Investing Billions - E32: Ashby Monk, Stanford Professor on How to Become a Billionaire in Private Equity

Starting point is 00:00:00 We met more billionaires in the alternatives industry than any other industry. There's more billionaires. Let's go look at the, what is it? The Fortune 500 or whatever it is, Forbes 500. Forbes. Yeah. There's twice as many asset managers doing alternatives investments as there are technologists. Now, the technologists are in the 100 billion category, whereas most of the asset managed billionaires are 1 billion to 50 billion. Not bad though, but twice as many billionaires in the asset management industry. Well, Ashby, I've been really looking forward to the interview. You have one of the most

Starting point is 00:00:44 interesting backgrounds in the space. And today you serve as the executive and research director at Stanford Long-Term Investing Research Center. Welcome to Limited Partner Podcast. It's awesome to be here. Any chance to talk about pensions and sovereign funds? I love it. Well, we both have the same professional and personal interests.

Starting point is 00:01:03 So we both kind of live pretty dull lives, but I'm excited nonetheless. What is the Stanford Long-Term Investing Research Center? We are maybe the only research center in the world focused on investment decision-making at limited partners, allocators, institutional investors. The funny thing about these organizations is we don't even really know what to call them. I sometimes just have to rattle them off. Pension fund, sovereign fund, endowment, foundation, family office, permanent fund, stabilization fund, legacy fund. I could go on and on. I've found about 45 different names for these asset owners.

Starting point is 00:01:45 The latest being a WAKFA, which is a Islamic charity. And there's 33,000 of them in Saudi Arabia representing $2 trillion. And I just learned about them about a year ago. But yeah, we study all these asset owners. That's our job. So you mentioned $2 trillion. That's a good hefty amount of money. But off camera, you told me that this asset class or the asset classes together total $140 trillion. How do you go about studying an asset class of $140 trillion? I sometimes joke that we're a little bit like the show Seinfeld. I feel like I have to describe the show now because we're all old and there's a lot of people who are like, what? But Seinfeld was a show about nothing, right? And sometimes it feels to me like I'm doing research projects about

Starting point is 00:02:35 nothing because I'm asking, hey, why aren't these big institutions investing more in infrastructure? US has huge infrastructure needs. These big pension funds want allocation to infrastructure. Why aren't they investing? So we end up asking a lot of those types of questions, which are like more about studying around the black hole rather than being able to go into the black hole because there's no data about things that don't exist. Why don't pension funds do more direct investing? Why don't sovereign funds do more venture capital? These are the types of questions I get constantly, and then those form the basis of research projects. We also do a lot of traditional stuff, case studies. We collect a lot of data. We run

Starting point is 00:03:17 regressions. We write papers. But anything and everything that relates to how these big pools of capital make decisions, that's fair game. And you're housed within the engineering center, not within the Stanford GSB, the business school. Why is that? Yeah, people love to just give me grief. They're like, you should be in the business school. And I want to say this is my great moment where then I'm like, have you ever worked at a pension plan? Do you know what it's like to work at the California public employees retirement system?

Starting point is 00:03:53 It does not feel like a business. Most of these asset owners have one foot sitting squarely in some administrative bureaucracy. Could be a university, could be a charity It could be the HR department in a company. It could be a government. Most of it is about governments around the world saying, hey, let's reduce the cost of some future benefit by incentivizing private industry to accumulate wealth in a fund. That's what a pension fund is. It is a way to reduce the cost of a future liability stream, the liability stream being a pension. Same stuff with sovereign funds and endowments and foundations. All these things are about paying down something in the future at lower cost. And the governments have decided we are going to incentivize that with tax advantages. Most of the times the contributions are tax-free, the money compounds tax-free, and the money is returned sometimes

Starting point is 00:04:51 tax-free. So none of that to me sounds like a business. And when you see how they operate, how authorities are delegated, how we compensate the people working in these organizations, they are definitely not like businesses. They are more like government entities, more like central banks than they are like Microsoft. It is an encumbrance on the commercial activity. It's also an advantage. It also gives them a long time horizon. It gives them legitimacy in the minds of the people. There are many reasons why we could argue they have advantages over the private sector, but they are definitely not operating in the same way that businesses do. They're not optimizing for shareholder value. They're

Starting point is 00:05:37 optimizing for a range of topics. And so I think it's for that reason, ultimately, that we think they need their own research program. In fact, I can promise you that there's basically no classes in the world, except for one that I designed, about how pension funds, sovereign funds, endowments, and foundations actually invest, why they exist, how they invest, and how they achieve their goals. So let's double click on that. So why is it that a pension fund? Why is it that endowment? Why is it that a foundation? Why don't they just purely invest for economic purposes?

Starting point is 00:06:14 Why do they exist? I'm serious. Tell me why they exist. They exist to distribute funds in a predictable way to their stated goals. Those are about right. Yeah. In the distance, they've got some liability profile. They're paying some pension. They're stabilizing some commodity price for a government. They are reducing the cost of healthcare research in the case of a foundation. Those goals are distant and those goals are usually social.

