June 25, 2025 • 64 mins
Michael Marvelli leads the private markets strategy at the UCLA Investment Company, managing a portfolio that spans private equity, real estate, and real assets. But his route to institutional investing wasn’t linear.
Before UCLA, he spent time at Prudential and The Irvine Company in real estate and mortgage finance, and even helped launch a venture-backed startup as COO and CFO. That operating experience gives him a unique lens when evaluating managers today.
In this episode, we talk about how UCLA builds conviction in lower-middle-market GPs, how they manage dry powder and fund pacing, and what it was like spinning out UCLA’s investment office into an independent entity.
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Episode Transcript
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(00:00):
So tell me about how you came to be the deputyCIO at UCLA Investment Company.
(00:05):
It took all of twenty years or so.
I've been at UCLA twenty two years.
When I joined, we were a 400 to $500,000,000pool of capital.
We've grown about 10x over the course of mytime here, and that's after distributing to the
(00:28):
campus an amount that would equal three to fourtimes the capital base, which when I joined.
So it's been a rewarding experience.
Today, I spend most of my time in the privatemarkets and outside of my investment duties, I
(00:48):
get involved in asset allocation as well asworking on our annual spending policy.
So you were at the endowment when you launchedin 2011 and it became its own entity.
Tell me about how that launch happened.
In the wake of the great financial crisis, wehad sort of resurrected AUM just above a
(01:12):
billion dollars.
We were more than twice the size of when Ijoined.
The portfolio was also a lot more complexbecause we had pushed into alternatives.
And we wanted to pause at that point and askourselves what structure would serve us best
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long term as we thought about growing theendowment from there.
And that's when we decided to set up a propermanagement company in 2011.
It's now been an independent management companyfor fourteen years.
How has the strategy evolved across thosefourteen years?
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There were three of us at launch and now thereare 15 professionals.
So you can, as you can imagine, you can doquite a bit more with that level of resource.
We can just take a much more nuanced view ofasset class strategy.
(02:15):
And, you know, frankly, that's where I'd liketo focus a lot of our time today is on
formulation of asset class strategy, because Idon't think enough time is spent on that topic.
Famous pension fund study showed that 90%, ninezero of the returns were due to the portfolio
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construction and only 10% to manager selection.
Do you think that still holds today?
I don't know about the percentages, but assetallocation absolutely drives the returns,
particularly in endowment land where the lessliquid pools of capital have outperformed over
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long periods of time.
So here we're talking about asset allocation.
And then what I would say is the asset classstrategy is the next determinant of
performance, followed by manager selection.
There's three layers.
There's portfolio construction, asset classstrategy, and manager selection.
(03:22):
So let's talk about that middle layer.
What is asset class strategy?
We might use the lower middle market in privateequity to illustrate that.
But I would say that a lot of endowments,they'll arrive at some, you know, asset
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allocation target, and then they'll just huntfor the best managers.
In my view, unless you're focused on the rightsegments within the asset class, you can be the
best manager selector in the world and yourperformance might be good, but it's gonna be
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suboptimal.
So the pieces that's missing is the strategy.
You said something that I wanna double clickon.
So what does it mean to have good managerselection and bad asset allocation strategy?
Give me an example of that.
Well, you don't have a specific strategy andyou're not targeting particular segments within
(04:31):
an asset class, then you're just left withfinding the best managers available.
And so if you're hunting in the most prevalentsegments of the private equity market, say the
middle market and the upper market, there's alot of really bright people and great teams
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that can, you know, talk a good story.
They can walk you through a very rational sortof model of how they invest.
And you're left, you know, thinking that, youknow, this is a high quality group.
They would be great stewards of our capital.
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And then you select on that basis.
And my point is that you could end up with abunch of, you know, quote high quality firms,
you know, of competent people, but you're gonnabe exposed to the segments of the market that
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they're investing in.
And those might offer good returns, but theymay not offer the best returns.
You mentioned private equity.
You have upper middle market, core middlemarket, lower middle market.
In venture you might have growth or pre IPO,traditional venture and then pre seed and seed
and it's before you even pick which manager,picking what part of that market makes most
(06:07):
sense as an overall portfolio strategy.
In my opinion, it's very important to do that.
And it's not just that there's a right or wronganswer, although you you probably argue in
private equity there is one.
There's also a portfolio construction questionwhich is what is your overall diversification
of your portfolio?
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Perhaps there's tax strategy if you're just aregular high net worth investor, not an
endowment investor.
There's other factors beyond just taking theright answer.
You're certainly, you know, wanting to considerhow the strategy is gonna fit within the
overall context of your portfolio.
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And, you know, as an endowment, it's a multiasset globally diversified portfolio.
And so you're really looking for private equityand venture, you know, to drive returns.
You're shooting for high returns.
Whereas in other asset classes, you might beseeking diversifiers or strategies that might
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hedge against inflation, or in the case of cashand fixed income to provide liquidity to a
fairly illiquid pool of capital.
So yeah, all these asset classes have a role toplay and the role for private equity and
venture venture is to help increase returns.
So you love the lower middle market of PE.
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Before we go into why, how do you define lowermiddle market?
What does that exactly mean?
This is a great question and there is noconsensus.
