Investing Billions - E53: Northwestern University - Harisha Haigh on Manager Selection

Starting point is 00:00:00 Let's double click on Northwestern's venture strategy. First of all, how big of a portfolio is venture? And tell me a little bit about your strategy as a whole portfolio. The portfolio today is about 20% of the total endowment, which is about $14 billion. From a dollar's perspective, we're just short of about $3 billion. It's a global portfolio anchoring in the US. Give me a framework on how VCs should think about selling to a secondary. VCs are optimists by nature. you may see the company continuing to hit its stride and see all this growth potential ahead but if it is a 10x for your portfolio i think it makes a lot of sense to crystallize those returns let's say you invest in

Starting point is 00:00:35 2024 vintage at which year do you know with some certainty that portfolio is doing well with high certainty and with absolute certainty those three time periods part of it is actually tied to the exit market right two or three years ago you might have said 2022 was the absolute year that you knew for certain because you had a venture fund that was 10 years old its companies were hitting their stride and they were about to go public and then the window closed and venture is a pro cyclical investment area and so you have to have an open market to realize those games so let me give you a hypothetical let's say you had a manager that had two or three top quartile funds in venture. How many mulligans does he or she have? How many poor performing funds before you're really like, okay, we're probably going to get out of this manager?

Starting point is 00:01:17 I think it would have to be. For more ideas on how to raise venture capital in this market, make sure to subscribe below. Harisha, I've been really excited to chat ever since Aaron Moore from Pivotal Ventures was kind enough to make the introduction. Welcome to the 10X Capital Podcast. Thanks so much for having me. Harisha, you have a very fascinating job. You cover a lot of different assets. You cover $7 billion in the private assets, including venture capital, buyout, real estate, natural resources. Tell me about what a typical day looks like.

Starting point is 00:01:44 Lucky enough, there is no typical day. I think that's what keeps this job so interesting to me. But there are, I would say, a few patterns. Every part of the day, I think, is engaging with our team and just catching up. I mean, so much of this business is about relationships, having that back and forth with your colleague about what they've learned. This job also requires a lot of travel. So annual meetings, meeting managers, going to conferences, those are all a big part of the job too. Sharing notes with their team, hearing what they learned, road earned calls with managers. Interacting with managers when we're on the road or having them into our office, hosting people and showing up Northwestern's

Starting point is 00:02:18 campus. There's a fair amount of the desktop work too, so looking through manager materials, looking at our portfolio, reviewing the returns, making sure that we get smart industry. So those are all aspects of the day. Tell me about your portfolio of relationships. Which relationships do you need to manage? I would say they all need to be managed.

Starting point is 00:02:37 They're very long-term relationships. Our goal would be to be invested with a manager over several funds. We have relationships with managers that have spanned generations. And it's nice to have that relationship where you can talk through that manager transition and also get to know that next generation. And that's gratifying for us to see that transition. The relationships are also important as you see some of the leadership managers change, whether that could be to lead a different strategy

Starting point is 00:03:06 or form their own firm. Relationships are really key to this business. How do you go about building a relationship with GPs? A lot of reps. It just takes time. I think showing genuine interest in their business. With venture in particular, I find that to be the easy part because innovation I find so exciting and across so many different spectrums, whether it's, you know, drug development on the, for devices on the biotech side, you know, AI obviously is what has gotten everyone excited in the past couple of years in particular. And crypto, I think even in the last few months, you know, crypto is coming back into its heyday

Starting point is 00:03:40 and you're trying to find use cases for that. The way that venture investing and how founders can have a profound effect on people's lives. It's just, it's really invigorating. And it's exciting to know that Northwestern can have a hand in that ecosystem. You mentioned crypto. How were you able to get an endowment to get its hands around the crypto asset class? I will have to quote my former CIO, Will McLean, several years ago when we made our first crypto investment, he said, let's make our mistakes slowly. So it was emerging as the class, our area to invest at the time.

Starting point is 00:04:11 And so, you know, we took baby steps and we began to learn about the space, rely on our Northwestern network, including our trustees, our professors, our current managers, you know, meeting with new managers, all about how can we get smart on the space. And so we do have a couple of relationships on the crypto side. What's the Northwestern strategy on crypto? We don't hold tokens directly. We do through managers. So our investments have been either through managers or I should say specific managers who specialize in crypto or through generalist managers that are also investing. I like to say anything worth doing is worth doing poorly at first. What mistakes did you make early on?

