E203: How Elite Endowments Invest w/John Felix

So right out of school, you spent two years at Washington, St.

Louis, one of the most storied investment offices in the country.

What did you learn during those two years at WashU?

So those are my first two years in the professional world.

And I had interned throughout college at a hedge fund, but, you know, everything was still kind of very theoretical at that point from what I learned in undergraduate business school.

And WashU

was really drinking from the fire hose for two years.

So I'd say the first first thing I learned was the art and the science of investing.

I started covering public markets when I was at WashU,

and we invested with long-only public equity managers.

We tended to favor very concentrated managers that did deep fundamental research, you know, very long-term time horizon, kind of like that private equity style investing in public markets.

And so I got a great training in just like really deep fundamental research.

My managers there,

my bosses started a book club.

This was a great crash course in learning from some of the greats.

And so we read Ben Graham and Philip Fisher and things like Margin of Safety and Zero to One.

The other thing that I learned was about transition.

And

I saw three different chief investment officers during my first two years at Wash Use Endowment.

I joined during the kind of tail end of the longtime tenure of Kim Walker, who had been there for almost a decade.

And then when she retired, Eric Eupin, who had actually run Sanford's Endowment for a period of time and then later went on to run McKenna Capital Management.

He was on our board.

He stepped in to kind of steward the endowment while we looked for a full-time CIO.

And Eric was there for about a year, kind of just steady as she goes.

You know, we didn't do a ton of crazy stuff.

And then we ended up hiring Scott Wilson, who came on and is still running the show now and has done an amazing job.

three different chapters during those short two years.

And so I learned a lot about just resiliency and change and like, you know, just being in a workplace where people come and go.

But it was amazing and really like learned a lot during the different kind of three chapters over those two years.

And you were around some of the best fundamental public investors at WashU.

Give me a sense for, do you believe that the market is efficient, whether in the long term, in the short term?

And how do you look at the pricing?

of public assets.

That's a good question.

And this is something that, you know, in undergraduate like business where you learn about this efficient market hypothesis and you learn about all of these like theoretical things.

And you're taught in school that a lot of these things are like how the real world works.

And

you're kind of taught them as gospel, but then you get into the real world and you realize that nothing is black or white.

And I think one of the biggest things I learned is that the market is often not efficient in the short term, or at least that's my belief.

And I think that lack of efficiency in the short term creates

longer term opportunities for investment.

The way a lot of our managers thought about it, the way I think about it is in the short term, the market can be inefficient and present, whether it's pricing irregularities or just areas for

really good long-term investment opportunities.

And I think in the long term, at least my philosophy is that over the long term, the market is efficient, but it might not be efficient at any given time.

But if you buy something that's mispriced or compounding over the long term, eventually that price should

eventually reflect the underlying fundamentals of the business.

It could take a year, it could take five years, but over a long enough period of time, those things should converge.

Eventually, the trading catches up to the intrinsic value of the asset.

Yeah, at least that was how we thought about it.

And that's how I think I still think about it today.

But again, it's hard to predict that timeframe and it's hard to predict like all of the incremental inefficiencies that might happen in the interim.

You spent some time under Scott Wilson, who's considered one of the top CIOs in the country.

What makes Scott such a great CIO?

Scott is very different than, I'd say, a lot of the traditional archetypes for endowment CIOs.

So, you know, the first thing is scott had a very non-traditional background um he was not trained by david swenson or he didn't kind of grow up in the endowment world um he was actually a rates trader and spent a lot of time in tokyo sitting on rates you know desks and he had kind of a quant background and i think this um was actually a really good thing for him because it it allowed him to come in and take kind of a first principle approach to endowment investing right he wasn't influenced by the way things had been done for many decades beforehand.

And he was able to kind of build his own approach.

And so the first thing I would say is, like, he disregarded convention completely.

You know, there was kind of a standard way, this endowment model of managing a portfolio that most other endowment heads had embraced.

And by the way, that had worked really well for a lot of endowments.

But Scott didn't really care what other people said or did and kind of built his own approach.

One of the tenets of, I think, like Scott as a CIO was he is just, he's completely ruthless when it comes to making manager decisions.

And don't mean that in a bad way at all.

I think that's actually like absolutely critical to being an elite investor, but is really hard for a lot of people to do.

There's a lot of psychological headwinds in this industry.

If you're invested in a manager over the course of many years or even a decade, you become friends with the manager.

There's a lot of close relationships.

And I think it gets really hard to, you know, get off the train.

And I think a lot of institutional investors are bad at putting in redemptions, are bad at, you know, not re-upping in funds that they probably should get off the train.

And Scott was really good at that.

And so the first thing we did when Scott joined was we went through every asset class in our portfolio and we force ranked every single manager in every single asset class.

There could not be a tie.

There had to be a one and there had to be, you know, whatever the last number was, right?

And

what that did is

it forced you to acknowledge and to admit, like, who are your really high conviction managers?

Maybe we should give them more money, but also who are the low conviction managers and like, why are they still in the portfolio?

