Kimberly Sargent – Passion and Mission at the Packard Foundation (EP.333)

27:06I think people are just too scared about the geopolitical situation. And I do think there are aspects of it that are scary. There are certainly some left tail scenarios to investing in China that weren't there a few years ago. But on the other hand, you may be getting paid to take those risks right now. and I don't think it's a moment to rush for the exits. We don't have a choice anyway. We have a certain amount of illiquid exposure in China so we're gonna be invested there for a long period of time. But sometimes when the market is telling you you're crazy and you're starting to doubt your own sanity, maybe that's the time to stay the course.

27:42So turn back to structure. We all throw around the words alignment of interest. How have you crystallized what matters most to you to make sure you're aligned with the managers you're investing in? So alignment of interest is really important. You want GPs putting their own money in the fund. You want them paid for performance, not for turning on the lights. I mean, these are things that we all think about. But there's another element to it, which is really understanding people's motivations. I think there are people who are truly intrinsically motivated in this business because of their passion.

28:21And those are people who keep working and working and working after they get rich. So in some respects, the alignment takes you only so far and the motivation of money takes you so far, but there has to be this just extra passion driving you forward. And that's a little harder to measure. So you were at Packard for a while before you took over for John as a CIO. What's changed in stepping into the CIO seat from being a senior person on the investment team? I think very little changed when I stepped into the CIO role after John retired. And partly that's because our whole team were so cohesive and aligned in building out this portfolio.

29:07It was really a team effort. felt like my baby as much as anyone else's baby. And I think we really had similar investment philosophy and approach. So that helped me make the transition smooth. On the margin, there were things that I changed. I do think in the early days, we tried to have 100 % generalist model. And philosophically, I love that. I think working on different things makes you a better investor. I think being generalist is more fun. And I also think and sense competition for capital in the portfolio that you really want. So philosophically, that was great. Operationally, that was hard to do, especially as the portfolio got more complex and more mature.

29:51So today we try to have something that's a little bit more of a hybrid and maintain the philosophy of generalism with having some areas of specialization in the portfolio. But for example, there may be a smaller group that works on a particular investment going deep, but there is constant interaction with the rest of the team in terms of updates. Here's what we're learning. Here's what we're finding. What do you guys think about this? Do you know anyone we should talk to? Such that everyone really does have a sense for everything in the portfolio and how it compares and the idea that it should compete.

30:28And I think that's a balance we're increasingly working on, specialization versus generalization. The other thing I would say is that we have this culture of collaboration and debate. People push back on one another very publicly. And I invite that. I love that. Sit in an investment committee meeting and disagree with me. I really want to hear what people have to say. And I hope that on our team, people feel comfortable speaking up because I think really that's how you get to the best answer. How have you structured the discussions in your meetings to allow people to speak up and feel psychologically safe?

31:04I ask people questions in front of everyone. I ask people questions who I haven't heard from. And I very often come to the team when I've changed my mind about something and say very publicly, so -and -so made me think differently about this. I've been thinking about this over the weekend. And here's my new point of view. You have to be vulnerable and be able to change your mind as an investor. How do you structure the research process from very brand new idea to something that gets into the portfolio? So anyone can bring an idea in to take a look at. There's no hierarchy around that. Ideas can come from anywhere.

31:41If it's something that feels like it could be interesting, we immediately bring a small team to work on it. And those are people with some expertise in that area. But we also often bring in someone with no expertise just to get a different perspective. The small team is constantly interacting with the larger team along the way to give updates, to get questions answered, to get feedback. And say in terms of our process, it is very much rooted in another thing that I think Yale did very well, which is deep due diligence. I've had people tell me that it's overkill. Like we do a lot of reference calls.

32:19We do a lot of case studies. But the idea is to get to that moment where you sign the limited partnership agreement and have a really high conviction that this is something that has staying power in your portfolio. What's an example of what that research process fully baked looks like? I'm thinking of some managers we've added to the portfolio recently on the private side where we would have 10 pretty in -depth meetings with the manager, with their team, doing case studies. We have done 25, 30 references on investments recently in the past. We really value the reference calls. We learn so much from them.