Starting point is 00:04:49 It ebbs and flows, honestly, because the asset class itself has been pretty volatile. If you asked me four years ago, I would have said that our bets weren't big enough. You asked me two years ago, I might have said they were too big. We are continuing to learn about crypto. We've done a pretty good job with it, honestly. We are continuing to learn about crypto. We've done a pretty good job with it, honestly. We're continuing to learn about it. To me, the most interesting thing is, you know, where will those use cases ultimately be? Because I think that, you know, we're still waiting to some degree on that part of it.

Starting point is 00:05:16 Do you see illiquidity as a big feature of being an investor in crypto funds? Our view in general is that when you have a longer time frame, that brings to your benefit as an investor to be a patient investor. And that I think is one of Northwestern's competitive advantages. I've wanted to now for three years, I wanted to create a HODL Bitcoin fund where you put in money and you can't take out money for 10 years. For the last 12 years, holding Bitcoin or holding ETH seems to have outperformed every single strategy that I'm aware of. I have a little bit of it. And there are times and it's so little in my personal account, that you kind of say, why bother? That's the other problem too, right? If you take it out

Starting point is 00:05:52 at a low point, not only are you realizing the loss, but you're getting out of it entirely. It's almost better to forget about it and have it as a nice surprise in 10 years. Where is Alphen Venture Capital today in 2024? I still think it's about manager selection from our perspective. You know, if you drill down to the opportunities today, I think the opportunities that in venture is only widening. You know, everyone has been talking about machine learning

Starting point is 00:06:16 and AI and having the compute power to really accelerate investments in those areas. The question of, is there going to be alpha there? I think we probably won't know that for a while. I think a lot of mistakes will be made and it seems like there's a good argument for the hyperscalers to have a big advantage there. Like all disruption, I think there will be areas of innovation for startups and founders to take advantage of. Thanks for listening to the audio version of this podcast. Come on over to 10x Capital Podcasts on YouTube by typing in 10x Capital Podcasts on YouTube by typing in

Starting point is 00:06:45 10x Capital Podcasts into youtube.com and clicking the subscribe button. On the YouTube version of this podcast, you could see the graphs, visuals, and key takeaways that accompany every episode. I think one of the miscalculations in venture today is how big future outcomes will be. Before it was a unicorn that was special and now then it's a decacorn. Founders Fund today says they need to have a hundred billion dollar company in every single portfolio, which sounds very difficult,

Starting point is 00:07:11 but I think they're on pace to do that. Do you believe that future outcomes will be larger than past outcomes? Depends on if it will be a winner take all or winner take most type of market. And it does seem like more and more of the economy is related to tech or there are more dollars that are going to be exposed to tech in one way or another. And venture capital seems well-positioned to benefit from that.

Starting point is 00:07:37 Let's double-click on Northwestern's venture strategy. First of all, how big of a portfolio is venture? And tell me a little bit about your strategy as a whole portfolio. Sure. So the portfolio today is about 20% of the total endowment, which is about $14 billion. So from a dollars perspective, we're just short of about $3 billion. It's a global portfolio anchoring in the U.S. And we also have a bifurcated portfolio.

Starting point is 00:08:01 It's made up of some large multi-strategy venture firms that go across stage, go across different areas, as well as some specialist firms. So how many managers is that across? So in terms of active managers, it's between 15 and 20 managers. That number also includes a number of legacy managers, but I would say 15 to 20 is our active portfolio today. Venture capital in particular tends to stay in the portfolio for a long time. So even though we have relationships that we haven't continued, we probably have funds going back to the 2000s in some cases. Is there a systemic bias for LPs to stay in funds?

Starting point is 00:08:40 You can say that across every different type of asset class. And why is that? I think part of it goes back to the relationship because you do have such strong relationships with your managers that sometimes I think can be a little bit more forgiving, either when they make mistakes or when there is strategy creep. I think one thing that we have to keep reminding ourselves is, for the private markets, but public markets as well, does the fund size fit the strategy? Successful managers for the most part generally raise larger and larger funds or their AUM grows. And so you have to make sure that they're still able to access the type of investments

Starting point is 00:09:17 that made them successful in the first place. Tell me more. It could be a manager who, when you first started investing with them, was investing out of a $200 million fund, and now they're investing out of a $2 billion fund. And so are they still able to see deals? Do they matter? Who's being staffed on those deals? What's the bandwidth of people? On the public side, for instance, a lot has been said about shorting. When you get to be a certain size, shorting is very difficult and it doesn't really move the needles. It's not just venture that doesn't scale. It's other asset classes, even publics. Absolutely.

