EP273: What the Best Family Offices Do Differently

0:00So you founded Endurance, which is a family office for three serial entrepreneurs. Tell me about the story of how you were created. So my two founding partners were GSB classmates, Stanford Business School classmates. We had all been investors before going to business school and then drank the Kool-Aid that they offer in Palo Alto about building startups. And so we decided to sort of put our lots in together and we wanted to work together and help each other in building businesses. But we were candidly a little afraid of the success rate of startups, knowing the statistics. And so there was a little bit of an insurance aspect to us forming a holding company as the launchpad for that.

0:37Additionally, we put some kind of shared resources around it and launched a series of companies. And fortunately, we had a higher success rate than we thought we would, where five of the six companies we launched ended up being successful. I started along with my partner, Sam Hodges, a company called Funding Circle, which became the largest small business lending marketplace globally. We merged with the UK company and then took the company public in 2018. And then my partner, Chris Klomp, started a company called Collective Medical, which provided hospital collaboration software for emergency departments.

1:04He sold that company in 2019 to a larger firm called Point Click Care. And then there were a few others which had also been successful, fortunately. As we started having liquidity from those, I think we faced the decision a lot of entrepreneurs have, which is, you know, what do you do with the money once you start selling companies? And we looked around at the commercially available options and decided that it was too expensive to engage a third party. And we felt like we had very differentiated access to opportunities. And so we started investing together. What I mean by too expensive is not, it is the fees, but more so than the fees, it is the fact that, or we saw that many of the commercially available options were sort of beta trackers or, you know, a safe pair of hands so that you didn't have to think about managing your money.

1:47And that wasn't our perspective. Our view is that even a few percentage points compounded over time of success end up creating a great deal of difference in how much your money does for you. And so we built our own investment office structure alongside our company building efforts. So today we still incubate businesses, though now we play more of a founding chairman role in each of the businesses that we create, generally incubating one or two companies a year. And then the investment office has become quite active where over the last 10 years, we've invested in about 200 different private funds and also have a wide ranging direct investment effort as well.

2:22Five out of six companies are successful. Obviously, incredible track record. It's one of the best success rates for half a dozen companies I've ever heard. You took that entrepreneurial lens into creating the family office structure. How did you use first principles to decide how to create this family office? It's a great question. And the answer is, it was entirely unintentional. And so we, but I think that's the version of, you know, pure product market fit in a way is that we just started building things that we needed. And it just so happens that that need was scaled for us. And then over time, we've started to have collaborators who have joined us because they also have a similar need, started making investments and things.

3:01And then we realized that it was really hard to have a fixed ownership structure when all of us had, you know, sort of different preferences for how much we liked either a deal or an asset class. And so we started creating these sort of annual vintage funds for ourselves. Once we started creating these funds that created infrastructure needs related, you know, some of it is kind of traditional tax and estate admin needs. But then we started having admin needs around the funds that we were creating for ourselves. And then we started adding team to build that. And eventually it just made sense to continue building infrastructure where, you You know, today we think it's evolved to a place that's very scalable because it was just in response to what we needed.

3:38Ever since I interviewed Ryan Hoover a couple months ago, he always solves his problems with products. So he would look at your admin need and say, what product do I build versus how do I create processor people? Have you created any products around your problems? And how do you look at that as an entrepreneur? Are you solving these things at scale or are you just throwing bodies at it? I would say we've created investment products in response to the problem. So we now operate 25 different funds that we created for ourselves that are specific mandate investment products that I sometimes call the Lego blocks of our asset allocation strategy.

4:08What that looks like exactly is an annual private equity, venture capital, real estate fund. Those are sort of the core private asset allocation pieces. And then we've had some opportunistic individual funds for blockchain, for digital currency, for private credit that we build a Lego block each time. And that's become a systematized process. And so those are our products. in-house, I think a lot of people would malign the fact that we use more traditional spreadsheet based fund admin products. I wouldn't even call them products. I'd say we created a process that works very well for us. And as we've understood and evaluated the third party ecosystem, I have yet to see something that does it better than how we do it in-house.

