Investing Billions - E54: Morgan Creek Capital’s Endowment Style Investing – Frank Tanner

Starting point is 00:00:00 Why are you focusing so much on venture? Over the Morgan Creek's 20-year history, one thing that we've kind of learned and observed investing across diversified portfolios is, you know, the power of the power law. For example, we would have, you know, a few positions like Lyft or Uber or Stripe, you know, Palantir, SpaceX. And in total, there's probably 40-plus unicorns that we've had exposure to over the tenure of Morgan Creek that just completely drove and outweighed any other return in these diversified portfolios. Break down the power laws. How much did those companies bring to the overall returns of the funds? Two of those

Starting point is 00:00:33 positions account for over a quarter of the overall fair market value for one of those global diversified vehicles. It's a very real example of the power law. Well, Frank, I've been really looking forward to chatting since our friend Steve Jason from Rothschild made the kind introduction, welcome to 10X Capital Podcast. Great to be on and been looking forward to it. Big fan. We have a mutual friend, Anthony Pompliano known as Pomp. Tell me about the origin story about how Pomp got involved in Morgan Creek.

Starting point is 00:01:04 It's a interesting story actually. So Pomp is a North Carolina native. At the time, back in 2017, my former colleague, friend at the time, we had a mutual connection. You know, we heard about Pomp through the news, and then we heard he was making some venture investments. One thing led to another, and we got introduced to Pomp and his partner, Jason, Jason Williams. So we brought them on board in 2018 and they launched Boring Creek Digital. Now they're on their fourth fund and done quite well. What makes POM so special? I kind of think about this in three ways.

Starting point is 00:01:31 One is just his ability to take in a lot of information and synthesize it into trends and kind of key long-term themes. And the second would be his ability to stick to his convictions. But what has stood out to me the most has been his work ethic. I'm a former athlete and I know what goes into,

Starting point is 00:01:49 you know, the work that people don't see and the dedication and time and blood, sweat and tears. And he's done a newsletter for five and a half years. He has only missed maybe a handful of days, which is incredible. He's done over 1300 podcast episodes in that same timeframe. You know, 1.6 million Twitter followers, has a growing YouTube kind of media presence and business

Starting point is 00:02:09 there. A really incredible work ethic and that's really paid off. So tell me about Morgan Creek. How did Morgan Creek get started? We've been around 20 years coming up this summer, actually. We were a spin out of the University of North Carolina's endowment, was in 2004. Mark Yusko is the founder of the firm previously at UNC's endowment as their CIO, founder of the management company there. He joined in 98 to lead that effort. And then before that was at Notre Dame working with Scott Malpass. Still have strong ties to the endowment world. We have UNC, Duke, Stanford representation, Notre Dame, Kauffman Foundation, several different organizations, endowments that

Starting point is 00:02:45 are represented on the team today. From an endowment standpoint, what are endowments looking for from Morgan Creek and from other asset managers? It's evolved over the years for us. You assume we would service some of the smaller endowments, some of the folks that didn't have in-house resources to run an endowment style model that was pioneered by David Swinson at Yale for decades. Those early days, 20 years ago, we were kind of that one-stop shop provider of alternative solutions to endowments. Landscape has changed. OCIO's advisory kind of models have made that a little bit more of a commoditized kind of

Starting point is 00:03:20 product in terms of getting access to alts. We've evolved the business to become more specialized. One of those is digital assets. So we have an independent team that runs that. I lead the effort on early stage venture. And now we're kind of look to for more direct kind of custom solutions. So you guys specialize in venture and digital assets. Where is the alpha today in venture and digital assets? Digital assets, I mean, it's broadly becoming a lot closer to shore for a lot of endowments and institutions, like with the launch of the 11 ETFs recently to invest into Bitcoin. There's several VCs out there. But early on, I mean, five, six, seven years ago, institutions didn't really have a way to get exposure. And they definitely didn't have a way to do it through a trusted partner. Morgan Creek had an established brand. Originally, I mean, we offered some of those