Starting point is 00:09:51 So you mentioned being forgiving of GPs. So let me give you a hypothetical. Let's say you had a manager that had two or three top quartile funds in venture. How many mulligans does he or she have? How many poor performing funds before you're really like, okay, we're probably going to get out of this manager? I think it would have to be sustained underperformance. I think ultimately you want to figure out why. Is it a capital allocation decision? So of our venture managers, I think putting good money after bad, I think is the really

Starting point is 00:10:21 critical decision. And that's really tough for them to make, but that really has a big impact on fund returns. So we found that our more successful managers, they may also have a high rate of failure when it comes to the number of companies, but their dollars of capital loss is less. My biggest pet peeve in all of venture is concept of defending your pro rata as if being diluted in in of itself is inherently bad. The way that I look at it as the opportunity cost of the incremental dollar, that dollar that I go from owning 6% versus 5% could be much better spent and a better opportunity. I think that's

Starting point is 00:10:55 right. I mean, because that dollar should also be considered for new investments. I think you're weighing different risks because investing in a founder that you've known for a long time. So you feel that founder relationship has been de-risked in that way. And they probably have some more customers. But so your risk is going to be different, too. It might be more of a scaling risk, more of an execution risk than a new relationship with a founder who, you know, at that point, it may not be much more than an idea on a page. And so there may be a greater technical risk. So these risks are very different. And it's you know, there may be a greater technical risk. So these

Starting point is 00:11:25 risks are very different and it's really hard to compare them kind of head to head. And so that's why I think, you know, a lot of times people don't, and they may think that execution risk is easier than, you know, maybe technical risk or willing to bet on a founder that you don't have a relationship with. What are some mistakes that you've seen the very top VCs make? Of late, it's been not distributing enough back to LPs. I think having a great outcome is one thing, but that DPI has become increasingly important. And I think knowing that you can predict what public investors company in your investment, I think it's really tough and it's a completely different skill set in my opinion. Give me a framework on how VCs should think about selling to a secondary. Sure. I think it goes back a little bit to the conversation that we were having in terms of how

Starting point is 00:12:13 do you think of the additional dollar of investment? And there's the phrase, if you're not a buyer, you're a seller. Let's say you had the opportunity to invest in a growth round and you decided that the valuation was too high, I think at that point, VCs should think about if they should take money off the table. There are a lot of reasons that are not economic why they might not, including the founder relationship and wanting to support the company. VCs should continue to push for it or seek other potential ways of liquidity, whether it's selling down to an existing investor. We understand that there are a lot of factors that go into generating liquidity. Also know that VCs may regret not having

Starting point is 00:12:51 sold when they did have a liquid stock, when they weren't on the board, only to see the stock price fall in subsequent quarters. I've seen a lot of VCs implement a regret minimization strategy, meaning you sell a little bit so you can't be upset that you sold too much or that you didn't sell anything. And that seems to be what most institutional would like as well. We are. And I think it's also hard because when you see a company that you know very well and you've known for a decade, VCs are optimists by nature. And so you may see the company continuing to hit its stride and see all this growth potential ahead. But if it is a 10x for your portfolio, I think it makes a lot of sense to crystallize those returns.

Starting point is 00:13:32 And LPs also have the ability to hold the stock. And so sometimes we see that as a signal from VCs that when they distribute the stock, holding the stock for their books after they distribute shares to us, I think many VCs continue to hold it in their own portfolio. So they take their carrying shares. That's always a good sign of a true believer in a company. You mentioned DPI and liquidity. There's on the manager side and then there's on the LP side. What practical tools are available to you in order for you to get liquidity if you need it? Our preference is through the manager. And then what we do when we get stock distributions, we use an external manager. And for instance, with Facebook, we had a distribution of Facebook and we probably held it for the endowment for another five years.

Starting point is 00:14:13 Amazing. Congrats. So we can get liquidity when we need it from that account. It's funny, continuation funds haven't quite hit the VC world yet. Maybe that will be coming. But the secondary market isn't ideal i mean you're generally taking a 25 30 discount real discount or nominal discount or how do you look at a discount off of true market value depends because a lot of venture funds don't mark to the last round and so you could be taking an even bigger discount right but it's it's to whatever we have as the nav you're in so many great managers and they do seem to concentrate on a couple of names. How do you look at somebody has something at par, somebody has something at 25 percent, 50 percent?

