E293: Inside GEM: How a $12.5 Billion Platform Selects Outlier Funds

0:00So, Kate, you recently joined GEM, which is a$12.5 billion AUM platform to lead the venture effort. For those not familiar with GEM, tell me about the platform. GEM was founded in 2007, initially with the name Global Endowment Management. And its initial business, and really still the core business today, is as a leading, fully discretionary, outsourced chief investment officer, OCIO. Today, on that side of the business, we work with about 40 endowments and foundations and other small nonprofits. In more recent years, we've been partnering with a wider variety of LPs who want to leverage our research and our manager selection in more targeted ways across alternatives.

0:37And by that, I mean in fund or fund-to-fund formats. I want to get into some of your venture thesis in a bit. But first, you joined the UNC Endowment immediately after undergrad. What did you learn at the UNC Endowment? How does that translate to how you invest today as a venture manager? That first job opened up a career path that I didn't know existed, but came to really enjoy. I certainly didn't set out to become a career LP. Not sure if anyone really does. The truth is, I did not know what I wanted to do professionally after college. I had a lot of interests. I enjoyed a wide variety of subjects.

1:10I did well in all of them. I really took advantage of a true kind of liberal arts education, and I loved it. I was a generalist, if you will. So the investment office at UNC took a chance on hiring me. I was a history major. I was a clean slate when it came to finance and investing. So I did have a steep and long learning curve, and I was lucky to have a supportive mentor. I learned a lot about allocating capital, taking kind of that 30 ,000-foot view of the world, but I did work primarily on a team that was managing the endowment's private investment. A couple of things stuck with me throughout my career that I initially learned there.

1:46One was the importance of asking good questions, both of the managers we met and frankly, with my own mentor for learning purposes. This is a job that requires continuous learning. I also learned the importance of professional relationships and network, right? They build over time, they build off of each other and last a long time. It's really hard to place a value on that in the beginning, but it absolutely becomes an asset over time. After the endowment, I worked for two different fund-to-funds. And I think it was at those firms that I really learned what a good institutional due diligence process looks like, particularly the art of conducting reference calls.

2:22And I learned, importantly, how important and hard it can be to raise capital before you even go on to invest that capital. I think a lot of people will be surprised to hear UNC is arguably one of the most underrated endowments. I think they achieved a 12.6 % return in 2024. Being at the UNC endowment, you mentioned asking the right questions. What's the one or two best questions that you ask today from managers that helps you really focus your time on managers that could end up being interesting? I'm going to use the word that's probably one of the overused words in the industry, and that is differentiation.

2:55But it really does come down to figuring out why in land of venture, why a particular founder wants to partner with a venture investor. But founders have a lot of choice in today's market. There's no shortage of capital. There's no shortage of venture capitalists. And founders are very, very savvy, probably much more savvy today than they were a couple of decades ago. So they have a lot of choice. So it's incumbent upon the VC to sell themselves on why they should be the right partner for a venture investor. And then it's incumbent on the LPs to understand that dynamic and understand who the best founders are gravitating towards as their capital partners.

3:37So it does come down to differentiation and that can take a lot of different forms. It comes down to that value add capability and what venture investors can bring to the table to help founders build their business. You mentioned references. I'm sure you end up doing multiple dozen references per GP, but at which point do you get a really good sense? Let's say you have an 80 or 90 % confidence on that manager. Is this reference three, reference eight, reference 12? Give me a sense for how quickly you ascertain whether this is a manager that you really want to double click into. I don't know if it necessarily boils down to the number of references.

4:11What really moves us from a maybe to a high conviction yes is the quality of the references. I think the reality is most of the references that LPs do are good, right? If you're going down the list of listed references that a manager has provided, a potential LP, all of those references are going to be good. The craft of doing references comes down to the types of questions you're asking, of course, but also some pattern recognition such that you can differentiate between what's a good reference and what's a glowing reference. Obviously, references that we do that are off lists, right, where we're leveraging people in our own network, people that we trust, people that we think we will get a very candid, truthful answer to our questions.

4:54Those references carry probably more weight than do others, but founder references are important. But again, it comes down to, I think, asking the right questions and being able to recognize through doing so many of these over the years, which ones are good and which ones are outstanding. and that's a bit of a nuance and a bit of something that's hard to kind of describe and put into words, but you can recognize what a glowing reference is and not just a - What is that telltale sign? What are you looking for to know that something's a glowing reference versus a good reference? Because there's a game theory to this where no founder wants to speak poorly on the VC.

