E328: Why Most Funds Get Rejected in the First Five Minutes

0:00Last time we chatted, you said that we reject most funds before we even see the IRR. What's the main reason why you would reject a fund? I would say there are three key reasons. First one is in terms of terms and alignment. Second on governance. And third is around the way they are growing. So let's start with the main one for us is the alignment, the importance of alignment, the fee structure, but also the alignment of the GP with the GP commitment. This is for us is a critical figure that we look at as a KPI. and if it's anything below 2%, we reject straight away. So 2%, GP commit, absolute minimum.

0:33What do you like to see? We like to see 10+. 10+. 10+. And we've been in funds that are 30 % GP commits. We've been to funds which are 20%. And we really chose the skins and game. On the governance side, there's a lot of things that we look for, but it's really how strong the systems are, how the structure is set up for us. We are based in Dubai, in UAE, and of course the tax situation is very favorable to us. So we need to make sure that it's kept throughout the structure of the fund. And finally, we hate funds that just double in size for every vintage. So we are very, we want to see people motivated for the performance and not the fees, on the management fees.

1:09At some point, you end up in an asset management business versus an investing business. That's right, that's right. Where do you hit that point? Where does a fund start to feel more like it's making money off of management fees versus Gary? Eventually it does happen. I think it's just part of how things develop and how funds grow over time. But I think it's really one of the things we look at is also like who gets the carry. And you have situations when it's only really a very few number of people in the fund that gets that. We don't like it. We like when it's widely distributed across the investment team and also support functions and others.

1:45But yeah, I think it's hard to put a number on it, but I think anything above a billion of AUM, it's measurement fees play a huge role already, right? I'm curious. There's obviously franchises that have grown successfully. that have been able to scale AUM and keep their returns. Founders Fund comes to mind among other venture firms. What's the common thread between the funds that are able to scale and still generate alpha? My view would be that they keep their edge and they keep their focus and their strategy. So there's no strategy drift. They keep doing what they're good at doing. Sometimes they could go up the chain and do bigger ticket sizes.

2:18That's one reason why fund sizes can grow. But usually, you know, I think those managers have the discipline of keeping with the same focus, the same strategy. And they just repeat that consistently. That's consistency is the critical variable here. So if they're doing a non-lead, a smaller check in seed, and suddenly they're trying to lead series A, that's almost like just a whole different business. Exactly. Or they say, we're going to grow the portfolio size from 10 companies to 50 companies. It's a very different strategy. They're a different relationship with the companies, right? You have to re-underwrite them in the new strategy as if almost you haven't invested before.

2:56That's right. That's right. So you're bullish on emerging managers and even specifically fund ones. While most LPs are not deploying in emerging managers today, why are you so bullish? Research shows that the best performing funds are the fund ones. The problem is that there are many of them and only a few of them actually do well. And very few of them will get to fund two, three, four, and so on and so. So you do get the alpha, you do get the performance, but it's just hard to find them. I think one of the reasons why they work is because it's basically your own shot. If you're doing your fund one, it has to work.

3:27Otherwise, you don't have the... It goes back to the alignment. The alignment. Usually, they have very strong pipelines. That's one of the things I noticed with fund ones. They've been working on that idea for a number of years, usually. And they would have a very strong pipeline of very high conviction deals that they are ready to do, and they just need to raise them on. Of course, that is the hard part for an emerging manager. But I think the pipeline is there. The hungerness is there. They're hungry. It has to work. There's their reputation on the line. and they are fully aligned on terms of performance, right?

3:56Because usually they are smaller funds and what really matters is the carrying on the management fee. Some of the best venture funds ever were actually not venture funds. They were the personal investment funds of Mark Andreessen, David Sachs before they became VCs. And one of the reasons for that is they had just come out of the startup network. So they were literally just investing into people that I'd worked with, that they had long track records of knowing how somebody would be as a portfolio of CEOs. And as you go from fund one to fund two, fund three, your network actually sometimes starts to age out.

