May 8, 2016
Interviewed by: Tom Franco
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What Endowments Look for in a Manager

Selecting the right manager is a tricky process for investors such as endowments, but there are ways to measure performance. Suzanne Streeter of Partners Capital talks with Tom Franco of CD&R and Daniel Feder of Washington University Investment Management Co. about how data, research, and other ways of “looking under the hood” can help make the selection process easier.

Selecting the right manager is a tricky process for investors such as endowments, but there are ways to measure performance. Suzanne Streeter of Partners Capital talks with Tom Franco of CD&R and Daniel Feder of Washington University Investment Management Co. about how data, research, and other ways of “looking under the hood” can help make the selection process easier.

What Endowments Look for in a Manager
With Suzanne Streeter of Partners Capital

Dan Feder, Washington University Investment Management Co.: We’re here with Suzanne Streeter from Partners Capital. Suzanne, maybe you could give us a little bit of information about what Partners Capital is and what you do there.

Suzanne Streeter, Partners Capital: Partners Capital is an outsource chief investment office. We manage about $17 billion on behalf of foundations, endowments and high net worth individuals. Our origins are the money managers, so a number of our high net worth individuals are GPs – former and current – private equity firms or hedge funds.

Tom Franco, Clayton, Dubilier & Rice: What makes you different?

Streeter: Well we are really implementing the most sophisticated endowment style model on behalf of individuals and smaller endowments. And so I think we have something in the marketplace that others just can’t get, particularly at a $50 million account size. People who can’t afford to have their own investment staff, we serve that purpose for them.

Feder: And from your perspective, what is it to you that defines endowment-style or endowment-like investing in private markets asset groups?

Streeter: Endowment-style investment is really long-term investing with a heavy weight towards alternative asset classes, in particular illiquid assets. And it doesn’t actually work for all client base, because of the illiquidity. Many, particularly high net worth clients, can’t take that kind of liquidity. So the way we adapt that model for high net worth individuals and some endowments is to maintain the principles of diversification, consistency and conviction, as well as trying to find the best alpha.

Feder: Is there something embedded in the approach that you take or that you characterize as the endowment approach that speaks to how you pick groups with whom to invest or what the selection process is that’s differentiated?

Streeter: I would say that the endowment model for manager select is all based on finding the highest alpha generating managers and sticking with them. Being true partners and for the long term. So the way we really try to enhance that is by being very data driven. And we think we are data junkies. We really try to dissect the historical track records of managers and in a forensic way actually. And try to figure out what trends we can identify.

Feder: Is the past predictive of the future? I mean, this notion of the Holy Grail persistence. What can you derive from the past that really helps you understand how a manager will navigate in the next cycle?

Streeter: Certainly persistence is – it is the Holy Grail. I try to determine whether they actually have had outsized returns in the past. So some sort of success rate, which perhaps can be replicated, is pretty critical. And then I really do believe you have to figure out industry evolution and whether these firms have evolved to compete in the current marketplace.

Franco: The private equity industry is not necessarily a good manager or a good steward of their own businesses. Is that part of the issue around persistence?

Streeter: I think it’s pretty interesting how unaware of the market dynamics and evolution of just organizational structure. Some of the managers don’t really take that into account. So we’re constantly looking at firms that can make room for new talent, particularly new decision makers. Looking for groups that tend to focus, continue to try to improve on their mandate, groups that have a real myopic need for excellence in everything that they do.

Franco: How do you get under the hood of a manager?

Streeter: Well I think it really does start with data. We dissect information in many different ways and then try to come up with trends. And then we really ask questions, leading questions, about whether or not these firms are aware of those trends. So for example, we discovered that this firm actually did very well. Every single time they bought a company at an auction, it ended up being over 2x. What was it about that particular dynamic that was successful for them?

So trying to understand how the culture of decision making works at these organizations is a big part of getting under the hood and really thinking about industrial psychology and organizational behavior I think.

Feder: What’s your process or how does that debate or conversation go at Partners Capital around well this is what the data say. And here’s what we think is the case, but it’s not completely quantifiable.

Streeter: I mean the blind pool risk is always there. So we really do try to scrutinize the pipeline of opportunities. It’s been where we spend a lot of time. But also looking at the pace of deployment in the past in different market cycles, really can give us an idea of how people behave in sourcing investment into other market cycles. And we try to forecast whether or not the fund capital is appropriate for the investment universe. And that’s a huge issue. I mean, as – this is the tug of war, right? We want to have the best returns and maintain fund size, but groups need to evolve and develop their organizations.                                                                                                                                                            

Franco: Let’s get back to kind of this manager selection and some of the factors that really help you understand motivations and going back to this term, persistence. What about incentives? Josh Lerner from Harvard Business School and the Private Capital Resource Institute has been doing some work around carry and how carry is dispersed throughout different models. How important is it to you to follow the carry trail, if you will. And how forthcoming are GPs, and what are you really looking for?

Streeter: Well this is a very important issue. We want to know exactly who’s getting what percentage of the carry. I think that the best GPs are trying to really think about their businesses, not just about their wallets. So they really are, in many cases, reserving some carry for inter-fund recycling. So people who have done outstanding work will get maybe a percentage more here and there – merit based – more so than just deal by deal or their direct performance. But we really do scrutinize this. And obviously, we don’t want all of the carry going to one or two people.

Franco: Clearly the GPs are very demanding of the portfolio companies. Pay for performance. Do you think the same pay for performance mentality is generally applicable to the world of GPs?

Feder: The general or the industry fund structure – especially as assets grow – competes pretty heavily against that. But I think in evaluating managers, it’s important to understand whether those managers are coin operated or not. So in many cases, it almost doesn’t matter what the incentives are. If human beings, meaning these people, are competitive and really oriented towards winning – and that means being competitive in the process of investing and hopefully getting outcomes that are worth the fight – it matters.

Streeter: The – back and [unintelligible] rents have been taken over by some GPs of late. We’ve seen some terms that are out there, and are actually – to me – a little bit of land grab based on historical performance. And I try to figure out what the signal is, whether it’s a [bearer ?] signal that they don’t believe they can continue to perform that way. We really have to understand the cultures of the firms, and you really need to understand whether or not they can produce those returns, and whether it’s worth it.

Feder: Suzanne, when you’re trying to kind of get a calibration around what happens inside a firm, how do you do that. Because you can get an answer that’s a truthful answer, but it doesn’t really convey what actually happens.

Streeter: We do a tremendous amount of referencing. We pretty much call every single person on the reference list. And then we call every single person that we can that’s off the reference list to triangulate on the answer, because you won’t necessarily get it from within.

And then I really do believe sitting down with the leaders to ask directly, “What’s your vision for your firm and your business?” Many people don’t have that answer. The traditional, classic private equity partnership that’s sort of the industry standard may not necessarily be the right model going forward.

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