Investing Billions - E373: What Most CIOs Get Wrong About Alpha

Episode Date: May 20, 2026

What if the best investment opportunities are the ones most investors avoid because they’re too hard, too small, or too inefficient to pursue? In this episode, I sit down with Raphael, Deputy CIO and Co-Leader of HighVista Strategies, to discuss the concept of “beautifully inefficient” markets and why durable alpha often exists where few investors are willing to spend time. Raphi explains how governance structures shape investment outcomes, why lower middle market private equity and biotech remain compelling, and how long-duration capital creates structural advantages in venture investing. We also explore continuation vehicles, portfolio concentration, and why the best allocators balance diversification with conviction.

Rafi, you're the deputy CIO and you co-lead Hyvista strategies, a firm with $14 billion in AUM. Last time we chatted, you said that you love markets that are beautifully inefficient. What does that mean? So my CIO partner and co-leader of Hyvista, Andre Perold, coined the term, beautifully inefficient. And so I'll give him credit where credits do. Everyone talks about inefficient markets, but what Andre figured out was that there are many markets that are inefficient, but they don't have the repeatability. that investors are after. Really to be a great investment opportunity.

You want it to be inefficient so you can get outsized returns, but you also want it to be somewhat systematic, somewhat repeatable so that there's some duration to the investment opportunity. And beautifully inefficient markets have the characteristic of having a great opportunity that hopefully persists for a reasonable period of time. Nothing lasts forever, but a reasonable period of time. And if you're really lucky, it's a market where you can build a sustainable advantage by participating in that market, so that over the course of time, there's also somewhat of a barrier

to entry to those who were early to those markets. Those are kind of the friction. So if you think on one side, you have this one trade. It's an amazing trade. Nobody's looking at it because no one's really set up to do that. They don't have the team to do that. But it might have a high Moik, high IRA, but it's one time. And then on the other end, you have a trade that's going to be around for 30, 40 years,

but at some point it's a consensus trade and the alpha gets traded away. You look for something in the middle. Absolutely. And what do you look at in terms of duration for the trade? What's the ideal range? Years, maybe even a decade is the time scale where there are great investment opportunities that last that long. If you're in a living investment organization with a dynamic focus, probably good chance that you'll find the next beautifully inefficient market that may be adjacent or some change in the market, but hopefully the experience that you're building in this current market environment will allow you to enter kind of the next great opportunity. We could just talk

about one example where let's just let's just talk about lower middle market private equity, where I think it's a market for the last 10 or 20 years, it's been an amazing opportunity in terms of outperformance and inefficiency. It persists as a great opportunity, but there's a number of adjacencies to that market where I think someone who has a sustainable advantage in lower middle market private equity, will be able to participate in those new emerging opportunities as well. I don't think I've ever met a investor that doesn't want to be in an efficient market. But what does an organization need to do in order to be able to pursue these inefficient markets? Let's just use the case of an endowment, a foundation, or a pension that's got a large pool

of assets and is trying to consider how they invest, where they should be passive, where they should be active, what their asset allocation is. So for most of those organizations, they're going to have a few foundational questions, how much risk to take, how to diversify. But then they're going to have to figure out where they lean in. And when we say leaning in, it could be developing in-house expertise or just really learning a lot about a certain market. And they may have to partner. Most investing is about partnership at the end of the day. But they're going to have their areas of focus.

And maybe that's being an activist investor in South Korea, or maybe it's investing in independent sponsored deals in the United States. There's many opportunities out there. We can't typically know everything about everything. So people do have specializations. But most investment organizations will pick a few areas that they really lean into, at least in terms of their expertise, and then maybe it affects their asset allocation. Because ultimately, if you have more alpha in some area of the market than another, you'd probably shift your asset allocation to have. have more exposure to the markets with higher alpha.

As I mentioned, you co-lead High Vista. So one of your jobs is picking the games that you're going to play, picking the asset classes, picking the sub-asset classes. What do you consider when you're choosing an asset class like lower middle market or the next asset class you want to go after? What's the criteria look like? People talk about total addressable market, Tam. I think Tam is a good way of looking at this, which is, you know,

the U.S. stock market today is a $60 trillion-plus stock market. That's an amazing tam. There's never been a tam like that in the world. But you don't need a $60 trillion tam to have a really compelling alpha opportunity. Trillion dollar markets are probably about the right scale where you get plethora of opportunities. You want thousands of potential securities, at least hundreds, never want to be down to 50 securities to choose from. So when you have 500 or 5,000 or 50,000 securities in your selection universe and it's right-sized, it's not filled with mega-th century. caps, but rather has a lot of midcaps or small caps with less coverage, with more opportunity

for dispersion, more of the power law in investing, you really can get outperformance. Said another way, even if there's thousands of securities, but let's say it's the public markets and it's highly liquid, the mere fact that there's a high quantity doesn't mean that it's inefficient. If there's thousands or millions of people looking at the security, you want the opposite side. You want enough quantities for there to be dispersion and not enough focus on it so that there is still alpha to be had in picking. Yes, and yet the world's gotten very funny recently. I think since I started at High Vista 20 years ago,

