The Twenty Minute VC (20VC): Venture Capital | Startup Funding | The Pitch
00:06:36 · Harry Stebbings, David Morehead
[00:06:36] S1: Is it possible to do both? [00:06:38] S0: Well, I've had finance faculty actually laugh at me. Right? So when I when I say, like what we're trying to do and I'll let you be a little bit the judge of that. I mean, effectively, we're doing is we run sort of like a value centric, high quality book, particularly on the equity side, because it's really, really hard to control sort of like the equity beta. So you could buy puts, that's kind of like a money losing effort, like over long periods of time. And so we try to do it thematically through factor allocations. But that then means, of course that to the upside when you're in a momentum driven market, a growth led market that you're going to trail. And so the issue is, you know, the market's up 70% of the time. If you're going to trail to the upside, that's going to be problematic. And what we've tried to do over the last really three to five years is we've tried to increasingly solve that with convexity. And we've tried to do that in a manner such that we're actually not paying a theta bill on sort of like a normalized basis. [00:07:41] S1: I have to ask, increasingly solve that with convexity before we move to theta. What do you mean by that?
00:07:48 · David Morehead
[00:07:48] S0: Yeah. So basically, what we've done is typically higher ed outsources the investment of the endowment to a whole set of different managers. And so by nature, we have a bunch of investments in a number of commingled funds. And commingled funds by definition means that there's one GP who's managing the money and then there are like 100 or 1,000 LPs who are receiving the returns on that money. The issue with commingled funds is of course at any given point in time, you're receiving the average risk return profile that that manager is providing in order to keep all of those LPs satisfied. And at any given point in time, Baylor's risk return need might vary from what the average LP in that fund would desire. And so what we've tried to do is kind of go directly to the GP and say, hey, this commingle thing isn't like totally working for us. We need to like optimize our risk return profile better. If we give you a bunch of money, would you would you run the same strategy but do it just for us? And then we have a look or a call into what's going into the portfolio. So let me give an example. Say we have Nvidia in the portfolio, right? And then the next marginal manager wants to add Nvidia to his or her portfolio. Well, we can look at the portfolio like the GP doesn't know that. We can look at our portfolio and be like, look, we've got plenty of Nvidia. We actually say no, we don't need more Nvidia. Or conversely, let's say that we value high quality. The next marginal manager wants to add Nvidia. And we're like, we actually don't have any of that. So we'd take the NVIDIA that you're offering, but why don't you make it three times as big? Because that's what we need to, like, back into a more appropriate, more optimized risk return profile for our portfolio. And it's actually worked, like, exceedingly well over the last two, three years.
00:09:50 · Harry Stebbings, David Morehead
[00:09:50] S1: Can I ask you, just taking a step up, when you think about portfolio construction today, you have a blank canvas? How do you at Baylor think about portfolio construction today? What does that blend look like? Publics, privates, credit, debt, venture fee? [00:10:03] S0: Right. It's interesting. We actually spend a lot of time talking about this. And in fact, I think we probably spend more time talking about this than we actually do manager selection, which is kind of unique in the space. Presently we're around 45% private, 47% private, 53%, 55% public. I think it's really important for if you're starting with a blank sheet and you're going to do privates, you really need to nail down the private side first, right? Because the private side is gonna suck your liquidity and sort of hog tie your ability to allocate between managers or between strategies. And so you really need to figure out what sort of liquidity environment can I live with on the private side and sort of determine what that allocation is going to be? And then I think you just need to sort of like box box it and set it aside and be like, this is what's going to be operating here. The reason you have to do that is because this can't change, right? I mean, you can do secondaries, you can tweak it at the margin, but it's really, really hard to move a private book around. [00:11:13] S1: What would your answer be for what sort of liquidity profile you thought you needed when you were considering this?
00:11:13 · Harry Stebbings, David Morehead
[00:11:13] S1: What would your answer be for what sort of liquidity profile you thought you needed when you were considering this? [00:11:18] S0: Right. So our allocation range around privates is 35 to 55, which means that we want 55 to be the case when we have a denominator issue, right? When equities have gone down and the public side is smaller than it usually is because of this particular difficulty in the market, that the private side isn't going to kick up so much that we're gonna be forced into selling, right? Like the number one thing to avoid is fraud and the number two thing to avoid is forced selling. That's a And so we kind of target 45% if publics race ahead, then it puts some downward pressure on that. And if we get into, you know, a financial crisis, something like that, it would put upward pressure on that. But for example, the last bit in 2022 when tech kind of slid a bunch or you could go back a couple of years prior to the pandemic, I think that our private side got to like 51, 52, But it wasn't so much that it either constrained our ability to allocate, and it certainly wasn't enough that we got into a forced selling situation. [00:12:28] S1: When you think about then the 45% say that we have as the ideal, drilling one layer blower, how do you think about how to split that up between venture, PE and every other private that we can do?
00:12:28 · Harry Stebbings, David Morehead
[00:12:28] S1: When you think about then the 45% say that we have as the ideal, drilling one layer blower, how do you think about how to split that up between venture, PE and every other private that we can do? [00:12:40] S0: We've had a different perspective on this over the last five or six years that really came out of what I was talking about before, when we knew that the school was going to have issues as it related to enrollment, right? And it's not just a Baylor thing, but like every school. Demographics can kind of be a slow moving train wreck, but the benefit of the slow movement is that we can sit back and look five years out and know what's going to happen. And so we started this five or six years ago, like shortly after the pandemic. And we basically said the single reason that privates exist is to make money, period, end of story. And so anything in the private book that isn't going to lend itself to excess returns. Again, we need to create money to create more distributions for the school that's gonna have enrollment concerns. And so if you're not going to keep up with the highest returns that we can generate out of the private book, we've kind of moved on from that. And so a lot of the real asset stuff in our book is sort of like winding down, not being renewed. And so we're really focusing to get back to your question, today we're focusing on VC expansion, growth equity capital and buyout, That's kinda it, right? So if we're going to lock up money, we want the highest returns.
00:14:04 · Harry Stebbings, David Morehead
[00:14:04] S1: How do you think about trying then, if you want VC, you want growth equity, how do you think about trying to get into the big names, the Sequoias, the Benchmarks, the Founders Funds, the... You name those big brands versus trying to find the young upstart, the little boutique provider that could do a 10 x? [00:14:22] S0: I will say that, you know, we're coming along a little bit later to the party than some of the Ivy Leagues or Stanford or what have you as it relates to the sort of like VC brand names that you're talking about. And so it hasn't been for lack of trying. It's just like when you knock on the door, they kinda like don't answer, right? So we've kinda had to go, we've kinda had to like try to figure that out, differently. What I will say though is that the ladies in our office have had exceptional, absolutely exceptional returns out of like the expansion growth equity category. So we've actually had, you know, some questions of like, should we just allocate more dollars to that sector of the market? At the margin we have. But I would say we still do VC. It's still in probably newer, upstarting names. David, do you like VC? I do. I'm a little I'm a little perplexed by the length of some of these funds. I've got to be honest, it's not clear to me that the GP incentives are aligned with the math that runs endowments. [00:15:35] S1: What does that mean?