[REPLAY] Ed Grefenstette – Bold Allocations at The Dietrich Foundation (EP.437)

25:17Ed Grefenstette:Small's going to outperform large. Equities are going to outperform fixed income. We're really pushing the bounds of that. For instance, we have not had a direct exposure to the U.S. S &P 500 or any U.S. index since 1997. Okay. This is not a portfolio that looks like anyone else's. So we explain what we're doing and why. And I think that's a big part of it, but it requires constant reinforcement. Some things are trivial, some are more serious. There's a trivial thing that we do. Whenever we present performance information, I always start with the first column being the 20-year return, and then the 15, and then the 10, and then the 5, and then the 3, and then the 1.

26:02Ed Grefenstette:And I have a big line across the top where the first column, it says, less noise. And there's a big red arrow going across. And the far right, it says, more noise. We always, of course, address the short-term performance. But we just keep reinforcing the idea, listen, you can't possibly target a performance over the long period that outperforms everyone else unless you're willing to embrace an uncomfortably idiosyncratic portfolio. And part of that has to be a willingness to look wrong some periods of time, something because you look totally different during those periods. So it's something you just reinforce, reinforce.

26:43Ed Grefenstette:I can't say it's easy. It's hard, especially when there's turnover in trustees. But we try to keep it consistent. We try to keep our thoughts well articulated in paper. This requires constant oversight. How did Bill think about the assessment of you as the CEO and CIO with a group of trustees where he wants you to have delegated authority, but there are, in theory, still some guardrails that the trustees have to monitor you within? No question. And it's very explicit in the Declaration of Trust and Bill's statement of philosophy. The principal responsibility of the trustees is to evaluate the CIO in present.

27:26Ed Grefenstette:But it said it should be focused on exceptional long-term performance. So in the end of the day, Bill said, listen, you got to give the CIO enough rope, but you might have to hang the guy or gal if they're not doing their job. So the expectation is very, very high. Fortunately, we have been performing, as far as we can tell by all reported surveys, our return to number one for the trailing 10, 15, and 20 years. But now we're being tested because this short period here with the S &P doing what it has done over the last 30-odd months and the private assets resetting a little bit, this is testing the conviction.

28:05Ed Grefenstette:This is where the fortitude risk comes out and is front and center. So let's dive into the investment program. So you mentioned a love of illiquids. What did Bill set as the goal for the investing of the foundation? The goal is exceptional, outstanding, long-term performance, and that's ill-defined. But in my conversations with Bill, we always said, well, take some broad equity global index, and we ought to be outperforming that by 200 or 300 basis points net of everything over long periods of time. And we've done that. In terms of the actual construction of the portfolio, Bill left that largely to the CIO, except to note in his documents that he felt that the private equity universe would continue to offer compelling risk-adjusted returns.

28:54Ed Grefenstette:That's a point about which I agreed with him totally. I think there's logic to that. It's interesting to me, in fact, that a lot of investors, when they talk about private versus public investing, talk about private equity should generate a premium return over public equities. I change the verbiage a little bit on that. When I think about it and I talk about it to people, I think private equity is true equity return, and public equity is a discounted or a lower expected return. The reason for that is simple, I think. There's no free lunch in this world. I think we can all agree on that. And you pay something for the luxury of, in a public security, owning a fractional share of a publicly traded company.

29:40Ed Grefenstette:And if you change your mind, you press a button and T plus two, three, you have the cash on the barrel head. That's an incredible luxury. You stop and think about that. Would you pay for that as a lower expected return? So over long periods of time, we should continue to enjoy higher returns from the private side. Bill summed it up by saying, Ed, liquidity isn't free. And therefore, you should be selling your liquidity to the market as much as you can. But there are limits to that. As we sit here today, we're 90 % illiquid, which is pretty much the upper threshold of my comfort. We'd like to be about 80 or 85.

30:16Ed Grefenstette:But it's been a first-class problem. We've gotten there through performance. So 90 % of liquid is a far extreme of what you hear about in a pool of capital like that. How did you come up with that number compared to a 50 % number that is more common in some of the more aggressive endowment and foundation portfolios? Well, it was just trying to capture that additional return. And we didn't set out saying, hey, we should target 90. When I took over the portfolio from Bill in 2010, I think we were probably 50 % illiquid. But the returns have been robust. We did not have, in the last 10 years, any U.S.

30:57Ed Grefenstette:public equity exposure except public positions in our private book. So that was the entirety of our U.S. beta. So the private actually continued to outperform the public in our book. So that stretched out. So we're taking the last five or seven years, We've been more careful and deliberate in terms of our fresh commitments to liquid strategies, trying to get that number down. What are some of the structural aspects of managing liquidity, commitment size that you've figured out that have allowed you to get to that upper bound? The portfolio is very mature at this point. Your listeners might be wondering, how does this guy sleep at night at 90 % of liquid?

