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- [00:00]
A
So you founded Endurance, which is a family office for three serial entrepreneurs. Tell me about the story of how you were created.
- [00:07]
B
So my two founding partners are, were GSB classmates, Stanford business school classmates. We had all been investors before going to business school and then drank the Kool Aid that they offer in Palo Alto about building startups. And so we decided to sort of put our lots in together and we wanted to work together and help each other in building businesses. But we were candidly a little afraid of the success rate of startups, knowing the statistics. And so there was a little bit of an insurance aspect to, you know, us forming a holding company as the launch pad for that. Additionally, we put some, some kind of shared resources around it and launched a series of companies. And fortunately we had a higher success rate than we thought we would, where five of the six companies we launched ended up being successful. I started, along with my partner Sam Hodges, a company called Funding Circle, which is became the largest small business lending marketplace globally. We merged with the UK company and then took the company public in 2018. And then my partner Chris Clomp, started a company called Collective Medical, which provided hospital collaboration software for emergency departments. He sold that company in 2019 to a larger firm called Point Click Care. And then there were a few others which, which had also been successful. Fortunately, as we started having liquidity from those, I think we faced the decision that a lot of entrepreneurs have, which is, you know, what do you do with the money once you, once you start selling companies? And, and we looked around at the commercially available options and decided that it was too expensive to engage a third party. And we felt like we had very differentiated access to opportunities and so we started investing together. What I mean by too expensive is not, it is the fees, but more so than the fees, it is the fact that, or we saw that many of the commercially available options were sort of beta trackers or, you know, a safe pair of hands, if so that you didn't have to think about managing your money. And that wasn't our perspective. Our view is that even a few percentage points compounded over time of success end up creating a great deal of difference in how much your money does for you. And so we built our own investment office structure alongside our company building efforts. So today we still incubate businesses though now we play more of a founding chairman role in each of the businesses that we create, generally incubating one or two companies a year. And then the investment office has become quite active where over the last 10 years we've invested in about 200 different private funds and also have a wide ranging direct investment effort as well.
- [02:23]
A
Five out of six companies are successful, obviously. Incredible track record. It's one of the best success rates for, for half dozen companies I've ever heard. You took that entrepreneurial lens into creating the family office structure. How did you use first principles to decide how to create this family office?
- [02:40]
B
It's a great question and the answer is it was entirely unintentional. And so we, but I think that's the version of, you know, pure product market fit in a way, is that we just started building things that we needed. And it just so happens that that need was scaled for us. And then over time we've started to have collaborators who have joined us because they also have a similar need, started making investments and things. And then we realized that it was really hard to have a fixed ownership structure when all of us had, you know, sort of different preferences for how much we liked either a deal or an asset class. And so we started creating these sort of annual vintage funds for ourselves. Once we started creating these funds, that created infrastructure needs related, you know, some of it is kind of traditional tax and estate admin needs. But then we started having admin needs around our, the funds that we were creating for ourselves. And then so we started adding team to build that and eventually it just made sense to continue building the infrastructure where, you know, today we think it's evolved to a place that's very scalable because it was just in response to what we needed.
- [03:38]
A
Ever since I interviewed Ryan Hoover a couple months ago, he always solves his problems with products. So he would look at your admin need and say, what product do I build versus how do I create process or people? Have you created any products around your problems and how do you look at that as an entrepreneur? Are you, are you solving these things at scale or are you just throwing bodies at it?
- [03:56]
B
I would say we've created investment products in response to the problem. So we now operate 25 different funds that we created for ourselves that are specific mandate investment products that I sometimes call the Lego blocks of our asset allocation strategy. What that looks like exactly is a annual private equity, venture capital, real estate fund. Those are sort of the core private asset allocation pieces. And then we've had some opportunistic individual funds for blockchain, for digital currency, for private credit that we, you know, build a Lego block each time. And that's become a systematized process. And so those are our products in house. You know, I think a lot of people would Malign the fact that we use, you know, more traditional, you know, spreadsheet based, you know, fund admin products. I wouldn't even call them products. I'd say we created a process that works very well for us. And as we've understood and evaluated the third party ecosystem, I have yet to see something that does it better than how we do it in house. And so we have this conversation a lot with other family offices about like, what do you do? And everybody seems to have a pain point around. How do you do the admin? Well, we have not found a better solution than just have really great people to run it and have them build systems internally.
- [04:57]
A
You don't have this principal agent problem. It's your own money. And knowing that it's your own money, how do you think about portfolio construction and how do you think that would also differ from if somebody else was.
