Matt Bank - GEMs on Risk, Asset Allocation, and Manager Selection (EP.419)

0:05 hello I'm Ted sides and this is capital allocators this show is an open exploration of the people and process behind Capital allocation through conversations with leaders in the money game we learn how these holders of the keys to the kingdom allocate their time and their Capital you can join our mailing list and access premium content at Capital allocators all opinions expressed by Ted and podcast guests are solely their own

0:35 opinions and do not reflect the opinion of capital allocators or their firms this podcast is for informational purposes only and should not be relied upon as a basis for investment decisions clients of capital allocators or podcast guests May maintain positions and securities discussed on this podcast my guest on today's show is Matt Bank the deputy CIO at Jem an oci that manages $12 billion for 40 clients gem was founded in 2007 by investment leaders at the Duke endowment and Duke

1:07 University investment management company our conversation covers Matt's path to investing under recent guest David Salem and lessons learned about risk and governance while under his tutelage we then turn to Matt's move to Gem and its positioning in the OC industry we cover Gem's approach to asset allocation and manager selection and close with Matt's thoughts on active and passive investing Venture Capital hedge funds and drivers of success going

1:38 forward before we get going this is a holiday week in the US and I want to offer everyone celebrating a very Happy Thanksgiving I'm deeply grateful for your engagement with our content and Gatherings and for my team that helps bring it all to you earlier this week during a strategic discussion with one of our partners he paused and said your job sounds like so much fun it's a true gift to be able to answer him yes it is

2:09 I hope you and your family have a wonderful break enjoy each other's company share a great meal and take time to reflect on what you're most grateful for wishing you health and happiness at the beginning of the holiday season and while you're at it with your family thanks so much for spreading the word about capital allocators please enjoy my conversation with Matt Bank Matt great to be with you thanks for having me Ted why don't you take me

2:38 back to your path that led to investing well to say I wasn't well suited for the professional World initially as an understatement I spent every break in college climbing mountains with friends we would go to Ecuador Patagonia Alaska Switzerland Colorado never thought I needed to get an internship never expected to have to do anything my line of sight ended at graduation it seems beginning of senior year I ended up getting a little bit spooked by watching

3:03 all of my friends getting their investment banking jobs and decided hey you know what maybe I should go to New York for a couple years decided to work at a law firm thought that gave me some optionality coming out and within a year was fortunate enough that a recruiter at Goldman saw enough on my resume to offer me a job there they had a hole on a principal investing team I fit the bill join that firm in 2005 and really the

3:26 rest is history I spent a little bit of time there eventually moved with a partner over to the asset management business within Goldman which was a strategic priority into and around the global financial crisis and had a terrific experience there first time really being around people who were as ambitious and driven and committed to Excellence as folks were that I got to work with what led you to moving over to the allocator side of the business so in

3:53 2007 my dad passed away unexpectedly it was really a shock he was relatively young relatively healthy that's one of those moments in life that really sets you on a different course it causes you to reflect on decisions you've made things you've done and I recognized in myself that I hadn't been quite purposeful enough about career decisions I'd made was drifting through my experience really ruminated on it for a long time and decided I should just go

4:19 back to business school pick myself up figure out what perspective I needed to get on what the future looked like through Serendipity I met a guy while I was at business school named David Salem who you had on the podcast not too long ago I met David for lunch one day and we bonded over David McCulla books and constitutional history and a whole slew of things that had absolutely nothing to do with allocating capital or investing

4:43 in any way and it was really my first entree into this liberal arts approach to investing thinking about organizational design psychology some of the history of markets things that really lent themselves to the curios that I had about the space I hadn't been exposed to the allocator world prior but David had just left Tiff and he was setting up a small private partnership in Boston at the time and I decided to join there between my first and second

5:11 years of business school and see what that was like it was not without a little bit of peril on my first day there David was still in the process of moving down from New Hampshire so he was not in the office another colleague was in the process of moving out from Virginia he was not in the office and so it was just me and a bunch of computers in an empty office space in Boston I thought well this will either work

5:31 really well or it'll be some form of Calamity we'll figure that out and it turned out to be a great experience so what did you learn over the path of the time you're working with David so I was involved in every aspect of building the firm as you could gather from the fact that there were really three of us there initially that was asset allocation portfolio construction manager selection putting together marketing decks putting together the trading apparatus anything

5:57 you could possibly do I was involved in and so first off there was this breath of exposure that I think was critical in my development second of all David's very much a first principles thinker it was a great education and curriculum in how to think about deploying capital for Perpetual or multigenerational clients the thing that really struck me most of all through my time there was just a recognition that the trust bar that is required to take discretion over is

6:30 really really high I always say anytime you're trying to be the investment office for an institution or a family you have to clear the highest trust bar in asset management for a family it's their hard-earned legacy for an institution you're often engaging with a committee whose capital it is not they are temporary stewards of that resource on behalf of an institution and the idea of handing that responsibility over to someone else is momentous just the fact

6:53 that you needed to approach any of these engagements with the utmost cander integ and client Centric mindset I think was all critical when you thought about the investment side what were some of the first principles that most resonated with you one would be risk first in all things the market offers what the market offers you cannot Will the Market to offer you more what you really need to understand first and foremost is what a client's risk tolerance is across a

7:22 couple of key Dimensions from there you can figure out how to deploy capital on their behalf but without a sense of what they're willing to live with what types and degrees of risk they are willing to incur and pursuit to their goals you can't deploy their Capital so that part of the process let's get structured for Success that aspect of things that happened well before the first dollar was invested in the first asset was a critical part of it the other one just

7:47 in terms of how you go about finding opportunities was looking for people that were really psychologically aligned with generating good returns I've come to view the money man world is really being subdivided into firms that are looking to find their way into the AUM Hall of Fame and others that are looking to find their way into the returns Hall of Fame and those are very different sets of incentives it's very different structures they look very different and

8:14 so making sure you align with folks that want to be partners with you for the Long Haul I think is a really critical feature when it comes to sitting down with a client and trying to understand their risk tolerance how do you both Define that and figure F out what that is for that person it's art science craft all the above I think institutions they have four horsemen of risk there's shortfall risk which is the probability