5:27Double click on how you really assess whether it's a glowing reference. Yeah, I mean, asking for anecdotes and very specific examples, understanding the dynamics of financings and the types of decisions founders make at various points in their capital raising journey to decide which partners to partner with. Seeing that a reference has made multiple introductions and referrals to whatever VC we're referencing, I think, carries a lot of weight. the detail with which they can speak about the relationship, can speak about how LVC has helped them, can speak about their personality and work style. I think it comes down to both the quality of the reference and the words used, but also the detail behind the reference.

6:15You can tell if a reference is positive at a very high level, but a reference that is very positive at a granular, detailed level, I think, pops out in our estimation. I've done some of the metadata is how long the person being interviewed actually speaks on the reference party, how long they talk about it, how glowing they, how much more they volunteer versus saying good or he was excellent or using these kind of generic words. I think the best references are often those where I don't ask many questions. And the person that I'm speaking to, they can't help but just go on and on and on about how wonderful the investor is.

6:55I do think it's important to ask very targeted and inappropriately timed questions in that conversation. But sometimes you don't have to ask much at all. You just get the full story. They just can't wait to tell you about the person you're referencing. And sometimes you're going to have to stop them so that you can get your questions in. They're a lot of fun. It's like it's one of the most fun parts of the job. I would argue it's really one of the main aspects that NLP could add alpha. References are kind of ground truth. Everything else kind of looks very, very undifferentiated to use your term, but references are one of those things where the truth really shines.

7:31You went early in your career from being an inch deep and a mile wide to today being an inch wide and a mile deep. How's that transition been? And what are the biggest trade-offs between those two ways of investing? As you said, at the UNC Endowment, I covered all private asset classes. So that's what I meant when I referenced an inch deep and a mile wide. I moved to a fund of funds focused on buyout and venture after that, where size was really the first screen. So I narrowed my investable universe based on size. And then most recently, prior to joining JAMA, I was with a fund of funds focused on venture.

8:09And honestly, you know, those doors, as I reflect in my career, those doors kind of opened for me in the right place at the right time. I've appreciated that opportunity to specialize over time to be kind of an inch wide and a mile deep. So now at GEM, I've in essence returned to my endowments roots in a sense, but I'm still specializing in ventures. It's a bit of a nice full circle moment for me. I've reflected along the way why I like my job as an LP, especially one focused on venture. You know, getting back to that liberal arts and education, Maybe it's kind of my well-rounded nature, but I am drawn to both the qualitative and the quantitative aspects of the job.

8:52Picking good partners, investing in venture funds is definitely part art and part science. There are a lot of human elements, right? Developing relationships and networks, evaluating the soft skills of investors, conducting reference calls, as we've talked about. If you're a people person, this is a great job for you. But there are also many measurable elements, right? evaluating track records, building models, dissecting strategies, researching markets and companies. If you're a person who loves data, who loves information and math, this is also the job for you. If you're intellectually curious, this is a great job.

9:25We get to talk to really smart, ambitious people every day. It's really a privilege. We're talking to founders, investors, other allocators. There's always another question to ask, always more to learn, always a new person to meet, another rock to turn over. Every day is different, but engaging in different ways. And then on the venture side, we have this front row seat to innovation, which is kind of a whole nother topic, but it makes the job a lot of fun. Double click on this fun math. It's one of these things everyone repeats as if it's an agreed principle, but many people have different philosophies.

9:58What's your philosophy when it comes to fun math? So yes, we are obsessed with fun math. When we reach a certain stage of diligence with a manager we're excited about, we build our own model, which we call the what you need to believe model. So essentially, we've developed some internal metrics and a framework to evaluate a fund's size relative to the number of positions in the fund, relative to the ownership targets, and then importantly, the reserve strategy. So how much capital is going in at that first check versus later stages at, of course, higher, or what we hope to be higher evaluations.

10:34We want to see, assuming a realistic range of outcomes, a path to 5X. And this is, you know, particular with, particularly when we're evaluating small early stage funds, oftentimes seed stage funds. We want to see how many single deal outcomes are needed to return the fund. We want to see how much market cap creation is needed to return multiples of the fund. This is so we don't have to have heroic assumptions. And that's what I meant when I said we don't have to squint to see a realistic path to a 5x fund. It helps us compare small funds that have different strategies and maybe different portfolio constructions of their own.

11:16It helps us compare apples to oranges, so to speak, in the industry. And it's important because we view, we assess hundreds of managers every year. Many of them have similar portfolio construction and philosophies, but there's always nuances and differences. So this gives us a framework to compare different funds against a similar set of metrics. One of the hardest things of investing is seeing what's shifting before everyone else does. For decades, only the largest hedge funds could afford extensive channel research programs to spot inflection points before earnings and to stay ahead of consensus.

