E235: The First Thing LPs Notice That GPs Never Think About

0:00When people ask me why I'm so interested in investing, the best way I explain it is the infinite game of investing. I think that's incredibly well said. And one of the things I've heard other people say, but the more I learn, the less I know. When I started my investment for you, I remember thinking I knew how to invest. I knew how to pick stock. And I thought I was very free that I knew nothing about stuff. And then after Warden Creek, I had such a great experience there. I knew the appropriate and only way to invest for institutions and even for families on the foundation. And it took me a couple of career goals and the life goals to disrupt how much I have learned, but how little I know.

0:48Alex, you've had a storied career going from Army to Morgan Creek to J.P. Morgan to Cleveland Clinic to Aberdeen, oftentimes starting groups at these allocators. So let's start with Morgan Creek. So you started there in 2005. What was your experience like at Morgan Creek? uh learned it was just such an excellent place to start as an analyst and i didn't know that i didn't know going into it that i was going to have this amazing experience it was a new investment team our new investment firm really the university of north carolina of chapel hill had hired mark years ago from Notre Dame. He was a senior investor at Notre Dame.

1:33He joined as the first CIO for UNC Chapel Hill of the UMP system in 1998. And then from 1998 until 2004, the UNC endowment was one of the best performing endowments nationwide. And a large part of that was a reflection of the investment philosophy that Mark and to Joel Mars Alley while at UNC. He wanted to do something bigger. He wanted to build something bigger. So at 04, he took the investment team with him and started working brief, capital management, and he brought this endowment model to the Oceano world, which today is quite ubiquitous. But over 20 years ago, these were really just buzzwords that no one really learned of it for.

2:22So the fact that I was able to start with such a high-quality team that had such a sophisticated way of talking about the world and investing was really just fortuitous. The real focus of the portfolio and the management, and this was a little bit different than others, was Mark and his co-founders, a guy named Dutch Kiper, came from Wellington, the COO, slash COO, and Dennis Minor, who were the sales cad that brought relationships to help found the firm. The real focus that they recognized was that holistic management of investment assets. So the fact that I got to join, you know, be a part of that and be a part of a team that was focusing on total portfolio mobile, focusing on it on a sophisticated way.

3:16As you mentioned, David Twenton, I just wrote the book on the modern endowment style. And Mark Yusko at UNC was starting to invest into asset classes like venture and then offering that in Morgan Creek. as Morgan Creek went from zero to 10 billion in assets, what were the characteristics of the early adopter LPs that embraced the Morgan Creek model? And how does that relate to LPs today that embrace trends early? What are the psychographic characteristics of those type of LPs? The first thing I'd say is, well, you mentioned this, and this was really what it was like, that the book Pioneering Portfolio Management had just come out just a couple years ago and it's not like today where people on Twitter on TikTok or subback, podcast, none of that existed and so a lot on the sharing of these investment philosophies and then also sharing of investment revolts you went to Yale, you were in the endowment community i remember back then i'm in kubo used to put out an annual report are the performance of most patients and if you were in an endowment you could see the list of how every institution did one by one and you could see at the very top you know harvard jack meyer harvard dammit sletton at yale uh the folks who voted i mean it was just most consistent don't know the pop.

4:52And so that philosophy, that endowment model philosophy that David Svankin has found and that we were Greek as found as well, that was something new. But there was another piece of the puzzle that Mark Dennis on Dutch realized early on. And that was that a lot of ultra high network individuals and families and volist institutions below a billion dollars were receiving piecemeal solutions from consultants, from banks, from Biden. It was, you know, they might have, I think, someone with equity, someone else with every annual folks' income, someone else that may have helped them with alternatives generally.

5:36But there was nobody 25 years ago that was thinking about a total portfolio solution and thinking about the necessity of a spending policy that reflects the spending needs of the individual institution as well as the liquidity availability of the underlying assets. If you're thinking of a multi-asset class approach that includes exposure to deep private assets that will not be liquid or semi-liquid assets like some absolute return funds. And so putting that all together into one solution is something back then, you know, sophisticated endowments, the other institutional would do. If you were under a billion dollars, didn't have your own investment office, you really didn't have that holistic viewpoint.

