Apr 22, 2024 · 1h 13m · capital-allocators
David Morehead – Top Down Allocation at Baylor (EP.381)
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gold bands on the timeline = statements, start to end. Hover to read, click to jump. CC turns on captions
Baylor University CIO David Morehead joins Ted Seides to detail his distinct top-down, macro-thematic investment philosophy overseeing the university's $2.2 billion endowment. He explores Baylor's contrarian staged deployment rules, rigorous qualitative manager diligence, downside-first risk framing, and internal team-building practices.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 16.3% of the talking time here. How this is scored →
Ted as informed peer 3.8 Guest teaching 4.8 Guest disagreement 1.1 Ted pushing back 0.0
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 16:20 Dismissing static asset allocation models
Morehead rejects the traditional endowment model of maintaining fixed allocations to cyclical asset classes like high yield regardless of underlying credit spreads.
Hardest push from Ted ▶ 39:25 Questioning private illiquidity lock-up trade-offsTed pushes on how Morehead justifies private market sizing given the severe ten-year loss of opportunity cost flexibility.
Biggest teaching moment ▶ 46:50 Distinguishing true humility from insecurityMorehead breaks down how insecure fund managers masquerade as humble but centralize control, offering equity distribution as the definitive diagnostic filter.
Ted holds their own ▶ 22:52 Framing top-down discipline across private versus public portfoliosTed synthesizes Morehead's multi-asset background to frame the precise tension between top-down active allocation and private equity duration.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Legal Disclaimer | 0 | 0 | 0 | 0 | Introductory monologue and legal disclaimer. Host introduces the guest and gives house updates with no interactive dynamic. | |
| David Morehead's Early Career Across Public Markets | 3 | 4 | 1 | 0 | Ted asks a broad opening question about Morehead's early career. Morehead walks through his varied background across fixed income, derivatives at CRT, sell-side research at William Blair, and energy trading at hedge funds. | |
| Transition to Baylor University and Higher Education | 4 | 5 | 1 | 0 | Ted probes into what key lessons Morehead extracted from diverse market roles upon entering Baylor. Morehead details the nuances of cash flow liquidity forecasting in endowments compared to hedge funds. | |
| Three Frameworks of Endowment Management | 5 | 6 | 2 | 0 | Morehead explains his taxonomy of three endowment management styles: manager pickers (70%), direct deal/co-investment allocators (15%), and top-down macro-cyclical allocators like Baylor. He explains why Baylor avoids permanent static asset allocation targets. | |
| Contrarian Allocations and Staged Deployment Rules | 5 | 5 | 1 | 0 | Ted asks how Baylor ensures high hit rates when taking contrarian top-down positions. Morehead outlines Baylor's systematic rules for staged incremental additions at successive market drawdowns. | |
| Manager Communication and Liquidity Partnership | 4 | 5 | 1 | 0 | Morehead explains how Baylor interacts transparently with external managers, clarifying that they pull capital during booms when managers have long lines of LPs and allocate counter-cyclically during outflows. | |
| Top-Down Allocation in Private vs. Public Markets | 5 | 6 | 2 | 0 | Ted asks how a top-down approach applies to illiquid private assets. Morehead explains that cyclical sectors like energy and financials belong in public markets where they can be traded, while private markets are reserved strictly for secular growers. | |
| Risk-First Portfolio Construction and Downside Ballast | 5 | 5 | 1 | 0 | Morehead explains Baylor's risk-first portfolio construction model, focusing on high quality to protect downside capital during market shocks while accepting potential underperformance in speculative bull runs. | |
| Capturing Upside Ballast in Dislocated Sectors | 4 | 6 | 1 | 0 | Morehead illustrates tactical contrarian trades that generate upside ballast, recounting historical moves into energy high yield in 2016, long volatility in 2018, and beaten-down small-cap biotech in 2022. | |
| Current Market Opportunities in Small Caps | 4 | 5 | 1 | 0 | Ted asks where Baylor is finding dislocated opportunities today. Morehead highlights the historic valuation gap between large-cap tech and small caps, accepting near-term pain for multi-year payoff. | |
| Sponsor Message: Ridgeline Investment Management Platform | 0 | 0 | 0 | 0 | Mid-roll sponsor break for Ridgeline investment management platform. | |
| Cost of Capital and Opportunity Cost Discipline | 5 | 6 | 2 | 0 | Morehead details Baylor's strict opportunity cost discipline, requiring a hurdle rate of cash plus 500 basis points and readiness to hold large cash reserves when attractive risk-adjusted returns are unavailable. | |
| Strategy Selection and Liquidity Filters in Public Markets | 4 | 5 | 1 | 0 | Morehead explains that on the marketable side, Baylor strictly confines investments to deep, liquid markets and narrows broad categories down to specific operational styles like convertible arbitrage. | |
| Evaluating Manager Character, Humility, and Culture | 4 | 6 | 2 | 0 | Morehead articulates how to evaluate manager character, distinguishing between genuine intellectual humility and insecurity that masquerades as humility, using equity distribution as an objective test. | |