8:41 that over time you will just not meet your liability stream so you need to have a portfolio that gives you a fighting chance to get there over long periods of time and that's just a candid conversation about what the purpose of the capital is what are you trying to do with this for endowments it's pretty straightforward there's typically a real growth element and there's a stable support of operating budget element and you can model those out pretty clearly

9:03 there's also draw down risk so draw down risk is about the path of returns can you live with the volatility that is endemic to markets that has a practical element which is you can't have too much volatility of the operating budget and so you have to be able to control that to make sure that the CFO and the finance teams these institutions can draw a stable amount of capital every year and it also has a behavioral

9:27 element which is how much can the committee tolerate because everybody has a Breaking Point and you have to know going in what that is for people so we try and be very clear with folks what Equity tolerance they have because Equity is going to be the primary driver of volatility in any of these portfolios and what that may mean from a path of return standpoint the third one's liquidity you not only need to follow a fairly steady path of returns over time

9:55 but you need to have access to Capital some institutions spend 4 and a half% like clockwork every December some want to spend 15% in some years and 3% in others and that changes very much your ability to use private Assets in the portfolio if one of those big spending years happens to correlate with a period of Market draw down where the liquid part of the portfolio is experiencing more pain that's problematic that becomes very expensive capital and so

10:22 you have to manage around some of the liquidity constraints and the last one which I think is the most delicate is variance risk or what I'll call with clients embarrassment risk which is how far behind benchmarks peers whomever are you willing to be at any given time that one is something that is generally unknowable in advance it's very hard for people to put a number on how far behind they're willing to be you have to intu

10:48 it from the setup is this a donor supported institution is there likely a capital campaign in the future advancement people hate going to big donors and saying we're great stewards of your money look how far behind The Benchmark we are you have to be sensitive to that whereas in certain cases private foundations where the governance is much tighter and clearer they may have a much wider embarrassment risk tolerance so that's through candid conversations trying to sus out with

11:16 individual committee members what their preferences are making sure you understand how the collective fits together and then obviously what the institutional needs are when you've taken this deep understanding of how are you going to work with clients and get into the investing side I'm curious what happened that led to you joining Global endowment so I had spent as I said six years alongside David in Boston had a great experience there but I'd also gotten to know Stephanie Lynch who was

11:45 one of the co-founders of gem and just became very enamored with Gem's business model its reputation what a terrific business the founders had built over the 10 years prior this is around 2017 and she invited me down to Charlotte I had never lived further south in West 12th Street in Manhattan and my wife hadn't either and so we made the trip down to visit the team see what it was all about and really just fell in

12:10 love with the place it was a perfect setup for me in the sense that the founders had built this terrific business this terrific reputation the Heritage out of Duke was a real advantage in the marketplace and you had a ownership group that was very interested in staying independent and perpetuating the business so there would be logical transitions off into the future of leadership roles and that was really important to me I wanted to have an impact on something and be able to

12:40 have real agency over the outcomes joining Jem in 2018 was a bit of a leap personally but professionally it was a very logical next step and gave me a chance at a bigger platform to continue to expound and engage with a wider array of clients why you tell a little bit more about the history of gem until you showed up gem was founded in 2007 by the CIO at Duke University's endowment duac THU Morton his head of privates and

13:07 Stephanie who at the time was the CIO of the Duke endowment which is the Family Foundation in Charlotte the premise was to deliver the governance model that the leading universities were utilizing which appeared to be at that time an extraordinary Advantage relative to consultant Le or committee Le institutional pools of capital and also the portfolio ication and access that came from having a dedicated team working in these markets all the time that was a well trodden path there were

13:36 some other firms that had done similar things Alice handy at uvimco spinning out earlier in the decade to found investure Mike mcaffrey and the team at Stamford founding McKenna and Palo Alto there were a couple others as well but we were the Duke team the model was really to just bring to bear all of what we'd learned from that experience and that form of Engagement with a single client and spread it across a select group of

14:02 smaller institutions that lacked the institutional scale to do it themselves what was the core of how you would describe that governance model that was successful for Duke historically governance is one of those things where the best practices are all very well understood and yet the execution is very inconsistent across institutions I think what the leading universities figured out was for one thing the independent management construct was really really helpful you had management companies that sat alongside the universities

14:32 where they had a single client they were deeply integrated with the needs of the institution and they understood how to construct the portfolio to meet those GES built differently from Harvard built differently from Stanford built differently from Notre Dame they all had their own unique approach to that but it was tied in with the University's specific objectives you also had a collection of individuals on the boards of these places that were well ensconced in what was expected of them what we

14:59 observe at smaller institutions is sometimes inconsistent expectations around committee engagement what that means and requires a lot from an investment committee chair to effectively shame the people who don't participate who show up cold to meetings who can't follow the material Etc and I think that the large universities obviously had the advantage of really sophisticated alumni bases from which to draw those folks but they benefited meaningfully from the really deep engagement and love for the institution that those people showed what have you

15:28 seen when there's a committee that isn't following these basic principles in terms of how you go about helping move them forward in the right direction first of all the forms of dysfunction are varied they can come from a lot of different places the first step is obviously diagnosing what it is that's going on is it political issues related to committees relative to other committees is it a weak chair relative to what the needs are for that

15:54 particular institution is it the composition of the committee is the construction in ins sufficient to deliver what the institution needs Charlie Ellis would tell you 5 to seven committee members is the right number we see some institutions where they have 14 to 17 that's too many it's very well understood that after a certain point the loss of motivation and the loss of coordination of a committee operating that way undermines any of the overarching objectives they might have

16:22 the skills and resources that committee members bring to bear is a critical piece too there's a view that well if somebody is any way related to investing they must be useful on an investment committee and I found that to be true in spots not universally true the more important things tend to be the soft skills is this person a good listener is this person open-minded do they work well and collaboratively in a group those are things interestingly that

16:50 often aren't typical of really successful money managers because they're used to being the sole decision maker it's everything from committ construction committee skill set the way the committee engages the way we try and help is multi-dimensional we share our views on these issues in delicate ways we write a lot of white papers on what good governance looks like to try and Lead horses to water and then you have to just develop advocacy and relationships over long periods of time