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13:02And one of the things that's perplexed me for years is this idea that you have to have a certain amount of the company versus having a certain amount of shots on goal. It seems like they should equal out. So five investments of$10 million should equal 10 investments of$5 million. Does that not just come down to evaluation and entry point? Is that what people are solving around? And why is there this idea that each single check has to return the fund? Where does this theory come from? If you think of venture, right, you're investing in very young companies and startups. Not all of them are going to become winners, right?

13:39Like venture is an asset class of many losses and fewer wins. So we expect a relative high loss ratio in venture funds. We track graduation rates as an interim predictor of performance, but at the end of the day, we care less about the loss ratios and more about portfolio exposure to those outsized winners. VC is obviously driven by power laws, right? Only a few companies each year drive returns in the industry and in our portfolio. So it's our job to pick the managers that we think can identify and lean into those outliers. to capture those outliers is a non-negotiable for larger funds in order to produce strong returns.

14:20But the reality is not every VC is going to have a power law company in its portfolio. That's just a reality given the relatively small number of power law companies there are relative to the number of venture funds and capital being deployed in venture. So if your fund is not sized appropriately, if your ownership targets are not appropriate for that size, you run the risk of of underperforming. And that's why venture funds have this really broad skew of returns. And then there's always this luck factor, right? There's always a little bit of good luck that accompanies the best portfolio construction and the good skill of any manager.

14:53Can a fund get to a 5x without a power law outcome? And is that what you're looking for, which is if this fund manager is not lucky, can he or she get to a 5x? I think a 5x is achievable without one of these power law companies in your portfolio. if you're a small fund. It's much harder to do that with a multi-billion dollar fund. And that, you know, maybe that is leading us into a discussion about this bifurcation we've seen in the industry. I'm happy to talk more about that. Yeah, let's talk about that. You look at venture almost as two different asset classes, which is these small funds and these multi-stage funds.

15:32One is, when did you start looking at venture in that manner? And how do you see it today? In our last conversation, I think we talked about this idea that there's two games on the field today. There's the access game in venture. There's the discovery game in venture. I think there's been an element of that dichotomy all along. But it was really in sort of the 2018, 19, 20, 21 period when we saw fund sizes escalate, when we saw this distinction in the market between sort of the haves and the haves not. So the market in more recent years has clearly bifurcated with more established, multi-stage brands at one end and a seemingly endless number of smaller, newer, early stage managers at the other.

16:19Our view is there will continue to be firms in that first group that will have a structural and competitive advantage going forward. Those advantages, I think, are in place because of the firm's reputations, their platforms, and really their scale. It's not rocket science, though, to know who these firms are. The challenge is access. Gem is privileged to work with, and we include a number of these firms in our portfolio. But these funds are larger. They are multi-stage. And they may not have the right tail skew that LPs want to see in their venture portfolios. Maybe they will if this idea that we're having trillion-dollar private companies, if that is a new norm, maybe those larger multi-stage funds will have that potential for right tail skew.

17:06But if LPs want smaller, early-stage funds in the portfolio, that opportunity is large, right? that part of the market is really hard to navigate given the sheer number of managers, many of them new and still emerging. It's crowded. It's hard to separate the signal from the noise. As I said, our team alone has reviewed hundreds of venture funds this year alone. Our framework at GEM is rather simple. We evaluate a venture investor's ability to source, to pick, and to win. I think it's much harder in practice to unpack those questions. GEM is uniquely positioned to execute well and try to answer those questions given a few things.

17:45We've got a lot of good resources. We're a high-functioning team that includes a dedicated sourcing team. So maybe we... Yeah, tell me about that. So you guys, and it seems like it would be obvious that most LPs would have this, but you guys are quite different that you have a sourcing team that's separate from the investment team. Tell me about the function of that and what should somebody that wants to build a sourcing team, what's some best practices? So today we have a three-person sourcing team, which we think is absolutely differentiated and a competitive advantage. I've referenced that the market is crowded and it does feel that way.

18:20So good information helps us to cut through the noise quickly. So the sourcing team, I mean, their mandate is to know about which funds are raising when, which VC is spinning out or leaving to set up their own firm, which firms other LPs think highly of. And look, we at John, we like to back managers early. That's kind of been part of our DNA and part of our track record across asset classes since the beginning. We like, you know, those emerging type of managers because earlier in their life cycle, because they're hungry, they're motivated. They're aligned with LPs, they're managing smaller pools of capital.