So you'll find people, you know, talking aboutsub billion dollar funds or, you know, sub, you
know, dollars 300,000,000 funds or you'll hearpeople talk in terms of EBITDA levels.
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To be a little bit provocative, it doesn'treally matter in the end.
I guess it matters from the sense that a labelhelps one, know, talk about what's important
about the market.
But what I would say is it's much moreimportant to think about it philosophically and
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what it means in terms of strategic value.
You know, allow me to kind of expand on thatpoint.
And so the easiest way for me to talk about itis in terms of EBITDA level.
So let's say I go out and I buy a $6,000,000EBITDA company for seven times.
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So that's $42,000,000 of enterprise value.
And let's say I put two turns of leverage onit.
So two times 6,000,000 is 12.
So 40 two minuteus 12 is $30,000,000 of equity.
And let's say I make eight of those investmentsin the fund.
So now we're talking about $240,000,000.
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So this is very typical of what we do.
Now, if I have one 8X outcome on 30,000,000 ofequity, I have now just returned the fund with
one investment.
And it just so happens that the preponderanceof those types of outcomes of that quantum
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happen in smaller funds rather than largerfunds.
And the way you get into the top quartile inprivate equity is not by printing these steady
3X returns on all eight of your investments.
You have one or two large outcomes that drivethose returns.
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And so the question is, you know, how arereturns generated?
And it's very important for us as investors tounderstand how returns are generated.
And so if you look at a value bridge and thatvalue bridge, you know, the drivers are cash
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flow accretion, debt repayment, and multipleARB.
And so now if you really study each of thesethree variables that drive value, drive
performance, you begin to understand thedifference of the opportunity offered in the
lower middle market versus upper markets.
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And of course, job number one is to drive cashflow.
We're all doing that.
We're all trying to do that.
And that's a big determinant of performance.
Debt's a bit different in the upper versus thelower market.
In the upper market, debt is very available.
A lot of these investments resemble leveragedbuyouts.
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So you start with a lot of debt, and then youpay the debt down.
And as you pay the debt down, that's valueaccretive.
So it's a value driver.
In the lower middle market, you can't get muchdebt.
And if you're doing a buy and build and you'reacquiring small businesses and adding them to
your platform, you're typically increasing yourdebt over the hold.
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So it's actually value destructive in the lowermarket.
But the single largest determinant of value orthe most distinguishing one when looking at the
upper versus the lower market is the thirdcharacteristic, which is multiple arbitrage,
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valuation arbitrage.
And I would argue based upon my own experiencethat there is materially more value arb
opportunity offered in the lower middle marketthan the upper market.
We've been at this ten years.
Our own experience across our realizations,more than two dozen realizations out of one
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hundred and one hundred and ten smallbusinesses in the portfolio, we've been able to
increase the multiple from entry to exit byseven and a half turns.
And that surprised us.
And we certainly don't forecast that we'll beable to generate that when we go from a couple
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of dozen realizations to 100 realizations, butit does illustrate the quantum of value
accretion you can add in the lower middlemarket by buying at a lower valuation, growing
the company, and then serving it up to thatnext rung of capital that has a massive amount
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of dry powder, unfunded commitments, where it'sfar more competitive and they're willing to pay
higher prices.
Unpack that seven and a half.
How much of that is due to increased cash flowor increased profits?
And how much of that is due to multiplearbitrage?
Yeah, so I want to be clear.
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So when I talk about a seven and a half turnuplift from the entry valuation to the exit
valuation, we're only talking about multipleARB.
So not to be confused with like a multiple oninvested capital, right, which we can talk
about.
But those three variables, you know, cash flowaccretion, you know, you're hoping to add one
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or two turns of MOIC, you know, through thatactivity, and you're hoping not to destroy too
much of that with the use of debt, right?
As I mentioned, the debt is typically going upfor us.
We've averaged about 2.9 times EBITDA ofleverage at entry, and that will tend to go up
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a bit.
But it's rare that it would exceed four turnsof EBITDA at exit.
But that third component is pure valuationmultiple ARB.
For us, when we look across all the sectorsthat we invest in and we're single sector
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investors for the most part, we blend in atbuying these companies at eight times and we
have sold them at 15 and a half times.
That's the seven and a half turn up with thatI, spoke about.
So in that example with 8x you're doubling themultiple of which you're selling them at.
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Almost.
And then you also have the increase the one to2x increase from the cash flow and then you're
paying some of that is being paid back in debtand the leverage that you put on the deal.
That's exactly right.
And so to frame this in terms of MOIC, becauseI think people are, you know, interested.
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I mean, ultimately people are going to select astrategy that hopefully delivers better
outcomes.
If you look at the private equity markethistorically, and I should qualify that I am
talking about, for the most part, controlequity and growth equity transactions.
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I personally don't invest in venture.
We have another colleague that's far better atthat than I am.
So when I refer to private equity, it's reallycontrol equity and growth equity.
The broad market has historically delivered atwo and a half times gross MOIC at the deal
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level.
So that's kind of the private equity market.
And we've been doing this for ten years andacross the realizations I spoke of, we've been
able to generate a return that is two turnshigher than the market.
So it's been a pretty compelling segment of themarket for us to focus on.
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Basically, going from a two and a half averageto four and a half for UCLA is great
performance.
