← How I Invest with David Weisburd
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- [00:00]
A
Chris, you run Equity Strategies at the Margaret A. Cargill Foundation. What part of the equity market keeps you up at night today?
- [00:06]
B
Being an investor or an allocator, you have to be kind of paranoid in general. So I would say everything. But to be more specific, I would say that AI risk is super topical. Obviously, aside from private credit, which I don't manage and is well publicized in the media, I think software related private equity could see an adjustment period. The AI risk is real. I think CEOs of SaaS businesses should be very scared of being disrupted. The critical part here is making sure that if you're invested in private equity that you have a very good general partner. On the other hand, OpenAI came out in fall of 2022, so it's not new. Deepseek made their announcement in early 25. So hopefully good GPs are aware of risks to traditional SaaS and depending on the asset, not all SaaS is going to be disrupted anytime soon. Think of like system of record critical software compliance software, highly sensitive data. The other thing is today there's going to be a lot of opportunities because everybody's aware of the AI risk. So I think there's going to be a lot of stuff that's coming through the pipe right now that could be quite interesting. And lastly, I would say top 10 tech companies in the US today are I think on average something like 35 years old. So they've gone through desktop, laptop, mobile, SaaS, cloud, and so not all these companies are going to disappear out of the blue. And on the other hand, it could be an incredible productivity boost and that might help asset prices long term.
- [01:27]
A
There's a meta angle to this. Clayton Christensen famously wrote this book Innovators Dilemma, which talked about the disruption of cycles, how the next cycle kind of disrupts the incumbent. But what happened was that this generation of CEOs, Elon Musk, Mark Zuckerberg, Sergey Brin, they all have this book on their bookshelf. So they're all much more self aware. Instead of being like the Kodak or the IBM of last generation, they're trying to actively disrupt themselves.
- [01:55]
B
I think that's a great point. As I wanted to mention, kind of aside from the AI risk, I worry about a lot of what other investors worry about. Sovereign bond prices, higher interest or interest rates spike because of it. You know, we have war going on and I think probably the bigger one is just structurally higher inflation, which I think is, is with us for the rest of my career. That's a big change from the past 40 years. So absent some exogenous shock, I think we're in for structurally higher rates. I'm not saying we're going to go much higher, but I'm just saying that I don't see us going back down below 2% inflation in the next 10 to 15 years.
- [02:28]
A
The national debt also keeps me up at night and thankfully I have a lot of resources. I could call up a lot of people. And it seems to be that the smart consensus view there is that the most likely scenario is not some austerity measurement, but it's the increase of inflation over maybe a decade, maybe two decades that's going to be able to allow the government to pay back its debt. What are your, what are your views on this?
- [02:49]
B
Yeah, I totally agree. I think David Rubenstein said something to this effect a couple of years back is that he basically made the point of like you cannot cut entitlements, you cannot raise taxes too much more. They're already very high in many states and federally. So the real way out of this is to slightly inflate so 3%, 3.2%, 3.5% inflation, which will significantly help over 20 year period. On the other hand, you have a new Fed chairman coming in who I think generally is considered a hawk and it'll be very interesting to see if this plays out. If I were to guess, I would say the new Fed chair is not someone who's going to tolerate 3 plus percentage inflation.
- [03:29]
C
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- [05:14]
A
howinvest One of the unique things about AI and this tech revolution is that it's not limited to the technology space in that if you had a biotech revolution, biotech might be transformed, but it's not going to transform SaaS companies.
- [05:31]
C
Talk to me about that.
- [05:32]
A
How do you look at the AI revolution, how it affects your entire equities portfolio?
- [05:37]
B
You mentioned biotech. It's already disrupting biotech. There's numerous examples of AI led drug research which is creating drugs much faster than they have in the past. It affects productivity everywhere. We're using it internally. I'm sure other companies and other foundations, endowments, et cetera, are using it. So that's the kind of crazy impact of this, which is still unknown. Right. As I mentioned, it might lead to a massive productivity boost. And similar to software, it's not a vertical, it's across every single thing. It'll eventually be in old school industrials, maybe even utilities and things that are otherwise quite boring. It'll take some time. Again, as I mentioned earlier with the whole critical software type of stuff, I don't know if anyone that runs a nuclear power plant is going to switch to an AI model anytime soon, but over time I think it will. It can disrupt just about everything that we know in the, in the economy.
- [06:27]
A
It's actually a very difficult question to answer, which is, what will AI not disrupt?
