Ana Marshall – The Climb to Investment Excellence (EP.360)

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2:31Hello, I'm Ted Seides, 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 CapitalAllocators.com. All opinions expressed by TED and podcast guests are solely their own 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.

3:11Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast. My guest on today's show is Anna Marshall, the chief investment officer of the$14 billion William and Flora Hewlett Foundation and a two-time past guest on the show. This time around, we discuss Anna's recently published book, The Climb to Investment Excellence. It's an outstanding thorough guide for any leader overseeing a pool of institutional capital. But don't take my word for it. The book jacket has praise from perhaps the best list of investment luminaries to ever adorn a cover.

3:51Seth Carman from Baopost, Sir Christopher Hahn from TCI, Paul Singer from Elliott, Doug Leone from Sequoia, Lei Zhang from Hill House, and Mark Andreessen from A16Z. Our conversation offers a walkthrough of the mountain investors must climb to reach their summit, following the metaphors of identifying the goal, preparing to embark or establishing governance, getting started or setting the investment strategy, working up the mountain or manager selection, and reaching the summit. Before we get going, my daughter Skylar is taking over the mic for this week's Spread the Word. I've just started my second semester of my senior year of high school.

4:33You might think that that's a time to kick back and relax, and it is. So while I slack off, have some fun, and don't tell my dad about it, I'd suggest you keep listening and do tell a friend about the show. Thanks so much for spreading the word about Capital Allocators. Please enjoy my conversation with Anna Marshall. Anna, great to see you. Great to see you too. I'm so excited. Why don't you walk me through how you came about writing this book? I wanted to share 37 years of experience in one handbook to provide how to do this in a practical sense for everyone involved in generating investment returns, especially those on the GP and the LP side that are doing this for compounding charitable assets.

5:23because if this book can help improve returns by 20 basis points per year, the amount of additional wealth we can compound to then solve the challenges in the world is tremendous. So the book was a book that I wrote at the urging of the board and really my investment committee chair, who felt that after years and years of being at the Hewlett Foundation, that there were a lot of things that other organizations could learn. And at the same time, I was teaching the class at Stanford that more or less follows the line of the book. And they're like, you already have most of the material done for your class.

6:02And you have all of this knowledge to share. Why not share it and sit down and write a book? So that's how it came about. And how about this analogy to climbing? The analogy to climbing was just I wanted something that didn't sound like a textbook. I was really trying to figure out what is the closest extreme sport to what we do. Because to do this in an excellent way, you have to be extreme at it. Anyone thinking that this is not a 24-7 thing is deluding themselves. I started reading books by climbers. And one of the things is everyone thinks they're crazy. They're really, really extreme climbers.

6:39You read their stories. Technique isn't enough. Planning isn't enough. Equipment isn't enough. you have to really know how to adapt yourself to the mountain. And it just sounded exactly like what managing portfolios is. When you manage a portfolio, whether it's managing a direct portfolio the way I did for the first 18 years, which is you can know your companies, you can know the markets, you can think you've got the legal docs set. You can think you know it all and something hits you from behind and just destroys you. Same thing happens in this side of the street. I thought it was a great analogy to how you have to plan, but at the end of the day, you have to adapt and really be trusting of your team.

7:20So just to be clear, are you a climber? I hike avidly. I do day hikes. I do not cocoon myself on the rocks. I tried bouldering and rock climbing. It requires really strong fingers that I don't have. So before we dive into the climb itself. What do you take away as some of the key themes that go across the book? I think the key themes are, this is definitely a group activity. This is not a solo climbing activity. Managing money well requires you to have people that can take the lead, that have different techniques and skills than you do, and people you really trust. And I think that's evident from the beginning of the book in the governance and how you form a team all the way to getting to the top of the mountain.

8:13You can't just rejoice and jump up and down at the mountain. You got to get yourself down safely. And that requires a team. A lot of people think that they get it all done by themselves, whether you're a hedge fund manager or you're an allocator. You really don't. It really does depend upon the relationships you have. So let's walk through this journey. Where do we start? Well, we start at the bottom of the mountain, which is trying to figure out what mountain you want to climb. Not everybody has to climb the same mountain. I think when pioneering portfolio management came out, it seemed like, okay, there's this mountain to climb.