Starting point is 00:04:07 initial on-ramps for some of the institutions. I mean, we had a couple of pensions anchor our original vehicle back in 2018. And that was a great way for them to kind of dip a toe. And even if it was one, two, three, 4%, that's been an incredible value add for their overall portfolios. On the venture side, kind of similar. We're pretty forward thinkers across all asset classes. And we saw this opportunity in early stage, which there's been kind of a fragmentation. A lot of the large funds have kind of moved into this mega fund kind of realm. And there's a lot of alpha to be had at what we think is true venture. Pre-seed, seed, first check writing is where we think the power law is strongest.

Starting point is 00:04:47 Endowments obviously have billions of dollars. They're an attractive asset class. Why do endowments and other LPs need to partner with somebody like a Morgan Creek? 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.

Starting point is 00:05:20 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. They don't on all asset classes, right? There's some sub-asset classes within private that you can do pretty efficiently. You can pick a couple of buyout managers. you have relationships, there's a re-ops, and that's a really great program. Same with real estate, private credit, et cetera. On the venture side, it's a little bit of a

Starting point is 00:05:53 different story. On one end of the spectrum, there's venture access, right? The winning strategy that's dominated venture for the past couple of decades. If you're not with the top handful of funds, it's not worth doing ventures. It's kind of been the wisdom. And that's been largely right. Over the past, I would say, kind of five to eight years, we've seen this fragmentation. So a lot of those top tier funds have moved into kind of this larger fund size strategy. And it's opened up this opportunity at early stage. It's just a space that there is opportunity in, but it's too expansive for an endowment to

Starting point is 00:06:25 dedicate the time, the resources within their team. If you don't have the access, there's not many other options for you within venture besides going early stage. By some estimates, up to 4,000 emerging managers in the market up from roughly 10 to 12, 15 years ago. So if you could before meet with every emerging manager, it's almost physically impossible for a single person or even for a small group of people to meet with every emerging managers. You have a founder, Mark Yusko, who's very prolific in the space. Tell me about Mark. Mark has had an interesting career. He's from the endowment world. He started at Notre Dame, like I mentioned, working with Scott Malpass. Then he came to North Carolina. I'm settled in Chapel Hill, set up the UNC management company in 98 and managed their endowment as CEO, CIO for about six years before leaving to start Morgan Creek.

Starting point is 00:07:13 He did some innovative things along the way. At UNC, they had virtually hardly any private exposure at the time, put them big into privates, you know, did some notable venture investments while there. Kind of common theme throughout his career has been, I think it's in our tagline of Morgan Creek, which is forward thinking about investments. What that means is just being an early adopter on, you know, trends, ideas, themes, innovation, the venture side. You know, we were early to set up a dedicated venture fund in 2012 on the fund to funds and co-invest side, continuing that theme of being an early adopter with digital assets and blockchain, Bitcoin. This idea and culture of taking risk is so deeply ingrained in our DNA. How big is Morgan Creek today?

Starting point is 00:07:58 We're around 1.6 billion as of today. So you guys are in Chapel Hill, you're in the triangle. Does being in Chapel Hill or North Carolina in the Triangle. Does being in Chapel Hill or North Carolina help or hurt you as a firm? 20 years ago, I would say it was probably a disadvantage. And a lot has changed over that time period. Certainly, Mark was instrumental in helping put Chapel Hill on the map. There's other pools of capital, Duke Endowment, some spinouts from both UNC and to now, you know, fast forward 15, 20 years, there's been a lot of family offices and especially post-COVID that have moved to the area. There's enough capital probably north of 200 billion.

Starting point is 00:08:31 It's a worthwhile stop for GPs, but it's still a small enough community here that Morgan Creek and the handful of other folks are definitely on the list to meet with for any GP that comes through. And that way we get kind of catered kind of attention and this distinct group of us make it a little bit easier to market map the area and get that call when a GP comes through, which is helpful. And then we're pretty collaborative.

