Investing Billions - E118: Loyola University's $1.2 Billion Edge

Episode Date: December 6, 2024

In this episode of How I Invest, we’re joined by Michael Kakenmaster, Director of Investments at Loyola University Chicago. Michael shares his journey and expertise in managing university endowment portfolios, with a focus on private markets and hedge fund strategies. He offers valuable insights on how to build sustainable, diversified portfolios and the strategies that have led to success in his role. We also discuss the evolving landscape of venture capital and how institutions like Loyola are adapting to market changes.

We have two venture funded fund commitments. One is focused on China VC, but they also have a US focused fund strategy and the other one is just a pure US focused strategy. What have been some of the most valuable lessons you've learned from your alligator friends as it relates to venture? If you're raising 50 million dollars, what does that look like? How many companies? What's your ownership target? What's your follow on? Or if you want to raise 100 million dollars, I think there's a big leap in what you have to do as a VC to kind of get allocation to when you're writing a $250,000 check into a round. It's a lot different than when you want to write a $1 to $2 million lead check into a

seed product. And so it takes a different skill set. You mentioned earlier that you have an opportunistic bucket. One of those opportunistic investments you made is into a helicopter lease fund. Tell me about what made you invest into a helicopter lease fund. It was actually something that was born out of my time at a family office prior to Loyola. So at this office, we had been kind of investors in private credit for a number of years. I'd say they, you know, hacked it to them. They were investing in private credit for a number of years. I'd say they had tipped to them, they were investing in private credit managers in the early 2010, 2011. So, spreads were nice and wide. You got after-tax return, after-tax yield was attractive, I think, relative to public options.

But as time went on and markets matured, and this was still back in like 2018, but by then, the private credit markets were a lot bigger than they were eight years prior and spreads were fairly narrowed. Just were in a low interest rate environment at the time. So there wasn't a ton of risk reward to be had going after tax yield, after tax returns for the family. And so we set out to try to find an alternative. And we came across this new fund that was looking to buy and lease helicopters. And there were some interesting tax benefits to it that the family got on board with. And so we ended up making a commitment. And fast forward, I come over to Loyola and this manager was looking to raise their second

fund. We had carved out this opportunistic private investment bucket to do interesting things that weren't necessarily a venture investment, a growth equity or buyout to leverage just our sourcing network and do stuff that we found can return something within our return thresholds, mid to high net return perspectives, and mid to high team net returns and do so in kind of a differentiated fashion. So we being the endowment, we don't have the kind of tax implications of family office, but we were able to kind of get comfortable with the strategy here and we're able to make

a commitment to the second fund. Does it basically just come down to there's just a limited supply of capital that's able to invest into something like a helicopter fund? So these very unusual or esoteric investments have this embedded premium? Talk to me about that. This kind of goes into a lot of things that we find interesting where there may be smaller market opportunities. And so you don't have a lot of maybe name brands, investment firms that are larger go after them because it just doesn't move the needle for them.

And I think in the aviation finance market, there's a lot of what you call commercial aircraft leasing funds or rail car leasing funds. And those are big markets. I think they're well understood. And the returns are, I think, easy to predict or expect because it's... Again, the market is very efficient in that matter. With helicopter leasing, one of the things that we did a lot of work on was just the

history and the why. If the esoteric market is so attractive from the return perspective, why isn't there more capital? And in this case, I think a couple of things was, historically, what we learned is that there were some tougher stories, some tougher outcomes for different helicopter leasing companies that I think might have deterred a lot of investment firms from taking a look. I think the implication of owning versus leasing aircraft, the economics of which was probably

not widely well known. I think in this case, this manager would tell you that leasing versus owning makes a ton of sense. And so there was, I think, just case, this manager would tell you that leasing versus owning makes a ton of sense. And so there was, I think, just a lack of just fundamental knowledge of the market. And just maybe if you did a quick Google search on some of these legacy players and maybe one bankrupt or out of business, you say, I don't want to spend time there. It seems like I might do that when I got perfectly good like midlife, commercial jet that I can lease and have a little bit more understanding of what the risk return is. So, I think that's kind of with this specific asset

class, the reason maybe kind of parlay that into applying parallels to other asset classes that will go more off the run. So, there was a period of time in the space that did not generate good returns and those circumstances have changed such that today from a first principle basis, it makes sense here. You're getting essentially a free premium for non-additional risk. Free premium, I don't know if that's, it's always the case here if I had a free premium, but there's certainly some risk inherent to it. I mean, that's something that we get comfortable with through our due diligence. But yeah, I think finding these markets that are very overlooked and you're able to go in and be a institutional capital provider