- [06:31]
B
My first guess is plumbing or electrical work, you know, kind of behind a wall. If you need a new light put in in your house, I think it's gonna be a long time before they have an AI robot that's gonna come into your house and do that work. Although I think at some point, maybe, maybe they will. I've seen a lot of very interesting roboticization applications that are coming, but I think that might be, you know, a decade plus off, if not longer.
- [06:53]
A
It's a famous Moravec's paradox, which is AI is going to struggle at things that humans could do and humans will Struggle at things that AI will do. MACP decided to put equities, public and privates under one roof, under you. Talk to me about that decision and how has that played out.
- [07:07]
B
We're a relatively young organization and one of the benefits, and there were some negatives too, but one of the benefits of being young is that we were able to kind of whiteboard on how to organize our CIO chose prior to my arrival, I had nothing to do with it, to organize us by risk assets. So equity, credit and fixed income and real assets. I was a high. I was very highly attracted to the structure as it dovetailed well with a piece that I co authored almost 15 years ago. It was entitled Hedge Funds are not an Asset Class Implications for Institutional Portfolios. This basically was the concept that many hedge funds, among other concepts. But one of the concepts was many hedge funds have traditional beta embedded in their strategy. So. So they should reside in those risk assets, if you will. This makes for a much simpler strategic asset allocation as they can be, you know, it can be uniform and singular. You don't have to have separate optimizations. For, for example, you have equity beta in perhaps three or four different asset classes. You have it in private equity, you have it in public equity, you have it in hedge fund equity, and you even have it in some credit portfolios, depending on what the strategy is. So running multiple strategic asset allocation optimizations in a vacuum, and each one of those is kind of clearly suboptimal. Moreover, equity is equity and doing diligence on public, private or hedge equity has significant overlap. There are differences, of course, on the periphery. Some short securities, some use leverage, some are illiquid, but in the end it's all equity risk. I'd also note that I think a lot of other institutions haven't structured this way and I think about why a lot of. At least used to. And I think that very few institutions had large private equity portfolios in, let's say, the 1970s. So they added a private equity group when private equity became popular. Likewise in the 90s, hedge funds became popular. So they added a hedge fund team, which totally made sense. And I think today you'd say, well, why don't they restructure? I just think there's a lot of operational pain there. You'd have to, you know, there's going to be turf warrants amongst people that run those different groups. They're going to have to go to their board and investment committee and seek permission to restructure. There could be job losses. And so outside of a Big catalyst internally, let's say a changeover of a cio or maybe a sustained period of underperformance. I don't see other groups doing a reorg to somehow fit our model. And I'm sure there's opposing views to our model.
- [09:22]
A
You were the second hire at the foundation after the cio. How did you go about building your investment strategy from scratch?
- [09:27]
B
It was clear from the start that we were going to build an endowment like model. I say endowment like because unlike endowments and some foundations, we had a sole donor. So we don't take in donations, we don't do fundraising like many peers in the E and F space. So in terms of risk, we're more conservative for a couple of reasons. First, we don't have fresh capital, we don't have fresh liquidity to work with or to help cushion the liquidity. Secondly, I think senior leadership here is committed to being a reliable donor to our grantees, so we take less risk in order to meet those commitments in both up and down markets. Aside from these differences, the strategy was to create kind of a lower risk endowment like model. So we have much larger allocations to credit and fixed income and real assets than other endowment peers for sure, and some foundation peers as well.
- [10:12]
A
When we last chatted, you mentioned that you use both a quantitative and a qualitative mindset. Talk to me about that and how do you fit that into the investment process?
- [10:21]
B
Until recently, with the rise of AI, especially like super AI, the one that does cognitive disaster thinking and has feelings, et cetera, I don't think that there's a model or a quantitative process that can pick the best managers. So I think the best allocators, and this is somewhat self serving, you know, as I have a liberal arts degree and a MBA from a school that's known for its quantitative analysis. I'll give you an example in. In venture capital, data rooms often are lacking hard data. And the one thing I always mention to staff is that we want to select general partners who lie a little bit to us rather than ones that lie a lot to us. I know that's very cynical, but I think it's hard to develop a quantitative model that could detect how accurate or how inaccurate a GP is being with us. If you work with models or if you have an optimizer, it's going to seek a solution and it might be a corner point solution. The famous example is mean variance optimization. So models love, you know, for example, in this case a return series that are low volume and persistent excess returns. But the Madoff fraud, for instance, was exactly that. It was persistent returns and a low volume strategy. So you can't rely on a model to pick that out because of course it's going to go there. That's what the model is designed to do. The other thing I'd say is like, you know, all models are false by definition. You know, I say that as a University of Chicago graduate school business graduate. You know, I, I'll give another example. I used to build model airplanes, you know, the plastic model airplanes, like World War II airplanes when I was a child. But nobody would ever assume that you'd fly that over the Atlantic because it's a model. So models are extremely useful, don't get me wrong. But one should always consider what is the logic of the model, how accurate is the data going into the model? Again, I mean, variance optimization relies on capital market assumptions. Capital market assumptions are frequently inaccurate. I've got ones in my drawer from 2010, 1112. They're all wrong. And so you have to be just highly aware that you're dealing with a model that's useful. But that is not a perfect solution.