33:00It's not about finding the gotcha. It's about, huh, there's an interesting comment about this investor that presents an angle that I didn't see before. And maybe it leads to some follow up questions and references are really important part of our process. We do try to not do those until we're really excited about it so that we're not wasting people's time and our own. How do you tease out bias from the person giving the reference? Often I will ask a quantitative question. I will force people to rank the person that we're talking about on some metric because you can have a positive, lukewarm reference call.

33:40And then when you say, is this one of the top 5 % of investors that you know, you can kind of get a different answer to that question. How do you ultimately go about the final decision -making process on any of the important investment decisions with your team? It's a team effort. Obviously, I have the final say. I'm responsible. I'm the CIO. But we really don't make investments where I'm the only one excited about it. And I really try to listen if the team is excited about something and I'm not and try to understand where the differences are. What happens in a situation that you described where you were excited about something, but the rest of the team wasn't for whatever reason?

34:20Yeah, that actually happened recently. There was a fund that we did a lot of work on. I was excited at the end. And I think my two partners who are working most closely on it with me got to the end and just hadn't built the conviction in spite of all the hard work. I think my approach in that situation was, look, there's a lot of great investments out there. Let's find something we're all excited about. What happened with that investment or that manager? TBD. I think they're just closing their fund now. So we will see. When you've gone through that process, love to hear how the portfolio is structured to asset allocation today.

34:58Let's start from least risky to most risky. We have about 7 % of the endowment that's full faith and credit, fixed income and cash. That's our lunch money. That's our money for capital calls, for grants. We do nothing fancy at all with that part of the portfolio. Next would be our hedge fund portfolio. Hedge funds is about 25%. We are constantly debating what we want in there and the role and what makes sense. But overall, it's supposed to have a beta of 0 .35. It's supposed to be diversifying. It's supposed to be marginally more liquid than our other assets. And it's a source of funds when things go backwards.

35:38What types of strategies do you have in the hedge fund portfolio? There's three buckets. The first we call opportunistic. That's our multi -strategy hedge funds. The second is long short. And the third special situations, which is anything that's truly event driven. So credit and other arbitrage strategies. Next risky. Well, we can debate this, but I would throw real assets in there. Right now, that's about 12 % of the endowment. It's largely value -added real estate and liquidating portfolio of natural resource funds from the olden days. And then I would say we have 35 % of the portfolio in public equity, which as I mentioned, is very diversified internationally.

36:21And then we have our 25 % in our private equity portfolio. So buyouts, growth, and venture. On the public side in the developed markets, let's say the US, I'm curious how you're thinking about the benchmark in a world where seven tech stocks are so much of the market? Well, we do have a global benchmark for our public equity portfolio. So there is no real U .S. benchmark. But of course, these seven stocks make up a large percentage of the global benchmark as well. So same question. Yeah, there's definitely a lot of zany stuff going on in the U .S. markets these days. So you have seven stocks make up 30 % of the S &P.

36:59You have Apple with a market cap greater than the Russell 2000. You have the rise of the zero day option and all this just really interesting trading oriented, pod shop oriented activity in the market. And it's certainly been a very difficult time to be an active manager in the US, nearly impossible. If you didn't own these big tech companies in size, it's been very hard to outperform. And actually we did this analysis. If you look at the Cambridge Associates data on the performance of the public equity global portfolios of foundations, and you can see what median has been, what top quartile has been, etc.

37:41If you underperformed the global stock market by 20 basis points a year for the five years ending 2021, that was top quartile performance. So another way of saying that is the benchmark has been top quartile. In normal environments, the benchmark's actually third quartile. So it just goes to show you how difficult it's been. The question is active versus passive. I think probably we're going to look back at this moment in time and say, that was a really bad time to go passive. We can all have a debate about whether value is going to continue to accrue to these large tech platforms through AI or whatever.

38:22But in some sense, there's probably going to be a point where there's an asymptote to that. It's going to be harder for Apple to double from here. I don't know. I'm cautiously optimistic about active management in this moment, but I think there are some real questions about it. I don't have the answer. I do know we are decreasing alpha in our models just in terms of what we expected historically. I just think it's getting harder. How do you think about the venture space? I'm really excited about venture in this moment because I do feel like we've gone through this 18 months of rationalization and now venture can be venture again.

