CIO Greatest Hits: Endowments – Scott Wilson (WashU)

26:34It's easy enough for me to be the bad guy, so I'm happy having those calls. It doesn't have to be the team. But certainly there's personal relationships that people on the team had with these people going back, everybody on the team is a generalist. So nobody's kind of married to any one geography or asset class. And we have people who have historical experience in privates or publics and tend to have more relationships there. But in general, we do things as a group and that makes it a little easier. Like we're trying to make all asset classes compete for capital. And that's a lot easier to do with the generalist model than it is when people are siloed into individual asset classes.

27:10And then it also gives us the ability to size things probably more. If you're thinking about the entire portfolio in context versus just my one little siloed asset class, I think the way you'd size positions is quite a bit different. So what kind of impact did it have on the team? Overall, it's been really good. The team is different. We've made changes to the team early on as well, but the team has done just phenomenally well. And I think it's really added a ton of value to the portfolio over the last couple of years. And the people who are still here, I think have really embraced this model of investing.

27:44It's a little bit of organized chaos at times running a generalist model with 10, 12 people on the investment staff. And oftentimes we have four people on a trip or five or six people, or even the whole team in a meeting where we probably only need five, but I think it's helped the portfolio over time. How do you think about the generalist model in light of the concentration that you want in the portfolio, where you could imagine the price of being wrong on something's a lot higher. Yeah, I would say that's definitely true, but also the benefit of being right is a lot higher. So if you're going to do something, do it in a size that will move the needle.

28:23And that's easier to do when you think about, you know, if you have say 5 % of the portfolio in one individual relationship, one manager, that's huge concentration if it's 20 % of your overall equity exposure. You're kind of betting the house on it if that's your silo. Whereas, depending on the underlying concentration, that may be perfectly reasonable for the portfolio as a whole. How do you match this top-down thinking and bottom-up thinking if top-down is traditional asset class or risk exposures and bottom-up is the one-off selection of the managers in your portfolio? Our focus is really on the bottoms up.

29:02If you look at even the way we think about diversification, we're trying to concentrate our exposures in individual investments that we think have completely idiosyncratic outcomes over some period of time. So if you look at the largest contributors to the portfolio over the last three years, you'd see a Brazilian utility company, a Swedish supplier of medical products, an Indian biosimilars company, a US-based aerospace and telecom company. And there's no reason why we think those investments should have correlated outcomes over some investment time horizon. Now, in the short term, like if we go through a crisis like we did in March, where the cost of capital rises for all risk assets, we don't expect that portfolio to be immune, but we expect those investment outcomes to be completely independent and over our investment time horizon.

29:53And that's a lot easier framework to find real diversification. Whereas if I step back and say, what are the diversification benefits for being in venture versus public equity versus private equity buyouts or real estate, like that's very difficult to quantify, particularly in times of severe market stress where you really need diversification. And I think that's a better framework for us to evaluate real diversification benefits in the portfolio as opposed to this top-down approach. Now, we use the top-down approach both presenting to the board and as a framework for thinking about how we guide our search, but really we're looking for those idiosyncratic, completely independent outcome investments from a bottoms-up basis, and that's how we like to concentrate the portfolio.

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31:30Learn more at srsaquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. And now, back to the show. So when you think about exposures and drivers of return, it sounds like you're focused on the position level as opposed to, say, even a manager as a position. Yeah. And even our individual managers on our public and privates, we're generally thinking about them as individual exposures as opposed to manager level. The returns aggregate through the partnership, but we think about the exposure on an individual investment level basis. How is it different in the way that you do your due diligence on managers? At the highest level, we look for all the things that all of our peers would have on their checklist.

32:25I think the way we evaluate them is really what we think based on the quality of the portfolio and we'll use our own lens for that. So the quality of the individual investment ideas and the attractiveness, essentially, do we want to own what they own and how does that fit in our overall portfolio? So like there's lots of managers that we think are talented investors, have a good process, but for whatever reason, we don't think their underlying holdings fit our portfolio or it's not something we're excited about. And we would probably pass on that. We're always trying to err, I guess, most of this job is saying no.