- [05:07]
B
Managing your money in portfolio construction, in asset selection? In every decision we make each of the partners. And this is probably a good time to say that while we are an affiliated entity, you know, it's not like we manage a pocket of capital for external people. That's not to say we don't have external investors. It's that the partners, personal balance sheets are the thing that matters. And it is encouraged in our investment committee for partners to pound the table and say, I do not want this in my personal, like I do not want my money going into this. And so that is the sort of underpinning of every decision. That's what we say to third parties is, you know, that's a good thing that we're not thinking about how it will look to you when we make an investment. We make an investment because we want our personal money into it or not. But at the same time I should also say, because I'm sure I'm going to make a number of statements about some of our practices, you know, these are my views. And our partners often will differ on these things. And the, the, the, another secret to our success is having people who are deeply engaged arguing on behalf of our own balance sheets. I think gets us to better answers. And when investment committees can be maligned for sort of groupthink type behavior, you know, this, this in some ways has been the antidote to groupthink for us. Your question was about, you know, portfolio construction. So we, we think of the two sides of the house as, you know, sort of the wealth building side, which is the, you know, new company creation work that we do and then the sort of wealth management side, meaning for our Own wealth, where we have an endowment style approach to how we manage the money. And so our, our pie just to, you know, call out, what we're talking about is 40% publics, almost entirely beta, 12 and a half percent each to private equity, real estate and venture, 5% of sort of idiosyncratic opportunities, which is where a lot of the company building work is done. And 6% to digital assets, of which 1% is specifically for altcoins. And then 10% to private credit, which we divide into. We actually think the distinction between opportunistic credit and private fixed income is an important one. And so that's how we think about the pie. That's how our family office, you know, puts together an asset allocation recommendation that the partners then draft off of and make their own choices about.
- [06:56]
A
And how has that evolved since you started Endurance?
- [06:59]
B
Every year we, we evaluate the capital market assumptions that go into that, which is both an understanding of where we think what is going to be market beta and then what do we think our capabilities are and then, and so over time we've grown more confident in our capabilities in certain areas. We've also grown a better understanding of the markets. And so I'd say that our lens comes more into focus on what the assumptions that go into that portfolio construction are. And then ultimately, you know, what hasn't changed is that we're, we are targeting, you know, the highest possible expected return with the, you know, highest possible Sharpe ratio. Managing towards the efficient frontier is the, I would say, the underpinning of every decision that we make.
- [07:36]
A
And you've been running Endurance now for over 16 years. Do you see this negative correlation between assets that are hot and assets that end up returning to the best? In other words, this kind of supply and demand dynamic and that the best time to invest in an asset As a general principle, there's many exceptions which, which we can point out. But as a general principle, is that directionally true, that the time to invest is actually when the asset is quote unquote cold?
- [07:58]
B
What I would say is there's a lot of different ways to make money and there are people who make money on momentum investing. Well, and my personal approach to investing has agrees with your statement. Right. So I get very wary whenever something becomes, you know, too hot. Right. So in today's market, I am, you know, wondering why nobody seems to be talking about the risks of to OpenAI and Anthropic and all the other models. And, and so, you know, we take a skeptical lens when the money seems to be piling into something. I guess this is another thing that we, you know, have. Why we chose to build our own vehicle is because by the time the sort of third party advisor community is hearing about something and then distributing it to the end user, my worry is that we are too late in the cycle. You know, you're sort of, you know, the last person to hear about it, you know, last the party first to leave type of situation. That feels like bad investor psychology or bad investor principle to me. So yes, we tend to have many contrarian views to, you know, what the moment is.
- [08:52]
A
I also think it's almost absurd where people talk about asset classes as if the pricing is fixed. They say early stage is cold or early stage is hot. But really you could have startups that are at a 4 million dollar valuation at a 20 million or a 60 million, which are fundamentally different economic value propositions. And when everybody else exits that space, now you're coming in at 4 million, it becomes a whole nother risk reward. And people talk about it as if it's fixed, as if you're always investing at the same valuation.
- [09:21]
B
That's entirely true. It's an. And I'm a big fan of the Jim Collins and. Right. You know, the genius of the hand versus the tyranny of the ore. Many things can be true at the same time. But, and so I agree with that. And we try not to be market timers and I'm probably the, the, the worst market timer of our partnership. And so I, I try to insulate the reason for these annual fund approaches is because one of the most predictive factors of, of success in private investing is vintage. And so we're trying to create the structures that mo. That, that force vintage discipline. Now we can, we can change how much we put into each vintage. I tend not to because of this market timer phenomenon. But, but you're right that you know where I can make tilts and sometimes I use a thermostat analogy where I say, hey, let's move the thermostat from 70 to 68. Right. You know, you wouldn't move a thermostat from 70 to 60. Right. And so when I'm feeling like, let's say venture is overheating, I tend to start turning the thermostat down. That doesn't mean no allocation. It just means, you know, we're getting a little cooler on how much we're willing to do. And that was, you know, when we're talking about venture, that is how we were behaving in 2021. We were sort of turning thermostat down, particularly on the mid and late stage stuff. Now we are also a good example of being contrarian is that we're, we're just, we're not buying into the thesis that people are talking about, about companies are staying private longer. Therefore everybody should be piling into the pre IPO stage. It's not that we have zero of it. It's that the bar for us to make an investment in a pre IPO stage manager is very, very high. It's a very small percentage of the portfolio. And so it's a tilt, you know, it's a, it's a thermostat tilt.