| Unconventional Diligence and 360-Degree References | 4 | 6 | 1 | 0 | Morehead details his unconventional diligence practices, including 60-minute calls with spouses and conversations with non-industry neighbors and college roommates to assess behavioral stability under stress. | |
| Structural Portfolio Shifts and Manager Turnover | 4 | 6 | 2 | 0 | Morehead discusses rationales for manager turnover, noting that manager terminations are rarely due to poor performance but rather portfolio structural changes such as cutting portfolio over-diversification. | |
| Developing Team Talent and Codifying Investment Processes | 4 | 5 | 1 | 0 | Morehead reflects on teaching and codifying the investment process for junior analysts, breaking down the separation between manager selection science and asset allocation art. | |
| Implementing Funds of One and Scaling Baylor's Endowment | 4 | 5 | 1 | 0 | Morehead explains Baylor's transition toward implementing funds of one and the managerial balance required when delegating real authority to high-performing junior teammates. | |
| Peer Collaboration and Institutional Governance Lessons | 4 | 5 | 1 | 0 | Morehead shares institutional governance lessons learned from peers like MIT and Rice, including why endowments should avoid buying local land strategic to their own universities. | |
| Sharing Investment Perspectives on Twitter / X | 3 | 4 | 1 | 0 | Ted asks why Morehead began writing publicly on Twitter / X. Morehead explains it arose from manager feedback noting his unique approach, concluding with closing rapid-fire questions. |
Statements from this episode (36)
Morehead: Endowments are less complex than hedge fund portfolios
“At the end of the day, running an endowment isn't any different than running any other portfolio. In fact, based on what endowments are invested in, they're a lot less complex than a lot of hedge fund portfolios. They're predominantly long biased.”
Morehead: Private capital calls make endowment liquidity management uniquely tricky
“Now, I would say the one thing that I found that is dramatically different Is the cash flow liquidity piece. That I think is very tricky to get that right. That takes a lot of thought and a lot of anticipation and forecasting and thinking through how you're go…”
Morehead: Baylor avoids high-yield credit when spreads are at 300 bps
“And so we can just follow what the high yield credit spread is. And when it's 300 over, like it is now, you could bet that we're not involved. But if it's 2000 over, like it was in oh eight, then we probably are involved. So we run our portfolio more that way.”
Morehead: Baylor stages liquidity to deploy capital at 10% market drawdown intervals
“We think about everything in terms of 10% market moves. If the market were down 10%, would we add? Maybe. Depends on what the value is. If the market was down 20%, would we add? For sure. And then we think about how many times we want to be able to add to the …”
Morehead: Baylor executes all endowment investments through external managers
“Yeah, so it's all through managers. We don't do anything directly.”
Morehead: Baylor pulls capital from top performers and funds struggling managers
“Look, when things are going right, and you're making lots of money, and people are knocking on your door trying to give you more money, we're going to be pulling money during that time. We just are. That's how we roll. And that shouldn't bother you because eve…”
Morehead: Midstream MLPs Offered 3-4x to 12-14x EBITDA Arbitrage
“So, 10 years ago, there was a private public ARB in the MLP space. You could cobble together the MLP Greenfield at three, four times EBITDA, and then you could sell it to the public markets at 12 or 14 times EBITDA.”
Morehead: Illiquid 7-10 Year Private Funds Are Flawed for Cyclical Sectors
“If you're in a seven to 10 year investment vehicle, and you don't know where the underlying market is going to be seven to 10 years from now, That's a real problem, because you could invest for seven to 10 years, and then by no fault of your own, or the manage…”
Morehead: Baylor Moved Most Cyclical Allocations to Public Markets
“So for us, that's tech, healthcare, the consumer, and then we do have some private energy. We do have some private financials. Both of those are cyclical, but we've moved most of the cyclical stuff to the public side because we can trade around that.”
Morehead: Baylor endowment trails in bull runs but outperformed in 2020 and 2022
“So we know going into it, that in markets like, 2015 to 2019, we're probably gonna trail. And we're okay with that because in 2020 and 20 22, we outperform.”
Morehead: Baylor exited 2016 high-yield energy trade up 50%
“For example, in 2016, high yield energy in particular, that was the downdraft in the energy markets when crude prices really came in. The joke at the time was that 60 was the new par. And by the end of 2016, that had come around and we were out Of that positio…”
Morehead: Baylor bought long volatility in 2017–2018 to hedge 2020
“We were buying long vol in 2017, 20 18, and just held on to it, and that was what gave us ballast in 2020 when the pandemic hit.”
Morehead: Baylor tripled biotech exposure in 2022 following 60% drawdown
“But in 2022, we basically tripled our biotech exposure when the small cat biotech was down 60% over the year.”