32:56If you think of how many opportunities you look at before one actually makes it into the portfolio. It's probably closer to 0.1 % than it is 1%. When you're looking at a manager, are you focused on underwriting their positions more than their process to find the next position? We use that lens of underwriting their existing position. So it's really just case studies of either what they currently own, what they have. And that's how we evaluate what caused you to make this investment. What was the process that led to this? Do you have a kind of unique differential view on the quality of the business or the industry.

33:30What is the real investment thesis? Is that empirically verifiable investment thesis that's different than what we think the market or how the market is viewing that business? And that's the lens through which we look at their process. How did they think about valuation? How did they think about risk and return? How did they think about the industry? We spend our time focused on looking at those individual names. How does that translate over into thinking about participating in the private markets? It's the exact same lens. You don't have the same, obviously, price discovery and transparency in private markets versus public markets.

34:06But oftentimes you have better access to financials and diligence materials and access to management teams. So when you roll all that up today, what's the structure of the portfolio look like? I'd say top-down, it hasn't changed that much. If you think we're roughly a third public equities, which bounces around, we're probably a little bit overweighted in privates. That's probably 45 % of the portfolio today just because privates, particularly venture and growth equities, had such a big run. And then we have 5 % to 10 % of the portfolio in real assets type exposure, another 10 % in hedge funds, and the balance would just be cash.

34:44And how much do you try to do on the margin, sort of in addition to just what the managers are doing on your behalf? We focus most of our process internally on incremental research. We typically know what their thesis is, like how do we verify it? How can we use our networks or people within the university to help verify and re-underwrite the thesis? And it's a super time-consuming way to invest, especially since you have to think you spend most of your time doing research on stuff that never makes it into the portfolio. And that can be a little disheartening at times, but ultimately when something does make it into the portfolio, you understand it that much better.

35:22You have a much better understanding of the process and the partnership. What opportunities are you particularly excited about today? Frontier markets is super interesting. I emerging in frontier markets for us has been a big bright spot in the portfolio. If you look at the headline return numbers and emerging in frontier markets, it's significantly lagged developed markets, particularly the US, over the last five years. For us, it's the opposite. We've been able to find really unique, interesting places to put capital on some of these markets that has been a big differentiator for us in terms of performance.

35:54Again, it tends to be individual name, individual securities, but we have a ton of really high quality partners on the ground there. And it's been an interesting hunting ground for the last several years. And I think it's gotten better over time, not worse. Is there a particular region you're excited about? We spent quite a bit of time in Africa, Bangladesh. Russia has been really good for us. Africa is probably where we're spending more time. And again, it tends to be kind of one-off idiosyncratic opportunities, but it's been a really interesting place to invest. What's an example of something that's worked well for you?

36:28Russia, we've made quite a bit of money in some of the more tech-based companies that would trade at 20 times revenue in the US that are trading at five times earnings in Russia, growing a return on equity of 60 % plus, growing at 30%, 40 % right through COVID. Super interesting companies that they're in Russia. So we're not going to bet the portfolio on Russia. And I know we have peers who basically said we would never invest in Russia. When we step back, our view is kind of, look, all investing involves risk, right? If you're paying 100 times revenue for an unproven business model in Silicon Valley, that's a risk.

37:05The question is, are you being compensated for that risk? And we wouldn't have a massive portion of the portfolio, but we found opportunities that are compelling enough. Even being in Russia, we think they're interesting and we've been well compensated for that. I'd say the same in places like Bangladesh. We've spent time in Pakistan and all over the continent in Africa. And what's that balance of you want to have a concentrated portfolio, so something's got to be big enough to move the needle. but then there's sort of known left tail risk so that you don't want it to be too big. How do you think about sizing?

37:39It's more of an art than a science. You size things based on how they fit in the overall portfolio and then whether or not you could underwrite the downside. And then again, we're always looking for things that we think add positive convexity to the portfolio, right? They have significant asymmetric risk and reward. As a general, if I tell the team, look, if we're not willing to put 1 % of the portfolio in it, then that's not a lot of conviction. And for 1 % for us is currently just over a hundred million US dollars. So we don't always have that type of liquidity, right? Like the opportunity set isn't always that big.