39:03And it can be about building sustainable businesses and not about just a constant fundraising mode, whether that's the companies or the funds and this greater fool theory. This is a moment where venture can get back to the basics and the fundamentals. And I think that's going to be a really good thing. In buyouts, I'm still a really big fan. I think that influence and control is still one of the greatest tools you can have as an investor. And if you look at history and you cut out the most recent vintages that are not mature, but look at the 20 years of vintages before that, and you look at buyout funds versus a public market equivalent like MSCI World, the median buyout fund has outperformed the public markets by 6 % a year.

39:51There's a lot of room for that spread to compress and it still belongs in your portfolio. So in the buyout world, I get excited about the opportunity to really improve and transform businesses. And I know that top down, I'm supposed to be really scared about my buyouts portfolio right now because the cost of debt has doubled and our buyout managers haven't marked their portfolios down all that much. And there's all these issues. We might be seeing a recession. When I talk to our partners one -on -one, you definitely get a different sense bottom up. I feel a little bit less scared. The leverage is not that high.

40:27The companies are very well capitalized. The cost of debt has gone up, but revenues have also gone up and the rest of the cost structure has gone up. So there's been some proportionality to this. And there's really not a lot of near -term maturities and restrictive covenants. So I have a lot of cognitive dissonance about this because I know from a top -down perspective, this does not make sense. So we'll see what happens. If we get this long -delayed recession, we could see some pain there. Have you thought about private credit? Well, first, maybe credit in general, and then we can talk about private credit.

41:01Credit seems to be getting more interesting. The thing that I would just caution though, is that we institutional investors have spent the past decade to 14 years living in this absolute return land where inflation was so low that we really didn't have to think about real returns. I would argue that the real returns on high yield and investment grade credit right now are only just starting to get more interesting. If your high yield was eight or nine and inflation was seven, that doesn't really get you that much. And actually, if you look at the risk premium, the spreads in high yield and corporate debt, they haven't gone up that much.

41:47At the end of 2021, your high yield spread was 300. It's now 400. At the end of 2021, Your corporate spread, I think, was 90 and it's now 120. So the risk premium for lending money hasn't necessarily changed all that much. So I do think credit will get interesting. We're just not there yet. Private credit could be very interesting. You have this bank retrenchment. You have, I think I read recently, $2 .5 trillion of commercial real estate debt coming due in the next five years. Who's going to refinance that? So I do think private credit could be really interesting. The challenge for us and for many foundations is how do we allocate our illiquidity budget?

42:29Because it is illiquid. And so we really want to be seeing very juicy returns to do that. You mentioned concentration and long -term relationships. And I'm curious how you balance the desire to have a focused number of great relationships with managers with the interest in keeping a portfolio fresh. Yeah, I'm glad you asked that because one of the things that we really try to do at the Packard Foundation is partner with talent early in their careers. And the best thing is when you can find someone that's just really compelling and you know you have that long runway for a relationship with that person.

43:06So it's something very important to us. I think if you are going to have a concentrated portfolio, and ours is, I think we have the The top 10 managers are 40%. The top 30 are 70%, I believe. There is a question of how do you refresh that portfolio and how do you have backup plans? Because these are some hefty core positions. The other side of it is we're a small team. I don't think we'll ever do farm team as well as some of the larger teams that really throw a lot of resources at it. But I think it is something that we've been considering more and more. Not only from the perspective of how do you have the backup plan, but also we're seeing other institutions lock up capacity of managers.

43:51There's just so many different LP types chasing after talent. And so how do you make sure there's room for you in the fund over time if you're not there from day one? This is particularly true on the private side. We are strongly considering having a farm team program that's more formalized than what we've had historically, although we've always tried to do it to some extent. As you've talked to other people who have farm team programs, what are some of the rules you're considering putting in place for how many get in and how you decide when they're going to graduate? My hypothesis is that the easy thing is finding the talent that you want to put in.