Morehead: Baylor is leaning into small-cap equities
“It's not particularly working right now, but that's okay because we're long-term investors. It's small caps.”
Morehead: Large-cap to small-cap spread is the widest ever
“Both those things impact small caps more so than large caps, and so the spread between large caps and small caps is the widest it's ever been.”
Morehead: Portfolio asset categories are merely communication devices
“Where we've gotten on that front is that categories are just communication devices. You can't really boil a portfolio like we're all running into four headers and have it accurately describe what's going on.”
Morehead: Allocators should pick good investments before assigning categories
“The important thing is that the categories not drive your investments. You should do the good thing and then figure out the category after the fact, not the reverse.”
Morehead: Venture capital industry in total has never lost money over 10-year period
“The industry in total over a 10 year period, I don't think has ever lost money. I'm not sure if I'm a hundred percent correct on it, but as close.”
Morehead: In private funds, sector exposure drives risk far more than company age
“Now, a single venture capital company is a risky thing, but in how we're investing via funds, it's actually not that risky. So from our perspective on the private side, the thing that really drives risk is sector exposure”
Morehead: Baylor Adds 5% Opportunity Cost to Treasury Yields for Hurdle Rate
“If that's the case, then the opportunity cost is five percent a year, and so that's how we think. You have treasuries that are two-year, five-year treasuries that are five percent plus five percent, and the hurdle's 10%.”
Morehead: Baylor Held $100M in Cash and $80M in Long Volatility in 2019
“So in 2019, we were having trouble finding things that had 15, 20% return opportunities in that environment. And so I think the endowment here at that time was maybe 1.3 billion or something like that. We had 80 million dollars in long ball and a hundred milli…”
Morehead: Baylor Holds Cash Regardless of Yield When Opportunities Miss Hurdle
“We are not afraid to hold cash if we feel like we're not getting paid for the risk that we're taking. So if we're not meeting that opportunity cost hurdle, we'll hold cash, and it doesn't matter to us if we're getting paid for it or not because there's this op…”
Morehead: Baylor University's endowment is roughly $2.2 billion
“We're talking about, for us, I think the endowment now is around 2.2 billion, something like that.”
Morehead: A 50/50 public-private allocation mitigates private market valuation lag
“Setting that aside, it increasingly seems to me that something around fifty-fifty feels right, and the reason for that is because of the valuation lag that occurs in private markets.”
Morehead: Delayed private market markdowns create multi-year return drag for institutions
“Because the investment managers at the private shops are incentivized to not mark things down, over time what happens is that same marking process has occurred, but it's occurred over two years. And so what that means for the institution is that you're having …”
Morehead: Baylor restricts marketable portfolio to highly liquid markets like US high yield
“And because we're running an active allocation portfolio on the marketable side, we can only be in liquid categories. We would participate in US high yield and European high yield, but we would not participate in Asian high yield because it's easy to buy somet…”
Morehead: Baylor allocates between $250k and $100M across individual managers
“We allocate, broadly speaking, between zero and a hundred million to individual managers. And we have some managers right now that have a hundred million dollars from us, and we have other managers, strategies that have 250,000 dollars, and the high yield stra…”
Morehead: Investors are wrong 45% of the time; lacking humility causes blowups
“One of the key characteristics that we look for is humility, because in this business, you hope to be right, 55% of the time. Well, that means you're wrong 45% of the time, and so for the person who is unable to admit that they're wrong, that doesn't work for …”
Morehead: Insecurity masquerading as humility centralizes power and drives talent away
“Is that insecurity masquerades as humility. And insecurity is a big issue because it infects the organization. If you're talking to portfolio manager, who at their core is insecure. Then they're not likely to give authority or rope or opportunity to the other …”
Morehead: Equity distribution across an organization tests manager security
“One of the obvious ways to test that is how widely is equity pushed down in the organization, because secure people will trust the people around them, encourage them. They want smarter people than them sitting next to them. And we'll reward those people, push …”
Morehead did a one-hour reference check with a fund manager's wife
“I have one manager in our book, and it was early in the life of this firm. I already had known the guy, but he was starting this new firm, and I actually called his wife. I was like, I need to know this is ok with your wife. So I called his wife and spoke to h…”
Morehead: People do not change, so personal red flags disqualify managers
“Because my view is that people don't really change. If they're cursing their neighbor out when they're taking the trash out, they're probably don't belong in our book.”
Morehead avoids quant managers because black-box algorithms prevent market timing
“There are great quant managers. Fantastic. But if there's a quant manager, I don't know when to allocate to it or take money away because I don't understand the black box. No one lays out their quant algorithm. Cause if they did, you could be like, oh yeah, we…”
Morehead: Excessive portfolio diversification diversifies away alpha
“Diversification cuts both ways. It eliminates systemic risk, but it also diversifies away your alpha if it's too diversified.”