The Exchanges

Q I know a lot has happened for you since your days at Uvimco. So why don't we start with your transition to McKenna?

A No, thank you, because it was soon thereafter. I've been at McKenna now almost four and a half years. It's been a wonderful transition, and the portfolio is very similar to what we had at Uvemco. Tremendous team. They had started McKenna about 16 years ago now, so at that time was closer to, say, 12 years. So it was a very mature portfolio, mature team, but, you know, at the margin, It's not my style to make dramatic changes, but over time, we've moved the team to more of a generalist model, not complete generalist, but having collaboration across asset classes, we've increased our allocations to certain asset classes. You know, when I started, we were about a five percent allocation to venture capital, despite our location on Sand Hill Road, and so we've slowly gotten that up over time to now closer to 13%, you know, still well below where large endowments are, but At a level where I'm very comfortable taking it up to mid teens over time, but doing it very slowly. We've reduced our allocation to credit. We've increased our allocation to those hybrid type of managers, but yeah, we've made slow changes to the portfolio. So I, I like where it is right now.

AI assessment note: “It's been a wonderful transition, and the portfolio is very similar”

Q And so were there specific lessons that you pulled out of those early experiences?

A I remember I was on the capital markets desk in the stock market crash of 87, October 87. And we're on the debt side, but everything just stopped. There was no new issuance. Everyone was following what was going on, the equity markets. But one of the things that was really Made a big impact. At the time, Goldman Sachs was still a partnership, and you saw what happened was that day, and partners at Goldman Sachs were always extremely hands-on, very talented, but you could see it firsthand where the senior people got on the desk and were actually actively involved in the trading because their money is on the line. Their, their partnership capital is on the line. And so, kind of contrasting that with the experience I had before that, earlier in my career at DuPont, where you have a large public company, you don't have that same notion of skin in the game. Anecdotes like that have had a pretty meaningful impact in the way I think about who we want to partner with, what does the structure of the partnership arrangement look like.

AI assessment note: “had a pretty meaningful impact in the way I think about who we want to partner”

Q So when did you start thinking about investing with a broader allocator's lens?

A This is somewhat serendipitous is, so I'm a professor at UVA teaching finance, and I was appointed to the state pension, the Virginia Retirement Systems Investment Committee in 19, early 1998. And it really opened up a whole window into how large pools of institutional capital are invested, large asset owners. At the time, VRS was probably 30 billion-ish in size, but just being involved with that, which was a very well-run institution, a woman named Nancy Everett was the CIO, was just a wonderful person, wonderful investor, wonderful leader, was very involved with that. Joe Grills, a retired CIO of the IBM pension, was involved with that. Lou Mulchart, the long time serving CIO at the University of Richmond, who then went on to found private advisors, was on. We had a, it was a very good investment committee. So I was very drawn in to that as a way of investing and allocating and the issues that arise with that, whether it's a manager selection, where do you focus your efforts in terms of how you allocate across the managers, across the different strategies. And at a board retreat, an annual board retreat, Nancy Everett had just lost her head of public equity to go to an investment firm, and she asked me if I would ever consider taking that position, and then overseeing a couple of the people. One was they had some internal management that was quantitative oriented. They had ex…

AI assessment note: “appointed to the state pension, the Virginia Retirement Systems Investment Committee in 19, early 1998”

Q It seems like a lot of the hedge fund spin outs have been very binary in terms of their capital formation. So they either start 1,000,000,001, billions of dollars, or it's really, really hard. Where have you sought to invest in some of those emerging managers?

A We've done I'm trying to think in recent history, we've done one on the hedge fund side, which was well publicized, got a lot of capital, we think is an extraordinary investor, won't name the person's name, but we're much more likely to invest in the manager that is not just getting the wave of capital, but we do, like, for example, even on longingly public equity, there was a big launch several years back, and we participated in that, but that is Unusual. We're much more likely, even within our long-only public equity, to be investing in a smaller manager, because what's really important to us is developing a close partnership relationship where they're more than just someone that we see returns from, because we certainly want to see that, but we want to be able to have a constant dialogue with them to help generate ideas for us from a bottom-up standpoint of how we deploy our capital Internally. And you're more likely to get that from a smaller manager that doesn't have as much of a following. And so it includes just being constantly in touch with them in terms of ideas in their portfolio, as well as co-investments. You know, it's been a big part of our strategy.