4:23Tell me about that. You know, I don't have the experience of being on a VC fund myself, but you can see how that happens. You, of course, for a fund one, you take your best contacts, the best network you have, and as you said, those people inside out. Because, you know, if you think about venture, especially early stage, you're investing in the person. The idea might even change or pivot later on. But the people are really, you know, they are really what will make sure that investment works. So I think you have a huge advantage as a first-time fund, having that network coming out of that network is another.

4:57So one of the strategies we look at is also managers there, although they are the first-time fund, but they are either coming from another fund or established platform, or as you said, they are coming from that startup ecosystem where they do have the network. So they might not have an institutional track record, but they have a track record working on a previous fund, so they have some attribution, or they've been angel investing, they have that track record. Exactly. Exactly. It's always tricky to verify that and to do the audit of the attribution. That's one of the things we look for. You know, the best fund one performers are also the ones that have that history, either as an angel or as a part of a larger platform.

5:30I want to double click on that because a lot of people think a track record is a track record. But sometimes history is a little difficult to ascertain who owns what, whose track record is it? Was it the brand? Was it the manager? how do you go about asserting a manager's track record and really figuring out whether it's actually them that achieve these returns we were looking at a hedge fund not venture but yeah you know a hedge fund that had a 12-year track record but 10 out of the 12 years the gentleman was part of the family office and he was running you know the same strategy inside a family office with very limited growth but a phenomenal performance and and somehow part of his deal with the family office when he left was that he could take the track record and the full attribution, etc.

6:14And that was the key question we had, the diligence. Is this real or not? Was it him really? Was it the strategy? Is that the same that he's doing? Because then he did for two years on his own as a fund manager. And ultimately, he had a BDO audit report that was shared. And of course, those things can be fabricated. We check with BDO itself if that was a real report, if it was really done. Of course, they couldn't tell us if the numbers were correct or not. is all confidential, but at least they could tell us that yes, this is a BDO report, it's not a fraud. So that was a real example where we went lots of steps to try to really verify and make sure, because the whole investment idea was predicated that that track record was real.

6:54So this is one example. I think overall in VC and funds, we ask for the information. It's very hard to verify if the information given is real, unless it's coming from, let's say, the person is coming from another fund and then you can call and verify, is that true that he works on this, this, this deal? So that happened once, we did it. But overall, we just have to take a face value of whatever is given. Otherwise, we don't have that many resources as well to go and do all those verifications. I think that particular case of the hedge fund, because we want to do a meaningful ticket, we did an extra mile there.

7:29One 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. Meanwhile, smaller funds have been forced to cobble together ad hoc channel intelligence or rely on stale reports from sell-side shops. But channel checks are no longer a luxury. They're becoming table stakes for the industry. The challenges has always been scale, speed, and consistency. That's where AlphaSense comes in. AlphaSense is redefining channel research instead of static point-in-time reports.

8:03AlphaSense channel checks delivers a continuously refreshed view of demand, pricing, and competitive dynamics powered by interviews with real operators, suppliers, distributors, and channel partners across the value chain. Thousands of consistent channel conversations every month deliver clean, comparable signals, helping investors spot inflection points weeks before they show up in earnings or consensus estimates. The best part, these proprietary channel checks integrate directly into AlphaSense's research platform trusted by 75 % of the world's top hedge funds with access to over 500 million premium sources.

8:37From company filings and brokerage research to news, trade journals, and more than 240 ,000 expert call transcripts. That context turns raw signal into conviction. The first to see wins, the rest follow. Check it out for yourself at alpha-cents.com slash how I invest. It's all probabilistic. People, I think, have a hard time understanding that the world in general is probabilistic. You can never know anything for certain even if it was their track record. Maybe now they're in different stage of their life. Maybe they just have kids. There's so many variables. You're trying to come to the best possible answer.

9:08I've had many conversations with LPs about attribution. I actually think there is a right answer. Most things are a little bit nuanced. But I think if you go, I think the source of truth is the CEO of the portfolio company. Why? If you go to the CEO of the portfolio company, they're going to tell you, A, why they made a decision, who provided the value. So another way, they're the least corrupted in the entire - I was surprised with that. I was in a real life situation where I was in a P fund. And we had this portfolio company with the CEO. And I was very close to him. And he was then given us a reference, you know, for reference checks for other LPs, etc.

