E334: Texas Tech CIO: How We Find Asymmetric Bets

0:00So Tim, you're the CIO of Texas Tech's Endowment. And out of the hundreds and hundreds of conversations that I have with Allocator, you're the only one really taking a deep dive on office space today. Why are you so bullish on office space? Right. I think if you pull the curtain back and look at office space in general, it's an abysmal story. And that's the headlines you see everywhere. Our job as investors is to dig beneath that headline and see if there really is opportunity. Are we hitting the turning point? When we think about office now, the vast majority of office, especially second tier cities, et cetera, we don't want to touch.

0:29But we think that there's a unique opportunity to buy at a discount to replacement cost, in some cases, a meaningful discount, trophy assets in growing areas. We specifically like certain areas of the Dallas market and the Plano market. We think there's a lot of opportunity there to pick up high-end trophy assets with a population that's growing in that area. And you'll see people migrate from these, call it class B or A-minus buildings to these trophy assets. There's a lot of opportunity there. Is that just a rule in asset management in general where some of the best trades are one or sometimes two levels below the headline?

1:04So the headline says, do not touch this asset. And then when you dig down, that's where the health is made. I would say that's almost a quintessential rule of investing, right? If we can talk about real estate, we can talk about private equity, private credit, just about any asset class you're thinking about. And the pain part of that asset class is usually talked about pretty quickly. Like last week, it was software and AIs wiping out all the software companies, right? That's kind of the canary in the coal mine for an investor to go look at his portfolio, specifically private credit in this case, and decide whether we have the right exposures with the managers and talk to them.

1:40Like, do you have exposure to software companies, specifically application type companies, right? Enterprise is probably going to be fine. The application companies are in serious hurt with AI coming. So we think it's a perfect opportunity to dig down to that next level, have discussions with our managers, and try to find out how they're repositioning that portfolio. If you go upstream of being able to make these trades, it's really a governance question. It's a question of whether your IC empowers you to make that trade in office space that everybody's saying stay away from it, but you see the alpha there.

2:14Absolutely. I've been doing this for almost 30 years and I can, I've worked in a number of different places and I can tell you that governance is the hidden thing that nobody really talks too much about. And it can radically impact your ability to manage your portfolio successfully, depending on how tight that governance is. At Texas Tech, we have the government's authority to make those trades. We don't go to an investment committee for approval. Our committee is myself and my investment team. So we're able to quickly do a co-investment if one comes across our plate that we really like. Or if we want to go into office, we can do that.

2:49We're held accountable at the broad portfolio level to that kind of global 65 plus 35 benchmark, which is our benchmark. So that's how the board of regents thinks about our portfolios. Are you beating that on a risk adjusted basis? And luckily for us, we are, but at times we aren't, right? I mean, markets go up down. We're probably a little more defensive than that benchmark right now. And I think that's the right place to be. But that governance authority to allow us to make trades, to move the portfolio around as we see fit is critical. Just think about a regular pension fund that may have to go to a quarterly meeting.

3:25They may have to go to two or three quarterly meetings before they get a change in the portfolio approved. That's pretty standard practice. A lot of times it takes two meetings, that's half a year before you're even moving. To me, whether that's a co-investment or whether that's jumping into a new strategy you think is going to be very good for the next year, year and a half, you're missing a large part of that play, all because of governments. Expert calls have always been one of the most powerful ways to build conviction, but today investors are asked to cover more companies, move faster, and do it with leaner teams.

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5:07All of it lives inside the AlphaSense platform, trusted by 75 % of the world's top hedge funds alongside filings, broker research, news, and more than 240 ,000 expert call transcripts, turning raw conversations into comparable, auditable insight. Take advantage of AlphaSense AI-led expert calls now. The first to see wins. The rest follow. Learn more at alpha-sense.com slash how I invest. So your committee is telling you this is what we want, but it's giving you flexibility on how to get it, which is a subtle distinction. A lot of people think governance is either loose or tight, but there's also about giving people the ability to pick their tools to achieve the objective.