4:44And so we have this conversation a lot with other family offices about like, what do you do? And everybody seems to have a pain point around how do you do the admin well? We have not found a better solution than just have really great people to run it and have them build systems internally. You don't have this principal agent problem. It's your own money. And knowing that is your own money, how do you think about portfolio construction? And how do you think that would also differ from if somebody else was managing your money? In portfolio construction, in asset selection, in every decision we make, each of the partners, and this is probably a good time to say that, you know, while we are an affiliated entity, you know, it's not like we manage a pocket of capital for external people.

5:18That's not to say we don't have external investors. It's that the partner's personal balance sheets are the thing that matters. And it is encouraged in our investment committee for partners to pound the table and say, I do not want this in my personal asset. Like, I do not want my money going into this. And so that is the sort of underpinning of every decision. That's what we say to third parties is, you know, that's a good thing that we're not thinking about how it will look to you when we make an investment. We make an investment because we want our personal money into it or not. But at the same time, I should also say, because I'm sure I'm going to make a number of statements about some of our practices, you know, these are my views and our partners often will differ on these things.

5:48And another secret to our success is having people who are deeply engaged arguing on behalf of our own balance sheets, I think gets us to better answers. And when investment committees can be maligned for sort of groupthink type behavior, you know, this in some ways has been the antidote to groupthink for us. Your question was about, you know, portfolio construction. So we think of the two sides of the house as, you know, sort of the wealth building side, which is the, you know, new company creation work that we do. And then the sort of wealth management side, meaning for our own wealth, where we have an endowment style approach to how we manage the money.

6:20And so our pie, just to call out what we're talking about, is 40 % Publix almost entirely beta, 12.5 % each to private equity, real estate, and venture, 5 % to sort of idiosyncratic opportunities, which is where a lot of the company building work is done, and 6 % to digital assets, of which 1 % is specifically for altcoins, and then 10 % to private credit, which we divide into, we actually think the distinction between opportunistic credit and private fixed income is an important one. And so that's how we think about the pie. That's how our family office puts together an asset allocation recommendation that the partners then draft off of and make their own choices about.

6:56And how has that evolved since you started Endurance? Every year we evaluate the capital market assumptions that go into that, which is both an understanding of what is going to be market beta and then what do we think our capabilities are. And so over time, we've grown more confident in our capabilities in certain areas. We've also grown a better understanding of the markets. And so I'd say that our lens comes more into focus on what the assumptions that go into that portfolio construction are. And then ultimately, what hasn't changed is that we are targeting the highest possible expected return with the highest possible sharp ratio.

7:30Managing towards the efficient frontier is the, I would say, the underpinning of every decision that we make. And you've been running Endurance now for over 16 years. Do you see this negative correlation between assets that are hot and assets that end up returning to the best? In other words, this kind of supply and demand dynamic and that the best time to invest in an asset as a general principle, there's many exceptions, which we can point out, but as a general principle, is that directionally true that the time to invest is actually when the asset is quote unquote cold? What I would say is there's a lot of different ways to make money.

7:59And there are people who make money on momentum investing well and my personal approach to investing has, uh, agrees with your statement, right? So I get very wary whenever something becomes, uh, you know, too hot, right? So in today's market, I am wondering why nobody seems to be talking about the risks of to open AI and anthropic and all the other models. And, uh, and so, you know, we take a skeptical lens when, uh, the money seems to be piling into something. I guess this is another thing that we, you know, have, why we chose to build our own vehicle is because by the time the sort of third party advisor community is hearing about something and then distributing it to the end user.

8:34My worry is that we are too late in the cycle. You know, you're sort of, you know, the last person to hear about it, you know, last the party, first to leave type of situation. That feels like bad investor psychology or bad investor principle to me. So yes, we tend to have many contrarian views to, you know, what the moment is. I also think it's almost absurd where people talk about asset classes as if the pricing is fixed. They say early stage is cold or early stage is hot, But really, you could have startups that are at a$4 million valuation at a$20 million or a$60 million, which are fundamentally different economic value propositions.