Starting point is 00:08:54 I think that's an advantage as well. Let's double down to your venture strategy. You've really focused on venture. Why are you focusing so much on venture today? Over the Morton Creek's 20 year history, one thing that we've kind of learned and observed investing across diversified portfolios is the power of the power law. For example, we would have a few positions like Lyft or Uber or Stripe, Palantir, SpaceX. And in total, there's probably 40 plus unicorns that we've had exposure to over

Starting point is 00:09:22 the tenure of Morgan Creek that just completely drove and outweighed any other return in these diversified portfolios. There were two main kind of observations. One, power law was strongest at the early stages, so in the smaller funds. And then two, the funds were smaller at the time. So $400 million average kind of fund size across all funds, so multi-stage and early stage. And then for the early stage was about $250 million. This was 10 plus years ago now. That meant like, where can we capture the power law and kind of double down on that thesis? And it was within venture and specifically within early stage. So that's why we're so focused on the asset class. You mentioned Lyft, Uber, Stripe, Palantir, SpaceX.

Starting point is 00:10:02 Break down the power laws. How much did those companies bring to the overall returns of the funds? For example, one of those funds across a couple of those positions, I won't give all the names, but two of those positions account for over a quarter of the overall fair market value for one of those global diversified vehicles. And how many positions does that vehicle have roughly? Probably 20 plus fund investments and then another 10 plus, 15 or so co-investments. So 20 funds, call it 20, 25 companies per fund and then another 10 co-investments. So four or 500 total positions. Yeah.

Starting point is 00:10:38 It's a very real example of the power law. We've seen it empirically in our data set. And then that's even more emphasized or accentuated with co-investing. So one of our vehicles, our 2012 fund had a co-investment alongside Kleiner and Beyond Meat, and that was a few million dollar investment. It returned 157 million to investors, which was more than almost one and a half times the fund. What's the best practices for being good at co-investing? Co-investing is tricky, right? Oftentimes the rounds you want to be in are competitive. There might be a top tier lead for those series A, series Bs that you want to be in. There's a real risk of adverse selection. Those kind of ideas go hand in hand. But for us,

Starting point is 00:11:19 I mean, co-investing has been kind of an extension of the convictions of the underlying manager. And certainly some GPs we've been closer to, they shoot straight with us and give us a real kind of read on which ones we should lean in on. And then we do our own underwriting. We don't rock the boat too much, not very disruptive in the process, just additional capital, an extension of that underlying GP's kind of partnership. Speaking of Alpha, you wrote a great white paper on the evolution of venture over several decades. Tell me about that. It's kind of an unpacking of what's happened in venture over the past many decades. So everything from kind of where it started in the 1950s as a cottage industry,

Starting point is 00:11:54 you know, high touch, very personal kind of relationship driven investing that went on all the way through kind of the early 80s and through dot com boom and bust when a lot of the early 80s and through dot-com boom and bust when a lot of the iconic kind of top-tier funds were started. So like, you know, Bessemer, NEA, Menlo, Sequoia, that's kind of what we think of as like the industrialization of venture. They started to accept more outside capital and more scaled capital, more institutional kind of investor base. And then starting after the dot-com boom, the industry shifted to become more pro-founder. And somewhere along there, certainly present day, the venture model is to be pro-founder, but not just that, but have a pretty key services component. That then used to be a word, founder-friendly.

