Inside the Mind of a University Endowment Manager | Dan Feder, University of Michigan | Ep. 14

1. 0:00 – 0:40

   Intro

   1. DFDan Feder0:00

      in the phraseology that Donald Rumsfeld made popular, there are known knowns, unknown knowns, known unknowns, and unknown unknowns.

   2. JAJack Altman0:08

      Mm-hmm.

   3. DFDan Feder0:08

      And things that are not known or not knowable is, is the realm of uncertainty, and that is where I think venture capital has its real power. [upbeat music]

   4. JAJack Altman0:19

      All right. Today, I'm here with Dan Feder from the University of Michigan, and this is the first time that we've ever gotten to have an LP on the podcast, and you're one of the most interesting, thoughtful people that I've gotten to learn from in this industry, and so I'm really excited to get to do this with you today.

   5. DFDan Feder0:35

      Well, thanks for having me, but first of all, you have to get out more then.

   6. JAJack Altman0:38

      I need to get out more.

   7. DFDan Feder0:38

      Yeah.

   8. JAJack Altman0:39

      That's a problem for me.

2. 0:40 – 2:59

   Becoming an endowment manager

   1. JAJack Altman0:40

      My listeners probably are gonna be less versed in sort of LP land than sort of VCs or founders. So could you start by just giving a little background? It doesn't have to be long, but just kind of orient us to sort of a little bit about you and how you've gotten to where you are.

   2. DFDan Feder0:55

      Well, it's a long story, so I'll keep it really, really short. I started out my career as a lawyer, um, so I had no idea about being an investor and certainly had no idea about what an endowment was or endowment management. And I got to endowment management, uh, really by accident. I was having lunch with a private equity manager who took a liking to me, and he said, "I think you'd like endowment management." This is in, uh, the year two thousand. And I said, "That's fantastic. What's that?" And he, like I said, super kind private equity manager, great investor, named Paul Levy, introduced me to, um, a person for whom he was doing guest lecturing at Yale, and that happened to be Dave Swensen. And Dave was also really, really kind, and he didn't have anything at Yale, and he introduced me to Andy Golden at Princeton. And at that time, Andy was the CIO at Princeton and was bringing all of the non-marketable asset classes back in-house. They had been outsourced. And we just got to know each other over a period of months. I had zero experience doing what he wanted someone to do. And, um, at the end of getting to know him and him getting to know me, he brought me in to lead venture and private equity at Princeton, and that, in and of itself, informs a lot of how I think about hiring people, uh, working with fund managers and investing because when we got toward the end of the process, I just said: "Look, you know, I don't fit the spec of what you're looking for. I'm happy to come in at a lower level and see if I'm right for you and you're... You know, and this is right for me." And he said, "It's fine. I'd rather hire somebody with a, a fast processor than a full hard drive." And that has stuck with me ever since then, and it informs a lot of my thinking and a lot of what I learned there in terms of thinking about investing, um, has informed everything that I've done, from Princeton to WashU, where I was, uh, in a similar role, and now at the University of Michigan, and then a couple of stops along the way.

3. 2:59 – 9:10

   Constructing an endowment’s portfolio

   1. JAJack Altman2:59

      You called it endowment management. Um, obviously, you know, there's a sort of a broader bucket of just being like an, you know, an LP, generally speaking. But talking about endowments specifically, can you talk about like, what are the building blocks of the way that an endowment thinks about constructing itself? So, like, let's say you zeroed out and, you know, Michigan went fully liquid, and you had to rebuild all the way from there, what would be the considerations? What are sort of the requirements? What are the must-avoids? Like, how does an endowment build its portfolio from, you know, the bottom up?

   2. DFDan Feder3:34

      So I think the, the, the starting point that you describe, in particular around going fully liquid, is a great place to start. So endowments have to do a few things. First of all, one, one clarifying point, an endowment is not a single endowment. It's an endowment pool comprised of many, many endowments. So at the University of Michigan, the endowment is comprised of over thirteen thousand separate endowments.

   3. JAJack Altman3:56

      That each have their own sort of mandates?

   4. DFDan Feder3:58

      Think of it as a mutual fund, and each endowment has a certain number of shares or units in the, in the fund. And so the scholarship to support first-gen students will have some number of units, depending on, you know, its size relative to the overall endowment pool, but it is, it is its own separate endowment. And that's something that gets lost in a lot of the conversation about endowment. What the endowment pool is intended to do for those endowments is, are really three things: One, support spending, and spending is typically defined as sort of four to five percent of overall value over some period of time, so averaging over three, four, five or so years. Keep up with inflation, and for endowments, it's higher edge inflation, which is a little bit higher than CPI, to preserve spending power. And then, if possible, make a return above that. But really it's to keep up with spending and inflation and support those programs in a way that supports them with intergenerational equity, so not too much ups and downs. And your starting point of going fully liquid is probably the right starting point, because if you're going to do that, which kind of solves out to an eight-ish percent nominal return for a period of forever without too much volatility, there aren't too many ways to do that, or probably are no other ways to do that other than having an equity orientation. So the logical starting point is fully liquid public equity, so you start with the deepest and most efficient markets-

   5. JAJack Altman5:29

      Yeah.

   6. DFDan Feder5:29

      - and then that might be, that might not be enough in terms of volatility or m- dampening volatility. Um, so you add other asset classes or other assets into the mix and take advantage of the framework around modern portfolio theory, which says that if you properly diversify a portfolio, you can actually get less risk defined as volatility for a unit of return or vice versa.