- [12:10]
A
I'm like, you have an MBA from tech school from Dartmouth and a master in psychology from Harvard. And everyone always comments, oh, that should be really useful. But I've actually never met anyone do both degrees. I think it's just there's no dual program. Is my, my simple, my Occam's razor to why more, more people don't do that.
- [12:26]
C
But when it comes to this quantitative and qualitative mindset, if you were to
- [12:30]
A
distill the main takeaways from that, when you're diligencing a manager, what exactly are you looking quantitatively?
- [12:37]
C
What is in the spreadsheet and what
- [12:39]
A
are you looking that's not in the spreadsheet?
- [12:41]
B
The simplest things in the spreadsheet are, you know, are they, are they, are they producing excess returns and what are those excess returns? You know, there's a lot of talk of alpha and then there's excess returns. I say excess returns because I know that there's alpha in there, hopefully. And there's probably some types of alternative beta or betas that make up that excess return. It could be timing, it could be sector selection, things that aren't classically considered alpha. That's something we're going to look at on a quantitative side, you know, maybe digging a little bit deeper is if it's a active equity manager, we're going to look for idiosyncratic stock selection. That's the highest that's the purest form of alpha and so that's got to be high. If it's a hedge fund, we're going to want to see if they're deriving alpha or excess returns out of their shorts. I don't want to just pay to have them short the market if they lose money on their shorts all the time. So that's maybe some of the higher level quant research that we'll do on the qualitative research. That's where it gets a lot more gray and a lot more foggy, if you will. We're looking for consistency and kind of what their strategy is in discussions with them, looking for that consistency through the entire employee stack from partner down to, you know, the first level analyst. It's one of the reasons I like in, in, in person meetings in their offices is that you can kind of get them separated by themselves and, and ask kind of the same questions, similar to what, what a police detective would do in a, in a crime investigation. And so those are kind of the softer things of like hearing consistency across, across what they're doing. And then on the know, away from just the manager meetings themselves, etc. Is you know, referencing, particularly off reference sheet references, which you have to do a lot of work there and kind of triangulate and figure out who, who should I talk to, who's not on this list, who probably knows this person from the past or maybe at their current firm left or you know, situations such as that.
- [14:24]
A
It's funny you use this analogy of a detective, Alex Adelson, who's been on the podcast three times. He's arguably the very best person I've ever met in terms of references. And he got his training as a deposition lawyer. So he knows exactly how to frame questions, how to ask questions and references, which are simultaneously probably the most boring part of manager selection and also probably the most alpha is gained in terms of picking managers.
- [14:50]
B
That would be a great background. I'm sure he's superlative at doing that. One of the things I was going to mention is I took a course, it was years ago by a group of ex CIA counterintelligence people and they basically did this whole study on what people say and how they act. Meaning, like what do they do with their arms? And they call them anchor points when they're lying. And they gave many, many examples and they showed many examples of famous people who were in either depositions or maybe just speaking to the press where they were lying. They're clearly lying. Everyone knows now because the Stories have come out, and it was really enlightening to see something where you can actually begin. It's not totally foolproof. And it's not just that they say one thing, that they're, you know, they're lying, but you can discern or kind of trace together dots if they're doing a lot of these different behavioral traits when they're speaking to you.
- [15:36]
A
It's interesting about references, which I obsess over on the podcast. I just think they're so critical is that you could have two institutional investors sitting in on the same conversation and they have a completely different qualitative read on the reference from each other. Two very experienced people.
