Investing Billions - E12: Jamie Rhode on Why 95% of LPs Can Only Achieve a 10% IRR when the Mean Return is 50% IRR | Why High Ownership % is Overrated | Investing into First Time Fund Managers

Starting point is 00:00:00 We talk to GPs a lot about don't be so focused on ownership. Make sure that you're in a winner. So you can have your core strategy and your targets. But if you think this company is going to be significant and all you can write is a $75,000 check when your typical check size is maybe $500,000, do not pass. We saw one GP write a $75, into a startup, and they had 120 companies in their portfolio. It was a $27 million fund, and that 75k check turned into 30 million of DPI. Jamie Rode, you've spent your career in really quantitatively rigorous roles in BlackRock to

Starting point is 00:00:50 Bloomberg to today as an LP, Advertis Investment Management, a single family office that's in its 10th generation, which is a little bit wild, but that's quite an accomplishment. Tell me about the data-driven approach that you bring to your role today. Yeah, I think it's a great question. And thank you for having me here. We talked about this stuff before the podcast. And my initial reaction was, oh, my time at Bloomberg, I had a data-driven approach there. I worked with data. And then I really thought about it.

Starting point is 00:01:19 And it's funny because when I started my career, I thought data-driven meant analyzing data, analyzing spreadsheets to be able to predict or make investments to make more money. And sometimes you're going to be wrong, but if you're a good data-driven analyst that you're going to be right more often than you're wrong. Now I have a total opposite opinion that I don't think being data driven necessarily leads to being able to predict winners. My time at Veritas and what we do with data driven really means using data to guide our investment decision making process. We're very long term investors and we use data to our advantage along with duration to our

Starting point is 00:02:06 advantage. So data here is really thinking about it from how can we create an edge in making our investment strategies and making our decisions, but not necessarily using data to predict who's going to be the next big winner. You mentioned you use duration to your advantage. What do you mean by that? As an individual, I have a lifespan of hopefully maybe 100 years, maybe if not longer. But working for a single family office that's in generation 10, our timeframe is multi-period. So we're investing for the very long term. And even individual investors, they have these biases that it's really hard not to make tactical decisions and you worry about short-term market moves. But at a family office where our

Starting point is 00:02:51 mandate is to compound capital at the highest rate possible for the longest period of time, there's some risk caveats there. The family can only tolerate a max drawdown of 10% to 15% on a rolling three-year basis. We have about a 1.5% payout of NAV. So those are two key contributors to how we build our asset allocation. But the time horizon is long. So when we're investing, we're not worried about the next two to five years. We're worried about the next 15 to 50 years and really focused on capturing steady state returns and where are my investments today going to be 10, 15, 25, 30 years from now. One of the most underrated aspect of being an LP is the adverse selection of LPs themselves. If you think about venture capitalists, GPs,

Starting point is 00:03:49 LPs worry about adversely selected, but it's a two-way street. And a lot of LPs are adversely selected. And then the question becomes why? And the answer is because they have not yet earned the track record of being positively selected. Every LP should be self-aware enough to understand that when they're in the marketplace, they're competing with institutions and family offices like Virtus that have been investing for 10 generations. When Jamie goes on my podcast and says we're long-term patient capital, that's not just a bumper sticker. That's actually something that you've earned over 10 generations. It's important to be self-aware. And if you're new to the game, what ways can you differentiate to compete against this in this hyper-competitive market? Because as we'll talk about, venture capital is more bifurcated than any asset class. The reason I wanted to have you on is you are very data driven against something

Starting point is 00:04:32 everybody else says, but you are to your credit. Before you even go into your data, how you went out building out your venture capital portfolio, I believe it was eight years ago. What was the first principles approach that you took? Yeah, I would say that the journey of shifting the family's exposure, which for the first 10 years or so of the family office, which started in 2004, was multi-stage focused. We fell into what I would call the cliche trap of venture that we needed big brand name access to get venture like returns. But around 2016 or so, we went on this journey of understanding that early stage venture is power law driven and that it can offer extremely

Starting point is 00:05:13 unique returns that we could not find in any other asset class. And the venture portfolio is the compounding machine for the family. We do not look to venture for DPI or liquidity, I should say. DPI needs to happen at some point, but it's not the liquidity bucket. We have a hedge fund portfolio, a long-only portfolio. We have buyout. We have real estate. Each asset class has its purpose. 90% of your return comes from your asset allocation. So asset allocation is really important and venture's role is to compound capital. So shifting the family's exposure to funds that write the first institutional check into a startup have allowed us to seek out compounding growth. We went down this journey, we realized, hold on a second. Public markets, buyout, real estate, they're normally distributed.