8:48Everybody does it like Yale. And then over the course of the last 15, 20 years, we've had so much more money run into this endowment model, yet every institution or family office is very, very different from each other and has different needs. And so I think the first thing is distinguish what mountain you're climbing. And to do that effectively, you have to have really honest discussions with your board, your investment committee, really understand the needs of the organization, know what mountain you're climbing, what team do you have to develop? And then from a board perspective, what kind of CIO do you need to climb that mountain?

9:23You might need a very different CIO to climb one mountain than you do another. And so I think too many people try to run the sexy part of the job is manager selection. But there's so much that has to be done beforehand. And if you just skip to manager selection, it's highly probable you could fall off the mountain. How did those conversations take place? Because most of these pools aren't new. They've been around. Maybe there's a new leader. Maybe there's a new board. Just curious, how do institutions get there? You'd be amazed. I always say, oh, these institutions have been around forever. Yes, some institutions have been around forever, but there is a lot of capital that is new money that haven't had these conversations that just show up one day and it's like, oh, we have this endowment.

10:12Let's just get an outsized team. Maybe if you're under a billion, you hire an OCIO solution. But once you're over a billion, you're like, oh, let's just hire a team and let's just move forward. And you have to stop and be like, okay, are we an institution that gets inflows? Are we an institution that is really disciplined about our outflows? Are we an institution that has a very demanding operating budget and therefore we have to make sure... Because then you have to run a portfolio completely differently. And so you have to hire a CIO that's suited for that. If you hire a CIO who wants to come in and do exactly the same thing they did at their old job without asking the questions, At some point, that breaks.

10:57How long do you think it takes for an organization to start to solidify which mountain they want to climb? It depends upon how institutional it is. So I would say if it's a family office or a foundation where the family members are still very active in the world and are still contributing money and they still feel like it's their foundation. It hasn't institutionalized per se. I would say that it usually takes maybe a decade, which is good because a decade gives you time to have at least one crisis. So you're going to have a tough conversation in at least the first decade. And you also can get a sense of the pace at which money would be contributed to the new foundation or the pace of what that family office is really going to do.

11:45If you're an institution that already has had perhaps a smaller endowment and they get a big gift, it's as if you start over. Because once you have a transformative gift, the organization starts dreaming bigger. If it's, let's say, a college, now you're building dorms and you're building stadiums. The needs are going to change. And you have to just be really honest. What is it we're aiming for here? If that is what you're aiming for, amazing. Our jobs as CIOs and as investment teams is to be able to support the needs of the organizations that hire us. It's not how much money can I amass and then return.

12:28And sometimes we forget that. I'm highly competitive. Sometimes I'm like, no, don't spend. Please don't spend money. And I'm like, wait, no, stop. That is actually why I'm here. I am here to compound money so you can spend it and do good in the world. It's human. But I do think that there's an evolution as those organizations are formed. And then presumably that gets encapsulated in some type of investment policy statement. It does. And so it's not unusual for investment policy statements to adapt and be changed in the first decade. But once you're over that first decade, your investment policy is pretty set.

13:05Okay. So now we're in good shape. We understand what mountain we're on and we got to get going. What comes next? So then you have to figure out what are the skills needed to get a team up that mountain and get that objective. So as a board, when they hire the head hunter to find the person, it's like, this is the mountain we're climbing. Be very clear. It might be the return maximization one. It might be the risk adjusted one. It might be a, we just want to take things calmly. And there's different temperaments. And I think when the headhunters really start looking for people, they have to find the right CIO and then the right team.

13:46And sometimes people get ahead of themselves. So they've hired a team and maybe you inherit a team, but you have to have the team that trusts the CIO and the CIO that trusts the team. And that has to be a very natural process because when you're facing tough times, if there is any distress on the team, it's going to really cause bad blood during the climb. Even before you start getting into the implementation and investing, both of these things, investment policy statement and figuring out the team, they don't feel linear in the sense that there's money. You're not waiting to the end of 10 years to get started.

14:27So how did these things derail while you're building the boat while you're sailing it? So the team and the skills that you need when you're building a portfolio from scratch are different from skills that you need for managing an amateur portfolio. You might end up having turnover on your team and you just accept that as part of it. And you set up your committee to know that. You have to be able to know the skills you need. If you're building from scratch, you need people who love finding new managers. The joy in their life is to meet with seven managers a day, find really one or two, do a ton of due diligence.