And I think it was kind of close to, you know, Jack Welch, who was a longtime CAO of GE, every year they would look at their workforce and, um, and they would fire the bottom 10% of their employees, right?

And I think Scott took like a very similar approach that if something was in the bottom, you know, quartile or 10% or whatever it was of our portfolio, why is it there?

And why do we still have capital with that manager?

And every day we continue to have capital with that manager, was almost making a conscious decision that we wanted to be invested with that manager.

And so he really, I'd say, forced us to look in the mirror and take a hard look at our portfolio and make those tough decisions and

do it in a really objective way.

It accounted for this consistency bias where

by default, you wanted to re-opt in a manager, but here his system was more an opt-in where you had to force rank and you had to consciously make a decision who to cut.

You didn't need a reason to cut somebody.

You need a reason to keep somebody in.

Exactly.

And I think that's something that a lot of LPs struggle with.

And look,

it's really hard, right?

Like the default every morning when you wake up is you have an existing portfolio already.

And so like let that existing portfolio continue.

And I think Scott's view is kind of the converse of that, which was, you know, like I said, every day you continue to have capital with that manager.

You know, you should view that as like you're making a conscious decision to re-underwrite that manager and have capital with them today.

And if you would not invest with the manager today, then why would you still have capital with them, even if you made that decision?

The zero-based budgeting type of framework.

Same with employees.

If you wouldn't hire them again, why are are they still at your firm?

It's

a lack of friction.

Yeah, and it's such a simple concept to understand, but I think

it's really hard to actually do it in the right way.

And I think a lot of LPs still get this wrong pretty consistently.

How do you balance being very opt-in conscious about your portfolio versus what people call relationship alpha or the alpha that comes from having deep relationships with managers?

After Scott joined Washington's Endowment, he did a podcast actually a a couple of years later and he talked about how they ruffled a lot of feathers in those first few years.

And,

you know, I think a lot of managers were unhappy with Scott, but

that was him coming in with a clean slate and wanting to rebuild the portfolio from scratch.

When

Scott decided to commit to a manager and re-underwrite a manager, you know, he would set expectations with them up front, like very much like, hey, this is why we're underwriting you.

This is what you said you're going to do.

And if you do it and you do it well, we will continue to be a great partner with you for a while.

But if you don't,

you know, like this is a business and we're going to move our capital somewhere else.

And I think just being really objective about it and not being personal about it and setting expectations up front is really important.

And if you're a rational investor, a rational human, rational business person, like you under, you should, you should understand that those decisions, while tough to make, like are often the right decisions.

And I think like the right managers did not take it personally.

And from my understanding, Scott is very focused on finding the best in class athlete, the best managers versus kind of trying to fit somebody in a box.

Talk to me about that strategy.

Yeah, so there's a few components of that.

So the first thing I would say is Scott very heavily favored concentration, both

as we thought about the number of managers in the total endowment as a whole, but also as we thought about positions within our underlying manager portfolios.

And so,

you know, we called our manager roster a ton when Scott joined and really tried to, you know, concentrate capital in like our top manager ideas.

But then going a layer beyond that,

Scott would also want to concentrate in underlying positions within those managers.

And so the way, like Scott's general philosophy as a whole was

he didn't really care so much if, if, if an opportunity came from

the public equity sleeve, the private equity sleeve, the real estate sleeve.

Like he took effectively this opportunistic approach where at any given time he wanted to concentrate capital in the best ideas, regardless of the asset class, regardless of kind of the end exposure.

And so we would actually like spend time with underlying managers.

And they started to do this a lot more after I left.

I mean, Scott kind of joined at

the tail end of my two-year analyst program there, but we started to do this.

And we would meet with our managers.

We would go through their portfolio.

We would talk to the managers about their highest conviction names within their portfolios.

And then oftentimes we would do our own research on those names.

And if we agreed with the manager where we had outsized conviction in a certain name,

we would often increase our exposure to individual names within our portfolio.

And this was something that

a lot of other institutional investors were not doing at the time, right?

Like they're, you know, the traditional endowment model is

identify best-in-class managers who are great at their domain, give them capital, and effectively like outsource your decision-making to them.

Scott had this perspective where we could do our own really good research.

Not that we thought we could do research better than our managers, but we focused on like incremental research, incremental insights, leveraging their

research and conviction and perspectives to maybe build a little more of an incremental perspective that would give us the conviction to, you know, to increase exposure to those individual names.

And that concentration

has really been a huge tailwind to watch these portfolios since Scott joined.

You can think about it almost as a counterbalancing factor to growth of AUM of some managers.

So if you think about it from first principles, the reason that returns go down as fund sizes go up is because deal flow does not scale in

proportion with the increase in AUM.

So let's say that the AUM goes up by 2x, but the quality of deal flow goes up by 50%.

So that incremental, you know, fourth of their portfolio is lower quality than it would have been in the previous fund.

And said another way is GPs,

GPs will never admit this, but GPs have a grading system for every single opportunity.

Now, it might be A,

A plus, A, A minus, B plus, and maybe no opportunity ever goes below B plus.