the change in markets is pretty dramatic. So just thinking about numbers, you now have all of the big tech companies, the biggest tech companies in the United States, each have a market capitalization that's bigger than virtually any country in the world outside US, China, Japan. So if you stack up France against any of the top three

or four tech platforms, the top three or four each have a bigger market capitalization than a France, a Germany, or the like. You also have a case of that $60 trillion of market capitalization. Only two, maybe three trillion dollars of that is in the small cap market. So right there, most companies in the U.S. public markets are small cap, right? You have 2,000 small caps versus 500 large caps and maybe 500 midcaps. So you have by number a tilt towards small cap, but yet it's only about 5% of the capitalization. And if your goal is alpha, as opposed to trying to figure out what's the best beta, which we can talk about, if your goal is alpha, pure security selection, you're going to

benefit from a larger N, a larger pool, and you benefit from the fact that the large capital allocators will have trouble moving a lot of capital around in those markets. They don't typically tolerate billion dollar investments. It's typically investors who are going to be able to invest tens or hundreds of millions of dollars in any one security. And so it creates an opportunity for those who are disciplined to develop a strategy for outperformance. I had a three and a half hour dinner with one of the chairmen's of the one of the top banks. You probably know him. But it was off the record. But he said that alpha, he said that his definition of alpha are things that are boring and hard. And I often think about this whole paradox, which is you're trying to find

alpha, but you also have outside LPs. So you also have to sell to LPs. And one of the reasons why Alpha persists is because LPs don't love or it's on love sector. How do you square those things together where it's something that there's alpha and that it's worth pursuing, but also something that's marketable to LPs? Great one. Let's go back to the LPs perspective. I think it's always useful to take how their dilemma and how they're thinking about the world. If you go back 30 or 40 years, you know, Yale pioneered asset allocation and really investing as a real money allocator. And the two innovations there were you need to own a lot of equities and diversifying within equities to own a bunch of different kinds of equities. That's most of where allocators

really need to spend their time is coming up with an appropriate asset allocation. Should you own fixed income, should you own equities. Remember, people used to invest a lot in oil and gas, and that was very fashionable amongst large capital allocators, and then they pulled back because they found the returns weren't as compelling. But that's really where they have to spend a lot of their time. There's a lot of return that could be driven from making great allocation decisions, and we've all seen those studies that so much of a pensioner or capital pool's returns will be determined by those few decisions. How much risk? What geography? What kinds of equities are you after? If you're buying the S&P 500, you're going to have wildly different experience than if you're

buying AQUI in a world where hyperscalers are winning, and all of that activity is in the U.S. Nearly all of that activity, I should say. So that's their job. When it comes to alpha and they want to add to whatever return they can get from asset allocation, alpha is purely additive. It just adds a return above and beyond that. that's why it's so precious. They might be targeting a seven or eight percent return from their asset allocation. But if they can add to that, that's just wonderful. Asset allocation gives you

a good baseline return, but it's the alpha that will really catapult you into that kind of top quartile-topped s-all. Said another way, they're relying on you to be the alpha part of their portfolio, which is said another way is they're relying on you to be contrarian and to take those shots on goal that are outside of just their pure beta. That's a very good way of putting it. They have to really focus on the big picture and getting the allocation right. And then they've got a partner. It's all about partnership figuring out how to add alpha on top of that. Because to really outperform you do need alpha, alpha is wonderful. It's by definition uncorrelated with the returns of the investor. That is the definition of alpha. So if you can add a source of return that's uncorrelated with the

rest of the portfolio, it adds almost no risk in total to the portfolio. The total portfolio risk barely budges, and yet you can move your returns kind of up and up. And so that's really what our firm's about. We're there to partner with the end investor. We do things that are hard. Some of it is quite difficult. We have a 30-plus person investment team dedicated to scouring these markets, and it's not just the number of people. It's the number of years of experience that those people bring to the table. And where they're to partner with investors who need access to these markets, which are less efficient, which are difficult, they're time-consuming, hard to diligence, hard to access. In some cases, you know, just take a lot of experience

and a lot of shoe leather. And you mentioned the Swenson model, which was developed by David Swenson at Yale now in the 80s, so many decades ago. I had Alex Ambrose from Alligator Training Institute, and he took me through the DPI model. So when Swenson model was around, there was a 24% DPI in private markets. In 2024, there was 9% DPI in 2025. Again, roughly 9%. Is the endowment model of old broken today? It's a big question. People totally need to recalibrate how they think about private investing, first of all. Private markets are much more mature than they were. And so the idea of sponsor to sponsor exits at the pace that we saw them over the course of our careers, it's unlikely to return to that level over the long run.

So if sponsors exit to sponsors at a slower rate, that means privates will be held for longer, it means less DPI, and it means calibrating your assumptions about liquidity. But it also means calibrating your assumptions about returns, because when you have a new market and it's growing, there's almost like a structural alpha, where there's flows, and the flows generate higher multiples, higher valuations, and it's just a wonderful feeling kind of everyone wins, rising tides.