6:23And so that, you know, which was brought for the Morgan Tree clients ranging from 20, I think the smallest client on the team's asset sheet was$25 billion. I think the largest individual client was one billion. most were around 250 to 500 million assholes so bringing that kind of holistic view as well as and this was something people talk about today a lot back then was still kind of new forward thinking about access to high quality managers or differentiated philosophical view so something that david talked about in his book that a lot of sophisticated investors talk about today, it is the view philosophically that if an investment manager is down performance-wise, that may be the best time to invest.

7:14And today, a lot of people know that a lot of people have heard this. Well, 45 years ago, 20 years ago, that was still very controversial. And a lot of performance, we call it performance chasing, people trying to buy last year's oil. So that view and implementation of a holistic portfolio solution, recognizing that sometimes it's best to invest when a manager is down. That was new back then. One of the best times to invest might be when a manager is down. Presumably that's because the entire market is down. The manager might have not made a mistake. It's just the nature of cyclical markets. And you also mentioned about separating sustainable returns or alpha versus beta.

8:03Alpha is somewhat intuitive. You might have structural alpha, you might have proprietary sourcing, you might have a special right to win. What are some hidden ways that managers advertise beta in a way that maybe they mask it in a way that maybe it looks like alpha, but it's actually high beta risk? How do you know when a manager is actually masking a high beta strategy? It's an excellent question. The first thing I'd point out, and this is something that seems to be systemic within the allocator community. I've seen it my whole career. I still see it to this day. When you look at pitch decks for managers, and when you look at the other side of a pitch You look at the holistic performance report or risk report or something presents you to an investment committee from the allocating side.

8:59So from the GP side about how that fund is built. And then from the out-of-the-side, when they're reporting to the investment committee or they're reporting publicly, something always jumps out. and that's a lot of statistics around risk for performance evaluation are focused. We'll have a number in there that just starts to fade on. And so you'll see something when people will talk about, oh, our beta or the beta plug is 0.6 or 0.7. There are cases in my career where we focused on a number where we wanted to have a beta closure of X or a given type of manager. but data from cap M is just a starting point and when Fama and French did the three factor model and then the five factor model well if you had the five factor model from Fama and French cap M is the beginning part of it and the worst part of it is beta which is just the factor exposure to the market problem is a lot of allocators to this game do not do factor exposure work beyond it because beta is a factor where it's normal, the largest back-edge, but even.

10:10And moving beyond that takes a little bit of quantitative and qualitative work. So in large part, a lot of funds have been able to kind of get away with it because they are reporting a true number, and they're just talking about the other number as much. For those that don't know, Fama French improved on the capital asset pricing model, CAPM, And they found that there was additional factors like whether the security, whether the company was small or large and whether it was value or growth. So they found other ways to more efficiently price the historic returns versus just the beta of the stock.

10:51So by adding those other factors, you're able to more effectively price whether it's actually beta exposure, which is maybe it's a smaller value kind of investment versus where it's two alpha, where it's out performance for the same risk and return. absolutely on that um that's something that i find to this day uh one of the first analytics we always run i mean at least for the last decade or so and just run them through a farm effects by tactic model see what you do um they're probably the easiest thing to do with the easiest way to kind of stop that out the thing where it gets tricky i've discovered impact for equity law only, equity law short, credit wealth value, if it's relatively easy to come up with a useful faster model to assess whether a manager is adding, number one, whether they're adding alpha, number two, will apply to the consistency of the factor exposure that they have, number three, whether you have any interest in you attempting to replicate those factor exposures.

11:56If they're only giving you a beta at the certain factor exposures, maybe that's the kind of beta that you want. The tough thing is, in my career, for macro managers, so like the bridgewaters of a world for example, coming up with a good background model to explain what very sophisticated macro managers like that are doing has always been important. Going back to the asset allocators that embraced this new Yale model in the mid-2000s and other forward-thinking LPs, what are some characteristics of either the institution or the individuals that are first movers in new strategies? One thing I always loved when sitting on the allocator side of the table is that allocators don't see other allocators as competitors.

12:50So they're very open to sharing information, very open to seeing processes, sharing about funds, learning about strategies. Something that when I was working on Wall Street could get you fired. You follow the competitor up, even if it was someone you knew, and after what they were working on. For the ones that are able to kind of leap forward in terms of their investment focus and hopefully a blow on their investment outcome, it's really two separate things. So, number one, and this is the first part, not as exciting, but it is useful, is operationalization of e-pots of seeds that allow the investment team to focus on and on goals.