31:36Ed Grefenstette:But if you look at the dollar weighted average age of all of the partnerships we're in, it's about 7.1 years old. So we are as a portfolio out of the J curve. So I actually looked at this number just the other day. If you look at our last 10 years, we've gotten distributions of$1.4 billion on capital calls of$1 billion. So that's$400 million. That's pretty much equal to our total distributions to our supported organizations, by the way, because this May we will make our next annual distribution, and I'll take us to$400 million. So the portfolio is mature. Even this last year in 2024, to give you a data point, when the marketplace was facing a lot of strain around the lack of liquidity, we had our second highest year in distributions and the second highest net distribution to minus capital calls.

32:31Ed Grefenstette:And again, that was due to having a very diverse and a very mature book. So that's number one. The other way we're able to manage it today is we do have a line of credit, which is we have nothing drawn on it today, but it's equal to about 12 % of our total NAV. So if we need to pull on that, it's available to us on a timing issue. And the other thing that allows us to operate this very high level, which is all by design, is that we are not a private Foundation, but structured as a 509A supporting organization under the code. As such, we don't have to comply with that 5 % payout otherwise required, and we can pay out 3 % of our NAV each year, which is the recommended amount in Bill's trust document in which our trustees approve each year.

33:22Ed Grefenstette:So that 3 % spend is obviously more modest than most organizations. That's helpful as well. We're going to take a quick break in the action to tell you about Ridgeline. Imagine starting your day with reconciliation already done. No spreadsheets, no breaks to chase, no duct tape holding systems together. Ridgeline is the first front-to-back system of record built for investment managers. One platform, one real-time data set. Embedded AI. Investment firms are replacing a patchwork of isolated and data order management systems, accounting systems, reporting add-ons, and client tools with this fundamentally new operating model, automating complex workflows, scaling personalized client experiences, and unlocking the full value of AI.

34:11If this is the year your firm is ready to modernize operations and harness AI, you can learn more at ridgeline.ai. And now, back to the interview. you. Before we dive into this private investment program, what do you do with the other 10 % of the portfolio?

34:30Ed Grefenstette:Well, you'd think it would be in cash. Some of it is, but we have a fair amount of exposure in China. So we have a bit of a hedge play there in the other asset pool, but we have some long only couple of hedge funds and we actually have a component in emerging market slash frontier market equities, but nothing in the S &P 500. So it's pedal to the metal. So let's dive into this private program. Within the concept of wanting to invest in less liquid assets to be out on the efficient frontier, where does that 90 % fall in, say, venture, private equity, and other areas of the private markets? So if I take the 90 as a whole pie, 100%, probably 55 % of that pie is venture.

35:17Ed Grefenstette:And then the other is split evenly roughly between growth equity funds and buyout funds. We don't touch any real estate. We do very little in the energy space. It's principally traditional venture across a number of sectors and then more traditional growth and buyout globally. So within that structure, how have you gone about figuring out how you want to deploy the capital? Stepping back, we really take a thematic approach to investing generally. From our perspective, as Bill always said, the market timers hall of fame is empty. Okay. So let's pick some themes that we believe are going to play out over the next decade or so and try to find the very best, most talented managers to exploit those themes in the right parts of the world.

36:03Ed Grefenstette:So the two major themes that kind of course through our portfolio are innovation and all of its forms. And second is the broad opportunity set in the emerging and frontier markets. Innovation is obviously best expressed through venture capital. And that's the belief that even though we've had incredible innovation in the last couple of decades, we still think we're in this super cycle of very exciting stuff across from deep tech. Obviously, AI consumes so much of all of our conversations today, all the way through healthcare to consumer. And we express that mainly through venture capital. And that venture piece is probably split evenly roughly between the U.S.

36:46Ed Grefenstette:and non-U.S. Most of the non-U.S. in venture is in emerging Asia and Latin America, a little bit in Europe. Bill always said Europe is the largest open-air museum in the history of man. So he said, I'd rather live in U.S., vacation in Europe and invest in Asia. That was another line of it. So we try to find opportunities that we think fit in that innovation theme. It could be across the globe. And we spent a lot of time traveling, trying to build ideas, connect the dots. As one person asked about this concept of connecting the dots, I said, well, first you have to find the dots. So part of this is traveling and getting out and visiting people on the ground.

37:29Ed Grefenstette:On the buyout side, we've been mostly biased toward the U.S. Most recently, I'd say the last five or six years, we've been really leaning in on the special situation subsector within buyouts because we think there's going to be some challenges ahead and some shoes are going to fall. So we want to have some dry powder prepared for that. I don't want to make it sound like we're dogmatic, however. If we run across opportunities that we think are extraordinary and fit, I always tell my team, the legendary football coach in Pittsburgh, Chuck Knoll, always said when it came time for drafts, he said, I always draft the best available athlete, regardless of position needs.