Why are there not more endowments like UCLAgoing into the lower middle market?
I think there are a lot of reasons.
At the end of the day, the stars have to alignin terms of the AUM you're managing, because
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that dictates what kind of team you cansupport.
And you need a large enough team so that youcan devote sufficient time to develop a
specialization to a particular strategy, thisbeing one that we pursue.
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And then on the other hand, if you write$50,000,000 checks and if you're worried about,
you know, being too large a percentage of thefund you're entering, then it becomes very
difficult to invest in small funds.
And if you reduce your fund check size, then itreally is not moving the needle for very large
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endowments.
Then you're not putting money behind partnersand managers that have a very strong brand
recognition.
In many cases, you're meeting managers for thefirst time as you get to know them.
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And therefore you need the right governanceframework.
And so it's extremely helpful if the team ismaking the decision on manager hires, as
opposed to say a board that you're reportingto.
And I'm very fortunate to have very strongsupport from my CIO, who appreciates the
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performance potential that this strategyrepresents and believes we can manage the loss.
And that also holds true for our board.
And I would also add that we have a strongcapability in operational due diligence, which
is important when you are diligent managersthat really don't have a brand name.
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And, you know, probably 12 of the 15 managerson our roster, entered at Fund One.
So there's very little in the way of trackrecord.
So for all these reasons, you know, size, youknow, governance model, and then, you know,
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capability in terms of specialization and ODD,all this kind of factors in to what kind of
firm can focus on this end of the market.
And I think that's why you see less in the wayof, you know, institutions investing in this
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part of the market.
And back to my earlier point, if you don'tformulate a strategy and you're just left with,
you know, know, quote selecting the like worldclass managers, you're not likely to focus on
this end of the market.
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I believe that you always have to invest inhighly competent people and teams, but I don't
like to use words like world class or, youknow, rock stars or golden boys or girls or any
of this nomenclature that you hear frequentlytalked about when people are talking up a
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manager.
So there's this paradox where you need somebodyhighly technical, very experienced in the
space, but also you can't be this megaendowment that has to invest billions and
billions of dollars in every strategy.
So you need almost this like Goldilocksendowment with precision asset allocation, also
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a board and a governance that supports thisprecision like strategy.
That's fair.
At least that's how I approach it.
And you mentioned something that triggeredanother thought.
Just as important as, you know, pursuing thesespecific segments because you think they offer
higher potential, it does another veryimportant thing for the team, and that is it
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allows you to completely ignore large swaths ofthe market.
And that's not only important to help us findthe better managers in the small market, but we
also have to manage a few other asset classes.
And so we have also developed pretty nuancedstrategies in those nuance, I'm sorry, those
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asset classes, which help us ignore largeswaths of those markets, because time is the
most precious resource that an LP has.
Just given that most of the time these arefairly small teams managing large pools of
capital.
Presumably you're becoming more skilled inwhatever you spend time, effort and turns on.
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So you're building your competency within thelower middle market versus if you were to
dilute it across all of private equity, youwould become a generalist across those
Absolutely.
That's true in spades.
I mean, we take it further and we invest in twostrategies within private equity.
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If we're buying performing companies, highquality companies through our partners, we're
doing that through a single sector format.
And, you know, the other strategy we pursue isspecial situations.
And we sort of relax that single sectororientation because we want them to cast a
really broad net because it's more of a bottomsup hunting exercise.
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But, you know, it's the lower middle market,then it's single sector or specialist sits.
So it gets very specific.
And that level of specialization allows you tohave a degree of pattern recognition whereby,
one, you're taking far fewer meetings, and thenthe meetings you're taking are highly
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productive, and you're using that patternrecognition to diligence different aspects of
their activities and business.
And it just helps you.
It's a much more efficient exercise than havinga group come in that says, hey, by the way, you
know, we invest in these four or five privateequity sectors, you know, consumer, tech,
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industrial, financial services.
It's very sort of discombobulating for me totake that kind of meeting today and spend
fifteen minutes on each of those sectors.
Don't find it very productive.
I would even further strengthen that in thatyour value as an LP to the GP is also your
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focus and that you're able to see because youcould only invest in so many funds and managers
and so many managers, you have much morevaluable insights across your GPs that you
could share with your GPs versus if you werespread thin it'd be more difficult to bring
value as an LP?
It's very important.
Like, you know, it's important that anendowment team be the partner of choice with
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the GPs that you're targeting.
And I think in their view, you know, the moreknowledgeable the LP is about their business,
the more likely that LP is gonna be able toride through the rough patches that are
invariably going to occur because we're allequity investors.
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We're just taking lots of risk.
And so it's never sort of a straight line to a,you know, a three or four or five X outcome.
And so that intimacy with their business, Ithink makes us a better partner.
You mentioned you do a lot fund oneinvestments.
I've had TIFF and Inatai Foundation on thepodcast talking about they even go earlier.
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They do independent sponsor deals.
Do you look at independent sponsor deals?
And what are your thoughts on?
Yeah, let me even back up further and helpflesh out this market and where it sits sort of
like downstream and upstream.
So we talked about what is downstream in termsof the middle market, the upper middle market,
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the large market.
And we can get into it, but effectively there'sso much dry powder in those segments that we're
trying to play underneath that wave of drypowder.