13:39For a lot of times, actually in my career, I used to go to a lot of times you'll have young analysts or member-based investment teams focused on what we call an ETL process. extract, transform, and models. So they're extracting data from different sources. They're transforming it into a way that can be viewed by others when they're loading models with others with them. So a lot of Excel came up, a lot of PowerPoint, a lot of PDFs that they email out, they want to find it out. And all of that worked. We always said, later in my career, if this is, if the task that we're doing is something we could hire a high school student to do, then we should not be doing it.

14:20This is just a time and time to the task that doesn't really add value and it's not worth upscrolling it. People, the real focus on the investment team, the real value add is analysis. Analysis of the investment, analysis of markets, analysis of the portfolio, everything focused on the analysis and the decision about how to implement analysis. So the second thing, so the first is really operationalizing classitude. The second is focusing on, and I hate to use this term because people of Egypt are so long, but I think it's appropriate, is focus on where the market is going to be, not where they're going to be.

14:59So having a good sense on where the markets are moving to or seeing, in some places, virtually seeing, you know, some things rule their very slow rate. Where markets and therefore where portfolios are going to go as one easy variable in phase. Interrate just dropped by 0.5%. Well, most people have a very good sense with the change from the operating framework, unlike the FOMC, that will probably continue downward without interest. And so it may not be as fast as people expect, unless they're the catalyst that will move up the end of the election, and being ahead of the expected drop in interest rates is better than being behind.

15:46that's that's really the two and that's that can be almost the toughest of investing and thinking about the portfolio in the future state and where you want it to be an airport trying to invest there knowing and this is the other part it's kind of cliche but it still exists and it's still part of our careers so we have to acknowledge it is that if you invest in a differentiated fashion from others, and you're right, well, people might just think you got lucky. People may not recognize that you took, well, a well-populated risk for the definite of a portfolio. If you take the differentiated view and the implementation of your portfolio and you're wrong, well, then you might not have a failure.

16:33And that's very difficult. And so the default, the Nash equilibrium outcome from that bite bone world career optionality is that many investors then tend to fall back to, you know, where are the consultants signed off on? And that means you still have decent returns for the portfolio, but that you'll be in the middle of the path relative to fears or relative to the affected outcome that you need. Given the inflation environment and the increased spending with the portfolio, So, and as well, this is a concurrent thing that is happening more and more so these days when I ever seen my entire school, the much lower rate of distributions on private asset proponents, which for grant making salvations or pension plans or endowments with pennies, you know, that actually would shut them up.

17:30So having a forward-looking thing move part in your portfolio with the implementation and processes. And separately, the first thing I mentioned, having an operationalized process where you can focus on analysis versus data. That's a way that teams can really work. You mentioned that the top allocators don't see other allocators as competition. Explain that. How do the top allocators collaborate with other allocators? Give me very specific use cases. I was very fortunate in my career to work on Wall Street and work in the allocated community. So I got the students on both sides of the state. When I was working on Wall Street, if I had called, well, while I was at the office, I'm expecting it.

18:18I was one of the office. If I had called a friend, I mean, one of the things, and asked them, well, what do they think about the markets? Well, how are they? what funds did they like? What tool did they use? I would have found it if. In contrast, what I experienced when working on the Alicator, I'll give you a specific example of it because I'm so proud of it, is that you could always call your fuse. And if you didn't know them, if you wanted to reach out to your Alicator, you had no connection. You're not connected on LinkedIn. in, you've never met this person, but I saw, you know, hey, this institution was in a recent magazine article doing something really important to keep in the value.

19:07They've implemented Top AX, which is talking about now. I don't know if you should call it. You can just leave that in with an A. Well, not to pick your brain about how you guys capture this. About sets, how you guys are implementing, I've done that. It doesn't have done this one. I'll give you one specific example that I think every alligator from Inflang. It was phenomenal. I was so glad to be a part of it. I was part of the Cleveland-Pittsburgh-Allocated Group. This was a non-profit volunteer group led by Alex David. And once a quarter, we would get together in first room at somebody's office.

19:44So we'd hang very long. And before the meeting, we would send around a template. Well, I was the president of this group for two years, so I was well-ordered. we would send that around at Suncliffe where allocators would put their portfolio and they could put in the actual names of the managers or they could put in just some code they were comfortable with that and you would put in your exposure sign either download or something we could put a good sign so this little group would maybe$25 ,000 and achieve them and then we would get together one supporter and we would sit around the big conference table one by one we would just talk talk about if you're a DB pension plan if you're thinking about doing a PRT a pension list and maybe you are maybe you were thinking about it maybe it happened if you're an endowment and you got a new spending policy that went into the policy behind which you guys decided to go through that process and how is that going advocates who do investment committee.