   7. JAJack Altman5:54

      So a lot of it is preservation of capital, access to, like, free cash flow. Those things are very important constraints beyond just driving good returns.

   8. DFDan Feder6:03

      Right. It's a pretty modest liquidity requirement, so, you know, four to five percent a year.... is something that's pretty manageable. So that's what enables endowments and pools like this to be able to go into asset classes like venture, and private real estate, and private equity, and, and other liquid, or sorry, semi-liquid and illiquid areas.

   9. JAJack Altman6:25

      So from this, like, zero-based budget hypothetical, where you're in some mix of, let's just say, like the S&P five hundred and bonds, and now you're deciding to peel out of that into illiquid stuff like venture capital, private equity, I don't know, commodities, whatever else.

   10. DFDan Feder6:40

       Mm-hmm.

   11. JAJack Altman6:40

       What is the driver that gets more dollars allocated there? Sort of without taking aside all of the sort of natural momentum that has-- we all know has happened, what from a theoretical standpoint, gets you to wanting to put X number of dollars in these different buckets?

   12. DFDan Feder6:57

       Well, there's pretty well-traveled math around how you do that optimization. So it's the, the most simple form of that is a mean variance optimization among some specified asset classes. And when you look at the, the correlations and the volatilities of each of those asset classes, come up with a mix that meets a return objective at a level of risk that is tolerable.

   13. JAJack Altman7:20

       Yeah. So then inside a bucket, so like private equity and venture gets whatever bucket it's gonna get. There's sort of this concept of, like, allocating, I guess, which is, like, this decision of, like, what slice of the pie should go into this whole thing, which is separate from investing, which I think of as like what you're picking inside that slice of pie. Is that, is that the right way to think about allocating investing?

   14. DFDan Feder7:39

       I think so, because I agree. But there, there really is a difference, in my mind, between allocation and investing. There, there's overlap for sure, but that asset allocation process is really a risk-based process. So in deriving what a model portfolio would look like, what you would do is look at return streams and correlations, uh, around those asset classes and arrive at, at that mix. But everything that you're looking at is risk-based in the sense of you're looking at the past to predict the future about what, what it would look like, you think, in the next several years. And so that is investing of a type, but it is-- it's a risk-based framework, and it's, it is a great framework for how to direct assets to different areas. It's also a super important behavioral framework, so we'll get to that later. But in an asset class like venture capital, you can have a lot of confidence or overconfidence in whether you're good at something. And so setting some parameters around how much or even how little of something to do, you, you take away some of these behavioral problems of doing too much or too little and guiding the portfolio into this, the state where the idea of that state, that model portfolio state, is that if you were dropped in from outer space after being away for a year or two and told, "Put together a portfolio to do these things," this is more or less the portfolio you, you would put together knowing nothing else. So behaviorally, that's what you should sort of gravitate toward.

   15. JAJack Altman9:09

       I

4. 9:10 – 13:07

   Risk-based investing vs uncertainty

   1. JAJack Altman9:10

      guess, like, trying to make an analog here to venture, like, you know, from the GP's perspective, the way I kinda think about allocation would be as though I were to go into a new fund and say: I'm gonna have this percent at C, this percent at A, and this percent for later follow-ons. I'm gonna do this percent in B2B, this percent in hard tech. I'm gonna do this much in US, et cetera. When I think about that for myself, I imagine it to be very hard for that to be where I got, or at least that I would-- I feel like I would need to do unnatural things to make that end result happen. And I guess either I'm thinking about the equivalence, and there's just some difference between, you know, the two ways that investing happens or maybe the constraints are in fact good, but, like, how would you react to the equivalent sort of allocation for a venture manager?

   2. DFDan Feder9:59

      I think venture is an extreme case among all the asset classes, and so therefore, it's a good case to, to talk about. Venture is really not, in my mind, that amenable to an allocation in and of itself and then allocations within it based on risk metrics.

   3. JAJack Altman10:14

      Um, an allocation in itself meaning from an LP?

   4. DFDan Feder10:16

      From an LP in terms of the, the allocation to the area. I think that's fine for the reasons we talked about, which is you wanna direct the capital to places where you think it makes sense on this risk-based system. But in terms of what one should invest in, risk-based investing or risk-based systems really don't align, in my mind, with what venture capital really is or what it ought to be thought of as being. So there's an economist named Frank Knight, who, when I read his work, uh, it kind of changed a lot of the way I thought, whose central thesis is that there is a very big difference between concepts of risk and uncertainty. And in the phraseology that Donald Rumsfeld made sort of popular, there are known unknowns, unknown knowns, known unknowns, and unknown unknowns. And things that are not known or not knowable is, is the realm of uncertainty. And that is where I think venture capital has its real power. And if you set up a system that's risk-based, so around these knowns or knowable things, you're not going to know how to deal with or incorporate those unknown unknowns into your, your portfolio in a sensible way. So what does an unknown unknown look like? It looks like an entrepreneur working on a problem that only he or she knows about, and therefore, it's not known to other people, and the, the, the project itself is not knowable. And if you can invest with that founder or in that founder based on information that others don't have, you would have an ability to make, in a sustainable way, real economic profit over time. Whereas risk-based investing, that alpha or trade or advantage around trade gets absorbed by the market over time. It's not durable over time. So when I think of venture capital or illiquid, uh, investments in the context of a, of an endowment portfolio, the active or illiquid end of that spectrum really ought to be pushed to-... investments that have aspects of uncertainty to, to them, because that is where if you can traffic in that well, you can make durable economic profit.