Let's just give the benefit of the doubt.

But there is a grading system.

So by actually going, double-clicking, having the relationship, and having the FaceTime with the managers, you can actually figure out you could double down on those A and A plus opportunities,

even forget about co-invest and lowering of fees.

That obviously moves the needle a lot as well.

But just by reconcentrating your portfolio, you could actually get higher returns than the underlying fund if you do it right, which is huge asterisks.

Yeah, yeah, exactly.

And like when I think about the traditional co-investment model, I think it's more like reflexive and reactive.

And a lot of LPs, you know, they'll wait for a manager to come to them with an idea.

And the manager might say, hey, like, I've got excess allocation, you know, in this company that's raising a new round.

We have really high conviction.

Do you want to participate?

And LPs might often participate in that.

Scott was very proactive about this, right?

Like, we would, we would, we would identify companies, right?

And we would, we would spend a lot of time building those, um, building our own conviction in those companies.

Um, and, you know, to your point, like, yeah, if we do a good job of that and WashU has done a good job of that, like that adds a lot of alpha to the portfolio.

And,

you know, you could, you could also, like, take a step back and say, well, like, if managers had such conviction in their top ideas, why not just make, you know, size those bigger in their portfolio?

We were already investing with very concentrated managers.

I mean, you know, the managers in our long-only

in our long-only public equity portfolio, they would sometimes already have 10, 15, 20%, you know, sometimes even more than that, 25% in their top name and often 50 to 75% of their portfolio in their top five or 10 names, right?

And so they were kind of maxed out on concentration, but we really thought, like, if you have such conviction in these names, why shouldn't we have more exposure?

And actually, one of the projects, one of the last projects I worked on at Washi before I left is we looked back at all of our public equity managers going back, I think, 10 years.

We looked at the performance of their portfolios as a whole, and then we compared each of their 10-year performance

periods to the performance of their top one, two, and three single names in their portfolio.

And almost always those top names outperformed.

It wasn't always like the top one name that outperformed the broader portfolio, but it was usually either a combination of like the top one, two, or three or some combination therein.

And that really gave us the conviction that like managers are generally good at sizing higher conviction bets better.

And that I think also gave us the conviction to execute on the strategy where we would buy more of their top names.

Said another way, you could be very confident on investment, but would you stake your entire career on it if you went over the ledge?

Or would you stake little Johnny's college tuition on it?

So, you know, asking managers to take a career risk is such a high standard.

And there's somewhere between that and the average investment in the portfolio, there's this alpha.

So you might be very convinced on it, but not willing to stake your career on it.

And there's still that conviction is still valuable, a valuable LP insight.

Yeah, exactly.

And like, you know, look, if we, you know, we, yes, we have the conviction in, you know, every position that we put more money in, but we would sometimes get it wrong.

And I think the way to mitigate that risk was to still have exposure to the manager's broader portfolio, right?

It wasn't like we wouldn't invest in their, you know, number two to 10 idea.

We would, we would still have that through their, our core LP check in their, in their fund.

We would just increase exposure to some of their best ideas as like a complement to that strategy.

I'm still struggling to understand how do you operationalize a best idea strategy within the context of an endowment portfolio.

So how do you go about taking that strategy and turning it into practice?

It's a really good question.

So the first thing I would say is, and the first thing Scott did was

prior to Scott joining, we were siloed by asset class.

And so I worked on the public equity team.

We had a hedge fund team and we had a private markets team, right?

And

anybody working within one of those teams, all you did was work on that asset class.

The first thing that Scott did when he joined was he got rid of that structure and everybody became a generalist and almost retrained and rewired us to think about not only finding the best ideas within a single asset class, but

at any given time, trying to find the best ideas in general, right?

And so we thought about this idea of like everything should be competing for capital against everything.

And at any given time, let's be opportunistic

and flexible to put capital in the best idea, regardless of asset class.

And so I think like decoupling, you know, any individual from one asset class just gave us like the broader mental space to not only think, you know, again, about like the best ideas within a constraint, but like the best ideas in general.

The other thing we did,

and they started to do this a lot more after I left, but

the WashU team is on the road traveling all the time.

They go meet with not only managers, but they're meeting with management of portfolio companies like constantly.

They're touring factories, they're talking to customers, they're doing like that really deep primary research that a lot of other endowments don't do.

And I think to execute this strategy well of really forming an opinion on individual assets, like you can't do that without traveling and without doing this level of primary deep research that the Washi team does.

Double click on that.

So let's say I'm backing Bill Ackman in Activist Investing, and I'm sitting with him and he's saying, this is my one or two best ideas.

Washi would also go and essentially visit these companies.

Let's say they're private companies for simplicity.

What are you trying to do?

How are you trying to get better information than a Bill Ackman or choose your top quartile manager?

So we didn't necessarily think about it as trying to get better information than the underlying manager, right?

A lot of it was,

we started from a place of one, validating the underlying manager, because as an LP,

you're really two degrees removed from the underlying asset, typically, right?

You're one degree removed from the manager, who's then another degree removed from the underlying asset.