20:53If someone's investing in a new asset class or a new country or they're going to visit some country, we would like to know, hey, do we know any managers in India? You know, people would raise their hand. Yeah, I'd talk to about that. We would do that for about two hours, and it was a closed-door session, allocators only, you know, Chatham House rules, but nothing said in the room, could leave the room. And then we would invite a GP to come by for lunch. And the GP, although well ahead of time, they were going to be there. They'd come in for lunch. You'd open the door. GP would come in. We'd have lunch delivered, paid for by the GP.

21:32So our GP would spend $300 on lunch. And over lunch, for about an hour, the GP was allowed to talk about whatever they wanted to talk about. It was always something interesting for the Alex. I remember Goldman Sachs came in one time, wanted to talk about private credit, had a really great discussion, learned a lot with them. Goldman Sachs loved it because they had an opportunity to meet with a lot of allocators in one space, and it was kind of a friendly space. And then after lunch, we all went home. So this was something we did once a quarter, all volunteer-led, no cost to the institution, but it was a way for our little group of allocators to get together, share information, share best practices.

22:14It was a really unique opportunity, really unique group. And it was really reflective of the fact that for allocators, you know, we weren't trying to sell each other anything or require a school for other information or employees. We were trying to share best practices so that we could all, you know, all state provided better out for the beneficiaries of the capital with those people in the past at the moment. perhaps this is obvious but the reason allocators are willing to trade information with each other is because most of the new trends and most of the top managers are not capital constrained in other words it's truly not a zero-sum game whereas let's say venture gps at the series a may not be as willing to share deal flow because there could only be one winners in that space is that basically what it comes down to, or is there more dynamic to it?

23:04No, Dave, that's a phenomenal point. And I'll give you just a quick soundbite on that part, because this would come out. Sitting around that table or talking with their allocators, and for the most part, yeah, you're exactly right. Almost every asset class was not controlled in terms of we invested and they invested. Actually, that's better for us. That really helps. We're on the same, we're locking our arms together. The one place where that may not be true is actually related to what you just said. If our institution has a relationship with XYZ Venture Capital Fund, and we just got an allocation to XYZ Fund 7, well, that's great for us.

23:50But us having that allocation is not reflective of us shoehorning out other folks. it's really a rough question especially for the very hard to access venture capital funds building long term relationships with those firms seeing them and them seeing us as long term partners and investors and what they're global and what we're investing in and that does not impune on the ability for other allocated global around the country to also have built relationships or created both those rules so it's usually this kind of separate thing where we're comfortable saying yes we're invested in this liquid asset class this liquid on the period that's the two that's great and acknowledging you know hey yes we did get an allocation to x y meme vector on seven you guys may not have invested or gotten an allocation but that's not because we did you know because we spent a long time building that relationship happy to introduce you to this tuning but you guys are just meeting So it's a really different kind of world.

24:56And it's very nice when you're on the allocator side of the table. People are very friendly. Everyone always says like, oh, what a great question. Managing risk for your business may be complicated, but your relationship with your insurance broker doesn't have to be. NFP and Aon Company can help you navigate insurance markets and negotiate with carriers to build the right coverage for your business, helping you turn your risks into leverage. NFP's advisors are total business partners who help you protect your business and connect you with solutions to your toughest financial and workforce challenges.

25:27Whether your goal is to manage risk more effectively, attract top talent, empower your workforce, or grow your legacy, NFP is ready to help you succeed. Visit nfp.com slash how I invest today to unlock your full potential. Andy Golden, who used to run PrintCo, he told me one of the reasons he retired is he wanted to see whether he was really that funny or whether it was tons of billions of dollars behind him. and perhaps this is naive on my side or maybe too direct but whenever i find myself in zero sum games i'm just explicit about it you know i'm trying to partner with this manager i'm deploying in and you know this is maybe not the best time maybe in the future there'll be future allocation and if it's non-zero sum i'm happy to make that introduction what do you think about this perspective of being kind of extremely explicit on where you could be helpful where you can't versus kind of making excuses.