5:45That's exactly right. When you think about the 65-35, we don't go down to the next level at the 35. So let's just call that stable value, right? It's benchmarked against the Bloomberg global aggregate. Nobody on the regents or our investment resource council are telling us, Hey, put money in the Bloomberg aggregate, put money in treasuries. Nobody has that discussion. We separately build a structure and a portfolio and we try to beat that aggregate, that benchmark on a very consistent basis, but at a high level. So like we're usually running 500 basis points over that benchmark over time. This last year was an exception.

6:23I think the Bloomer Aggregory was up close to 8%. We're still going to beat it for the calendar year 25, but it was a much tighter spread this year. It was a little tougher benchmark. But overall, we get to take and manage the risk profile of that portfolio. Many endowments, when I talk to them, they talk about their alpha strategies, how they're contrarian. But then when you look at their returns and their asset allocations, They're very tightly banded. It seems like there's a hesitancy to go against the grain because there's so much incentive not to do that. What has led you to be more independent and willing to take risks where other endowments are not able to?

6:58That's a tough question. Other endowments is a hard thing to answer on how they invest in their governance style. There are many endowments that, in my view, take way more risk than we do. And they build massive venture capital portfolios, which is kind of the endowment model. I would say if you look back at our portfolio over the last few years, we had quite a bit of venture capital at one time. And it really wasn't because we planned to. It was because I think it was 2022 or 21 where our venture portfolio shot up by over 100 % in one year. Right. Fast forward today had three years of no returns.

7:30Right. It's been flatline. We're starting to see signs of it coming up now. And that's been like how endowments thought about adding lots of value is really through these private equity portfolios that were massive. Our teams got together and said, we actually don't even like that model. So we're probably anti-endowment in that regard. And we're lowering our venture capital exposure pretty dramatically in favor of what we think is a more consistent returning asset, which is lower middle market buyout. Yes, we may not get the highs that venture capital does, but we're going to be much more consistent in that space.

8:02And frankly, the companies are easy to underwrite, right? They have revenue. They have EBITDA. There's a game plan that says how many bolt-ons we're going to do on that company. and we're able to underwrite that much easier, at least my team, than a venture capital idea. Right. So Whoop is a perfect example. We did a co-investment in Whoop with one of our managers. Loved the idea. Didn't have any idea that the ring thing was going to come out and six other devices were going to come out and make Whoop not quite as valuable as we originally thought. I think venture capital is very tough from that regard.

8:36So we're kind of pivoting to a different way of managing the portfolio than I think the traditional endowment, if that makes sense. When we last chatted, you said that you like to spend a lot of your time with managers, talking to them about their best ideas. Maybe double click on what that looks like and what you're trying to ascertain in these meetings. The manager selection and partnering with managers is probably one of the most critical things that we do, right? That's how we get our alpha. That's where we get it from. It's not like anybody in my office is doing really internal trading, right?

9:07It's all through managers. So that partnership is everything. So a perfect example of, of that was when we were in Europe, we were really trying to focus on small niche secondary managers that we could find over there. And we found one and it was a spin out from another company. And we sat down and talked with them about how would you go about building a secondary strategy? And we partnered with them. I think we're the first institutional capital really to partner with these guys for that. We get a piece of GP economics out of them. And we also have co-investment rights and we negotiated rights in the future funds for capacity.

9:43This is a perfect example of like talking to managers and getting out on the road and finding ideas that really work for you and can add value. I would say the other piece of that is every one of my senior guys on the team, they talk to all of our managers minimum once a quarter. And some of the managers they're talking to once a month or once every two weeks to pay on it, how much dialogue they have with that individual manager. That flows through to the entire team about ideas and what they're seeing in the market. It flows through at our pipeline meetings and it also flows through at our strategy meetings that we have.

