most of them are operating within a 60, 40 to 70, 30 risk appetite range. But then importantly, almost nobody around that table thinks that they are going to get meaningful alpha from public markets. So they're really trying to maximize their equity exposure to private equity, to both capture an illiquidity premium and to capture an opportunity for alpha through manager selection. And about where they've ended up is that they can reliably have roughly 50% of their equity exposure in private equity. I really don't expect it to go up from there. So you said before 30, 30, 40, and I assume what you meant by that was your 60 was getting split in equal parts liquid and illiquid equities. And I think that's a very value maximizing portfolio construction. And if you said no, we want to take a little more risk and have a 70, 30 type risk exposure, then I would say, okay, take your 70, divide it in two, and that's about where your maximum target for private equity should be. As you probably know, the endowments have led most other asset owner cohorts in terms of how much exposure they have to private equity. And there seems to be a fair amount of evidence that other asset owners, like hospitals, like insurance companies, like pension funds, even now, like individual investors, are starting to edge up their private equity exposure in that same direction. And eventually what I think they will find is there's an upper limit. And the upper limit is defined by the duration of your capital and your liabilities. In the case of the endowments, it's typically a 5% annual liability, which gives you a duration of about 20 years. So 5 times 20 is 100% of your portfolio would have been sold every 20 years. And so there's some pretty simple math that you can do to understand the limit of how much private equity you should have. It's unique for every investor. And I get asked a lot, you know, how much illiquidity premium should we expect and want for private equity? And the answer is, well, you should want as much as you can get. But if you had absolutely no need for the money for all of eternity, then you should only need a basis point above public markets to incentivize you to give up liquidity that you're not going to use otherwise. Now that's of course the most extreme example. And most investors are going to say look, I'm giving something up. I want hundreds of basis points. And whether it's 100 or 200 or 300 or 500, I think is the individuals choice, not us the allocator to figure out. I can say what I think the industry will give, then other people have to say how much appetite they have for that.
- [20:25]
Bill Kelly
I know that you're dealing with the ultra to high net worth individuals and I want to go all the way down to the average individual investor. And then we can come back to summation. I know you've commented a lot on democratization as I have too. So your thoughts will be helpful here too. If I talk to the average investor and how am I defining that below the ultra high net worth say? And if I say to them why do you want access to the private markets and what's your expectation? A good answer would be I want exposure to risk premia I can't get in the public markets. I think that's a good answer if people are brutally honest with that question. I think the answer I would get more often than not is I want higher returns and Higher returns have more risk attached to them. And what does that mean on a risk adjusted basis? And then, oh, you want high returns and as much liquidity as you have in Your S&P 500 index fund, I can make that happen for you as well. But the more there's a misunderstanding about expectation and the more I'm accommodating the liquidity needs when the underlying is illiquid, I just don't know if it's going to end well. And I've got some thoughts about the dynamics of the DC versus the DB space. But before I get into that, am I right in that the motivation is people think they can get higher returns as opposed to exposure to risk premia like the small cap space, which is largely a private market phenomenon? Now, in my opinion, I would firmly agree with you.
- [21:57]
Roger Vincent
I mean, we spend a lot of time on the theoretic side of our financial decisions, but we also report up to a committee. I've got to say, most people are making actual investment decisions on things that don't come straight out of the University of Chicago. I would have to believe that the median investor is focusing on private equity for higher returns, not for some esoteric view on risk premia somewhere. And I also share your view that it probably is not going to end well. And it's not that I don't believe in private equity or believe in private equity for the long term. You've got to get it in the right way. A lot of these vehicles that are coming out are not getting good portfolio construction and then they're layering on so many fees that you have to imagine they're eating up all of the incremental alpha in the system. And I put this question to a group of industry participants that had gotten together to talk about interval funds, which give you some exposure to private equity and some liquidity. I call it quasi private equity and quasi liquidity because it doesn't really give you either one in great measure. And I pointed out the fact that while there might be individuals in that room that were going to do so well that their fees were going to be worth it after fees, but on average, if the room represented the whole industry and we could only produce average returns as a group, and we were charging fee loads that were above the illiquidity premium of the asset class, weren't we as a group talking about selling a product that had a negative alpha to it relative to fully liquid equity markets? And there wasn't a lot of appetite to engage in that dialogue. And perhaps the best answer I heard that day was, well, isn't that what we do with mutual funds? I'm afraid that the industry is setting its target a little bit too low to give investors what they want on the surface, but at a fee level that ultimately is not going to serve them well. And in 10 or 15 years the SEC is going to come knocking on the door of the industry and say, hey, we experimented with this idea you guys were pushing us towards of making exposure more widely available. And now 10 or 15 years later people are looking at their IRAs and saying, I would have been better off just being in the S&P 500. This experiment was a failure. And so I think that's sort of the base case for where this is all heading.