I don't think we're in an environment where it's sinking tides. It's fine, but you have to recalibrate. It's not going to be as fast an exit. And the emphasis on finding good businesses at really good valuations and finding management teams as well sponsors who can operate those businesses and actually add value, it's very clear that the market's shifted and investors are spending a lot of time thinking about that as opposed to, oh, let me just invest a large amount in private equity and the beta will take care of itself. Expert calls have always been one of the most powerful ways to build conviction, but today, investors are asked to cover more companies, move faster and do it with leaner teams.

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They don't want their capital tied up now for 10 plus one plus one plus one years. They don't want there for 14 years. They don't want their capital basically burning a hole in their wallet and cash. And they want to have control. Is that something that you see in the market as well? There's some elements of that. Some of that's just about investors trying to contract with investment manager and just make sure that they're getting the right thing. We think it's important for investors, for example, one way or another to have some transparency into what they're

buying, what kind of companies they own at what valuations. Our own program is very focused on lower middle markets where we think pound for pound, we're just getting better value because we're buying businesses at better prices. It takes more work. But you get get paid for that work. So there's return on work. In the largest end of private equity, there's less of return on work. It's more competitive because the rewards are so great. If you can write a billion dollar check to buy a business, well, many sponsors would like to do that. That's a very privileged position to be in. So it's more competitive, more of an auction dynamic. And so I think part of it's just about identifying the opportunity, making sure the investors

really get comfortable that there is alpha. We found that for many, if you have a really consistent playbook and can show that you're executing on that playbook over and over and over, they can get comfortable that they're underwriting almost like you said before, a sustainable source of alpha. So something that's beautifully inefficient. And they may not need to get down to the granular level, show me a deal. They might be willing to do more of a blind pool. But there's definitely an emphasis as well on co-investing and seeing identified pools.

We think one trend in private markets that's really exciting now is the continuation vehicle. technology, I'm going to call it a technology, because I think people are thinking of it as a market. It is a market, but it's also a technology. It's a technique. And it could be used in many different ways. You can use a continuation vehicle to take the companies that are struggling in your portfolio and hold on to them for longer, or you could take them, take the same technology, rather, to go after the crown jewels of your portfolio, the businesses that you know have moated advantages that you want to see grow over a longer period of time. So we think the continuation vehicle market that technology will now increasingly be used by sponsors to hold on to their best businesses.

That's not how it started, but that's where it will be applied. And that's an exciting opportunity because if you're an endowment, you can look at a business and say, I like this business. I even did a call maybe with management team or I have a partner in that market. And I know the business. I know the track record of management on execution. I know the track record of the sponsor. And I want to be invested in that business for the next five years.

I love continuation vehicles. I had Michael Lull House from TBG who has a, $1.9 billion fund just focused exclusively on that. I think they just crossed $110 billion in AUM continuation vehicles. They've really proliferated in the buyout space. Do you see them making more of an appearance in the venture capital space? I've seen a little. I think it's underpenetrated. Even lower middle market is very underpenetrated. We've studied just the buyout market alone. And what you see is that overwhelming percentage of deals are flowing to the middle market. and actually, as you know, most companies are lower middle market, most sponsors are lower middle market.

That's by number where the opportunity is, but it's not where the dollars are. So if you're a broker, it's going to be more exciting at least at first to go find the bigger businesses that you can do CVs with. But the technology is out there. It's pretty well established. People aren't confused by it anymore. They kind of know how it works. They know how incentive alignment works.

They know how to structure, how to document. And so now that it's more of a developed market, it will be. be applied more and more in lower middle markets. And I think the same could be said for the technology world, venture capital and growth capital, where it definitely is going to make a stronger appearance over the next decade. But it's going to follow a buyout. Buy out will lead the way. And it's so interesting that continuation vehicles are this new vehicle where you might have a fund and your fund is at the end of its life. And now you double down. Instead of selling that your best asset, you put it into an SPV and you raise money around it. But if you think about it from first

principles. I had Sam Zell's long-time partner, Mark Soter, who still runs his family office. And he talked to me about the absurdity of how private equity works, which is you take an asset, you build it for five years, and then you sell it to your competitor. And it's just not, doesn't really make sense from first principles outside of the DPI schedules and LPs, I would argue, fetishizing DPI and wanting to constantly redeploy capital, even if it's in suboptimal investments. But if you think about it, not only do you have asymmetric information on that asset. So you've now worked with them for five years. But the entire process of buying and selling companies over and over, it has huge frictions, not only financial frictions, but also time friction.

The first year, you're getting up to speed on the asset. Then for three years, you're actually productively growing that. And then the last year, you're growing it up. I see this all the time. I've never met a buyout portfolio company in its last year. That's not somehow dressing itself up for acquisition. It is just the nature of incentives. And if you think about now you have, you contract that. And you still have the one year where you're setting up with the asset. Now you have three years, but now you get to compound that asset for seven, eight years with the same management, with continuing to press your advantages. Just imagine high vista. You've been there since before you even started in 2005 as a firm.