- [10:49]
A
Given that it is mostly the partners own money, do you find opportunities for high IRR low MOIC rates where you could pile in money into something that an institutional investor might find is a waste of his or ton?
- [11:02]
B
I generally experience it as the opposite where when I talk to some larger institutions they feel more IRR focused because they think they have better ways to manage the cash than others. While I actually think we do a good job of short term cash management, maybe better than most, I'm not eager to trade IRR for or to to take IRR over moic. Even in a. And I mentioned, you know, we have 200 private investments. Right. The even in the context of we, we have a very wide portfolio, it still takes a lot of work to get to a. Yes. And so the amount of work that take that goes into making an investment decision, I I getting the money back and then having to make a new investment decision I think constricts our ability to do diversification well because we, you know, you know, the more decisions that you're forced to make, the less quality are in those decisions.
- [11:51]
A
In that case, it's not a principal agent problem in that both the principal and the agent has a finite amount of time to create the most economic value. And even as a principal it's a waste of time.
- [12:00]
B
It might be a pennywise and pound foolish choice for us. Now that's not to say that you know, a group that had a much bigger cash man, you know, much bigger diligence team and a much bigger, you know, admin ops team that could, you know, recycle the cash well, might not have a different trade off but for us, you know, we the o. If you looked at the overall portfolio, I think we would have a lower return if we, you know, took a, took a short term IRR benefit that then brought us cash back faster that we then had to figure out a way to redeploy effectively. Because where, where I guess what I'm saying is I'd rather have a 15% IRR over 10 years than I would 20% IRR over four years. And I'm making numbers, you know, picking numbers out of the sky because that's still above our, our threshold and target. And compounding over time, you know, we find is the way that, you know, we're more focused on, on multiplying the capital base as long as it's above a certain level. Right. And I, I shared with you earlier what or you know, I don't think I said that Our, our portfolio expected return is a 14.7 and then each asset class has its own expected return thresholds. And so they're quite high and ambitious as they are. So I think it might be a different story if we were talking about single digit returns, then we might make the trade in the other direction.
- [13:16]
A
A lot of the most elite endowments, they target roughly 7 to 8%. Why is it that you believe you guys could get a 14, 15% return on your portfolio?
- [13:25]
B
It's interesting and I sit on an endowment committee that is managed by one of the leading endowment advisors and recently had a heated discussion in the investment committee room about this very topic where I think that there are principal agent issues in rooms like that. I think there's a groupthink issue. I think there's a personal incentive and motivation issue from the people who are contributing to investment committee discussions. Even in, well, in well, resourced endowments that have, you know, full time professional managers, those people are compensated in certain ways that don't incent them to take to move out on the efficient frontier. They need to make defensible choices that they can explain easier to that will land with a wider audience of less sophisticated people. And so I think when I look at the capital markets assumptions that go into making those choices, people, well one, I'd say a lot of people are not as focused on what their efficient frontier looks like. So you know, we take it as kind of a first principle approach to, you know, well, this is, this is how you should, you know, start the portfolio. I think others may, you know, may do the exercise, may not even do the exercise. And it becomes more of a political conversation about who likes privates, who likes publics. And then, you know, is VC a real thing or is it not? And then the committee argues about IRR versus not. And ultimately there's cat and then there's cash hoarding. And so one idea I've heard from institutional investors that I really disagree with is that, you know, well, for an institutional endowment you have to manage it in a certain way. And I, you know, I'll retort to that, that you know, I care a lot about this institution that I help manage the endowment of and at the same time I care a heck of a lot more about my kids trust funds than I do the school's endowment. Right. And a good example of this is, you know, I think institutions are just starting to add a digital currency allocation, but they haven't even put it at the Swenson sort of 5% minimum level or not even close. They're just sort of dabbling in it. And you know, it's something that I would advocate obviously by our asset allocation policy. And I think institutions will get there over a long period of time. But I hear people say, oh well, I would do that personally, but that's not appropriate for the institution. And I'm thinking to myself, you know, why is that appropriate? Why would you do it with your own money but not, not for an institution? And I could go on a rant here, and I probably already have to some extent, but there are behavioral factors that I think make institutional decision making candidly worse. Right. That, that make it lower return seeking with less safety in, in the way that, in the way that those choices are made there.
- [15:46]
A
There's two closely related factors at play here. One is principal agent, in that you care about your own money more than necessarily investing somebody else's money. Everybody, the, the, the proverbial you. And then also, if an asset has even a 5% chance to get a zero or could go down 90%, you could just torpedo your career. You're not willing to get that extra 2 to 3% per year with that risk factor. There's this almost, it's a negative asymmetric career.
