E294: Endowment Model vs Total Portfolio Approach: The Real Trade-Offs

0:01What is the simplest way to explain New Republic Partners and what problem did you see in the ecosystem that you wanted to go after? For New Republic Partners, we are a multifamily office founded by a group of seasoned investment professionals and two prominent multigenerational families here in the Southeast. And really our aim is to offer clients the expertise, the resources and scale of a multibillion dollar family office. And we started that multifamily office because there was a shared appreciation of the advantages of an MFO between the founding team and those two families where we could offer customization, minimize conflicts of interest, and also attract some top tier professionals.

0:42while maintaining and getting that scale that's necessary to access institutional quality investment opportunities and have a deeply resourced team and infrastructure, which we didn't think at the time was in the industry, where if it was out there, I think we would have sought it as a single family office and we sought to create it at New Republic. Give me a sense for where New Republic Partners sits today at an AUM level. So New Republic today sits at about two and a half billion in assets under management. Two-thirds of that is discretionary and mandate, a third non-discretionary. And as a firm, we're headquartered in Charlotte with offices across the southeast.

1:20We have 27 employees as a firm today. You said you wanted to minimize conflicts. In what ways are other multifamily offices conflicted? Talk to me about that. So for MFOs or RIAs more broadly, we're seeking to stand apart from the mix by being open architecture in our investment platform. We don't have proprietary products or vehicles that I'm incented to put a client's portfolio or family's portfolio in. I just think, we just think it's a tough argument to hold to say that you believe you have the best growth equity or stock picker in-house. And therefore, we should have our clients' growth equity or U.S.

1:56equity allocation only go through those managers. That's just a tough argument to make. And so our platform is open architecture, open scope, such that we are seeking, searching for the best managers and to get the best execution and talent in a particular asset class or sub-asset class. Sounds simple, but not easy. You say open architecture. Does that mean that any of your clients can send you a fund and say due diligence on this fund? What does that practically mean? If you think about how we look at kind of the pipeline investments, we're trying to keep the top of the funnel as wide as possible.

2:28And so, yes, we're open in the sense that we would be doing searches in a particular asset class to kind of fill the top of that funnel. Also, it would be the case if our clients or families had brought us different managers that they had seen, we would be looking at doing the diligence on those managers too. So completely open scope in that regard and really trying to aim and find those great managers within specific sub-asset classes and broader asset classes. Maybe you could walk me through a case study of a$200 million family comes to you or a small foundation. How would you go about building their portfolio?

3:04With each family, we design portfolios that match that family's risk tolerance. It also aligns with their investment time horizon, income, and liquidity needs. Because as you've heard, if you've met one family office, you've met one family office. All can look very different based on how their capital base was built and their journey when exiting the family business and moving into a family office format. So after establishing those risk, liquidity, income, and time horizon parameters, the cleanest way I can bridge to a model portfolio construction for that family is to think about their investment portfolio really in three shades.

3:39Growth assets, your income assets, and diversification assets. And when I talk about growth assets, that's the span of liquidity within that bucket. You have global equities, long-only equity on one side, and then private equity venture on the other. And then even in the interim, you have hedged equity, which we view as an asset class unto itself. Within income assets, you have traditional fixed income on one end all the way to private credit. And then diversification assets, it includes real assets and absolute return hedge funds because it's meant to act like a counterbalance to the other two pieces of the portfolio.

4:13So, you know, let's say putting it all together for that family that has a payout need of three to 5 % and a risk tolerance that matches up with a 60-40 stock bond benchmark, you would end up having 65 % in growth assets, 20 % in income assets, and about 15 % in diversification assets. And on a look through basis, you know, that private allocation would be in the zip code of 15 to 20 % of the total portfolio. So in our view, that's the construct that we would have in order to meet what is the core needs of that family to deliver strong risk-adjusted returns that exceeds that spend rate or that payout that they might have plus inflation.

4:52And how we would think on and translate for them how we think about putting together that model portfolio construction for a family. What's the most common mistakes that other multifamily offices make? And what are some misnomers that you see and some errors being committed all the time? Mischaracterizing certain assets and expecting an outcome that, you know, historically, you would think act in a more diversified way than it does. And so let me put an example on it. One aspect that people have always tended to lean on just because of the recent history over the past, call it even 20 years or so, that if you just had a more traditional portfolio of 60, 40 or 70, 30 stocks and bonds, there's an expectation that that fixed income component of your portfolio can act like a diversifier when the equity side of your portfolio kind of falls out of bed in tough market periods.