44:27And the hard thing is developing a framework around when is up or out under what criteria. Maybe these are people that just don't have a long track record yet, but really show a lot of promise or you can't get the references you need to really get comfortable and make it a core position. So there's some issues, but I think it's important to have a sense going in for what you want to see over the passage of time that's going to make this turn into a core position to really believe that every farm team position could become a core. How have you incorporated different asset classes into the farm team concept?

45:02It really is applicable for us only to the public market asset classes. I don't think farm team works on the private side only because if you're really undersized in fund one and fund two, a manager becomes proven, there isn't going to be capacity for you in fund three. So you really have to make that bet early on. In the last couple of years, there've been all of these other factors, think of ESG and D &I, that have impacted the way people thought about their portfolios. How have you thought about that and had it impact the portfolio Packard. We actually have a carve out of our endowment. That's a mission investment portfolio.

45:40That's a 3 % carve out. That portfolio has a really different set of goals and objectives that align really closely with the foundation's grant making areas. It's also a different team. I think they have a different set of skills than just pure talent scouting. I mean, the results that they're wanting from those investments are very specifically tied to the grant making areas. So that's one way. On ESG, it's always been something very top of mind for us. I think it didn't have an official name for many years, and now it's becoming much more standardized. But it's always something that's been important to us, and I would say to our managers, to make sure that we are acting in accordance with the foundation's values and taking our responsibility as providers of capital seriously, looking at the effects of our actions and our decisions.

46:30So that's not new. It's becoming much more formalized now. So you go to AGMs and managers will have a slide on their ESG initiatives and they may have a written policy. So it's all becoming a lot more formalized and on paper. We have always had a socially responsible investment policy. It's evolved a little bit over time, not a lot, but it guides us. But the main principle is making sure when we do our reference calling on managers that we are not backing people where we have any question about their integrity and moral compass. And I often do ask managers before we partner with them, tell me about a time where you had a moral dilemma in investing and how did you handle it?

47:12And I don't expect everyone's moral compass to point in the same direction. But if the manager cannot think of an example of that, I think it's sometimes a red flag. Have you really never run into a situation where you wondered if what this company that you were about to invest and was doing was really right for the world. So that's just the philosophy of it. The concern that I have is the tools that help investors make these choices in this moment seem very rudimentary and very arbitrary. And so I hope those tools develop and give greater information to investors to help make these choices. But for now, I think take things case by case because some of these scoring things that are out there that try to say, well, this company has a different ESG score from that.

47:58Like when you peel back the onion, some of these things are really hard to justify. Diversity inclusion, again, very important to us. We have done a number of things on our team to try to advance diversity in the industry. We can talk about our summer fellowship program that has a partnership with SEO, but we're trying to bring more diverse talent into the investment management industry. We also talk to our managers about it and about their philosophy about it before we invest with them. We wanna be partnering with people who recognize that the industry needs to change and feel some kind of a sense of responsibility for that.

48:34I know it's sometimes easier said than done if you're a really small organization that's not hiring a lot, but I think there are things that you can do. So it's definitely a conversation that we've been having. We've also made a concerted effort to try to go to conferences that are highlighting diverse talent and just open our pipelines a bit more. And what's actually been really encouraging about some of the recent conferences we've been to, we'd actually already met a lot of those managers. So maybe something in the pipeline is working about what we're doing. Everyone on my team also has selected an organization that is working to advance diversity and inclusion in the finance industry to volunteer with.

49:16And we all got to choose our own. So it was a process of researching these organizations. What are they doing? How can I get involved? And we've all picked different ones. So it's great to see getting involved with a lot of those organizations. How has the internship program that you created come to be and has it evolved? So the fellowship program we have is called EMIF, Endowment Management Investment Fellowship. We started it about six years ago with our friends at UCSF and the Irvine Foundation. And it was really in response to this sense that a lot of talented undergrads that were interested in business or finance, we're getting channeled into these investment banking and consulting roles, really without a sense of what the other options are out there.

49:59I have the best job in the world. And I get people who call me at age 40, 45, and they say, Kim, I want to do what you do. That just sounds so interesting. How do I do that? And in my mind, I say, gosh, it's hard when you're this experience to make a lateral move into the endowment and foundation space. It's very much homegrown in terms of its talent. The leadership opportunities don't open up that often because people tend to stay in the industry. So this was really a program with the idea of exposing talented undergraduates to the possibility of a career investing on behalf of a nonprofit. And so what we do is we now have 26 fellows this summer, and they're across a number of different institutions, endowments and foundations.

