Masterclass for Capital Allocator CIO
Reflection on Capital Allocators' Interview with Larry Kochard
I met Capital Allocator 5 years ago. It was Episode 11, published on June 7, 2017. Ted Seides interviewed Endowment Professor Larry Kochard, who was CEO and CIO of the University of Virginia Investment Management Company (UVIMCO). As the fifth-year CIO of my own multifamily office, I was searching for guidance. Unlike the student time, as I grew up, I found it difficult to find a teacher to bring me to the next level and there were really only two books written about the endowment approach and they were both written by David Swensen. I was looking for more.
Ted's conversation with Larry was eye-opening. I couldn't believe how much Larry was willing to share... not only his investor's journey and philosophy but also his struggle to manage the portfolio and team at a large institution. Larry's message, however, was simple--be long-term and keep it simple.
From Endowment Professor to OCIO Chief at Makena Capital is Ted's second interview with Larry, who moved on to the next role at Makena, a San Francisco-based outsourced CIO after spending 7 years at UVIMCO. When Larry left UVIMCO, the endowment managed about $9 bn (today, $14.5 bn). Makena not only manages a much larger asset ($25 bn), but also has many more clients with different mindsets.
Emerging Markets and Manager Selection
One of the most intriguing topics of the interview is Emerging Markets. Over the last 20 years, the emerging market's equity index significantly underperformed the developed markets' equity index. A lot of people were lured to the emerging markets, including China, due to the premise of high economic growth, however, it was a disastrous mistake for many allocators. Larry's investment in the emerging markets has been on the premise that it's not about the economic growth, but the ability of the managers who can exploit the market inefficiency.
I completely agree with Larry. Many allocators tend to forget that manager selection is as equally important as asset allocation. The following chart is from Yale Investment Office's 2013 Annual Report. Yale analyzed the source of their outperformance between 1994 and 2013 (20 years) and concluded that 2.9% of the outperformance was generated through the manager selection while 2.2% was coming from asset allocation.
The importance of the manager selection is applicable not only to the emerging markets but also to other sectors such as biotech where investment managers who have superior scientific knowledge and experience should be able to outperform other tourist managers. On the other hand, this rule probably does not apply to the sector such as consumer internet where everybody can become "experts".
Venture Capital and Asset Allocation
I was surprised to hear that, when Larry joined, Makena only had a 5% allocation of venture capital despite being located in the centre of the venture capital world. They slowly increased the exposure over time to 13%, but it is still much lower than typical endowments and foundations (20-40%). This is, however, not new to Larry as the University of Virginia's asset allocation was also very different from other endowments and foundations. As Larry discussed during the interview, the University of Virginia historically had much greater exposure to public equity (including Equity Long/Short). For example, in June 2017, the University of Virginia's exposure to public equity was 46% vs. Yale University's 19%. At the same time, the University of Virginia only allocated 16% of its assets to private equity (including venture capital and buyout) vs. Yale University's 31%.
Nonetheless, the University of Virginia continuously generated strong returns. From July 2010 to June 2017 (this is the period when Larry served as CIO), the University of Virginia generated a 110% return (11.2% annualized), compared to Yale University's 121% (12.0% annualized).
The University of Virginia has a strong association with Tiger Management. The university's former CIO, Michael Bills, was Senior Managing Director of Tiger Management (1986-1991, 1995-1999). John Griffin, CIO of Blue Ridge Capital, who is a former President of Tiger Management and an alumnus of the University of Virginia, is also helping the endowment management. Such relationships and resources apparently helped the University of Virginia to access high-quality public equity managers.
Venture capital as an asset class apparently outperformed almost any other asset class over the last 10 years (well, we will see how the current downturn will play out over the next 10 years) and many endowments and foundations relied on venture capital investments to generate superior returns that everybody envies. However, Larry's track record at the University of Virginia indicates that the endowment approach is not all about venture capital investing. It is through how you invest through identifying managers you can build a long-term trustworthy relationship.
Co-Investment and Direct Investing
Many allocators are interested in co-investment. We, Star Magnolia Capital, also participate in co-investment opportunities brought by our managers. However, I'm still skeptical if we are generating better returns through our co-investment programs. These investment opportunities are brought up to us by the managers we have built trust over many years of relationship, but what kind of edge do we have to pick the best investment ideas from the portfolios carefully invested by our managers? Are we participating in co-investment opportunities because we can save a small % of the management fee and carried interests compared to investing in funds?
During the first interview, Larry said:
(regarding co-investment) This is something that we've been debating internally. Is there a way that we can do internal management we've gone in many circles and ultimately what I tried to always come back to is what is our edge?
In theory, because we can get back just kinda core tenets that we think of ourselves as long-term investors. In theory, there are certain great companies that our managers naturally gravitate towards that we could just hold forever. And that sounds great in theory, and if we can do that without paying higher fees, that sounds wonderful in theory, but figuring out how you do actually do that on a sustainable basis I think is going to come down to something as simple as, is there someone that I could find that quality-wise as an investment manager, is as good as we could find by hiring them externally that we could sustainably keep them in the team, and it doesn't become a distraction to the team. They're not.
At Makena, Larry made a change. He started allocating a small amount of capital (5%) to a pool of public equity positions owned by the managers they trust and managing it internally. Larry said,
It gives us more liquidity, but it just gives us a better dialogue with our managers. It gives us a better lens into our managers doing a good job of doing this bottom-up underwriting. Trying to keep that focus on the bottom up, I think it's easier to do that if you actually do this direct investing and co-investing.
Never Stop Learning and Continue Evolving
The endowment approach is not a static solution to portfolio management. Rather, it will keep evolving over time as we learn from our own mistakes. We also have to adapt ourselves to changing environment as well. Larry Kochard, a 20-year veteran CIO, never stops learning and continues evolving. His changed approach to co-investment is a good example as the co-investment and direct investment activities give allocators opportunities to understand our managers and engage with them more deeply. These co-investment and direct investments themselves may not generate superior returns, but we will become better allocators. Thank you, Larry, for sharing your investor's journey again. Hope other listeners will also learn something from this conversation as I did.
Listen to the Original Interview
https://capitalallocators.com/podcast/from-endowment-professor-to-ocio-chief-at-makena-capital/
Episode Description
Larry Kochard is the CIO at Makena Capital Management, a $20 billion OCIO formed by senior executives from the Stanford Management Company in 2005. Larry joined Makena in 2018, following a storied career serving as CEO and CIO of University of Virginia Investment Management Company, as the first CIO at Georgetown University, and as Managing Director of Equity and Hedge Fund Investments for the Virginia Retirement System. He was an early guest on Capital Allocators discussing his path, and that conversation is replayed in the feed.
This time around we discuss Larry’s transition to Makena, the differences between leading endowments and an OCIO, and his perspective on specialist versus generalist teams. We then dive into different investment opportunities across crossover funds, hedge funds, co-investments, REITs, venture capital, emerging markets, real assets, and crypto. We close with Larry’s take on market risks, opportunities, and managing his team.