Starting point is 00:06:06 Those means and medians are very, very similar. So if we want to outperform, we need to be concentrated and pick the best companies or the best funds to give us access to those companies and outperform. In venture though, the mean return is so much greater than the median, four to five times greater that we were like, hold on a second, this distribution looks different. So do we have to go about investing or what we call here at Veritas, sampling the asset class differently. And so we went about realizing that because it's power law driven, we need to seek out capturing that mean return, not the median, because the median return is below public markets or below buyout. And those asset classes offer lower risk relative to venture. Let's repeat that. So you're saying the median is significantly lower than the mean. How could that be? With a power law, it is simple as the small number of winners drive all the return. So when we look at the data set, we see that it's a Pareto. It's 80% of the returns come from 20%

Starting point is 00:07:21 of the funds or 20% of the startups. And so it's really, really important to be in those outliers because the 2% of the winners make up for all the losses. Let's put some numbers to what you're saying. If you look at that mean return over 1990 to 2017, the neutrally weighted IRR. So if you invested a dollar into every single solitary fund, you would have gotten a 50% IRR, where the median is more like a 10. And so that's kind of strange. Wait a second. If I did every single solitary fund from 1990 to 2017 in early stage venture in the US, I would have gotten a 50. But if I only did a handful over those years, I would have had a high probability of getting the median, a 10. That's strange. So what we did was a Monte Carlo analysis that said, okay, how large of sample do

Starting point is 00:08:22 we need to capture that mean return? Because in the public markets, which are normally distributed, you don't need a lot. I mean, the Dow Jones is 30 stocks and the Russell 3000 is 3000 stocks. And they're about 96% correlated. So 30 stocks gets me the index, okay. But in a power law, you need to sample differently. So we went through and ran an exercise that said, if we capture 20% of the underlying US seed ecosystem, we are 95% confident that that mean return would be within our sample,

Starting point is 00:08:59 or essentially that we could capture that mean return. So you looked at the entire data set of all startups, because what is a fund? A fund is something that invests into startups. And you ran a simulation on what percentage of that entire universe you would have to have a predictive sampling of having the mean return. How does that translate into your portfolio? Reminder, long-term investors. So we look at steady state returns, we made assumptions that about 2,000 startups per year get their first institutional check. So over a three-year period, that's 6,000 startups. And the way we think about investing in venture is on a three-year period

Starting point is 00:09:38 within our internal vehicles. And so if we could sample 20% of those 6,000, so 1,200 underlying startups, we would have that confidence to capture the mean return within the 1,200. And it's interesting, the market data tells you that about 1% to 2% of startups in any given vintage year become an outlier. So the baseline was 1%. We built our portfolio to be a better beta version of seed stage venture in a simplistically ETF style way. And so we target key networks and geographies with consistent outlier production. So we underwrite to a 2% outlier production rate. So we targeted managers that could give us access to those startups in the key networks. YC, which has more of a 5% outlier

Starting point is 00:10:34 production rate, the Teal Fellowship, the Stanford Network. We also like California. We're along California. They produce a lion's share of the outliers. And it's not just outlier production rate, it comes down to expected value. What are those companies exiting at? And California exits are huge. In terms of making sure that you're not adversely selected, what is your strategy? Yeah, so that 1200 company exposure that I mentioned, that exercise that we did is without replacement. So those 1,200 companies need to be unique. So when we're going about seeking managers that can give us exposure to the 1,200 startups, we need to be cognizant of their networks and who their co-investors are.

Starting point is 00:11:20 So we built an internal network graph that shows our existing ecosystem today. It also shows key VC funds that we want to see as co-investors. And so we built this network graph. So any new GP that we're considering, we'll overlay their network into our existing network to see, are you enhancing my network diversification that I'm looking for? Are you just giving me exposure to the same startups that another GP is giving me access possibly can. That is what drives that mean return to be so high. And we ran this Monte Carlo and this simulation and had this confidence before we started deploying. And a lesson learned that we saw with the data is that if you capture that mean return, it's highly correlated to the top quartile returns in venture. So if you capture that mean return, it's highly correlated to the top quartile returns in venture. So if you capture the mean return, you're essentially capturing the top quartile return

Starting point is 00:12:53 in early stage venture. So it sounds like a great philosophy. Now let's talk about results. How have you done? In the beginning days, my biggest fear was finding fund managers that matched the philosophy that we had. But in late 2016, the family gave us some small dollars and said, prove it. And so we went about investing in 20 seed stage funds over four vintage years, 2017, 18, 19, and 2020, and have 1300 underlying portfolio companies and 38 unicorns, which is significantly greater than the unicorn count that we expected. We expected somewhere between 7 and 18. Now it's still early days. So who knows what it's going to look like at the end. And we underwrote to about a third of the portfolio being total zeros, and we're well below that today.

