E203: How Elite Endowments Invest w/John Felix

24:50How would you explain it? I would say very manager driven. And so, you know, we had somewhat less opportunistic than WashU in the sense that like we did have asset allocation targets and parameters and we did view our portfolio more in buckets, but it was very network driven. And so we would, you know, Bowdoin would get in deep in a network, whether it was Stan's network or a venture network, and just continue to compound with that network. And so being early to venture and investing in Sequoia's funds in the early 2000s meant that we got really close to, and this was before my time, but Paula got really close to the Sequoia team, built really deep relationships in venture, and then would back people that came out of those networks.

25:38And those networks compounded over those 20 years. And so we ended up being really early to a lot of great new funds that launched between 2005 and 2015, funds like Founders Fund and Andreessen. And I think being early and really leveraging those networks to compound was core to Paula's philosophy. She really took advantage of those networks that she built to get really good access. And that was where I first really... Scott was much more about the individual manager and underwriting them and being opportunistic. And Paula was very much about, we have this amazing access to these amazing networks.

26:15Let's use that for all we can and use that to get access to really interesting things. That's almost like founder product fit. they both played to their strengths and really leaned into their strengths than trying to kind of fit their personality to a strategy. I think that's definitely right. And again, it goes back to this whole philosophy that different things work for different people, right? And what works really well for one person might not work for another person. And then you went to Allocate, which just full disclosure, I was a C investor in the platform because I believe in it, obviously.

26:49What was your role at Allocate and what were some of the lessons that you learned there? So I joined Allocate right after it had raised its seed round. And I effectively launched and led Allocate's emerging manager platform. So Allocate is, you know, it's a startup, it raised venture capital, and it's building an alternative investment platform with a couple different parts. On one end, you have this asset management platform where we would, you know, we had fund to funds that we managed, but we also would get access to really good venture funds and effectively syndicate out that access. And then on another end of the platform, we built software for the private markets.

27:25And it's funny, the reason I joined Allocate in the first place was by this point in my career, I had kind of become a venture specialist. I moved away from being a generalist and I really wanted to concentrate in venture. But I thought that still being an LP inventor, you're always two degrees removed from the real action. And I thought that if I worked in a startup and saw that zero to one phase, it would give me a lot more empathy for my managers, but it would also just make me a better investor and make me able to ask better questions. And so, you know, we were, even though I kind of managed a fund of funds and acted like an institutional investor, we were still doing it within the context of a startup.

28:04And we were breaking conventions and really like doing things from a first principle standpoint. We didn't have to like do things the way they've always been done, which is like the worst thing you could ever mutter within the context of a startup. And so we backed a ton of emerging managers when I was there. We also backed a lot of non-emerging, a lot of big platform firms. And I learned a lot about selling and sales and things that you didn't have to do within the context of a non-for-profit endowment. I often think about with how I invest, I think about how do people become better investors?

28:41And one of the things that's really important is to get ground truth in different industries. How could you be a great endowment investor without understanding AI and what's driving that market? How do you become a good venture investor without understanding what drives startup returns? So I think it's really important, especially if you're focused on one asset class to go as close to ground truth as humanly possible in order to be better and be able to go back 10 ,000 feet up and be a better investor. Yeah, absolutely. And I had never seen how the sausage gets made within a startup. I didn't know what it took to scope out building a software product, working with an engineering team and a product team and actually building and shipping something.

29:26These were things that were very much in the abstract for me and still, I think, very much in the abstract for a lot of institutional investors. but being an allocate, like seeing that zero to one, seeing what it takes to hire a team and go from 10 people to 50 people, seeing what it takes to raise a series A. These were all things that happened when I was there and just seeing it upfront, I think gives me, it just gave me a lot better understanding and appreciation for like how hard these things are, like how hard it is for founders to build companies, how hard it is for investors to pick companies and understand companies.

