How I Invest with David Weisburd - E91: How Elite Endowments Invest in 2024

Episode Date: September 3, 2024

Renee Hanna, Managing Director of Investments at Baylor University sits down with David Weisburd to discuss how Baylor balances allocation between public and private investments, how its private investments are built around returns hurdles, and thoughts on appropriately sizing commitments.

At a high level, we're a $2 billion endowment. We do invest across public and private investments. The breakdown is roughly 55-45 today. We have five investment professionals in-house. We're led by Dave Moorhead, our chief investment officer. Do you take into account the macro cycle when you think about your 55-45 split? So it does tend to be more permanent.

We have an allocation budget that we manage each year. We're only investing in categories where we think can clear our net return hurdle, which we define as 15%. And we're going into categories where we see secular long-term tailwinds. And so it tends to be an area like enterprise software, like healthcare, where we see a long-term catalyst that's going to drive growth and allows us to be comfortable making a 10-year commitment. Talk to me about the different shades of liquidity. One of the things that we really try to juggle is IRR and multiple of invested capital. And so for us, we've talked about how we think about venture as an asset class and being very long duration.

You guys have consistently beat the large endowments. How would you attribute Baylor in Texas beating the large Ivy League endowments? What's the secret to success? Yeah, I mean... Renee, I've been excited to sit down and chat. Thank you to your CIO, Dave Moorhead, for making the introduction. Welcome to 10X Capital Podcast. Thank you. Thanks for having me, David. Excited to be here. So tell me about Baylor's strategy when it comes to asset management at a high level.

Yeah, absolutely. So at a high level, we're a $2 billion endowment. We do invest across public and private investments. The breakdown is roughly 55-45 today. We really try to manage to the strengths of the team that we have in place. So we have five investment professionals in-house. We're led by Dave Moorhead, our chief investment officer. In a previous life, Dave was a former trader. And so we leverage the skill set on the marketable side and seek to be nimble and use the size to our advantage. So unlike some others, we do not have any multi-stress in the portfolio. We don't have a buy and hold approach. He's very nimble in how he rotates capital. We have a lineup of position players. Everybody has a job to do and effectively he's rotating capital as warranted, buy low, sell high, and making those asset allocation decisions across the portfolio.

Across privates, we manage it in a holistic way, but effectively we have a very similar mandate in terms of position players, very limited overlap, high concentration across the private book. So tell me about your private book. It's 45% of your total strategy. Why are you willing to invest so much into privates? So the private investment category is really one that has steadily grown over the past decade. So I joined the endowment in 2008. At the time, we went through a number of leadership positions until about 2010. And then it wasn't really until 2014 where we started making decisions, looking at our portfolio, looking at some of the legacy decisions. And we decided at that point to sell some exposure into the secondary market.

We effectively went to the market with $200 million in an AV. We sold $100 million. And the balance of what we sold was brought back onto our book at secondary market prices. And so that enabled our team to really have a fresh start, to really have attribution from that point forward. And so at that time, the allocation was 22%. Over time, it has steadily grown. And as the portfolio has matured, as we've gotten away from the J-curve, we now have a self-funding private investment portfolio. That's really freed us up from a liquidity standpoint because the decade it took for us to get to a self-funding portfolio, all of those cap calls were coming from the marketable side of the portfolio and caused a real drain in terms of liquidity and needs and how we could manage the portfolio on top of the 5% spend that we have as the endowment

going back to the university for scholarships. So for us, it's really just a function of liquidity and getting more comfortable. And so now we're making decisions on how we allocate dollars into this higher earning return category, which is often private equity. We have the flexibility to do that because the liquidity drain is no longer there given the maturity of the book. I also think if you look at some of the larger, more established endowments like the Ivies, you'll see that they tend to have a higher level of privates as well, just likely for some similar reasons. Do you take into account the macro cycle when you think about your 55-45 split, or is that a permanent type of asset diversification? So it does tend to be more permanent. We have an allocation budget that we manage each year. It's a function of what we think

we need to maintain the asset allocation at 45 to 50 percent within privates. But one of the things that we've done is we no longer are trying to be overly diversified within private equity. We're only investing in categories where we think can clear our net return hurdle, which we define as 15 percent. And we're going into categories where we see secular long term tailwinds. And so it tends to be an area like enterprise software, like health care, where we see secular long-term tailwinds. And so it tends to be an area like enterprise software, like healthcare, where we see a long-term catalyst that's gonna drive growth and allows us to be comfortable making a 10-year commitment.