Starting point is 00:06:43 So they are typically today the foundation of our modern social welfare state. And you can say, but that doesn't get in the way of the investment practices. Fine. That's fine. You can say the investment practices need to be about maximizing risk-adjusted returns. And for the most part, all these organizations, except for family offices, where there's a principal involved, do say they are maximizing risk-adjusted returns. But it doesn't change the complicated nature of the organizations themselves. The people on the boards of directors are policemen, firemen. They're citizens of Emirates.

Starting point is 00:07:21 These are not icy-veined capitalists. There's a representative interest to oversee the investment strategy to ensure it meets the social objective. Because somebody's decided they're not going to spend the money today, otherwise they would just spend it. They're going to put it into this organization for the future. Well, once you put it into the organization for the future, then you're going to need oversight. You're going to need compliance. You're going to need regulation. You're going to need all these different things. And that starts tying it back to the government. And that's where it becomes difficult to just say, shouldn't these just, shouldn't they just maximize risk adjuster returns? Yeah, well, they should, but we aren't actually unleashing them to do that. Go look at the compensation of CalPERS, CalSTRS.

Starting point is 00:08:08 How about Contra Costa? Go look at their compensation and think, does that feel like the free market operating? No, it's the government. You mentioned CalPERS. We were introduced by Dr. Russell Reed, former Chief Investment Officer of CalPERS and current CIO of 10X Capital.

Starting point is 00:08:26 And we could both look up what he earned at Calipers, which we'll both agree was underpaid given the responsibilities that he had at Calipers. How should pension funds and how should these asset managers be compensating their CIOs and the rest of the management? With more money is the punchline. If know, if you think about as a society, we're totally comfortable paying football coaches three, four or five million bucks a year. You know, these are state schools and these football coaches, you know, they're in effect overseeing a state program and they're getting huge wealth. You flip the script around and you say, OK, how about these state employees overseeing $30 billion, $100 billion, $500 billion? Who's going to add more value to the state's

Starting point is 00:09:10 bottom line? Who's going to actually protect the state from insolvency? It's not the football coach. And so you start to ask yourself, well, why aren't we recruiting the best and brightest to come and work in these organizations? We are now, we're starting to. Over the last five years, you've seen compensation and incentives dramatically transform. But up until then, you were really relying on people's public service instinct, their desire to work on Stanford campus and be a member of the community. A big part of the Yale model was Yale alums working at Yale, giving allocation to Yale. It was all about giving back. And ultimately, I would simply say that was a huge subsidy to the private equity industry.

Starting point is 00:10:01 For not paying people at the base of capitalism, the pension funds, you're going to pay somebody else a lot more to manage their money. And that's what we've observed. The Canadians used to say it costs 10x less to do it in-house. And we don't have to generate the same return, the same gross return, to achieve a higher net return. And so that's why you saw so much internalization going on there. Tell me about the Canadian model. I know they have a unique model that have people making seven figures. How did that come about and how is that working? Came about because they have a crown corporation model that allows them to first select and

Starting point is 00:10:42 appoint board members that are kind of fit for the task of overseeing a multi-hundred billion dollar pension plan. It's a double arm's length nomination procedure and the jargon of governance nerds like myself. So the people that end up sitting on the boards are usually people who come from industry. And the boards have huge authority. They pay salaries, they set delegation frameworks, they resource the organization, and they approve the asset allocation. So that's a lot of different stuff that the board does. Most important is, in my view, resourcing the organization for success. And when they're looking at their liability profile, they're looking at their asset base, they were one of the first systems to get very granular on the fees and costs paid to the private equity, venture capital, hedge fund, on and on and on. And they just sat back and they said,

Starting point is 00:11:37 is this the best way to produce the return stream? Just giving money to the for-profit managers. And the realization was, well, actually, if you can build internal teams, maybe you can produce returns at lower cost and actually reduce the risk. And it all started with transparency data. And starting in the 90s, moving into the 2000s, the Maple 8, they all have the same Crown Corporation model. They all began to internalize. And then they all began to realize there were certain asset classes. This is kind of flashing forward 20 years to almost the present. Certain asset classes, it makes tons of sense, real estate, infrastructure, timber, land. Certain asset classes, it doesn't. Venture capital, private equity, where you need on the ground,

Starting point is 00:12:25 personal relationships, the deals are smaller, it's harder to originate things. And so in those asset classes, which I know you're probably most interested in, they are very much partners. They're partners with the GPs. So no one's going after our two and 20 or the Sequoia three and 30 in the venture capital after the class anytime soon. That's great. Oh, don't. Yeah. You disagree? Actually, you're right. No, no, you're right. There are platforms that are now out there trying to seed new managers, but I think that will take time to disrupt the auto-correlation embedded into the Sequoia model. Even if these folks got embarrassed in FTX for not doing enough due diligence or actually imposing a board, they're still seen as the preeminent brand. And I think their returns also show this over the long term that accessing the top quartile venture is still one of the greatest asset classes in the world. One thing that shocked me is how

Starting point is 00:13:31 many pension funds there are in the United States. Tell me a little bit about the TAM. Well, you can almost back into it and just say to yourself, where does the typical money manager, professional money manager, not retail, but professional get their money. They usually get it from an endowment or a pension. And it's usually not a defined contribution plan that you have at work. It's usually a big public pension plan. There's about 700,000 pension funds across the US. That number is changing because plans are consolidating, closing. The old defined benefit pension plan, which promised you a pension until the day you died, was sort of an annuity mixed with an employment contract. Those are really going away in the private sector. I don't have one. You would think that I might