Starting point is 00:14:51 On the one hand, we do like the conservatism and appreciate the conservatism. But, you know, the other side of it, you know, when you do see that disconnect and you know that someone else's portfolio might be up higher. And I'm talking about from a competitive standpoint. So if we see a peer who has the other manager who may have the same holding, but that manager didn't take a discount, then you might think, oh gosh, well, I wish that we did have that higher mark. Is that one of those points of trust

Starting point is 00:15:17 where as you develop trust with an LP over time by carrying your book at fair market value? Absolutely, I think so. The market is getting more liquid from the standpoint of at what valuation would employees sell their stock, right? I think the secondary market within venture is also getting more robust. Do you ever look at buying in the secondary market as an opportunity to increase your exposure to a manager?

Starting point is 00:15:41 Absolutely. Yes. We're in that position right now where we could, you know, be increasing our exposure to our manager? Absolutely. Yes. We're in that position right now where we could be increasing our exposure to our very best managers. I will tell you it's incredibly difficult to do because those best funds are being used to price a portfolio. And so if you're a seller, you may need to keep that fund as part of a broader portfolio to get a sale. It goes back to relationship. If you have a close relationship with a VC and you could be a first call, even for a small position, you know, that's something that we would absolutely do. And allows you to build scale within your managers. Yes. Yes. That's exactly how we think of it. What is the most difficult part about growing

Starting point is 00:16:18 your book of managers? Venture in particular, I think it's keeping on top of the company's venture. I think it requires really more face-to-face interaction. And in person is best when I say face-to-face, but also, you know, phone calls and, you know, other ways to stay in touch. But, you know, ultimately, our goal is to know a portfolio well. And when you have more managers, you know, it results in more companies. Unpack that a little bit more for me. Why do you have to understand your portfolio on the granular level of portfolio companies? With venture in particular, it takes a while before you can measure things from a quantitative perspective. Earnings, that's going to be several years out. Revenues is going

Starting point is 00:16:53 to could be several years out. So it's really understanding what progress that portfolio companies have made. It's also things like signal with venture that I think is incredibly important. I think that's why there's more persistence in returns in VC than versus other asset classes. So how are managers able to win deals? Ultimately, that's what we look for in venture capital managers is we want managers who are the first call for those founders. Let's say you invest in 2024 vintage, at which year do you know with some certainty that portfolio is doing well, with high certainty and with absolute certainty? Those three time periods. Part of it is actually tied to the exit market, right?

Starting point is 00:17:31 Two or three years ago, you might have said 2022 was the absolute year that you knew for certain. We had a venture fund that was 10 years old. Its companies were hitting their stride and they were about to go public. And then the window closed. And venture is a pro-cyclical investment area. And so you have to have an open market to realize those gains. Well, I think you're probably still going to be at least four years, four to five years before you really know. And unless you have a breakout winner, which you might at that point, but I wouldn't necessarily expect it. With a lot of our venture commitments, I mean, we say it's going to take kind of two fund commitments. You asked about a fund certainty,

Starting point is 00:18:09 but when I think about a manager, because unfortunately, we don't pick funds, we pick managers. And we hope to invest in managers over multiple fund cycles. Some of those funds may outperform by a multiple or two more than others. You said four to five years, which is notable because that's two vintages out. So in two years, essentially a little bit blind to financial metrics. What metrics are you looking for as leading indicators to a manager's success? Some of that is signal. So, I mean, ultimately what we look for is access and selection. So you want to invest in a VC that sees everything and is able to invest in

Starting point is 00:18:47 everything. And then the other part of it is what do they actually invest in? And so I think those are the two critical things that we look for. 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. D-E-E-L. Deal is the all-in-one HR and payroll platform built for global work. 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

Starting point is 00:19:29 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. Sourcing and picking. What about winning? Isn't by the Series A, Series B, the winners are more or less known from an expected value standpoint? I think that people will recognize some value or see something special, whether it's in a product, whether it's in a founder, whether it's in a market. And I think different VCs probably weigh those things differently. And that might cause them to, let's say, lose a term sheet. You remind me of a story on Uber. There was a round.

Starting point is 00:20:01 I won't say which fund, but the fund was basically dragging its feet. And Menlo was just on the sideline, just close to the basket. And eventually Travis got tired of dealing with the fund and he let Menlo come in and obviously one of the greatest returns in history. So there is a skill actually to winning that supersedes Rand. I also think it might also be about firm dynamics too. Some investors within their firm are able to have more, let's say, independence or maybe support and can make those types of decisions think it might also be about firm dynamics too. Some investors within their firm are able to, you know, have more, let's say, independence or maybe support and can make those type of decisions based on their track record, the support that they have in the firm. But at other firms, you know, people may just say, you know what, this is too expensive and I don't think we're