And so a lot of LPs take whatever a manager says at face value and you have to believe them, but WashU did not ascribe to that.

And I think we were like, very much, we started with, let's re-underwrite the asset and build conviction in the manager's thesis, right?

So almost like testing what the manager told us.

And then from there, seeing if there was any incremental, you know, value or insights that we could add.

But we didn't, we definitely did not think that we could do a better job of underwriting the asset than the underlying manager.

It was like doing the work to kind of re-underwrite it, understand their thesis, borrow a lot of conviction from them, and then see if we could add anything incremental.

Another way to look at it is co-investments.

There's a lot of pressure to give co-investments to large institutional investors.

If you think about that from a first principles perspective, that pressure could lead to bad incentives and offering the incremental co-investment that maybe is the average investment in the fund or maybe even sub-average, but there's so much pressure to offer that that the GP may have no choice but to give kind of a sub-average opportunity to LPs.

So you have to re-underwrite that from your own perspective just to make sure that truly is a great opportunity.

Yeah, exactly.

And I think to your point, like in the co-investment world, the biggest problem that LPs deal with is adverse selection, right?

You have to understand, well, if this is such a great deal, like, why am I seeing this?

Right.

And

I think that

problem is more prevalent in the private markets where things are capacity constrained and less prevalent in the public markets where anybody can go and buy a security in the open market.

But we did a lot of public markets, you know, almost co-investing as well, where we would go and buy more of a stock, typically through an SPV that the manager set up to align incentives where they would manage the asset.

But it was, again, it was much more of that proactive approach where we weren't waiting for managers to send us an idea where, you know, who knew what the incentives were.

Like we were really going to them and saying, hey, let's talk about your best ideas today.

And even if you weren't planning on like actioning on them, let's create a structure where we can increase our exposure and align incentives at kind of the appropriate way.

So after Washu, St.

Louis, you went to Bowdoin College, so considerably smaller endowment, but still today a couple billion dollars.

What was the difference in Bowdoin versus Washu St.

Louis?

There were

a lot of differences and some similarities, but both had done exceptionally well over a long period of time.

And, you know, the first thing I

observed at Bowdoin was just excellence.

I joined at the end of Paula Valent's tenure.

She had spent 20 years at Bowdoin and grew the endowment from something like 400 million when she joined to over $2 billion.

That was net of spending, net of paying out distributions to the college.

So just an incredible track record.

And I learned a few things from Paula.

The first was kind of going back to this Buffett adage of like, be greedy when others are fearful.

And she aggressively leaned into venture capital in the early 2000s after the dot-com bubble when I think a lot of LPs had still had scar tissue and trauma.

And,

you know, she, she wasn't at Bowdoin before that.

And so in a way, it was like fortuitous that she joined after this and had this amazing opportunity to invest like without the legacy baggage of, you know, major markdowns and that trauma from that bubble popping.

But she was really greedy during that time and it worked out really well.

And she was early in a lot of amazing Sequoia funds and other great other great managers.

So like definitely learned the be greedy when others are fearful.

One big difference between Bowdoin and Washu is Bowdoin was a lot more diversified than Washu under Scott.

So you know Scott had this really concentrated approach.

Bowdoin had a lot of line items, a lot of manager line items, and Paula wasn't afraid to kind of try things out.

And if it didn't work, you know,

redeem capital and kind of move on.

And so, you know, what that resulted in was a much more diversified portfolio, but still a portfolio that generated exceptional returns.

And so, this, you know, kind of made me question convention a little bit or what I learned at Scott.

And I think it made me realize that there are more than one ways to win in investing.

And, you know, it works for somebody, it might not work for somebody else.

And another kind of good example of that was

Scott was really allergic to

macro managers, right?

Managers that did not do fundamental research, but took more of a tops-down approach.

And Bowdoin, especially under Paula, really leaned into that type of manager.

Stan Druckenmiller, who's a Bowdoin alum, was

on the Board and Investment Committee and

obviously famously Rand Duquesne, which had done really well and was probably one of the best macro shops ever.

And Paula leaned into that, really leaned into his conviction.

A lot of his network, folks that had worked

either for him or at Soros and spun out.

And those managers had done really, really well for Bowdoin over a long period of time.

And so, again, challenge like some of my convention that

maybe those didn't have a place in a portfolio and made me realize that actually they can't, you know, those type of managers can do very well.

And again, goes back to this like one-size-do-not-awares-fit-all kind of approach.

What would you call Bowdoin's investment philosophy?

How would you explain it?

I would say very manager-driven.

And so, you know,

we had

somewhat less opportunistic than Washu in the sense that we did have asset allocation targets and parameters, and we did view our portfolio more in buckets, but it was very network-driven.

And so, so we would,

you know, Bowdoin would get in

deep in a network, whether it was Stan's network or a venture network, and just continue to compound within that network.

And so being early to venture,

you know, and investing in Sequoia's funds in the early 2000s meant that we got really close to, and this was before my time, but, you know, Paula got really close to the Sequoia team, built really deep relationships in Venture, and then would back like people

that came out of those networks.