AI assessment note: “we're much more likely, even within our long-only public equity, to be investing in a smaller manager”

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A Yeah, I think that's one of my other challenges, is we have, as well as a lot of other endowment foundations for years, been traveling around the emerging world, traveling around the world in general, looking for those next undiscovered managers that have skill. And for the last two year, two and a half years now, we have not been on the road. And that inability to source new ideas makes me uncomfortable. We're not going to make any investments. We have not made any investments in emerging markets with managers that we have not been able to kick the tires of their underlying positions in their home geography. So I think that's a real issue. And I don't see that You know, opening up anytime soon. So to me, that's one other impediment versus what we could just do in terms of sourcing managers in the US, you know, developed Europe. So I, I think that's a real concern.

AI assessment note: “We have not made any investments in emerging markets with managers that we have not”

Q We seem to be in this situation right now, again, with significant macro risks. Inflation, for sure, there's real question of, obviously, What economic sanctions mean, how this affects China, and would love to hear in the context of your whole portfolio, what do you do about these new risks?

A Going back to their basic principles or philosophy, I'm a firm believer of, again, playing to your strength, and our strength is not macro. So what I try to do as much as possible for the team Is to tune out much of that as noise. With that said, we want to make sure at all times the portfolio has a level of risk that is close to the 6040, sort of as a drawdown risk. And we operate within bands. The minimum is a .55 beta. The maximum is a .65 beta. And then we have liquidity guardrails in terms of the level of unfunded commitments, the percentage of the portfolio we can turn into cash. Within a month, a quarter, and a year. And so living within those guardrails allows us to manage the portfolio through a cycle that would be stress tested. With that said, there's some leeway, and I do think there are elevated risks right now. So we are running at a lower, slightly lower beta to the markets. Than we have been over the last several year period of time. And so we are really not rebalancing that much back into equity. So we're running at a slightly lower risk level, because I really do think, you know, Russia, that's a risk where, you know, we've, you know, we've fought in wars. We're not fighting in this as a war yet, but there's a risk of that. But we have survived, whether it's, you know, Vietnam War, Korean War, World War II, and And so we have invested through those periods of …

AI assessment note: “we are running at a lower, slightly lower beta to the markets”

Q If you could start over today, money was no object. And you couldn't be an allocator or, or an investor. What would you most like to do?

A Oh, hands down. I would just teach. So I love being in the classroom. I often thought it'd be fun to be a high school math teacher because I feel it's oftentimes the way it's taught is not how I would teach it. And that's something I think I helped my kids with. But when I do find the time to get in the classroom, it's just, Time just passes. You're getting this, this kind of special zone. This, this, this, the, the, um, the book, The Rise of Superman, this, this concept of the state of flow. I know it's not like doing extreme sports, but you get that same sense where it just, you're just, it's hard to describe.

AI assessment note: “Oh, hands down. I would just teach.”

Q Larry, what, what's next on the horizon for you, either in terms of research projects or ways you're trying to adapt and evolve within McKenna?

A So I think right now we're in a good position from a staffing standpoint. We're constantly trying to hire young people and grow our own talent. So I feel good about where we are. They're constantly pushing the team to look for that next idea. That's going to be like crypto. I can't come up with anything. You know, everyone's looking at energy transition. We're looking at it too. You know, a lot of people are looking at biotech. This one that As I said, we've redeployed capital into that, but so it's not really a new area, but it's a growing area. We are reassessing emerging markets. So those are kind of ongoing research projects, and then otherwise, I'd say it's business as usual on re-underwriting managers. From my vantage point, I'd say the biggest thing for me is I will be here for another five years. We have a succession plan in place. So we promoted a deputy CIO last summer who is just fabulous. He will likely be the person that will then be in several years co-CIO with me, and then in five years or thereabouts, I can retire and will be a senior advisor to McKenna, because I do want a long relationship with McKenna, but having that in place, and because very few firms, you know, we deal with investment firms all the time, and There's always succession, transition, challenges, and setting the wheels in motion in place early, I think is really healthy for the organization, a…

AI assessment note: “So those are kind of ongoing research projects, and then otherwise... succession plan in place”

Q Within that area, have you changed at all the types of managers that you're investing in?