   5. JAJack Altman12:28

      First of all, I love the framework, and I wanna talk about that more. But does this also work when you're thinking about what venture managers you're gonna invest with? Like, is there some equivalence here where investing in uncertainty is a good framework as an endowment, or is this really only applied to VCs investing in founders?

   6. DFDan Feder12:46

      The founders are where it all-- where the rubber meets the road. And so the VCs or part-- business partners with whom we invest, whether it's in a fund or, or outside a fund, in my view, have to have some ability to access opportunities in a way that is advantageous. So information about who these people are, access to who they are, and some legal inside information about the opportunity.

5. 13:07 – 16:28

   Incentive structures in LP land

   1. JAJack Altman13:07

      A lot of these types of investments, I think, don't get made because they look weird for a long time, and it seems to me that there's sort of like a cascading herd thing that happens, where the things that are clear and sort of on the-- in that risk, you know, area that you talked about, people know those will keep getting funded, they'll keep getting marks, you know, they'll, they'll, they'll always have capital available, et cetera. And I'd imagine that for LPs also, there's some thing here, too, where certain things are gonna look better for longer periods of time. And I'm curious just to hear your take on, like, the incentives, structures inside LPs and the short and long-term orientations, and all the rest of it.

   2. DFDan Feder13:47

      There's something that's been bugging me quite a bit, and I haven't really thought it through com- fully, or even if I did, I'm not sure that it would be any better than what I'm gonna tell you. [chuckles] The notion that venture capital is an asset class in the first place bothers me because I don't think it, it is, and it just violates the characteristics of what an asset class is. But more to, to the point is that where we started with venture capital years and years ago is very different from where we are today. So in nineteen forty-six, Benjosch Schmidt Senior, who was one of the founders of J.H. Whitney, one of the first venture and private equity firms, came up with the term venture capital, but it was a shortening of the word adventure. And so I think if we went back to a construct and we said: Look, let's just put venture capital as a term off to the side, and let's look at two categories of investing within it: adventure capital and then capital for ventures. And it could clarify, I think, what, what it is we're talking about. Things that are, things that are uncertain, where the, where the founder is doing something hard and ambitious, where it's really risky, where the future is not known, not really knowable, and requires, um, going out on an adventure. And that takes away also the idea that we look at things through the lens of seed early, later, et cetera, because even a company that is at a later stage can still be doing things that are adventurous, highly ambitious, and, and new. And it-- and then it also can clarify that a lot of what goes on in venture capital is what I think a lot of VCs just don't want to admit, which is that... And this is why you and I, or you especially, you know, dress like this, is because you don't, you don't wanna be confused with the-

   3. JAJack Altman15:34

      Dress like this, like, no, no, no jacket.

   4. DFDan Feder15:36

      Well, you don't wanna be con- confused with the cufflink crowd. In the s- the sense that this is about financing companies, and doing finance is not a bad thing; it's a good thing. And it's-- I think it's okay for VCs, it's more than okay to admit that what they're doing for companies that have gotten past the stage of being truly adventurous, is that those companies need capital, and there's still opportunity to do value add with those companies, but it's different. And where we, because it, it really does align better with our portfolio, shine our spotlight, is more on the end of the adventure end, and I can go into that, but that's-- that aligns better with our time horizon, our networks of information and opportunity, and sometimes our ability to influence outcomes, even as an LP.

6. 16:28 – 22:26

   Team construction

   1. JAJack Altman16:28

      How do you set up the team culturally or with incentives or structurally to have the, what I assume, is a longer-term orientation to do, you know, the uncertain bucket versus the risk bucket?

   2. DFDan Feder16:42

      It's really hard because the, the practice of endowment management has changed quite a bit over the last... Well, the la-- you know, over the time I've observed it, which has been the last twenty-five years. And so endowment management was a place where people found themselves in it without really knowing what it was. It's kind of a-- it really wasn't a known, um, career path. It really-- and there really was not a career path to get to endowment management. So people who came to endowment management came from oddball places and were in those seats because they have a sense of, um, alignment of mission and a view that this is where they wanted to be. And there's a-- I think there's also a really powerful intellectual draw to doing investing in the context of an endowment, where you have a long time horizon, at least for the time being. No or very little tax efficiency to work at, but-- and more importantly, an alignment of interests in terms of governance that is not available in many other places, all the way from trustees to boards, to people, you know, in the investment offices and so forth. And so it was much easier in that context. So I think one of the, the, the insidious things that crept into the system is that endowments got larger, asset classes got more popular, more capital flowed in, and now there's a career path in endowment management, which is good.

   3. JAJack Altman18:06

      Mm-hmm.

   4. DFDan Feder18:06

      It's nice that there's a career path. [chuckles]

   5. JAJack Altman18:07

      It is good.

   6. DFDan Feder18:08

      But it's also... It, it comes with, with a downside, and the downside is that-... now that there's a career path, there's more of a premium on demonstrating a track record to move from one place to another.

   7. JAJack Altman18:22

      Can you talk quickly, what is that career path like? What are the things that you need to prove? Let's say you graduated, you know, from school, and you joined an endowment for, you know, first time. What is-- What are the, what are the central unlocks to get from there to where you are?

   8. DFDan Feder18:37

      A way to do it is to go from, as it is the case in any other financial enterprise or fund or what have you, go from analyst to associate, to principal, to director, to MD, to CIO, or, or head an organization. And a lot of times that will involve moving from place to place to create your own promotions.

   9. JAJack Altman18:56

      And it is mostly, aside from organizational things, is the way to get promoted to-- is it to be in good names? Is it to get markups? Is it to find a good thing early? Is it to support your managing director on a great investment? Like, what is it?