38:09Ed Grefenstette:I want the best available athlete, and we take that approach. So when we travel the world, we meet with 300 managers plus a year. We have a lot of friends who are part of our network, which help us filter before things go in the funnel. We run across people who are sometimes extraordinary in unexpected places, and we'll dig in there. That other large theme of emerging markets certainly was a lot more popular, say, 10 years ago than it is today. How have you thought about that allocation going forward and the potential revision of that thesis as many of those markets have not performed as well as the U.S.?

38:45Ed Grefenstette:That's an important question. And you're right. If you step back and look at the broad arc of globalization, you can really make the argument that when the Berlin Wall came down in 89, if you made any bets that were long on globalization, long on geopolitical stability, you were rewarded until a couple of years ago. So now it's especially challenging, we think, because as allocators, you've had this muscle that hasn't been exercised in a long time. And that is, how do you underwrite the effects of geopolitics? How do you underwrite the effects of this movement from globalization to what you might call modern mercantilism with less cooperation and more competition?

39:33Ed Grefenstette:So we spent a lot of time thinking about this very issue. It's not easy because there can be screaming opportunities, and China might be a perfect example today, where intellectually a lot of CIOs know these valuations are getting unjustifiably cheap. But back to career risk. They don't want to walk in in front of their investment committee who have been reading these horrific headlines and inundated with bad news about the state of affairs, and they just don't want to stick their neck out. And they don't want to be told, I told you so. So there's this tough dynamic, but an important and new necessary underwriting around geopolitics.

40:14Ed Grefenstette:It used to be just a left tail analysis, but now it applies to innovation as well. You have to think about geopolitics, how that affects where innovation's developed and how it's sold. And on top of that, supply chains to support it, even capital flows. It's a complicated environment right now. We're in the middle of re-underwriting that theme. When you put together innovation, emerging markets, take out Europe and Asia, it leads to China. I'd love to hear more about your full history investing in China, how that's evolved to where you are today. I don't want to leave that European remark, by the way.

40:51Ed Grefenstette:I want to make sure I tell my European friends, we love you. Okay, we're spending more time in Europe. I'm not as dogmatic as Bill was. So Europe is actually growing in focus for us. Didn't want to look at a common hand. But China was an amazing insight that Bill had. And I'll tell you the quick story on that. During these many lunches that he and I had, I think it was 2006, he had just returned from China and his eyes were like sausage. He was very excited. And he leaned across the table and said, Ed, now's the time. And I said, for what? He said, I'm going into China. hard on privates. I said, really?

41:32Ed Grefenstette:I said, that's the dumbest thing I've ever heard, Bill. I said, the only way to make money doing that is invest, lose all your money, and then write a book about it. And he said, no, no, no, you're wrong, Grefenstedt. Let me explain. And he went through his thinking. In 2006, he began to build a little sub-portfolio in China. He didn't believe U.S. managers could parachute in. He only wanted to support local teams who had the Guangxi to get the real deal flow and understand the market. So he approached it in a thoughtful way. 2006, he said, I'm going to invest a little bit with about 10 different GPs.

42:08Ed Grefenstette:No real track records here. So I'm going to learn as I go, understand these people, understand how they perform, and then over time, go deeper with a high conviction subset, which was to me, a very logical approach. So he began to go to China three, four, five times a year, week on end. And by the time I joined him in 2010, the China allocation was probably about 6 % or 7 % or 8 % then. And I began to travel extensively too. I think my wife keeps track. I think I've made 50 trips to Asia since 2007. And when I took over his Dietrich book in 2010, our China portfolio was mostly growth equity, a little bit on the venture side.

42:53Ed Grefenstette:When Bill and I sat down, I told him, hey, we should really go all in on venture because there's a lot of reasons why that's going to be, I think, more compelling. And he agreed and we did. Where did that 6 % or 7 % grow to? We timed it pretty well because we began to invest during a great run-up in the Chinese private markets. We peaked at a total portfolio exposure in China of 38 % in late 2020, which is a big number. today as we sit here, we're about 19 or 20%. I was just preparing some data on that. And of course, some of that was the fact that the last couple of years, we've had a reduction in the unrealized value in some of these holdings.

43:39Ed Grefenstette:But we also got a lot of liquidity. In fact, our portfolio in China over the last 10 years produced 160 million of excess liquidity, 160 million distributions over capital calls over the last decade in our China book. That's great. That shows the pipes work. So many of my friends in the business say, the pipes really work to get the money back. Yes, we get the money back. So a big chunk of that reduction of 38, 39 % exposure down to 20-ish, 10 % of that, half of that reduction was really distributions. And the rest was probably the rest of our portfolio outperforming the venture over the last five years.

44:17How have you thought about continuing commitments going forward with that exposure from where we are today?

44:25Ed Grefenstette:China's hard to underwrite in the best of circumstances. Bill always said, you got to go down on a plane and go to do direct due diligence, especially in a place like China. He used to sum it up by saying, Ed, you can't shoot moose from the lodge. You got to get mud on your boots. So we would travel quite a bit from 2008, 2009, all the way until 22. We felt like we had a very good sense of the risk parameters around investing in China. Our confidence was really in the fact that having studied the market and studied their political tendencies, whenever China faced a really hard period, they tend to pivot back toward pragmatism.