Starting point is 00:14:19 have one because I work at a university, but I don't. I have a defined contribution plan. And all of that stems from the realization that people are going to live a lot longer, and how long is a little bit uncertain. If we get the nanobots flown through our bloodstream, could we live to 140? Maybe. I don't know. I had some colleague at Stanford tell me at one point that the first thousand-year-old has been born. It's like, well, I don't want to pay a pension for, you know, 930 years. That's a long time. And so you're seeing the shift to define contribution. And those DC plans usually aren't quite as professional. They aren't as well governed. They don't provide as much private equity venture capital hedge fund access. If you think about the average person listening

Starting point is 00:15:05 to this might have a 401k through their employer. They won't generally have a choice to invest in private equity. So most of that alternatives exposure is coming through those traditional plans, defined benefit, public sector, university endowment foundation. In the US, we have these things called permanent funds. They're really just sovereign wealth funds by another name, but there's a bunch of them. There's like 13 of them. Today's episode is sponsored by Badaw Insurance Group. Badaw Insurance Group is run by my close friend, Amit Badaw, who insures me both personally and at the corporate level. Most people are not aware of the inherent conflicts in insurance, where insurance agents are incentivized to send their clients to the most expensive option.

Starting point is 00:15:51 Amit has always been an incredible partner to me in 10X Capital, driving down our fees considerably while providing a premium solution. I am proud to personally endorse Amit, and I ask that you consider using Badaw Insurance Group for your next insurance need, whether it be DNO, cyber, or even personal car and home insurance. You could email Ahmed at Ahmed at LuxSTR.com. That's A-H-M-E-T at L-U-X hyphen S-T-R dot com. Thank you. So are all pension plans the same? What are their typical strategies and what are they optimizing around in terms of asset allocation?

Starting point is 00:16:29 Yeah, they are not the same, almost universally. So the old saying was, if you know one family office, you know one family office. That's the same for all asset owners. And part of it is a function of the sponsor being in a distinct place on the planet. So Alaska Permanent Fund is in Juneau, Alaska. And when you're setting out to build an asset allocation, the first thing you need to do is look at your organizational capabilities. And we wrote a long paper, a series of papers on this topic, but really it was crystallized in one we wrote this year called the investor identity. And the investor identity is

Starting point is 00:17:10 about unraveling like the organizational capabilities because every investor may be different. They may be their own little snowflake, but every snowflake is made of H2O, right? So even though they all look different, we can reduce down to a common formula. And the formula in investing is people, process, information, and capital. That's the production function. People, you can internalize them like the Canadians. You can hire consultants like the American small county plans. Process, you can run a delegated process like the Canadians, or you can run a bureaucratic process where every manager has to present in front of the board.

Starting point is 00:17:51 Information, you can get it out of a Bloomberg, or you can set up an office in Rio de Janeiro. There's all these ways. The input that tends to be the most critical is the capital. What is the liability profile? What are the encumbrances? What can I do with the money? So you have that in your head and you have your people processing information, and then you can design an asset allocation. Inevitably, I then get asked, well, how can I improve my production function? How can I make more money? And that's where we did the second series of research projects where we said, basically, you only have three levers. You can pull the governance lever, the culture lever, or the technology lever to improve your people, process, information, and capital.

Starting point is 00:18:35 With that, you have the entire identity of every investor on earth. And I can tell you like a thumbprint, everybody's different. Their people are different. Their process is different. Their capital, even pension funds will have different capital because their liability profile will be different. The Canada pension plan and Ontario teachers pension plan have very different profiles, different identities today because Ontario Teachers is a mature defined benefit pension plan, and the Canada pension plan is still in the accumulation phase, building up into the 2030s. So they can invest in very different things with different liability profiles. They can have different technologies underpinning their organizations. So let's unpack that. So

Starting point is 00:19:22 governance, it's an interesting lever. I interviewed the CIO of Alaska Permanent, Marcus, and he has a very flexible governance that allows him to really make some very interesting investments to have high concentration and funds. What are some levers that institutional investors could pull on the governance side to improve their returns? So the governance, they control the resources, the organization, the risk budget. Generally, they're approving a strategy. So in my view, the board is everything. Basically, I've just described all of the biggest value drivers of institutional investors. Most people in our industry will say asset allocation is the biggest driver because they're relying on the famous Brinson work that showed that asset allocation drove most of the variability in performance. That's why everybody says they do the Yale model. They don't do the Yale model. They don't have a college campus. They don't have the golf course that Swenson used. They don't have the Rolodex, but they have an asset allocation that looks from a top down that it's like Yale. And for the most part, that does a good job. But the board also then says,

Starting point is 00:20:31 how much should we be investing in our technology? How much should we be paying our people? Marcus sits in Juneau, Alaska. You should ask him what it takes to hire a private equity professional on that team. I know you've already done that. I can tell you it's hard. You used to. Yeah. You have to go stand in front of the freaking state legislature and say, I want to pay these people 300 grand. But the reality is, when I look at the governance, I often have a couple of little tricks in my mind that I'm looking for, and they align incredibly well with the caliber of the plan. One, you can look at the