Starting point is 00:20:38 going to see the return. When it comes to fund dynamics, there's two different styles. In some cases, you have one partner that's empowered to pound the pavement and make an investment. Other firms require consensus or some even unanimous. What's the best strategy that you've seen that delivers returns? To get outsized returns, you need to have the VC really believe in the deal. I do believe there's something to the pound the table aspect of it. I think you have to earn that, though. And I think there are also only so many maybe missing that. Investing in VC, there is a bit of serendipity to it. I think

Starting point is 00:21:10 that where we found firms be the most successful is when you can have high ownership in the most transformative companies. VC is all about taking risks. And so when you're not willing to take that risk, it's probably a little bit more luck that you're able to get those outside returns. Founders Fund is famous for putting 25% of their fund in different vintages. In some cases, like SpaceX and Airbnb, they reinvested in different vintages. How do you look at that in your portfolio when funds take very large positions in single assets? We're diversified enough that I think from our portfolio standpoint have a dramatic effect on our endowment. I mean, one, you have concentration limits for a reason. So presumably

Starting point is 00:21:49 it's within that. We don't have a problem with it. I think we'd like to understand why they're doing something and have they had a history of success in doing it or what makes this time different. So let's talk about manager selections. If you could wave a magic wand, what would be the characteristics of the ideal manager? You know, I think venture is so competitive and there just seem to be more and more entrants. I think the founders, I think, in recent years have, in a way, have had their, you know, very best VCs. And so, you know, going back to the access point, you know, our ideal VC would be able to see all the deals out there. Not only that, but we would want them to be the first call that founders may have very tight relationships with them. Venture capital is an access class. The target actually picks the winners. It's the

Starting point is 00:22:36 founders that choose the VCs. When it comes to a spin-out manager, how do you go about ascertaining the track record and figuring out the attribution? I would say a lot of those calls. Reference calls. And are you referencing people at the fund, founders, LPs, all of the above? All of the above. It has to start with the person whose track record you're underwriting, right? And really trying to understand at each stage, what was the decision they made? And from that standpoint, you have a lot of data actually when you're looking at VCs, right? Because if they invested in five different rounds, you can go deep on each round. Ultimately, the founder's ground truth, right? Whoever the founder picked out the firm is the attribution. I think in general, that's correct. You could have that selection, right? So relationships with founders could change over time too. If you were a VC that had a disagreement with the founder,

Starting point is 00:23:26 I mean, picking that investment to begin with could have been a good decision, but that relationship could change over time and maybe that founder wasn't the best as that company scaled. So that's why I think you need multiple perspectives on it and not just the founder view. So are you talking to your managers once a month, once a week, once a quarter?

Starting point is 00:23:43 I think it's a balance because we want to be informed, but we don't want to be a burden, you know, a few times a year. I think it would be great because it's not all the communication has to be in person either. For instance, if they have really good reporting, then, you know, sometimes that could be enough or, you know, that could be the impetus to say, well, I saw this and question about it.

Starting point is 00:24:02 And so, you know, is that something where they are going to get back to you pretty quickly, like their bedside manner it. And so, you know, is that something where they are going to get back to you pretty quickly? Like their bedside manner there. Other times it's, you know, it's more casual. The portfolio could be looking really well, but you happen to be in town and want to grab a coffee. Well, Harisha, this has been fascinating. Thank you so much for letting me pick your brain

Starting point is 00:24:16 and thank you for sharing everything with the audience. What would you like our listenership to know about you, about Northwestern, about anything else you'd like to shine a light on? I would say venture is a really important part of our portfolio and a driver of returns for the endowment for many years. And we expect it to continue to be a really important part of the portfolio. We are open for business. So we have room to add new managers. We have a couple of people on our team, Qian Hao Wu and Brett Taylor, who have been meeting with new managers really across the globe.

Starting point is 00:24:47 We are global investors. As a university, we believe in and invest in innovation, whether it's through the endowment or our managers, but also through research. And, you know, so we're in it for the long haul and continuing to invest in the space for a really long time. Well, thank you, Harisha, and look forward to meeting up in New York or in Chicago winter. Otherwise, I will come and visit. Thanks for the opportunity, David. I really enjoyed time. Well, thank you, Harisha, and look forward to meeting up in New York or in Chicago winter. Otherwise, I will come and visit. Thanks for the opportunity, David. I really enjoyed it. By popular demand, the 10X Capital Podcast has officially launched our newsletter powered by Carrier 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

Starting point is 00:25:21 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 10xcapitalpodcast.com. Again, that's 10xcapitalpodcast.com. We thank you for your support.

Investing Billions - E53: Northwestern University - Harisha Haigh on Manager Selection

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