- [24:30]
Bill Kelly
I think, Roger, if the question is why does the industry care? Why has democratization become such a catchphrase? I've been reminded as I looked up some numbers just in advance of this call and you're going to be either generally or specifically familiar with this. So this is as of the middle of last year. If anything, these numbers may have gone down given what's gone on in the markets. But the US retirement marketplace crossed $40 trillion for the very first time. And interestingly, public and private sector DB plans, which really drove the PE space for many many years were about 11.7 trillion of that 40. So about 25%. DC was almost as much 11.3 trillion. But if you put on self directed and IRA accounts that was another 14.5 trillion. So you've got of that 40 trillion just to round this up. About 25 of it is controlled by the individual IRA first and defined contribution combined. And the DV sector is about half of that. The Willie Sutton analogy, why do you care? Because that's where the money is. So clearly the machinery is geared toward convincing those individuals they need greater access to the private markets. That's going to fund fund number X +1. And I think on the plus side, if capital formation is happening in the private markets, the home of yield is in the private markets. We need to find a way of doing this responsibly. But if we're just going to add this to the lineup of offerings in a 401k. So I've got XYZ index fund, another mutual fund, and oh by the way, here's fund X at this GP who does the due diligence that is really part of the institutional model that you saw at Cornell and a lot of the big DB plans have. So I think absent that due diligence that is a big missing factor for this to be successful.
- [26:25]
Roger Vincent
I do believe that there needs to be professional intermediation between the vast majority of asset owners and the GPs, the underlying investors in the industry. And I do believe that there should be democratization. I'm not as cynical as to say, hey, it's happening just because that's where the money is. The GPS want the money. I can tell you the endowments would not survive very long if they didn't have access to the returns that they were getting in private equity. Is there a strong argument to say this industry should be kept small enough and hard enough to access that only the 1% institution of the world get to benefit from it? I mean, these are wonderful institutions with needy missions, good missions. They need the returns. But there are a lot of people out there that need the returns and are going to put those returns to good use. So I think that other asset owners should have good access to private equity. My issue with it really is just the model and whether they're aligned and whether they are low cost enough that without being heroic on manager selection, which individuals can do, but the industry as a whole has to be average, that it's a positive for the average investor. So our model is very focused on this. We are trying to not cost anything to our investors above the 2 and 20 that they would pay as a headline price to get into the private equity industry. And so there's some innovation that we've done on our fee structure to try and get to a fee neutral structure. You go and look at your average democratization vehicle and there's probably 4, 5, 6, 700 basis points of extra fees in there. That's the issue is there's maybe, I think a reasonable number for your estimate of illiquidity premium and private equity is 300 basis points. As soon as you see more than 300 basis points of cost in your allocation layer, you have got to be thinking that I'm now generating a vehicle with negative alpha. And if I want to overcome that, I have to have that much faith in the intermediaries, the allocators, manager selection and portfolio construction skill. But you're starting in the hole and that's not a great place to start. I'd rather be starting with 300 basis points of illiquidity premium for taking on the illiquidity and then gaining alpha because of good manager selection and portfolio construction on top of that. I mean, that's just up at our starting point.
- [28:58]
Bill Kelly
It took me about 30 minutes to get there. But this Brings us right to the heart of summation. So as a transition, back to my analogy that if I'm looking down my offerings in my 401k plan and I have pedestrian index fund A, pedestrian index fund B, but then I've got son or daughter of summation capital, that's going to be sort of my outsourced CIO for allocating to the private markets. I should be willing to pay a fee for that because now I've got something, I've got an agent that's going to help me accomplish this. So am I right in thinking that the parallel to summation is that if I'm an ultra high net worth individual, I've obviously had a very accomplished career, I've got a big balance sheet of investable assets, I can pick the public index funds quite well and decide how much equity exposure I want. But then when it comes to the private markets, or maybe more specifically for summation private equity, I really don't know where to begin. Would it be fair to describe summation as my outsourced CIO for the private equity sleeve of my portfolio?