   10. DFDan Feder19:12

       I think it's probably all of those things, but it's to demonstrate relevance, I think, at the end of the day. And I think this is also the case within VC firms and, and other, other institutions. But when you start looking at metrics that are visible in relatively short time frames, you are focused more on the outcomes of those-- of every decision or everything that you've been involved in. So you're, you're more outcome-focused and less input-focused. If you're much more long-horizonted in your thinking, you're, you're gonna tend to be more input-oriented. So what will that look like in venture? A way that we do or that I-- that I look at venture investing, is just to spend a lot of time listening to people who I think are smart and who are gonna tell me what's coming next. And, and what we'll do is put in motion a number of ideas with people. It's not like a spray and pray. There are some, some areas where we'll start paying attention and put some conversations in motion, and it might take years for those to percolate to the surface. And when they do, it seems like it's fairly obvious that they were good ideas, but those ideas themselves may take years to mature into something that looks good. But that's what I mean by sort of input versus outcome or output focus. That is the way that I think we really compound on our knowledge and our networks and what our advantages are with time horizon. But if we are looking at even single or, you know, multi-year periods, we're gonna tend to be more focused on what does that look like in a year from now. And VCs are here to help. They spin up fantastic narratives, [chuckles] and they themselves are incentivized, I think, internally, um, to fund high-momentum trends. And it all aligns so that there's a sort of a, a self-feeding process where the provider of the product is, is producing something that provides outcomes.

   11. JAJack Altman21:15

       Yeah, we've kind of talked about this, that like, I felt this a little bit as a founder. Now that I'm in an investor seat, I can really sort of see even more of the dynamics of how it's more of like a craps table than a poker table. Like, everybody in some level is kind of like winning together and losing together, and there's a lot of incentives where everybody just wants all the numbers to all be going up all the time. And so you get these overinflated moments collectively. You know, we obviously have, you know, in the last ten years, gone through a bunch of these moments and, and then it kind of goes down altogether. But everybody's in on the conspiracy in their own ways, and it's like nobody's fault, but all the incentives seem to be driven towards, you know, acceleration up and down.

   12. DFDan Feder21:53

       I like the, the poker versus craps table. We, we like to play cards in the sense that when we're putting together these ideas or we're following them for a period of time, what we're doing is basically we're, we're, we're building our hand. And then when things come together, we start playing that hand, and we're playing from a diff- different position. We already have relationships with people with whom we trust. They'll start guiding us to things that we should invest in and not to, to other things, and that just works really well.

7. 22:26 – 26:06

   Backing strategies that are at odds

   1. JAJack Altman22:26

      When you're backing managers, obviously, you're backing a lot of venture firms and individuals who think really different things from each other. And, you know, most venture investors have, like, their own internally consistent set of ideas, whether it's, "I'm early stage, I'm late stage, I'm concentrated, I'm broad, I'm cyber, I'm B2B, I'm har--" whatever. And you're listening to that, you know, individually and thinking, "This is really good." But then you're backing other people who are thinking, sort of embedding in a different way or perhaps even the opposite way. And so I'm curious, what's the mindset as, as an LP, sort of thinking in general about how you're gonna work with people, given that these strategies that you're backing can, like, simultaneously be at odds?

   2. DFDan Feder23:11

      Yeah, you're, you're describing my own sort of tortured life, basically. [chuckles]

   3. JAJack Altman23:17

      It sounds like it could be like a chaotic headspace.

   4. DFDan Feder23:19

      Yes, most of the time, I'm walking around... Maybe all the time, I'm walking around in a state of cognitive dissonance, and I'm trying to make sense of that, and also trying to determine whether I'm actually just completely undisciplined and have no point of view and just investing in everything, and it's just one big mess. But the cognitive dissonance is exactly that, which is we're, we're constantly investing with people who have very different views of the world. We have specialists and generalists, we have, um, sole GPs, we have firms, we have larger firms. And the passion and the, the drive that these people have, and they're super smart and really accomplished, they believe this is the wi-- the right way, and in many cases, the only way, and the other ways are wrong. But yet we back the people who we think are smart, think are wrong, and vice versa. Uh, you know, each of them thinks the other's wrong. And a great thing about investing, at least it's a great luxury for-... for us, I think, is that in investing, you don't have to be right about everything. You just have to be right enough about the things that matter in terms of being right about them. And it can be the case, and it is the case, that there are approaches that are different among, among groups, and it's also part of what we need to do as an investor in a portfolio that's supposed to be resilient over time. And the way that I look at our portfolio construction, it's pretty concentrated. So we have across venture and private equity, thirty-six active relationships. Only nine of those are in private equity, uh, twenty-seven in, in venture, and it's, it's a large-scale portfolio, so it's a concentrated roster of firms or people. And one of the, the advantages of intentionally constraining the number of relationships is that it forces you to pick among groups that do something specific. So instead of taking the approach of, we're gonna do a diversified allocation and select five groups that basically do the same thing in the hopes that we catch the one that is the exceptional one, and the other ones will be good, we, we focus on picking the one. And then since we're picking the one in that area, that means that each other area, what we're looking for are people and groups that do something that is different. They'll overlap a bit, but that will be complementary or distinct in terms of where the returns come from and how they're derived. And it's an uncomfortable position, but it also really forces that sort of tortured existence of now you have to really concentrate into a few dozen groups that disagree with each other.

   5. JAJack Altman26:05

      I'm curious

8. 26:06 – 27:38

   Why LPs invest in venture

   1. JAJack Altman26:06

      your view on just, like, venture as an asset class overall. Like, you know, you're going through all this torture, you could just buy QQQ and call it a day. Like, what, what's your opinion on this whole asset class and why you're putting it in your overall portfolio?