45:08Ed Grefenstette:They tended to pivot toward business-led decision-making and stimulus and policy reform and whatever it took to get the GDP growth back. Those GDP numbers are all wrong, by the way, but they're directionally correct. But they would pivot always toward pragmatism away from strong ideology. 22 was very disappointing. We saw in Xi and the other Beijing policymakers really a disappointing tone deafness to what investors around the world were looking for in terms of guidance and predictability. They did some things with respect to their every five-year Congress that we felt was reason for some alarm.

45:52Ed Grefenstette:So we put pencils down. We haven't stopped looking. We haven't stopped investing entirely in China. But our allocation pacing has changed dramatically. So I think there are many more unknowns today than there are knowns. And it's not just on the China side. It's how the U.S. administration is going to handle capital flows and so forth. So I think it's a time for don't just do something, sit there. That's probably the best advice right now with respect to China. But at some point, the valuations could get so compelling that we start to lean in again. And then I think the intrepid may be rewarded.

46:29At the onset, you talked about lesson from your father and also, Bill, about the importance of people in this business. How have you gone about sourcing and selecting managers to fill this portfolio? you?

46:43Ed Grefenstette:So we've taken a couple of approaches. First, we travel quite a bit. I'm probably on the road 80, 100 days a year. The rest of my team have younger families, so I don't ask them to do that much. So traveling is important. And we try to meet with smart people on the ground, allocators, investors, and we try to build our own views. We also trade notes with like-minded investors. So we have a network that we're proud of, a bunch of other endowments and foundations, who kind of approach investing as we do. We actually, Bill started a great idea 21 years ago, a golf outing just outside of Pittsburgh at Laurel Valley Golf Club called the Dietrich Private Equity Invitational.

47:26Ed Grefenstette:It is an oversubscribed event. So we have a hard cap on it that we're actually keeping the hard cap, Ted. And we invite about 64 either CIOs or heads of private equity from endowments and foundations and fund to funds. That's a great amount of fun. It's a couple of days. But there's also a good amount of gossip that goes on about GPs and who's in the market and what spicy off-balance sheet information's out there about a GP. So that's part of our network as well. But really, it's at this point interviewing maybe 300 GPs a year to get to only a couple we might add in as a new relationship. In what's been for a while a very competitive market to access the best GPs, particularly in venture, how did Bill and then you go about trying to get allocations when you're not the biggest player in town and so many people want access to these great GPs?

48:24Ed Grefenstette:Bill had a competitive advantage because he was one of the all-time great salespeople. Personality-wise, he had this remarkable charm. He was a great storyteller. People just really enjoyed speaking with him. And when he found a GP that he wanted to get in early on in Dietrich's portfolio, he would approach you with every ounce of energy, finding other LPs that might be able to make a warm introduction. And I remember one time he said, Ed, when you get down to the wire, you got to fight like you're the third monkey going up the ramp into Noah's Ark. you've got to do whatever it takes to get and he just had this ability once he got in in front of the gp he would say hey this isn't about bill dietrich making more money i'm not buying another yacht this is about charitable good works and can you find a million for us maybe he would squeeze his way in for a million or two and he did that with excel and it ultimately became a significant relationship for us, for instance.

49:31Ed Grefenstette:So he had this incredible charm and personal appeal that was a big advantage. I think now part of our appeal is we've been at this a long time. Our team is very stable. We're totally committed to venture and other private asset classes. We have a great story to tell. Bill Dietrich was a remarkable philanthropist, and I think people really enjoy his drive to help Western Pennsylvania. So that's an appealing feature. And we try to be good partners. We bring a lot of experience to the table. I think GPs who are with feel comfortable reaching out to us and having us as a sounding board when they run into either portfolio difficulties or personnel issues.

50:14Ed Grefenstette:So we try to be available and not a pest, but an available and helpful LP. When you're working through a new GP, so not a GP that people want access to, how do you go about doing your work to underwrite a new manager? It starts entirely with integrity. It has to be a situation where you're 100 % comfortable and happy to be partnering with the people involved. If there's any issues around that, that's a non-starter pencil down, move on. Secondly, I think it's fair to say we would look for a level of self-awareness or authenticity in the GP. And that's hard to tease out sometimes. So as a result, when we're interviewing with a GP for the first time, we try to get them off the pitch book as soon as possible.

51:01Ed Grefenstette:We try to ask questions that can give us a glimpse into whether there's really hubris at work here or whether there is some level of self-awareness, because I think a little bit of fear is a good thing. If a GP doesn't have any fear about execution. I have a lot of fear. So there ought to be an edge around that. And there's some questions we ask to try to tease that out. We also get into portfolio construction. What are their investment sensibilities around that? Are they getting the right ownership in the venture case? That makes sense. Are they managing their reserves properly? That's a big part of it.