50:48We bring them together in the beginning of the summer for a three -day seminar where they read David Swenson's book. We do the Yale HBS case study. We have visits from a number of managers who talk about what they do. So it's been Endowment Management 101 for three days. Then they go for eight weeks to their respective institutions. And at the end of the summer, we all come back together and they give a presentation on a project that they did that's of interest to all the institutions participating. We also have a partnership with SEO to try to bring more diversity into this program. And I'm really excited about where it's going.

51:23How many people are involved today? So we have 26 fellows this summer, and I think it's somewhere between 12 and 15 institutions participating. When you gather your interns together at the end of the summer, and you describe why you think you have the best job in the world, What is it that you tell? A big piece of it is the mission. To be able to go to work every day and work for a mission -driven organization, whether it's an endowment or a foundation, I think is a real privilege. And there's meaning in that. And it's motivating. And every time I get on a red eye or I'm working late, I think about that.

52:02The breadth of investments that we work on is so interesting. There is never a dull moment. It's constantly changing. The things that I thought about 10, 15 years ago were not the things that matter today. Today, I'm thinking about the energy transition and AI and cryptocurrency, any number of things. 10, 15 years ago, there was a different set of topics. So it's this constant learning as an institutional investor because the world is your oyster. What do I do every day, Ted? I build relationships and have conversations with the most talented investors all over the world. Yes, please. Sign me up.

52:41All right, Kim, I want to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? I love doing anything that has nothing to do with my brain. So I have to turn the brain off. I have to turn the body on. So that would be working out, hiking, cooking, anything with the senses. What's your biggest investment pet peeve? One is just dishonesty, not saying what you mean and meaning what you say. The other is lack of accountability and personal responsibility. There are people in the world who, when something goes wrong, it's always someone else's fault.

53:17And I just find that tough. What investment mistake have you made that you'd never make again? I'm thinking of two. From a pure numbers perspective, not figuring out a way to get invested with Sequoia when we started up our team in 2008, I think was probably pretty costly. We also, back to short only fund in 2015, wonderful people, wonderful research, but it was a really, really tough time. And they ended up going out of business and we lost a lot of money feeding the beast over those years. I might have a screw loose, but I actually think that short sellers provide value to society. So they keep management teams honest.

53:57They expose fraud. They keep the market in check. There's an opportunity for people to lend securities if they want to do that. So I actually think that short sellers bring a lot of value to the financial markets. And I really hope they don't go the way of the dinosaurs, even though we had this one experience that didn't work out. Which two people have had the biggest impact on your professional life? Well, we talked about David, not only because he got me into this industry and took a chance on me, for which I'm very grateful. It's not even what I learned about investing from him, but how important mission was to him.

54:32And that's just something I've kept with me. The other is a woman named Elizabeth Appling, who is the founding artistic director of the San Francisco Girls Chorus, which is an organization I spent a lot of time with growing up. I could go on and on about Elizabeth and all the impact that she's had. But suffice it to say, she demanded excellence from young girls. And she taught me what it was to give my all to something. And she had this way of making you believe that you had a gift that you owed to the world and not getting up there on stage and performing was actually selfish. And it was just an interesting time in my life because you think about pubescent girls.

55:15They want to hide from the world. They don't think they have anything to give. And this woman just pulled it out of us. What teaching from your parents has most stayed with you? Definitely the value of education. We were middle class. We didn't go on fancy vacations. We didn't eat out at restaurants, but I had the best schools. And my mother saved and saved for college. And I had a great education as a result. And it's something that has really changed my life and something that I hope for my girls as well. All right, Kim, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

55:51Time is fleeting. My daughters are 13 and 11 now. I feel them slipping from my grasp. And when they were young, my career was on a very steep trajectory and I was traveling all the time. And I wish I could go back and just carpe diem with those years. Kim, thanks so much for sharing your insights. Thank you, Ted. Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators .com where you can access past shows, join our mailing list and sign up for premium content. Have a good one and see you next time.