38:13So things aren't always sized there. But again, if you're not willing to put 1 % of the portfolio in it, and if you, let's say you do a disastrous job underwriting the downside and you lose half your money there, we can tolerate 50 basis points on the overall portfolio and hopefully make that up in other places. particularly if we think it's very, very idiosyncratic, right? We're looking for opportunities that aren't based purely on our macro view of the world. But for us to go above that again, we would have to have a significant view of downside and really be comfortable with the underwriting process.

38:46So if you're willing to go to Russia, go to Pakistan, Bangladesh for investments, are there areas that you avoid? There's certainly certain markets that are tough that make Russia look like a very developed market, particularly across Africa. There are places that are just really difficult to invest, whether that's property rights or contract enforceability. There's lots of things that just make it a very, very tough place to invest, particularly in the type of size that we're hoping to do. So there's certain places that we just don't go hunting, but I'd say very few places are completely off limits.

39:22How does the process sort of work for your team in finding a new idea? So you can break it down. Where does the sourcing start? We try and spend a lot of time on the ground in the various markets that we're investing in. And it's really randomness and optionality. You never really know what the next interesting idea is going to come from, what it's going to look like, and which partner it's going to come from. So it's just basic blocking and tackling. I'd like to say we have a great funnel where we're looking at this really high level interesting set of opportunities and it boils down to a small group of investments that we end up making, but it's really random.

39:59And I think it's just hard work out there, knowing what our partners are doing, knowing what our partners are looking at and trying to find interesting places to put capital. If you think back to one of the more recent, maybe it's pre-pandemic, but one of the more recent new commitments you made. Walk me through the process of how you found it, where it came from, and what that due diligence was like. A recent one would be a co-investment in an additive manufacturing company that one of our Silicon Valley partners based out there. At the last annual meeting, this was one of the companies that had presented.

40:37We thought it was a super interesting company, spun out of a really great institution on the East Coast, at least the intellectual property did. Our partner in California was one of the original seed investors of the company. Interesting software platform, interesting hardware platform, what we think is very unique, defensible IP. When we saw the CEO present at that annual meeting, I guess it was 2018, came back and said, look, this is a company we should start doing some work on just in case. So we spent probably six months just diligencing the company. We spent time talking to people in the industry, talking to potential customers, spent time with the management team, and just basically trying to position ourselves just in case they raise capital at some point.

41:22We could come in as a preferred provider of someone, hey, we've already done all our diligence. We're super interested in this. If we think the valuation makes sense, we'd love to be involved and have a great relationship with that particular partner in California. And when they did come back to market with that round, we weren't able to get the full allocation that we would have liked, but we're able to put in a fairly sizable chunk of capital in what we think is a really interesting company for the next two decades. So that example brings up a whole host of questions in and around process. So the first is, how do you think about time allocation when you're spending all that time with a chunk of your team on one company?

41:59The truth is, if I think about the overall portfolio, if we find four or five companies like that a year, we've done our job, like four or five places, and how much capital we have to reallocate every year. We hope you have a very long time horizon. And most of the time we're allocating to our core partners and re-upping in funds. And we have lots of places we can put capital if we have excess capital, but finding these four or five differentiators of return, places where we have excess exposure and we think it's super interesting over a long period of time, like that's all we need. So the truth of it is that most of your time ends up being relatively unproductive just because you're looking at things that don't ever make it into the portfolio, but we have a big team and we have a lot of resources.

42:42And if we can produce a small amount of alpha compounded on a$10 billion portfolio over long periods of time, that's definitely worth it. How does that change the nature of the relationship you have with the manager, in this case, private equity firm, who already has a position in the company and may want to put more in if it's doing well? And you're, in some sense, their partner, in some sense could be a competitor for a limited amount of capital investment? Well, I mean, we always say that they would obviously get their fill before we would get anything. So in this particular case, they were bringing us on instead of another outside partner.