17:18 I think that's one of the beauties of Jem in that we have a few dozen clients we are not trying to be all things to all people the engagements that we can have with clients are much deeper we are much more integrated we are intending at all times to effectively be there inhouse investment office a partner at the table with them trying to solve all these various issues and challenges rather than some vendor who flies in

17:45 quarterly for performance reviews that's an important piece of it too I'd love to ask you about Gem's business model in the context of say Ocio as an industry you joined 10 years in has changed a lot it has it's changed even in the six years since I've been at Jam I view it as really three phase shifts the third of which we're embarking on now the first phase really 2002 is I would credit Alice handy with

18:14 kicking off this trend until about 2015 was really governance driven it was about a recognition that committees Gathering four times a year in a consensus oriented environment of their peers would was not an optimal model for making portfolio decisions that was turbocharged through the global financial crisis when people realize they didn't have necessarily a terrific handle on the risks in the portfolio and also access to more and more complex and crowded markets the second phase I like

18:46 to characterize as the death of diversification in 2015 onwards which is the more simplistic the portfolio the better from a returns perspective the more us large cap equities you owned the better your portfolio did did and you really didn't need much else Bonds were sufficiently negatively correlated to equities that in draw down periods that protected you interest rates were zero volatility was low there was very little need for other types of beta Commodities credit real estate Etc and the niche

19:17 strategies that had led endowments to have so much success in Phase One weren't really necessary in fact there were some pretty stiff headwinds that those strategies faced what did that due to the Ocio business when the bells and whistles of active management didn't really matter in that phase two psychologically what it's LED people to believe is that Ocio investing total portfolio investing endowment investing however you want to characterize it has become commoditized When Things become commoditized and industries mature they

19:50 consolidate and so what you've seen is a lot of consolidation in the space you've seen wealth aggregators buying up OC IO businesses bolting them onto their practices recognizing that gez I think we need more scale here in order to distribute more products through the pipe and that will be the key to generating the kinds of profitability that we need as a business we don't think of ourselves as business people we view this as a profession rather than as

20:19 a business per se doesn't mean we're blind to the business pressures associated with it but in general the philosophy is different we've resisted the siren calls for consolidation and come to the view that our independence is actually critically important in our ability to do the right thing for clients no shareholders looking over our shoulder with a revenue Target for us we don't have salespeople running around the world looking for oci mandates we are going to win on investment

20:50 excellence and our deep integration fast forwarding now into phase three we're in a different environment now we can all talk about the nature of theet Market regime that we're in more inflation volatility likely higher interest rates for longer likely US Stocks have a huge valuation premium relative to the rest of the world maybe that persists but maybe it doesn't and maybe expected returns going forward or lower and maybe you need an alpha engine in the future

21:15 to make sure you can meet your nominal return goals our view is the quality of execution and the engagement that you can have with institutions to make sure a portfolio is optimized for their specific set of needs those are going to be the touch stones for the next 5 to 10 years so I'd love to turn to how you go about doing that for your clients and maybe start with how you think about managing the pool the first thing for us

21:41 is to start with what we call an Enterprise assessment which relates to a number of the risk factors we talked about earlier what you're trying to diagnose is an Institutional tolerance to Bear certain forms of risk how do you do that for an institution that has an operating business let's just take your typical School endowment and we look at it in a couple different ways one is what's the budget Reliance how much of the budget does the draw support if the

22:09 draw supports a very small part of the operating budget all things equal that makes you a little bit more tuition dependent which may be a good thing may be a bad thing depending on how confident you are in enrollment demand we look at the operating condition are cash flows positive or negative are margins positive or negative what are the trends ends in capital demands out of the institution that changes your flexibility in terms of how much risk

22:34 you can take we look at endowment flows there's some institutions that have very loyal alumni who give very eagerly on an annual basis offsetting the draws that come out of the endowment that is a huge Advantage relative to institutions that are spending four or 5% out every year and then the health of the balance sheet unrestricted versus restricted how much borrowing capacity might there be you're trying to get a sense there of if there's some shortfall in endowment draw

23:01 what other levers can the institution pull in order to plug that deficit and what you come out with is not a prescription about how much risk an institution should take but a sense of the flexibility that institution has to take certain forms of risk if they choose so then there's the qualitative element of what does the committee care about are they trying to grow this resource over time to build a new building or increase the commitment to

23:29 academic Excellence or provide more scholarships or whatever it might be or are they satisfied with just meeting the return goals over time preserving intergenerational equity and preserving the real value of that Corpus and that becomes a choice that the committee has there are a lot of institutions in particular I think postco that are going in very different directions higher ed is a classic case where you have one college or university closing or merging with another every week now on top of

23:58 that you have an enrollment Cliff coming around the pike because people stopped having children in the global financial crisis and so those kids would be 17 or 18 years old now enrolling in college in theory but there's going to be 15% fewer of them over the next few years so there are some real strategic issues that a lot of institutions in that space in particular are facing and there's similar versions of that if you look at

24:20 foundations or Health Care Systems do they all have their own idiosyncratic business issues to deal with and the key is understanding what can the institution bear in them what is the committee trying to accomplish with the assets to help it with its Mission so the end of that Enterprise assessment you can imagine some type of a spectrum of say risk tolerance or what they're trying to accomplish you then have to put that into action how do you think

24:45 about what to do now that you've made that Enterprise assessment the nice thing about it is each of those risk factors that we talked about shortfall risk draw down risk IL liquidity risk variance risk risk Maps pretty cleanly to a form of risk exposure that you might have in the portfolio you know as a endowment investor that your nominal return goal is going to be high enough that you need a very healthy dose of equity in there it's going to have to be

25:14 at least half of the portfolio probably a little bit more than that and then the question is what forms of diversification away from that do you need to incorporate the first thing for us is always deflation hedge in the form of interest rate risk there are also periods of un anticipated inflation beyond that you use things like Commodities and real estate to hedge those particular periods and you can run all of these factors through your model