Why not focus on diversification? Talk to me about the trade-off between diversification returns. I don't wanna say that we don't think about diversification across the portfolio, we do. We just don't think about it within a silo where private investments in isolation has to be diversified. For us, when we think about private equity, we think that

private equity at the end of the day is long-only equity. It's levered. It's illiquid. And so when we're bringing it into the portfolio, it's not really because of the correlation benefits that we think it's providing relative to what we're getting on the marketable side of the house. If we're getting any type of smoothing or mitigated downside, we view it more as a function of the valuation policy that's within privates, less a function of true correlation benefits. So if we're trying to express a diversification trade, which we will, we tend to do it on the marketable side of the house. For example, leading up to COVID, so 2019, as valuations felt really lofty to us, we were putting on long ball trades

on the marketable side. And those trades delivered in 2020 with the quick downturn of COVID that created returns and liquidity gains that we could then take and plow into public equities to rebalance our portfolio. Private investments does not exist for that reason. And so therefore, we're pushing those dollars into categories that can create a 15% return. And we're comfortable allocating to a small subset of sectors that can deliver that. And asset classes that don't, which to us are private real estate,

private credit, infrastructure, don't meet that hurdle. And so we don't invest in them in private investments. So you just see it as an inferior asset class. I don't want to say it's inferior, but for us, when we look at a liquidity premium and what we need, we want to invest in private investments that can generate a return that's 350 basis points above public equities. And public equities is 6%, so that gets you to 9.5%. We also believe that over the course of a four-year period, there's likely going to be some type of correction in some asset class across the marketable universe that's going to create a 20% opportunity. And we will not be able to participate in that because we're invested in private investments.

So we add a 5% opportunity cost to account for that per annum. So that gets you to 14.5. We round up. And so our line in the sand is 15 and if you have a strategy that doesn't warrant or can't deliver that type of returns you know oftentimes it's something like private real estate well if you look at public reads they've generated a return of roughly eight percent you know annualized over the long term so i can just do that it's not that we don't have that exposure it's just it's not giving me the premium that i need to justify the lack of liquidity

and so i'm not going to participate in private investments. We'll make the decision on the marketable side to bring that exposure in-house. Do you see capital that's locked up for 12 years, maybe as a pre-seed fund, the same as capital that's locked up for five to seven years, like a growth equity? Talk to me about the different shades of liquidity. We think about that. Absolutely. When we're allocating to different strategies, we're thinking about duration and risk. And so one of the things that we really try to juggle is IRR and multiple of invested capital. And so for us, we've talked about how we think about venture as an asset class and being very long duration.

You know, the party line oftentimes in venture is a three X net fund is a good fund in venture. And I think the follow-up question for us is, you know, that's fantastic, but how long does it take to get you there? And when you do simple math and you think about a 3x return over a 10-year period, you're getting roughly a 14% IRR. If you can have a 2x return over a five-year period, that gets you to about the same. I think the math strikes out to about 15%, but I can get that capital back, give it right back to the GP. And at the end of a 10-year period, if I get the same 2X return over five years, at the end of that 10-year timeline, we're left with a 4X versus the 3X that we were getting from the VC fund. We do think about it differently and we tend to overrate lower middle market buyout,

expansion capital strategies, groups that are investing in the middle of the country in a bootstrap business, because it tends to be a more repeatable process. It tends to be a more concentrated portfolio. It tends to have a shorter hold versus some of the other stuff that's out there, particularly early stage venture. A lot of your peers would say, I don't care about IRR. I can't eat IRR. I could only eat Moik. What would you say to them? Yeah, I would say, I think you have to look at them in conjunction. And while you can't eat IRR, you have to think about the benefits of compounding and you have to think about liquidity. And both of those matter to institutions. We think about them in conjunction when we make investment decisions. Unlike some of your peers, you do focus on fund one, fund twos. You focus on sub $150 million venture funds. Tell me about the rationale of your strategy when it comes to venture capital. For us, it's really just kind of lessons learned from the legacy portfolio that we have in place. We believe that at the end of the day, within venture in particular, it tends to be a hits business.

Within every fund, there's going to be one to two companies that really drive returns. And we're going to have a higher probability of generating the venture type returns that we think are necessary to justify being in the portfolio, which we define as 5x plus. And so we migrate to smaller funds. We also think groups managing a portfolio funds one through three tend to be hungrier. And we also think there's better loyalty and alignment with the LPs. And so all of those things we're attracted to and are willing to take bets on funds earlier with a smaller hungry team. A lot of, you know, if I gave some of your peers a truth serum, they would probably tell me that there's slight misalignment in terms of, you know, getting into the multi-stage platform funds seems more impressive than this is no name fund one fund two.