43:19So they took their pro rata rights and we were able to come in on the back of that. And then we'll set up an SPB and still pay them. They'll manage the position for us and fee and carries. Typically, there's not a management fee associated with those, but we'll still pay them for all the help that they've done and manage the position over time. So we're rarely trading kind of on our own balance sheet. And we would never do that without expressed written consent from the partners. There are times we have gone directly on the cap table, but only because that's how we were asked to invest. But for the most part, we're setting these up as SPVs.

43:52And how about the skillset of the people on your team where underwriting a company can be a different skillset from diving in underwriting managers? Yeah, it's a very different skill set. It's a very different mindset, I would say, but that's taken a lot of time and effort to kind of bring the team up to speed. And it's a very different, I don't think someone who comes from a traditional allocator background and grew up in that world, it takes, I think, several years of learning and mentoring before they're comfortable with this kind of investment style. Where have your people come from generally?

44:25I think it's fairly random. People who come from traditional asset management industries, consulting backgrounds, I think are good. Private equity investment background is really good. And then we have people who were one person on the team who was a PhD in physics and smart, curious, intellectually curious people. They enjoy investing this way. And if you step back like why it's interesting to work for an endowment, you have this pool of capital that's not too big, You're not a$100 billion pension fund. So you can do interesting things that will move the needle. And you have an opportunity set that's pretty much any asset class, any geography within reason in the entire world.

45:04So that's a super interesting, very long time horizon, unlimited opportunity set. And you're only looking for a small handful of really great investments every year. That's a super interesting framework to start from. And certain people fit well within that framework and certain people don't. Because as a team, we might be looking at, again, a Brazilian utility company one day and a medical products company in Sweden. And they're both interesting investments, but it's a very different diligence and underwriting approach. And some people enjoy it, some people don't. And we've had great people, great investors who it just wasn't the right framework for them.

45:39And then when we can, we can hopefully be helpful to them to find someplace where they're going to excel. And when you add it all up, how many positions would you say you have in the portfolio today and how does that compare with a more typical endowment? We have more like 100 positions that really drive performance on a look-through basis. If you looked at our top 100 positions, that's going to be probably a third of the portfolio and maybe even slightly more than that currently just because we've had such a big run in some of those names over the last 18 months. But it's a manageable position for a team of 10, 12 investment professionals.

46:19We're typically looking for ways to concentrate that further, not less. What have you learned the most from being in the seat the last bunch of years? Coming from a smaller endowment, realizing how much the team matters. You can't be on every call, you can't be in every meeting. And being able to leverage the team and leverage resources, that's been a huge shift going from a$2 billion endowment to now$10 billion endowment. And then governance, having a board that buys into the strategy that gives you the autonomy and flexibility to manage the portfolio. The way we manage it, I think it's been just super important.

46:56And that governance thing, I think, is maybe the most important thing that really is the North Star for all endowments. That governance process drives so much. And the institution here has just been amazingly supportive. What does the day-to-day look like or the week-to-week look like on your team? We try and organize it as much as we can, but we'll typically have one to two team calls per week. Typically Monday morning, what are we working on? What do we think is interesting? What's in the pipeline? What can we kill? And we'll include the entire team on that, including operations folks. And we try and integrate investment and operations as much as we can.

47:34That's mostly pipeline focused. And then what's interesting that's happening in our portfolio, like who's adding to what names, how our position size is changing, what's performing, what's not performing, what are interesting hunting grounds, places to at least start your search. Right now, it's very different just because there's no travel. I would have said I spent 30 % to 50 % of my time in any given week or month on the road, but that's not happening. And then from there, again, it's very random, like what kind of names or what geography, what we're spending our time on. It really depends on what's happening with our various partners in any given week.

48:12So that tends to be really random from one week to the other. And we organize the team so that nobody's over-focused on one geography or one asset class. So you could have three calls in a day looking at new investments or existing investments. And there'll be five people on each call, but none of those five people overlap on any given call. So much of the process of investing ties to trying to identify a competitive advantage or an edge. And I'm curious what you think yours is taking this approach. I step back and say, look, our top peers, these are smart, well-intentioned, thoughtful investors.