Starting point is 00:21:11 nomination procedures to the board of directors. Two, you can look at the delegation frameworks, a very sophisticated delegation framework from board to chief investment officer, chief investment officer to team. We'll speak volumes about how the caliber of the investment team is. And last but not least, I'm playing with this one. How hard is it to fire people that are underperforming? Because in a big public pension plan, this is where it's not a business. You asked me earlier, are these, why don't you sit in a business school? Well, go ask big public pension plans if you can fire underperformers. And most of the time the answer is no, they can't. It is more like a government. Some of them are even unionized. And the culture of these organizations can suffer if you have the people who stay are the people

Starting point is 00:22:06 you'd like to fire. That's a bit of a tougher one. It's not, it's not my favorite one. It's not a cocktail party one, but it is an interesting heuristic. Ask them how hard it is to fire underperforming people. And if they're like, we just can't, then you have a sense for the bureaucracy and the challenges they're facing to get things done. So presumably you would call them underperforming people. I would call them C players. A lot of these C players are in these organizations. How do C players make decisions when it comes to asset allocation investment decisions? In my experience, there are a lot of A players in pension funds because they're mission driven.

Starting point is 00:22:46 Like if you go, for example, to the Australian super funds, these people believe in the mission. They are willing to accept a slightly lower salary because the mission gives them joy. And that's the same at the Yale endowment, at the Harvard endowment, at the Stanford endowment. And you will meet a lot of people at public pension plans that are like, I'm here because I believe in the mission. So you do get A players and also people hate fundraising. So if you hate fundraising and you end up at a good pension plan and you can just invest, that's also a delight. I've seen a lot of people that are like, I like to just invest. I hate the whole business part of asset management. But then there are C players. They are there, right? And it's because it's hard to get rid of

Starting point is 00:23:33 them. And that's where a lot of the bureaucracy comes from. We build process around these people, because in part, we don't trust them not to make a big mistake. And so it's funny, the more you pay your team, the more trust you have that your team can execute, the more risk they can take, the more return they can draw. And so actually just hiring great people does a lot for these organizations. It allows you to push those decisions to the edge, power to the edge of the organization. And then they can move faster. They can do co-investments with private equity. There's all these great reasons. But anyway, I'm rambling about some of this, but I think a lot of it comes back to having

Starting point is 00:24:21 really good data that can prove out the business case of hiring internal people. And some of that is showing the cost of external managers, which has been pretty hard to pin down. You would think that the unions themselves and the pension plans would have a high incentive to make sure that their defined benefit and defined contribution plans would have the right amount of funds and would have high performers running those funds. I think some of it is just not being aware of the dynamics of this industry. I wouldn't say it's a conflict. In fact, I see unions pushing harder for high expected returns, which in effect drives the pension fund to allocate capital to private equity and hedge funds, the very asset managers that are often trying to take down the unions. And so pension funds are this weird vehicle through which unions are in alignment with hedge funds.

Starting point is 00:25:18 Because if you are using an actuarial estimate of performance and you can say, oh, well, past performance is an indicator of future performance. So we just need more private equity. And then the unions are like, let's do more private equity because if we can say we're making an 8% return, then the fund looks overfunded. And then I can promise more benefits to my members, which by the way, as a union is what I'm negotiating for every single day. And so there's that strange bedfellow moment there. And so then it's left people like us to be like, oh, don't make these promises. Don't overpromise on your expected return because it distorts this whole system.

Starting point is 00:25:57 We're underpaying staff at pension plans because we don't want to stomach paying public employees millions of bucks. But at the same time, we're saying, go make 7.5% a year. It's hard to do. So then they have to go over allocate to private equity. That's why we mint so many billionaires in private equity these days. You think they're managing their own money? They're managing pension money. Tell me more.

Starting point is 00:26:23 We mint more billionaires in the alternatives industry than any other industry. There's more billionaires. Let's go look at the Fortune 500 or whatever it is, Forbes 500. There's twice as many asset managers doing alternatives investments as there are technologists. Now, the technologists are in the 100 billion category, whereas most of the asset managed billionaires are 1 billion to 50 billion. Not bad though, but twice as many billionaires in the asset management industry. And really, I joke with my students. I'm like, look, those of you that have ambitions to be a billionaire, you need to get it right. You need to set up an alternative investment business and manage pension capital. That's the fastest path in the

Starting point is 00:27:08 world today. And how do you get to pension capital? I know they don't do first time funds, second time funds. Wouldn't it be like fun if we designed the path to be a billionaire right now? Here it is. Yeah. Let's do it. Okay. Here it is. So you graduate, you do your two years at. You graduate Stanford or Harvard. Let you graduate you do your two years at you graduate stanford or harvard you get let's say you do princeton undergrad okay you run the crew team so you you have the potential to suffer then you did two years at kkr then you did business school at harvard or stanford then you went back to kkrR and a more senior team or Carlisle or Apollo or Blackstone or any of these folks. And you get authority. You quickly make a name for yourself in deal teams. Some senior partners fed up of paying all their carry to the powers that be