- [15:50]
B
That's a good point. I really like the diligence with one of my colleagues. And the reason is, you know, people, you know, I hear things that maybe they hear or they don't hear or maybe I get it backwards sometimes. And so I think it's really helpful to have more than one touch point when you're doing diligence and maybe multiple touch points. I say that multiple touch points, meaning in private equity, I much prefer to meet the general partner prior to a fundraise, you know, a year in advance, two years in advance, you know, meet with them two, three, four times prior to the fundraise. Because in the fundraise, you know, there's at least two things that happen. One, the book is marked up in advance of the fundraiser almost always. And secondly, they're. It's a beauty pageant at that point. They're. Everything is framed in the best light. And if you get in there year, year, two before, and, you know, I always ask what assets are doing well, and then give me at least one example of something that's not doing well. And what's, you know, what's the learning point from that? You get, you get much better dialogue prior to the fundraise, when they're not in kind of sales pitch mode.
- [16:47]
A
You're also measuring the slope. Where were they a year ago? How have they evolved over the last year, or ideally two, three years? You mentioned that you like to go to the manager's office and meet them in their office. Why do you like to do that?
- [17:01]
B
First, we want to establish that they have an office. I know that sounds ridiculous, but I think it's important. Secondly, I want.
- [17:07]
A
Or that they're even human.
- [17:11]
B
Yes, true. Secondly, I want to meet with partners and employees below the partner level. Um, you know, maybe a famous example of this was during Pandemic when they did virtual annual meetings, and I was Convinced, first of all, it was just the three, maybe four head partners that spoke. Secondly, I was convinced it was the script that the general counsel had reviewed. So it was very sterile and maybe not enlightening at times. It's much easier to meet with maybe the, you know, first level analyst when you're in their office. I also start diligence at the front door. What is the mood of the office? When you walk in there? You can sense mood. If you look around and see are people having a chat and in a good mood, how are you greeted at the door? I think that's an important one. I think you can get a sense of culture from the minute you walk in and certainly after you spend a few hours. I also start, I mentioned this earlier, I start with a uniform set of questions so I can get answers that are hopefully consistent and ensure that I have conversations in isolation. And sorry if that sounds paranoid, but I think many investment managers are, you know, they're, you know, investment managers, Wall street, whatever you want to call it, are motivated by most, many, not most, many are motivated by fees. And performances can be an afterthought. And so we're trying to figure out are they, are they high quality and are they really motivated for performance? Not just the, you know, the management.
- [18:31]
A
In many ways, diligence is just the operationalization of paranoia. Figuring out whether what you're being told
- [18:38]
B
told is the truth, that's brilliant. I'm going to use that future.
- [18:41]
A
I want to double click on going to the office.
- [18:44]
C
So is there one office culture that outproduces others? Is a happy office better or do you, are there like chip, chip on the shoulder offices? What's a predictive office culture that leads to success?
- [18:56]
B
That's a good question. I, you know, I don't know if I know, but I'll say this. In places where we've made mistakes, not always, but many times it's bad culture. Partners leave or people below the partner level leave.
- [19:11]
A
Turnover is always bad.
- [19:12]
B
Yeah, exactly. Turnover's bad, especially in a private fund. And so I do want a high performing office that maybe has a little bit of edge to it, but I also want to see a good culture. And I could go into things like this concept of Radical Candor, which is a book by Kim Scott. Anyone? It talks about basically this, this concept, like I'm gonna say what I need to say to you because I care about you and I care about our performance or work as a firm. And you know, I think that's kind of critical. So it's It's a bit of a balance. It's like I don't want everybody all chummy and like all friends and no focus on making sure that the hard work is done and that they, you know, that's a high performance up and out culture. I actually quite prefer up and out cultures. But the up and out culture can also be, it can also have a good culture to it where people are open, honest, communication's good. And so those are the things you're looking for. So it's a little bit of a mix, if you will.
- [20:03]
A
It's kind of like the seven dwarfs. They're working but they're happy. It's kind of like a jolly, jolly working culture.
- [20:09]
C
So as a subset of building out
- [20:11]
A
the equity strategy, you had to build out your venture program. What were your first principles when you went about building a venture program?