Why are you guys different? How are your incentives aligned in order for you guys to really encourage this type of risk-seeking behavior internally? One of the things that we think about is just if we look across some of those platforms, the numbers don't make sense. So if I'm looking at the types of returns over the duration that it takes to get there, the IRR math doesn't beat the other stuff that we could do in the market with lower middle markets and expansion capital. So for that reason, for us, it was an easy decision to look at other ways

to maximize returns within venture. I also think if you truly believe you can get outsized returns by making an investment with a smaller fund earlier in its fund lifecycle. And there's some great white runs out there with people who have spun out very well networked, great domain expertise, you know, tackling opportunities where there's gaps in the market. You know, the return profile for those is likely greater. So I can have less exposure. Maybe the commitment for us is 10 million versus your standard 20 million, but get a similar type of absolute dollar value creation from that. If we're wrong and it goes to zero, it doesn't have a detrimental impact to the portfolio because it's sized appropriately. And so I think that's a key piece of this is sizing your commitments in an appropriate way.

We don't size that early stage commitment the same way we would size a lower middle market buyout commitment. It's different in a meaningful way. Because of that downside exposure. Correct. How do you look at your exposure and your risk within venture? We think about the outstanding NAV that we have relative to all of our private investment dollars. Those portfolios are going to be more diversified, so they're not as concentrated

as everything else in the portfolio. We want everything else in the portfolio outside of venture to be an underlying portfolio company position of $3 million or greater. You know, venture's different. So we size those checks smaller. We understand that it's gonna be a longer duration. We understand that there's gonna be a higher loss ratio

and that you're really banking on one or two companies to drive returns. And we allocate the size of the commitment accordingly. In terms of concentration limits, do you guys care about, you mentioned $10 million check. What if it's a $15 million fund? Will you be 20% of a fund? Will you be 30% of a fund? How do you think about risk and concentration limits?

We would. We're willing to be a high position in a smaller fund. Generally, we like it. We want GPs who are investing with conviction and willing to make outsized bets. We want them to be uncomfortable when they sleep at night because we think that ultimately it's going to lead to better decisions. They're going to make sure that they get it right. They're going to pay attention to the details because you have so much on the line for this one particular company. We think it's a good thing. We also think in general, we were just overly diversified in the past. If you think on

average, an allocator has 25 GPs, three funds per GP, each fund has 15 positions, give or take. I mean, that's over a thousand portfolio companies. It's too many. And so we're happy to partner with somebody who's willing to have a more concentrated portfolio and we seek that out. You want everybody's kind of best ideas. You're already diversified as an LP versus within the fund. Yeah, absolutely. You seem to have a bit of a contrarian view on correlation between different asset classes. Are pre-seed and seed funds correlated with S&P 500?

Have you done any analysis in terms of cross-asset correlation and diversification or lack thereof? I think it varies by strategy. If you're looking at late-stage ventures, companies are staying private longer. There absolutely tends to be a high correlation between those companies in which you can get in public indices. And I think that's going to persist. The interesting things, I think, are just the supply and demand. So one of the interesting things that we saw was a massive correction in late-stage venture over this last growth investment cycle. As tech declined, late-stage got hit really hard.

So many people pivoted early stage, and those valuations actually started to go up, even in this market. A lot of dollars started to chase those companies. We're paying attention to what's going on in the public markets and making those tradeoffs of, is it a better time to invest today? Is there better value in public securities? Small caps, for example, has been an area that we've been excited about relative to what's going on in private equity and how should we allocate our dollars when we have excess cash flow. Moving to relationships with GPs, you guys are in a lot of great funds and have a great reputation in the space. How can GPs be better partners with Baylor? Yeah, I think one of the things we really look for is, you know, obviously groups who are transparent, but more than that, they're willing to share info and share intel and help us be in the flow. I think that's something that's really key in the business that

we're in. It's a game of information. And to the extent that we have GPs who are willing to be good sharers, we seek to be good sharers as LPs and try to leverage that as we are making investment decisions, you know, enabling us to ask better questions. But we really want to have a relationship with our GPs, and that goes a long way. What is some valuable information or intel you've gotten from GPs previously that's helped direct your investment? Going back even recently to what was going on with the regional banking crisis and Silicon Valley Bank in particular, just what are best practices?