Starting point is 00:13:46 It's definitely shown us that the data-driven approach and taking a more diversified approach to investing in venture is something that the family is comfortable with because I think a key piece of being diversified is the path to a venture-like return is much more smooth. You smoothed out the volatility by being diversified versus being concentrated. It's a lot more volatile of a journey. Your standard deviation is much higher. Was there a power law aspect within those unicorns? Did you have one or two companies that really outperformed significantly? And how did that affect your overall portfolio? So I would say it's early days. When I look at those unicorns, most of them haven't reached the EV values that we've underwritten them to.

Starting point is 00:14:35 There's a couple that are significant. What was great is we talked to GPs a lot about don't be so focused on ownership. Make sure that you're in a winner. So you can have your core strategy and your targets. But if you think this company is going to be significant and all you can write is a $75,000 check when your typical check size is maybe $500,000, do not pass. We saw one GP write a $75, into a startup, and they had 120 companies in their portfolio. It was a $27 million fund, and that 75K check turned into 30 million of DPI. So small checks in large expected value winners are significant and can really return a whole fund. So it's important to hold your

Starting point is 00:15:26 opinions loosely. And that's a philosophy that I have had to learn working at Veritas. Hey, we'll continue our interview in a moment after a word from our sponsors. The Limited Partner Podcast is proudly sponsored by AngelList. If you're a founder or investor, you'll know AngelList builds software that powers the startup economy. AngelList has recently rolled out a suite of new software products for venture capital and private equity that are truly game Thank you. office provider. If you're in private markets, you'll love AngelList's new suite of software products. And for private companies, thousands of startups from 4 million to 4 billion in valuation have switched to AngelList for cap table management. It's a modern, intelligent equity management platform that offers equity, issuance, employee stock management, 409A valuations, and more. I've been a happy investor in AngelList for many years, and I'm so excited to have them

Starting point is 00:16:23 as a presenting sponsor. So if you're ready to level up your startup or investor in AngelList for many years, and I'm so excited to have them as a presenting sponsor. So if you're ready to level up your startup or fund with AngelList, visit www.angellist.com slash TLP. That's AngelList slash TLP to get started. Back to the show. You've said something very heretical, and our mutual friends, David Clark and Michael Kim, will send you to the principal's office. Yeah. How do you reconcile? Obviously, Michael and David have a phenomenal track record.

Starting point is 00:16:53 How do you reconcile their philosophies with yours? I think when you look at LPs that invest in funds and when you do multiple funds, in theory, you're leaning into diversification because you can do four funds that do 25 deals each and that gets you to 100. Or we could do two funds that do 50 deals each and that also get us to 100. Now, so you can be diversified through fund-to-fund style vehicles. But the key piece, and I mentioned this earlier, is the journey. So we've done some analysis that shows being concentrated and focused on ownership or being diversified and focused on shop on hold

Starting point is 00:17:33 over the long period of time gets you to a very similar place in terms of your return. But the path is way different. The volatility. So focused on ownership, if you're in a fund that's only doing 20 to 25 deals, if you catch a winner, that return could be huge. No doubt about it. But if you don't catch a winner, then your return could be awful. It's a high risk situation of either catch a winner or you don't get a venture-like return versus if you do 50 deals and you don't catch a winner, your return may not be as awful. So for us, we see it as a smooth volatility type of journey to the very similar expected return of the two portfolios. Also, the expense to onboard a GP is significant. I don't know what their due diligence process is like,

Starting point is 00:18:34 but for us, we do background checks, we do legal review. They need audited financials. I'd say legal review gives me a big headache. We're married to these GPs for 15 years and my CFO does not let me forget that. So if I have to churn out of a manager because they failed or because they've stage drifted or they're not grounded in seed stage venture, that's costly and that's expensive. So we want to build this portfolio in the most efficient way possible and give our GPs the highest probability of success, which we believe is a more diversified approach.