- [20:17]
B
I am going to take it beyond venture, but I would say that a couple of things. When we came in, the public side was heavily indexed. So to some extent we could just start working on privates. Plus, privates takes a lot longer to build. It takes longer. You know, funds aren't open all the time. They're closed end funds by definition. So, so we spent most of our time in, in private, starting out. You know, if I, if I think back and think what should I have done differently? You know, I wished and, and we tried, but we, I wish we had delayed and taken our time, I think for two reasons. First, I think we would have made marginally better picks by doing more comprehensive market mapping, for instance, and just taking our time. Secondly, I think we would have had more flexibility. So let's say co investment, direct investment, specific secondaries. Keep in mind, we were building this portfolio during a very frothy period, you know, 2015 through 2019. And my colleague and I were thinking at the time, let's go slow. We're building a portfolio for an entity that will exist in perpetuity. So why, why do we want to rush forward in three to five years? And you know, and the reason we, we, I wouldn't say we rushed forward, but we moved with alacrity, is that there were some technical items in our reporting related to benchmarking and it was painful from a performance perspective to go slow. These are technical items though. The other thing I'd stress is I don't, I don't have a, you know, that's, that's a minor regret. The portfolio is, I think, in great shape. You know, it's doing well. But when I think about, when I Think back, think this was an area of improvement that, that we could have, that may have been improved.
- [21:49]
A
A couple of best practices that I found on that one is this was originally popularized by Founders Fund. They didn't let any of their GPs make an investment in the first year. So you had to see it's impossible. You come into venture, you meet a venture capitalist. By definition, they're the 0.1% of person you'll ever meet. You think, wow, this is awesome. And you invest in the first three funds because they're all 0.1%. You're actually right. What you don't know is that you're actually looking for the.01% because everyone's 0.1%. You want to be in the top 10% of that. So there's this principle of you have to see 100, 200, 300 managers before you really make that first investment. And you could, you could operationalize that. The second, perhaps like very qualitative approach to it that I've seen some foundations and family offices do is start by investing into secondaries because they get exposure to early vintages, so you get more vintage diversification. You minimize the J curve. So you get to start to show how venture works. It's very difficult if you back cycle when you invest and you're like, okay, just Trust me for 14 years, this is going to work well. So there's a behavioral aspect to that. And the best way that I found people kind of institutionalize this patience is North Dakota Land Trust. I have the CIO, Frank McHale. And before they invest, they actually find a way to capture the index of that portfolio, whether with an evergreen fund or with some other mechanism. So they're always exposed to, let's say venture. And then they only invest if they can beat that index. So it allows.
- [23:15]
C
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- [27:14]
A
to be exposure to the, to the beta of the asset class, which doesn't sound sexy, but behaviorally I love that because, you know, you're incentivized not to take action unless it's a really good manager.
- [27:25]
B
A couple things on that is that we did consider secondaries and in retrospect maybe we should have done some. However, I'll note that like, and the reason I say that is at least one reason is that we were building a portfolio. So after we kind of built the portfolio in 2019, our average asset life was like 1.8 years. So we had a portfolio was, you know, deep in the J curve, nothing mature because we were brand new, if you will. And so that would have helped bring in some kind of older vintage and may have been cash flowing out. On the other side of that is that when you buy a secondary, let's say it's a, let's say it's 2020 and it was a 2014 vintage secondary. We're buying, you're buying a 2014 vintage price in 2020, you're not getting a discount, you're not getting a, you're not getting the initial investment that's now gone up 3x or 2x or whatever the case is, you're buying into the 2x or the 3.3x. So I, I, you know, I caution to say like it's a. It's a panacea, you know, some type of magical potion to fix a situation when you're building a portfolio. But, but I also think, like, maybe we should have stopped and done that. Keep in mind, we were building. So it was very much a startup environment. We were building performance systems, we were building risk systems. So to stop and to do a separate project like secondaries, as opposed to just continue to fundamentally underwrite, you know, direct fund investments, it would have come at a cost. We could have done secondaries, but then we would have done less fund investments, and maybe that would have been better. But also, as I mentioned earlier, the portfolio, I think, is in great shape, significantly outperforming our benchmark. And so it's ultimately a positive.
- [28:52]
A
I guess when you're investing for a foundation, you want to get vintage diversification, which means you want to get diversification to different years, especially in venture capital, because some vintages are way up, some are way down, as we know historically. What do you consider a diversified portfolio from a vintage standpoint? Is this three years, six years? Is it just over longer time periods? Give me a sense for how you know that you're adequately diversified.