What if you were cut off in 2010 or 2012? How much more room is there for the firm to grow? Yeah, the geometric growth, the potential, whether it's in growing a firm like ours or the potential for a company is so obvious. Not every business has that, right? Some run out of ideas. They had their playbook. They need to make a quick fix, and then they should just sell it to someone else who has a better idea. Because ultimately, companies should be owned by the management team or sponsor that has the best idea for them.

That's what's so great about our economy. It's so dynamic. It's so easy to transact relative to other places in the world. And we're blessed by that because it really creates a lot of efficiency. But this is a new tool that will enhance efficiency because when the sponsor can convince the capital that they have the best idea to continue with this business, that actually keeping the management team in place, creating even stronger alignment of incentives, they have a great plan. That's a wonderful outcome. And yet, the privates for longer trend means that some investors don't necessarily want to hold onto their businesses for 10 years. They may be

very happy. If they have a three or four X outcome in year five, they might say, that's great. I want to take some or all of the winnings off the table and redeploy it, or maybe they have actual spending need. So it really gives investors more flexibility. It gives the sponsors an ability to lean into what they're doing best. And it gives investors, I think, the opportunity to align with the sponsors and really challenge and make sure, you know, is this the business that we want to hold on to, that the sponsor has a right to win, that is this the right management team? And so I'm excited about the technology.

I think it's going to be used in venture growth world as well. It will mature. You know, we're kind of going into a second decade. It's 10x in the last decade. It was $100 billion market last year. which is kind of an incredible number. And it will continue to grow. I don't think it will 10x in the next decade,

but it's going to grow and it will enter new markets and it will be applied in new ways. When I think about venture, one of the leading pioneering firms on this is Harbor Vest. They're starting to really actively do CVs. There's also a fellow Bostonian firm. From our window, we look right out at HarborVs. And I think one of the frictions there is CVs are still considered secondaries.

So firms are not RIAs are going to struggle for a while. to do that without the right financial partners. But if you take a step back and look at DPI on the venture side, there's no reason to believe that the quote unquote DPI crisis or DPI is going to return to venture capital just because we're going to have the open AIs, SpaceX, Anthropics, there's no reason to believe that that's going to solve this DPI crisis in the future. No, it's, it really is a case where I think investors are realizing that early stage venture is a long-hold game, and you're not likely to find exits in the first five or ten years. It's going to be in years 10 to 15 and sometimes beyond. You're seeing venture funds that sometimes

have amazing outcomes, but it takes them the full 15 years. So it isn't for everyone, but if you're a patient institution that is investing over the very long run, investing in the means of production, whether that's through industrial companies or service companies in the buyout space or with the innovative economy in the venture space is really the only way to invest outside of fixed income markets. You have to ultimately invest in the economy. Some of that's in public markets, of course, super important, but there's 3,000 public companies in the U.S. and there's probably something like 100,000 investable private companies. So it's just a much bigger market. It's in many ways a more important market for investors. Not more important for the world. The public markets serve an

amazing function, but for investors, the private market just gives you way, way, way, more flexibility, more opportunities, but you do need the right duration of capital for venture capital. And particularly if you're not investing in the top 10, 50 or 100 businesses, the ones that are likely to go public in the next few years, that's also a great opportunity set. Some investors are focused there, but there's still early stage innovation to invest in. Which is another form of alpha. Everybody is saying, I want DPI, I want shorter timelines. One source of alpha is going in the opposite direction saying, I'm okay to be the long time partner, as long as I have these higher hurdles.

Yeah, we're 100% believers. So our lineage in venture investing goes back to the mid-1990s. It's actually a team that joined high vista. Yeah, tell me about it. Team that joined high vista used to be called Flag and started this in the mid-1990s. So it's now 30 years of investing in early-stage venture. So totally focused on the innovation economy. You end up taking bets on things that are head-scratchers because they just sound crazy at the time. But in the fullness of time, you know, They kind of make a lot more sense. So I remember actually when I started at High Vista 20 years ago, 22 years ago almost, Google had just gone public. And it was like, what, these guys are like a better form of Yahoo or something? And it's like, I don't know, is this like $20 billion plus, you know, valuation?

Like, does this even make sense? Like how will they ever make money? Like how much money could they make? Fast forward 20 years. And you see like what kind of innovation they've brought to the economy and the rewards for that innovation, as well as the monopoly positions they've created for themselves amazing business. And those are created in the venture capital ecosystem every single year. There's always great companies being born.

The challenge is there's thousands of businesses being formed every year. You know that. You're very involved in the space. You know how many businesses there are. And there's a thousand venture capital firms funding these thousands of businesses that are created every year. Most will fail. Most should fail. That's what's great about markets.

and it's that power law where the most successful businesses will be in that bright tail and could get you 100,000 X returns or maybe even greater than that. When you find something that just fits right, you end up wearing it more than anything else. And for me lately, that's been my rag and bone Miramar jeans. What really stood out to me is that they look like traditional denim, but honestly feel more like sweatpants. They've got that clean, structured look, but with a level of comfort that makes them easy to wear all day.