30:02and it just gave me a lot more empathy, I think, for what all of these players in the ecosystem have to go through. And I'm really glad that I did it because I think it's made me a better investor. So then you went on to found a fund of fund, Pattern Ventures. Why in the world do we need another fund of fund? It's a good question. And my somewhat snarky response is like, the world doesn't need another fund of funds, actually. And I tell this to managers we meet with. The world doesn't need another venture fund. But if you have the right to exist, then I think there's always room for more. And I think we earned the right to exist for a few reasons.

30:42In venture, if you want exposure to the big brand name firms, the Lightspeeds, the Sequoias, the Andreessen's of the world, it's really purely an access play and you don't need a fund of funds to do that. You can try to get access directly, or you can leverage a platform like Allocate to get access. There's ways to get access. It's not really like a diligence or an underwriting game, it's an access game. And I think it's becoming increasingly easier to access these bigger firms. But in the emerging manager world, it's much less of an access game, and it's much more of a discovery and diligence and manager selection game.

31:20And it just takes a lot of time. There's thousands of venture funds in the emerging manager world to pick from. You need the right network to find these funds. You need the right skill set to diligence them. You need to reference them. It takes a ton of time. Return dispersion in this world, in the emerging manager world, is massive. And so manager selection matters even more. And that means you need to spend a lot of time meeting with a lot of managers to pick the right funds. And a lot of LPs just don't have that time or don't have the bandwidth or the skillset to do that. And so to do this part of the market right, I think a fund-to-funds makes a lot of sense.

31:59And I've been doing the emerging manager LP investing for a while. My two partners who started Pattern have been fund-to-funds investors for multiple decades, and they've been investing in venture companies for multiple decades. And so I think we've earned the right to do this, but I don't think the world, again, needs another fund of funds unless you have earned the right, like I think we have. Another way to look at return dispersion, there's obviously just beta and market beta, but I would actually call it LP error. I think there's significant LP error in the venture space. Said another way, the return dispersion is only partially due to actually just variance or randomness.

32:45A lot of it is actually due to picking the wrong managers. I caution people to really think critically about their venture exposure. First of all, it's completely idiosyncratic to every other asset class on the planet. There's no learnings. In fact, if you know a little bit or maybe even a lot about private equity, it's a recipe to be a terrible venture investor because of power laws versus downside protection and things like that. The second aspect is there's a right way and a wrong way to enter any asset class that you have no experience with. So if you look at how endowments or institutional investors enter asset classes, at least most of them, the humble ones, they'll start actually with a fund of fund.

33:28They'll start with the most high view, kind of 10 ,000 square foot view. Then they'll start to see what does good look like. Maybe the fund of fund will start giving direct exposure into the funds. So they get kind of this sense for what does good look like. It's almost impossible in the first year to even know what an asset, what a good asset looks like. And then maybe five, 10 years later, they'll start to actually build out a direct platform into the actual underlying companies. And if you look at the behavior of 70, 80, 90 % of high net worth investors, when they go into venture, they actually go the other way.

34:04They go directly into startups because that's what naturally comes into them. Then they go into funds if they kind of learn from their mistakes. And then once in a while, they'll go into fund of funds. But again, the LP error on the manager side, and even more so on the startup side, that LP error, because there's almost no barrier to entry start a startup, is so massive that whatever investors save in fees, they pay 5, 10x oftentimes. Oftentimes, they just lose all their money. It's like, do you want to pay 2 % management fees? Or do you want to pay 100 % mistake piece. Anytime you're going into a new asset class, even if it's for the first year, maybe two years, going with a fund of fund and learning the ropes on somebody else's dime, I think is so valuable.

34:51I completely agree. And it's the crawl, walk, run approach, right? And it's funny, I made this mistake earlier on in my career, actually, after WashU, I joined an OCIO where we manage endowment capital. When I joined, we had almost no venture exposure. and I kind of took the lead on building out our venture program. And we were starting from zero and this was when my venture network was very, very limited. And we basically spent a year trying to just get up to speed and understand. And then we started making a few commitments the following year. But I think in retrospect, I should have started with a fund of funds to help me get to know the ecosystem and build relationships and then maybe co-investing alongside the fund to funds directly and some managers as you build kind of conviction and then eventually going to do it myself.