Starting point is 00:19:10 You mentioned the cost of onboarding. Many people in the industry, when I talked to them about you, they said you're one of the most disciplined investors in venture. Seriously, tell me about your discipline. Tell me about your sandbox and tell me about the criteria that you look for. I would say holding your opinions loosely is a key philosophy to working at Veritas. So we're a single family office and we don't just invest in venture, there's other asset classes. And so it's really important to be humble and kind. And just because something doesn't fit perfectly in my sandbox of 50 deals and no reserves doesn't mean that we shouldn't consider investing. And we've absolutely made investments like that. What's important to us is making sure that the GPs have long-term plans to stay grounded in seed stage investing. So we'll underwrite the GPs not only for their current fund, but for future funds, because this is a marriage and we're sticky

Starting point is 00:20:10 capital. We really look heavy into their sourcing. We'll stress test their portfolios. So we'll really look heavily into what we think the expected value of their exits are. So we also do life sciences, which is a totally different profile. Therapeutics has a 10% outlier production rate, lower exit values. General tech is 2%. Higher exit values, especially California's exit value is $9 billion. And so we'll do a lot of that. We'll do a lot of institutional LPA work. We spend a lot of hand-holding time around those LPAs. We'll do significant references. And I think a lot of LPs do the references on list and off list. Also, what's unique is our CFO will do a lot of

Starting point is 00:20:59 operational due diligence and have conversations with the GPs and their service providers just to give them best practices and say, you know, we've invested in so many funds, not just in venture, but across the board. This is what we've seen as best practice to build a firm over time. And that's advice that I think a lot of our GPs really appreciate. I'm sure some GPs do not pass this operational due diligence. What are some red flags and what has made you say no when the returns are good otherwise? very, very important. And if your LPA says 120 days after year end, I'm going to report and you miss that, communicate it. Things happen. Mistakes happen. I mean, even in our public markets portfolio, managers draw down and we expect it. Just be transparent

Starting point is 00:21:59 about it. And so say, hey, I messed up or this was an issue and now I'm going to switch this service provider around. Just being humble and kind about the challenges that you're dealing with and telling your LPs that this isn't up to par, I'm having issues, can you help me figure out how to hire the best service providers and stay on top of it is really important because as a taxable LP, I have to file taxes by a certain timeline. And so we found that not all GPs, and we understand it, prioritize the operational piece of running an institutional firm. And we've seen a bifurcation between some GPs that prioritize it and they raise more institutional capital and some GPs that prioritize it and they raise more institutional capital and some GPs that don't

Starting point is 00:22:45 prioritize it. Let's talk service providers. I know you also use a lot of data sources. Tell us about your data stack and also what you see as the best practices for GPs in terms of their service providers. I think for the GPs, it also comes down to your fund size and how many GPs that you have. We back solo GPs. We love solo GPs. We don't have any issues with that. But if you can have someone that's maybe even part-time or if you could leverage now AI or any type of apps out there to really make your time more efficient,

Starting point is 00:23:17 and if you prioritize the back office piece of it, some GPs blame the service providers, some GPs blame themselves or different situations. I think it's just sitting down and thinking about the type of firm that you want to run. For us, the tech stack, we use a lot of what I think most LPs try to take a look at. We love PitchBook, we love CB Insights. We'll use Burgess data, which is our favorite because that's LP reported cash flow. I mentioned this before, but we look at steady state returns. We look at what the underlying distributions are and what the downside is and what the upside is. And we needed a data set

Starting point is 00:23:58 that would show us what the long-term steady state return is of each of those asset classes. And so Burgess has allowed us to take a look at that from an LP reported standpoint, so you don't have any of that survivorship bias. Yeah, I think survivorship bias is a huge issue. What is your ideal GP? I would say that for us, my ideal GP is one that understands the power law and understands the odds of success in early stage venture, which the odds are 2%. That's a really challenging job to take. I mean, I wouldn't go to the casino if my odds of success were 2%. And so we want GPs that understand that and want to build a portfolio around maximizing those odds of success.

Starting point is 00:24:48 So if it's 2% at random, because we're long-term investors, we want the GP ideally to do 50 deals times 2%, get to one outlier. Any picking skill that they have on top of that is gravy to us and hopefully will capture more. We also want those GPs to be investing in networks and geographies that have consistent outlier production. So playing the odds to their favor, investing in geos like California, which includes L.A., New York, investing in networks that can increase their probability of success. Because when you look at those EV values, they really, really matter, especially in a more diversified portfolio. Because I know there's conversations around ownership, but if you own 20% of a company and it's not a winner, I don't care. I invest in buyout. I invest in other asset classes.