And those networks compounded over those 20 years.

And so we ended up being really early to a lot of great new funds that launched between, you know, 2005 and 2015, funds like Founders Fund and Andreessen.

And

I think like being early and like really leveraging those networks to compound

was core to Paula's philosophy.

And like she really took advantage of those networks that she built to get really good access.

And that was like where I first really like Scott was much more about the individual manager and like underwriting them and being opportunistic.

And Paula was very much about like, we have this amazing access to these amazing networks.

Let's use out for all we can and like use that to get access to really interesting things.

That's almost like founder, product fit.

They both played to their strengths and really leaned into their strengths and trying to kind of fit their personality to a strategy.

I think that's, I think that's definitely right.

And again, it goes back to my, you know, this whole philosophy that like

different things work for different people, right?

And what works really well for one person might not work for the, for another person.

And then you went to Allocate, which

just full disclosure, I was a seed investor in the platform because I believe in it, obviously.

What was your role at Allocate and what were some of the lessons that you learned there?

So I joined Allocate right after it had raised its seed round.

And I

effectively launched and led Allocate's emerging manager platform.

So

Allocate is, you know, it's a startup.

It raised venture capital and it's building an alternative investment platform with a a couple of different parts.

On one end, you have this asset management platform where we would, you know, we had fund of funds that we managed, but we also would get access to really good venture funds and effectively syndicate out that access.

And then on another end of the platform, we built software for the private markets.

And,

you know, it's funny, the reason I joined Allocate in the first place was by this point in my career, I had been,

I'd kind of become a venture specialist.

I moved away from being a generalist and I really wanted to concentrate in venture.

But I thought that, you know, still being an LP and venture, you're always two degrees removed from like the real action and i thought that if i worked in a startup and saw that zero to one phase it would give me a lot more empathy for my managers but it would also just make me a better investor and and make me able to ask better questions um and so you know we were even though i i i kind of managed the fund of funds and and acted like an institutional investor we were still doing it within the context of a startup and we were breaking conventions and really like doing things from a first principle standpoint.

We didn't have to like like do things the way they've always been done, which is like the worst thing you could ever mutter within the context of a startup.

And

so we backed a ton of emerging managers when I was there.

We also backed a lot of non-emerging, a lot of big platform firms.

And I learned a lot about selling and sales and things that you didn't have to do within the context of like a non-for-profit endowment.

I often think about with how I invest, I think about how do people become better better investors?

And one of the things that's really important is to get ground truth in different industries.

How could you be a great endowment investor without understanding

without understanding AI and what's driving that market?

How do you become a good venture investor without understanding what drives startup returns?

I think it's really important, especially if you're focused on one asset class, to go as close to ground truth as humanly possible in order to be better and be able to go back, you know, 10,000 feet up and be a better investor.

Yeah, absolutely.

And like, I had never seen how the sausage gets made within a startup.

I didn't know what it took to, you know, scope out building a software product, working with an engineering team and a product team and like actually building and shipping something.

You know, these were things that were like very much in the abstract for me and still, I think, very much in the abstract for a lot of institutional investors.

um but but being an allocate and like seeing that zero to one seeing what it takes to hire a team and go from 10 people to 50 people, seeing what it takes to raise a series A,

these were all things that happened when I was there.

And just seeing it up front, I think gives me, it just gave me a lot better understanding and appreciation for like how hard these things are, like how hard it is

for founders to build companies, how hard it is for investors to pick companies and understand companies.

And it just gave me a lot more empathy, I think, for what all of these players in the ecosystem have to go through.

And

I'm really glad that I did it because I think it's made me a better investor.

So then you went on to found a fund of fund, Pattern Ventures.

Why in the world do we need another fund of fund?

It's a good question.

And

my somewhat snarky response is like, the world doesn't need another fund of funds, actually.

And I tell this to managers we meet with, like, the world doesn't need another venture fund.

But if you have the right to exist, then I think there's always room for more.

And I think we earned the right to exist for a few reasons.

You know, in venture, if you want exposure to the big brand name firms, the Lightspeeds, the Sequoia, the Andreessens of the world, it's really purely an access play and you don't need a fund of funds to do that.

You can try to get access directly or you can leverage a platform like Allocate to get access.

Like there's ways to get access.

It's not really like a diligence or an underwriting game.

It's an access game.

And I think it's becoming increasingly easier to access these bigger firms.

But in the emerging manager world,

it's much less of an access game and it's much more of like a discovery and diligence and manager selection game.

And it just takes a lot of time.

There's thousands of venture funds in the emerging manager world to pick from.

You need the right network to find these funds.

You need the right skill set to diligence them.

You need to reference them.

It takes a ton of time.

Return dispersion in this world, in the emerging manager world is massive.

And so manager selection

matters even more.

And that means you need to spend a lot of time meeting with a lot of managers to pick the right funds.

And a lot of LPs just don't have that time or don't have the bandwidth or the skill set to do that.

And so

to do this part of the market right, I think a fund of funds makes a lot of sense.

And I've been doing the emerging manager, you know, LP investing for a while.