is a nice place to be in. So we were happy to support Ms. Manjurajan. Walk me through your process for diligencing these unique asset classes like helicopter leasing. So it comes to your desk, how do you process an incoming diligence? We have a small team and I'd say we are very big proponents of putting certain strategies into like the too hard to understand market. Where if we can't understand and confidently effectively communicate why a fund performed the way it did to our board, our committee or our stakeholders, we shouldn't be doing it. And so when we look at something that's a little bit more esoteric, like helicopter leasing, we make sure that is at something that's a little bit more esoteric like helicopter leasing,

we make sure that is this something that we could discuss with our stakeholders, our board, our committee in a way that they would understand exactly what the return profile is, the risk profile, how they make money, etc. And with this one in particular, I think that the best way to do it is, and what we did here is kind of frame the strategy or the asset class in a way that's familiar to us. And then work with the manager to kind of tell us where we're right, tell us where we're wrong, tell her where it's similar, tell us where it's similar, tell us where it's different. So with this leasing strategy, I say, I understand how...

I don't own apartments, but I've leased an apartment before. I understand how that process works. Walk me through how it's similar in terms of just the structuring, the term of the lease, the pricing, how is it different? What sort of insurances are you taking, things like that, to come out with, okay, this is exactly how this market operates. And now I understand it through a lens of something I'm more familiar with but now can communicate it in a more effective way. I should say that there are a lot of nuances to this particular strategy that I'd say the manager is much more qualified to walk you through. But we really spent a lot of time

with him and just asking a lot of what may be perceived as dumb questions. But it just... I think that's one of my biggest learnings in my career is ask those questions early because it helps really kind of set the table and help you learn. And how many people in the space do you speak to in order to underwrite what the manager is telling you and to get more comfort around the strategy?

We spoke to with this one, a lot of references that just, you know, we're familiar with leasing, maybe more other aircraft leasing verticals, just trying to understand partially back to what we said about just why or why not helicopters. And doing a lot of research into the history of the market, speaking with folks that might have a little bit more knowledge. It's a lot harder to find those folks for a helicopter leasing strategy than for a venture fund. But hopefully through our network, we were able to find a few people. I'd say also the benefit of Loyola,

we're not unique in how to invest in committee, but we have a lot of smart people that kind of look at what we're investing in and a strong affiliation with the university and want us to do well. And so they have various backgrounds spanning from private equity, venture capital, hedge funds, real estate.

And so we show them something like this and they ask us a lot of questions that maybe we didn't think of and have a different perspective on it. In one case, one of our IC members had invested in a company that I believe had business in the aftermarket helicopter parts business. And so he just had a unique insight onto, hey, how is this manager valuing these helicopters? What's their terminal value underwriting? Because eventually, they're going to sell these things and that price can vary based on XYZ. And so that just kind of opens up us for more questions, learning more and stuff like that.

So it's a really iterative process that we can kind of get to our final answer. In venture, you have this paradox where the best investments oftentimes don't have the support of the entire investment committee. There's disagreement around it. They end up, you know, returning a hundred X, a thousand X and some rare cases. Is there similar dynamic and other asset classes where sometimes controversial ideas could lead to some of the best outcomes? Oh yeah. No, I think so.

I think, I mean, if you're investing in something like venture, from the perspective of a VC fund, I think finding things that are off the run, not love, kind of out of vogue, that's how you generate the best return because you're coming into something that other investors have said, no, thank you. So maybe you're getting a better price, you're a first mover into something. And so that maybe gets more deals in that space. So I think that's pretty common. In public equity markets too, I think having a differentiated view on a stock or in credit markets on a bond, it creates this unique entry point that if you're right, you can earn an excess return to different degrees.

So I think definitely having a differentiated viewpoint is important. Having a differentiated viewpoint amongst your investment committee, I think is helpful for conversation. But obviously, the other day, you want everyone to be on the same boat. It's never great to know that if you're investing in a fund and there's dissension among the investment committee, but they're making the investment anyways, that opens up a whole swap of questions you want to ask about what their process is like, how do they construct the portfolio. So, I think it's yeah, having a contrarian view is great.