9:10And when everybody else exits that space, now you're coming in at$4 million, it becomes a whole other risk reward. And people talk about it as if it's fixed, as if you're always investing at the same valuation. that's entirely true it's an and i'm a big fan of the jim collins and right you know the genius of the hand versus the tyranny of your many things can be true at the same time and so i agree with that and we try not to be market timers and i'm probably the the worst market timer of our partnership and so i i try to insulate the reason for these annual fund approaches is because one of the most predictive factors of of success in private investing is vintage and so we're trying to create the structures that force vintage discipline.

9:50Now we can change how much we put into each vintage. I tend not to because of this market timer phenomenon. But you're right that where I can make tilts, and sometimes I use a thermostat analogy where I say, hey, let's move the thermostat from 70 to 68. You wouldn't move a thermostat from 70 to 60. And so when I'm feeling like, let's say venture is overheating, I tend to start turning the thermostat down. That doesn't mean no allocation. It just means we're getting a little cooler on how much we're willing to do. And that was, when we're talking about venture, that is how we were behaving in 2021.

10:22We were sort of turning the thermostat down, particularly on the mid and late stage stuff. Now we are also a good example of being contrarian is that we're not buying into the thesis that people are talking about, about companies are staying private longer, therefore everybody should be piling into the pre-IPO stage. It's not that we have zero of it. It's that the bar for us to make an investment in a pre-IPO stage manager is very, very high. It's a very small percentage of the portfolio. And so it's a tilt, you know, it's a thermostat tilt. Given that it is mostly the partner's own money, do you find opportunities for high IRR, low MOIC traits where you could pile in money into something that an institutional investor might find is a waste of his or her time?

11:02I generally experience it as the opposite, where when I talk to some larger institutions, they feel more IRR focused because they think they have better ways to manage the cash than others. While I actually think we do a good job of short-term cash management, maybe better than most, I'm not eager to trade IRR or to take IRR over Moik. And I mentioned we have 200 private investments, right? Even in the context of we have a very wide portfolio, it still takes a lot to get to a yes. And so the amount of work that goes into making an investment decision, getting the money back and then having to make a new investment decision, I think constricts our ability to do diversification well, because the more decisions that you're forced to make, the less quality are in those decisions.

11:51In that case, it's not a principal agent problem in that both the principal and agent has a finite amount of time to create the most economic value. And even as a principal, it's a waste of time. It might be a penny wise and pound foolish choice for us. Now, that's not to say that, you know, a group that had a much bigger cash man, you know, much bigger diligence team and a much bigger, you know, admin ops team that could, you know, recycle the cash well might not have a different trade off. But for us, if you looked at the overall portfolio, I think we would have a lower return if we took a short-term IRR benefit that then brought us cash back faster that we then had to figure out a way to redeploy effectively.

12:30because I guess what I'm saying is I'd rather have a 15 % IRR over 10 years than I would a 20 % IRR over four years. And I'm picking numbers out of the sky because that's still above our threshold and target and compounding over time, we find is the way that we're more focused on multiplying the capital base as long as it's above a certain level, right? And I shared with you earlier, I don't think I said that our portfolio expected return is a 14.7. And then each asset class has its own expected return thresholds. And so they're quite high and ambitious as they are. So I think it might be a different story if we were talking about single digit returns.

13:12Then we might make the trade in the other direction. A lot of the most elite endowments, they target roughly 7 % to 8%. Why is it that you believe you guys could get a 14%, 15 % return on your portfolio? It's interesting. And I sit on an endowment committee that is managed by one of the leading endowment advisors and recently had a heated discussion in the investment committee room about this very topic where I think that there are principal agent issues in rooms like that. I think there's a group thing issue. I think there's a personal incentive and motivation issue from the people who are contributing to investment committee discussions, even in well-resourced endowments that have full-time professional managers, those people are compensated in certain ways that don't incent them to take, to move out on the efficient frontier.