And we're taking, yeah, we're taking theexecution risk of doubling or tripling the size
of a small business and graduating it up over acertain EBITDA threshold where the buyer
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universe opens up, the debt capacity opens up,debt pushes value, competition of capital
pushes value.
And that's where you get that multiple ARP.
Whether it's two times, three times or sevenand a half times, you can count on some level
of multiple ARP.
Now, upstream from the market that I've beentalking about is I would not define it.
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I think you have to separate size versuscapitalization.
You know, so we talked about the independentsponsor market.
That's really a capitalization lens to lookthrough.
So you have to a lot of times those folks arebuying middle market, upper middle market small
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market companies.
So you can't just say that independent sponsorsare buying smaller companies.
They're not, okay?
And then, of course, upstream from them is thesearch fund market.
And those break down into funded search orunfunded search.
And the funded search, know, you know,committed capital vehicles, you know, those
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folks typically going after larger companiesthan the unfunded search.
And we can run into those folks.
And I prefer the risk in the lower middlemarket to funded search because the team is
just far more resourceful and has a lot morevalue creation levers to pull because the
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portfolio tends to be more concentrated,whereas funded search, they're doing, they
could be doing, you know, two dozen deals.
It's hard for them to really add a lot of valueas say a GP.
The unfunded search, we can't touch it.
It's more just one off.
It's just some person that has found a companyand then they're passing the hat looking for
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capital.
We're not set up to invest in that opportunityset.
So back to your question on the independentsponsors, you know, of course, there's always
one off co investments to be made there.
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We have not done that.
And then, of course, now you see funds beingraised that would invest in independent sponsor
transactions, either one off, you know, sortof, you know, partner by partner or
programmatically where they're funding maybethree or four deals for the partner, preparing
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them to launch a fund, you know, at a latertime.
And, you know, we haven't had to consider thatbecause our performance has been sufficient.
I don't see any performance advantage right nowin pivoting our focus to that end of the
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market.
So you've chosen not to be in the middle marketand upper middle market private equity funds,
but as an endowment, you do have to bediversified.
How do you think about it from a portfolioconstruction side, not having exposure to that
part of the market?
Back in the old days, when we first launched,we were much more opportunistic than methodical
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in deploying our private equity.
And so there might've been years where we madeone investment or two investments in private
equity.
I personally don't think that's enough.
I think private equity is probably the bestbeta out of any asset class, if I'm defining
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beta as just the market return.
And so through cycle, you know, rolling fiveyear periods, rolling ten year periods, private
equity is the best performing asset class inour portfolio.
And I think it's probably the best in most.
And so I like to think that you wanna, when youhave a great beta like that, this is getting
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into portfolio construction, which you askabout, you want to make sure that you're
harvesting that beta.
And so if you're making one or two investments,the return dispersion within private equity and
venture is so wide that, you know, you might belucky enough to, you know, have participated in
a first quartile fund or you might haveparticipated in a fourth quartile fund.
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So in my view, four is kind of like the idealfour per year.
And I think a good range to think about isthree to six commitments per year.
And that's going to diversify you sufficientlyso that you're harvesting that return.
But through manager selection, you stand achance of outperforming the market.
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So you're adding the alpha.
So three to six funds per year, which may havehow many positions under?
My preference is for five to nine positions.
You know, in the old days, you'd see a lot ofthese groups, again, were, a lot of them were
multi sector.
And so they had, you know, teams working inconsumer and fin services and software and, you
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know, industrials, and they were all expectedto populate the portfolio.
So you'd see 12 to 15 positions.
I think the other thing that's changed is thecommitment period.
You know, in the legal docs, it's still fiveyears.
In the old days, people were using five years.
Today, they're not.
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I think it's shortsighted not to think in termsof like the value of the optionality that
you're given with the five year commitmentwindow, but you rarely see that today.
It's What's the typical deployment in lowermiddle investment?
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I don't think it's, I don't think it's toodifferent across a lot of other asset classes.
I think it's probably gravitated to closer tothree years and that, you know, that creates
its own vagaries because if you're a serialinvestor and you're trying to invest, you know,
we like to say arbitrarily where you would loveto get three funds out of a relationship.
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You know, I've been here twenty two years andwe still have a group that's in the portfolio
that we put in the year in which I joined.
So there's, you know, three serial funds isarbitrary, but you can imagine that if you're
on a three year cycle, by the time you get tofund two, more likely than not, there's been no
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realizations in fund one.
And by the time you get to fund three, youknow, maybe you've seen a few.
And so it puts a lot of pressure on the LP.
And so you have to start looking at thefundamentals at the portfolio company level and
you have to start to, you know, evaluate whatthe company has done in actuality along the
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lines of revenue, EBITDA margins versus whatthey underwrote for a company that might be,
you know, three, four, five years into its holdperiod if it hasn't, you know, been sold.
So you have to start looking at the fundamentalperformance.
And the investment period may be similar acrosslower middle market, middle market, and upper
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middle market.
What about where the value is from the GP side?
So we talked about you do less leverage and youhave more multiple arbitrage, but are the top
GPs, the top quartile GPs, are they topquartile pickers, negotiation, you know, all
that?
Or are they top quartile value add andoperational people?