- [16:17]
B
It's a harder decision. So you know, I've seen institutional portfolios that will have a absolute return bucket with a north of two sharp ratio, right? No leverage on the portfolio. That's one that's begging for leverage. But okay, you know, I actually don't understand the argument for why you wouldn't use leverage. But, and, but okay, if you're not using leverage, so then that's a license to take risk elsewhere. But instead you've got a huge chunk of money stuffed under the mattress. And it's great that it's producing a sharp ratio, but to, to what end? Right? You have to use that risk elsewhere, otherwise you're just going to have Like a really safe low return. But that's you know, under, you know, under the efficient frontier. Those are examples of, of, you know, how I, why I think that these endowments, you know, have modest expectation and modest returns over time. And you know, candidly, ours are, are, are much better and, and, and reliably much better. We think. Now granted, I, I don't get to run this as a 10, 000 iteration game. Right. You know, we only have the 15 years that we've been doing it. So you know, maybe at some point we'll be, we'll be, be, will be wrong. We're proven wrong. But you know, I believe in the, the free lunch of diversification. And that's why we, why we target higher risk assets because we think that they, you know, if measured properly and, and, and, and done in appropriate quantities, you can, you can have that free lunch of, of, of of the high expected return of 14.7 and what we have. I don't think, I don't know if I mentioned our, our sharp is. And I think we could do better than that. I think we, you know, that we're making some lazy choices in doing that that you know, we could be pushing it out further.
- [17:52]
A
I think there's these paradoxical beliefs in asset management that you simply cannot challenge. Cliff Asness, when I interviewed him, he said the idea that zero leverage is the right answer to every single situation is absurd. That it's literally, it should be zero in every single situation makes makes no sense. You talked about, about crypto investing. In crypto I have this whole soapbox about the virtue of illiquidity. I think all things being equal, many asset classes are better served illiquid. I interviewed several top decile venture funds in crypto. So if you think about millions of crypto investors, a couple thousand of them have been beholden to other people's money. So they're like the top of the top and then top desk, all of them. And most of them will secretly admit that their best returns have been in their most illiquid buckets. So even the cream of the crop, the NBA players of crypto actually believe liquidity is good for them. So why does it not apply to the non NBA players? And of course that's also paradoxical. And you just, you literally cannot have these discussions. It's not even that you can even have these beliefs. You can't actually bring these things up or you'll get the equivalent of canceled within, within the investment office.
- [18:57]
B
I agree with many of the things that you said There and I thought it was eloquently done. So I don't have more to add to it.
- [19:02]
A
You have invested 200 funds. Nobody bets a hundred. What have been some of the mistakes and where have you really evolved your strategy over the last 16 years?
- [19:09]
B
The mistakes question is, it's, you know, this gets back to the institutional mindset versus the principal mindset. You know, we always were cool on a thermostat towards big brands and but when we first started out, we gathered comfort from, you know, there was, there was some like, do we, do we know what we're doing here? And there was comfort that we afforded to the fact that we would have, you know, some very institutionally known brands and we made a few choices that would be extraordinarily defensible. Our biggest mistakes have come when we, you know, sort of had fear of missing out because, you know, we felt lucky to get into a big brand that had a big fund and a big toll and, and they were doing, you know, sort of hot late stage investing and venture or, you know, kind of mega LBO stuff that, you know, I think conventional wisdom would tell you you can't go wrong buying IDM type I don't want to call at any one specific firm. And so then we started realizing and sort of digging into these, you know, larger brand returners. It became so obvious to us that as AUM rises, returns are inverse correlated. And so, you know, the, the, the trick that we have found is that, you know, how do we get in early enough or how do we gain enough conviction to get in early enough at high enough conviction? That last part is the thing that we're working on to, to benefit from these, these firms as they grow? And then how do we have the, the conviction to sort of down, start downgrading people as their AUM rises and they start harvesting their market position? And so, you know, your question about the mistakes, you know, have largely been in, you know, in these big brands and, and large funds. And so over time the thermostat has gone from 68 to 66 to 64. And it's not that we never do it now. And there are certain situations and we think some are better than others and we think some are taking really unique strategies, but we've been able to really focus on, you know, what matters about a market leading brand and are they, you know, are they still truly a market leader if they're presenting their product in a certain way that, you know, seems highly unlikely to succeed in the future? So I'd say That's, that's kind of in the biggest mistake category of, you know, how our fund investing strategy has evolved.
- [21:15]
A
The way that I look at these brands that grow is a. What is the growth of the asset class? So maybe an asset class itself is growing and opportunity set might be growing three times. Then on average that fund should be three times larger, even though that's obviously quite a step up. Two is, are there's economies of scale of brand. For example, in venture, you might argue at certain stages, brand is really important as you get all these portfolio services signal all these things which we could talk about. And then three is, are there, are there other things within the organization that are growing? Are they growing their talent gp, are they getting top GPS in and all these other things? In other words, is their alpha growing alongside their fund size and to the proportion of that alpha growth over their fund growth is what you really want to be identifying. And sometimes you have such some parts of the market that are growing so fast that actually the alpha might be outgrowing the fund size even though the fund's grown two, three times.