51:35Ed Grefenstette:And then repeatability. This business is hard to discern skill from luck. I think if there's any silver lining to the last handful of years is probably this. We can go back now and look at the behavior of GPs in 1920 and say, how did you do? How were you thinking about valuations? How were you thinking about portfolio management? When everything was up and to the right, it's hard. But now you have at least some data. That's not insignificant. Even on the DPI front, today, there's a lot of pressure, as we know, for GPs to improve that DPI number so they can raise fund X plus one. And we've often said that the GPs who are selling good assets, probably at a low valuation just to get the DPI up, that's a red flag.

52:23Ed Grefenstette:And everyone knows this. So we really try to drill down on how they're thinking about exits and whether that is aligned with our long-term expectations around returns. You mentioned certain questions that allow you to tease out aspects. What are some of your favorite questions that get into that aspect of integrity? Well, this is like losing all my best stuff now if I go on air and tell people what we like to ask. But I'll share one. On this issue of self-awareness, say a manager's coming in and raising Fund 3 for$300 million target. At some point in the conversation, we'll ask a question like, assume the following.

53:06Ed Grefenstette:Assume you raise the 300-year targeting for this fund and assume you deploy it in the fashion you've just articulated. And assume further, there's no widespread economic calamity in the next five or seven years. And assume we sit down and have a cup of coffee in five or seven years and we look back at this fund three and assume we're all disappointed on a relative and absolute basis. What will have been the most likely cause? Now, this is not an overly complicated question, but it's often one they haven't thought about. When you take the economic sort of externality risk off the table, it forces them to step back and look at where the real soft spots are in their execution, sourcing, exit strategy.

53:53Ed Grefenstette:Sometimes, if you can believe it, Ted, the GPs refuse to accept the premise of the question. And they will say, well, we've never failed. We've never had an underperforming fund. I refuse to accept the premise. And that's usually a pretty big flack. But sometimes they say, you know what? We've spent a lot of time thinking about this. And if we screw this up, we have a great track record. But if we blow this going forward, it's probably going to be because of X, Y, or Z. That's an interesting response. And usually we then double-click and say, well, what are you doing then to mitigate the risk of X or Y or Z?

54:27Ed Grefenstette:and how do you think about that? And how do you maintain awareness around those risks? Hey, do you have it on the corner of your whiteboard in your office? And occasionally you say, hey, are we doing X, Y, or Z? Then it becomes a self-denying prophecy. So it gives you a little glimpse and decide of whether they occasionally step back, perhaps offsite, and really do self assessment. Hey, we have to do this better or we have to really avoid these mistakes that we know are within our control. You touched a little bit on the aspect of portfolio construction and mentioned the importance of reserves.

54:59What do you like to see, let's say a venture manager, in how they go about thinking about portfolio construction?

55:06Ed Grefenstette:I don't want to name names, but there's a very large, prominent leading VC that is now raising two, three,$4 billion funds. What we've liked about their philosophy and approach, which has kept us with this GP as they've gotten larger is how they handle portfolio construction. This particular manager is willing to stick the neck out. When they see a company they've backed in the seed in series A, they will lean in hard on the subsequent rounds to the point where at the end of portfolio construction, they might have 40, 50 % of the fund in three or four companies. That to us is exactly how a two or three or$4 billion fund needs to be structured in order to hit a four or five X net return.

56:04Ed Grefenstette:Now, if you're talking about much smaller seed managers, that is really strategy dependent to some degree. What gives us pause, however, is when you have a manager maybe trying to jump from seed to series A, they don't have the reputational firepower to really lead those rounds. Or if they say, we only want to lead the rounds, we really probe as to whether that's adverse selection. Maybe reputationally, you only have the opportunity to lead in deals that the big dogs don't want. It's a very complex mosaic. And we look at the specific circumstances of every case to try to figure out, hey, should this be a strategy we should be comfortable with where they write one check, no reserves?

56:49Ed Grefenstette:We want to get as large a piece as we can. Or do we see a skill set where they can say, hey, 30, 40 % is going to be reserved. We know how to lean in for the breakout winners. How do you apply the same thinking to your own portfolio construction about sizing of commitments and how you build it up across the strategies? Well, I think there's always a temptation to size based on conviction. I was talking to a friend who runs a prominent fund of funds, and he said, yeah, we did all the math on this. And really, at the end of the day, it should be equal weighting every, every. I said, yeah, but that's no fun.

57:26Ed Grefenstette:get this enthusiasm for a manager. Hey, we want to lean in. But it's good discipline, I think, to be biased toward equal weighting because there's a tendency to say, okay, well, I'm not quite sure about this one. Let's do a half of a bite on this one and see what happens. I think that's a very dangerous, slippery slope to get on. We have a saying that there's only so much beachfront property in the Dietrich portfolio. So it's either hell yes or no. We've been migrating toward that. And I think that's the healthier approach to take, but it's tough because there's some stuff you really, really like, but it's not a hell yes.