9:42Or other, in this particular case, was another portfolio company that we were looking to acquire. And he gave a very positive feedback. And I knew that he wasn't happy with how things were going. There was a lot of micromanagement on the P side. And then I asked him, why did you lie? Why you didn't tell the truth, right? He told me, because if I lie, it means that I did a bad deal, right? Why did I sell to this particular fund? And it would look bad on me that I chose to give a majority stake. And I thought, wow, that is true. It would look bad on him if he says that, you know, okay. So sometimes there are other companies.

10:20So I think, yeah, you have to be careful. You have to be careful. You really need to know the person, which in most cases is very difficult, right? I think references are the most underestimated aspect of alpha in investing. Why? Because they're boring. They're hard. We talked about this earlier. But also, a reference is not a reference. You could have two institutional LPs on a single call. Let's say there's a third party asking the questions, and they'll have two completely different reads on the reference. There's an R to it. True. But among FEMI offices, the beauty of it is that we share a lot of things.

10:51Incentives are aligned. And we're not competing with each other. We're not competing for deals. We're not competing for allocation in funds. And if you ask a family office, even if you don't know the CIO or CEO very well, they will give you, I think, most cases an honest answer. You're right. You might hear different answers from the same manager. One likes, one doesn't, which makes it hard in many ways. But at least, you know, the network is so strong that people are very open to share and give their honest opinion. Double click on that. I think family offices to 99.99 % of the world are this very opaque, secretive community of essentially billionaires.

11:25Talk to me about how family offices work with each other and where there are areas for collaboration. Is there areas where there's competition as well? There's this myth that family offices do club deals or invest together. And I think this is really the minority of the cases. I think in most cases, the collaboration is purely sharing, you know, opportunities, things that they like or they don't like. Referencing is super powerful. And I think overall, people are always very open to disclose it. I think it's very different, for example, with sovereigns. They don't share anything. But family offices are very open to share.

11:58And in a lot of cases, you know, I don't see cases of competition, to be honest, I think. Because you might have that in families that like to do direct deals. And, of course, you have limited capacity. You have limited access. But that's not what we do. So I think, you know, that could be one situation where there's competition among family offices. But in general, there isn't. You had this internal discussion whether you should do direct deals or not. You decided not to do direct deals. Why is that? We see direct deals not as an asset class, but as a capability. So unless you have the capabilities to do it, you know, you shouldn't do it because it takes a lot of effort.

12:33It takes a lot of bandwidth across, you know, among the team. And because they are single name checks, you have to size the check very well. So usually you have to do smaller checks. And that creates a problem because you do all this work and then at the end you write a very small check. So we rather do funds where you have also a lot of work to diligence. But once a fund is selected, then you can size it well. The other thing is the complexity to monitor and track a direct deal. It is very hard to get the information from the companies. It's very hard to aggregate those things, to keep a close eye on it.

13:10When we do, for example, an audit, we need to have the numbers for December. And there's always a pressure, like when is the audit coming out, etc. etc. So directs are a headache in that sense. You have no control also around the exit timing. Usually they always say, oh, it's going to be the next 16 to 24 months. Yeah. And it never happens. Always. I used to hear 18 to 24 months, but I guess it's now 16. Yeah. It's tough. It's tough. And you have such a small stake that you don't even have access to the company itself. So in our case, we only do directs if there's a real reason for us to be on the cap table.

13:42And in most cases, we'll be... And we've done one or two where the company actually wanted to expand in Dubai or the UAE. You have a right to win us. Exactly. And especially what we say, especially in the Middle East, is that if a deal gets to my desk, it's because it came to all the desks in New York and LA, Miami and Europe and London. In the Middle East, UAE, Saudi, they're really focused on being the first call. Do you think that's evolving now that the Middle East is getting the first call on these because of the size of the checks? Or do you think they're still kind of second to the US? I think they're second.