Starting point is 00:25:44 I'm looking for an early stage venture like return. And if you can't capture an outlier, that's not what I'm looking for. How much in your diligence do you look at the startups and how they make decisions? One of the things that you're highlighting that is very interesting and very worth noting is that I think a lot of people when they come into venture capital, they think there's this mythical land of these 10 startups that nobody has ever seen that people invest in and that benchmark comes in and invests in. The reality is benchmark comes in and out competes everybody else on a known space. So how much of this are you looking from the startup side and who they want to partner

Starting point is 00:26:19 with? For us, we leverage VCs to give us access to the startups that we want exposure to. I mean, there is no better beta ETF of early stage venture. So we just decided to build it ourself in-house. It's really important to stay diversified and get that vintage year exposure every single year to the startups. So for us, it's diversified coverage in California. It's diversified coverage in New York. It's diversified coverage within early stage venture and therapeutics. So we target California and New York for that. And when you think about it in terms of capturing that mean return over the long-term period, it's amazing what compounding can do. The long-term CAGR of early stage venture is a 25%. If you compound that over 12 years, which is the typical fun life,

Starting point is 00:27:16 that's a 14.5x. That is huge. So getting that exposure to those startups in those ecosystems and networks is very, very important. But we can't buy that ETF. So we find GPs that can help us build it in-house. You mentioned something that's very heretical, especially in 2023. You do not care about DPI. You care about compounding returns. Could you explain that? Where that 25% is the long-term steady state of early stage venture. Now, the last 20% of time produces 46% of your return. So for us, remember, we're taxable and we invest in other asset classes. If you're compounding an asset at 25% and you want to sell it out early because of marketing and DPI matters and I need to give my LPs capital back, one,

Starting point is 00:28:14 I have to go pay taxes on that and then find another asset that's compounding at 25%. But if you sell out at your 9.6, which is roughly that 20% of time before year 12, your multiple will be an 8.5x. I want the 14.5x. That's what I'm in it for venture. So if your asset or your portfolio company has shifted and is compounding at say 10% now, which we can find in public markets, or in buyout, the long-term CAGR is at 14%, then go ahead and seek the secondary or go ahead and sell out early. We do understand that. But if the asset is compounding at a high rate, do not sell. Compounding is really hard to think about in the tail end of the life, because that's where the massive return comes from.

Starting point is 00:29:10 Last night, I was at dinner and somebody told me that Benchmark, of course, became famous through its eBay investment, and that there was some weird lockup at the time of 12 months for them to sell their eBay investment and went up something like four to six X, and it took them from a 200 to 1200. People could fact check me on Twitter. But the point is compounding could be very powerful, especially if you are a taxable entity. I think one of the reasons people can't viscerally appreciate the 25% compounding is because very few people actually have a 25% compounding. What percentage of venture investors over the last 10, 20 years do you actually believe are able to access a product or a strategy that results in 25% compounding? I think a small percent. Just like early stage ventures, small percentage of those

Starting point is 00:29:58 companies are the winners. I think a small percentage of LPs can access that type of return because it's hard. Behavioral biases are real. And I think a small percentage of LPs can access that type of return because it's hard. Behavioral biases are real. And I think one of the most challenging things about being a long-term investor is not doing anything, not making tactical decisions, not moving out of the market when you're fearful because of market conditions or interest rates or an SVB or FRB, having challenges and going under. It's really hard to be patient and let those returns show up because I mentioned, if you have an asset compounding at 25%, at year 9.6, it's an 8.5x. But if I wait till year 12, that's a 14 and a half X.

Starting point is 00:30:48 But I have to be patient. And I think that's really hard. I'd like to really shed a light on some LPs, not necessarily only top performing, but also you said kind, I like to call it value added and non zero sum in terms of who are your favorite LPs to co invest with and maybe talk a little bit about what makes them special. The biggest thing about investing with other LPs is avoiding groupthink. So when the family office started, our contacts were endowments and foundations. And that was really, really helpful for building out the asset allocation. We have an endowment style model. It was really helpful for getting access and kind of following them into a lot of the funds that we were in in the beginning days. But we started to realize that we have different needs. We do have a small payout

Starting point is 00:31:32 like endowments, but we are a family office. We're a taxable entity. We're here to compound capital for a very long period of time. So finding other family offices to invest and do diligence with has been really, really helpful and has allowed us to avoid the group think because my team that I'm on, it's myself and two other colleagues. And we've all been there since basically the beginning days of our seed stage strategy. And so we try to push each other and have a button that we can press that we say this VC fund, I know you're not a fan of, but we need to invest and this is why. And that's what's really cool about the family office is that it doesn't matter who you are, what your background is, you can come pitch anything.