25:38 and figure out what is the optimal mix that gets the client to its goal within the constraints of its risk budget you overlay obviously the alpha that you think you can generate in each of the opportunity sets that you'll ultimately leverage how much can you get from private assets how much can you get from public assets Etc and bolt that on top of what the beta is providing you from perspective but it's a fairly straightforward model I don't believe

26:02 that we're trying to win in terms of portfolio Construction in the way the assets are assembled we're mostly trying to win through manager selection within those tools but the key is making sure the portfolios are arrayed in a manner that's aligned with those goals so you said there's a range and there are some clients have more Equity exposure because they can tolerate more draw downs and they're seeking a higher return goal over time some have lower IL

26:27 liquidity Target targets because they need more access to variable capital or they need it more frequently those two end up being big drivers passive and active is another component of this conversation if you have low variance risk then maybe some of your Equity exposure should be passive or indexed in a manner that's going to reduce your tracking error to underlying benchmarks and you'll have to make up for the loss of Alpha from that somewhere else so

26:51 these are all trade-offs that you make over the course of a modeling exercise so in this phase 3.0 when you've made these tradeoffs you mentioned Alpha's going to be super important you got to get there through manager selection let's walk through that process of sourcing of managers it's varied by the asset type but I think at a very high level we're looking for three things we're looking for skill we're looking for an attractive market and we're

27:18 looking for alignment of interests so breakdown each of those in turn and skill absolute skill is pretty easy to find these days everybody out there is well trained they've got a great story looks really good the question is what's the relative skill this is a Michael mbison concept this Paradox of skill that when the aggregate skill level goes up in a universe or a population luck has a disproportionate effect on the outcomes the key is finding these games

27:46 that you can play Within These different markets where relative skill is really what's dominating the outcome we spend a lot of time trying to figure out who's got some kernel of Excellence that leads them to have an Advantage relative to their peers or competitors ideally it's durable no Edge is ever fully durable and ideally it's predictive of better outcomes in public markets those things can be an aspect of portfolio strategy it could be risk management it could be

28:15 analysis it could be temperament that lead you to a view that this person has a chance to be excellent relative to everybody else that's in competition in private markets that's source ing capability it's often times deal hustle it's structuring it could be operational chops depending on the nature of the strategy pursued how do you go about assessing the difference between two managers so's say public markets that seem attractive on a lot of those

28:47 characteristics but you really only want one for your portfolio public markets are in my view very interesting because you typically have a lot of data and as a result you you get a chance to look at trading history you get a chance to look at letters they've written in advance of Market moves and understand what was the thesis how did that play out we spend a lot of time with managers talking through decisions they've made and why

29:13 that's the primary driver of it you see the data and you ask people what their rationale was for when things transpired why they transpired in that way you're always trying to disentangle luck and skill there have been situations where people are right for the wrong reasons and you ding them for that and there are times when people are wrong for the right reasons and you try and give them credit for that and then you try to make

29:38 sure that you examine that data and those conversations over a long enough period of time that you get different Market environments I always joked after covid we learned more about our managers in those six months than we had in the prior six years because you see how they react to Market stresses and stimuli in a different way temperment ultimately becomes a key feature in this that you often don't get get enough iterations to really see but some managers that we

30:02 were watching turtled during that period and didn't turn over their portfolios and others really rose up and traded out of things that had a 20% forward irr for things that had a 30% forward irr and were very active and I think that element is something you just have to get through a lot of monitoring and discussion so to get at more data requires more time how do you balance your interest in a fund that's been around for a longer time and therefore

30:28 or you have more data to assess with something that's earlier in their stage of development there's typically things you can see for day one launches and there's things you can't see the thing you can see often is business analysis research intensity you can reference those things with peers and former colleagues and bosses what you can't see are things like portfolio management and temperament you spend an inordinate amount of time trying to predict how people will behave and act but it's

30:58 always imperfect there's other things that can creep up that cause challenges too how is this person going to build a team over time to support them often times young managers haven't had to deal with that we try and lend our expertise in some of those areas to help them through those processes but again you don't know xan part of it is how you size and how you control the risk within your own portfolio I think we're always

31:19 trying to build conviction one of the things that we do with a lot of relationships is look to secure capacity rights in the future that tends to be the scarcer resource because once once it's obvious the manager good it's too late and so you'd better have a relationship early you better have added value in some other way to them you've better been a good LP along the way so we just try to make sure that we're

31:38 crawling walking running with people who are building their own firms for the first time so in the context of doing your due diligence I'm curious if there are any techniques questions processes that you have that help you get there there always are I won't reveal all the secrets sauce here but I think we've tried to take a very multi-dimensional and multidisciplinary approach to this issue the team is extraordinary that we have they are very well experienced in

32:07 this we have years of networks and relationships that we can draw on to ask about people and their pasts and what their workstyle has been and then we look at other forms of insights we had someone from an intelligence agency come in years ago and give us a tutorial on how do you detect deception how do you read body language it's an interesting insight into other ways to sit across the table from someone and how to Gan

32:32 information we spend a lot of time on how do you ask questions it sounds like a very basic thing but analysts come in and people don't know how to ask questions particularly questions that are open-ended enough that it leads you to truthful candid answers getting people to ask questions that are not leading that don't guide somebody to the correct answer is very difficult actually you have to ask things in a way and in a manner that gives people people

32:58 across the table from you permission to answer it in the most candid way that they can that's another art form that I think goes into this that is subtle and we're constantly trying to improve on to make sure that the answers that we get are most instructive in leading us to the truth is this person really good have they been successful because of the skill that they have is that skill durable and can we underwrite it and

33:23 back them in the future because of it what are some of your favorite tips for how to ask good question questions the biggest one is being quiet after you ask there is a strong tendency psychologically to fill space with words often times it's elaborating on a question or changing the framing of a question if you don't immediately get an answer and instead of doing that just be quiet just hush up Let the person sit with it and figure out how they're going

33:53 to deal with it that tends to be the biggest thing you have to coach out of people the other one is asking things that are truly open-ended meaning you're not encouraging a particular form of response you just ask it in a manner that is almost Curt sounding when you phrase it because you need them to not only answer it but interpret what it is you mean and often times they'll get anxious about that if the interpretation