35:39We could have jump-started the program a lot better. And like we made some mistakes early on backing managers that, you know, in the early days, everything sounds great, right? When you're, and even now when I'm, you know, training like our analyst or intern, you know, in the beginning, everything sounds great and everyone's interesting. And by the way, like almost every manager we meet with, even if we pass, they're all very impressive. They have great experience. They have great backgrounds. They worked at a great company or they worked at a great firm. But it's really hard to delineate between who's just okay or good and who's really great.

36:11And we've had LPs come to us and say like, hey, look, I tried to do this myself and I just got really burned and I just need help. And I don't think it has to be like an either or. You can use a fund of funds and use it as an educational experience to start doing this yourself, which a lot of our LPs too. And so I I definitely am a big believer in the crawl, walk, run approach. I made the same mistake, which is why I so intimately understand it. I think I probably did 100 startup investments before even investing in a manager. So I did not take my own advice had I known it. I, of course, would have done it.

36:48I want to double click on something that you said that's rather obvious for people in the industry. But if you made your money in a widget factory and then you start investing in venture, the average, let's call it the bottom quartile venture investor is the top 1 % of society or the top 10 % of Ivy League. So the bar to even have a venture fund or raise 20, 30, 50 million, 100 million is so high that even just to be in the game, there's a quality bar. That's why you have to meet like 100 managers before you actually know what good looks like. It's because everybody actually looks pretty good.

37:23That's a common mistake that people make. Yeah, absolutely. Like everybody's smart in this industry, right? Like when we talk about the managers we like, it's, you know, we're not saying things like, oh, they're so smart, like we need to invest, right? Like those are, that's table stakes. And I actually think this is what some managers get wrong about their differentiation, right? Because we, you know, we'll talk to some new managers and I'll ask them like, why do you think you have the right to exist? Or why do you think you have the right to win? And they'll say something like, oh, well, you know, we're operators and we have great operating experience and founders want that.

37:56And by the way, that's great. And maybe you do have great operating experience, but I've met with 200 other firms that also, you know, were operators at great companies. And that in and of itself is not enough, right? It's impressive. And it's impressive when these folks worked at great companies and did great things. But it's almost table stakes. And it makes it a lot harder to really differentiate, again, if you haven't met with hundreds of firms and you don't know, like, where that relative baseline kind of is. So for your fund, you're targeting sub$50 million managers. Tell me about your strategy and your portfolio construction.

38:29Primarily what we do is$50 million funds. The reason why we settled on this is, well, there's a few reasons. One, when my partners were setting a pattern, they went back and looked at every fund going back about 45 years, I think to 1980 until today, and looked at every 5X net venture fund in that period. And what we noticed was the largest cohort of 5X returning funds was in the sub$50 million range. This is for a few reasons. One, smaller funds are less competitive against the bigger incumbent firms. You don't have to compete for that lead spot. Leading around is binary. You either win the lead position or you don't.

39:09Sometimes you can co-lead. But if you have to have a bigger fund and you have to deploy more in lead, now you're becoming competitive against not only the other seed funds, but also the big income and kind of tier one brand name firms that occasionally do seed as well. And so we like that smaller funds are less competitive. They can get better access to deals. We also like that they're purely focused on pre-seed and seed, where we think the biggest opportunity for outlier power law-driven exits exist. Valuations are better. And the fund math, most importantly, to get to a good return, it's just a lot easier, right?

39:44You don't need to rely on the next Uber, just a three extra fund. If you're a$50 million fund, an acquisition at a couple hundred million dollars can really move fund level returns. And if you get a single billion dollar company that could return your fund sometimes multiple times over. And so venture, we believe is hard enough as it is. And we just want to try to stack the odds even more in our favor in terms of generating great returns. And so that's why we've focused on this sub$50 million. I had recently had a podcast with a guy that runs a lean AI leaderboard, which is looking for these one person led kind of, he calls it seed strapping, which is you raise a seed round and then you become profitable.