A Yeah, I mean, so for one, I'm not as big a believer. I think there's a role for some having some credit managers so that they can actually size up in case there's a big opportunity, but I'm not The next big credit opportunity is always right around the corner, and I just don't think it's necessarily right around the corner, but I want to have the optionality in the portfolio of having, right now, we just have three managers that have that credit background, that we could size that up if the opportunity becomes right. So that is one area where we've made some changes. Otherwise, you know, we've moved to You know, you constantly, like we do across the portfolio, replenishing, your managers get big, you develop multiple products, and over time, you might not fully terminate them, but you'll reduce their size in the portfolio, and then try to layer in more emerging managers, which has been a big theme of ours, is constantly looking for what we think will be the next great manager that's spinning out of somebody else, And so there's a constant natural turnover and move to smaller single product funds.

AI assessment note: “there's a constant natural turnover and move to smaller single product funds.”

Q How do you think through, you know, when to hold them and when to fold them?

A So I, I'll talk about what I'd like us to do and what we should be doing in theory, and then what practice is. In theory, the performance, especially when you're investing in concentrated managers, you have to know going in, there's going to be a lot of volatility, which again, gets Very much diversified out when we combine them with other managers, with other investments. So the volatility in and of itself is, is not for, at the individual manager level, it's not a problem. With that said, what could be a problem is if the manager themselves, the volatility that they're experiencing, does that cause their business to suffer? And so there's, it's an existential threat to the organization.

AI assessment note: “what could be a problem is if the manager themselves... cause their business to suffer”

Q How do you think about the sizing of those direct portfolios relative to your external managers?

A We're never going to become a direct investor. It's going to be a, I think our edge ultimately is forging these long-term partnership relationships with managers. And what we're trying to do is leverage those over time to develop some of these co-investments to get closer to the underlying companies. And so to answer your question, it's probably only going to end up being five to 10%. Of the total portfolio. Right now, it's closer to five percent. I think the most that we get up to is 10%, but we're still, ultimately, our edge is unsourcing, evaluating, and forging these close partnership relationships with our managers. And when I think of the people on the team, what they're really good at is having these relationships. So even with, you know, we met, we talked about before the big fund launch, And, you know, that's a fund that has multiple relationships. Even in instances like that, we do a particularly effective job of carving out very close relationships with managers.

AI assessment note: “it's probably only going to end up being five to 10%. Of the total portfolio.”

Q And what were the formative lessons you learned in that seat that were maybe different from what you expected going in?

A So one is, you know, VRS at that point, it was very much of an experiment of whether they could do some internal management. And at that point, it was only about a hundred million dollars that was being managed internally. And very talented investor named JT Greer started this as a process and trying to learn off of a lot, a number of the quantitative managers that That were employed by them at the time, and so it was built out, and then seeing some of the challenges of how do you kind of maintain what you could, you, you could do as an institution like that, and have any kind of edge of investing, and as it pertained to some of the, the quantitative strategies, because we actually took in a lot of those, which, you know, still done today in terms of Looking at value, looking at earnings quality, looking at a number of factors that a lot of quantitative managers look at, but being able to employ that in a extremely low cost manner, but knowing that probably the best way to implement that is in a very low tracking error approach. So tracking error on the order of, say, a 102 hundred basis points. Because knowing that if you tried to have too big a tracking error, If you really underperform for a period of time, you'd have to have, have the hard decision, constant, difficult decision. What do we do with this? And how does it compete with the external managers? So it was intention…

AI assessment note: “knowing that probably the best way to implement that is in a very low tracking error approach”

Q What's the biggest mistake you made, and what did you learn from it?

A Hands down, again, this relates back to philosophy, which I'll talk about in a second. I'd say the biggest mistake I made, there were a couple of instances of people that I knew I was close to that I had no idea what they were really like. And in fact, I led with this at our offsite retreat back in September of talking about our sixth core principle, which is people matter. Which potentially I've had one of our clients say, that should be your first core principle, people matter. Because ultimately what we're doing, you know, we look at bottom up at companies, we look at these global risks, we look at different strategies where the inefficiencies that can be exploited, but ultimately we are trusting these partners, managers, whether it's public equity, hedge funds, venture, private equity, we're trusting these people to invest over a long period of time. And the mistakes that we will make that we want to avoid making are on the people side, and it's very difficult. It's really hard to get to know people, and so the mistakes I've made from a personal standpoint of people that I really didn't know, that I trusted, fortunately did not have business dealings with them, that is really a lesson learned in terms of When we think about developing these close partnership relationships with managers, that we just have to go to the last mile of turning over every stone, of really trying t…

AI assessment note: “the biggest mistake I made, there were a couple of instances of people”

Q someone's thinking about allocating capital, I love to ask people, what do you believe about investing that governs how you think about asset allocation and implementation, and in your case, there are five core principles that you brought that are repeated in your annual letters, and I'd love to ask you questions about each one, but why don't we start by your just Saying, what are those five core principles?