   2. DFDan Feder26:23

      Well, we're supposed to.

   3. JAJack Altman26:24

      Yeah, that's an honest answer.

   4. DFDan Feder26:26

      So-

   5. JAJack Altman26:26

      Yeah. What else?

   6. DFDan Feder26:28

      I think that's why most people do it.

   7. JAJack Altman26:29

      Do you think that is really the reason? You don't think it's that people think that they can outpick or something like that?

   8. DFDan Feder26:34

      I think that, um, if you were to go out on the street and ask a hundred people whether they're an above average driver, ninety-eight of them would say that they are, and I think that that sort of dynamic applies in venture. The dispersions of returns, even though they've narrowed considerably, are still pretty broad, and it is a pretty lousy area to invest unless you are investing or, or getting exposure to the underlying companies that really matter.

   9. JAJack Altman27:00

      In which case, it's obviously very good.

   10. DFDan Feder27:01

       It's very, very, very good.

   11. JAJack Altman27:03

       Yeah.

   12. DFDan Feder27:03

       But this isn't like Wobegon, and not all the children are above average-

   13. JAJack Altman27:07

       Yeah

   14. DFDan Feder27:07

       ... but they [chuckles] -

   15. JAJack Altman27:08

       There's also the-

   16. DFDan Feder27:09

       All the parents think they are.

   17. JAJack Altman27:10

       Yeah. It's probably also the thing you mentioned about, like, GPs are, you know, good at narratives, and firms have learned over long periods of time how to tell the right narrative.

   18. DFDan Feder27:18

       It's one of those magical things. I mean-

   19. JAJack Altman27:20

       Yeah

   20. DFDan Feder27:21

       ... LPs love a good story, and GPs love to tell a good story.

   21. JAJack Altman27:24

       Yeah. How do you think about, like, your investing at Michig- You know, you said-

   22. DFDan Feder27:27

       I didn't mean to sound that-

   23. JAJack Altman27:28

       No, of course. No, it's-- No, I mean, I think there's-- I think this is, this is true in general in sort of business, is that there are narratives, you know, drive a lot of, you know, capital movement.

9. 27:38 – 32:29

   UMich framework to investing

   1. JAJack Altman27:38

      But given that, you know, you're not just sort of at a place in your career now where you're investing because you have to, you are doing, you know, you're, you're setting strategy. Like, what is the overall framework for how you think about investing at Michigan? I mean, you talked about the managers, you know, the breakdown and, you know, the concentrated portfolio approach, but can you click a little bit more into sort of what it looks like specifically for you all in terms of how you're set up as an endowment?

   2. DFDan Feder28:03

      Well, we're set up in a, in a fairly conventional way, which makes a ton of sense. So we have the five basic areas of investment classes: cash and fixed income, public equities, absolute return, real assets, and venture and private equity. What's under the hood, I think, really is going to have to change, or the, the model of how we think about doing endowment management, when we look back five or ten years from now, will be very different in terms of best practices than what it has been for the past, call it, three decades. And the things that have changed have been, there aren't just a small handful of endowments doing this sort of investing. The alternative asset classes that prove the point of multi-asset class investing for endowments are no longer really alternative. These are very well traveled, very highly capitalized. The number of really smart and accomplished people who are on the LP or the allocator side has just gone way, way up. The sophistication's gone way up. You know, the whole thing has just gotten bigger and more sophisticated.

   3. JAJack Altman29:09

      You're saying the average LP is better than they used to be?

   4. DFDan Feder29:11

      Well, I think in terms of if we're looking sort of at objective measures of how sophisticated are these, these people who are managing these pools, the, the, the office-- There are investment offices now that are well-staffed, well-run, well-organized, and that wasn't the case twenty years ago. So it's no longer the case that you can be a large endowment, have unfair access to a small corner of the market that produces high returns, and call it a day. And there's more to it than that, but that's, that's no longer going to be the way to win. The way I look at it is that the positioning of, of being an allocator has been pretty comfortable for a while, and that allocating among asset classes is not the same thing as investing. So what do I mean by investing in that context? What I mean is that there is not one model that's going to work. And each institution, whether it's an endowment, a foundation, a pension fund, or a fund of funds, will need to look at its own portfolio. And its own portfolio is-... how much capital they have, what's their positioning, what sort of access to opportunity do they have? And invest in a way, especially in this part of the portfolio, meaning the illiquid or the uncertain part of the portfolio, that plays to those advantages, and not do things that don't. So at the University of Michigan, for instance, we're a very large university with a deep and broad research function, with a alumni network that is, numbers in the many hundreds of thousands with a lot of loyalty to the insti- loyalty to the institution. And so when we look at investing into those areas of uncertainty, the lens I look at it through is: Does that investment, whether it's a fund investment or something that we're doing in a more direct sense, align with one or more of our three advantages? So our three advantages are access, so we have access to information, people, and opportunities. We have a long time horizon. If we want to make good use of it, it's there for us. And then every once in a while, we can do something that might change the outcome of an investment, or there might be an opportunity to do that. And I don't wanna overstate it, because it's not that we're trying to be value add venture capitalists, but it's that every once in a while there might be an introduction or a phone call or a connection that can have high, high marginal impact and change the outcome of an investment. So if, if all three of those things are at play, then that's starting to enter our strike zone. A small liberal arts college is not going to have that same portfolio-

   5. JAJack Altman31:57

      Yeah

   6. DFDan Feder31:57

      ... of advantages, but it'll have other things. And so it's less neat and tidy in the sense that each of those institutions to really do this thing, which is very hard, that eight percent nominal return with limited volatility forever, is not going to be able to look at a recipe book and say, "This is how it's done." They will need to look at the institution's own positioning and see to what extent should it be active or passive. And maybe the answer is, and it could be in many cases, just take the passive exposure.