58:01Ed Grefenstette:So we try to keep warm and keep an eye on. How have you thought about co-investments? I always remember the Groucho Marx line of, I would never want to be a member of a club that would have me. That's the ultimate adverse selection joke. We always think about that. If we get a call from one of our GPs, we always ask, We know we're charming, but why are they really calling us? So the first question is always, is this, in fact, an adverse selection situation? If not, we'll look hard at it. We have a couple of GPs where we have such a close relationship. We really feel like they are reaching out and giving us some preferred looks at some deals they're excited about where they've maxed out on their capacity.

58:42Ed Grefenstette:And so we have done some of those. So I think we did only a few through 2014 through 2018. We've done more as we've really tried to build closer relationships with some GPs. So I think we've done about 32 in the total portfolio. And it only amounts on a cost basis, maybe about 5%, 6 % of the total NAV. So we're going in baby steps. What's your take on the concept of co-investments as a way of defraying fees, which isn't something you've mentioned? Well, we certainly ask for that. And that's part of the appeal. I think I told you once about the story of a very, very large pension fund that I was on a panel with one time.

59:29Ed Grefenstette:And co-investment came up and people were talking about performance. this very large not-to-be-named pension fund representative said, well, we've done a thorough analysis and we've outperformed in our co-investment program all of the primary GP fund returns from which the co-investments came. Kind of looked and said, well, that's interesting. Can I ask my panelists a question? And I said, well, that's pretty remarkable. I mean, if you normalize for, he was saying normalize for fees, The co-investments are outperforming the underlying fund performance. I said, well, that tells me that you're doing something that maybe your GP should do.

1:00:09Ed Grefenstette:You're filtering somehow, some way better than your GPs are, aren't you? And took offense to that question. But in truth, you think about the math. And a typical bio fund might have 12 positions. If you look at all the data, maybe in most cases, only three of those 12 outperform the total fund return. If that GP comes to you and says, Ted, I got a co-investment for you, what are the chances you're going to get one of those three out of the 12? Otherwise, you should give an incremental dollar to the fund and you have a total portfolio. Now, you normalize for fees. Maybe you get a little buffer in there.

1:00:43Ed Grefenstette:But the venture is even worse because of the power law. And there's only a couple of companies that outperform the whole fund. So I'm skeptical of those who have large co-investment programs who claim they're outperforming the underlying fund managers because it's hard. And if they're doing a better job than their GPs, they should bring their GPs in and give them some instruction. What are your thoughts on continuation vehicles? I think it's a good thing that there's more creativity in creating liquidity today, no question. I think we always look at each individual or circumstance independently.

1:01:18Ed Grefenstette:We always start by asking, why isn't this company being sold right now? What's preventing this company from being sold in the normal operations of the fund? And is there a reason to hold it? And is this GP the right GP to be holding this asset at this point? And you have to get into the specifics of the alignment and the incentives around it. The old joke, if you meet one foundation, you've met one foundation. Every organization has different features to it. Every SPV seems to have nuance to it. And that's hard work on the LPs. And that's why LPs are, I think, stressed about it because suddenly you have 10 of these a year you have to underwrite.

1:01:57Ed Grefenstette:But we're not immediately adverse to it, but we would always like to see the option of rolling your equity exposure without much prejudice. I'd love to ask you a bit about some of the challenges in continuing to outperform with the model that you have at Dietrich. The first that comes to mind is just the attractiveness of these private assets relative to how they were, say, when you came in the seat 18 years ago. How do you think about continuing to pursue the strategy in a market where the private assets are generally more expensive and more competitive than they were? And the fees and carry structure is premium in some cases.

1:02:38Ed Grefenstette:We have a European GP. We actually are underwriting right now. We really like the firm. But the way the waterfall is calculated and the fact that the GP is actually charging some fees to the portfolio companies, they need to generate a 5.6x gross to hit a 3x net for the LPs. That's a non-starter. So, yeah, there's more competition. There's more premium term funds out there. And that's putting a lot of pressure on the thesis that private equity will return over time. We just think you just have to be slow and patient. We have the benefit of being small. We're only$1.5 billion. We don't have to write 50,$75 million checks.

1:03:21Ed Grefenstette:And I think if you swim around and look at the opportunities and smaller fund situations, you're still going to find some inefficiencies. You're still going to find some returns that are impressive. The evidence of persistence of high quality funds and that premium, they're both under pressure. So this is not an easy game, but we think it's still worth playing. It sounds like you haven't been challenged on the liquidity side in these last couple of years. Maybe it was a little different in 08, but you probably hadn't built up to as much privates as you have today. How do you think about managing through where you really don't control the assets and you have so much in illiquidity?