34:20 could be in a negative way so there's a lot of little tools and tricks and the team is constantly trying to refine those and share them love to turn back if there are any differences in your assessment of private Market managers privates are very different in the sense that you typically have a decision point which is are you going to commit to the fund or are you not going to commit to the fund you watch people who focus on

34:43 public markets and there's this constant rumination that goes on about okay the quarterly letter comes out how is the Arc of the thesis evolving how has the market moved there's a very pensive process that goes on in const L evaluating the public managers private side it just tends to look more transactional and execution oriented and that's the nature of it in the underwriting process though it's a fairly similar exercise we try to understand what has led to a person's

35:15 success we do a lot of references on individuals again it depends if there's an established track record there or if there isn't if it's a new manager to us or if it isn't you obviously have a lot more insight into to the portfolio and where things are likely to go if you've been in funds one two and three and this is a reup for fund four but is the sourcing Edge still in place do they have a credible path to generating a 3X

35:38 net return that's our bogey for private markets we expect private equity in particular to deliver 5 to 7% ahead of public markets over time and does the strategy and does this manager allow for that fund size is probably the number one aspect that we underwrite is the opportunity set allow for them to deploy this amount of capital is the team structured in a way to allow them to deploy this amount of capital there are some strategies that are much more

36:03 operationally intensive buy and builds for example if you're going to do a lot of add-on Acquisitions the integration processes are difficult do you have a team that can support 8 to 10 platform businesses and the associated taxes that come along with that those tend to be the big ones I think when you're dealing with emerging managers on the private side often times it's a challenge to associate a track record specifically with them so that really raises the bar

36:29 on what you have to reference you're calling not only peers and colleagues but CEOs of portfolio companies that they were involved in other people they may have associated with at different phases of life to try to put together a mosaic of how successful this person is likely to be why they're spinning out on their own and what it is that's going to lead to success in the future for the Carl area of public market managers how

36:51 do you think about the assessment of data that is available in normal times when there are distri butions and other sorts of things that lead to funds opening and closing and having a natural life cycle you do have quite a bit of data it's not a lot of swings and we've had situations where a manager's historical track record is mixed at the firm that they're with and yet we decide it's a good investment opportunity given how they've reshaped their approach what

37:18 their deal box is where they're going to spend their time how they've built the team what their sourcing Edge is so you have to take it in context I think one of the things that we've done done over time is backed managers in a deal by- deal format in an independent sponsor context that's been compelling for a number of reasons one is the returns that have been associated with that strategy have been excellent over time another though is that you get a lot of

37:45 insights into how deals evolve that you wouldn't have gotten otherwise that as a fund one LP trying to diligence a pre fund track record you would not have been able to monitor over time obviously you're doing this all X poost watching someone live through a collection of deals engaging with them along the way helping them navigate different things that pop up with businesses CEO resigns something goes wrong covid happens is incredibly helpful one of the things

38:14 we've done obviously to amplify our own ability to underwrite these things is just get in earlier and do things on a deal by deal basis where then you can build conviction into a fund one commitment when you started doing the deal by ideal investment and then analysis I'm curious if there are things that you learned because you had say more transparency into what was going on that you weren't quite sure how to calibrate because you hadn't done that

38:40 as much as investing in funds yeah I think there are always learnings here we started this process in about 2015 my partner Jay Ripley really LED this and it was born out of a series of visits to private Equity annual meetings where they show you the page of per performance track records and the pre fund deals are great 3 and 1/2x whatever it might be fund one is good fund two is okay fund three is fund four and

39:07 monotonically downward sloping returns as the assets under management group and so the joke was always well how do we get exposure to that thing that first one so there was a view that this was going to be a better opportunity set for us there have certainly been a lot of learnings over time one of those is how do you structure these types of engagements do you put them in a single vehicle do you have them in spvs how do

39:29 you deal with follow on Capital there's a whole slew of terms and conditions that really varied across the different strategies buy and builds are different from turnarounds are different from corporate car outs how you supported a manager building a team over time getting involved with conversations about when do you hire a CFO what if you're having a partner issue all these things that sort of border on therapy you learn over time how to navigate those and what the right guidances and

39:57 best practices how to educate people and those sorts of things and I think to constantly raising the bar on our sourcing apparatus to continue to find new folks and top grade for a long time the way this worked was we would look at all the big firms typically firms that had a really compelling strategy typically firms that didn't necessarily pay the money makers all that well so there was an incentive to leave and run through all those firms and figure out

40:26 who the real stars were that's a great method it's a very crowded space now and there are folks that are spinning out of all sorts of firms all the time and so making sure that you have a dedicated sourcing apparatus that is constantly in this market trying to make sure that we are the first call for them when people decide they want to leave whatever Middle Market firm they're at that has been a concerted effort over time that

40:54 was always part of it but I think as the world gets more complicated ated and more crowded that's becoming even more important I'll give an example six members of our team were at the McGuire Woods conference in Dallas last week which is the biggest independent sponsor conference in the world a number of years ago there were a handful of capital providers this year there were 430 Capital providers to go along with obviously a growing number of sponsors

41:17 as well interestingly about a quarter of those Capital providers were people from other larger private Equity firms who recognized that it's a sourcing apparatus for them to partner with independent sponsors so the world has just gotten very crowded we all have stories of people who are trying to roll up HVAC businesses and plumbing companies and Paving businesses and things like that but there are a lot of services opportunities out there and you have to be able to separate the wheat

41:42 from the chaff there's a lot of chaff finding those folks that have credible referenceable track records and a real path to generating excellent returns it requires a lot of proactivity so this idea of finding an opportunity early like independent sponsors but then over time D grows and gets crowded leads to this original question about the second assessment of markets next to manager assessment and we just love your thoughts on how you go about assessing a market that a manager is participating

42:09 in at a very high level I think you're looking for a dynamic where there's some advantage to be had so corporate car routes are always been our classic example where on the other side was a big public conglomerate new CEO installed wants to divest from a particular business unit that's under performing that's a great setup they typically have a Time Clock where they'd like to get rid of that thing and if you pay three times four times five times