- [30:06]
Roger Vincent
It would. In practice, I think that type of asset owner that you just described, I mean they do have some access, some knowledge in some segment of the private equity market. They are a successful business person, they're a wealthy individual or family, they know people in the private equity industry and they oftentimes can get some access there. And sometimes it's very good. Other times it just so happens that your next door neighbor's not a great private equity investor, but you think they are because of what the extension they just put on their house or some other signal of performance that they are exhibiting. What we tend to be for our investors is the diversified private equity access. And if you look at the endowments, they place a great premium on getting high quality diversification. And there are very few asset owners out there that know the full breadth of the private equity industry well, everything from venture capital to growth to buyout around the world in all the markets in which private equity is done so without making this their full time job, and it is a full time job for at least a small team, they're not going to get what I would call endowment quality private equity, which has that diversification feature to it. And so what we do for a lot of them is give them that center of the plate, high quality portfolio and then they can do some of their own manager selecting angel investing, direct deals on top of that to customize their exposure to what is particularly meaningful to them or Whether they think they have particular insights, but what oftentimes doesn't work well is for people who are doing a little bit of private equity, but they're doing direct deals, they're picking some funds, but they're not building a high quality portfolio. On the one hand, they're trying to do a little bit too much and we can be that outsource for that piece of the portfolio. And then for other of our investors were 100% of their private equity. They either don't have access or don't want to spend their time selecting managers from among their network or doing deals. They have other interests in life and they just want to know that they have a portion of their assets in private equity, that it's as high quality as what they think a great endowment would get, which is what we're trying to achieve. And they're getting it for a very low and aligned price.
- [32:30]
Bill Kelly
And you mentioned it earlier, I believe, either directly or in passing. Roger, criticism of the private equity model is that am I paying a lot for beta? I think of the concept of paying up for alpha. It's very hard to find a perpetual alpha machine and if I can find that person, I should be willing to pay a lot for that kind of access. If it's pure beta, I can get for one or two basis points in the public markets. Why am I bothering it with first place? So I think you would say your model is based on charging your underlying client for alpha, not beta. How does that work and how do you determine and separate the alpha from the beta component?
- [33:09]
Roger Vincent
I'd like to think that the endowments, as I've said, are really being very thoughtful about their approach to their overall endowment, but also to private equity as a group. They have been in the asset class pretty much longer than anybody and they've done more of it as a percent of their portfolio than any other cohort of asset owner out there. They've had to think a lot more deeply about how to do it and how to do it well. One of the things you will observe if you look is that they pay a lot of attention to incentive structures. Many years ago even the large IV endowments outsourced much of their private equity to fund a funds. And the typical fund of fund structure is called 1 in 10 and 10% is what we're really focused on. It's the carry and it's paid on all the profits that the vehicle generates. But as you are observing, that includes both the beta of the market and any alpha that they achieve over the Last four or five decades, the cost of equity beta has gone from something that was meaningful in the 80s, when you started in the 90s when I started, to one or two basis points today. So the idea of paying for equity beta in a portion of your equity portfolio, the private portion, is a little bit galling. The PE professionals at these endowments sit around and talk about how irritating it is to see their GPS getting paid for beta, and wouldn't it be great if we could pay them for Alpha? That doesn't exist today in the endowment world. They're only paying their allocation layer for Alpha. The way an endowment works is the team is hired, they're paid a reasonable base salary, but as much of the comp as possible is put into performance in SAP and that performance is based on outperforming in your portfolio relative to a benchmark or in the entire endowment. What the endowments have done is figured out how to pay at least one of the layers of this system for Alpha. I got to thinking, well, are there other vehicles out there where if I'm an asset owner, but I don't happen to have my own professional team and I'm not an endowment, but I only want to pay for Alpha where I can access that same fee, fee structure. And somewhat to my surprise, after a great deal of looking, I did not find one. And so you have this strange world in which the largest and most sophisticated allocators to private equity are paying for it one way and everybody else is paying for it another way, which I would argue is sort of, on its face, inferior. That was a big insight and motivator to founding summation is we wanted to create a fund structure that got people professional exposure to private equity and everything that is entailed in that, but only charge them for what we consider true value add. And that is the alpha. So the second question is, okay, well, how do you define alpha? And we really just borrowed straight out of the endowment playbook. Most endowments define the beta of the equity portfolio as some broad based passive index. Typically it's not something like the S&P 500 because these are global investment vehicles. So it'd be something like the MSCI Acqui or the MSCI World Index that defines the beta that the endowment could have achieved if they had not bothered to allocate to private equity. And the alpha is all of the returns in excess of that. And so what we do for our investors is we measure the performance that we achieve for them relative to what they would have gotten if they just left it in liquid equity markets and we only take performance incentive on the outperformance.