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You know, like I think most investors, we werevery focused on, you know, operational value
add.
And I mean, really the quantitative metric isgrowth of cash flow.
And I'd throw in margin there, so revenuegrowth and margin.
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And so that's the ballast of the return.
And I think everybody is focused on that.
But back to the value bridge, I think what alot of people downplay, and you'll hear general
partners make comments like, well, you know, wedon't underwrite multiple expansion.
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And I think that's fine.
You know, that expresses a view ofconservatism, which I think is healthy.
But I think on the other side of that coin,it's also a illustration that they believe that
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multiple ARB is fleeting, meaning that it comesand goes over the course of a market cycle.
And I'd like to make a comment about that.
So when you look at the price at which themiddle market and the upper market are buying
companies, know, a high, it's not only is it ahigher, you know, sort of relative sort of
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multiple than the lower.
So if the lower middle market is down here, theupper middle market's up here.
But the other fascinating thing that you findabout that market characteristic is that
through time, the amplitude of the purchasemultiple in the upper markets, that amplitude
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swings more than the lower middle market.
The lower middle market is pretty steady.
You don't take a lot of market risk buyingsmall companies.
You know, the multiple might flux, you know,one turn over or under its historical trend
line, But you can see really massivefluctuation in the middle and the upper market.
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And the reason you see that is that there's alot more capital washing around that market as
represented by unfunded commitments.
And there's a lot more debt capacity.
You can put on a lot more leverage.
And as the interest rates fluctuate, you know,we came out of a really low interest rate
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environment up until a few years ago, thatreally pushed those multiples quite a bit
higher.
And then when those rates go up, you see themultiples, you know, come down because those
partners, know they can't get as much debt andthe debt isn't as accretive.
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So they got to make their return more, youknow, from a higher amount of equity.
And so they recognize they have to pay less forthat in order to get their return.
So that's another really interesting dynamicabout the lower versus the middle and upper
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market.
Upstream you have the interest rate.
The interest rate goes down.
Private equity managers are able to eitherraise, probably raise bigger funds and also pay
more because now less of that is equity andmore of it is debt.
So now that drives up pricing.
Is that a lagging indicator?
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In other words, if interest rates go down in2026, will it take a couple years for that to
flush out in the market?
Or is it more like an efficient market where itbasically the prices go up almost immediately?
The way that we get impacted in the smaller endof the market, it's not on the buy, it's on the
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sell.
So if our manager's done their job and they'vetripled the size of a company and they've
graduated up into this, you know, this higherrung of, you know, higher valuation segment
where all these middle market firms are, youknow, they're trying to find the best new
platform, right?
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Or they might even be trying to find an add onto a larger platform and and our platform
becomes their add on, right?
The way we get impacted is they might comeback, you know, if rates go up as they did,
this did happen to us, you know, rates shot upand that buyer came back to our partner and
(40:08):
said, Hey, you know, I can't get the debt Iused to get.
I can't pay as much.
You know, I'd have to re trade you and I wantto offer a smaller amount.
And, you know, our partner just pulled the dealand decided just to kind of wait it out to see
(40:29):
if things would improve.
And I think it happens pretty fast.
So if, I don't know, I'm not gonna be aprognosticator of where rates go, but if they
do go down, then I think you'll find peoplejust, you know, putting on more leverage.
(40:49):
Because the leverage essentially is on a dealby deal basis, not on the fund basis.
That's right.
Yeah.
Double clicking on that GP, on the ideal GP,the ideal GP avatar.
If you had to choose between somebody that wasreally good at picking and negotiating versus
(41:11):
somebody that was very good at operations,which one would you pick and why?
The way we've evolved, David, is, you know, Imentioned when buying performing high quality
companies, we come at it through a singlesector orientation.
So we're big believers in this.
(41:34):
In other words, they may do nothing butconsumer or fin services or gov services or
industrial or business services or healthcareservices.
So we have exposure to all those managers andwe're probably one to three deep in each of the
(41:55):
sectors.
You know, so the question is, why do we dothat?
We want the manager to have the best odds atbuying the highest quality companies at the
lowest possible price.
So we want their value proposition to theprospective portfolio company to be
(42:18):
overwhelming.
We want the portfolio company to meet with themanager and reflect on that meeting and come to
the conclusion that they don't even want to goon it.
A lot of times these sellers are wanting toroll equity and stay involved, take some chips
(42:38):
off the table.
But they do want to roll equity and they wantto stay involved.
And so they want to find the right partner togo on this journey with.
And so, you know, if we're talking about theindustrial sector, generally speaking, we want
our managing partners to come from not onlyinvestment backgrounds, but it's very common
(43:02):
that there is a former PE backed CEO involved.
And, you know, why is that important?
Well, it gets to exactly what you're talkingabout.
I'll come to value creation, but just stayingon the purchase opportunity for a moment, the
(43:23):
way you get to really strong returns is you buya company at a lower price than it is
prevailing in the market right now.
Okay.
So if that sector is trading here, you'rebuying at a turn low or whatever.
Then once you purchase it, you're you, youembark on your value creation initiative and
(43:47):
you grow cash flow.
And then you graduated up into this higher rungof capital that's willing to pay a higher
multiple.
So all those things come into play in producingyour return.