42:35 eight times doesn't really matter what the CEO can't do is show up to the Wall Street analysts next quarter and say we still own this thing so whatever it takes to get rid of it they're going to do and that has been a really really powerful Dynamic it turns out the lower the purchase price the better your return prospects might be surprise surprise I think more broadly though market assessment is about Dynamics where an Edge can be exploited so

42:58 biotech's another example where there's clearly in that Marketplace an advantage to specialization there aren't many like that in public markets where the generalists are clearly at a disadvantage to the Specialists you can develop an edge you can develop an interesting viewpoint on different disease therapies and different drugs that are coming to Market and win that game and there's a lot of cases that all the endowments of firms that have done really good job in that space over time

43:24 China for a long time was a good Market because the share of equities owned by retail investors is very high and so in theory again back to the main point about relative skill that's a situation where the skill dispersion is high in theory of Institutions trading with less sophisticated retail buyers that should be an attractive market and then there are some corners of markets that are just capacity constrainted and so you know that the large asset managers

43:48 cannot play in them those with a significant efficient deployment of capital problem are not going to be there moving inefficiencies out of the way and so those are situations that we also like those tend to appear more again in private markets or in sort of alternative betas than they do in public markets when you're building your portfolios of managers you like to have all of the managers in these Alpa generating areas of inefficiency but over time things get more competitive

44:17 and you kind of have to have a core of things that hopefully someone's outperforming but it doesn't have that area of specialty as you go to construct your portfolio how do you think about balancing to of the need to have core asset exposure with this constant search for something special I think it varies a bit by the opportunity set in public markets for example we think of about half of our portfolio should be in what we call foundational assets so these are

44:42 things that are going to provide you core beta often times quality like exposure maybe tilt larger cap you can't do the whole public Equity portfolio in Niche special situations managers to be sure and then you have a couple of other buckets you have have structural opportunities that may be things like biotech where regardless of the beta you like the alpha opportuni so much that it's going to have a place in the portfolio then you have opportunistic

45:08 assets where that might be related to dislocations or things that are more transitory where those managers might come and go depending on where the opportunity set is over any given 3 to 5e period and then you have this sliver which we call diversifiers which would be things to balance the rest of it there are parts of public markets where active managers just don't go very much Consumer Staples utilities parts of energy sometimes but you need those to

45:34 manage your overall tracking error so I think there's always a core satellite Dynamic we think about it in terms of how attractive is the baup how attractive is the alpha there are situations where you'd love to have everything where the beta was attractive and the alpha was attractive but often times those aren't always aligned on the private side same idea you have more willingness to seek Alpha there first of all that's the role it plays in a broad

45:59 portfolio so you need to generate Alpha from the private side but are there zero large buyout funds that can generate sufficient returns to have a place in our portfol of course not no and we have several that are measured in the billions and they just happen to have compelling enough strategies that they think they pass the bar the key on the private side is you have a much broader opportunity set and so we have a lot

46:21 more diversification there by manager and by strategy that portfolio is just a longer list of line items than the public is and so I think you have more degrees of freedom to get to a sufficiently diversified Place through more diversification on the public side that core part of your exposure how do you think about the movement to passive management there's two kinds of passive there is what I'll call anti-active which is really a philosophical view that active management in public markets

46:51 is a loser's game to borrow Charlie 's term it can't win no one can win it's not worth trying there are clients of ours that hold that view and we are perfectly capable of building portfolios that incorporate a portion of a portfolio that's passive I have a very strong view that the portfolio a committee can stick with is the best portfolio for them and if you constantly bang your head against the wall trying to get someone to believe that active

47:22 can be better the first whiff that it underperforms they will immediately scrap the whole thing and shift passive and at Great cost to them so we're happy to build a portfolio that has passive component to it as long as people recognize you now have a higher Alpha bar at the rest of the portfolio and therefore may need additional liquidity or something else to try to increase expected returns I think from here passive the anti-active version is just

47:49 less compelling than it has been in a long time if you go back to 2014 and you look at the expected returns for equities at at that time and you run it forward it was about 4% and what we've gotten is nine or something extraordinary 1.8 standard deviations over what we expected at the time if you do that from here where expectations are even lower today given where risk Premia are and where valuations are it's going

48:15 to take more than 1.8 standard deviations from here to continue to meet the bar that a lot of clients have for their passive Equity exposure so I think the bar on passive has just gone up in my opinion it's hard to fight with people who have an anti-active view about that it's an unwinable argument the other form of passive which I'll characterize more like indexed exposure for a long time it was very difficult to find compelling active management in

48:40 Japan so what did we do we plugged that beta similarly in some of the segments that active managers don't often play Consumer Staples we view indexes as a compelling tool for balancing tracking error for completing exposures and making sure the portfolio is properly balanced we use them that way we typically don't use passive as simply a plug to reduce tracking a when you are filling part of the portfolio with passive and you need that increase in

49:09 Alpha on the active side you immediately think of venture capital so I'd love to get your views of how Venture Capital going forward plays in your portfolios venture capital is in an interesting part of its evolutionary cycle it has been a primary return driver for a lot of leading endowments for a very long time interestingly for a lot of that period if you asked 20 of the largest endowment teams what their roster of the 20 best managers were in the space you'd

49:39 have I'll be conservative here and say 60% overlap in terms of what's on that list so it was very much an access game it was very much can you get into as many of those folks as you possibly can to have a credible path to generating really good returns we've just gone through a serious Capital cycle in Venture where postco everything accelerated valuations assets raised and now we're on the backside of that and we are in the process of DEC capitalizing

50:08 that space broadly and that's going to have implications for how people use Venture going forward the base rate in venture has always been terrible 60% of venture capital firms generate less than costs so not only are you not keeping up with equities you're losing money in more than half of venture capital funds rate bed it has always been a power law right tail oriented asset class even for firms firms yeah and what you're seeing now is that there's still demand tons of

50:38 demand for what was on that list of best firms previously where we have really refocused our attention is engagements with those great brands that have been disciplined about fund size there are a number of other firms that are great brands that have not been as disciplined about fund size that are now supermarkets for lower cost of capital investors the space is institutionalizing very rapidly in that sense and certain forms of alpha are becoming beta they're selling a