10. 32:29 – 36:40

    Picking individuals vs firms

    1. JAJack Altman32:29

       So maybe this is a good time to go to, like, manager selection and how you think about who you partner with. Maybe like a starting point is how you think about individuals and firms and sort of like, you know, the person versus, you know, the, the chair they're sitting in. And, um, I'm just interested to hear your perspective after, you know, a lot of time investing across different cycles and individuals, small funds, big funds, super established firms. Where is your mindset now on how to think about that in particular?

    2. DFDan Feder32:58

       The objective that we're trying to get to is not to invest with firms or with business partners. That's what we do, and I enjoy doing that, but what we are really trying to do is have exposure to underlying companies.

    3. JAJack Altman33:13

       Yeah.

    4. DFDan Feder33:13

       How do we do that in an operationally efficient way around the world, across all sorts of things that are super hard? And the way we do that is we find really great people to do the work for us, and we draft off them.

    5. JAJack Altman33:24

       Mm-hmm.

    6. DFDan Feder33:24

       Does that mean that we're committed to only investing in big firms or only to individuals? Is there a right answer or a wrong answer? And for us, it's how do we get the, the best fidelity in terms of capital going in, reaching those, those companies and those assets in a way that will be meaningful to the, to the endowment? And the thing you said around the, the seat of, of people and where they sit, it's important in, in sort of looking at that is like: Well, where does the seat end and the person begin?

    7. JAJack Altman33:55

       Yeah.

    8. DFDan Feder33:55

       Because it's hard to pull those things apart a lot of times. So there are great firms with great people.

    9. JAJack Altman33:59

       Mm-hmm.

    10. DFDan Feder33:59

        And some of those great people would not be as great without the firm.

    11. JAJack Altman34:04

        Right. There are people who are great in a context of a firm and wouldn't be good independently, and I think vice versa is true also. Like, you know, particularly in some of those people who are meant to be investing in those uncertain buckets, I think it's, like, way harder to do that type of investing at certain firms. I think there are some big firms that are great at both, but there's probably also pulling that apart, too. The large, you know, established, really good firms, they see everything. They can win most things, and the hope, I guess, is that their picking process makes-- I mean, what you hope for is that it makes people better pickers, not worse pickers. I think of the three, that's the one I'm the least sure about, but I'm sure it helps them see and win more stuff.

    12. DFDan Feder34:39

        And they'll attract really great people to be-

    13. JAJack Altman34:42

        Partners

    14. DFDan Feder34:42

        ... partners there.

    15. JAJack Altman34:43

        For sure.

    16. DFDan Feder34:43

        So that's, that is certainly important. A thing that I've changed my mind about a bit over the past couple of years or so is that, uh, in the context of, well, we- we're really trying to get as much concentrated exposure as we reasonably can into the best companies and assets across the portfolio. And the shorthand for that has been, well, let's keep the number of fund relationships or, or partnerships low. And by doing that, we'll therefore have fewer underlying or investee companies in the portfolio, and therefore, we'll have more exposure to the companies that matter. The thing I've changed my mind about a bit is in that area where it's not really clear where the seat ends and the person begins, or the firm's franchise ends and the, the individual's franchise begins, it may make more sense to back more groups with fewer people. So, for instance, if you take a firm that has, call it six capital P partners, there are two partners in that firm that we would back independently and think that their, their own productivity is either, uh, independent of the firm or a big part of that whole franchise. And then there are the other four who could be very good, but we wouldn't back independently. What we get if we back that firm is the productivity of all six.

    17. JAJack Altman36:07

        Yep.

    18. DFDan Feder36:08

        And we really want the productivity of those two. And where we've-- I've modified my thinking a bit is, instead of backing that firm, maybe we should be backing two or three firms of-... a couple of people or one or, or single practitioners, because, again, what we're trying to do is get the most exposure-

    19. JAJack Altman36:28

        Right

    20. DFDan Feder36:28

        -to that productivity.

    21. JAJack Altman36:29

        And then I guess the calculation is if those two out of six are really generationally productive investors, you know, maybe that's just the cost of doing business, and it's worth it anyway.

    22. DFDan Feder36:38

        Could be.

    23. JAJack Altman36:39

        Yeah. Another

11. 36:40 – 40:48

    Big vs small funds

    1. JAJack Altman36:40

       topic, um, that has come up around manager selection or firm selection in general has been like fund size. This has become like a sort of hotter, more popular topic, I think, as funds just have gotten, you know, much bigger than they've ever been. Josh Kopelman talked about this with me on the podcast and, um, put it in, you know, this very succinct way around venture arrogance score, and, you know, what the math is ne- gonna need to be to get the outcomes. Obviously, a lot of very smart people have articulated a different perspective. Um, maybe by the time I've posted this, we'll have posted, you know, sort of a, a contra view, which I'm not confident in my ability to, you know, be- believe anything with high certainty in this business so far. But I'm curious your own lens on this whole topic of fund size, and when you hear about, you know, a big fund, what do you think?

    2. DFDan Feder37:26

       The problem is like, in the case of Josh Kopelman, he laid out a fantastic case, and he believes it wholeheartedly, and this is exactly the problem I was talking about. [chuckles]

    3. JAJack Altman37:34

       It's a conundrum.