And I would just add one more thing.
You're professionalizing the company and you'reimproving the quality of the earnings.
(44:10):
And although that may not show upquantitatively in growing cash flow, it will in
the margin and it will absolutely result in ahigher multiple.
So all those things are important.
But back to single sector, you know, wantingoperating executives and investors on the team
(44:37):
and just sticking on that topic for a moment,you can just imagine if you're going to a
meeting with a potential seller who wants torule some equity in a sector like in
industrial, and your partner is a former PEbacked CEO that had three successful outcomes
(44:59):
in industrial, you know, he or she can sitacross from that owner and, you know, sort of
reminisce about their shared experience.
And ultimately, what you hope happens is, youknow, you have several factors that the
(45:21):
seller's considering when selling that company,Price being one, but, you know, you know,
potential partnership is another.
Terms might be another.
You know, I think about this as a key buyingcriteria.
It's a marketing term where, you know, ifyou're pitching your product to a customer that
(45:44):
that customer has, you know, four or fivecriteria that they're considering when deciding
to buy your product or service over another.
So, you know, hopefully, hopefully through thatkind of dynamic, you know, you're you're able
to persuade that that seller to deprioritizeprice amongst their criteria of selling the
(46:14):
company to the right partner.
And so that's how, you know, that's why it'simportant on the buy.
And that's the value that a single sector fundthat has operating capability sitting inside
the partnership brings to the table.
I gave you a false binary.
I said, do you want the lowest price or do youwant the most value add?
(46:38):
Your response was the most value add will leadto the lowest price and also lead to multiple.
You want the lowest price and you want thehighest value add.
There's a circular aspect to it in that thelowest price will also get you the highest the
highest return on highest absolute return on itas well.
(47:00):
So you might buy a $20,000,000 company for$15,000,000 because you have the value add and
because of the value add you could now increasethe value by 3x versus by 2x.
So you get this multiplicative.
A very excellent formula to think about is, youknow, to buy a company a half a turn or a turns
under the comp set that's prevailing in themarket, double the cash flow and sell it for
(47:27):
three turns higher, right?
And use modest leverage.
That's gonna lead to a very attractive outcomethat every private equity investor is gonna be
happy with.
And so that is, I think it's extremelyimportant for people to understand the value
drivers and how you generate a return and howmuch each of those value drivers can flex and
(47:53):
therefore how much they're contributing to thereturn.
And then you can start, you know, puttingtogether your diligence sort of process based
upon trying to answer those questions.
So let me try to break this model.
So let's say you have three operating partners,best in class operators, and you have either no
(48:16):
investment people or maybe some junior partnerthat has been at one of the top PE firms for
ten years.
Could that work?
Only operating GPPE fund work or does it alsobreak if you don't have enough investment
acumen?
I think it's helpful to have both.
You know, I think both backgrounds bring animmense amount of value to the table.
(48:44):
And I'm trying to think, so we have apartnership where there's three operators and
one investor and the investor's the juniorpartner.
We have another one with, you know, twooperators and one investor.
And then you see an awful lot where there's oneinvestor and one operator.
(49:05):
The investment acumen is important, you know,for a couple of reasons.
I would just say, generally speaking, fundmanagement, you know, portfolio construction,
governance.
You know, I think another really importantvalue they bring is capital allocation of
(49:30):
making, you know, because the operators, theycan dream up all kinds of value creation
initiatives to embark upon once you own thecompany.
But the best teams know that their time islimited and they need to prioritize those value
creation initiatives.
(49:52):
And there's no better way to do that than interms of thinking about return on time and
return on capital.
So that gets to capital allocation.
And generally speaking, the folks with theinvestment background are better at that, have
more experience at that.
(50:12):
Thank you for listening to join our communityand to make sure you do not miss any future
episodes please click the follow button aboveto subscribe.
Do you find that in the lower middle marketsince a lot of those companies are owned by the
original founder the family operator they tendto have more rapport with the operators versus
maybe if a private equity fund bought thecompany, they have more rapport with investor
(50:34):
types.
Is there something to that?
Absolutely.
Like there's no question.
I had a really interesting diligence call acouple of weeks ago with a seller and he was a
rolling equity.
So this was the founder of a small business inthe industrial space.
(50:57):
And you could tell this gentleman was extremelyreticent to sell to take on an equity
investment.
And it was a controlled transaction, but he wasrolling a very substantial amount of equity.
And you could tell that he had so much pride inhis business.
(51:18):
It was so important to him.
And he had kind of a chip on his shoulder andhe was a little wary of how much value the
private equity firm could offer him.
And he said repeatedly throughout the call, youknow, whether or not he thought they would add
any value.
(51:39):
But you, of course, you know that he hoped theywould add a lot of value, but I think it gets
back to the idea that he had a lot of pride.
It dawned on me during that call that thatcompany would never sell to the vast majority
of private equity firms, even though, you know,that company was for sale and it was
(52:01):
represented by a broker and anybody, you know,could have thrown in a bid.
Anybody could have potentially meted with themanagement team.
It dawned on me that the vast majority of themwould have no chance at any price to sell to
that gentleman.
(52:21):
So double click on that because I want to putnumbers on that.
So let's take it to the extreme.
Let's say it's a 100% sale of the company.