Starting point is 00:32:15 And so finding investors that can poke holes in our thesis, because I would say it is a bit contrarian and we lean in hard to it to make sure that we're not missing a red flag. I was listening to Harry Stubbing's interview of David Veles and he was mentioning how he was working with Mike Moritz as an intern. He got a voice at the table as well. I think triangulation of information is really important. I'm going to hold you to my question. Please list other non-Verdas LPs that you believe are very value-added and that you would like to highlight as good members of the LP community. You know, I would say, especially on the life sciences side of things, we've seen

Starting point is 00:32:57 Memorial Sloan Kettering go into some of the life sciences funds, and that's a strong indicator to us, especially because they do some direct deal flow there. We've seen some of the fund to funds out there where we've chatted with Sapphire Ventures before. Even though Sundana and I may have complete opposite views, they've shown up in some of the investments that we made. We really like to see top tier or Horsley Bridge have some type of relationships with the underlying GPs that we're looking at. I mentioned handholding on the LPA side, being a very institutional investor, even though we're a family office, when we see the GPs working with those types of investors, that really gives us a strong indication that they're focused on

Starting point is 00:33:43 being an institutional fund, even if it's small, because we'll invest in a $15 million fund. We're not shy about it, but it gives us the indication that they've thought about being institutional. Thank you for those shout outs. Of course, Michael Kim is incredible. We're going to interview Beezer from Sapphire, who's incredible as well. And a lot of really interesting LPs that I'm looking forward to meeting. In terms of life sciences, you've brought it up several times, you obviously have a passion for it from a purely investment standpoint. What is the opportunity set today, Q3 2023 in life sciences? Yeah, I would say coming into Veritas, I knew nothing about science, I would say science was my worst subject in high school. But what was

Starting point is 00:34:26 really cool is just learning about the ecosystem and the space, especially through COVID and seeing a lot of the benefits that this space has brought to the world. And so on therapeutics, the number of FDA approvals has significantly increased. Biopharma has outsourced a lot of their R&D to M&A. They really can't make money off of internal R&D, so they purchase a lot of the startups in the ecosystem. It's why we see the number of outliers being higher in early stage venture in therapeutics, but it's so weird where the incubation model works in life sciences. It doesn't work in general tech, but it works in life sciences. Companies will IPO for financing, not for liquidity. They IPO without even revenue. Talk about no profits on

Starting point is 00:35:20 the general tech side. They IPO with no revenue. It's pretty wild, but we see a lot more of the M&A happening with the IPO market being more challenged, with public markets being more challenged. That gives these biopharma companies the opportunity set to go purchase the startups. It's not always a $2.5 billion purchase price upfront. Sometimes you have milestone payments, so it could be $500 million upfront. And as you make these achievements, post-acquisition will receive additional payments for the company. And the biggest benefit for us adding life sciences to the overall portfolio is it helps protect the downside. So with the family needing more smooth returns, and can't handle significant

Starting point is 00:36:06 standard deviation, by adding life sciences to the portfolio, it protects us a little more on the downside, because you have more outliers, they happen earlier, happen at lower valuations, but it helps protect the downside. In terms of smoothing out returns, the same intuition that you see in top VCs, as you do in top LPs, is the ability instead of compromising on your values and saying we don't want this interesting binary bet, building a more diversified base in order to be able to take many different binary bets and simulate different outcomes in a way that still decreases the overall volatility but maximizes the expected return. You also mentioned something interesting in biotech, which is the milestone aspect of it.

Starting point is 00:36:50 You have phase one, phase two, and then you go public before there's even a final clinical approval. One CXO of one of the top pharma companies, what he told me is the issue internally is that there's too much career risk in going after individual targets. And I'd rather actually overpay 5, 10x more and wait for more milestones to be hit. If you look at that from first principles, that is alpha. So if you're looking where you're getting essentially compensated for coming into an opportunity and illiquidity of your asset, that's essentially alpha. There's going to be some interesting opportunities in biotech as a whole. It's a