Starting point is 00:28:02 that own the name on the side of the wall. And they say, let's go start our own fund. You still haven't done anything entrepreneurial yet. You just tag along. You're 27 years old. You just tag along with this person. And this person has a track record, starts building multiple funds. By fund two or three, you're now a named partner. Maybe you're a junior partner, you're named partner, but you're building a name for yourself. And then you start your own fund. You have a track record. You have all these deals you've done. And even though it's a first-time fund, you have a ton of experience and you will give warmth to the limited partner community. You might be obligated to accept seeding capital

Starting point is 00:28:46 and give up a little bit of your GP, but maybe not. Maybe you have some partners around you that help round out your weaknesses. And once you've got your own general partner in private equity, you're on a track. Obviously, you want to stack funds, you want to build more products, you want to do all those things. But if you can get to fund three in your own fund, it's yours to lose the billionaire status. Because the whole table is tilted directly towards your pocket. It's like most of these big pensions only do fund three, they look at your track record, you don't get fired for backing the manager that has a demonstrated performance and the fees are outrageous. It's a one way option. So anyway, that's our path. Maybe I should have you. In terms of the path on a specific fund and the life cycle of fund, you don't go to pension funds,

Starting point is 00:29:50 but we talked off camera about this progression of different asset investors starting with high net worth and ending with retail. Can you take us through that life cycle? Great question. So if you're sitting there and we just did our pathway to billionaire-dom, at some point you want to go start your fund and you're going to need an anchor. We'd all love to walk into the Canada pension plan and ask them to drop down 250 million and get me going or the Abu Dhabi Investment Authority. It doesn't happen that way. In general, all of the emerging managers, the new managers,

Starting point is 00:30:27 the people who are taking a bet on their own capabilities and building their own firm, they start with families. We have this family office model, which I literally said last week for the first time, it feels like first on board model because they're willing to be the first. Do you remember when we used to have YouTube and there would be the comment section and people would just write first at the bottom of the comment section? I miss those days. But anyway, family offices were like writing first for your fund. They were the first into hedge funds, into venture capital, into crypto. They are also first anchors, first willing to make a bet on a new manager. And part of it, I think, is the principles of these firms are often entrepreneurial themselves.

Starting point is 00:31:22 They've seen what it is to be entrepreneurs. They've made their money. Now, as you get into multi-generational wealth, I think they start to look and feel more like endowments and foundations where they're a little bit more conservative. It's their career rather than their money. If it's their money, they're like, heck yeah, I'm going to make a bet on this, you know, brilliant young person who's going out on their own. And so I'm often introducing first-time managers to family offices. You use the families to build your track record for fund one. Is that an alpha position or is that a dumb money position?

Starting point is 00:31:59 That's an alpha position. The small managers are the managers that outperform. I mean, that's research, you know research we could post in the show notes. Small entrepreneurial managers is actually, there's a famous quote by Swenson that's like, that's where the outperformance comes from. So getting yourself in a position to be first with entrepreneurial managers is important. Obviously, you have to do the diligence. You got to make sure you're picking people that can run businesses, not just invest. This is running a business now, but that's where real outperformance happens. In fact, if you're just investing at fund three, which a lot of the pension funds

Starting point is 00:32:37 and sovereign funds do, you're basically committing yourself to overpaying. At that point, if there's real outperformance, do they need you in the fund? Maybe, a pickleball league? You know, like there is a classic fund for problem too, because the wealth gets so big, you get distracted. And so, you know, basically these pension funds are like, we've got fund three, you know, that's it to like really outperform. And then you got fund for problem. Wouldn't it be great to have the fund for problem as a GP though? You're like, oh man, I just got, I got my, my box at the symphony. I've got my basketball team. The fund for problem is a pension problem, not a GP problem. No, exactly.

Starting point is 00:33:35 Yeah, that's so true. It's a problem for the LP. Keep you motivated. Understand who's the next generation. How are you sharing your carry? And boy, if you've ever read an ILPA DDQ, you will know that there's a lot in there about transition plans and how are you going to manage that fund for problem. They don't call it fund for problem, but that's what's in their heads.

Starting point is 00:33:58 So then you go from family offices, is it next endowments and foundations? What is the next asset class? You could actually get some endowments and foundations? What is the next asset class? You could actually get some endowments into fund one. So the classic thing would be, say you're starting a hundred million dollar venture fund. You get some well-known famous billionaires to plunk down money to give you a little bit of legitimacy. You know, you get Mark Andreessen and Peter Thiel, and those are good ones to anchor your fund. Then you get some family offices. And now it's starting to feel de-risked, especially because you have a fundraising period of 12 to 18 months.

Starting point is 00:34:37 So you're doing some deals. Maybe you're even having some markups. Then you go to your alma mater. You go to the place you went to college. And you say to the CIO, I'm a badass. I'm doing these great deals. I've got these super famous people in my fund that you will see when that mission creeps in and there is this sense of alignment, then you will see a couple of foundations and endowments, especially those that are used to going early like MIT or even UC Regents. They'll go early and they will come in and participate in the rounds. And then you're sort of off to the races because then if you deliver quick markups, that institution will

Starting point is 00:35:33 be your first institution to anchor the fund to. If you do a good job, then they'll be like, yeah, we're in for another 25. And now you're hitting your fundraising circuit saying, I've got this endowment in for 25. I want to bring in mostly endowments with some of the original backers getting their share. And then your goal in fund two is to get a pension, get one pension, find one to participate. Now you might have to save $50 million of your allocation because they don't get out of bed for much less, depending on who you're talking to. It doesn't move the needle. And then once you have a pension in fund two, then fund three, this is the sweet spot. This is where you crack into that Forbes 500.