- [22:08]
B
That's an interesting way to put it. You know, I would enjoy sitting with a whiteboard with you and like, you know, charting that. The way I cut through it is to say I'll talk about it in venture, but I think this applies to private equity as well. We roughly target a third, a third, A third what we call market leaders, established brands, you know, a third growing funds or breakout funds that are on sort of, you know, call it fund three to six. And then, you know, emerging managers which are on fund one to one to three. And we think at each stage there's an advantage, you know, in your parlance, like there's an alpha, you know, there's a curve. And if you plotted all the firms on, you know, what their unique advantage was, that would generate alpha for them versus not. And they're going to have different things at each stage. So for a market leader to be success. So, you know, of course brand adventure is really important. And so some of those market leaders have that. But many of them are hampered by how much money they have to put to work. I'm thinking of one market leader in particular who's just known for showing up at, you know, some of our companies that were, you know, one of our companies that we're building now had one of these big brand market leaders come in and say, you know, we'll triple your, you know, we'll triple your latest term sheet, right? And, and it's like, is that a good investing strategy to just like pay up for, for everything because you have so much money that you need to deploy, is that likely to generate, you know, the top decile of returns? And so just because they have that great market leadership position, you know, I don't know that that's a good thing. Other market leaders that have amazing brands are requiring you to be 3 to 1, 4 to 1 into their pre IPO stage, round, right? Which is a form of toll. People are requiring 2 and a half and 25 with ratchets up to 30 and even more in some cases. And so, you know, all these tolls of the market leaders where, you know, there are some brands out there right now, and in fact, we have turned down some of the brands that, you know, if you talk to, you know, your casual lp, they would say they would fall over themselves to get access to these brands. And like, the conventional rule of thumb is, well, there's only 10 firms in the valley that make any kind of money and you've got to be in one of them. I don't think that that is true. When we think about, like, what we define as a market leader, they're, you know, we're kind of measuring how much of those tolls are there, what is their right to win. Today, things like fund size matter. Invest in a firm that's probably like a one, a brand, you know, clearly not the one that everybody would fall over themselves to get in, but certainly in the conversation of, of big brands. And they've recently, you know, made a hard pivot into being AI native and they've done deals with a couple of the major, you know, sort of infrastructure model companies that, you know, have really made them authentic in the AI community, where we're seeing and hearing from people on the ground that they're, you know, able to, you know, play in the top game. But they have a normal fee structure, they have a fund size that's under 500 million. We're not required to dump money into some other fund that has a different expected return and standard deviation. And so we look at that and say, hey, you know, if I look at all the things that we could invest in the market leader category, that's actually probably better than one of these brands that people would fall over themselves in, right? So that, that is, you know, a version of like charting the alpha, as I heard you describe it, in that market leader category for us, the same goes in each, in each other category. And so like in a breakout, in the breakout category, we have A couple of firms that we think exhibit first choice behavior, meaning, you know, everybody wants, you know, all the, all the entrepreneurs are falling over themselves to work with this firm, but they have not grown so big yet that they're able to charge these kinds of tolls. The LP community doesn't quite realize it yet. So that to us is a great, you know, it's a pile into that, you know, pile into those. And so that's what we're looking for in the breakout category. And that's sort of how I see the sort of alpha to each, each stage comment that you made.
- [25:33]
A
I've had Professor Steve Kaplan, Professor Gregory Brown from unc, Steve Kaplan from Booth, and all the data points to venture being an asset class where the founder picks the VC and buyout being where the buyout firm picks the company. And that's where the alpha is. So knowing ground truth, knowing who the next wave of founders is picking, is really the source of diligence. That's, that's the ground truth for who will be the next great fund.
- [25:58]
B
There's a lot to that for sure. I haven't done the research and so I don't, I, I'd be interested to read their research. I think it's one of many important factors for sure.
- [26:07]
A
What's something you've changed your mind on past year?