51:08 different thing so engage with the brands that have been really disciplined here and then figure out who's going to be on the list of great Brands five years from now it's a really hard game Adventure really really hard and historically we had a view that well let's wait till fun three once we can see that this is is working and the brand is established you don't have that opportunity anymore and you need to get in early in these situations our

51:34 sourcing apparatus has turned on to seeden Micro Managers today trying to figure out who is going to provide the returns going forward that's going to allow them to establish a credible brand we just backed a group raised $350 million for fund one it's three partners coming together out of three storied franchises they have a view that particularly series a and early stage Founders are underserved by the multi-stage firms they're small

52:04 multi-stage Partners have other things to worry about and there's a view that they can do a better job so I think that's all part and paral of an evolution in the strategy the math adventure is just very daunting particularly at Mass scale when you think about the likely probabilities that certain number of companies are going to fail certain are going to be middling outcomes and then a very col few are going to be very right tail

52:28 extraordinary experiences how big do those extraordinary companies need to be to justify the fund size and even at$ 300 to $500 million you need to be a part of a couple of 10 to20 billion Enterprise Value companies which is not small and you need to have avoided delution along the way to some extent there's a lot of things that go into it and if you're raising 5 billion just multiply all those figures you B basically need one of five generational

52:58 companies within that portfolio to meet the return bar how do you think about hedge funds hedge funds for us have been a source of alpha in the sense that we want Total returns we've never really used hedge funds not in the long time at least for volatility dampening we can do that in other ways we just take down Equity risk and increase Bond exposure so we wanted our hedge funds to be able to generate sufficient net returns that

53:25 they were sort of compelling in their own right that led us over time to a place where we had a lot of directional long short managers who had sufficient Alpha that they could overcome some of the volatility dampening just endemic to being less than one net the portfolio overall today is about 50% net exposure we have some AR again that's partially related to stock Bond correlation going up and our view that going forward you're going to need more Diversified

53:51 sources of portfolio protection so we've done some things in reinsurance space we've done some things in Market neutral we've done some things in Arbitrage strategies hedge fund space in general is an interesting industry Dynamic at play launches are down relative to history it's getting harder and harder I think for a standalone single strategy manager to build a durable business and some of that's related to what the pods multi strats are doing hoovering up a lot of the talent that's out there when

54:21 you meet with those firms you realize what an extraordinary data Advantage they have in managing their talent and seeing where skill really resides and evaluating that on a minute by minute basis and then obviously the leverage component is huge too when you cut through the data the long short spread of the equity long short strategies the pods is good not always world class relative to what we see in other situations but if you lever that 3 4 5 6

54:51 seven eight times it becomes very very compelling so I think that shift of Talent toward these bigger platforms is likely to continue that'll have some consequences for the industry overall but I think it's just fundamentally changed the game a bit in terms of how you get that exposure today so let's turn to the last pillar of your assessment in alignment when you think about alignment of your Capital with your managers how do you try to implement

55:19 that we have seen this every which way over time there's forms of over alignment there's forms of under alignment I think what you're trying to solve for is first off what motivates the person across the table from you what is the intrinsic driver of their commitment to success are they returns focused are they committed to Integrity are they going to do the right thing irrespective of whether this goes well or poorly that becomes a critical

55:51 analysis piece because you cannot structure your way into alignment if it is not inherent to the person you're across the table from now you try you try to defend yourself in some instances in terms of fee structure we try to make sure that we're paying for Alpha not beta paying for the outcomes that we're going to be happy with and we try to make sure that the level of fees is appropriate for the strategy that the

56:16 manager is running and then you think about terms broadly as well what's the liquidity of this overall portfolio because there a trade-off to be made there what are capacity rights that you might secure because you don't want managers to outgrow the opportunity set too soon and so you almost are willing at the early stages to pay a little bit more than you otherwise would in order to incentivize that form of behavior you're trying to lead breadcrumbs down

56:41 the path to really good outcomes for you and for the manager in a way that keeps everybody in the same boat rowing in the same direction we don't want to be adversely selected either a lot of times managers that are willing to negotiate with you on fees are not managers you want to invest in one of the partners had a phrase long ago that was we're trying to convince people who don't need our money to take it that becomes the

57:03 fulcrum Challenge in a lot of these negotiations and so sometimes you have latitude and sometimes you don't this is another area where being early really matters both on the public and private side because you can help craft those terms and find ways to endear yourself to a manager be treated well and fairly all the way through the relationship how do you think about the impact of LPS so if you're early there are other people that are trying to step in early

57:31 as well if you're later on there are other LPS who may have had influence or continue to have influence along the way it's a critical piece of our diligence and I think the lp base can be a source of edge for managers depending on who's in there if at the first whiff of a downturn in a public markets portfolio the person's on the phone with 16 different LPS that's not a great setup for good decision making you do really

57:57 want to be aware of who else is in here that doesn't mean you're deferring your diligence to those folks we don't over rely on who's done the work previously as a signal for quality but it does tell you what other sorts of pressures is this manager going to have on them we've had situations where leading university endowment for its own causes will try to persuade a manager to change his or her strategy and in one particular instance

58:23 he called and said gez this institution is trying to get me to focus on this particular Market I think I'd be better served not doing that and we encouraged him to do what he believed was right because guess what if pivoting doesn't work then that institution is not going to blame itself the only thing you can do is do what you believe is right over time and if that institution doesn't like it you can find another LP if your

58:46 performance is good enough over time you will be fine and fortunately stuck with it and it's been one of our best performers over a long period of time but it's really impactful and you have to understand what the in Ines are of the other LPS at the table as you're investing today and you look out over the next couple years what are the different ways you're thinking about the process of manager selection compared to what you've done in the past there's

59:10 always an arms race in terms of the execution here and so our team is laser focused on how do you continue to Scout and access Talent effectively I think there are a couple things that are going to continue to be very important number one is relying on the causes that our clients serve we are blessed to have this handful of clients who have discret missions things they support programmatic objectives and it is very rare for us to be unable to find a cause