Starting point is 00:36:19 So it's essentially having one foot in the tail end of the previous fund, one foot in the next fund, kind of straddling funds in order to get the right institutions in each fund. Yeah, isn't it like, can't you brag about pushing these organizations out of their comfort zone just to get access to your financial product? You know, like they wouldn't normally do it, but for you, they will. That's a pretty compelling story. Let's call out the most entrepreneurial individuals in institutions and at foundations. I'm sure they'll get a lot of emails, but that's okay. We want to celebrate those people that do take real risks and generate alpha for their institutions. Who are some of these endowments? Who are some of these pension funds that have been early adopters? Yeah, so Jagdeep Bashir at University of California has anchored many a vehicle,

Starting point is 00:37:12 and he is a true innovator. UC Regents. Yeah, UC Regents. So he's a true innovator. At BCI, which is British Columbia Investments, but I don't think they go by that anymore. I think they're just BCI. We're supposed to just say the initials. They've got a $30 billion private equity book. They've got a new venture book. They're seeding and anchoring

Starting point is 00:37:29 managers and their performance is astoundingly good. In New York, there's a platform called Wafra, which is actually owned by the social security of Kuwait. They've anchored and seeded tons of stuff. First of all, they've anchored and seeded a bunch of GPs. Then they led the pathway to launching Constellation Capital, which is an anchoring and seeding platform made up of other asset owners, including Alaska, but also Railpen. And I think there's a few others in there like OSERS and Canada Pension Plan and maybe a few more. That's incredibly creative. Yes, they're partnering with peers to do that. But boy, if you're a private equity manager, you now know there is this asset owner-led platform that exists to put you in business.

Starting point is 00:38:18 They will try to own some of your GP. But why not share some of the wealth back with the pensioners? Mission alignment. How do you look at that? The way that I look at it is I look at a GP and as a franchise, as a stream of cash flows. If I could bring my stream of cash flows by one year, then that's a DCF. And now from a DCF standpoint, I could give away 10, 15%. Is that the way to look at it? It could be a way. I mean, that's definitely the LPs want to juice their returns and own the means of production because they've

Starting point is 00:38:51 observed how wealthy GPs get. And it is a great place to be. You want to be an owner of the GP. Remember, this is the billionaire factory. So it's a great place to juice returns. From a GP perspective, I think, yeah, you're right to be thinking about it in terms of discounted cashflow. What am I going to have to give up in the next 18 months to get this business running? A lot of people go, especially in venture, they go without salary for two years. It's just the two and 20 on a $50 million fund doesn't cover a lot of overhead. I mean, once you hire a team, have a CFO, get the things in place, you're paying yourself next to nothing.

Starting point is 00:39:33 So if you can make the claim... Now, in the GP staking business, you have to be able to make the claim that you're building a platform because they don't want to just have the carry in the $50 million fund. They want carry in your billion dollar special opportunities, you know, growth fund where the numbers get big and the performance and fees really drive that kind of residual. So moving into the venture capital asset class, as you mentioned, this is a VC show. Although I think it's really important to understand the context for the LP asset class in general. But moving on to the venture capital asset class, what are some best practices? You gave some phenomenal advice for private equity managers. What advice would you have for venture capital managers that are starting maybe on their fund one, fund two? What's their path to a billion dollars? So it starts with being an

Starting point is 00:40:27 entrepreneur. This part, you guys are going to know better than me probably, but here's my perception. And this is a perception that I think LPs know, but they might not. You start companies, first one fails. You start company number two, you have a decent exit. You start angel investing with your money. And either the angel investing goes so well that you can kind of break out on your own. Or after you sell company number two, you come in as kind of an operating style general partner in a fund. Let's assume you do the angel investing, call that the, you know, Andreessen Horowitz style. Those guys were just out there doing angel investments. If you, if you have a big enough name and you're doing enough interesting deals, you will get families ready to put you in business. You know, like, especially if it's just

Starting point is 00:41:15 clean terms, you know, two and 20 and no, you know, you can demonstrate track. I know that two and 20 isn't light in venture capital. I saw your mouth go, what? Where's my tuna? I preferred return once I delivered the 3X. All that's great, but the reality is just keep- You must be a listener of the podcast. Yeah, exactly. But I think you're not trying to get rich off your angel investing or your early stage stuff.

Starting point is 00:41:42 You're trying to get a track record, an institutional grade track record. So more important is to demonstrate your ability to get into high quality deals, invest other people's money than to like optimize around your fee revenue in this initial phase. So then let's assume that you build a portfolio that isn't just a lottery ticket. Like you happen to invest in Stripe because your friend's roommate was there, but you can have a demonstrated repeatable strategy. That's the next key part that as the LPs start to go in, they're like, what is repeatable here? So ideally, as you're doing your angel investing,

Starting point is 00:42:18 you've got some belief. In my world, we call them investment beliefs, but they could be investment strategies, whatever. You have some edge in the world where you think you have an informational advantage that you can apply. And in my world, that would be investment technology. I think I'm one of the world's leaders in investment technology. I wrote a book on the topic. The book won an award. It's been published in terms of languages and English. That's all. But most people read English. So that's fine by me. So I would say I'm like an expert on investment technology.