But obviously, you want everyone that you're investing in the fund is to be going in the same boat or in the same direction. What are some of the characteristics that makes the best investment committee member? Asking good questions, understanding of just the portfolio, the strategy, our process is really important. Being helpful where you can, I think pushing back where appropriate is important as well. At Loyola, you have $1.2 billion under management and you have these ranges across your assets, meaning you could invest, it's not a fixed amount, but it's a range. How do you make

the decision where the incremental dollar goes, whether it's private equity, or venture capital, or private credit, or helicopter leases? Well, I think we're pretty well structured when it comes to deployment. Since on the private equity side, we're in the midst of growing that allocation. We have a unique position relative to some other allocators where we can lean in and we want to add exposure. And I think there's some bandwidth and capacity limits to, hey, can we do 10 venture funds? I think that would be... In a given year, I think that would be a lot. So try to have a good mix. I think in our private equity portfolio, we're going to lean more on the buyout side, but definitely want to keep doing venture and so keep that balance. But across the whole portfolio, when we think about

the incremental dollar, I think we know exactly this slight overweight that we have in public equities that can go help fund our growth in the private equity side. Our hedge fund portfolio is fairly well built out. If we want to add something, that means something has to come out and manage the portfolio from there. And then this opportunistic bucket, as I said, is an area that we can, in a way, scratch the niche that we're seeing, you know, if it's an interesting opportunity coming through our network that we feel offers a nice risk-adjusted return for, you know, liquidity that we're giving up, we want to be able to pursue it. You have a relatively new venture program. You started in 2022. Walk me through how you went about building your venture capital investment. Lots of meetings. It's just that I, I, I've never been one to manage my calendar well,

but when it comes to venture and we've, we've decided to kind of focus in on the earlier stage and I can talk a little bit about that as well. But there's a lot of GPS out there, a lot of new GPS, a lot of existing GPS. So I there's a lot of GPs out there, a lot of new GPs, a lot of existing GPs. So I have done a lot of meetings. I've gone to conferences where I can and just network. And so that's been the process so far. We did early on. We have 2 fund-to-fund, venture fund-to-fund commitments. One is a firm that... One is focused on China, BC. But they also have a US-focused fund-to-fund strategy and the other one is just a pure US-focused strategy.

So we lean on them to help us maybe craft our asset, our venture strategy. And then as we're seeing things that we think are interesting, maybe there's a shorter fuse on the capital raise, we can reach out to these fund-to-funds managers and be like, hey, can you give me five minutes on this GP versus that? And really, we should be focusing on one or the other. Let us know. Or if both are kind of not interesting for various reasons, we want to know that too. So we can kind of get to answers and refine our pipeline as quickly as possible. The other piece too is my allocator network. Folks that have had more experience and time investing in venture capital than me. I really try to pick their brain as much

as I can on not just like, what are they investing in, but how are they evaluating managers? I think the way you look at a seed stage fund that's raising $30 million is different from the seed stage fund that's raising $200 billion. That's different from a series A and B fund that wants to raise anywhere from 100 to $300 million. So a lot of nuances come back. And I think there's not one perfect way to go about doing it. If you looked at our venture portfolio today, you'd see funds ranging from that $70 million up to $200-$250. And so we've played across just take smaller ownership positions, we take bigger ownership position, what's their follow on policy, their reserve ratio,

all that stuff. And a lot of that just due diligence questions and understanding has just come from picking the brains of allocator friends that should say, thank you now because it's been a big help because it's helped us get up to speed. It's been a steep say thank you now because it's been a big help because it's helped us kind of get up to speed. It's been a steep learning curve. And so it's been just instrumental into our venture portfolio development. What have been some of the most valuable lessons you've learned from your allocator friends as it relates to venture?

With Reventure, I think it's again, coming down to fund size and strategy and what was a you know, looking at a GP's previous track record, whatever that might be, whether it's angel investing, or they've worked at a different fund and how to frame that into what they're doing prospectively with their current fund. And you talk a lot about, if you're raising $50 million, what does that look like? How many companies? What's your ownership target? What's your follow on? Because... Or if you want to raise $100 million, I think there's a big leap in what you have to do as a VC to get allocation to... When you're writing a $250,000 check into a round, it's

a lot different than when you want to write a $1-2 million lead check into it. So it takes a different skill set. And that's something that at first, I didn't quite realize. And a lot of the emerging managers that we talk about come from different backgrounds. And let's say they were working for a tech company, making angel investments in friends and colleagues. That is great. But how translatable is that to what they want