A Well, the first one is the fact that we're a long-term investor. Everyone says they're a long-term investor. And getting back to some of the things I talked about before is, can you build a decision-making framework, a governance framework, and a team that will enable you to do that, knowing there are so many impediments, whether they're behavioral biases, Whether they're organizational constraints to cause you to not behave that way, whether they're market constraints. I would argue that the world has become much more short term focused, has become much more macro focused. And, you know, one of the, the dirty little secrets of the rise of ETFs, one of the values is you can express In a very, in a lower cost way, various views of the market, but that's also one of the downsides, is because you're constantly buffeted with different views of the market of whether the Fed is dovish or hawkish, or taxes are gonna go up or down, or, you know, Europe is falling apart, or now, you know, it's doing well, or what's going on in China, and, you know, every publication, every, you know, whether it's CNBC, Bloomberg, Fox News, Business Channel, You know, people are just being buffeted by different macro views. You know, people are able to express those views through ETFs very easily, and people have become much more short-term in their focus, and so trying to maintain that discipline of bei…

AI assessment note: “Well, the first one is the fact that we're a long-term investor.”

Q So what's a, what's typically the largest size position?

A A large position for us is going to be in the order of an, at the underlying company level, a hundred, maybe 200 basis points. And so that's, that's it. So that's, there's a lot of diversification. That gets to the second question. You could almost argue that since we're attracted to To these managers that have, you know, anywhere from 10 to 30 securities. Some of those are quality companies that you might hold forever. Wouldn't it be nice if you just own a portfolio like that? Well, the problem, you can't do that with a manager. Well, then, well, why don't you just do it directly? And then we get back to the, again, the circular argument we talked about before, where the problem is related to us doing it internally. It just becomes a challenge, uh, So yes and no. Given our implementation, the way we can implement, I think it's probably a reasonable amount of diversification, because for us, a large allocation to an individual manager is going to be several hundred million dollars. It's hard to get much more allocated to the managers for, for whom most people are closed, and we just can't get any more allocated. So that's diversification. The other thing I would say on diversification is you have to have the humility to know that you are going to make mistakes. And it gets back to the kind of the first point is never let, even though, you know, people always say, well, if you'r…

AI assessment note: “at the underlying company level, a hundred, maybe 200 basis points.”

Q Well, Larry, I can't let you leave without a couple of closing questions, all of which have pretty much changed since we last spoke. So here we go. What is your favorite hobby or activity outside of work and family?

A So for years, my favorite hobby was tennis, golf, sports in general, but getting back to my age of 65, as my body just breaks down more and more, I'm out there on the tennis court and golf course less and less time. So, uh, which I guess, which is what allows me to work more, which is what I'm, I'm probably working more now than I ever have, but really it's probably just travel and it is family. I mean, so my kids are all out of the house, and right now we have our first granddaughter, um, And my second son is getting married in June. And so even though we don't have that same level of intense family time as we did when the kids were, you know, your kids age, that it's still really fun and really meaningful to get the family together.

AI assessment note: “really it's probably just travel and it is family.”

Q Which then leaves you with the same problem of what do you do with that portfolio?

A And you would have to certainly have the discipline to shut it down, but I've seen too many instances where that doesn't happen. And so trying to figure out what is our sustainable edge, I don't think that's it right now. We constantly focus on it. Is that in a lower return world, fees take a disproportionately larger percentage of the total return, and anything that can be done to knock those down a bit is, you know, going right to our bottom line. So trying to figure out ways that we can reduce fees without sacrificing quality is a conundrum that we constantly try to address. We do a little bit by co-investing on the private side, but it's, It's not that scalable either.

AI assessment note: “discipline to shut it down, but I've seen too many instances where that doesn't happen.”