Investing Billions - E44: Chris Prestigiacomo of SWIB ($140B AUM) on What Pensions Look for in VCs

Starting point is 00:00:00 You're absolutely right. The returns aren't going to be there in the more recent funds that you've been investing in. So what we look at, you know, did they execute on the strategies that they laid out to us, you know, when we were underwriting the previous funds, any material changes to the team, any material changes to the market. And then also, I think the most important thing is doing more of a deep dive into the companies themselves. So like, you know, when they made the original investment, you know, did everything go as they were expecting and if not, why? And hopefully what you find is, yes, the investments and the companies that they made, everything is tracking as they expected. For more ideas on how to raise venture capital in this market, make sure to subscribe below. Chris, welcome to 10X Capital Podcast.

Starting point is 00:00:39 Thank you for the invitation. Looking forward to it. So, Chris, you have an interesting background. You're a son of Wisconsin and you've spent most of your life there. looking forward to it so Chris you have an interesting background you're your son of Wisconsin and and you've spent most of your life there tell me how you became a portfolio manager at state of Wisconsin investment board also known as whip yeah so yes born and raised in Madison started my career here in Madison out of undergrad went to go work for a regional bank here in town, which seems like 100 years ago. But I joined SWIFT in 2001.

Starting point is 00:01:13 So when I was at the bank, I was a commercial lender, and I was working with middle market companies, wholesale banking, commercial lending, and a few of the companies I worked with were technology companies. So that was probably the mid-'90s. So working with startups on the depository side as well as on the lending side. And then in 2001, I left the bank and moved over to SWIFT to help manage a private debt portfolio, which I still manage today. And then in the mid-2000s, I took over the responsibility of a regional venture capital portfolio. And we've grown and expanded that portfolio over time. And today, it's primarily a U.S.-focused venture fund.

Starting point is 00:01:41 And we tend to tilt more into IT, software, and tech-enabled businesses from a sector perspective. And you mentioned private debt. Is working and managing private debt portfolio somehow make you a better venture portfolio manager? So it gives you another lens or a different perspective. We do have lots of conversations with venture debt funds. So it just brings another perspective when working with startup companies. On the venture side, we're primarily focused on making basically equity investments, early stage equity investments directly into companies,

Starting point is 00:02:15 as well as the fund commitments that we make to our managers. What do you think about venture debt? Where is venture debt today? And is it an attractive asset class? I just had a conversation with a venture debt manager a few days ago. You know, I think from a returns perspective, it does continue to hold up even in this difficult market.

Starting point is 00:02:34 I mean, the returns are in the kind of the mid-teens, primarily focused around cash pay interest, some pick an equity kicker or success fee. The managers that we've looked at or talked to, the loss rates are still extremely low. Default rates are very low. So it seems like it's holding up. Now, I don't think we've seen the depths just yet in venture. So there could be some additional stress, but I do think it is an investable asset class from an institutional perspective. You guys have a $140 billion fully funded pension plan. First of all, what does it mean to be fully funded? And then tell me at a high level your

Starting point is 00:03:10 asset allocation strategy. Yeah, so from a funding perspective, the assets that we have or are managing actually can fund the liabilities of our beneficiaries. There are a lot of state plans that unfortunately aren't in the same position as us. So having that fully funded status, that liquidity and in good times and bad allows us to invest in all business cycles. A fund, typical fund life, right, is 14, 15, 16 years. So having that long-term perspective is extremely important. Do you think venture returns are inherently counter-cyclical? Valuations are coming back down into a more, what I'll call normal level.