10:14And those are every two weeks. So they're pretty constant updating on what the managers are seeing. Think of it as just a funnel of knowledge, right? Is how we think about it. Scott Wilson at St. Louis Wash U is famous for this. he would meet with his manager and he would actually ask a very simple question, which is, what is your biggest position and are you at your concentration limit? And for those that were at their concentration limit, he would ask to co-invest more. So the idea was that if you have a concentration limit of 20 and you're 20%, you're actually underweighted. You still have to manage your portfolio and sometimes you have constraints as a manager.

10:48So he would look to literally co-invest into the manager's best ideas. He saw the signal that their best managers were actually underweight in their best ideas? We haven't gone through and done that per se. I think when we think about co-investing, which is really what we're talking about here, we really are looking for asymmetry in the co-investment. Five years ago, we did a lot of co-investments and we've really slowed it up. And we've slowed it up for two reasons. When we went back and looked at it, when we were doing lots of co-investments, and we did that because we thought we could one, lower fees, and two, improve our returns because these were great ideas for managers, right?

11:22It had to be for a manager that was in our book that we trusted that was already putting it in their portfolio, right? So that was our way of like keeping the guardrails on and allowing a small team to still be able to do co-investments. Because what we found is that we still did too many. The returns were kind of middling, like they kind of did okay right around the fund returns, but they weren't providing outsized returns. When we look back and decided to really dig in and say which ones were outsized returns, they were ones that we really commented on the high asymmetry of the trade and i'll give you an example one of the companies that we invested in recently has contracts with the u.s government and it's a very technical company that uses lasers and atomizes metals to then print right so you could for instance uh if you wanted print a a missile or you could print anything really anything metal.

12:18It does it at a super fast speed. It's an autonomous factory basically is what these printers become. And we looked at the contracts that they had that were coming in and we said, this has a lot of asymmetry in it. We're already protected by the first few contracts that came through. If they're successful in any more contracts coming through, that's pretty sticky money when you start talking about Department of Defense. So those were ones where we had success at. So we really look for that asymmetry and we really look for locked in contractual income that we know is going to come in those deals.

12:45And we'll go bigger on those. When you meet with a manager and they present you an opportunity, how do you know that it's something that you should double click on? That's a great question. It goes back to a little bit of that asymmetry, right? I think the second piece that we think about is how successful, like if we have a manager in the book and he's sending us stuff, how successful have we been with that manager? Because most likely we've been doing other co-investments, right? If he's proven track record, the one that he's feeding us over time that they're working, we have much more confidence to continue that process.

13:17And then the second step after that is individual underwriting of that deal. Is it like the other deals we have in the portfolio? Is it differentiated? And does it have asymmetry? And does it have long-term staying power in contracts? If we see that, we like it a lot more. Curious, you mentioned asymmetry. So on one end, that's potential 10X. On the other end, oftentimes it's a zero. How do you think about that? Do you have to present the zeros to the investment committee? Are you presenting on a net basis, the symmetry on the downside? Is that something that you care a lot about or is it just part of the game?

13:49It depends a little bit on what asset class. When you go to like private equity and private credit, we're really looking for consistency. I don't think we do very many co-investments at all that we think could have the zero. Back in the day, we used to do venture co-investments. Those definitely could have had a zero. But as we've moved more to lower middle market and growth investments for co-investments, we don't believe we're going to hit zeros on any of the ones we do. We think downsides in a lot of them could be, you know, single digits. You could have that kind of downside and upsides could be, you know, 30, 40, 50 % kind of IRRs on those trades or multiples in the three to five X.

14:29There's very few that we underwrite where we go, oh, we think we can get a 10 X. I think there's only one in the portfolio that's been mentioned that we think we could have a 10x on. And most people don't even pay attention to that because it doesn't happen very often. Tying back to what we talked about earlier, you said that you went away from heavy on venture to more lower middle market in simple ways. They have somewhat similar returns, but venture once in a while will have this huge outperformance. We'll have this 10x fund, which is much more rare these days. What are the second order effects of having a more stable portfolio and focusing more on lower middle market versus venture?