Starting point is 00:12:34 It comes down to being able to win these deals, right? You know, see, pick, win. And it can be an edge, right? If you have a really strong brand and you're founder-friendly, you move quickly. Do you think the golden age of venture is done, the 30% plus compounding returns? I'm more excited about venture than I've ever been. Not necessarily, you know, the multi-stage kind of strategy. Where the real opportunity is, is that early stage. There's a bit of nuance here even because some of those large funds will do, you know, quote unquote early stage, see deals, et cetera. But even the kind of makeup of those deals has changed quite a bit. What we're getting at here is that where

Starting point is 00:13:08 the power law is strongest, you know, where you can get 100, 200, 300 X on an investment and then have a 10, 20 X fund is at that first check. $1 million, $2 million investment. It's the very first check, the very, you know, it's very relationship driven between founders and VCs. I think that's where we're excited about. Tell me about your portfolio construction. Our primary lens with that context is early stage. So pre-seed, seed, it's kind of the core. Usually managers might or might not follow on at the A if they have a reserve strategy,

Starting point is 00:13:40 but certainly first check, pre-seed and seed. We're big believers in fund size as strategy. So with that primary lens of early stage, most of our funds tend to be sub hundred-ish million. Generally, some of the dynamics start to fray as you start to scale, you know, much beyond that for pre-seed investing. You have an interesting model of the kind of the 12 core funds and the nano funds. The 12 core funds and the nano funds, the nano funds add a little bit upside asymmetry, we feel, to the portfolio. They index a little bit more with emerging newer, often younger GPs are just getting their start, but have really strong

Starting point is 00:14:15 resonant, like generational resonance, if you will. Good experience, but not as a robust of track record, even on the angel side as some of the more core positions. The core positions tend to be a little bit larger in fund size, but still generally sub-hundred million. And one thing I would add here, which is pretty unintuitive characteristic of asset management, but given the power law is so strong within early stage venture, there's actually an increasing expected return with larger portfolios. This has been well studied by a lot of folks in the industry. Jamie Rode is a great data-oriented investor here. And then Abe Hoffman, he's done some good work here too at AngelList. Both guests of the pod. Yeah, I've listened to them both and know them both. But yeah, so the more shots on gold,

Starting point is 00:15:01 the more your expected return increases. Can you distill that? If you look at the distribution of returns by asset class within private markets, generally they're normally distributed for each sub-asset class. So you look at buyouts, right? You're going to have the fat center and then small tails. Within ventures, unique because it follows a parallel distribution, there's a handful of companies that will drive the majority of those outcomes, enterprise value for any given vintage. There's a lot of dispersion. So venture has more dispersion than any other asset class. And how that looks in terms of statistics and the measures around the distribution, the mean return exceeds the median return in venture because those outcomes

Starting point is 00:15:41 kind of drag that mean return up. The implications for portfolio construction are a couple of folds. You can have more underlying positions and not, you know, over diversify, diversify as some call it, like you would in other asset classes. The second point here is you can eliminate the bottom quartile or even bottom half if you have that level of alpha in manager selection. And by doing so, that return can be a top quartile return. And that's based on Cambridge data. You don't have to select every best fund out there. But if you have a sufficient sampling of funds in quartile one, two, three, that could be a top quartile return, which is totally unintuitive and unlike any other asset

Starting point is 00:16:25 class and one reasons that we're so excited about early stage. 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 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. How do you make sure that you're not missing any great GPs? It's mainly through our network, mostly GP, LP referrals of the funds that kind of make it through initial screen about 80% through first screen. And then probably 90% of the funds that we backed over the past few

Starting point is 00:17:13 years have been through referrals. And this is driven by kind of a hyper focus on the opportunity in early stage, having a dedicated program, having clear perspective thesis, ultimately like driving alignment and having similar perspectives to these GPs. And we don't have to be sold on why early stage, why micro VCs and rehash all those risks and considerations there. We're already over that bar and that's just powered our flywheel over the past several years and getting these referrals. And how do you select the funds?