- [36:50]
Bill Kelly
You're using some form of a pme. Maybe it's the agwe. How precise do you need to be about sector and industry exposure? So you might have a portfolio from venture to growth to buyout that's got much more of a tech or maybe healthcare centric exposure. And the index may or may not mirror that. Is that an important part of trying to come up with the separation of alpha and beta or is that getting overly technical?
- [37:17]
Roger Vincent
It's probably attempting to do something that the tools aren't even close to allowing you to do. And so your exposures in private equity are generated through very blunt instruments. You can commit money to a country fund and they might invest in deals that are outside of that country, or a sector fund and they might invest in deals outside of that sector. Or your actual exposure depends on the nav or the underlying performance performance of every single investment you have. So if you have some allocation to tech, but then we end up in a bull market for tech, you're going to end up at a different weighting than perhaps what you had targeted. So these give us some guidelines, but we're not trying to match the index, we're just trying to outperform the index. To do that, we invest in what we think are the world's best private equity firms. But we do it on a very highly diversified basis. And I think it acknowledges an inherent unpredictability of the world. And so yes, we might like tech, we may overweight tech, but we're investing really important money that has to be there far into the future, regardless of whether that sector does great or whether that sector ends up having meaningful headwinds. Same thing on a bunch of geographies. So the hard work is not picking one or two good ideas. The hard work is finding really world class managers, highly diversified set of strategies, sectors, geographies, so that you get both the outperformance of that manager's capabilities and the diversification of being in that globalized and well diversified of a portfolio. We estimate that you can get a beta of about one in a well diversified private equity portfolio. Another interesting debate where reasonable people will disagree, but we think that the goal should be to have that level of diversification that you're not taking, you're taking illiquidity. But beyond the illiquidity, your private equity portfolio is actually not generating additional risk in your portfolio.
- [39:24]
Bill Kelly
And like so many things, Roger, in our industry, it's a marriage of both art and science. And I think being clear as to where you're making those decisions, which you have been, is the name of the game. One last area, and if we have time, I want to ask you about AI and where you see that fitting in either at summation or elsewhere. I think one of the problems we still have to solve for is the wrapper. And if I think about Cornell or any large institutional investor, the drawdown fund was the vehicle of choice and they had the institutional wherewithal to think about manager selection. They sign onto a fund, they make a commitment and then it's drawn down over periods of time and capital's returned. And that's not worked so well in the recent period with DPIs being upside down. But it's a model that is well known to institutional investors when it comes to ultra high net and then individual investors. This concept of an ongoing capital call and a drawdown structure is a very, very hard thing for people to get their heads wrapped around and be chasing a bunch of individual investors when the capital call is suboptimal as well. I know the summation has given this part of the funding of capital commitments some thought and just curious to get your views on that subject.
- [40:38]
Roger Vincent
It's another good reason to have a professional layer at the allocator layer. Part of the work of that layer is not just manager selection and portfolio construction. It's the operational complexity of having a diversified portfolio composed of of drawdown funds. A well diversified PE portfolio as defined by how an IV endowment might construct it is probably going to have something like 50 private equity managers and it could have upwards of two or 300 funds from among those investment firms. You're going to be generating maybe double digit capital costs every single month. So the operational complexity of doing this would be beyond the reach of almost any individual investor. I mean, you really have to have a team processing all of this. But what I think would work really well for a lot of asset owners is to have a vehicle that wraps that all up for you in part of the work process that the vehicle is doing so that you get 1k1 distributions. Nobody minds getting dozens of distribution checks a month, but ideally you should have a solution for getting dozens of capital calls a month. You know, some ultra high net worths are well set up and you can outsource the logistics behind this to do it themselves. But we wanted to make our vehicle available and practical to people that didn't have that. And so I think another part of being a really good allocator or allocation layer is to Try and make this all very turnkey for your investor. And so we developed a vehicle where our investors could either invest in a drawdown vehicle with us and manage their unfunded liabilities themselves, including the capital calls and the processing of it, or we could do it for them. We do it all without charging anything additionally. And now what the investors do is they determine how much of their portfolio they want managed in highly diversified private equity, long duration assets, they hand over to us that portion of their portfolio, we get what we call a total equity return on that money. So they know it's all invested in equities at any one point in time. But we're incentivized to try and optimize how much of that is in private equity versus liquid equities. And the private equity is where we can earn alpha and an illiquidity premium. So we want to get as much in there as possible. But you've got to be very careful. If you over allocate to private equity, which even a bunch of very prominent endowments did, you can get denominator. And that's both uncomfortable, but it hurts your long term returns. We thought we were very successful at managing without getting hit with the dominator effects during my time at Cornell. Wouldn't a lot of asset owners prefer to outsource the responsibility for that to a professional allocator? And again, the answer is, yeah, I think they would, so long as you're not charging them an amount that would offset the value you're bringing. We don't charge anything for this. So we clearly think it's an attractive proposition for our investors as you think.