48:53Like, do we really have a sourcing edge? No. Do we have an underwriting edge? Probably not. If you look at what's really generated our returns, if you look at our performance this year and how we've done over the last three years, we'll end up towards the top of our peer group over that timeframe. It's our willingness and ability to go where our peers are not, I think. Like go to certainly geographies and take outsized risk positions in assets where we think we have an underwriting advantage. And because these underlying investments tend to be uncorrelated, again, we're looking for independent outcomes over our time horizon.

49:32I think it's reduced the overall risk in the portfolio while enhancing returns. But I'm not so sure there's a clearly definable edge, if I'm being intellectual honest. From a top-down perspective, we would have similar looking portfolios, but when you look at the underlying exposures is where our tracking error comes from. And when you're looking at, you mentioned potentially an underwriting advantage, is that compared to, say, endowment peers that are picking managers or is it compared to the managers doing the underlying security work? I always compare ourselves to our peers, other larger endowments.

50:09Certainly, we're not doing what the underlying partners are doing. I'd say we're trying to recognize super interesting opportunities. We're not necessarily sourcing those on our own. Although we're doing our own work, we're leveraging everything that our partners are doing. And hopefully, we can find incremental ways to add value to that research process. So again, most of us come from non-traditional backgrounds. We have our own networks and own people within industries and certainly people who are tied to the university that we can leverage. How have you found those differential insights helping the process of just manager selection?

50:44Everything looks good on paper, right? Like you've never seen a pitch book or whether it's someone's pitching you an individual investment or it's a manager pitch book. Like it always looks good on paper. And again, it's peeling back the onion to understand where these positions come from, how are they sourced, what was the underwriting process, what do we think of their framework around risk or valuation. And I think doing your own work on the underlying names gives you – you have your own opinion on all that stuff and you can compare and contrast it with what your partner is doing. And that's a valuable framework that I'm not sure everybody does.

51:23Where do you think you've tripped up the most? The list is long and undistinguished, is what I would say. We make mistakes all the time. And I would say certainly a big lesson over time is make sure you understand the bear case on every investment, whether it's a manager or underlying company. And overestimating your ability to, whether it's underwrite the downside, understand competitive dynamics within the industry. it's a super super long list of like places where i think we've learned over time both on the manager side and individual selection side i'd say our partners with managers is typically if you look at what's ended more relationships it's we disagree with them on size of the opportunity set or what the right size of AUM is or their ability to find idiosyncratic ideas or places is where the manager has become more thematic investors than bottoms up research-driven investors.

52:21We're always looking for idiosyncratic risks. So most of the partners who are really thematic tend not to fit our portfolio or the way we look at the world. But entry point is one thing and we've made all kinds of mistakes on exits. My old boss and through his training used to say, there's no good or bad trades. There's only good and bad exit and entry points. and there's some truth to that. So if you look out five or 10 years at your portfolio, what do you think will evolve? I don't think we're going to do things much differently over the next five, 10 years. We certainly have like some positions, if you look at them over the last two, three years have become outsized risk exposures in the book just because of organically the positions have grown.

53:06And over the next five, 10 years, some of those positions could get really big if they continue on a similar trajectory. But I can't imagine we change our overall process significantly. How do you think about taking this model and applying it in the venture capital area? Venture capital is tough, right? Just the nature of the industry. It's tough to underwrite. If you look at our partners, and we have a great group of partners who have done extremely well for the portfolio, But we haven't had really much success in kind of the micro VC world. Like there's so many of these small micro VC funds.

53:45And again, these are a lot of smart, talented people who come from good places. But it's just really tough for us to underwrite and find unique, differentiated thinkers in that area. And so we've just shied away from it. We typically, I guess we've concentrated our exposures in people that we think we can partner with very closely. and we have ways to monetize the relationship outside of their ability just to pick really good early stage companies and that we can grow our exposure with them over time, either partnering in these co-investments or finding ways to add capital to what we think are the most interesting ideas.

54:20So does that prevent you from investing with some kind of the perceived best of breed that are always massively in excess demand? No, I mean, let's say we're still opportunistic. There are certain partners who we think are just great investors and we have no ability to partner with them closely, but we still think it's a great investment. And we're happy to take whatever capacity we can get in some of these underlying partners and just think that they have a great process, a great pipeline. They've done tremendously well over long periods of time. And it's a group of just really talented investors and whatever they're doing, we obviously would like a piece of it.