- [29:19]
B
It's a good question. I think three years is too short. Six years might be about right, but 10 years might also be about right. I think what you want to do is. Because we don't know what the future holds. As I mentioned, back to the mean variance optimization. You're lucky to get the sign right in the S&P 500 in any one year, much less whether it's up 8 or 12 or 15 or 20%. And so because of that, in privates, it's even harder because you commit. But they call the capital, so you don't know when the capital is going to be invested in. So I think you need to be really consistent and have a liquidity that you're putting out kind of. You're equally waiting every year unless you have a crystal ball and you know that one year is going to be better than another, but we don't have one. And I wouldn't suggest to most investors that they should try to do that. So if you're being consistent and constantly putting out more or less the same amount of capital with respect to your assets each year, I think you can achieve that diversification. The other area that I would mention is vintage year risk is a bit of a very complicated situation. I'll give you an example. A fund holds a dry close in September of last year. They call no capital during last year and we have a current situation like we have with a war and lots of concern over the economy. And so they call 15% of the capital this year and next year they call 35% of the capital and the year after that they call 15%. What's the vintage year? Is it 27 because they called 35% of the capital? Is it 26 because that's when they first started calling capital. And so it just creates a complicated measurement as to why what the vintage actually is. We have a rules based approach where it's the year that they first call capital. However, in reality, I know in certain cases it's actually next year's vantage, not this year's vantage because they might only call 5 or 10% this year and they call the majority of it in the future years. So it's a very tricky question once you actually look into the details of when capital is called.
- [31:14]
A
So another way you might have to be more diversified because it's not, if you invest across 10 years, you're not doing 10, 10, 10, 10, 10. It might be 5, 5, 15, 5, 5, 15.
- [31:23]
B
Yes. I'll give one other example. In October of 21, we committed to a fund that I think is a top tier buyout fund in tech. And they didn't call capital for over a year. So I didn't know that in its 2021 budget that I used for the private commitment, they didn't call capital, I think until the end of 22, maybe even early 23. It's very hard to account. Like what vintage is that? I would say it's probably 23, 24 vintage. Even though we committed in 21.
- [31:51]
A
I've been on a bit of a soapbox about this, keeping unfunded liabilities in cash. And everybody says you have to keep it in cash because you don't know if it's going to be called. My perspective is it's better to do it in a diversified public security because you still have 10 days to take it out. Why do you have to keep unfunded liabilities in cash?
- [32:10]
B
Well, because you have to meet those, those capital calls when they come in. I don't think you have to keep in cash. You know, we, we basically funded out of our public equity. If we were an extreme case where equities were selling off super hard or something like this, we might look at, maybe we'll tap governments to fund it, depending on the size of the call, etc. You know, that's managed by a separate team here. So I would Have a. I'd be able to comment on that but. But we basically have a mechanism to fund it out of our, our. If it's a private credit fund, it would come out of the liquid side of the credit portfolio. If it's a, if it's private equity fund, would come out of the liquid side of the equity portfolio.
- [32:45]
A
Right now we have this transformation in venture capital. Call it a tale of two cities where Mark Andreessen jumps on a zoom call. One call raises 15 billion and you have by some accounts 75, maybe even more emerging managers that are on their last fund. What do you see as the future of venture capital? Do you see this consolidation or do you see a reversion to the mean after kind of some of these emerging managers leave the market?
- [33:11]
B
Short answer is I, I don't know. But if I were to guess I, I think I'd note a couple of things. You know there was a big rise in small seed stage VCs between I don't know, 2014, 15 up until I think 2021 or 2022. I think some of those managers will survive and have done well. I think many probably won't raise another fund. But I also feel like there's, there is definitely a bifurcation going on. You have small funds which I would actually categorize between let's say 75 million up to maybe 500 million. And then you have the kind of giant multi stage groups. I think it hold, it makes sense to hold both or at least have both in your portfolio. I say that from kind of a career preservation perspective. But I also find it hard to believe that a multi billion dollar venture fund, or call it whatever you want, multi billion dollar fund, can have historically venture like returns, let's say 3x net or higher, 4x 5x net. It's just a burden of a scale of large numbers. Turning 10 billion into 40 billion is a big lift. Those funds I think frequently are not concentrated. If you have a hundred investments like that, you better get a lot of those right if you're going to achieve a forex return on a 10 billion fund where a hundred million dollar fund, it's a lot, I don't say easier but it's a lot more feasible to achieve a high venture like return.
- [34:34]
A
Back of envelope math. If you have 100 investments of 100 million on average, you have a $10 billion fund. In order for one investment to return the fund you obviously need 100x. But in order for it to return the fund three times, you need a 300x and the problem is you're trying to deploy a hundred million dollars. So that's not a seat check. Although there are some seed companies or some so called seed rounds going on with those kind of capital raises. When we started last year, there was a huge DPI crisis in the private markets.
- [35:05]
C
Has the DPI crisis been solved? Are we still in the midst of it? And if we're in the midst of it, what ending are we?