Starting point is 00:03:50 There's less capital available. And so the best entrepreneurs, the best companies are getting funded at better valuations. And over the long-term, we think those will generate very nice returns for us. Chris, can you say more about what kind of GPs you like to back or what you look for in managers and how you think about just architecting a venture portfolio? Yep. So Eric, so we like early stage. We define early as seed series A and series B. And most of our later stage

Starting point is 00:04:15 investing has been through the opportunity funds of our early stage managers. When we're looking at underwriting an early stage manager, fund size obviously is important. So David, you and I had some conversations about what type of a manager do you like to back. Fund size wise, we like to have smaller funds we think is better from a multiple and an IRR perspective. A manager that's raising a 350 to 450 size fund is a good size for us. Now, obviously, that's not the case in every situation. There are

Starting point is 00:04:46 some managers that have raised billion-dollar Series A funds, and we'll participate in those, but we think that the manager has something special to them. Say more about the type of managers you backed. Are some of them emerging managers? Have they been long track record? Are they founders? What kinds of archetypes do you have in the portfolio? All of the above. We haven't been very active on the emerging manager side. Most of the groups that we have backed have had a track record. So either that's a track record from a previous firm and maybe they're out raising fund two or fund three and we'll come in and make a commitment. Or it's an existing manager that it's a new relationship to us, but an existing manager that has a good

Starting point is 00:05:21 track record. How are you guys able to deliver alpha at the scale that you're at? The individual or individuals that we back have to have some type of a track record, whether that be a track record from a previous fund that they were at or potentially, let's say an angel track record. David Sachs is a great example, right? So a proven entrepreneur, you know, early employee of PayPal, built that up, sold it, went on to Yammer, had a really nice exit there, then basically started investing his own capital, had generated a great track record there, and then decided to professionalize or institutionalize and start craft. That's a, that, that for us, that's a good kind of emerging manager

Starting point is 00:06:02 profile. What do you think is the trade-off between operator-turned-VC versus finance-turned-VCs? Having more of an operator background is probably a bit more important from an ability to really help a founder if they do have a problem, whether that's building code or hiring the right individuals. But having that network, I think, is extremely important. Essentially, hiring the right individuals, but, you know, having that network, I think is extremely important. Essentially it's sourcing, picking and winning. How do you guys rank those as imperative for, for long-term return of capital? Returns are something that we do look at, whether it's from a previous fund, uh, that they worked at or their own, you know, uh, personal angel book. Um, and then again, we look at what, what their background is, their experiences is. So are they

Starting point is 00:06:45 an operator? Are they a company builder or a founder and entrepreneur that's built businesses and sold businesses, has walked in the shoes of the founder? We think that's really important. And then we also look at the team that they're able to kind of surround themselves with. We think having a good team is extremely important as well. And then obviously, the sector that they're investing in, is it a sector that we think has has likes to it's going to continue to grow? What returns are you are compelling for you? We'll continue our interview in a moment after a word from our sponsor. Most businesses use up to 16 tools to hire, manage and pay their workforce. But there's one platform that's replaced them all. That's deal DE-L. Deal is the all-in-one HR and payroll platform built for global work.

Starting point is 00:07:27 Smartest startups in my portfolio use deal to integrate HR, payroll, compliance, and everything else in a single product. Focus on what you do best. Scale your business and let deal do the rest. Deal allows you to hire, onboard, and pay talent in over 150 countries from background checks to built-in contracts. You can manage an entire worker lifecycle from a single and easy-to-use interface. Click the link in the show notes below to book a free, no-strings-attached demo with Deal Today. So my view is if you look at the long-term net returns of venture, if you're posting 25% to 30% net, that's a very strong, very strong venture portfolio.

Starting point is 00:08:03 In terms of venture, as part of your portfolio, you guys are managing $140 billion. What is the purpose of venture and how does it interplay with other parts of your asset management strategy? Yeah, so it's a relatively small overall asset allocation. So again, the core trust funds, let's call it $140 billion. The venture allocation to the core trust fund is about 3%. So it's a very small piece of the overall trust fund. That said, there are instances where if you get into the right fund or you get into the right company on a direct basis, you can have a meaningful contribution to the overall core trust fund returns. Given that it's only 3%, how much are you

Starting point is 00:08:42 focused on diversification given that it's such a small piece of your overall portfolio? As I said before, we try and run a, I'll call it a concentrated book. So 25 managers. I think if you grow the manager base more than that, then you're probably more of a, it's more of a beta return, right? So investing in a smaller number of managers and then doing some things on the margin, like secondaries, or direct investments that give you that alpha on top of kind of what the core venture portfolio is providing. What is your strategy when it comes to directs? How do you avoid adverse selection? So we've been investing in directs since the early 2000s. We don't lead anything on our own. So you can imagine with a pot of money, $140 billion, we have a lot of companies that will call us

Starting point is 00:09:29 and seek financing. And what we'll do is we'll, if we think it's a good team, a good technology, a big market, and that we think that business can scale, we'll actually refer it out to one of our managers. And then if our manager invests, we can actually make a direct investment alongside of the fund.