- [43:51]
Bill Kelly
About putting that money to work. And maybe you started summation far enough after the end of 2022, so this might have been in the calculus. But how important is secondary exposure? Because if I think about the inefficiencies there and getting in at maybe a very good price point, the benefits of the J curve, et cetera, is that part of your selection? Are you looking at the secondary space?
- [44:15]
Roger Vincent
We typically don't look at the secondary space. This tends to be a little bit of a Roche test for how people view the market. We do think that getting through the J curve in a smart way has a lot of merit to it. There are other ways to do this other than through secondary funds. We've deeply analyzed the secondary market and we just don't think that it provides a lot of alpha relative to public markets. It sounds good. It sounds perhaps too good to be true. Our evaluation is pretty much is too good to be true.
- [44:50]
Bill Kelly
Last remaining minutes Roger and the answer is probably not much, but just curious to know is AI a little bit of the camel's nose in the tent? And how do you see either summation in the industry maybe starting to use it today around manager selection or ongoing due diligence or thinking about any kind of other issues from an investor perspective? And then where do you see it going, say in the next five years?
- [45:15]
Roger Vincent
We're thinking deeply about it, both because we're investing into AI strategies or we're investing into people whose businesses may be confronted with challenges or opportunities from AI. And then we also think about it internally. Like many people on the internal side, we're using it to enhance productivity first and foremost and it's not something that I think is going to be a credible tool for manager selection anytime soon. Time will tell. On the investment side, it's really interesting. I don't think there's any debate that it's a transformational technology, but that doesn't make it any easier to invest in. And to me it's very analogous to the time I spent in venture in the dot com era. The Internet was highly transformative. E commerce, which was very prominent as an investment strategy at the time, ended up taking meaningful market share from bricks and mortar retail. But that didn't make it any easier to invest in as evidenced by the.com bust that followed the.com so one of the advantages of having been around for now three decades is having had some of those experiences and had some of that scar tissue. It gives you a slightly more informed way of approaching the opportunity without trying not to get burned by what may be a hype cycle.
- [46:38]
Bill Kelly
A thoughtful observation and I agree with you. And I'm a little bit older than you in the experience quotient. Nice to know that history and mindset and past experience still matters for something. I've always felt that the machine is not coming for our job, but the person and the machine together is going to change how every function in our industry is performed. And I think the smart professional, the smart investor has got to be thinking about that on a regular basis and you said as much a moment ago, Roger. I really enjoyed the conversation. Happy one year plus anniversary. I know that you're just getting warmed up. I know you had a very successful first fund and I suspect there's going to be more to come. Perhaps we'll have you back on in the second or third year anniversary and continue to learn from you. And nice to know you've taken the very sophisticated investment principles of a successful endowment and brought it back to the individual investor, albeit at the high net worth. But some of these lessons we can learn from models like Summation I think should be very applicable to the average investor where they can get access. But with education, transparency and maybe informed consent from an agent is going to be a critical part of the successful version of that model.
- [47:52]
Roger Vincent
Bill, thank you for having me on. It's fun to tell the story and talk at a deep level about deep insights in the industry. I think there are a lot of threads we could have pulled on a little harder had we had more time. I would love to come and be a guest again and thank you and the whole Kaya organization for doing a good job of educating the world on proper investment principles.
- [48:12]
Bill Kelly
Excellent. All right, all the best. Thanks, Roger. Thank you for listening to Educational Alpha. I'm your host, Bill Kelly. Learn more about the Chaya association and subscribe to the show@caia.org that's C A I a.org See you next time.