15:06That gives them joy. If you put a person like that in a mature portfolio, they'll be so sad. In the same way that if you have somebody who is a masterful person at portfolio construction sizing portfolio management, and you tell them, go and meet with 1 ,500 new funds, they'll be miserable. Know where you are in your cycle and hire the people appropriate to them. Okay. So once you have a team in place, once you have some sense of what you're trying to accomplish, what's the next step? Then comes, what are the tools we need in the back. Delegation of authority. Are we going to have a heavy load?

15:45Are we going to have a light load? If you have a delegation of authority that delegates everything to the CIO, which I consider to be a light load, it's much easier to understand what tools you need. If you have delegation of authority that perhaps has much more involvement by the investment committee, then you need to build a system and a process and a framework that satisfies the needs and gives the committee confidence. Because the only way that you're ever going to get up the mountain is with the confidence of the investment committee. All your process and framework should be directed to how does the investment committee gain confidence as we climb this mountain?

16:24You pick your tools and then you figure out in your tool bag the role. Am I going to do this direct? Am I going to do it through funds? Am I going to do publics, privates, hedge funds? what asset classes am I going to include? And then you do your asset allocation, which really is creating the map that you and the committee agree with. You can't leave base camp without a plan of action. So the asset allocation then becomes your plan of action. That's where you both agreed you're going to live. And then how much you've been delegated authority is the degrees of freedom to deviate from that plan as you're climbing the mountain.

17:06So that all sounds like the basics of sound governance approach. Who's doing what? Who has the authority to implement in what way? That's great. And now you have to actually get into markets and do it. How do you take that analogy further as you're climbing up the mountain? You've done your asset allocation, you've agreed on a plan, and now it's time to construct the portfolio. If you have managers in mind, you can start that that way. If not, you start with index funds and then you find the managers. You start building your private portfolio. It's a process that takes time. Even taking time, we make tons of mistakes.

17:46This is an industry where we are guessing the psychology and the probability that a manager will execute a strategy. So there's a lot of psychology, a lot of business risk in the firms, let alone what the markets are doing. Trying to rush the process doesn't really help. What do you do? You create a portfolio. You say, I want this much equity. I want this much private equity, this much venture. These are targets. They're not written down rules. there's rebalancing ranges and your committee might want you to have tight ranges. I have the fortune of having a very wide delegation of authority with very wide ranges because they believe that giving me the freedom to have these wide ranges allows me to survive and really do the tough parts of these climbs.

18:39But nonetheless, you understand your constraints and then you figure out how to live within those constraints. And you start figuring out managers, you start figuring around geographies. You start figuring out how much liquidity did we agree with the committee? Do you have enough public active managers? Are you going to index? Where are you going to spend your time? I would say at the early stages, having really strong public equity and hedge fund expertise is really important because that's where most of the assets are going to live. You can dream about getting into venture funds and buyout funds and all of that, But most of your portfolio return is going to be generated by the public part of your portfolio for at least the first seven years.

19:25Yeah, got to have chops there. The manager selection in privates is really cool and everybody loves privates and I get that. But a lot of people stub their toes by spending so much time on that and really trying to get the expertise there, which is important, but you're not going to see it in your portfolio for the first part of the climb. As you're starting to assimilate that roster managers, how do you begin thinking about putting it together into that portfolio construction? Portfolio construction is my favorite part of this. Manager selection is great, but portfolio construction is really where it matters.

20:01And it really has to do with sizing positions in a way that if the manager does what you think they're going to do, and the opportunity set is as good as you think it's going to be, so let's say it all worked out perfectly, that it actually impacts and generates both beta and alpha for the portfolio. If you size it too small, then even if it does your wildest dream, it's not going to matter. If you size it too big, if you're wrong and you will be wrong, no one gets them all right. It could actually cripple your ability to deliver to the institution that is counting on that money to do research, to give for developing world, whatever it is, you're going to be cramped on being able to provide that money.

20:49So portfolio construction is the art of trying to, in a three-dimensional way, know how to size something while being able to say, it's big enough to where if they do it right, it'll matter, but not too big to where if they underwhelm you, it won't hurt that much. And that's the art of portfolio construction. Does that art get attached to a mathematical science when it comes to sizing? You can do it mathematically. You can do the volatility and we model it and we can do all that. But there is a third dimension to that confidence in the probability of execution. We sit there and we're like, okay, in this three-pronged model where I'm thinking, okay, I have about seven different types of risks I'm managing at the same time, none of which could be observed.