    4. DFDan Feder37:34

       Like you're like, "Josh, you're-"

    5. JAJack Altman37:35

       You're like, "Yeah, that's right.

    6. DFDan Feder37:36

       Exactly right.

    7. JAJack Altman37:37

       Yeah.

    8. DFDan Feder37:37

       But then, you know, we go do other things. So the, the question I have when somebody says something along the lines of, "Fund size is the enemy of return," I ask, in, in ser- in all seriousness: Do you mean too big or too small?

    9. JAJack Altman37:52

       Yeah.

    10. DFDan Feder37:53

        Because the fund size is really a, a symptom or an outcome of an approach, and it could be that for an, a- an ambitious venture capital approach, actually you need a lot more capital.

    11. JAJack Altman38:07

        And that'll drive better returns.

    12. DFDan Feder38:09

        And that'll be better.

    13. JAJack Altman38:09

        Yeah.

    14. DFDan Feder38:10

        In some cases, you know, funds get too big and water down what they're supposed to be doing in the first place, or the, the fidelity in terms of the quality of underlying companies decreases as fund size goes up. So I don't think there's a specific answer of, oh, big fund size bad, small si- fund size good, and we see it a lot, um, around a seed at a very early stage where there's just a lot of frustration. Fund size is too small to actually execute on inve- getting the, the right level of exposure-

    15. JAJack Altman38:45

        Yeah

    16. DFDan Feder38:45

        ... or investment into companies that are going to be important.

    17. JAJack Altman38:49

        I also think, like, being able to lead rounds of whatever size is like a big advantage, not just for the investor, but for the founder, which I guess then translates back to the investor. So if you're undersized to lead rounds in whatever your strategy is, I think that can make things hard sometimes, too.

    18. DFDan Feder39:05

        Yeah, I mean, all these things are just these dialectics where the, the seeds of destruction are sown in the, [chuckles] you know, the, the actual thing. So if you have more capital to invest in the later rounds, then you're just gonna... You know, you have the potential to-

    19. JAJack Altman39:16

        Of course

    20. DFDan Feder39:17

        ... actually do the wrong thing.

    21. JAJack Altman39:17

        So when you're thinking about this fund size question, and you know, your kind of mindset is like, well, I don't know, is big or small better, depending, are you trying to figure out with and agree with the strategy on your own, or are you just trying to get to confidence that this is a great manager, and then I'm not gonna think about it?

    22. DFDan Feder39:36

        What ideally we'd like to be positioned or how we'd like to be positioned is to be in the conversation. I d- I don't want my job to be to tell people what to do, but what I really would like to be doing is to be in the conversation about, How are you thinking about this? What's the strategy? And the reason that I think that can be helpful is that some of these things that really matter are just really uncomfortable and contrary to what the easy path would be. And if we can be in a position where we can say, "Okay, that's-- that makes sense," or, you know, "That, that's, that's the approach you're taking, go for it." If things don't go well, he made a good decision, and there was an unhappy outcome, but we were there because where the, the really great things happen is when I think whether it's a founder or a, or a fund manager or an LP, does something that is uncomfortable, but right. And, and, and providing that kind of support through engagement, I think is just very, very important.

12. 40:48 – 45:41

    How to pick fund managers

    1. JAJack Altman40:48

       How do you pick fund managers? Like, VCs talk so much about what they're looking for in founders, and I think that's, like, all very well trod. You know, there's a lot of different opinions, and maybe some people know how to do it better than others. But I think between LPs and VCs, I think there have been fewer words shared on sort of like, what is it that people look for, aside from all the basics of: Does the strategy roughly make sense? You know, is the setup good? Whatever, but, like, what is it about people for you?

    2. DFDan Feder41:14

       Well, a few things just on selection, whether it's VCP, uh, just managers in general have an orientation going into LPs or in whatever shape or form. I have an offering that's just on its own, you know, in isolation, great. So I should win. So what is it that I need to do to win? And it's not how you sell something. The way you sell something is by understanding what the buyer is looking for. So for us, what we're looking for are investments that fit in the portfolio. So if it's an opportunity that is excellent but overlaps or is redundant with something else in the portfolio, it's just-

    3. JAJack Altman41:54

       You look at it

    4. DFDan Feder41:55

       ... it's just not gonna, it's just not gonna make it in. The way that we, we source opportunities is, it is only through introductions and qualified referrals. There's just no other way. Uh, we do have advantages around networks and information networks around people, and we have a team of roughly eight people doing all this work. If we tried to see the whole market, we couldn't, but we shouldn't. That's not what-- where our advantage is. The way that we look at-... manager selection, are there five things that everyone has to do? Whether you're whatever asset class, you have to source opportunities, transact them, own the investment well, exit, and then run your firm in a way that doesn't detract from those first four. And so that's the framework. You know, being more precise than that, it's, it's-

    5. JAJack Altman42:48

       But-

    6. DFDan Feder42:48

       -finding opportunities that, that, that fit and are complementary and make sense in the overall portfolio through advantage networks.

    7. JAJack Altman42:55

       And when you're backing people, is there something about particular people that gets you, you know, to a place of wanting to be in business? Or is it each manager is a special snowflake? Is it, you know, diligence work that you're doing? Like, if somebody is, you know, coming to you, how are you deciding whether this person you think is equipped to, you know, get special returns or not?