14:12Maybe the exception could be the sovereign funds because they have a lot of firepower and they have a lot of capital to deploy, big checks. So I'm sure they are getting first calls for some of the strategic deals and you see that happening, right? But for family offices, definitely not. Definitely not. Speaking of fund investing, you just recently changed your investment policy to invest in the final close only. Talk to me about that. This came out of our portfolio four years ago when I joined the firm at zero private markets allocation, right? Only real estate, but nothing on PE, venture, private credit.

14:46And we started deploying. And what we notice is that a lot of the funds will take a long time to come to their sort of fundraising end, right? The final close. During this entire period, they use facilities or, you know, and they will not call any capital. So there was one particular case where for two years we had 5 % of the capital called. Basically just to pay the measurement fee. And the principles, the mentality is like once you make an investment, the money goes out of the door. You start accumulating all the returns, you get distributions, et cetera, et cetera. And of course, when you pitch, let's say, a private equity fund, you're saying, oh, you know, we're going to get 20 % IRR.

15:23And then when you report on a monthly basis and you see that, you know, the IRR is minus five, minus 10, minus, of course, it's a J curve, which is in itself a hard one to explain. Let's be honest. Subscriptions out of fast. Streaming services, apps, memberships you forgot you even signed up for. And canceling them is usually a pain. That's where Experian subscription cancellation comes in. Experian can take the pain out of canceling subscriptions by handling it for you. You just keep the ones you want and put money back in your pocket. Over 200 subscriptions are cancelable. You can also save money by letting Experian negotiate the rates on your bills.

16:01They'll keep an eye out for new deals and saving opportunities and negotiate directly with your provider on your behalf. And the best part, you keep 100 % of your savings. Get started with Experian app today. Results will vary. Not all bills or subscriptions are eligible. Savings not guaranteed. Paid memberships with a connected payment account required. See Experian.com for details. Let's be honest. Subscriptions out of fast. Streaming services, apps, memberships you forgot you even signed up for, and canceling them is usually a pain. That's where Experian subscription cancellation comes in. Experian can take the pain out of canceling subscriptions by handling it for you.

16:43You just keep the ones you want and put money back in your pocket. Over 200 subscriptions are cancelable. You can also save money by letting Experian negotiate the rates on your bills. They'll keep an eye out for new deals and saving opportunities and negotiate directly with your provider on your behalf. And the best part, you keep 100 % of your savings. Get started with Experian app today. Results will vary. not all bills or subscriptions are eligible. Savings not guaranteed. Paid memberships with a connected payment account required. See Experian.com for details. Let's be honest. Subscriptions out of fast.

17:21Streaming services, apps, memberships you forgot you even signed up for, and canceling them is usually a pain. That's where Experian subscription cancellation comes in. Experian can take the pain out of canceling subscriptions by handling it for you. You just keep the ones you want and put money back in your pocket. Over 200 subscriptions are cancelable. You can also save money by letting Experian negotiate the rates on your bills. They'll keep an eye out for new deals and saving opportunities and negotiate directly with your provider on your behalf. And the best part, you keep 100 % of your savings.

17:58Get started with Experian app today. Results will vary. Not all bills or subscriptions are eligible. Savings not guaranteed. Paid memberships with a connected payment account required. See Experian.com for details. And to accept. You must feel it. It's hard to internalize until you feel it. Exactly. And for someone that never done it before, they start asking questions. Is the manager doing anything at all, right? Are they just sitting on the commitment and not doing deals? And then you explain, no, they are, but they are borrowing money. Why are they borrowing money for that? Why are we, I'm paying interest on this?

18:27And again, the capital, it creates a cash drag in the portfolio because we have that cash. Let's say we commit 10 million. You know, you would think about, okay, two and a half million a year. Yeah. Four-year capital call schedule. Exactly. So this$2.5 million, I cannot have to sort of keep almost like cash or quasi-cash. Why is that? Can't you put that money and put it in public securities? Typically, you have 10 days for a capital call to call in your money. Why not just put it into S &P 500 or MSCI or something like that? The reason is because we have an SAA, a strategic asset allocation, where we have an equity target.