What are people doing? And then you can share that knowledge with other GPs. If you're looking to bring in secondary banking relationships, who did you use? Who was helpful? Just one recent example, which was very relevant just as we went through our portfolio and we're talking through exposures and what people were facing and being able to bring that back to other GPs. Another example is we see a lot going on with the underlying portfolio companies and being able to be a connector and broker of relationships, connecting different GPs in our portfolio. If they don't know each other, trying to help them establish a relationship and it's resulted in M&A activity that's happened across our portfolio. Exits have happened as a result

of this. So just using our seat to be a good share of information as well. How do you vet the qualitative factors for GPs? What do you look for qualitatively? I think this is one that we've gotten better at with time. Obviously, we've got the references that they provide. We do a ton of work like everybody else on off-list references. More than that, we really want to understand who we're partnering with over the long term. We ask for personal references.

We ask for a neighbor. We also ask for somebody who you've had a long-term professional relationship with 20 plus years, a friend from college, just to try to understand who the person is, you know, how they've changed over time, because ultimately we think you are who you are. And so just trying to get a better understanding of who we're partnering with. And we really like to find a chip. I feel like some of the better investors in our portfolio have a chip on their shoulder and the reasons vary, but really wanting to invest with somebody who's motivated by something other than just pure dollars, because we think that's going to allow you to win

over the long-term. Congratulations, 10X Capital podcast listeners. We have officially cracked the top 10 rankings in the United States for investing. Please help this podcast continue climbing up in the rankings by clicking the follow button above. This helps our podcast rank higher, which brings more revenue to the show

and helps us bring in the very highest quality guests and to produce the very highest quality content. Thank you for your support. Do you use any third party referencing companies, any resources to help in your referencing? We don't. So everything. And how many on average references are you doing on a potential manager? The one we just did, I think we did 25. It was a new relationship. We will not do that many with each round. It'll go down over time. So we're pushing through two commitments right now. One is with a manager where we've made five commitments

at this point. Another one is a fresh manager. And so we did more on the new relationship. When you're doing it for a second, third, fourth time commitment, are you looking to make sure that those qualitative factors are staying constant in terms of the hard work, the value add? What are you trying to suss out from the re-ops references? Speaking to the one that we just did, and I think it's a really good example. Yes, it's making sure they stay constant, but it's also kind of trying to better understand the next generation that's going to take over the firm, succession planning, who are the rising stars. We will spend more time talking to portfolio companies and just making sure that they're still getting the same level of service that we would expect from when they were smaller, making sure things aren't changing as the funds generally

tend to get a little bit bigger with each iteration. So wanting to make sure that we feel like the firm culture and dynamics are staying consistent, but also using it as a way to vet some of the rising stars within each firm. We spoke previously, you're a big fan of spinouts. Why do you like spinouts? Yeah, some of the similar reasons within each firm. We spoke previously, you're a big fan of spinouts. Why do you like spinouts? Yeah, some of the similar reasons why we like funds, you know, one through three and smaller for venture. We think they tend to be smaller, they tend to be hungry and loyal to LPs that come in, which helps us maintain our allocation as we grow with the firm over time.

Even if you don't get all the way to pulling the trigger and making a formal commitment, it's a great way to vet and really understand the intel of what's going on at the prior platform and what's going on to the industry, why they moved, what they think their angle is and the gap that they're filling. Because there tends to be some type of motivation that helps them launch that firm. For those reasons, it tends to be a beneficial underwriting process, even if we can't get to the finish line. And oftentimes, I think if we don't get there, it's usually tends to be more often than not, we don't feel like there's been a well-defined framework or culture for how they're going to build the firm into a long-term generational firm. It tends to feel more like dealmakers and transactional versus a long-term approach. And I think sometimes people

underestimate the value of the platform. And so trying to really sniff out the attribution and what that platform brought versus starting a new flag, I think those are some of the reasons why we ultimately don't get there on every spin out that we review. You mentioned sussing out kind of attribution for the success of the managers. What else do you focus on when it comes to diligencing spin outs? I think oftentimes it tends to be not finite enough. Where we've gotten really comfortable is when they have a very tight box that's very directed at what they can do, what they cannot do, what they're good at, what they're not good at. Oftentimes to be a candidate, it's a lot easier if somebody has a prior book of business that they can point to and say, here's what we did. We're going to continue this or here's what we did.

Here's what worked. We're going to only do this going forward. It makes it a bit cleaner for us because I think we're really good at evaluating data. It's much harder for us to just say, oh, we think they're going to get it right. I don't think we've done a good job at that in the past. And so we want to stick to what we're great at. And we're great when we have a set of data to value. And that's where we tend to lean in.