Starting point is 00:09:46 So to avoid adverse selection, David, I think the most important thing for us is to do our due diligence upfront and underwrite our managers and make sure that we really understand how they think about investing. We get to know the partners, what they're looking at, what they're seeing. And then the other thing too, is we make sure we communicate to them what we're looking for in direct opportunities. You guys have probably one of the most unique governance structures for $140 billion pool of capital. So tell me about that. Tell me about how you interact with your investment committee and how that's a source of advantage for you guys. We're very fortunate to have a fully funded pension plan and it gives us a lot of flexibility.

Starting point is 00:10:23 We call it the SWIB Edge. So the governance structure of the Wisconsin Retirement System and SWIB gives SWIB staff the investment discretion. So our board of trustees sets our guidelines, our investment guidelines, and as long as we stay within those investment guidelines, we have the ability to make the investments that we're underwriting and looking at.

Starting point is 00:10:41 The review and approval process is pretty flat, so it's essentially me sitting down with my CIO of private markets. We don't have to wait around for a monthly investment committee or a loan committee or a trustee committee that meets on a quarterly basis to get our investments approved. We can move pretty fast. We actually, we did a, this goes back about two years, but we got a phone call from a GP. It was a, it was a later stage transaction. They had a little bit left of a round to fill. They called us on a Thursday and we got approval over the weekend and we closed the following week, which is pretty fast for a public pension plan.

Starting point is 00:11:18 Let's get controversial. So I know for you, DPI is a big important thing and a fun. And of course, in this kind of market cycle, of course, I love DPI as well, both as a GP as an LP, but I would argue DP is a hugely lagging indicator. Why am I wrong in saying that DPI is a lagging indicator? The first, DPI is important, right? DPI will come back. I think GPs are actually a little more focused about DPI.

Starting point is 00:11:44 Most of the meetings that we're having now, they are actually a little more focused about DPI. Most of the meetings that we're having now, they're spending a little bit more time on their philosophy on how to either generate or manufacture liquidity. So let's say I have a $300 million fund. I have a position I put in $20 million. It's marked at $500 million today. It's up 25x. As an LP, that's highly diversified and investing at a 3% pool, what would be your advice for how I should manage the liquidity on that? I would ask if the GP is like, what was your target return? What were you looking to generate return in that particular investment? And if it exceeded that level, that amount,

Starting point is 00:12:18 then maybe it makes some sense to take some dollars off the table. My view is, you know, don't sell 100% of the position down, but you know, maybe 30%. And then you've got, you know, what, you know, 70, 80% of the remaining holdings to generate some significant upside, if you still have high conviction in the business. Tell me about your philosophy when it comes to your portfolio. Yeah, so we would we would we would like our managers swing a bit more for the fences. And that's why we're investing more on the early stage. Explain to me the practical limits to adding more managers. Why can't you manage a portfolio of 100 managers?

Starting point is 00:12:52 It's a resource issue, right? So we don't, I mean, I don't have a 10-member team. So there are some resources that we need to factor in. That number of managers is probably dilutive to the overall returns of the portfolio. And then if you're managing 100 managers, you can't, I don't think you can really develop close relationships with the people that you're investing in. And I think developing, you know, venture is a relationship business. Developing close relationships, you tend to get better opportunities.