    8. DFDan Feder43:19

       Well, the net-- the referencing and the networking holds a lot of weight, and so, uh, we just try to listen to people we know and trust pretty carefully and hear what they're saying. There are people in this world who are just special, and I don't know how to put my finger on it other than to say there, there aren't a lot of them. But almost by definition, they're, they're super rare. But when you encounter somebody who is in that category, it's, it is pretty glaringly obvious. And I wish I had a better way of articulating what that is, but there are so few that it's just a sort of rare thing.

    9. JAJack Altman43:55

       And it just comes down to taste, I suppose, at some point, of your own taste, and that's what, you know, makes for a, a good, you know, LP manager.

    10. DFDan Feder44:03

        So there are two words that are in the lexicon right now that I think are getting overused a bit: taste and existential.

    11. JAJack Altman44:09

        Why?

    12. DFDan Feder44:10

        They just [chuckles] -

    13. JAJack Altman44:11

        But I mean, why do you think it's too much?

    14. DFDan Feder44:12

        It seems to be a shortcut.

    15. JAJack Altman44:12

        Do you think taste is like-

    16. DFDan Feder44:14

        Because-

    17. JAJack Altman44:14

        ... is it like a cop-out that doesn't say something specific? Is that the issue?

    18. DFDan Feder44:17

        I think it's, I think it's a cop-out. I think it's, it's a way for... I, I understand it's not always-

    19. JAJack Altman44:21

        No, I like it.

    20. DFDan Feder44:22

        But I just think that [chuckles] -

    21. JAJack Altman44:24

        It's too much?

    22. DFDan Feder44:24

        Yeah, I could-- you could talk yourself into all sorts of silly stuff by just saying, "It's just about taste. I just feel it in my gut. This person's a money maker."

    23. JAJack Altman44:32

        Well, it's sort of a fallback to, like, when people can't explain why they're making a decision. I guess, to steel man taste, it would be the hope is that your brain's doing a bunch of background calculations or having emotions around a person or an idea, and that there's signal in that.

    24. DFDan Feder44:48

        That description maybe muddled a couple of things. So if you go to Daniel Kahneman's Thinking Fast and Thinking Slow, or the Type 1 and Type 2 thinking, there is a place and a time for that kind of taste. Um, that kind of taste is like, "Oh, there's a ferocious-looking dog on the street. I think I'll go to the other side of the street. [chuckles] I don't really need to figure out if that's a nice dog." But that, I think, is important in terms of kind of reflex or decisions you have to make in a very short timeframe. But just saying it's taste for a relationship that's supposed to go on for years, I think you gotta do some slow thinking there.

    25. JAJack Altman45:25

        Yeah. What about existential? What's the issue with that?

    26. DFDan Feder45:28

        I don't know. It's just, uh, just-

    27. JAJack Altman45:29

        Too dramatic?

    28. DFDan Feder45:30

        There are too many things that are existential now. [chuckles]

    29. JAJack Altman45:31

        It's all existential.

    30. DFDan Feder45:32

        Either we're just, like, doomed, and we'll be done tomorrow, and no one will see this-
13. 45:41 – 48:24

    Herd mentality in LP land

    1. JAJack Altman45:41

       I enjoyed it. Last topic I want to hear about is, there's a lot of herd mentality in venture, and I think it leads to... I don't know for sure whether it leads to bad decision-making. If the people who are following decisions are, in fact, people who wouldn't make good decisions on their own, you could argue it actually leads to better decision-making, and it's, you know, the way in which capital gets efficiently allocated. That aside, I'm curious about herd dynamics in LP land and what you've observed over your years doing it.

    2. DFDan Feder46:10

       Well, I don't want to discount the wisdom of the crowds, so that's-- there's, there's something there.

    3. JAJack Altman46:14

       For sure.

    4. DFDan Feder46:14

       And, you know, just being an independent thinker doesn't mean that you disagree with the, the herd. It just means you should think independently. Um, sometimes that means the herd is correct. But I, I do think that there are some strong and independent thinkers around the periphery who really do, when things are kind of stable and normal, keep, [inhales] you know, on the inside of that periphery or, or institutions or investors that for incentive or practical or whatever reasons, are happy to be within that, that herd and let the kind of the stronger perimeter dictate where they go. The problem arises that when stuff happens and things start moving around, then that structure gets broken, and the kind of the weaker investors or the, the herd mentality investor becomes exposed and highly, highly vulnerable and doesn't know what to do, makes the wrong decisions at the wrong time. My aspiration is that we ought to be independent thinkers, willing to be on the outside of that or on the perimeter of the herd, and when the time comes to leave, we can leave if we want to, but in any event, we'll be self-sufficient.

    5. JAJack Altman47:32

       Did you want to share the story about your dad and the animals?

    6. DFDan Feder47:34

       Well, my dad was a scientist, and his research is around, uh, animal behavior, specifically around reproductive behavior. So from a very early age, I was learning about not the birds and the bees, but the ring doves and the guinea pigs. But I was on a safari trip, and this exact dynamic played out with a, a herd of water buffalo and two lions that were attacking the herd, and it took hours and hours, but eventually the herd started moving, stuff went crazy, and then the lions ate. And when I was watching that, observing that, the first thing that went through my mind was not how the LPs behave, but thinking back on it, [chuckles] it seemed to be that way.

    7. JAJack Altman48:10

       Well, this is awesome, Dan. Thanks for, thanks for taking all the time to, to share these thoughts, and I learned a ton, and I, I always enjoy getting to talk to you. So really appreciate it.

    8. DFDan Feder48:18

       No, thanks for having me. It's been a ton of fun spending more time with you.

    9. JAJack Altman48:21

       It's great. [music]

Episode duration: 48:25