I've been wearing them pretty consistently, whether I'm recording, traveling, or just out there during the day, and they become one of those go-to pieces I don't really have to think about. Even after long days, they don't feel restrictive, which is something I didn't realize I was missing until I started wearing them regularly. With rag and bone, it's not just about one pair of jeans, it's about having reliable staples in your closet. You could dress them up a bit or keep a casual, and they just work. The washes are clean, the cut is sharp, and they hold up really well over time. It's that balance of comfort and structure that makes them stand out compared to most. If you're looking to upgrade your denim, I definitely recommend checking out rag and bone Miramar jeans.

You get 20% off sitewide at www. www.rag-dashbone.com using code invest. Again, that's 20% off at www. www.R-A-G-B-O-N-E dot com with code invest. When you find something that just fits right, you end up wearing it more than anything else. And for me lately, that's been my rag and bone Miramar jeans. What really stood out to me is that they look like traditional denim, but honestly, feel more like sweatpants. They've got that clean, structured look, but with a level of comfort that

makes them easy to wear all day. I've been wearing them pretty consistently, whether I'm recording, traveling, or just out there during the day, and they become one of those go-to pieces I don't really have to think about. Even after long days, they don't feel restrictive, which is something I didn't realize I was missing until I started wearing them regularly. With rag and bone, it's not just about one pair of jeans. It's about having reliable staples in your closet. You could dress them up a bit or keep a casual, and they just work. The washes are clean, the cut of sharp and they hold up really well over time. It's that balance of comfort and structure that makes them stand out compared to most jeans. If you're looking to upgrade your denim, I definitely recommend

checking out rag and bone Miramar jeans. You get 20% off sitewide at www.org-Rag-B-W-B-W-B-O-N-E-com with code invest. When you find something that just fits right, you end up wearing it more than anything else. And for me lately, that's been my rag and bone, Miramar jeans. What really stood out to me is that they look like traditional denim, but honestly feel more like sweatpants. They've got that clean, structured look, but with a level of comfort that makes them easy to wear all day, I've been wearing them pretty consistently, whether I'm recording, traveling, or just out there during the day, and they become one of those go-to pieces I don't really have to think about. Even after long days, they don't feel restrictive, which is something I didn't realize I was missing until I started wearing

them regularly. With rag and bone, it's not just about one pair of jeans. It's about having reliable staples in your closet. You could dress them up a bit or keep a casual and they just work. The washes are clean. The cut is sharp and they hold up really well over time. It's that balance of comfort and structure that makes them stand out compared to most jeans. If you're looking to upgrade your denim, I definitely recommend checking out rag and bone Miramar jeans. You get 20% off sitewide at www.org.org.com using code invest. Again, that's 20% off at www.R-A-G-B-O-N-E dot com with code invest. And every venture investor, their dream is that they have an unusual batting average

and they're going to find a disproportionate number of those 100x,000-X returns. You have to be in the ecosystem. You've got to know the right groups that have the right access to that deal flow. It's very hard as an investor to just wake up one day and say, I want to be an early stage in venture. I'm going to move to Sandhill Road and see what businesses come my way, they're unlikely to knock on your door. But there's so many venture firms that one could partner with and as well as innovative ways of investing in that we think it's a great

place to be invested if you have that time frame. I've coined this term strategic ignorance when it comes to venture capital, which is venture capital, capital V, everybody wants it. Everybody wants to get these funds. But if they knew what they were investing into, especially at the time, they would not like that. They would not like, why are you investing in defense tech a decade ago? how are you going to go against the large primes? Why are you investing in this cryptocurrency? Isn't it going to be hacked? Every single trend by definition for it to be an early stage investment and for it to grow 1,000x needs to sound crazy. So it makes a lot of sense, especially when people are managing other people's money and that's somebody to report to, to have this wrapper around this portfolio that's called venture

capital with these extremely spiky assets that since the 1970s have has outperformed every other asset class on average if you're in the right managers. Not knowing exactly what's in your portfolio, not figuratively, not literally, but figuratively is a huge advantage to investing in master class. 100%. And the way we look at early stage venture, let me start with this, is one of our partners had a slide a number of years ago that showed what was the best business created in the venture ecosystem every year going back in time and where did capital flow in that year, which sector was capital flowing to within venture and where was the best business?

And it was never the same. So the best outcomes was always in some space that people weren't thinking about and all the money was going to this, you know, into the crowded trade. So there's definitely a part of being a great venture investor that requires a discipline, almost being a contrarian and looking for weird ideas, but really great entrepreneurs in potentially very large markets. The best venture firms have figured that out. A lot of it's about entrepreneur. The business plans adjust. But if they're in a great space and you've got a great team, magic can happen. And we've seen so many examples. of that where businesses started with business plan A and then they become known as completely

different company. I mean, let's think about an automobile company that's become an AI company, for example, right? Tesla is just the perfect case study of how much they've accomplished as almost nothing to do with automobiles. And so that's so important in venture. You need this large portfolio, large number of bets, so if you want a somewhat predictable outcome over time, but you also need to think in a little of a contrary in style, I'm not just going to put all of my money into the hyperscaler. I'm actually going to go look at some very differentiated. Some of it's in the AI native companies, but some of it's in other areas of innovation. I mean, defense tech is obviously going through a massive innovation wave. And I think the next