1:04:04Ed Grefenstette:I should have mentioned in the global financial crisis, Bill, before I joined him or I joined 2010. But I remember if you looked at his unfunded commitments as a percentage of his NAV, he was hard charging, as I said. He had probably 70, 75 % unfunded relative to NAV. In a portfolio, there's only 50 % liquid, by the way. So, Bill, what are you doing? And he had a line of credit. And he said, Ed, I'm going to the secondary market. It's time to throw some sandbags out of the hot air balloon to get over the mountains. He did it. He went out and went to the secondary market and got rid of maybe 40 or 50 million of unfunded commitments and got paid.

1:04:53Ed Grefenstette:He took great pride in that and went back to the bankers, by the way, and had a lot of fun telling them, you guys have this AAA paper you can't push. And I was able to sell these secondary interest in illiquid assets. This is a deep market. And at the time, the secondary market was probably in total$10 billion. I think last year it was$160 billion global market for secondaries. So the secondaries continue to be deeper and deeper. Today, that unfunded as a percentage of NAV for us is about 19%. We don't have a lot of logs we're thrown on the fire right now. So we're being very careful and we're trying our best to keep our important relationships, but maybe adjusting the check size a little bit until we get the illiquidity down a little bit.

1:05:38You mentioned earlier that this last couple of years haven't been the best for the strategy on a relative basis. How do you continue to communicate with your trustees to make sure they have confidence in you? Sure, the 20-year numbers are good, but maybe 10 years from now, if this continues, it could be a tougher slog. Yeah.

1:05:57Ed Grefenstette:Well, we've tried to be as transparent and clear as possible that we think that this is just another shiny object in front of us, the S &P 500. And you know this, and most of your listeners probably do. The amount of concentration today in the S &P 500 is extraordinary. If you take the top decile relative to the remainder public securities in the U.S., it's at 3x. It's the highest ratio market cap in 100 years. So you have really seven stocks that are driving a lot of the S &P 500. What we've tried to do is just remind our trustees, we're playing a long game here. And I actually, in a recent presentation, went back and showed the 70s and said the energy stocks were the thing.

1:06:44Ed Grefenstette:Energy stocks, six of the top 10 market cap companies in the world in the 70s were energy stocks. And they were 24 % of the S &P 500 versus 4 % today. And everyone said, that's the new normal. Forget about bonds. This is energy. And then that collapsed. And then it was Japan. And the next decade, Japan's the new normal. The Nikkei has exploded. And eight of the 10 market cap companies in the world were Japanese companies. And Japanese stocks were, at that time, 45 % of the MSCI world, and the U.S. was 33%. The next decade, of course, the tech bubble or the NASDAQ was up 15x every 10 years. Oh my gosh, that's a new normal.

1:07:24Ed Grefenstette:So you try to bring historical context around these periods of time where there's something shiny. Whereas if you look over long periods of time, we think our portfolio holds up pretty well through cycles. But the S &P is having its day. Now the US stocks are what, 65 % of MSCI world. That's an enormous number. I'm not saying we're in a bubble, but I'm not saying we're not. I just think we have to keep our eye on the horizon and go back to first principles. And our first principles are, I think we're going to be rewarded if we maintain the fortitude. So as an additional challenge, one of your first principles is innovation.

1:08:02And for sure, the MAG-7 seemed to have captured a lot of the innovation economy. I have to imagine at some point in time, you scratched your head and said, what would Bill say about these stocks that are innovating and capturing such share of that? How have you wrestled with that portion of the growth of the Mag7?

1:08:22Ed Grefenstette:Well, there's no question they're driving a lot of innovation. The question is at what price can you access that? As we sit here today, I can't tell you that it's a no-brainer to put more money into those companies versus maybe the vertical winners that are going to emerge as a result of, say, AI becoming more of a utility. I think NVIDIA is a play on many different themes and theses, but ultimately we're talking about, is the platform at issue? Is AI going to become a commodity layer? And will it become like AWS? People are just buying their share of time. And the more interesting plays from this point forward might be the verticals that sit atop.

1:09:10Ed Grefenstette:That's the question we're wrestling with. But I'm not ready to back the truck up and go into the MAG-7 right now at these valuations. So you still have some time left before you hit Bill's espoused 70 years old. So much of this model ends up being tied to you as the leader and Bill as the leader before, how have you thought about succession? Bill did throw out the 70 number. I'm 58 right now. 70 seems like a long way away. I think I'm going to think long and hard about that over the next five years and think about how much gas I got left in the tank, because this isn't an easy enterprise traveling around as much as we do and really preparing for that successor.

1:09:51Ed Grefenstette:And you're right. When Bill was in the final stages, he looked me square in the eye and said, hey, Your biggest job is going to be finding your successor. And I don't take that lightly, but we also got to make sure we have the board prepared and the new trustees all singing off the same sheet of music about what we're trying to accomplish. And that way, the successor will have a fighting chance to keep this thing going. How have you worked through thinking about your successor? It goes back to first principles. Bill even put in that statement of philosophy document, hey, I want to see a force of personality and a work ethic that doesn't typically align with most foundations.