Starting point is 00:42:49 I would go after that and I would invest in a bunch of startups there. And I would sort of build a rep with founders because the LPs will go talk to the founders about the value you're adding every time. And you'll need to give a list of like 30 references, not three. And so all of this builds kind of like your college application. You're like building this profile of entrepreneurial credibility, investment strategy, access, ability to discern and spot the right deals to do, ability to add value, ability to avoid headlines and be a crazy person. Some people may be really good at going on Twitter and saying

Starting point is 00:43:32 crazy things and getting famous, but I don't know. Most LPs aren't interested in taking on that type of litigation risk or profile. Most LPs manage healthcare workers' pensions. You just need to remember having a bit of a low profile is in their DNA. And so then you start the same process I described with the private equity where you're getting a couple of family offices to throw you a bone. Maybe first fund is 10 million. Second fund is 25. Ideally, what you're telling people is you're not changing the strategy. You're not changing the stage. You're just adding a zero. That's a classic line. I'm not changing the strategy. I'm not changing the stage of investment. I'm just adding a zero. And that resonates. And then because nobody wants you to go from a seed incubation investor

Starting point is 00:44:26 to a Series B investor. They're totally different functions. You can do it later, but you'll hire a team later to do it for you, or you'll hire a team to help you do it. And the way that's typically broached is with an outside team that has a track record doing that specific strategy. Yeah, I guess I'm implying like when you see these traditional venture funds launch, Oh, this is our growth fund.

Starting point is 00:44:49 Like there'll be somebody who was a senior Goldman Sachs banker on the team. And you're like, okay, that's the growth stage where somebody has to build the financial model. That same KKR guy, the prototypical guy, maybe girl that went to HBS, went to Princeton undergrad. That's another route for that person to become a billionaire as well. But that billionaire will eventually hit the B. That's a pathway to a 50M.

Starting point is 00:45:20 But the B, that person would then need to spin out their own growth stage and would, you know, do something wild. Like let's do a crossover fund between late stage growth and public equities. And we can short the public markets that we're investing in the companies and private and we're shorting the public. You know, they're going to have some story that's going to be real exciting. I'm tempted to mention managers, but we'll leave that for another day. Yeah, well, it's your show. It's my show, but it's also my reputation. You know, I did tell you, I have to be honest,

Starting point is 00:45:52 you're not the one that wanted me to ask about all of your companies, but I legitimately think you are one of the top technologists in the space. It might be a very non-competitive space, but I think you're, if not the top entrepreneurs, one of the top entrepreneurs. I think you're building some really interesting technologies. One of your companies was acquired by Adapar. Tell me a little bit about your operating principles in terms of building for pension funds and building for the institutional space. Yeah, my lens is always, will this piece of technology change an investor's portfolio? I don't want to spend my time helping an asset manager sell more product.

Starting point is 00:46:34 I don't want to help distribute an existing set of products to retail that doesn't get me up in the morning. But if I can find some data, what I call a portfolio positioning system, it's like GPS for your portfolio. Those are risk tools, ESG tools, impact tools, alternative data sets. Those are giving investors a granular understanding of what they own, portfolio positioning. Those are the types of things that an investor would have on board and immediately say to themselves, wait, we're over there? I thought we were over here. That's a really powerful type of company to build because once you can show investors that they're holding something they didn't believe they were, or that they're not holding what they thought they were, you are triggering a portfolio change. And that is the most valuable thing in financial markets

Starting point is 00:47:26 today, moving money from A to B. And so the reason I do that for software companies and data companies is like, once you can show an investor that this software is going to help them hold less cash, which is like one of my favorite things to go after. It's like, let me help you reduce your cash drag, which until nine months ago was a big problem. Now it's people are like, my cash is great. It's like, yeah, your cash is pretty good right now. But have you moved it? That's the other thing. How many people are still just leaving their cash in a frickin bank account, earning half a percent when they could be making four and a half percent. If you're listening to this podcast, don't be that dumb. Get your cash into something that's optimized. But like you can really help a pension fund by helping them model their commitments to venture capital.

Starting point is 00:48:15 Help them understand. You keep hearing about the denominator effect, but like that is a heuristic. That's a, you know, they're like, oh, we're using the Takahashi Alexander model, which was invented in the 80s by Yale in order to model our unfunded commitments and run scenarios. I promise you we can do better with software. Okay. We can do better with scenario planning, next generation analytics, alternative data. the one that I sold to Adapar, we have helped investors on average reduce their cash holdings 1.1% and increase their contributions to alternatives by 3% a quarter. If you can't make a ton more money with that profile, then you're just not an investor. You're not doing it right. Yeah. So that's the type of stuff. You asked me what my principles and beliefs were.