When founders found the company, have you everseen a founder take less money because they
thought the company would be in better hands?
Oh yeah.
I mean, that's almost the formula.
(52:41):
That's an emotional belief in what you've builtand wanting it to be in good hands.
So not a quote unquote rational decision.
So you're bringing up a very important point tomanaging risk.
You are very hopeful that your manager isn'tbuying 100% of the equity.
You know, you're, these are small, we haven'ttalked about the risks of small businesses,
(53:05):
but, you know, there's, there are risks.
And, you know, of course the founder of a smallbusiness is, is potentially very important,
particularly through a transition.
And so one way to manage your risk is not tobuy all the equity, but to make the transaction
(53:29):
very meaningful for the founder so they cantake some chips off the table and they have a
nice pool of capital that they can diversifytheir lifestyle with.
But they're rolling equity.
And, if the manager has done their jobcorrectly, they have shown, to the founder what
(53:57):
the potential is for them on that amount ofequity rolled.
And many times, the potential at the ultimatesale five years later can result in, you know,
a higher amount of capital flowing into thepocket of the founder than the initial
(54:17):
transaction amount that they take off thetable.
And so if that's the dynamic, then you canappreciate the importance of selecting the
right partner to go on that journey with,right?
That individual has to really trust the peopleinvolved and they have to buy into the business
(54:45):
plan, the value creation plan.
And if they don't, they're never gonna sell tothat partner.
What advice would you give to youngerprofessionals that are looking to get into
private equity and maybe this part of theprivate equity market, the lower middle market?
What's the best approach to to land in thatpart of the industry?
(55:07):
My answer is the same across all asset classes.
I think it's really important to, you know,just, you know, bring a lot of independent
thinking.
You know, the term gets overused, but firstprinciples, take a fresh look at asset class.
(55:30):
And I think immense value for investors andyoung people in particular to really get
familiar with the variables that are that aredriving the returns in the asset class.
So what are the what are the components thatare driving the returns?
(55:51):
There's no better way to do that than to builda model, an Excel model from scratch, you know?
So build a, I call it a J curve model.
It's really a fun model that, you know, you'dbuild it quarterly, you'd deploy it over five
years, you'd define some hold period.
You would add a variable that grows cash flowfrom entry over the course of the quarters in
(56:17):
the hold period.
You would make some assumption about whereyou're gonna sell that at on some EBITDA
multiple versus entry.
You'd add leverage to the model.
You'd add a waterfall.
And once you have all this, you can start playwith these variables and you can understand the
relative importance of each on the totalreturn.
(56:42):
And then once you're comfortable with that, youcan look at the dynamics of the asset class.
And in private equity, I personally think oneof the most interesting things is just where
all the dry powder sits.
And so if you look at this mountain of drypowder and you start stratifying it by fund
(57:03):
size, you'll find that it all sits above fundsthat are $500,000,000 and larger.
So that was the original basis for our strategyin the lower middle market is, hey, once you
strip out all that dry powder above500,000,000, you're basically left with this.
Like if you were to take like a fat tip blackFelty and just draw it on the zero line, that's
(57:30):
the dry powder in the lower middle market.
And then of course, there's far more targets inthe lower middle market than the large market
in terms of the number of portfolio companiesto buy.
So that was the basis of our original thesisis, Hey, like if we buy these small companies
(57:50):
that are trading at lower multiples and they'retrading at lower multiple because there's less
capital splashing around and we could take theexecution risk of double or tripling the size
and then selling them into this next tier ofcapital where all this capital is washing
around and where this debt capacity is higher,then you know that's a good formula.
(58:14):
You mentioned first principles.
I agree that's something that's overused.
One other way to say the same thing is top downthinking versus bottom up thinking.
Usually top down thinking you look at whateveryone's doing and you start asking why and
9095% of the time it makes sense.
It's an efficient market.
They're doing them.
(58:35):
They're doing things the way that they shouldbe done but sometimes five to 10% of the time
and it could be asymmetric that could be areally big opportunity they should they're just
following what everyone else has always doneand that's the wrong strategy and that's where
you could really generate alpha, which is justrisk free return or additional return that is
(58:59):
not commensurate with the risk, the definitionof alpha, so I think as an investor you could
use you could just keep on asking the questionwhy and why.
You can get some interesting answers and a lotthere's a lot of sacred cows in our industry
that nobody dares question why they're donebecause most of the time you have a question,
(59:19):
you have an answer and you look like an idiot,but sometimes you uncover something special.
This is absolutely true and you're spot on Andit makes me think of, I think, something else
that's important for me to say, particularly toyounger professionals.
You know, my team didn't wake up and just havethis epiphanyal moment and, you know, and just
(59:47):
sort of like envision this grand strategy thatthat we just hypothesized overnight.
It just doesn't work that way.
Right.
Like all, you know, this whole conversation iskind of capstone.
It's a capstone of ten years of effort.
Right?
And so hopefully you have some market insightinto one of the, like the very important basic
(01:00:14):
elements of market structure that is occurringin an asset class.
You know, for us that epiphanyl moment inprivate equity was where the dry powder sits.
In natural resources, it was, hey, you know,you're facing a real steep cost curve, so you
better be very low.
And then you just start pulling these threads.