5:48call it in the GFC or even more recently in 2022, even back in COVID as well. And I think the argument that we've been pressing is for people to think about that fixed income, that income asset side of portfolio a bit differently, because the aspects about having both income coming from your traditional fixed income and diversification, don't believe that those elements will persist going forward or there's no guarantee of that. And so that's why we dedicate a piece of a client's portfolio to diversification assets. Because in a period like 2022, you had stocks down mid-teens and you had fixed income down mid-teens as well.

6:28And you needed that ballast in your portfolio, those diversification assets to show up for you and also give you a place where you could draw from to kind of take advantage of different opportunities and be opportunistic with that capital during that timeframe. rain. And so I'd say that's one area where I'd say from a construction standpoint, I think family offices need to be thinking a little bit more broadly of how they define what is a growth asset in their portfolio, what is a income asset and diversification asset such that it can act how you want it to in a portfolio given different market scenarios.

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8:28Yes, they use the fixed income part of their portfolio, both for income as well as diversification. And sometimes it only really provides income. It's not really truly diversified. Correct. And it's one where there is a need for those income pieces of your portfolio to be in there, to deliver what you're asking of the portfolio. But you just need to dedicate a portion of your portfolio to something that's truly diversified. And these diversifiers, oftentimes they're hedge funds and they're these mysterious black box strategies. Take me through the terrain of these diversifier funds. What are the different types?

9:03What are some common use cases? And what are some best practices when picking diversifiers? So what we like to do is to separate out, I call it more of your hedged equity or your directional long short managers from everything else within hedge fund land. Because I do feel that oftentimes as a grouping, people will just bunch them all together and take that 60-40 portfolio that I mentioned before. On the 40%, they'll say, okay, I'll do 60 % in equities, 20 % in fixed income, and then 20 % in alts. But the alts are all together in one big bucket, even though there's kind of 31 flavors of different types of hedge funds underneath.

9:40And so first off, I want to separate out those hedged equity managers where they do take some market direction, have some higher net exposure in the portfolio. And we put them in that growth assets bucket. And then I'm pairing that with what we view as absolute return hedge fund strategies that can take on different shapes. But when putting them together, they have qualities such that they are lowly correlated to one another and make for a great diversifier. So that can include everything from your larger multi-strap pod shops, for one, in that bucket, as well as distress credit, market neutral equity, relative value credit as well.

10:17And if you're within the right sizes, kind of marry those together. One that I had forgotten as well would be discretionary macro, systematic macro managers that you would include in that bucket. That when taken all together, you get a portfolio exposure that ends up being lowly correlated to stocks and bonds, which is the aim. But yet also still has an expected return that's more in the zip code of kind of a mid single digit to low double digit return. And so that's additive to the portfolio, not only just from a correlation standpoint, but also from a contribution from a return standpoint, too.

10:53So that's one thing that I key in on typically and try to separate because people just throw hedge funds all into one bucket. But there's a different purpose. It's such a good and underrated point in that people put these labels on their portfolios that either serve no purpose or actually confuse the purpose of their portfolio and putting into growth, income and diversifiers. Then you're forced to say, why am I in this asset? In other words, if I'm in a hedge fund that's long short and I'm paying$2.20, do I want to be in a hedge fund or do I want to be in the index fund? Because they're both taking the same level of concentration in my portfolio versus saying, well, this is a hedge fund structure.

11:29This is an index structure. It's almost like the wrapper around the strategy is much more trivial than actually what it's doing in your portfolio. Agreed. It's really answering the question of like, why do I own this manager? Why do I have this asset in my portfolio? What's its core purpose? And then I want it to compete against other managers or other assets that have that similar quality such that there's a tradeoff in competing within them. I know there's this whole discussion that's occurring about taking a kind of a total portfolio approach versus the endowment model style and getting too ingrained on asset classes and sub-asset classes.

12:02I certainly have come up in the school from the endowment model and still lean in that strategic policy portfolio way of management. But I think there is a bridge between those two in the sense of you're just trying to loosen up those buckets and not be so dogmatic about the asset classes specifically. Get at what that ultimate purpose of that strategy or that manager is in your portfolio and make it compete. And so for growth assets, there's a trade-off of having long-only equity exposure versus locking it up and having a growth asset type exposure, but doing it in private equity or with venture.