Starting point is 00:37:29 very tightly, tightly controlled ecosystem. There's the biotech mafia and other players as well, but I think there's going to be significant. And of course, if you're looking to change the world, I hate to say it, the next Uber-like delivery service is probably not the way to have the highest impact. It's a new pharmaceutical that could, even if it solves the disease of 50,000, 60,000 people in the world, it really does change the world. Beezer, who we mentioned, also Chris Duvaux, started the OpenLP movement and bringing more transparency. I know you speak a lot about that and you advocate for that. Speak a little bit more on that. Yeah, the transparency piece just blows my mind in venture, especially

Starting point is 00:38:11 when I started at Veritas being on the public market side. I mean, there's a lot more transparency there. You get daily transparency. So on the venture side, a pain point for the family when we started to shift the portfolio to seed stage was lack of transparency. They couldn't really understand what they actually own. So we made it a point when investing in GPs at the seed stage to make sure that we could be as transparent as possible back to the family so they could actually see what the underlying investments were, what stage it was at, what geo, what sector it was. And so for us to do that at the same time, we also needed to make sure that we could be transparent with what we're looking for and educating the LP community. I think it's really hard on the LP side to be transparent because especially in family

Starting point is 00:39:02 office world, a lot of times the families want to be hidden. They don't feel comfortable putting themselves out there. On the LP side, there's also, you mentioned it on the biotech side, there's career risk there too. So for the LPs to come out and say, I support emerging managers or I support first-time funds and I'm going to take a chance on this network. If you're wrong, you look stupid or you could lose your job. But if you say, I'm going to go safe and I'm going to go with this brand name because historically they've done pretty well and it doesn't do well, that's okay. You went the safe route. You backed a GP that had done well and maybe it was just a bad vintage year, bad market timing. I mean, it happens all the time. So for LPs to put themselves out there and make some bold statements or to support

Starting point is 00:39:49 certain ecosystems that haven't done well historically, there's a lot of risk there. It goes back to the old adage, nobody ever got fired for hiring IBM. A lot of that happens in the LP world. A lot of LPs, especially as you go down from the elite, the top 10%, you'll see a lot of outdated thinking. You invest in a lot of them came from fund ones. And I think that when we look at our seed vehicles going forward, there is re-ups. I'd say it's about 70% re-up rate. But it's always important for us to be adding new GPs to that portfolio because the outliers in venture come out of the tails. So as venture funds raise successive vehicles, their networks start to change. The networks change more from founders in their prior funds, friends of those founders, their portfolio companies. And that doesn't mean that they're not going to find winners in their current network that's evolved over time, but they may miss out on these emerging sectors or emerging networks

Starting point is 00:41:10 that because they're not at a fund one or they're not just starting that they don't see. And so it's always important to make sure that we're covering those tails and that we're accessing the networks that may have evolved over the past few years. And so it's important to find GPs that are aware of that and that deploy their strategies into what I would call power law style investing. Presumably, you're also an investor in GPs for multiple vintages that have not succumbed to this kind of network creep, for lack of a better term, what has been their best practices? And what do you advise GPs to

Starting point is 00:41:51 make sure that they're always on the cutting edge of power law driven companies? Be humble, and I would say kind, but really, it goes back to the key principle here of, you know, hold your opinions loosely. And we invest in more generalist funds, but a lot of them have sector tilts. And so just making sure that they're intellectually curious and always willing to push themselves to learn about emerging sectors. Or you said you were going to do XYZ, and now it's year three, and I have to think about ARIA. But maybe you did XYZ plus three and explain to me

Starting point is 00:42:26 why you did the plus three. And it's because the tilts that I had, they changed or there's a new emerging sector coming up or I learned about something interesting and I wanted to take a shot on investing in this startup. It was more beneficial from a knowledge standpoint. We really like to see that. We like to see the GPs be collaborative with other GPs in the ecosystem. They can really benefit from investing with other GPs. And interestingly enough, I know that LPs can't stand quick investing, but we like our GPs to be faster rather than slower. So we've seen the GPs that will deploy more like three years versus five years. I'm not a fan of a one-year vintage. That doesn't work for me. But if you deploy your capital

Starting point is 00:43:13 in the first three years, that means you have in a 10-year fund life, seven years worth of compounding. The GPs that deploy slower because of market environments or they're concerned, one, you could be missing out on any outliers that come out in that vintage year because you really don't know when the next big winner is going to come. And two, that means if you made your last company investment in year five, all you have is five years worth of compounding. And remember, the last 20% of time really drives a lot of the return. One of the things, and it's a very fine line, you need boldness in your GPs. And I think one of the things that of course, a lot of LPs look for, but probably not enough is GP commit.