14:03They need to make defensible choices that they can explain easier to, that will land with a wider audience of less sophisticated people. And so when I look at the capital markets assumptions that go into making those choices, people will want, I say, a lot of people are not as focused on what their efficient frontier looks like. So, you know, we take it as kind of a first principle approach to, you know, well, this is, this is how you should, start the portfolio. I think others may do the exercise, may not even do the exercise. And it becomes more of a political conversation about who likes privates, who likes publics.

14:33And then is VC a real thing or is it not? And then the committee argues about IRR versus not. And ultimately, there's cash and then there's cash hoarding. And so one idea I've heard from institutional investors that I really disagree with is that, well, for an institutional endowment, you have to manage it in a certain way. And I'll retort to that, that I care a lot about this institution that I help manage the endowment of. And at the same time, I care a heck of a lot more about my kids' trust funds than I do the school's endowment. And a good example of this is I think institutions are just starting to add a digital currency allocation, but they haven't even put it at the Swenson sort of 5 % minimum level or not even close.

15:12They're just sort of dabbling in it. And it's something that I would advocate, obviously, by our asset allocation policy. And I think institutions will get there over a long period of time. But I hear people say, oh, well, I would do that personally, but that's not appropriate for the institution. And I'm thinking to myself, why is that appropriate? Why would you do it with your own money, but not for an institution? And I could go on a rant here, and I probably already have to some extent, but there are behavioral factors that I think make institutional decision-making candidly worse, right? That make it a lower return seeking with less safety in the way that their choices are made.

15:46There's two closely related factors at play here. One is principal agent, in that you care about your own money more than necessarily investing somebody else's money, everybody, the proverbial you. And then also, if an asset has even a 5 % chance to get a zero or to go down 90%, you could just torpedo your career. You're not willing to get that extra 2 % to 3 % per year with that risk factor. It's a negative asymmetric career. It's a harder decision. So, you know, I've seen institutional portfolios that will have a absolute return bucket with a north of two sharp ratio. Right. No leverage on the portfolio.

16:30That's one that's begging for leverage. But OK, you know, I actually don't understand the argument for why you wouldn't use leverage. But and but OK, if you're not using leverage, so then that's a license to take risk elsewhere. But instead, you've got a huge chunk of money stuffed under the mattress. And it's great that it's producing a sharp ratio. but to what end, right? You have to use that risk elsewhere. Otherwise, you're just going to have like a really safe low return that's, you know, under, you know, under the efficient frontier. Those are examples of, you know, how I, why I think that these endowments, you know, have modest expectation and modest returns over time.

17:04And, you know, candidly, ours are much better and reliably much better, we think. Now, granted, I don't get to run this as a 10 ,000 iteration game, right? You know, we only have the 15 years that we've been doing it. So maybe at some point we'll be wrong, we're proven wrong, but I believe in the free lunch of diversification. And that's why we target higher risk assets, because we think that if measured properly and done in appropriate quantities, you can have that free lunch of the high expected return of 14.7. And what we have, I don't know if I mentioned our sharp is a, and I think we could do better than that.

17:44I think we, you know, we're making some lazy choices in doing that, that, you know, we could be pushing it out further. I think there's these paradoxical beliefs in asset management that you simply cannot challenge. Cliff asked us when I interviewed him, he said, the idea that zero leverage is the right answer to every single situation is absurd. that it's literally, it should be zero in every single situation makes no sense. You talked about crypto, investing in crypto. I have this whole soapbox about the virtue of illiquidity. I think all things being equal, many asset classes are better served illiquid.

18:17I interviewed several top decile venture funds in crypto. So if you think about millions of crypto investors, a couple thousand of them have been beholden to other people's money. So they're like the top of the top and then top decile of them. And most of them will secretly admit that their best returns have been in their most illiquid buckets. So even the cream of the crop, the NBA players of crypto actually believe illiquidity is good for them. So why does it not apply to the non-NBA players? And of course, that's also paradoxical. And you just, you literally cannot have these discussions. It's not even that you can even have these beliefs.