12:38One's locked up for 10 years plus ultimately, but that means you need to raise the bar as to what your expectation is from a return standpoint. But we like that way of kind of putting those asset classes and those assets in those buckets because it makes it compete. ultimately. I'm always thinking about what the opportunity cost is of trading off one versus the other within that. Taking to the extreme, just as a thought experiment, you could be 60 % in long equity, 20 % in junk bonds, which are correlated to long equity, and 20 % in quote unquote alternatives. But really, when you double click on it, you're in long short hedge funds, which are also correlated with your equity portfolio.

13:13So it seems on outside your 60-20-20, but you're really 100-0 from a correlation standpoint. There's an element of kind of a growth allocation that you've just wedged into all three of those buckets without pulling. I would take that 20 % that you had in hedge funds. And actually, I'd put that more aligned with that equity bucket that you had at 60 % for long-only equity. And the same for high yield. Just let's take it today. Ultimately, I know it's the case that rates are higher than they once were, but you're really not getting paid much from a credit spread standpoint and taking that extra credit risk within high yield or investment grade today.

13:48And so you need to be cognizant about what valuations look like and how you're stepping into each of those three buckets as well, because you could be susceptible to that risk that you just outlined there, where you're taking very similar risk across those three buckets of feeling diversified. I had the ex-CIO of Northern Trust, Thomas Sweeney, episode 224. And he double clicked on this whole concept, which is people, the 60-40 portfolio, in order to get more gains in that 40, investors would keep on going down on the risk spectrum to these junk bonds. And they found that the 60-40 portfolio, some of these portfolios with a lot of junk bonds were highly correlated to each other.

14:27And instead, his strategy was to take treasuries and essentially put synthetic leverage on it so that they're truly negatively correlated to the stocks. and one of the points that he made which i think is extremely underrated is one of the main reasons to diversify is when there's that once in a decade drawdown it's two one is to avoid taking wrong action so you don't want to sell at the exact wrong time which is like the most predictable and the most common behavioral finance mistake but two is actually as your stocks go down your bonds go up and you're able to systematically rebalance and actually buy the dip.

15:07It's a way to kind of systematically buy the dip without having to take heroic action. And I thought that framing on building a portfolio for diversification, because the question is, why diversify? You're not supposed to ask. It's supposed to be solved out. But one of the best answers to why diversify is when things go down, you don't make a mistake and you also can be opportunistic. To say it a bit differently, too, that's core to how we measure risk appetite for a family when they come on board. We're asking, or I'm asking them perhaps directly in a meeting of what kind of portfolio peak to trough drawdown can that family tolerate?

15:42I want to calibrate the portfolio such that it matches up with that risk tolerance so that we can be opportunistic when drawdown periods occur, which they will occur. And we also want to make sure that we build in those portfolio exposures like the absolute return oriented hedge fund strategies that can act as a counterbalance or a ballast and drawdown periods. The only piece that I would quibble with your guest earlier before was just saying, I think it's tougher to be able to say that your long bonds today can act in the same manner that they have in the past. Like was the case, as I mentioned in 2022, where it actually hurts you during that period when rates went the other way and the Fed had kind of pushed things up.

16:23Your long bonds actually didn't end up acting as that ballast. And partly you could say it's a commentary on our fiscal situation and ultimately that there needs to be some type of further premium that needs to be jammed into the long end of the curve. And that's where we then balance and say, hey, you need to have true diversification through this allocation to absolute return hedge funds to really act just like you described and such that you're able to be more opportunistic when drawdowns occur. Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, manage staff, and keep everything running in one place.

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18:10Run your business smarter with Square. Get started today. Hopefully a third of your capital goes into co-invest. Why are you so active in co-invest? And how do you know that you're not being adversely selected? You're right. Right. And our typical allocation in both private equity and private credit is two-thirds to funds, a third in directs and co-invests, though that can vary based on opportunity set. And we feel co-invests are important as they allow you to average down on investment costs. They help improve, reduce any J-curve in your portfolio, and they give you more control over portfolio construction too, let alone they deepen relationships with the GPs you're investing with.

18:48And I'd also, one could argue the other side of that adverse selection question. Rather, I mean, you're getting access to a set of higher conviction investments that these managers are doing when you're doing co-invest and selecting them appropriately. So as you mentioned, you have to have some processes in place to do your best to mitigate the adverse selection. And two ways to mitigate that, in our view, is one, full stop, you have to know the GP is thoroughly ex-ante. And that is typically the case because usually we've already underwritten their funds, their ability to operate in the verticals that they've chosen.