Starting point is 00:43:56 Another thing that I'd like to see change in the industry is I talk a lot about it about tiered carry structures. So a certain upside to actually having really big outliers, because those outliers come with a cost. They come with some incremental career risk that should be compensated. A lot of LPs push back on that, not necessarily in a smart way. I believe the pushback should be more on the management fees personally. Having that tiered structure and encouraging innovation, encouraging cutting edge thinking. As a VC, I invest in a founder, they have their entire skin in the game. A lot of times 99% of their net worth is in one startup. They have a huge incentive to push the boundaries. A lot could come from the LP side and to focus on what matters, which is absolute returns to

Starting point is 00:44:43 LPs themselves. Yeah, I would say for the GPs, especially at the early stage, they're in it for the carry. And they need to make sure that they're, to your point, being bold and taking those risks. And for us, we don't mind if they make little bets. That's a book that I read earlier this year, which I very much love. Do some experimentation, Test it out in some of these startups that maybe you're not as knowledgeable in in that space. But who knows? Those startups could be the big winners. And that's what's going to change your life is the carry piece of it.

Starting point is 00:45:16 The fees and expenses, when you look at a fund, they're stagnant. They're not going to be a significant impact to your return because they stay pretty linear through the fund life. It's the carry that is more exponential. So if you hit the winner and you 10x your fund, that's going to actually eat more into the net return. But we rather the GPs be incentivized by their carry structure? Because if their carry pays them not significant, that means we win too. There's a singular policy you could take to guarantee you will get the median, not the mean, and that is not to invest funds that have tiered structures. I think that is almost the textbook definition of adversely selecting yourself. And I think that's something

Starting point is 00:46:02 that I'll get a lot of hate for, but good medicine to give. In terms of what would you like to see changed in the venture ecosystem and the LP ecosystem? You've obviously very active on LinkedIn. I recommend everybody go and follow Jamie on LinkedIn, on Twitter. But what would you like to change? If you had a magic wand, you could change something in the industry. What would you change? This is a great question. I would change the legal side of things. And just like YC created the YC Safe for startups, I would love if there was a simple LPA for emerging managers, if we could create a standardized LPA that emerging managers or even early stage or any type of GP could use. And if you want to make

Starting point is 00:46:48 incremental changes to it because of certain carry structures that you would like or certain terms that you want to see a little bit different, if that's redlined only 5% of the LPA, that's a lot easier for LPs to digest. And it would be a lot easier for LPs to invest in fun ones or fun twos because I know what your LPA says and it's cleanly laid out. We're members of ILPA and they've done some great work on standardized DDQs and LPAs and things like that. But there isn't one that's geared towards early stage venture. And we've done legal review many, many times with the same law firms. And each L Avlock soon. Maybe I'll ask him live. We'll see if he listens to this podcast. I think that's really important. And I think it goes back to your point, which is, if you want to really have good returns as an industry, you have to be more

Starting point is 00:47:55 diversified. But there is a fixed cost of diligence. So if we could drive down that diligence, we could access more diversification to individuals. One thing that I'd also like to change, a lot of people talk about it. One of the sources for the alpha that you could see in an industry is actually diversity of managers. And it's important to understand why that is. One is groupthink and all these things, but also diverse managers invest in diverse startups,

Starting point is 00:48:21 which go after diverse end users, which almost by definition, to quote Peter Thiel, competition is for losers. So if you really want to build sustainable businesses, you have to go where others are not. So Jamie, you've been a great guest. In terms of what would you like people to know about Virtus and yourself and anything else you'd like to share with the audience? I'd say that we love to be very collaborative. We love to talk with other allocators that think like we do or don't think like we do. We find that the biggest benefits is just by leveraging our network. And you mentioned accessing a diverse pool of opportunities. So it's really important to keep our networking going strong. So we're always open

Starting point is 00:49:01 to chat and share our data. And please push back on my thought process. As I mentioned, you are known as a very disciplined investor, but also forward looking. This is what a lot of people say about you. And I think it's something that you've earned over eight years as a very active and very intelligent investor in the most cutting edge part of venture capital. So I commend you on that. Thank you so much for taking the time to jump on the Limited Partner Podcast and hope to see you soon. Thank you so much for having me. This was super fun. Thanks for listening to Limited Partner Podcast. If you like this conversation, please like, subscribe and review on YouTube, Spotify or Apple. Thank you for your support.

Investing Billions - E12: Jamie Rhode on Why 95% of LPs Can Only Achieve a 10% IRR when the Mean Return is 50% IRR | Why High Ownership % is Overrated | Investing into First Time Fund Managers

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