Starting point is 00:17:43 We look at CPIC-Win. That's the classic kind of framing, but we expand that out a bit, right? So we have the five S's, source, select, secure, support, and signal. And we look at those five S's and really try to go one layer deeper, a couple layers deeper on what's the root source of their ability to do CPIC-WEN, right? A lot of CPIC-WEN kind of empirical evidence is in the track record. That tends to be a lagging indicator. So we try to take a go-forward view on CPIC-WEN, and that requires some deeper kind of understanding and analysis under the root kind of sources of those abilities. You work with a lot of first and second time GPs. What are some mistakes that the top first and

Starting point is 00:18:28 second time GPs make? I mean, there's some obvious ones like portfolio construction. What do you like to see for a pre-seed-seed reserve? If they're smaller, right, that's no reserves, right? Just get max ownership at first check. If they're larger, perhaps there's good reason to have a reserve strategy. But yeah, generally 30 max 50% for like a 80 to $100 million fund is kind of makes sense. The attrition rate between pre-seed and seed is pretty similar. You don't actually de-risk a ton by waiting another stage and then trying to protect ownership. So just get max ownership.

Starting point is 00:19:00 There's only a couple of levers you can pull. You can take more ownership in the rounds you're investing into, the same rounds, or you can increase your number of bets, right? Based on the brand, the access that brand affords this VC in the market, you may or may not have much leverage on those two factors. So for example, if you're writing half a million dollar checks to a million dollar checks, you can be collaborative. Your fund model works. If you double your fund size and now you have to lead rounds in those same rounds, you're going to be bumping into potentially other stronger branded kind of VCs, top tiers potentially. Let's say you're a 30 to $50 million pre-seed fund. What are some legitimate reasons to get bigger to get $7,500 million? There's many legitimate reasons. A lot can change between funds. If you had some great

Starting point is 00:19:48 outcomes, you might not be the same kind of caliber. You might have kind of leveled up a few notches between funds. So that makes a lot of sense. And the more ownership, I think the better. And if you can demand that in the market, it makes all the sense to increase size. If essentially your implicit value to the company has increased, your check size could increase. If you've added another partner, that's another good reason. Most frequent example is that manager just wants to scale and maybe become a multi-stage fund. And that's the next logical kind of step in that journey. That might not always be for us, right? If they're on that path. How does Morgan Creek provide value and how do you get into the top funds? Fund one and twos for micro VCs, emerging managers often. It's not always an access

Starting point is 00:20:34 play. It's more collaborative even on the LP side. There's strong performance, strong brand, and really strong discipline on their fund sizes. We try to keep a really high LP NPS. How do you keep a high LP NPS? One is just being an advocate for micro VCs, like in LP conversations, discussions like this, it goes a really long way, kind of having that kind of thought partnership and alignment. Yeah. In all seriousness, we're highly, highly focused and dedicated to the space. We've done 450 like GP meetings last year, and that comes with it. A lot of insights and a lot of data points. And we rigorously track those, you know, we can pull out insights and share that in conversation and best practices. And

Starting point is 00:21:17 we also call on us and can be a value add, but increasingly we're seeing some GPs ask us since we're registered to help them with solutions on the secondary side as well. Interesting. Tell me about that. If there's an opportunity in a follow on, like there's not really a way for them to exercise that option, so to speak, within their fund or within an SPV because they can't stand up the SPV alone and do a secondary. Maybe there's not like a primary opportunity. So we have a solution where we can share some economics, set up the SPV for the founder. They're not switching out investors. It's the same person they've known since day one. So that's helpful. And it's a win-win,

Starting point is 00:21:56 like gives us more exposure, helps the founders and the GP as well. Frank, this has been a fascinating conversation. I took a lot of notes and I learned a lot. What would you like our listenership to know about you, about Morgan Creek, about anything else you'd like to shine a light on? This has been a great conversation. There's a big opportunity in early stage and it's an expansive market. So we love talking about it and working with close thought partners on this opportunity. Well, Frank, I'm inviting myself to visit you to go to UNC game. I'm looking forward to that and looking forward to sitting down and chatting further. Yeah, looking forward to it. You're welcome anytime. So I really enjoy it.

Starting point is 00:22:33 Thank you, Frank. Thanks for listening to the audio version of this podcast. Come on over to 10xCaval podcast on YouTube by typing in 10xCaval podcast 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.

Investing Billions - E54: Morgan Creek Capital’s Endowment Style Investing – Frank Tanner

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