- [35:11]
B
That's a good question. I think it's in the process of being solved. Our portfolio and I'm talking about private equity. So buyout growth inventory was very close to our model DPI last year for the first time since 2021. It was well below our model in the years in between. But we need the public market to be able to continue to absorb IPOs. And last year was a much better year than it was. There's rumors of some really big IPOs coming here in the venture market soon. Apart from that though, I think investors have to realize that companies, and I'm sure many know this already, companies are staying private much, much longer. I think the number of public companies fallen by over 50% since maybe the late 90s or early 2000s for a couple of reasons. There's a very high cost to, to being public. I'm sure there's other reasons. You know, that the expectations are kind of revenue. You know, years ago you could go public for a very low level of revenue and now I think it's probably approaching 500 million or higher. So you have to be much bigger. So we don't have any expectation that venture is going to suddenly cash flow back much faster, et cetera. And in fact our model, we've extended venture funds to 15 years. And you know, in most of the limited partnership agreements it's a, you know, three to five year investment period, a 10 year term, you know, extensions by the general partner. And I'm like that probably doesn't fit anymore. It should probably be a 12 to 15 year term and extensions on top of that. Because I'd say that the some funds might extend out 20 years.
- [36:36]
A
Very curious because you have a very unique vantage point in that you do both public and private equity, which includes venture capital. Second order effects. If companies are staying private until they have 500 million in revenue, is the hundred to $500 million venture companies, are they not the small cap of the 2010s? In other words, is there not an argument that you should be invested more into the private markets in order to be truly diversified?
- [37:04]
B
There's certainly an argument for that. We used to, you know, model Russell 2000 small cap index as like a private equity index. But you may have to go back and think about that. And so far as companies are, you know, have to be or should be much larger now in order to IPO
- [37:21]
A
the CIO of Hurdle Callahan, which has 20 billion under management, he talked about. He explained why value stocks are doing poorly in the ca in the public markets. Because value stocks are not your value stocks of before today. They're broken SPAC deals. They're companies, fallen angels. Companies that used to be mid and larger cap companies that are now small but the true kind of high octane value and also small stocks. Do you think about that as well on the public side?
- [37:48]
B
I guess we do. I was going to make a couple comments. It's like, you know, value for years. It's come back a lot here recently and it's had a couple of, you know, I think a decent run in 2022. And I was hopeful that once 2022, when rates went up a lot, the big change was everyone was paying for growth because interest rates were zero. The cost of money was zero. So you'd say, hey, you know what, I'll just take growth, I'll get my dollar in the future because the cost of money is low or zero. Once rates went up, I thought, boy, this is going to be really good for value because I want the dollar of earnings today because high interest rate. And that happened a little bit and we're continuing to see it, but it's still not. I mean, obviously like last year, growth was growth that kind of finished up at its highs. And value investing, you know, was a great strategy and it came about, you know, 50, 60, 70 years ago, Graham and Dodd, et cetera. Today there's something like 7,000 bucks or more on Amazon. At value investing, the cost of computing obviously has dropped precipitously. I'm not talking about AI data centers, but just the cost of a PC, et cetera. And so everybody can run value pricing models at a quite cheap level. I think there's a Quantopia website where there's gazillions of value models, et cetera. So everybody's focused on values value. I want to believe in it in terms of theoretical finance, it supports it. But I also think it's just a heavily crowded, heavily watched area. And so absent some type of catalyst in these stocks, I don't see what moves the needle. Given the immense amount of analysis in that space,
- [39:21]
A
what's something central to how you invest today that you've changed your mind on in the last couple years.
- [39:26]
B
Quantitative versus traditional fundamental stock picking in the public side. We looked at our portfolio, we have both types of managers in our portfolio and by and large over the last several years the quants have done incredibly well. They do go through periods of de grossing and de risking. Trying to think of the time periods of that, maybe 2018, end of the year, etc. But in general quant managers have been able to keep up in this market which last year was a very narrow market. And but if you look at it from a fundamental perspective, let's say if you looked at paler, which was trading last year at one point at I don't know, 100 or 200 times sales and even higher PE multiples. So any logical, rational, fundamental investor would look at that and say that stocks way overpriced. However it continued to go up in price. And so a lot of fundamental managers underperformed last year because they couldn't get their heads around incredibly highly valued tech stock. Quants have somehow found, I think through their momentum models an ability to keep up in that market. And you know you can, you can pitch the concept of like hey, we'll keep up with the index in UP markets but we're really going to protect on the downside. And that's a great notion, sounds great. I think it's, you get buy in from investment committees on that, but that only lasts so long insofar as they're going to want some excess returns. That's why we're here. And so I've really kind of started to think is, is does it make sense to hold any fundamental managers in, in the portfolio There are some very good ones that have incredibly good excess returns. But I don't know if we have long enough data sets to determine if that's locker skill. And so what I do know is that many good quant managers have persistence in whatever sub asset class they're in, Whether that's Russell 1000 or MSCI World, et cetera. And so I really think that, you know, while before I thought we needed a balance in fundamental versus quant, I don't know if we want to balance anymore.