40:24I've been thinking about the second order effects of AI on investing. So if AI does bring down costs and what I've kind of settled on is this bifurcated model, pre-seed and seed, and then the mega funds. So you need money to prove out your thesis, and then you need capital as a moat. So in my version of the future, you see these highly value-added pre-seed and seed investors, and then the Andreessen's and Sequoia's writing kind of the billion-dollar checks. What do you think about that thesis? And help me refine that thesis. So I agree. I very much agree that venture is becoming bifurcated. And I think you either need to be like a small, nimble, collaborative early stage investor, or you have to be really a deep pocketed multi-stage, big brand name.

41:13I think in the middle, it's really hard to win for a few reasons. Put it this way. I think a lot of founders at the pre-seed and seed stage, they know the risk of taking capital from those big incumbent tier one multi-stage firms, right? The risk is you're kind of an option check to them at the pre-seed or seed stage. And if they don't follow on and do your A, there's material adverse signaling in that, right? And so a lot of founders say, I'm going to raise my pre-seeder seed from a smaller specialized pre-seed seed fund where I know I'm going to get really good engagement from the GP. Often it might be a solo GP where like, I know exactly what I'm getting and who I'm getting it from and they can be really helpful and I'm meaningful to them as a part of their portfolio.

41:53But the best founders, when it comes to the Series A, I think they want to raise from a big brand name firm because it's signaling, you know, raising from a big, great firm in your series A is a great signal. But more than that, those firms have deep pockets and can fund you, you know, theoretically through IPO and beyond, right? And if you're a founder - Which they want to do too. It's kind of their new business model today. Yeah, absolutely. Which they want to do. And if you're a founder, the biggest distraction to your business is fundraising. It can take a lot of time. And if you have to go out and fundraise for every round of new process, like that's a big distraction and a big time commitment.

42:27And so, you know, if you can just raise your Series A from a big brand name firm and then effectively not have to worry so much about raising subsequent rounds because you can just go back to them, like that's a really attractive value proposition. And I think it makes it really tough for, you know, the mid-sized Series A specialist funds, you know, like the$200 to$400 million Series A funds who maybe they can lead your A, but after that they can't and you're going to have to go out and find a new Series B investor And again, a new investor beyond that. So I completely agree with you that this bifurcation is definitely happening.

43:00And I think it's only going to get more pronounced. You're investing in these sub$50 million funds. Is there a pattern in terms of are they concentrated? Are they leading rounds? Are they collaborative? Distill what you see as best in class strategies. So we take a very GP centric approach to investing, meaning we focus a lot on the GP. And what I mean by this, and kind of going back to something you and I talked about earlier, this concept of like GP thesis fit or founder market fit, what works for one GP might not work for another GP and beyond. And so we want to back GPs where their strategy is really playing into their strengths.

43:36And that means sometimes we back very concentrated GPs where we think like they're exceptionally good at picking or engaging with founders and like they have to have a more concentrated portfolio. but sometimes we pick more diversified GPs where maybe they have really good network, really good deal flow, really good access. Maybe they're not as strong on the picking side. And so having a more diversified portfolio like allows them to like really take advantage of their network and their deal flow without having to make like even more concentrated bets. And we've seen both models really work out.

44:07We have a pretty eclectic portfolio where our managers look different from one another. Like we've got, so we have a lot of solo GPs in our portfolio we have one or two partnerships. We actually tend to prefer solo GPs. This is maybe a little counterintuitive to what a lot of other LPs think, but I think there's more risk in a partnership, actually. I've just seen so many partnerships blow up and I've seen so many partnerships formed out of convenience rather than out of a real reason to partner with someone. And if you're a solo GP, you don't have to worry about, you know, dealing with someone else and the psychology of that.

44:46And investing is such a business of biases. And I've, you know, I've seen in organizations where people become possessive about their investments and when people want to strike down other people's investments, because, you know, maybe that person has struck down one of your investments. And like, I think the decision making and staying power and underwritability in a solo GP is actually more attractive at the end of the day. And so we tend to focus a lot, a lot on those. But we're open to partnerships so long as there's a real reason for the partnership and we don't think there's a lot of risk there.