few years we're going to see even more of it. Investors have to kind of pick their spots. Speaking of contrarian investing, you guys are bullish on biotech. Yeah. many people are withdrawing from the segment and think it's very difficult due to many different issues, China, the IRA and other kind of pricing mechanisms that are going against biotech. Why are you so bullish on biotech? So let's start with health care. You know, you hear people talking about health care is out of control. It's just too high a percent of GDP. But if GDP compounds the way it's been compounding, actually health care will grow as a percent of GDP. And it's almost

almost like a rule of economics, actually. The cost disease, there was a, I think a noble prize given for this work, kind of explains why health care costs will rise over time. It's one of those things that rises to the top, top of the right. Yeah, as a society gets wealthier, the amount they'll spend on the raw ingredients in their meals goes down. The amount they'll spend on oil or coal or natural gas or rubber or steel goes down. but the amount they'll spend on experiences as well as wellness just goes up and that occupies a

greater and greater percentage of income. So, you know, we're sitting here in Soho and how many restaurants are there within a few blocks distance? And if we were to go back to generations, how many restaurants were here? People didn't eat out as much. People are eating out more. They want great health care. They want wellness. Well, within that basket, so you have GDP growing, you have health care growing faster than GDP. And then what's going to take a bigger and bigger percentage of health care, technology or manual labor? And it seems pretty obvious that it's technology. So biotechnology is wonderful because if you can get the right medicine, even if it's only for a small population, if you can get the pill that helps 1,000 or 10,000 people, that's an incredible

amount of value that you can bring to this world. And compare that to the rising cost of health care of staffing a hospital or an outpatient clinic. Yes, it's expensive to develop these medicines, but there's so much leverage and you develop it once and you don't have to hire as many people to treat that population. So the macro is wonderful. You have this tailwind of growing GDP, growing health care as a percentage of GDP and growing pharmaceutical innovation as a percentage of health care spend. Yes, there's headwinds in the form of people don't like hearing about the drug prices, often priced in the thousands, tens of thousands or sometimes hundreds of thousands of dollars. These are very expensive and particularly for those

very small populations where you have some orphan particular indication where you could be only few hundred people taking a certain medicine that's going to be very expensive to develop on a per person basis. That's the backdrop. What we like about biotech is that backdrop, but also the alpha opportunity in the public markets. Alpha in general, this is a pet peeve of mine. People talk about asset classes as if the pricing is fixed. For example, they'll say, I love early standards.

stage investing or I hate early stage investing. But if you have the same asset, you're investing at a $25 million valuation or you're investing at a $5 million if it's extremely out of favor. That is fundamentally a different investment. And people talk about it as if it's good or bad versus what the right way to talk about it is whether it's overpriced or underpriced. Yeah. There is no really bad asset. And same with biotech. If everybody in the world now thinks biotech's a bad sector, at some point it becomes one of the best sectors in the world because there's just so many opportunities. And when everything goes down, even if there are a lot of bad assets, sometimes there's some gems there that no one's looking for. 100%. It's challenging because you get these

pro-cyclical moments where when the market turns and becomes pessimistic, it's hard to access capital. And some of these companies, when they can't access capital, like in the venture ecosystem, you know, it means they go away. So you need to maintain access to capital. That's why there's so many public. There's a momentum aspect. There is a momentum. There's a short-term momentum and a longer-term reversal. And so they're great contrarian value investors who saw biotech just getting hammered over the last few years. And some of them timed it really well, kind of getting in at the nadir and just saying like, okay, yes, there's a lot of headwinds in terms of momentum. But eventually there's a reversal. You get to some point where you're buying businesses for less than the net cash.

And you're saying, okay, even a mediocre management team should be able to handle this one. I mean, we're trading it less than the liquidation value. This is amazing. And then if you have a good management team, it's like many ways to win, right? This is amazing. So you get those opportunities. There are moments in biotech where the beta turns very favorable. And there are moments where it's less favorable. We as a firm don't think we're like the best at market timing. We leave that to others. Kind of got to know what you're good at, what you're less good at. We tend to focus on the more consistent application of alpha generation. So it's the security selection. How do you get relative value? But there are investors. That's really like the CIO's job at, at, and at an endowment to say, I'm going to reallocate some money from China to biotech or from biotech to Korea. So there's principal agent issues on your side, which is if you go to these LPs and the LPs know that biotech is out of favor, it's a heart.

You need to have a lot of political capital to do that. But also, let's say that the head of biotech or the head of ALTS wants to do the investment. Now they have to go to their CIO. And then their CIO has to go to their board. So it's all these levels of governance and all this complexity that you're going against friction. On your point on market timing, I've actually pretty much come to the determination that market timing is an unknowable force. And the reason I could say that with high confidence is I've talked to some of the best public investors in the world and none of them know what catalyzes

a recalibration. And I actually don't even think it's that they don't know. I think it's unknowable. I'll give you an example. GameStop. Was that a knowable thing? That was fundamentally unknowable. But even smaller aspects of that, sometimes you have somebody come in with an activist campaign. you know, could you predict that? Well, maybe if you knew that activist and they gave you a phone call before that, which would be, of course, insider trading. But outside of that, there's these memetic things in the market, especially now with social media that are fundamentally unknowable. What will actually catalyze the change? What do you need to do as a great public investor? You need to make sure that you have enough of a runway for luck to basically run its course. I think that's right.