54:55But it's hard for us to scale up those relationships over time. There's just limited capacity. With an increasingly concentrated portfolio, I'm curious how you factor in some of these broader issues that are increasingly coming to light, like the sustainable investing lens and diversity and inclusion. We've obviously spent a decent amount of time on that. And I did when I was at Grinnell. That kind of ESG lens, I think it's a framework that plays in everything we do. We don't have a specific kind of ESG mandate, but we're always looking for partners. I tell the team, we want somebody who has a similar moral compass.

55:34We want people who have a framework and has similar value systems that we do and understand the mission of the university. And nobody works at an endowment because they're trying to maximize their current compensation. If you can't buy into the mission, this isn't the right place to be. And I think that's something that pervades everything we do, whether it's hiring people on the team or finding new partners. And we obviously just recently went through this. Over a third of our partners, either in the U.S. or even more internationally, are managed by people of color or female heads. And that's not something that's a purely bottoms up driven outcome.

56:14And we don't positively or negatively screen for that. It's just, I think, an important framework for how we view the world. All right, Scott, let's turn to a couple of closing questions. What's your favorite hobby or activity outside of work and family? I can't say I get to spend that much time outside of work and family, but I grew up in small town Alaska and I love downhill skiing and fly fishing, which were just two activities that I grew up with. And obviously, I love sharing those activities with my family, best of all. What's your most important daily habit? I think just reading, being intellectually curious.

56:48I always want to know what's going on, not just with the portfolio, but in the world in general. What's your biggest pet peeve? I've got a lot of these. Behavioral pet peeves, I guess, people who are just unproductive and lazy. I think working in an endowment, again, we have this huge, wide open space where we can invest in, within reason, anything we want, anywhere in the world. Like if you can't find something to look at, something to do, you're probably not in the right seat. And then people who spend time complaining or kind of whining about circumstances, like I'm sure I inherited that from my father.

57:22But if you're complaining about something and something's wrong, then fix it. If you can't, then there's no reason to complain about it if you can't fix it anyway. I guess maybe one other thing I would say like firms that quote gross returns and not net returns, I think is another probably pet peeve that shared with a lot of our peers. What's the biggest mistake you've made? In terms of investment mistake, talking to a friend about this recently, I think when I graduated from college, I knew nothing about investing. I was a math and econ major and I'm dumped down into junior seat in equity research.

57:56And I spent the first two years paying off student loans, right? I was sleeping on the floor trying to save enough money so I could actually buy a stock or whatever, you know, put some skin in the game. And finally, I got a bonus, you know, in February, March of 2000 that I could invest. And I think the first thing I did was buy like a bunch of just disastrous tech names that I'd been following for the last two years. In hindsight, it was a cheap lesson, right? Because I didn't have that much money to lose, but I think certainly it's been a positive influence for the last two decades with that in hindsight was a really quick way to evaporate half my tiny capital base.

58:34What teaching from your parents has most stayed with you? Work ethic. I mentioned neither of my parents went to college. My father worked in construction. My mom was a bookkeeper and did odd jobs when I was a kid. And they're both just super hardworking people. My father is just one of the most productive human beings. He never went to college, but he's just super intelligent person. And I'd say now that he's been retired several years, he's still just amazing, hardworking, productive human being. Scott, last one. What life lesson have you learned that you wish you knew a lot earlier in life? We talked about mindfulness training before.

59:12I think my big takeaway from that was just speak less, listen more. It's something I wish I would have known when I was younger. I think the other thing too is intelligence is only one small factor in people being successful. Like when I was young, I thought that if you didn't have kind of a logical analytical framework, you'd have a hard time being successful. Whereas like people who are really good at driving consensus, communicating ideas, great salespeople, like all those things are just a huge facet of what makes you successful. Scott, thanks so much for taking the time. Yeah. Well, thanks for having me.

59:47I appreciate it, Ted. Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com, 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.