15:04What are you solving around? The first thing a CIO solves around is ensuring that his stakeholders are happy because that is your career, right? So when you think of the Board of Regents or donors at Texas Tech, what they want to see is consistent outperformance over the benchmarks. And as soon as you introduce a ton of venture, that volatility and that ability to have two, three, four years of middling returns creates a lot of stress on the time and a lot of political stress. From my standpoint, that's probably the main driver of wanting to push that direction. The second piece has to do with benchmarks.

15:42It goes right back to governments again, right? So some endowments will have a venture cap benchmark, a buyout benchmark, a growth equity benchmark, and they blend those three together. And that's what they're trying to be. Well, if the benchmark has 30 % venture in it, you're naturally going to push to 30 % venture because you're trying to match that benchmark up. So whether venture is a great deal or not, you're in it. We don't have that. The Acquia is our growth benchmark, Acquia plus 100, for the entire growth portfolio, whether it's public equity, long-short equity, private equity, real estate, whatever.

16:15That's what we're trying to beat. So when you think about that as your benchmark, you're not compelled to invest in venture. You're compelled to invest in something that will build a portfolio that will consistently beat that benchmark and beat it handily, right? Not just by a little. in the private, you probably want to double that benchmark at least, right? I don't think that's possible in years where ACWI is running at 20%, but that's rare, right? That's happened the last few years. That's not going to continue. The ACWI over time, 70 % return. So if we can get high teens to 20 in our private asset portfolio on the growth side, that's all brought.

16:46And that's what we're trying to do. When I had Larry Cochard, former CIO of McKenna, UVA in Georgetown, he talked about this. And he also had a storied career over many decades. And he found that what's very underrated is the sustainability of the endowment strategy. What does that mean? It's all fine and dandy if you could get 9 % versus 8 % for seven years. But then if a new CIO comes in, and then they have to sell via secondary, and then the next two years are 6%, you're going to end up at the same 8 % versus if you actually have a compounding strategy that could survive over many decades, you're actually going to outperform a very spiky portfolio that the stakeholders might not like.

17:21A couple different things when you think about that, right? I think the first one is governance and turnover. If, if from a governance standpoint, the university in this case is not taking care of its team and paying people appropriately, you're going to have massive turnover. Every time you turn over a private equity guy and hire a new one, he has a new strategy that he wants to employ. There's always turmoil and change. If you hire a new CIO, that's gargantuan wholesale change at the portfolio level. Like we run portable alpha, we run different strategies. most of that stuff would probably be wiped out by the next guy.

17:57That sustainability partly is driven by governance and how they manage the relationship with the office of investments at the university. The second piece is sticking to your long-term knitting, right? Obviously we're not in some ways, right? Like I'm moving away from venture. We're making that smaller to go to lower middle market. And that's after probably seven, eight years of building out the venture portfolio. Now we're going to keep the ones that we like the best in that portfolio, but we're shrinking that exposure. So I would say in some ways we're not being sustainable in the venture portfolio because we're not doing it the same size, but I still think by going to lower middle markets, a better portfolio for us.

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22:33So we're getting the same return. What we're getting out of doing a swap is we're not putting any money out really to get that exposure. So let's say we want to put a hundred million dollar portfolio together. I'm going to buy a hundred million dollar swap on the ACWI. I've spent no real money. So what am I going to do with a hundred million dollars, right? This is a levered trade, right? So I get the exposure of the market for a hundred million. Now I'm going to take that a hundred million. I'm going to put 70 % of it in multi-strat hedge funds, maybe some short biased hedge funds, stuff that doesn't correlate with that a hundred million dollar of market index exposure or very lowly correlated.