Starting point is 00:13:18 So we want to, again, we'd like to run a more concentrated book. And one way that you can augment, if you only want 20 to 30 managers in the portfolio, one way you can augment that is you can do secondaries, both funds and directs. You can do opportunity funds. So there's ways to scale the portfolio up a bit, but not dilute the overall returns that you're looking for. So you're looking to re-up and you certainly don't have DPI. You probably don't even have TVPI to base your re-up decisions. What are you basing your re-up and you don't have, certainly don't have DPI. You probably don't even have TVPI to base your re-up decisions. What are you basing your re-up decisions on? You're absolutely right. The

Starting point is 00:13:49 returns aren't going to be there in the more, more recent funds that you've been investing in. So what we look at, you know, did they execute on the strategies that they laid out to us? You know, when we were underwriting the previous funds, any material changes to the team, any material changes to the market. And then also I think the most important thing is, is doing more of a deep dive into the companies themselves. So like, you know, when they made the original investment, is the company two years later at plan? You know, did everything go as they were expecting? And if not, why? And hopefully what you find is, yes, the investments in the companies that they made, everything is tracking as they expected. So that's one way to kind of work on diligencing a manager if you don't yet have any returns in the bank.

Starting point is 00:14:29 Do you have a part of your venture portfolio that's almost like an automatic re-up and then some people on the fence? We can't invest in everybody. Unfortunately, sometimes tough decisions and cut loose the managers that for whatever reason aren't performing. When do funds get too big such that it doesn't make sense to re-up? That's the billion dollar question. Like I said before, 300 to 400, 450, it's a nice size fund. And if the GP runs a concentrated LP base,

Starting point is 00:14:56 so you get a decent allocation and you can really, if there's a couple of companies in there, their home runs, you can really drive returns. My sense is that when vcs back founders founders pivot too right but my sense is that vcs are uh are perhaps more flexible or more interested in the founders pivoting if they've noticed a new opportunity and maybe lps have more of a sense for what they want because they have a portfolio and say hey if you're

Starting point is 00:15:19 covering sas we don't want you to do crypto because we're already in crypto i think what you're getting to is portfolio construction so let me construct a portfolio how I see fit versus having my manager do that for me. When you're talking to your peers, people who do the same exact thing as you, or look at the same managers, are there any common disagreements you find yourself, or ways in which you see the world? References are such a big part of evaluating managers. What are maybe a non-obvious question or a non-obvious thing you're looking to assess when you do references of your managers to identify prospective managers?

Starting point is 00:15:55 Hey, is this someone we want to be in business with? We'll get right back to the interview, but first to stay updated on all things emerging managers and limited partners, including industry trends and insights on how to raise LP capital, please subscribe to our newsletter powered by Carrier Labs, a full service content marketing firm that's partnered with us on the newsletter. Visit 10x Capital Podcast to subscribe. That's www.10xcapitalpodcast.com. Thank you.

Starting point is 00:16:19 From a reference standpoint, we obviously like to talk to entrepreneurs that our managers have backed, both good outcomes and bad outcomes. you want to see you know how did they work through difficult situations we also like to talk to co-investors of the manager so how you know how do they how do they work on the board are they are they you know constructive or not how many references are you looking for in this on a new new relationship For a brand new relationship, so we'll probably do anywhere between five to 10 calls. It really depends. So a lot of times we'll kind of know the manager or have been following the manager. It's pretty rare that we'll like meet a manager and then kind of roll right into diligence

Starting point is 00:16:57 in a closing. So a lot of times we've been talking to managers for a while. So you get to know them. You get to go to an AGM or two, get to meet some of their LPs, some of their LPAC members. So you build a relationship over time. And then when they come back to market, you're in a better position to pull the trigger. Well, Chris, you know, somebody who grew up in the Midwest, and I know Eric went to University of Michigan. And, you know, when you're on the coast, the entire Midwest is like a state. So it's been great to chat. And thank you for sharing everything with the audience. What would you like our audience to know about you, about Swib, or about anything else you'd like to shine a light on?

Starting point is 00:17:30 I guess what I would say is our approach to venture isn't static. We think we're dynamic investors. Venture is an important asset class for us. We've been investing in venture since 1985. Continue to try and build stronger, deeper relationships with our existing GPs, but also just want to leave the audience with we are open to new opportunities as well. So we like to meet with as many managers as we can. It makes me a better investor. I get to see what other people are interested in thinking about and investing in. So we welcome those those those those conversations.

Investing Billions - E44: Chris Prestigiacomo of SWIB ($140B AUM) on What Pensions Look for in VCs

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.