45:15What's one or two mistakes that you've made early on that you've since corrected? One thing that I've actually changed my mind on really over the course of my career, but more over the course of the past couple of years is, I used to think that having meaningful reserves in your portfolio was a really good way to increase exposure to the best names and like juicy returns even more. But I think it's really hard, at least what I've noticed and observed is a lot of pre-seed and seed managers, it's really hard for them to effectively deploy their reserves. And here's why. If you're a seed manager and you invest in the seed and maybe you have reserves to take you through the A, you know, series A companies still have a very high failure rate.

45:59And it's, you know, you often don't have a lot of time to gather a ton of new incremental information between a seed and a Series A or even a pre-seed or a seed, right? And so by the time you have to deploy those follow-on reserves, you're often doing it only with marginally incremental more information. And you're doing it at a materially higher valuation usually, right? And so I think reserves are actually really tough to be effectively deployed for pre-seed and seed funds. And I would almost rather those funds just buy up more ownership in the early days. And I can't tell you how many times I've talked to managers and asked them, like, if you went back and, you know, by the time this seed company raised at Series A, like, did you know which companies were going to break out or did you know which companies were going to fail?

46:45And oftentimes they say, you know what, we actually did it. Or the companies that we thought were really, you know, strung out of the gate ended up plateauing and stagnating. And the companies that were slower out of the gate ended up really ramping up. And so I do think reserves can be really effective, but I think they're more effective actually in the later stages. Like Founders Fund has been like exceptionally good at deploying reserves and doubling and tripling down, but that's because they can deploy massive reserves. And like the Series C and D and beyond, we're like, there's metrics, there's traction.

47:16You know which companies are already like really on that hockey stick trajectory. And so I've kind of come around and actually prefer our managers to have lower reserves, if that makes sense. It makes total sense. And it's very interesting that the managers are telling you that they may not know who the breakouts are because there's a very direct incentive for them not to say the opposite, to say, oh, yeah, we should have just let's double our fund size. We could have piled into these three. We knew for sure that these three were. But the fact that they're saying the opposite despite the incentive is a pretty strong signal.

47:48Yeah. And I think this is a tough thing that you need to try to figure out with managers. it's very easy for managers to retrofit a story and to say, oh, you know, we made this investment, like five years ago, we made that investment because we had this thesis on this thing that nobody else believed in. And we did it. And we knew that this company was, you know, going to break out and become a billion dollar company or$10 billion company. The reality is venture managers think every one of their companies could become a$10 billion company at the time they invest, right? But obviously not every company is going to be successful.

48:22Most actually aren't going to be. And I think what people don't realize is oftentimes it's not until much later when it becomes obvious that a company is going to be successful. This has been an absolute masterclass on down investing, fund of funds. What would you like our listeners to know about you, Pattern Venture? Is there anything else you'd like to share? The first thing I'd say is, Pattern, we're open for business. We're actively deploying. And so So we'd love to chat with any managers that are really high quality and raising. And we source through our network. We source through a data tool that we have.

48:51But we don't have a monopoly on sourcing. We don't believe anybody does. And so we're always happy to meet with folks that people really highly recommend. And the other thing is, I would just say, when we were building Pattern and how I've thought about being an LP over the course of my career is I've seen too many LPs that I think feel entitled or feel that GPs owe them something because we're giving them capital. And I just think this business needs more like true partnership. And I think like at the end of the day, these are marriages. These are really long-term relationships. They're two-way streets.

49:22And so I would just like encourage everybody listening to like really think deeply about partnership, both if you're an LP or a GP and recognize that like none of these relationships are one-way streets. And I think that's like something that we really hold near and dear to us here at Powder. Big purpose of this podcast is to tell the LP story in hopes of basically telling kind of both sides of the story so that there can be more empathy and relationship in the industry. Thank you, John. Look forward to sitting down in person very soon. Likewise, David. Thank you for having me. Thanks for listening to my conversation.

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