- [26:10]
B
So interestingly we, we just changed one of the most important held beliefs in our firm, which is that until this year we have done no proactive conversations with outside capital. So we've had close collaborators join us and it gets to some of this, you know, sort of religious description I had earlier of, you know, why we think principle based investing is important. And so you would say, well then Alex, how could you possibly make the choice to do that? When we think about why we're doing that, we see opportunities to be more excellent and sort of the North Star of investing for us. And I guess I say our North Star is, our mission statement is we chase meaningful problems with people we care about. You have to remember that we're entrepreneurs and we build things as well as the investing side. But within the investing side, the North Star is making our own investing more excellent. And so we are now, because of our market position, being in these 200 different vehicles and having invested in dozens and dozens of fund ones and seeing what works there, we believe that we are very well suited to the anchor investing in many of these funds and being a true partner to those businesses and building them. But it requires a bigger chip stack in order to do it. While maintaining the diversification principle that we have. And so having more money in that case actually allows us to enhance the efficient frontier. That's very important separately, and I think, I'm guessing this is on the mind of many family office investors or principal investors that may listen to your podcast. We do a lot with a lean team. I think there's a behavioral psychology thing that if, if normally when I'm running a company, I need to have a 12 to 1 decision in order to make a new hire. When you're making, when you're running a company or when I'm running within endurance, I feel like we need to have a 50 to 1 decision to make a new hire because there's this conservatism around your own money and you know, kind of pouring into, into new resources that I don't think is on the efficient frontier of choices. I think most people would say that alignment is very important and I agree that it is obviously. But I think it can also get to be orthodox. We, you know, we struggle with getting to higher levels of conviction as evidenced by the, you know, we have this great pool of investments that we've made, but we very rarely get to a very large check and having more team will allow us to do that.
- [28:19]
A
I'm sure you've thought about this and I want you to be explicit. What is this the golden check size? What is the ideal check size for asset class that's not too big to have to go to these brand name firms that, you know, just sound good on paper but don't return and not too small not to get the attention of the funds you want to get in? What's that ideal check size?
- [28:37]
B
You mean the check size that a, that a manager, a GP would.
- [28:41]
A
What's the, what's the ideal check size for an lp? What is the checkbook you would want to be walking around to maximize your returns while not having too much money where it's hard to deploy?
- [28:51]
B
You know, I'm not going to give you a specific number because I haven't thought deeply about it. Right. And I, and I, I think that that deserves a deeper thought. I guess I look at it on a marginal basis. You know, right now our, again, I'll talk about our VC pocket, but it applies to the PE pocket and the real estate pocket as well. You know, our VC pocket makes 8 to 15 fund investments per year and probably 20 or so direct investments per year. I am confident that the expected return and the, and the standard deviation of that fund and our portfolio therefore would be Greatly enhanced if we got to, you know, if we showed up and wrote a 25 to $50 million check and put someone in business and anchored their, and anchored their fund. We, in a couple of cases, sort of unintentionally did that with some of our collaborators where, you know, we picked our head up at final close and realized that we represented, you know, 20 to 40% of their capital base and said, huh, you know, maybe we should be more thoughtful about this and be able to participate in the economics of, you know, we, we, we've done something, you know, we made the decision obviously, because we would never make a decision because that we didn't think was going to return well. But we should also benefit in, you know, what we've done in creating this firm here and doing that, you know, just materially enhances the economics of that choice. So it's an interesting thing because in Mo and I just articulated earlier that in most investing contexts, more money is bad. In this case, we see opportunities that we can't access unless we have more money. And so on a marginal basis, that's going to be true for quite some time.
- [30:26]
A
One of the top institutional investors that anchors and seats managers, they actually said that the biggest benefit for them is they were on the other side of the table with the GPS when it came to new opportunities, new funds, and they had just a higher quality flow of information. They also obviously had superior economics, but they actually benefited more from the deal flow and the information flow than they did from the actual underlying investment on. In that one seating.
- [30:51]
B
I believe that there's value, certainly there's value to that to be true. I mean, it's part of the reason why, you know, we do the two, you know, why we do, you know, you say 200 investments and like that's such a big number, right? When you think about it, it's like, well, it's 10 years and it's seven asset classes, right? And, and we have all these vectors of diversification that matter to us, you know, manager stage, you know, when, like, what type of thing they're investing in, geography, et cetera. And so if you're trying to get a truly diversified approach, you know, that's how you end up at 200 pretty quickly. Doing more diligence doesn't enhance the expected return. It just decreases the volatility. And so if you, you know, the, the extra, the amount of work utils per volatility, confidence is immense. But when you do the 200 investments, you get a synthetic benefit of the information flow that's coming back. And so what you were describing as, you know, being at the table with the gp, I think that would be another version of that synthetic benefit of, of being in market and, you know, I guess, you know, taking it to our entrepreneurial side as well. We have found so much that, you know, you can sit in a room and think yourself into, you know, around the table. But, you know, there is a magic to just putting yourself in the market and feeling what's going on in the market. And so right now we do that with the, you know, lightly, with the passive investments that we make. And I suspect if we were, you know, when we get into bed with a GP that we're going to, you know, build a business with, I suspect that will lead to another set of insights that will make us even better and is a better form of diligence.
- [32:15]
A
It's interesting because beta and alpha are not commonly understood in that alpha is taking the same amount of risk but getting a higher return, same amount of market risk. So an efficient portfolio would actually have a bunch of these highly asymmetric investments that, on it that you could diversify away. So the presumption in the modern portfolio theory is that you should be able to diversify away a lot of those factors. So to your point, it's not actually about picking the investment that, you know, for sure won't go down. It's about which one has the highest expected return and then building a portfolio around it that lowers the volatility across the entire portfolio. That's like elite portfolio management.