Look, geometrically, you may have some understanding of a market, but it may not work out arithmetically. And let me explain the difference, right? You look at GameStop and you say, I kind of know where this is going to end, but you don't know where the next day, the average of the next hundred days might be very bad if you go against the mania. Over the long run, you might be right, but you might be carried out before you're right. And so particularly when you're short, it's extraordinarily difficult to be short because it becomes more of an arithmetic game. And on some days, you could just lose so much money that you can't even make up for it.

When you're a long, you know, biased investor and you're holding a security, you sometimes could fight the crowd. It's possible. You want to diversify because you never know there could be corporate events that change the ultimate trajectory. But I think fundamentally the point you're making is right, that it's very, very difficult in these situations to kind of time and to get those dynamics exactly right.

We're more focused on the dispersion of opportunity, making a basket of investments where you think the basket is biased towards that kind of top quartile outcome. When you have a high dispersion market, you don't even need to be 99th percentile. If you're 60th percentile on average in a high dispersion market, you just are going to outperform by hundreds of basis points. Kind of goes back to this strategic ignorance aspect, which is if you need every single investment to work and to get the timing right,

you are misusing the asset class. But if you build a basket of it, knowing that on average, you're going to have these very spiky, very high alpha trades, then you could actually have a pretty diversified and pretty predictable alpha producing portfolio. Yes. Now, I want to go back for a minute to what you said if we can. You said the magic word before, governance. I think so much of this is about governance and agency. And if every investment organization, whether you're an investment manager like high vista or a pension or a sovereign wealth fund, if every investment organization could clarify what they do, what they don't do, where they should focus their time and how

decisions will be made. That will lead to just much better outcomes. There are organizations who we've partnered with who really can lean in and out of markets who have the governance to do that in a time effective way. They can actually move around their asset allocation in a pretty dynamic way. Most organizations can't. And if you have that knowledge of which organization you are and how your governance, do you have to go to your investment committee? Does the CIO have discretion? How much career risk would the CIO be taking, by the way? And can the CIO withstand? And do they have upside? Do they have upside? What if the market goes against them? Will they double down when the market's down? Or do they cut their losses? Why should they double down? Why should they cut their

losses? Obviously depends. Sometimes market moves against you. You say, information's on my side, and this is just random or even worse than random. It's just some nonsense fad, you know, trend that's going to reverse itself. I got to add even more to this position. There's other times where kind of more of the classic hedge fund approach, which is, hey, it's moved against me. I just have to get out, cut my losses, and I'll reevaluate and see if my thesis is intact. Both have their place as risk management or investment philosophies. But you need to think that through in advance. You need to know if you're going against the crowd, if you're making a big decision,

what will you do on the day where it goes against you? And how will your teammates, how will your supervisor or your committee react? It reminds me of this famous pension fund study that found that 90% of a pension fund's performance could be predicted by their asset allocation. Yeah. And their sub-asset allocation. And then you think upstream of that, what is that? That's governance.

Going back to Alpha, governance is probably the most importantly sexy thing on the planet. And yet when I interview people, especially former CIOs, where I love to interview former CIOs because you get the full picture from them, they're no longer within the organization. And I interview people like Larry Kochard, who's former McKenna, UVA, Georgetown, or Britt Harris, who's actually become an advisor of us, former U. Timco, CIO. they all say the same thing. A, it all comes down to psychology. They basically realize 20 years into their career that they're a psychologist. And then two is it comes down to governance. And even current

CIO is Scott Chan, if you ask him, how did you return 13% on $360 billion at Calisters? The answer is he had a decentralized system. Because how else do you move with so much capital? You need to empower everybody in the organization to be able to make decisions. Now, of course, you have risk guards on that, certain check sizes require discretion, all these things, but you have to allow people at the edges to execute their discretion. 100%. It's really aligning between the particular dynamics of the capital source, the organization that's formed around that to get to the right governance model.

There's no one governance model. I think, you know, in our own case, because we're investing across lower middle market private equity, early stage venture, asset back private credit, as well as biotechnology, there's a lot of ground to cover, and we couldn't do it without having a really strong platform, which means governance. And it also means, of course, having great client functions and operating functions so that investment teams can really focus on making great investment decisions. There's different investment committees, different composition for each of our different areas of focus. And so those investment teams can focus on their craft, on making good decisions and

partnering with an overall broader platform that supports that craft. You mentioned this whole aspect of career risk. My favorite example of this is Scott Wilson at University of Washington, Westview, St. Louis, and he meets with his managers. They've done well. They've done exceptionally well. He's one of the top CIOs in the country. Incredible.