- [41:19]
A
And that may not even be figuring in fees. If you're paying 2 and 20 to a fundamental manager, that's 600 basis points per year. That's, you have to be outperforming by at least 600 basis points because that's a fixed fee in that, that's, that's a high Bar.
- [41:33]
B
Yeah, I totally agree. I, I've always looked at a fundamental manager or, I'm sorry, any active manager and if they're outperforming on a five year basis by 1%, that can be wiped away in any one bad year. So you're right, you need a much larger margin for A to factor in the fees that are, that are constantly a headwind and, and B, if they have lumpy performance, which many fundamental managers do, they need to be aware of that. There was a piece written 12, 13, 14 years ago that we actually replicated. It was a vanguard piece, you can find it online called the Bumpy Road to Outperformance. And in that piece they use just mutual funds. But the best managers, the ones that performed over time, you needed sometimes to withstand a seven year underperformance period. The problem with seven year underperformance is that people in my seat are not going to go to the investment committee for seven years and defend the manager. They're going to fire them after maybe three. And that leads to, that's a good career preservation move. It's a bad performance move according to this piece and we replicated it last year and found that that piece still holds, but it's just unsupportable if you want to keep your job.
- [42:34]
A
When I sat down with Cliff Asness, he used that same anecdote. Three years, one year disappointment, two year benefit of doubt. Three years, you're five.
- [42:41]
B
Yeah, exactly. It brings up another guiding principle of mine, which is you can underperform a little bit for a while, but you can't blow up. And if you think about seven years of underperformance would be, I'd put that in the blow up category and that's career ended or potentially career end.
- [42:56]
A
You've had three decades of trial and error. What one timeless piece of advice. Do you wish you could go back to a younger Chris and whisper in his ear in order to accelerate his career or help him avoid costly mistakes?
- [43:08]
B
Again, I'm getting this from another person who I highly respect in the industry. But when I think about throughout the career, we're all going to make mistakes, we're all going to get things wrong. So what really matters is sizing the investment. If you get something wrong that's giant sized, it's a major problem. So the sizing of a trade or the sizing of an investment matters much more than the actual outcome of the investment. Because you're going to get things wrong, you're going to make mistakes. But if you're thoughtful about sizing. Any one mistake or even multiple mistakes is not going to create a major problem either in your career or in the portfolio.
- [43:42]
A
It's funny because I just watched an interview with Stanley Drunkenmiller and he said the one thing he learned from Soros was that he was undersizing.
- [43:50]
B
Yes, I have great respect for him and I think for a macro manager, especially successful ones, I totally agree with that concept. But I'm talking about managing an institutional portfolio in an endowment or a foundation. I'm not a macro manager. We're not a macro firm. And so I think that makes sense in that strategy. I don't think it makes sense in, in a portfolio that we're basically trying to make sure that we can ensure our grant making pay for the organization's costs and keep up with inflation.
- [44:17]
A
I think sizing is such an underrated aspect of investing. There's this whole concept in crypto which is getting off zero. So many people will spend 10 years debating whether they should put all their money into bitcoin or not, or 20%, 30%. But there's a strong argument, at least in that asset class. But in any spiky asset, to just put a little bit to get access to that asynchronous return, so that high upside without having to really put a lot of your portfolio risk.
- [44:44]
B
I know there's lots of differences, but in some ways I would, I would think of it as like an allocation of gold. I think you should have some gold, but you shouldn't have 50% gold. You should have, I don't know, zero to 10, maybe zero to 5% gold. So I think it makes sense to hold, you know, alternative assets like that, but at the margin of the portfolio.
- [45:00]
A
Well, we have a whole nother podcast on gold, but thanks so much for jumping on. It's been an absolute masterclass. Looking forward to doing this again soon.
- [45:08]
B
Great, thanks. Thanks for asking me to join.
- [45:10]
C
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