- [32:52]
B
That's exactly right. And taking it back to some of the institutional conversations I've had and what's, you know, I get asked to revise on things and they say, oh, well, you're the venture guy. And by the way, we do all these other things and I, I think we're good at them as well. But, you know, what's the one bullet? You know, who's the one emerging manager that you should invest in and say, well, we invest in six to eight venture and three to five PE a year. Right? Because, you know, there isn't one bullet, right? And I think that's part of the institutional decision making that ends up with the least common denominator answer where there's, you know, you'll pick an emerging manager who is not objectionable, you know, or like, doesn't, you know, technically doesn't trip one of the trip wires, but is not likely to be excellent when really what, what a portfolio construction should be is exactly what you just described with, you know, a lot of really spiky managers where one of them is, is, you know, not going to work out and is a poor choice, but because you've got the collection of them as a group that they will, they will perform better the, the free lunch. As, as I said earlier said another.
- [33:45]
A
Way, you should never have to defend any one manager selection. That should be almost a maxim, meaning if your entire portfolio is delivering 15% for 15 years, no one should have even the right to question that one manager because that might be the, that might have been an alpha in another simulation of that same strategy. So it should be, it should, that should be the paradoxical thing. So it's the exact opposite of what is hedoxical.
- [34:05]
B
That's one of the problems with committee based decision making, right, Is that, you know, everybody ultimately is like, who wants to pound the table and you know, hang their name on one. One choice. The psychology of committees I think is interesting.
- [34:15]
A
I. It remained unnamed the university endowment, but there's a university endowment that's struggles to bring in a top CIO because of the board and because of how vocal some of the board members are about certain things, they feel like they would not be able to execute their strategy. So ironically, even the entire governance, and not even governance in terms of levers, but the individual people on a committee can adversely select the CIO process in that endowment that then flows down to return. So the behavioral psychology behind these, these investment vehicles are insane. And the only way to really, if you want to completely collapse that you have to manage your own money, which I guess is to go full circle. What you came to, I was saying.
- [34:54]
B
You know, the big change we made this year was saying, hey, we're going to, we're going to start telling people about it, which I'm not even sure is a good choice because I'm immediately feeling the tension of, you know, of the conflict of interest that comes from doing that.
- [35:05]
A
You said, you said that one fund was great, that one fund didn't do well. You're an idiot. Yeah. Versus, versus, like, look at my returns. Versus. You're corrupting in many ways your own thinking totally.
- [35:15]
B
And, and you know, and then the other, the other parts of it are a lot of people wonder how we, you know, we do so much, you know, saying, oh, well, you know, you're incubating one or two companies a year and how do you spend your time? And what I realized was, you know, when I was a sitting, you know, CEO, you know, half my job was fundraising and talking to outsiders. And then, you know, now, you know, for the last seven years or eight years or whatever it's been, I haven't had that job, right. And so in a sense I'm able to, you know, I've been able to focus just on building new companies and making good investments. And, and so now I've, you know, kind of added a third job of talking to outsiders, which we're still doing a lot less than we're trying to, you know, back to the thermostat analogy. We're trying to turn the thermostat up one or two degrees on, on the talking to outsiders piece. But the, the immediate feeling of conflict of interest is there. And so we're start. We're trying to put in things that insulate the investment committee from those outside choices. So, you know, as an example, we banned the concept of, you know, some, somebody made the mistake of saying, I think people will really appreciate that we included this, you know, this company and you know, that we really, that we put that investment in that that will land well with outsiders. And that is the biggest taboo statement you can make in our investment committee. And almost, you know, makes it hard for us to make the investment because it would, it would tell us that maybe we have these other motivations around why we're putting it in the portfolio.
- [36:28]
A
The antidote to that, a couple at Mike Maples a while back and he, he talked about his fundraising strategy, which is to look for people that align with his, with his mission. Jeff Bezos taught Jeff Bezos on the public side for a decade, told his investors, we're not going to be profitable for a decade. We're building and a lot of people were turned off by that. And the people that weren't turned off, also known as, as his investors. So if you're willing to make that trade off in the short term between who you bring on board, you could actually bring kind of create this cult of your, your investment principles. Obviously Warren Buffet and Charlie Munger did that as well. But it compounds slower. But it is a way to build kind of a more isolated strategy from outside perspectives.
- [37:12]
B
Better or worse, we're heavily influenced. You mentioned a bunch of legendary investors. Our first investors in one of our companies was this firm investment group of Santa Barbara, igsb. And these are, you know, they're so low key, they have no website. They, you know, their office is above a shopping center in Santa Barbara. And they've compounded their own capital at an amazing, you know, it's. Now, I shouldn't speculate at how big it is. But you know, they're these sort of if, you know, you know, type investors. And we were so influenced by that that we, you know, I think we built a lot of religion around not bringing outsiders. And so for, for better and worse, you know, we have built that, you know, sort of religious like approach to what matters to us, conviction in our approach and ability to, you know, avoid the noise. And sometimes we get caught up in fomo. But you know, I think in general we're better at it than most people of, of not following the herds. But that's come at a cost. And so we, we probably have been too conservative in that respect and, and you know, are now thinking as a firm about how we evolve and you know, do it without throwing the, you know, baby out with the bathwater.