18:58We are eager and comfortable discovering those managers before other LPs maybe realize their potential and before it's maybe obvious to the broader market. But that takes a lot of hunting. It takes a lot of screening. And in order to have a good picture of the market opportunity, we like to know and see everything in the market. But that takes time. It takes resources. It takes people. And we have invested in those people in order to make sure that we are seeing anything and everything and to help us make the best decisions. You evaluate your GPs on sourcing, picking, and winning. As an LP, what is the one part of sourcing, picking, and winning that is most important to being an elite investor?

19:41it's hard to boil it down but but i will say you know before you can pick before you can win you need to see the opportunities you need to source so so one enables the other two sourcing um again it's one of these easy questions to ask and easy questions to answer but really unpacking how a vc is meeting founders um what what are their network nodes how are those network nodes different from other investors? Why are founders coming to them first or early? You develop this picture, this narrative around sourcing. And I think it truly is something that can set apart a good investor from a great investor.

20:27Again, just to play devil's advocate, I would argue that GPs have to win hyper-competitive deals. Oftentimes, they're the lead or the second position. There's only so many investors in a round. In LP, it seems like there's room for multiple winners. When you want more, you start your business with Northwest Registered Agent. They give you access to thousands of free guides, tools, and legal forms to help you launch and protect your business all in one place. With Northwest, you're not just forming an LLC, you're building your complete business identity. From what customers see to what they don't see, like operating agreements, meeting minutes, and compliance paperwork, you get more privacy, more guidance, and more free resources to grow the right way.

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21:36And with Northwest, privacy is automatic. They never sell your data because privacy by default is their pledge. Don't pay hundreds or thousands of dollars for what you could get from Northwest for free. Visit northwestregisteredagent.com slash invest free and start using free resources to build something amazing. Get more with Northwest Registered Agent at northwestregisteredagent.com slash invest free. so does that change the dynamic of what it takes to be an elite lp and that you're not always you don't have to have as sharp elbows and there's a different game to it right than than being a great gp both have an access uh component that's i think important um i think being being an elite lp yeah you have to be good at the access but you have to be good at the discovery piece too and And look, it's hard, I think, to be like a value-added LP, right, to our GPs.

22:35Like one, your relationships and your portfolio and your performance kind of can speak for itself. But those are very long feedback loops. Like we've talked about before that how venture is a very patient asset class. It takes a long time to know whether your decision to back a manager, your conviction in a manager is actually a great decision, right? I question this. There's this meme that you don't know until year 10, if you're a good GP, and it's something everyone repeats. And there's a lot of wisdom to that frame of thinking, like you have to play the long game. But I actually question that where to me, it could end up being absurd if taken to the extreme.

23:12You invest in a seed company at$10 million, it's now$10 billion Series F. Yes, technically, you haven't sold any shares. And technically, it's only on paper 1000x or whatever. Isn't that a, especially if you have multiple companies like that, isn't that a, clearly you're skillful in picking, even if you haven't had liquidity. So I think there's almost this, this dogmatic view that unless you have literally returned cash, it's impossible to know whether somebody's good. Isn't there a little bit of an overcorrection on that theory? Yes, yes. I was, yes, there are obviously other signs and signals along the way, along the, the paths of a, of a company to try to determine if an investor is, is, is a good picker.

23:51You're invested and you're now two years in. What's a sign? Like, I hit it out of the park. This is going to be a home run manager versus maybe the opposite, which is I made a mistake. Yeah, I think an early signal could be one graduation rates, right? There's good information and data in the market about sort of average graduation rates. So you can track your underlying portfolio's progress in terms of graduation rates from C to A, from A to B. So that's one signal. I think the more important signal for us is who are the follow-on investors? What are the best seed managers that Series A investors are tracking and investing in their portfolios, right?

24:29The quality of the follow-on investors by firm, but also by partner, I think is a great signal. if a follow-on round is led by a firm that nobody has heard of and that maybe doesn't bring any strategic value to the table, that maybe makes us question the progress of that VC and the importance of that company in a portfolio. So I think there are signals related to follow-on capital that you can monitor and assess along the way. But look, over the last couple of years, DPI has been this kind of elusive metric for LPs. As a patient, long duration asset class, we are signing up for an instrument that returns capital on the back end of an investment.

25:19With a lackluster IPO environment in the last couple of years, LPs have struggled and have been lacking meaningful distributions from their portfolios, especially relative to 2021. 2021 was such an outlier. It sort of set people's expectations at probably too high of a level. In the absence of distributions, which have certainly been more absent in the past couple of years, there are good signals in terms of, like we said, follow-on capital, graduation rates, where things are trading in the secondary market. I think that's a meaningful and good representative of progress of a company, demand for a company in the secondary market.