21:43The only risk that can be observed is volatility, but I'm managing seven other ones. And we've tried to do it with vector math. You can't. That's what experience is. And that's the judgment. And again, I don't always get it right. There are times when I'm like, damn, I wish we would have been a little bit smaller here. Or wow, I can't believe I didn't lean in when I should have. Doesn't always work. I want to use the Mike Tyson analogy, getting punched in the face. but since we're on a mountain, a gale force wind starts knocking you off course. How do you manage the portfolio to anticipate something that you can't anticipate?

22:25Whenever you're climbing a technical mountain, and this is through conversations with a lot of these guys I've learned, is you always have to be prepared to be knocked off the mountain. You just cannot let your guard down. So everybody's clipped in, everybody is following protocol. Everybody's following the process. There is no, hey, I just want to sleep in until 10 a.m. kind of thing. No, everybody is on plan because you let everybody else on the team down if you're not on plan and it can really hurt you. But to your point, I've managed through so many crises and I've managed teams through so many crises, both when I was managing money as well as on this side.

23:07The first thing you do when you see the gale force wind coming or you even feel it is you take shelter. You sit with your team and you're like, what is the plan? This is not a time where one guy goes off and says, oh, I think I've got this. No, you have to have a plan that everybody agrees on, or at least they may not agree, but they're willing to follow the leader because then it becomes a game of being open to different ideas. How about if we go through this crevice? How about if we take shelter in this? You start having to adapt the plan on the spot. If you've hired the right team and you respect how each of them thinks, the more people that are contributing to adaptation, the higher the probability you will survive it.

24:00There's always an opportunity cost to taking shelter. And I'm curious, how do you balance this all-important task of protection, defensiveness in a portfolio when you think something really bad is going to happen with wanting to be exposed to market forces in every other period of time so that you can compound capital? So we don't market time. It's not that I'm sitting there hiding. I'm saying when something comes, whether it's 08, whether it's the 97 Asia crisis, the Russian crisis, all of these different crises, when they hit, half the people just stare at screens with their mouths open and are frozen in place.

24:4508 was the same way. I'm not saying you're going to pre-position the portfolio. I mean, to an extent you do, but we had a short on mortgages, but it was so small relative to the rest of the portfolio. You have to look at it. And instead of just staring at the screens, turn off the screens. Let's sit down. Let's have a rational conversation. How do we move forward? In the day after everything shut down with COVID, we did exactly this. We're like, okay, we have no idea how long this is going to last. Where is our exposure in the portfolio in hospitality, airlines, toll roads, every sector affected so that then I could go back to the investment committee and the board and say, this is how much of the portfolio is exposed.

25:28We have no idea where this is going. We also know that our managers are well-positioned to take advantage of it. We've got enough money with enough managers to where if there's a great opportunity, they're going to go after it. I have every confidence in that. I don't need to go after it. They already have our money. It's having the confidence that you've got the managers that would take advantage of an opportunity when they saw it so that we don't have to market time. Our job is to make sure that we have a resilient portfolio where we don't need cash. We have enough cash on hand to where if the market shut down, we could still pay grants for the year.

26:07It's really basic, but you have to make sure that you can survive to climb the mountain. You can't just be like, oh, hey, yeah, we're down and no, we have no liquidity. That's my job. Your number one job as a CIO is to be able to hand the CFO the cash. Yep. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead. When it comes to M &A innovation, SRS Aquium has reshaped the way that deals get done, streamlining processes for maximum efficiency and minimum headaches, professional shareholder representation, online M &A payments, digital stockholder solicitation.

27:03SRS Aquium pioneered each and continues to set the bar for game-changing innovation. So leave the days of disjointed deal management behind and define your future with SRS Aquium, the smartest way to run a deal. Learn more at srsaquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. Any other aspects of the portfolio construction on the mountain before we start talking about manager selection? So I would say it's key and it's a great bridge to manager selection is to separate the opportunity set. Because I think sometimes we pull together manager selection and opportunity set. And I think you have to separate those out between the GP quality, which we can get into with manager selection, and the opportunity set.

28:01If you've identified an opportunity that you're really excited about, go figure out that opportunity. Then figure out who can execute the strategy that you have envisioned for that opportunity set. And then you'll be much more focused on your manager selection than if you're just blindly meeting managers. I'm curious when you disaggregate that, because a lot of times opportunity sets come from conversations with managers. It's rare that an opportunity is going to come from a manager that you don't know and that you don't have a lot of confidence in. It's usually existing managers. So if they're talking about an opportunity, then are they going to take advantage of the opportunity?