59:42 that really resonates with a GP within our client base the universities have been using this for decades and we effectively have 40 some odd different missions that we can point to which is really really powerful a lot of these firms have decided they really only want to serve LPS that are doing social good in some way and so whether it's scholarships or medical research or social Equity or whatever it might be there's someone in our client base

60:08 that's really pursuing that objective number two is just burning Sho leather we live on airplanes doing residencies in Europe in the Bay Area we have a colleague now who's in Singapore full-time covering Asia for us there's just a lot of intensity that goes into the consistent need to top the portfolio this sourcing construct is something that Jay brought over from his private Equity days which was this view that if your deal people are doing a deal then

60:35 your pipeline is running dry and so you need a separate set of people that are constantly refilling that Pipeline with compelling opportunities so that you know you are always in a position to be underwriting something deal finishes there's something new in the pipeline maybe it's better than the thing you were just about to look at that sort of thing has been really really helpful in helping us turn over more and more Stones creating what I would call sort

60:59 of micro Brands within some of these niches independent sponsor is a great example obviously we were sponsors of this Maguire Woods conference we've become known in that Community as a funer of these types of sponsors and we have a very compelling pitch because we can ultimately anchor their fund one we can be full life cycle investors unlike others that play in the space may want to take credit for the deal it's just a different Dynamic that's been really

61:25 helpful we get calls early from people who know that their friend's friend also did something similar three years ago and we backed them Talent follows Talent those are the big ones continuing to lean on our client causes amplifying the sourcing apparatus meaningfully and enhancing the decision- making of the team I would say is the third one we are a robust team we very much focus on collaboration culture that's critical it's not something you can do at Mass

61:54 scale but making sure that information is Flowing very rapidly allowing a lot of autonomy to our team to look at things that are compelling that meet their bar do the work on it send it up the flag pole let us evaluate it that's been really critical because you have to move quicker than you used to I know some LPS where you could be at the firm for 10 years and you're still monitoring an old portfolio position that was three

62:19 cios ago and that's a recipe for a really stale portfolio and we try and arm our very ambitious talented people with autonomy to go out and find the next great thing you mentioned that Jay had this idea that if your deal team is working on a deal you need people to continuously sourcing it sounds like that could have come from a private Equity Firm and I'm curious if there are other important lessons that you've brought into your investment process

62:42 that you learned from some of your managers we are always trying to use the best of what we see in the GPS to inform our own work sourcing was one of those I think some of the process structure and how we systematically vet opportunities has been something we've brought over from other experiences and then really how we try to motivate incentivize the team culturally look we do not want to have a

63:15 massive multi-office apparatus at any point in the future the distractions of scale are really difficult to deal with for large firms goes back to consolidation I understand the business logic of consolidating into a big apparatus you can push product through you can distribute more easily you got this Army of salespeople advisers nobody has ever been able to explain to me the investment rationale how does this help us find good GPS how does this help us

63:46 deliver investment Excellence for clients how does this help clients at all so I think that commitment to staying a boutique staying focused on the ultimate client objectives is really a critical piece of this and that's something we obviously learn watching firms that we backed maybe outgrow their opportunity set or change their stripes or lose their culture or some of these things culture is a very finicky thing you have to apply constant pressure to it to make sure it retains the shape

64:18 that you want it to if left to its own devices it will go in all sorts of directions and we are very conscientious about that and and making sure the team is properly incentivized that we hire well that we train well that we develop well and give people autonomy that has been a another lesson of the great investment franchises out there that have stuck to their knitting great Matt well I want to make sure I get a chance

64:40 to ask you a couple fun closing questions what is your favorite hobby or activity outside of work and family I love being in the mountains I don't get to go as often as I once did in the past but try and definitely imbu in my children a sense of peace and comfort in the wild in the outdoor what's one fact that most people don't know about you I am an avid and sometimes successful home Gardener we

65:03 had an absolutely bumper crop of sun gold Tomatoes this year but I'll grow cucumbers peas carrots Swiss Shard melons all kinds of things just love the patience and the vigilance that that craft requires something you learned on West 12th Street yeah that's right that's right what's your biggest pet peeve well since I flew here today I can say one of them is people who listen to shows on their phones without headphones on had somebody next to me who was

65:33 watching I don't know the third season of some Netflix show just free and clear which requires just a flagrant disregard for everybody around you professionally it's arrogance I think acknowledging that we've all had so much good fortune to end up in the position that we're in if you can't do that it just strikes me as very off-putting which two people have had the biggest impact on your professional life one's my dad this one's a little bit

65:58 nuanced he served in the Army after college for a long while was incredibly disciplined and regimented just a workaholic through and through was gone before we woke up in the morning was home after we went to bed at night and he probably did that for 30 years I don't know that it helped his health but whenever I'm feeling tired or fatigued I always do remember his constant reminder to put your head down whenever things got difficult put your head down and

66:24 that is the way through do try to balance that against the recognition that you I want to see my kids and spend time with my family and do all the things that make me happy in life too and who's a second I'll credit partner at Goldman who took me under his wing pretty early in my career there and was instrumental in my having an ability to grow at that firm guy named Steve mcginness he was a terrific guy

66:46 everybody needs somebody at some point to take a flyer on them and just find something about them that they appreciate and help them along the journey and and Steve was that for me early what's the best advice you've ever received the idea that passion comes from the pursuit of Mastery not the other way around it's a big hoax out there that you're supposed to find what you're passionate about and then go do that that's not where it comes from the

67:10 idea that you get up every day and try and get a little bit better at something that's where passion comes from all right Matt last one what life lesson have you learned that you wish you knew a lot earlier in life well I'll give you one that I'm still terrible at but I keep trying to get better it's keep your friends close we all go off in different directions these days people come and go through your life and finding ways to

67:30 stay in touch with people you care about who care about you is a critical source of mental health and wellness and I continue to try to find the energy and time in my day to give people a call and check in on them and share how our lives are going Matt thanks so much for sharing these great deep and nuanced insights into what you do thanks so much Ted for having me appreciate it thanks for listening to the show to

67:54 learn more hop on our website at Capital allocators tocom where you can join our mailing list access past shows learn about our Gatherings and sign up for premium content including podcast transcripts my Investment Portfolio and a lot more have a good one and see you next time