You've been at Baylor's Endowment for 16 years. What do you wish you knew when you got started? I love this question. I wish that I would have asked more questions in the beginning. And I want to expand on that a little bit because it's not just asking questions. One of the things I love about this job is we have exposure to some of the best in the business, people who have really deep domain expertise. And oftentimes people come in and, you know, as we all do when we're passionate about a subject, you start really deep in the weeds and they don't break down the fundamentals. And so

when I'm getting started early in my career, I wish I would have had the courage to raise my hand and be like, can you break this down for me? Like I'm a first grader because I'm not getting it. I feel much more comfortable doing that today. And I feel like oftentimes when you're having that discussion, people are so happy to teach about something that they're passionate about. So there's a lot that you can learn when you come in and just break down the fundamentals. And I think you're sitting in that seat, you feel like, should I know this? And people coming in are feeling like, well, they probably know this. So I don't want to back it up too far because that's not productive. And so just helping whoever is giving you the pitch or

talking about the idea, understand where you're at and where you need to be to understand the fundamentals of how this business makes money, how the strategy works, why it's differentiated. So you can ask better questions down the road. And you started at the Baylor Endowment several months before the financial crisis. So tell me about that. So I started in May of 2008. I was at a multifamily office for a couple of years prior to that and came into the institutional investing realm, very green. And one month later, the CIO left. Like six months after that, the number two in the seat left, and we had quite a bit of turnover thereafter. So it was a tumultuous time in-house, as well as just everything going on with the GFC. In hindsight, it was probably the best thing that

could have happened for my career, because I'm getting all of the lessons learned from the global financial crisis, seeing everything break. But I don't have any attribution for making any of these decisions, right? Like I could just kind of sit back and watch and be like, oh my gosh, this is terrible. But it was really good lessons learned for, you know, what not to do going forward. You guys have consistently beat the large endowments. How would you attribute Baylor in Texas beating the large Ivy League endowments? What's the secret to success? Yeah. I mean, listen, it's an honor to be in that crowd, right? They've been crushing it for a while. One of the benefits that we have, again, is our size.

With a $2 billion endowment, we can do a lot of things that a $30 plus billion endowment cannot do. So we use size to our advantage. We use it, you know, are able to be nimble and rotate capital around in a quicker way than I think most of our peers. Also, I think we have the benefit of sitting here in Waco, Texas. We're not constantly in the flow in terms of what's going on at the coast or different meetings. We're a little bit isolated. And so it allows us to kind of go on the road, which we travel quite a bit, come back, sit with our thoughts. And then we have the freedom to be contrarian and come to a conclusion that we think is right for the portfolio, make an investment decision, and aren't constantly reminded of what everybody else is doing that we're not when we go to a cocktail party or to a dinner.

And so I think that works in our favor because we are a little bit isolated on that note. It allows us to maybe think a little bit more freely without noise coming in and making us question the calls that we're making that might be different. How much does governance and your IC play into your structural advantages? It's huge. So we've really been, you know, we view our Baylor Executive Investment Committee as just a function of our team. And so without them, we wouldn't be able to be as nimble, as I mentioned. I mean, they've been very flexible with allowing us to jump on a call to get the recommendations that we need for a co-investment or to execute a strategy in between the quarterly cadence. We also have domain experts on our board that serve as reference calls for us, connect us to

people within different strategies that we're vetting, and they help us set asset allocation and talk through those different things. Our board has been instrumental in our success, and we've also gotten to a really nice cadence of when people roll on and roll off. And we've got this really nice deck of institutional knowledge that's been there for some time and in place. And that continuity has been really key to our success. What would you like our listeners to know about you, about Baylor University, about anything else you'd like to shine a light on? I feel really blessed to be in the seat that we're in at Baylor.

It's my alma mater. Our investment team, four of us graduated from Baylor. And I think that, you know, being alums, being from the Waco area, it just gives us a nice passion for what we're doing and helps us stay really aligned with the mission of the university. At the end of the day, at the highlight of all of this, just kind of bringing it back to the core of what we do and why we do it. We want every endowment out there to win and generate quality returns because it just means more students are going to get a great education. And I just want to bring it back to that because that's the reason why we all do this. And that's

why it's really important to highlight the issues that you're addressing on the asset allocation and just make sure we're all thinking about the risk that's out there to generate the best returns. Because as these pools of capital get bigger, it just means more people get to go to school. Well, as always, overperformance over long periods of times is rarely random. So I really enjoyed unpacking the strategy and learning more about Baylor. Thanks for jumping on the podcast. All right. Thanks, David. I enjoyed it. For more ideas on how to raise venture capital in this market, make sure to subscribe below.