26:19Yeah, that's such a really great point. I believe the one thing, and this does come up, this did come up in Mike's career. I have seen this where, well, if we are in a best form, if we are an investor in a fund, especially a private fund, well, for the most part, comfortable sharing that with other allocators talking about it, you know, we've really discreetly without publishing this on a website. so similar. Sometimes it would happen, though, where we're evaluating funds. We're looking at investing in certain types of fundings. And so we need to keep that discreet. Either discreet because, you know, we know, hey, this is a new fund.

27:02They're only taking a certain number of clients. And, well, we're one of a few that's a positive because of legacy relations falls. Well, you know, we really value that and we don't want to share that up with it. So we're not going to share that publicly and we're not going to put it in people's face like, hey, we got an access to this fund. You haven't even heard of it yet. So it's really a matter of just trying to be respectful, professional, and polite and open where you can be. The other piece about that too is a reflection of the culture of the institution and a reflection of the culture of the senior leadership on the investment team.

27:40So I'm just fortunate that the leaders that I work with in the allocated community were very open to sharing, very open to meetings. Some allocators I heard don't really take a lot in meetings. Your portfolio is home or don't call you up thinking. Whereas places that I worked are very fortunate because with my personal policy, well, hey, it's someone from the town. If we have time, you can eat with them. We'll be up for the work they will not. It's really, I think of the allocated community, the community of discretion where necessary, but trying to be polite and priming because this is a wall of a wall of a game.

28:20And the allocated community of bad discover is a very small wall. Everybody knows everybody. And if not in your first line connection, you're all one, usually maybe two, usually just one connection. What do we talk about? Well, most people are very polite and flexible application. Otherwise, they don't really work for a whole lot. You mentioned that as an allocator, you always wanted to go where the puck is going. So let's say you had a thesis on GP stakes 10 years ago when Dial was just getting started. Assuming that you can't invest in a brand new asset class, how do you operationalize digging into the asset class?

29:04And what are those steps for an allocator either getting into a new asset class or getting into either getting into an asset class that the allocator had previously not been in? So perhaps they're now getting into venture capital or getting into an asset class that's brand new or that's really risen in the last couple of years. That's a great question. And at the first, and this is where being on the allocator side of the table, you're very lucky in this regard. That if you're encountering a new asset class that you haven't invested with before or not been coming asset class. So thanks for credit for the last 10 years.

29:45In fact, the last few years has been a little hot. One thing that you're able to do easily is call every GP and ask to get smarted. so you will call the big banks about J.K. Morgan and Goldman Sachs asking to fly to wherever you are if you're in Battle Creek, Michigan or St. Louis, Missouri they will all fly up to come see you and you can ask and we've done this many times we just want to get smart on this asset finance and every big bank every consulting firm they get paid on not just the friendly meeting but on the execution something after the time a lot of times the execution can only start the initial process of education and so you reaching out and asking for that education while people all and over at BISP provide it for you so you have this opportunity from the investment managers alone and you can get locked up with perspectives because they know you're just entering the dating pool and you're trying to see which type of fund you'd like to swipe right on.

30:55The second thing that you can do is talk to, like I mentioned, when they leave one Pittsburgh allocated, talk to other allocators. So reach out. Reach out first to your WARN network and ask like, hey, has anyone invested in this specific fund, this specific asset platform? You may already know this, but it's a very quick turnaround. You know, within the next day, you'll have a response. You know, oh, we haven't, but you could talk to these guys. This team over here, she has the new CIO brought this strategy to the table. So she'd be a great person to speak with. And you can get them on the phone, even if you don't know them.

31:36You just send them an email. Hey, we're an allocator. We're looking for a better strategy. We heard great things from someone else. We gave you a friend. We'd love to talk to you about it. So within just a day or two, you can have set up a bunch of calls with other allocators. We'll find out and learn more. And then the final part, if they're getting closer and closer to thinking about investing in a new type of fund, new type of asset class, well, specific fund, meeting with them. And one thing that's happened, especially in the COVID era, is that a lot of meetings, a lot of initial meetings, especially, take place over Xeon or over Teams types of calls.

32:17one thing we always like to do where i came from you might have that first call just kind of get to know people just kind of level set like okay is this something you know what's eating about but then go see them go she cans go see the office going person a lot of these funds are in major metropolitan areas and there's always an excuse to get new york city to boston philadelphia to chicago los angeles we're following other allocators other funds that you can see around than that. And if you can make a good day of it, then you can make it worth it. Meaning, you don't have to have all of your meetings over Zoom and go shake hands to get to know people.