- [38:19]
A
One of the things I always reserve the right to do is to contradict myself. Even within the same sentence, I always reserve that right. I think that's, that's, that's the mark of a good thinker. You're so purposeful about who you surround with the different things that you consume. What's your information diet look like and how have you improved that over your career?
- [38:39]
B
Uh, this is funny. Um, I'm a big. I, I take a lot from Tim Ferriss four hour workweek and one of the things that I took very early on from him was don't read news. So I don't read news. Now you might hear that and think I'm a Luddite, you know, and you don't know me that well and others don't. But I think most people would characterize me as somebody in the high end of, you know, the information flow. What Ferris, you know, talks about is that the important things will get to you. And I think that's been, that's, that's been how I consume information, is that the important things get to me. I don't feel uninformed. You know, there's maybe a half dozen times over 15 years that I have really not known something that I probably should have known. And you know, at the end of the day that wasn't that big of a deal. And, and it actually filters out a lot of the bad news and the noise from, from, from having that low information diet. I also do things like, very controversially, especially amongst the people in my community. I don't use text messages. I'm not on X, I'm not on, you know, any of these. I mean, I have a Facebook account, but I rarely use it. Right. And so I'M not on Instagram. And so I, I try to insulate myself from information and that's been a working formula for me.
- [39:57]
A
One of the things that I've been talking a lot about is this concept of negative alpha. It's been around for many years and not many people talk about, but you actually have negative alpha, which is same, same risk, but lower return than, than beta. It's a real thing. And a big component of that is negative information. People think either somebody's good information or they're neutral. No, some of the worst things that you'll ever do, and this goes to investing life, anything is by getting bad advice from people. It is certainly does not. It's certainly not positive or neutral. Some of the worst investments that I've made that I took full responsibility for came from this negative information and having certain people in my life that are just free feeding me negative information that are so subconscious that I didn't even realize until years later why I had been thinking that way.
- [40:41]
B
Yes. And it occurs to me, I also, you know, when I'm in the same breath as I'm saying I don't read news, one thing I do do is I have a number of podcasts that I generally listen to a lot. And I've now added how I invest to that list because it is so, you know, a curated, thoughtful group of discussions. Right. And so, yeah, I, you know, over the last five, five to seven years, you know, sort of integrated, you know, podcasts as my downtime and way of filtering, you know, for things that, you know are going to be very high likelihood of being high quality. And that's one of the ways that the right information gets to me.
- [41:15]
A
I like you, I am on X. I try to spend as little time on there. I think it has a negative, more negative effect on me than positive for a lot of the reasons around the algorithm. I think podcasting and interview style, long form podcasting is one of the most positive developments we've had in the last decade of mostly negative information, negative social media and those things. So on that note, if you could go back 16 years ago when you first started investing your own money via endurance, what is one piece of timeless advice you would have given yourself at that point that would have either accelerated your success or helped you avoid costly mistakes?
- [41:49]
B
I knew it at the time, but I the biggest, well, I'll share with you like the biggest mistake I've made investing. At the beginning of COVID I started watching CNBC pretty closely and, and thought, you know, we were in Some, you know, disruptive moment. And I'm like, well, this is the moment where, like, a lot of stuff is going to change. I got to pay really close attention to the daily market movements. And, and so I started market timing, and I didn't understand the maximum, don't fight the Fed, right? And so that was just something I missed in my, you know, I thought I was all over all the details. And then, you know, of course there's this detail that overrode everything. And so I was saying to myself, I don't see how the market doesn't drop by X percent. And I had a whole model for, you know, like, I was going short, short the market. And so, you know, the, the. The maxim of, you know, market timing is really hard. You know, was something I knew, and every time I forget it, I. I get burned. And so vintage discipline is deeply built into our structures because it's such a natural human emotion to think that you know something. But I think very rarely do, you know, very rarely can people do market timing well. And I think the ones that do are doing it a part of it in an aspect that they really know well, where they have a unique advantage and they're finding ways to put up blinders so that they aren't influenced by the other things that are going on. So, yeah, don't try to mark the time as the sort of true advice that I would give myself.
- [43:07]
A
That's great advice. Well, Alex, thanks so much for jumping on the podcast and looking forward to the whiteboarding session soon.
- [43:13]
B
Awesome. Thank you, David.
- [43:14]
A
That's it for today's episode of How I Invest. If this conversation gave you new insights or ideas, do me a quick favor. Share with one person in your network who'd find it valuable or leave a short review wherever you listen. This helps more investors discover the show and keeps us bringing you these conversations week after week. Thank you for your continued support.