My two partners who started Pattern have been fund of funds investors for multiple decades, and they've been investing in venture companies for multiple decades.

And so I think we've earned the right to do this, but

I don't think the world, again, needs another fund of funds unless you have earned the right.

Like I think we have another way to look at return dispersion, there's obviously

just beta and market beta, but I would actually call it LP error.

I think there's significant LP error in the venture space.

Said another way, the return dispersion is only partially due to actually

just variance or randomness.

A lot of it is actually due to picking the wrong managers.

I caution people to really think critically about their venture exposure.

First of all, it's completely idiosyncratic to every other asset class on the planet.

There's no learnings.

In fact, if you know a little bit or maybe even a lot about private equity, it's a recipe to be a terrible venture investor because of power laws versus downside protection and things like that.

The second aspect is

there's a right way and a wrong way to enter any asset class that you have no experience with.

So if you look at how endowments or institutional investors enter asset classes, at least most of them, the humble ones, they'll start actually with a fund of fund.

They'll start with the most high-viewed kind of 10,000 square foot view.

Then they'll start to see what does good look like.

Maybe the fund of fund will start giving direct exposure into the funds.

So they get get kind of this, this sense for what does good look like?

It's almost impossible in the first year to even know what an asset, what a good asset looks like.

And then maybe five, 10 years later, they'll start to actually build out a direct platform into the actual underlying companies.

And if you look at the behavior of

70, 80, 90% of high net worth investors, when they go into venture, they actually go the other way.

They go directly into startups because that's what naturally comes into them.

Then they go into funds if they kind of learn learn from their mistakes.

And then once in a while, they'll go into fund of funds.

But again, the LP error on the manager side and even more so on the startup side, that LP error, because there's almost no barrier to entry start to startup, is so massive that whatever investors save in fees, they pay, you know, five, 10x oftentimes.

Oftentimes they just lose all their money.

It's like, do you want to pay 2% management fees or do you want to pay 100% mistake fees?

Anytime you're going into a new asset class, even if it's for the first year, maybe two years, going with a fund of fund and learning the ropes on somebody else's dime, I think is so valuable.

I completely agree.

And it's the crawl, walk, run approach, right?

And

it's funny, I made this mistake earlier on in my career, actually.

After WashU, I joined an OCIO.

where we manage Endowment Capital.

When I joined, we had almost no venture exposure.

And I kind of took the lead on building out our venture program.

And

we were starting from zero.

And this is when my venture network was very, very limited.

And we basically spent a year trying to just get up to speed and understand.

And then we started making a few commitments the following year.

But I think in retrospect, like I should have started with a fund of funds to help me get to know the ecosystem and build relationships.

And then maybe co-investing alongside the fund of funds directly in some managers as you build kind of conviction and then eventually going to do it myself.

We could have jump-started the program a lot better.

And like, we made some mistakes early on backing managers that, you know, in the early days, everything sounds great, right?

When you're,

and even now, when I'm, you know, training like our analyst or our intern, you know, in the beginning, everything sounds great and everyone's interesting.

And by the way, like

almost every manager we meet with, even if we pass, they're all very impressive.

They have great experience.

They have great backgrounds.

They worked at a great company or they worked at a great firm.

But it's really hard to delineate between who's just okay or good and who's really great.

And, you know, we've had LPs come to us and say, like, hey, look, I tried to do this myself and I just got really burned

and I just need help.

Right.

And

I don't think it has to be like an either or, right?

Like, you know, you can you can use a fund of funds and use it as a, as an educational experience to start doing this yourself, which a lot of our LPs do.

And so I definitely am a big believer in the crawl walk run approach.

I made the same mistake, which is why I so intimately understand it.

I think I probably did 100 startup investments before even investing in a manager.

So I did not take my own advice.

Had I known it, I of course would have done it.

I want to double-click on something that you said that's rather obvious for people in the industry.

But if you made your money in a widget factory and then you start investing in venture, the average, let's call it the bottom quartile venture investor is the top 1% of society or the top 10% of Ivy League.

So the bar to even have a venture fund or raise 20, 30, 50 million, 100 million is so high that even just to be in the game, there's a quality bar.

That's why you have to meet like 100 managers before you actually know what good looks like.

It's because everybody actually looks pretty good.

That's a common mistake that people make.

Yeah, absolutely.

Everybody's smart in this industry, right?

Like when we talk about the managers we like, it's, you know, we're not saying things like, oh, they're so smart, like we need to invest, right?

Like those are, that's table stakes.

And I actually think this is what some managers get wrong about their differentiation, right?

Because we, you know, we'll talk to some new managers and I'll ask them, like, why do you think you have the right to exist or why do you think you have the right to win?

And they'll say something like, oh, well, you know, we're operators and we have great operating experience and founders want that.

And by the way, that's great.

And maybe you do have great operating experience, but I've met with 200 other firms that also, you know, were operators at great companies.

And that in and of itself is not enough, right?

It's impressive.