1:10:31Ed Grefenstette:He thought most foundations were sleepy. He wanted more of a Dietrich Industries sense of urgency because he always said, hey, the only reason why we succeeded is we were always three bad quarters away from bankruptcy. He always said, good Lord, that gets you on your edge. I think that's necessary for a CIO in this position because you have a lot of responsibility and a lot of weight on the shoulders to maintain the boldness necessary to outperform over time and during tough periods articulate the reasoning and rationale behind the approach you're taking. So yeah, I'm thinking a lot about this.

1:11:06What are you most excited about in the portfolio going forward?

1:11:09Ed Grefenstette:We're really excited about some of the companies in our portfolio that are in defense field. We have a nice exposure to Endural and we have a couple of others that we're really excited about. And Enduro is not going to be the only winner in that space. We have some direct co-investments in that we're super excited about. I don't want to name names and jinx it. We also have been building our portfolio in India. India, Bill and I had invested in back in 2010. It was a disappointing experience. I brought on one of my managing directors in 2014. And when he joined us, I said, what do you know about India?

1:11:48Ed Grefenstette:He said, nothing. I said, you're perfect. I said, I have a bias. I want you to re-underwrite, throw Clorox on the whiteboard and start scratch. And he did. And he traveled and he met everyone that we thought was thoughtful in the space. And we've been rebuilding and building that portfolio. We're really excited about some of the managers we have there. India is, I think, on a really exciting trajectory. It's hard to compare India to China for many reasons. But the demographics are far superior. I think 50 % of Indians are under 30 years old. I think it's 32 % of Chinese. Capital markets are reforming and maturing before our eyes.

1:12:27Ed Grefenstette:Modi, and Modi's got a lot of faults for sure, but he's done a remarkable job in terms of the tech stack and the ID program that they've implemented. Urbanization, tech leapfrog. India is an exciting theme for us, so we have probably as much unfunded commitment there as we do in China. So we're excited about our relationships. Ed, I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? Since I was 12, I've been passionate about golf. I played in college. It remains a passion of mine. I have always said it's the one game that teaches you a lot about life.

1:13:07Ed Grefenstette:I think Bobby Jones called it a fickle mistress. You never know what you're going to get. But good bounces, bad bounces outside of your control. and all you can control is how you respond. So it's a lot like life. What was your first paid job and what'd you learn from it? First paid job was delivering newspapers and the penny saver. I think I was nine or 10. I was so excited because I got one of those metal change makers that you clip onto your belt that held nickels and dimes. And I just felt like the king of the world when I was able to go up and collect when it was due and all the responsibility went with counting the money and so forth.

1:13:44Ed Grefenstette:That was a good first job. How's your life turned out differently from how you expected it to? I think if I would go back to my 21-year-old self in college and say, hey, when you're 58, you're going to be an asset allocator and you will have traveled the world many times over and you'll have all these exciting conversations with smart people investing in innovation and so forth, I don't think I would have believed it. I think my 21-year-old self would have said, oh, back up. What's an asset allocator? What does that mean? So, yeah, it's amazing how the twists and turns in life take you to places you never expected.

1:14:22Ed Grefenstette:And as I said at the outset, Bill Dietrich was a huge part of where my life ended up. And I'm grateful for having met him and I'm honored to carry the torch for. What's a mystery that you wonder about? So professionally, I wonder how any LP could agree to terms where there's an American waterfall. Okay. And for those who are uninitiated on this topic, an American waterfall pays the GP a carry on a deal-by-deal basis. Okay. Imagine the absurdity of this in an extreme case. Nine zeros in a row, nine complete wipeouts, and the 10th deal is a 3X, and the GP gets paid on the carry on the 3X. A European waterfall is a total portfolio return.

1:15:06Ed Grefenstette:GP doesn't see any carry until the LP gets all of his money back. There are American waterfalls out there, and somehow, some way, LPs are committing to those funds, and that's a mystery to me. On the personal front, I have almost three granddaughters, and I can't understand how she can eat so many popsicles. She usually eats six popsicles and a tiny little body and come back and say, I want another popsicle. So that's a personal mystery. All right, Ed, last one. If the next five years are a chapter in your life, what's that chapter about? I think anytime you go into your 60s, you're thinking about the future and, as I said earlier, how much gas you have in the tank.

1:15:44Ed Grefenstette:So I'll be focused on my succession planning at the Dietrich Foundation and then thinking about if there's anything else I want to try to accomplish professionally before I spend more time. And regardless, I'm going to spend more time with the grandkids. So that's probably how I'll spend the next five years, just doing some planning and hopefully seeing the portfolio just be a rocket ship again. Ed. Thanks so much for sharing this incredible story. Thanks, Ted. Great being with you. 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.

1:16:30Have a good one, and see you next time.

1:16:39Thank you.