to do, perspective? I think just figuring out those nuances between... Does the VC understand portfolio construction, portfolio management? How does their strategy scale? It's been a big learning for us and something that we're just incorporating so much into our conversations with new VCs. Let's move to hedge funds. Loyola has a pretty substantive hedge fund portfolio. What do you look for in hedge fund managers? We have event-driven managers, we have macro managers. Macro environment can be pretty dynamic depending on your breadth of focus. If you're looking at global markets or emerging

markets, belt markets, things like that. We have some smaller kind of event-driven strategies that I think are looking at different corporate events from a unique lens. And so yeah, so we also have some arbitrage plays and some relative value investments. So there's all these markets that I think are good hunting grounds. What we've done over the past few years is trade out of managers that are, call it, bigger, long-short, generalist strategies where I'm not seeing a ton of differentiation in the returns. They might have a little data because they're running lower net exposure, but really when you do the analysis, you're seeing there's not a lot of excess return on their invested

capital. So really looking for folks doing unique things. Given our public equity exposure being the biggest allocation, we certainly look for strategies that are going to provide some diversification to that public equity data that we get. So I'd say we wouldn't really consider something that has a high data, but a lot of our managers today are calling it a low beta, low correlation. It's all like a beta sub 0.4, which is great. So it adds some diversification. We're not giving up a ton on the return side. So that adds a lot of utility to the overall endowment portfolio.

And then on the qualitative side, it's the same across every entry we look at, but like, strong alignment. I mean, we need to see that there's... We're all kind of working for the same goal, which is the best risk-adjusted return at the end of the day. And how are they getting there? I mean, if it's a... You got to walk through the process and walk through investment examples and have to really determine if this is something that is repeatable, if they're disciplined in their approach, which can have many factors. And obviously, focusing on the same market, having a stable team is important. So, how repeatable is this process? If they had success in the past, what's the likelihood they can do it going forward? So really kind of dig it on that

side too. So it's multifactor approach. A lot of things that we've looked for, maybe taking into account. Do you believe in the fish and market as it relates to the public markets? This is probably not the best answer, but I think there's different degrees of efficiency. I think that there's, if you're looking at... If you try to invest in large and mega-cap US-listed companies, that's going to be tough. If that's your bogey, it's going to be a tough bogey to beat because those companies are well covered, not only by the sell side, but just different publications, media, social media.

Everyone has a view. And I think a lot of that information is priced in the past and future. As you go down market into the small and microcap space, where you find things that aren't well covered, then you see maybe more pockets of inefficiency. And you can look outside of the US into emerging markets, or just international stocks, because sometimes the street just doesn't know how to cover those appropriately. Yeah. And it seems like the efficiency is correlated with the amount of capital in it. You even see this in around the election,

you see the betting markets and the less liquid ones seem to have a higher spread than the more liquid ones, which are much tighter across the platforms. For sure, yeah. What do you wish you knew before starting at Loyola's endowment? Honestly, I think it would have been nice to maybe have a few more reps with venture capital managers

and a little more knowledge on the venture capital market and its history. It's funny because when we started looking at venture, I sometimes felt silly because there are certain firms I just... I was like, who's that? They would name a well-known VC fund and I'd be like, oh, I've never... Who are they? What do they do? And maybe the people I were talking to looked at me like, who is this guy? So that was a bit of a learning curve for us. Understanding some of the dynamics that go into portfolio management and construction would have been helpful.

But I'd say that, but I also believe that the time that we were investing in or starting to look at venture. So I started looking when I joined in Loyola in early 2021 and then more earnestly in 2022. You could make a strong argument that the market was fairly distorted at that point in time. And our apprehension or maybe just our patience or just our way of still playing our deployment worked to our advantage because we didn't put a lot of capital to work in those years. We really, I think our commitment pacing is picked up in 2023 and now in 2024. So,

knock on wood, we avoided some of the excess and maybe avoided investing in managers that might not have the fund to or subsequent fund. So, it'd be great to have maybe a more leg up on VC market history and underwriting, but maybe it works for a benefit. I think the one pattern that I hear across asset managers, especially the expert managers across multi-assets is whenever they enter into a new market, they make sure to size their checks small. They know they're self-aware enough to know that they have ignorance in that space and

that they're paying off their ignorance debt in the first two, four, five, 10 investments, depending on how different of a market it is from asset testing. Well, Mike, I've really enjoyed our conversation. Thanks and look forward to seeing you down soon. Thanks so much. This was a lot of fun. Appreciate the time. Thank you, Mike.