And he meets with the top managers in his portfolio, and he asks, where are you at your concentration limits? In other words, you're 20% in this position. I want more of that. What he's implicitly saying is that even at 20% you're underweighted. Why? Because Lil Johnny still has to go to college. because that CIO still has a certain risk factor that they could take.

So he fundamentally goes and meets with every manager, figures out where they fundamentally cannot put in more and actually doubles and triples down on that, which is very counterintuitive. Usually you would think about in portfolio construction, you want to do the opposite. But because he's so diversified across managers, going back to the structural alignment,

he's able to take these asymmetric bets in their highest conviction bets. And that, I think, was pioneered by the pod shop, really. The pod shops really came up with this idea of a center book where you're upsizing. We do that across all our portfolios, actually. So we're doing that in private equity, venture, private credit, and biotechware. We'll partner with specialist GPs. And then you're trying to lean in. You have to build a lot of diversification to be able to lean in because if you lean in on an undiversified portfolio, in the end, you're just taking too much idiosyncratic risk for the client. But if you have 100 plus company diversification in a portfolio, you could afford

to lean in and still not really be taking on that much risk. How do you get to 100 plus company diversification in any program? You need to do it through partnership. No organizations really set up to invest directly and know hundreds of businesses cold. You need to know the businesses, but also have really good partners that you can rely on. And then co-invest, whether it's an independent sponsor or a small venture manager or a hedge fund, co-investing alongside them or upsizing a name is a very powerful tool. I think this is one of the fundamental flaws in asset management, this idea of

of over diversification. There's this rule of 22 and a half, which is completely arbitrary, just means that you have like 97% diversification. If you take it to the most extreme, you have many founders that have 100% of their money in one company. And then you think, okay, how diversified,

I'm in one asset, that doesn't sound very diversified, and it's not, of course. Then you think, well, now I do nine more investments, I have 10 investments. How diversified am I? It's actually a very easy math equation. You're now 90% more diversified. And now you do another 10,

now you're 95% diversified. this is where the 22 and a half, it's just this, it's an arbitrary rule. It's this number that people have come up with, but there you're 97% diversified. But at what cost? And a lot of, this goes back to principal agent problems. If you're an endowment and you're CIO and you don't necessarily have the upside, you want to make sure that if, if everybody else is at 8%, you're between 7.5 and 8%. So from principal agent problem in a principal agent position, it makes a lot of sense to be hyper diversified, but from a net return to the underlying capital pool, it makes much more sense to be spiky in the way that Scott Wilson does it and you guys do as well.

So a couple comments on that. I think that's right. When you diversify roughly, the idiosyncratic risk that you take relates to the square root of the number of investments you have. So if you go from one to nine investments, you kind of cut your, you cut your idiosyncratic risk by factor of three. When you get to 25, you cut it by factor five, assuming they're all kind of different sectors and that you're, at some point, you're actually making many bets in the same sector. And so that's where that diversification really does start to matter less once you get to the 10, 20, 30. You feel like diversified, but you're not. Yeah, because when you start diversifying cross geography or sector or themes, in the beginning, it's very powerful, but then you have many

bets in the same theme or the same sector. It's not as powerful. For the capital allocator, their job is actually not to over diversify and to not think, I need to hold equal weight U.S., Spain, Vietnam. That gives me more diversification. Like, that's nonsense, right? When you're thinking about capital allocation at the highest level, your starting place should be the world. Take the AQUI index, for example, and say, like, hey, that's a pretty good index.

And then if you want to lean in one direction or another, sure, lean. Once you drill into market and say, hey, how am I getting exposure to VEFEC? Vietnam or Spain, well, yeah, you don't have to index in that country because it's not really going to matter. If you made three bets versus 30, it doesn't matter. Then it's just about agency risk. Once you're in the drilling down one layer, it becomes about agency risk. But agency risk, I would argue is real. I think even when you invest for your own portfolio, if you don't have enough diversification, you might make the wrong decision at the wrong time. Make some more fragile. More fragile. You might lose faith in a strategy that you had thought through pretty carefully

because you don't see enough evidence that it's going in your direction. That's the other thing I'm obsessed about, rootedness of thesis. An example I use on Bitcoin, if you had invested, if your friend, you went to MIT, your friend came to and said, there's this awesome thing called Bitcoin, you have to invest, and you invest at $10. And then it goes up to $160. And you're like, great, I'm up $16. And then it goes down 20% to $120. What are you going to do? Yeah, so actually, a friend of mine from my days in Cambridge did come to me 14 years ago. and he's a brilliant computer scientist. Actually, this is his field.

And he said, this was going to change the world. And he was, I think, on a professor's salary. So I don't know how much he invested, but he was advocating that, like, everyone should invest. I actually just had no idea what he was talking about and couldn't understand it, so I didn't invest. You know, I think I would be in a very different situation today had I taken his advice. But, yeah, you have to understand what you're investing in. you have to have core beliefs and you have to be willing to stick to those even when the evidence is a little murky. Well, Rafi, this has been absolute masterclass. Thanks so much and

thanks for being a partner to our firm and thanks so much for jumping on. Thanks for having me. It's really great to be here and look forward to our next conversation.