18:50You can't actually bring these things up or you'll get the equivalent of canceled within the investment office. I agree with many of the things that you said there, and I thought it was eloquently done. So I don't have more to add to it. You have invested in 200 funds. Nobody bats 100. What have been some of the mistakes? And where have you really evolved your strategy over the last 16 years? The mistakes question is, you know, this gets back to the institutional mindset versus the principal mindset. You know, we always were cool on a thermostat towards big brands. But when we first started out, we gathered comfort from, you know, there was something like, do we know what we're doing here?

19:30and there was comfort that we afforded to the fact that we would have, you know, some very institutionally known brands. And we made a few choices that would be extraordinarily defensible. Our biggest mistakes have come when we, you know, sort of had fear of missing out because, you know, we felt lucky to get into a big brand that had a big fund and a big toll and they were doing, you know, sort of hot late stage investing in venture or, you know, kind of mega LBO stuff that, you know, I think conventional wisdom would tell you can't go wrong buying IDM type. I don't want to call it any one specific firm.

20:01And so then we started realizing and sort of digging into these larger brand returners. It became so obvious to us that as AUM rises, returns are inverse correlated. And so the trick that we have found is that how do we gain enough conviction to get in early enough at high enough conviction? That last part is the thing that we're working on to benefit from these firms as they grow. And then how do we have the conviction to sort of start downgrading people as their AUM rises and they start harvesting their market position? And so, you know, your question about the mistakes, you know, have largely been in, you know, in these big brands and large funds.

20:43And so over time, the thermostat has gone from 68 to 66 to 64. And it's not that we never do it now. And there are certain situations, and we think some are better than others, and we think some are taking really unique strategies. But we've been able to really focus on what matters about a market-leading brand. And are they still truly a market leader if they're presenting their product in a certain way that seems highly unlikely to succeed in the future? So I'd say that's kind of in the biggest mistake category of how our fund investing strategy is involved. Dell PCs with Intel inside are built for the moments that matter.

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21:50Find technology built for the way you work at dell.com slash dellpcs. Built for you. the way that i look at these brands that grow is a what is the growth of the asset class so maybe an asset class itself is growing and opportunities that might be growing three times then on average that fund should be three times larger even though that's obviously quite a step up two is are there's economies of scale of brand for example in venture you might argue at certain stages brand is really important as you get all these portfolio services signal all these things which we could talk about. And then three is, are there other things within the organization that are growing?

22:31Are they growing their talent? GP, are they getting top GPs in? And all these other things. In other words, is their alpha growing alongside their fund size? And to the proportion of that alpha growth over their fund growth is what you really want to be identifying. And sometimes you have some parts of the market that are growing so fast that actually the alpha might be outgrowing the fund size even though the fund's grown two, three times. That's an interesting way to put it. You know, I would enjoy sitting with a whiteboard with you and like, you know, charting that. The way I cut through it is to say, I'll talk about it in venture, but I think this applies to private equity as well.

23:03We roughly target a third, a third, a third, what we call market leaders, established brands, you know, a third growing funds or breakout funds that are on sort of, you know, call it fund three to six. And then, you know, emerging managers, which are on fund one to three. And we think at each stage, there's an advantage, you know, in your parlance, like there's an alpha, you know, there's a curve. And if you plotted all the firms on, you know, what their unique advantage was that would generate alpha for them versus not, and they're going to have different things at each stage. So for a market leader to be successful, of course, brand and venture is really important.

23:36And so some of those market leaders have that. But many of them are hampered by how much money they have to put to work. I'm thinking of one market leader in particular who's just known for showing up at some of our companies. that we're, you know, one of our companies that we're building now had one of these big brand market leaders come in and say, you know, we'll triple your, you know, we'll triple your latest term sheet. Right. And, and it's like, is that a good investing strategy to just like pay up for everything? Because you have so much money that you need to deploy that likely to generate, you know, the top decile of returns.