Starting point is 00:49:03 I'm looking for technologies that change portfolios. And that's what I like building. And what was the name of that tool that sold to Adapar? That one was Navigator. Yeah. The company was RCI. We had RCI Navigator and Navigator was unfunded commitments and modeling projections into the future. It started with liquidity. I started that with Kanishk Parashar and Joe Lonsdale. And crazy, crazy, we sold it to Adipar, given our founder and chairman was the same founder and chairman. Shout out to Joe Lonsdale. In terms of what are you currently working on? I'm partnered with a founder, young founder, Harrison Shaw. He's 23 years old. He's walked into my office three years ago and said, I want to work on pension funds. And I was like, what?

Starting point is 00:49:51 It's like, this can't be happening. That's an exciting guy. Yeah, this can't be happening. 20 year old. Yeah. And he's a genius. I mean, like he's, and basically I keep giving him rope with the pension fund community, the sovereign fund community. And he keeps tying these beautiful knots with it. So that is a company called Shelton AI that is basically taking all the unstructured data

Starting point is 00:50:11 in PDFs and turning it into delightful dashboards in real time. So it's not just taking the data out of PDFs, it's actually putting it in a context that's private equity and venture capital and allowing them to do things like see-through into portfolio companies, do real-time audits, fees paid, all that kind of stuff. Again, that's like you've got all this data, you don't even know what you own. And now all of a sudden, literally it takes 10 minutes to upload every single one of your PDFs, 10-minute onboarding. I should have said that in the beginning. That's the tech breakthrough. You've heard of other companies that might take stuff out of PDFs and present them, but it takes 10 minutes. You can take a thousand capital call

Starting point is 00:50:54 documents, upload it, and we'll do it in real time. Then you can see into your portfolio companies and you can say, oh, wow, this is where your venture capital people are going to hate us. This venture capital fund is holding this company at X. This other one is holding the same company that I'm in at Y. Same share class, same company. Why are they holding it at different prices? Then as an LP, you can go and ask the one that's holding it higher and say, why are you holding it higher? That is the type of see-through and transparency that brings changes to portfolios that I'm after. Well, Ashby, I really appreciate you jumping on the podcast. I know you're very busy. You're busy teaching. You're busy building things. You're busy evangelizing on behalf of the

Starting point is 00:51:37 change that you want to see in the industry as a parting words. What would you like our listeners to know about yourself or about Shelton, about the Stanford Long-Term Investing Research Center, anything that you'd like to shine a light on? I just want more people to know about pension funds. I kind of said at the beginning that I think there's four great levers society has to make a better place for our children and our grandchildren. You can hate this comment or love it, but we've got government, which kind of sets the rules for the system. You've got corporations, which are building all this stuff. Then you have the for-profit financial intermediaries, which are kind of like businesses. Then you have the asset owner community. In my mind,

Starting point is 00:52:19 having been working at this for 25 years, those are the key four players. There's 100 trillion of GDP in the governments. There's 110 trillion of market cap in the companies. There's 98 trillion of AUM in the for-profit asset managers, and there's 140 trillion in the asset owners. Of those, the asset owners are not studied or even understood. Every university in the world has a political science department. There's 10,000 business schools studying corporation. There's 484 accredited finance and economics departments in the world. There is one course in the world on pension funds, sovereign funds, endowments, and foundations, and I teach it.

Starting point is 00:53:05 And I'm just blown away that we haven't spent more time as a society unraveling how these asset owners make decisions, which is why I'm on this podcast with you, David. Because I'm so pumped that you have dedicated a podcast to this ecosystem that does get me out of bed in the morning and fires me up every day to try to make the world better by making them better. I think one of the reasons that I'm in this podcast specifically is I really personally believe in emerging managers because I believe they're the spear of capitalism. I think without emerging manager managers, the incremental company does not get started. To use the old adage, nobody ever got fired for hiring IBM,

Starting point is 00:53:47 but people do get fired for investing in emerging managers. So I think it's really important to make a strong case for investing in emerging managers. I was going to say, on that, you can come check out our podcast at Stanford called the Don't Get Fired Podcast. Yes, please check out the Don't Get Fired Podcast. Also, please check out the Don't Get Fired Podcast. Also, what is the name of your book that you wrote?

Starting point is 00:54:08 It's called The Technologized Investor. The Technologized Investor. I will put it, hopefully you have an audible version. Oh my goodness. It's in English, is it in audible? I've heard there's good tools that will turn my written word into audio now. I will be your first audible listener.

Starting point is 00:54:26 Okay, sweet. And thank you again for Dr. Russell Reed, former chief investment officer of CalPERS, as well as former chief investment officer of Alaska Permanent Fund. And we're very excited at 10X Capital that he is our newest chief investment officer as of last November.

Starting point is 00:54:40 We're coming up about a one-year anniversary. So thank you, Dr. Reid, and thank you, Ashby, for jumping on the podcast. I loved it. By popular demand, the Limited Partner Podcast has officially launched our newsletter powered by Ikaria Labs, a full-service content marketing firm that's partnering with us on the newsletter. In our weekly newsletter, we will keep you updated on all things emerging managers and limited partners, including industry trends that are critical to know as an LP, VC, or founder. To subscribe to our totally free newsletter, please visit www.limitedpartnerpodcast.com.

Starting point is 00:55:16 Again, that's www.limitedpartnerpodcast.com. We thank you for your support.

Investing Billions - E32: Ashby Monk, Stanford Professor on How to Become a Billionaire in Private Equity

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