Recursion

In new news, last month I joined the private equity team of a public pension — a return to the world of limited partnerships, blind pool commitments, and creative performance metrics presented by fund managers to show themselves as top quartile. I’d previously written about the opportunity for institutions to back micro VC investors, and that still holds true. However, that’s just a subset of the grander opportunity: to help grow a program early in its lifecycle, to apply the lessons from both my first stint in the field and the years following, to explore whatever issues and ideas and rabbit holes that arise. The following come to mind.

“Why does this footnote say the chart doesn’t include your two lowest-performing deals within that subset?”

Investing in products that don’t trade on the daily whims of people (or algorithms) is a different sort of game. You can’t just buy a share of a private equity fund on Charles Schwab — unlike the public markets, it’s a two-way street. You have to develop a relationship with the manager of said fund over several months (or even years), eventually to the point where two conditions are true: you’re comfortable enough to commit a large amount of capital, and the manager is comfortable enough to accept that large amount of capital from you. Managers have no obligation to accept your commitment (even if you’re a prior investor) — though if they’re more incentivized to gather assets than to generate financial returns, the question of access becomes less of a concern. That point aside, in order to increase the likelihood of their commitments being accepted, investors need to provide value beyond just capital to fund managers and help them build a more permanent business. Which admittedly, is something I need to figure out.

Relationship-building aside, how do you find new managers with whom to partner? There’s no Bumble for institutional investors (yet) where you can swipe and match with experienced managers raising several hundred million dollars to buy high growth, cash-flowing businesses. It would be easy to just rely on inbound deal flow from consultants and placement agents, but the very best opportunities won’t always come through those channels. You must do your own outreach, to turn over all stones and meet the universe of managers who are doing interesting, not-so-simple things.

In order to outperform the market, investment firms are often required to include arboreal or geological references in their names.

Performance analysis for these managers is another puzzle. I mentioned the creative metrics earlier — but let’s assume you receive the necessary track record data, which typically occurs. A skilled Microsoft Excel jockey is useful here, but will only take you so far. You have to ask for more information to actually dissect the data and qualify the story of each line item. It’s not enough to simply look at a portfolio and its returns — you have to understand why each deal performed as it did, and then determine whether the pipeline of deals going forward shares the same characteristics as the highest performers.

TAKE MY MONEY

Limited partnerships, the vehicles through which these investors and fund managers join forces, are flawed. The current business model for these managers is to raise a fund with a stated lifespan (ten years is typical), with the first few years spent making investments and the remainder spent selling them. However, this creates several issues. Fund managers have this short time horizon in which they need to make improvements to the portfolio companies — improvements that optimize the company for a sale, not necessarily for its long-term future. Investors want cash (which is king, yes) returned sooner rather than later, and portfolio companies may suffer as a result. There is a lack of “permanent capital” vehicles structured to align the interests of investors and managers and portfolio companies, so I guess you could consider this a request for those. “RFPCV” rolls right off the tongue.

I really did want to draw an elaborate picture to show how cash is king, but then I decided to live my life.

Even if people can agree on there being governance issues in this field of investing or that markets are frothy/over-heated/etc., no one really knows what the next 6, 12, 18 months or beyond will hold. And, there’s so many different directions to move in preparing for these unknown conditions. The capital you commit today won’t be fully invested for several years, which means your performance in 2020, 2025, 2030 is being determined right now. Which makes this the most exciting time to be an investor (aside from all the previous times, of course).

This does not constitute investment advice.

Every pitchbook read, every meeting taken, every investment opportunity encountered will require a similar sort of analysis in solving for whether or not to invest. Time and experience will (hopefully) refine the questions asked on a single portfolio company, which will roll up into whether a fund manager is adept in implementing their beliefs, which will roll up into whether their portfolio is performing beyond expectations, which will roll up into our decision to invest. And once all those question functions have been run, we’ll be left with our own portfolio — one designed to perform. Top of top quartile.

It’s been a dream of mine to design a corporate motivational poster.