19:24And two, you need to have a team of professionals that have honestly been principal investors before as GPs so that they can underwrite those co-invests, call out the ones that come across as the GP is stretching to make a deal work. It takes one to know one in that respect. and in doing the co-invest work. And like I mentioned at the front of the call as well in keeping that funnel really wide, that means you're going down a lot of different rabbit holes and there's some dead deal costs that are associated with it and some time sink as well. So having that dedicated team is crucial when trying to affect a program where even we're just doing kind of a two thirds, one third split between our fund investments and co-investments today.

20:04You've set up family offices under 250 million. So a quarter of a billion dollars should not have their own family office. Why do you believe that? What is the hard truth about going alone at scale at under$250 million? With family offices under$250 million, we think they face some structural challenges that can limit their ability to operate with the same rigor, sophistication of the larger institutions. So we do believe that joining a larger platform creates some meaningful advantages, really in four key areas. One, access to broader investment opportunities. At sub$250 million in scale, it's difficult to source and underwrite truly differentiated investments, especially alternates.

20:48You have minimum check sizes, operational complexity, and manager access often locks smaller families out of the most what we view as compelling private equity, credit, and real asset opportunities. And so a larger platform solves this by offering the institutional quality deal flow, shared due diligence, and the ability to invest alongside a scaled capital base. So that's one. Two, it actually, if you're joining a larger platform, you're lowering your cost and you're upping higher quality infrastructure. Running a family office is expensive. With limited AUM, it's hard to justify best-in-class technology, research, reporting systems, or a full in-house investment tax team.

21:31And larger platforms spreads those costs across many families, given each one the infrastructure they'd expect at a multibillion-dollar institution, but at a fraction of the cost. You know, the third area for those 250 million family offices to think about is that a larger platform would give you some strength in governance, risk management, and continuity. You know, smaller family offices, they often depend on really a handful of key individuals. So you have some real concentration risk in that respect. And a platform ends up bringing you depth within governance frameworks, compliance oversight, succession planning, and consistent processes that then can help you protect that wealth across multiple generations.

22:14The final point I would say, like the simple advantage would be that a larger platform gives the family the ability to stay focused on what matters most. For many families, the goal of the family office is not to run an investment firm. It's to preserve and grow wealth while allowing family members to focus on their lives, their businesses and philanthropy. Being part of a strong platform offloads that operational burden and can deliver peace of mind. So for families below 250, joining a larger platform, it isn't about giving up control. It's about gaining access, stability, and expertise that would be nearly impossible to replicate independently.

22:50You alluded earlier about two different philosophical approaches to portfolio construction. One is the endowment approach, endowment model, and the second is the total portfolio approach to TPA, which is a newer framework. What are the strengths and weaknesses of those two approaches? For the endowment model, it's one that helps set up a framework so that you can think about, as we were discussing earlier, what is that asset doing in my portfolio and how should I think about what its aim is in the portfolio? To be crude, I think TPA is really a way for CIOs and managers to really loosen a lot of the constraints that they have felt about an endowment model and give them much more discretion on where they can move capital ultimately.

23:35because the endowment model itself and having a strategic policy portfolio and having it set where you're working with a board, it's a great governance framework because you can create a great relationship as you need with the governance of that particular foundation or endowment and the hired hands that are meant to be stewards of that capital. There's this tension about wanting to have flexibility and moving capital across asset classes. And I think that can be built into the endowment model and the ranges that you give each of those asset class buckets. In a vacuum, it's great to think about because you're having every asset or manager kind of compete against one another.

24:15And so that is attractive. Like we were mentioning earlier, you're always thinking about the opportunity cost and tradeoffs. But I think also you have to watch out because you've kind of loosened up a lot of the guardrails in why the endowment model works so well and making you think about having your factor exposure spread out or your diversification assets work for you as you intended. Managers love it because they have more discretion and they have less belt suspenders and handcuffs as to how they can allocate capital. But you can build that into the endowment model as well. Is there a place to stay out of entire asset class?

24:53For example, today, a lot of people are saying we don't want to be in large buyouts. We just think the entire market is overheated. Is that good investing or is that not diversified enough or not risk constrained enough? Do you want to be cognizant about anything that looks like market timing? We know that does not pay off well over longer periods. And, you know, the Hall of Fame of investors that are market timers or there's no one in it. On that. So right now, I hear what you're saying in terms of you don't want to pick market timing, but also there are supply and demand dynamics and so much money has been raised and there's only a finite opportunity set.