And it's impressive when these folks worked at great companies and did great things,

but it's almost table stakes and it makes it a lot harder to really differentiate again if you haven't met with hundreds of firms and you don't know like where that relative baseline kind of is.

So for your fund, you're targeting sub-$50 million managers.

Tell me about your strategy and your portfolio construction.

Primarily what we do

$50 million fund.

The reason why we settled on this is, well, there's a few reasons.

One, when my partners were setting up pattern, they went back and looked at every fund going back about 45 years, I think to 1980 until today, and looked at every 5x net venture fund in that period.

And what we noticed was the largest cohort of 5x returning funds was in the sub-50 million dollar range.

This is for a few reasons.

One, smaller funds are less competitive against the bigger incumbent firms.

You know, you don't have to compete for that lead spot.

Leading around is binary.

You either win the lead position or you don't.

Sometimes you can co-lead.

But if you have to have a bigger fund and you have to deploy more dollars and lead, now you're becoming competitive against not only

the other seed funds, but also the

big incumbent kind of tier one brand name firms that occasionally do seed as well.

And so we like that smaller funds are less competitive.

They can get better access to deals.

We also like that they're purely focused on pre-seed and seed, where we think the biggest opportunity for outlier power law-driven exits exists.

Valuations are better.

And the fund math, most importantly, to get to a good return, it's just a lot easier, right?

You don't need to rely on the next Uber just to three extra fund.

If you're a $50 million fund,

an acquisition at a couple hundred million dollars can really move fund level returns.

And if you get a single billion dollar company, that could return your fund sometimes multiple times over.

And so venture, we believe, is hard enough as it is.

We just want to try to stack the odds, you know, even more in our favor in terms of generating great returns.

And so that's why we've focused on this $50 million.

I had recently had a podcast with a guy that runs a lean AI leaderboard, which is looking for these one, one person-led kind of, he calls it seed strapping, which is you raise a seed seed around and then you become profitable.

I've been thinking about the second order effects of AI

on investing.

So if AI does bring down costs, And what I've kind of settled on is this bifurcated model, pre-seed and seed, and then the mega funds.

So, you need money to prove out your thesis, and then you need capital as a moat.

So, in my version of the future, you see these highly value-added pre-seed and seed investors, and then the Andreessens and Sequoia is writing kind of the billion-dollar checks.

What do you think about that thesis?

And help me refine that thesis.

So, I agree.

I very much agree that venture is becoming bifurcated.

And I think you either need to be like a small, nimble, you know, collaborative early-stage investor, or you have to be really a deep-pocketed multi-stage, you know, big brand name.

Um, I think in the middle, it's really hard to win for a few reasons.

Put it this way: I think a lot of founders at the pre-seed and seed stage, um, they know the risk of taking capital from those big incumbent tier one multi-stage firms, right?

The risk is you're kind of an option check to them at the pre-seed or seed stage.

And if they don't follow on and do your A, there's material adverse signaling in that, right?

And so, a lot of founders say, I'm going to raise my pre-seed or seed from a smaller, specialized pre-seed seed fund where I know I'm going to get, you know, really good engagement from the GP.

Often it might be a solo GP where, like, I know exactly what I'm getting and who I'm getting it from, and they can be really helpful, and I'm meaningful to them as a part of their portfolio.

But the best founders, when it comes to the Series A,

I think they want to raise from a big brand name firm because it's signaling, you know, raising from a big, great firm in your Series A is a great signal.

But more than that, those firms have deep pockets and can fund you, you know, theoretically through IPO and beyond, right?

right and if you're a founder they want to do too which they want their new business model today

yeah absolutely which they want to do and if you're a founder the biggest distraction to your business is fundraising it can take a lot of time and if you have to go out and fundraise for every round and you process like that's a big distraction and a big time commitment and so you know if you can just raise your series a from a big brand name firm and then effectively not have to worry so much about raising subsequent rounds because you can just go back to them like that's a really attractive value proposition and i think it makes it really tough for, you know, the mid-sized Series A specialist funds, you know, like the 200 to 400 million dollar Series A funds, who maybe they can lead your A,

but after that, they can't.

And you're going to have to go out and find a new C or you know, Series B investor.

And again, you know, a new investor beyond that.

And so I completely agree with you that this bifurcation is definitely happening.

And I think it's only going to get more pronounced.

You're investing in these sub-$50 million funds.

Is there a pattern in terms of are they concentrated?

Are they leading rounds?

Are they collaborative?

Distill what you see as best-in-class strategies.

So we take a very GP-centric approach to investing, meaning we focus a lot on the GP.

And what I mean by this, and kind of going back to something you and I talked about earlier, this concept of like GP thesis fit or founder market fit, what works for one GP might not work for another GP and beyond.

And so we want to back GPs where their strategy is really playing into their strengths.

And that means sometimes we back very concentrated GPS where we think like they're exceptionally good at picking or engaging with founders and like they have to have a more concentrated portfolio.

But sometimes we pick more diversified GPs where maybe they have really good network, really good deal flow, really good access.

Maybe they're not as strong on the picking side.

And so having a more diversified portfolio like allows them to like really take advantage of their network and their deal flow without having to make like even more concentrated bets.