19:02Our case, for example, is around 25%. and if I take this$2.5 million and put it in there, that$25 will go up. So I would be unbalanced. You'll be over-allocated. Exactly. And again, we have our equity allocation, so I don't want to have to use that cash, the committed capital for that. So that's why we changed to final close because then at least in most cases, very quickly you get that sort of 25, 30 % of the fund out of the commitment, out of the door very quickly. The other advantage is that because we are targeting a high concentration on private markets, the quicker we deploy, the better.

19:38So velocity is also important to us. You want your capital at work. Exactly. We like, for example, Evergreen funds. They are beautiful because of that. Because you go straight. There's one capital call. So managing capital calls is another headache. Yes. So you have one capital call, the money's out of the door, and you start accumulating. That's one reason why we also have been doing a lot of Evergreen. I've had pension funds on a podcast that are investing into Evergreen funds because of this cash drag. Yeah. They realized that that 200, 300 basis points they could get per year is actually alpha.

20:04And if you think in the long term, because you're 100 % invested, if you think about a 10-year period, you know, comparing to the traditional fund where, you know, you're at best, on average, 60 % invested, you need a much lower IRR on the evergreen. I think the metrics are like, to get a 2x, you need a 9 % or 10 % IRR versus a 20 % in the traditional private equity fund. So it's a huge, half the IRR gets you the same like. And this goes really at the heart of incentives of private equity and to somewhat venture managers, which is they want to boost their IRR, which is why they're using the strategy.

20:39They're not doing it to annoy the LP. They're doing it because they want to show a higher IRR when they go out to fundraise for their next fund. That's right. That's why they use it. That's why IRR for us is not a key variable. It is important. But we like Moik. We like the DPI, of course. Track record on that is very important. You have situations where you have funds, back to the VC world where it is a 2018-2020 fund with zero DPI, it's a massive red flag for us. How can in seven years they couldn't distribute a single dollar? It's not a good sign. I had Alex Ambrose from the Allocator Training Institute.

21:17He was formerly at Cleveland Clinic and a bunch of other institutions. And he gave me the stat, 50%, 5-0 funds of the 2000 vintage are under 0.1x DPI, 5-0. So you have heads or tails, whether your fund that you invested six years ago has returned less than 10%. Yeah, exactly. What are the downstream consequences for endowment? It makes sense. They have to pay tuition. They have to do all these things. What are the downstream consequences for family offices when they don't get their capital back? We're fortunate that we have capital inflows coming every year. The family still has, you know, they still own operating businesses that generate dividends.

21:50I'm not involved in those, but they do get this inflows every year. so we don't have a problem that we have to have a self-funded portfolio, which I think most of the endowments have. So in that sense, we're okay. We are patient. We don't have that pressure that we need a DPI to fund the commitments. But I think for someone that endowments are a classic case where by design they built a self-funded portfolio, they're definitely in trouble, right? If their capital doesn't come, they cannot. The David Swenson-Yale model assumed a 25 % DPI per year. 2024 we had 9 % 2020 which was the lowest I think since 2000 2025 we had between 9 and 10 % it's not yet finalized and that's the exact that's the news so two and a half times less liquidity than the model suggested and that's just having all these problems in terms of liquidity in terms of asset allocation so it's a huge creates a good opportunity on secondaries yes tell me about that it's something we like as well as a diversifier but also because we started investing four years ago it's great to have access to secondaries so we can get a 2000 2000 you know not 2020, 2021, 18, 19, vintages, which again, secondaries also have a role in terms of generating DPI quicker.

23:01So we like that as well. So it's an opportunity. We like it. It's a huge diversifier for our portfolio. I obviously love venture, but a strategy is only as good as you could apply. And if you're not getting DPI to year eight, the worst thing that happens is people stop investing to venture. The venture is something that you have to stay in. If you're in a good fund and you miss a fund, you're in the penalty box forever. So having that mitigated J curve could really keep you in the game, which is the most important thing. That's right. That's right. Speaking of venture, you have a barbelled approach to investing in venture.