And we've seen both both models really work out.

We have a pretty eclectic portfolio where our managers look different from one another.

Like we've got, so we have a lot of solo GPs in our portfolio.

We have one or two partnerships.

We actually tend to prefer solo GPs.

This is maybe a little counterintuitive to

what a lot of other LPs think, but I think there's more risk in a partnership, actually.

I've just seen so many partnerships blow up and I've seen so many partnerships formed out of convenience rather than out of a real like reason to partner with someone.

And, you know, if you're a a solo GP, you don't have to worry about

dealing with someone else and the psychology of that.

And investing is such a business of biases.

And

I've seen in organizations where people become possessive about their investments and when people want to strike down other people's investments because maybe that person had struck down one of your investments.

And I think the decision-making and staying power and underwritability in a solo GP is actually more attractive at the end of the day.

And so we tend to focus a lot on those.

But we're open to partnerships so long as there's a real reason for the partnership and we don't think there's a lot of risk there.

What's one or two mistakes that you've made early on that you've since corrected?

One thing that I've actually changed my mind on

really over the course of my career, but more over the course of the past couple of years is, you know, I used to think that having meaningful reserves in your portfolio was a really good way to increase exposure to the best names and like juice your returns even more.

But I think it's really hard, at least what I've noticed and observed, is

a lot of pre-seed and seed managers, it's really hard for them to effectively deploy their reserves.

And here's why.

If you're a seed manager and you invest in the seed and maybe you have reserves to take you through the A,

you know, series A companies still have a very high failure rate.

And it's, you know, you often don't have a lot of time to gather a ton of new incremental information between a seed and a series A or even a, you know, pre-seed or a seed, right?

And so by the time you have to deploy those follow-on reserves,

you're often doing it only with marginally incremental more information and you're doing it at a materially higher valuation usually, right?

And so I think like reserves are actually really tough to be effectively deployed for pre-seed and seed funds.

And I would almost rather those funds just buy up more ownership in the early days.

And I can't tell you how many times I've talked to managers and asked them, like, if you went back and, you know, by the time this seed company raised its Series A, like, did you know that, like, did you know which companies were going to break out?

Or did you know which companies were going to fail?

And oftentimes they say, you know what, we actually didn't.

Or the companies that we thought were really, you know, strong out of the gate ended up plateauing and stagnating.

And the companies that were slower out of the gate ended up really ramping up.

And so I do think reserves can be really effective.

But I think they're more effective actually in the later stages.

Like Founders Fund has been like exceptionally good at deploying reserves and doubling and tripling down, but that's because they can deploy massive reserves like the series C and D and beyond, where like there's metrics, there's traction, you know, which companies are already like really on that hockey stick trajectory.

And so I've, I've kind of come around and actually prefer our managers to have lower reserves, if that makes sense.

It's, it makes total sense.

And it's very interesting that the managers are telling you that they may not know who the breakouts are because there's a very direct incentive for them not to say the opposite, to say, oh,

we should have just, let's double our fund size.

We could have piled into these three.

We knew for sure that these three were, but the fact that they're saying the opposite despite the incentive is a pretty strong signal.

Yeah, and I think this is a tough thing that you need to like try to figure out with managers.

It's very easy for managers to retrofit a story and to say, oh, you know, we made this investment, like five years ago, we made that investment because we had this thesis on this thing that nobody else believed in.

And we did it.

And we knew that this company was, you know, going to break out and become a billion dollar company or a $10 billion company.

The reality is, venture managers think every one of their companies could become a $10 billion company at the time they invest.

But

obviously, not every company is going to be successful.

Most actually aren't going to be.

And I think what people don't realize is oftentimes it's not until much later when it becomes obvious that a company is going to be successful.

This has been an Episode Masterclass on endowment investing, fund of funds.

What would you like our listeners to know about you, Pattern Venture?

Is there anything else you'd like to share?

The first thing I'd say is, you know, Pattern, we're open for business.

We're actively deploying.

And so we'd love to chat with, you know, any managers that are really high quality and raising.

And we source through our network.

We source through a data tool that we have, but we don't have a monopoly on sourcing.

We don't believe anybody does.

And so we're always happy to meet with folks that people really highly recommend.

And the other thing is I would just say, like, you know, when we are building pattern and how I've thought about being an LP over the course of my career is I've seen too many LPs that I think feel entitled or feel that GPs owe them something because like we're giving them capital.

And I just think this business needs more like true partnership.

And I think like at the end of the day, these are these are marriages.

These are really long-term relationships.

They're two-way streets.

And

so I would just like encourage everybody listening to really think deeply about partnership, both if you're an LP or a GP and recognize that like none of these relationships are one-way streets.

And I think that's like something that we really hold near and dear to us here at Powder.

Big purpose of this podcast is to tell the LP story in hopes of basically telling kind of both sides of the story so that there could be more empathy and relationship in the industry.

Thank you, John.

Look forward to sitting down in person very soon.

Likewise, David, thank you for having me.

Thanks for listening to my conversation.

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