(01:00:36):
And, you know, you're surrounded by reallysmart people that are contributing to these
conversations, and you're just iterating.
And you're pulling on these threads and you'redeveloping your, your, your, your strategy
evolves and you just put one step in front ofthe other, you know?
And, and, and in some cases it's two stepsforward and one step back, right?
(01:00:59):
Where you make a mistake, you make a mistake,right?
And then you course correct.
And then you take another step forward and thenyou ultimately end up with a really robust
strategy that, and I should say, well, I'll sayanother thing.
I'm not very tactical.
I used to think that it would be smart to getreally cute and, you know, make one or two
(01:01:27):
tactical investments per year.
Maybe do that, but I'm not trying to do that.
And that's very hard to do.
And so my point is that you want to think morestrategically.
And so you're hoping that whatever element ofthe market structure that you're focused on is
(01:01:49):
going to have some legs, right?
It's not going to be this fleeting six month orone year sort of trade, right?
I honestly believe, that we could be executing.
I mean, we've been executing this lower middlemarket strategy for ten years.
And if we don't get too big, you know, it'skind of damned if you do, damned if you don't.
(01:02:12):
You know, we want the endowment to be as largeas possible so we can have the biggest impact
to UCLA.
But on the other hand, you know, at some pointwe're gonna grow out of our ability to invest
in the most attractive segment of the market.
(01:02:32):
But I believe that we have some runway still,You know, back to, you know, young people and
young professionals, I would also say, youknow, really think about your personality and
your strengths and weaknesses.
And, you know, I happen to be a big believer inMyers Briggs.
(01:02:53):
And my younger years, I was never really thatfocused on, okay, what are my strengths and
weaknesses?
Today, I'm very attuned to what my strengthsand weaknesses are.
And I function better in private markets than Ispent my first ten years as a generalist.
(01:03:15):
So across the entire portfolio, public markets,hedge funds, etcetera, I am as a personality
type, much more better equipped to work inprivate markets.
And I would encourage people, you know, to, youknow, put one foot in front of the other, get
(01:03:38):
familiar with what drives returns, and thendevelop, you know, an approach.
And what comes with that development isconfidence.
And then with confidence, you're willing tokind of, you know, stretch the boundaries of
(01:03:58):
your strategy and your approach, and you'reable to take on a little bit more.
And then you're gonna find yourself, I think,in a spot where you can bring all that to bear
on behalf of your organization and really driveperformance.
(01:04:19):
Well, Michael, this has been an absolutemasterclass in the lower middle market.
Thanks for taking the time and look forward tocontinuing this conversation in person.
Thanks, David.
It's been my pleasure being with you.
Thanks for listening to my conversation.
If you enjoyed this episode, please share witha friend.
This helps us grow.
Also provides the very best feedback when wereview the episode's analytics.
Thank you for your support.
So tell me about how you came to be the deputyCIO at UCLA Investment Company.
(00:05):
It took all of twenty years or so.
I've been at UCLA twenty two years.
When I joined, we were a 400 to $500,000,000pool of capital.
We've grown about 10x over the course of mytime here, and that's after distributing to the
(00:28):
campus an amount that would equal three to fourtimes the capital base, which when I joined.
So it's been a rewarding experience.
Today, I spend most of my time in the privatemarkets and outside of my investment duties, I
(00:48):
get involved in asset allocation as well asworking on our annual spending policy.
So you were at the endowment when you launchedin 2011 and it became its own entity.
Tell me about how that launch happened.
In the wake of the great financial crisis, wehad sort of resurrected AUM just above a
(01:12):
billion dollars.
We were more than twice the size of when Ijoined.
The portfolio was also a lot more complexbecause we had pushed into alternatives.
And we wanted to pause at that point and askourselves what structure would serve us best
(01:33):
long term as we thought about growing theendowment from there.
And that's when we decided to set up a propermanagement company in 2011.
It's now been an independent management companyfor fourteen years.
How has the strategy evolved across thosefourteen years?
(01:54):
There were three of us at launch and now thereare 15 professionals.
So you can, as you can imagine, you can doquite a bit more with that level of resource.
We can just take a much more nuanced view ofasset class strategy.
(02:15):
And, you know, frankly, that's where I'd liketo focus a lot of our time today is on
formulation of asset class strategy, because Idon't think enough time is spent on that topic.
Famous pension fund study showed that 90%, ninezero of the returns were due to the portfolio
(02:36):
construction and only 10% to manager selection.
Do you think that still holds today?
I don't know about the percentages, but assetallocation absolutely drives the returns,
particularly in endowment land where the lessliquid pools of capital have outperformed over
(02:57):
long periods of time.
So here we're talking about asset allocation.
And then what I would say is the asset classstrategy is the next determinant of
performance, followed by manager selection.
There's three layers.
There's portfolio construction, asset classstrategy, and manager selection.
(03:22):
So let's talk about that middle layer.
What is asset class strategy?
We might use the lower middle market in privateequity to illustrate that.
But I would say that a lot of endowments,they'll arrive at some, you know, asset
(03:45):
allocation target, and then they'll just huntfor the best managers.
In my view, unless you're focused on the rightsegments within the asset class, you can be the
best manager selector in the world and yourperformance might be good, but it's gonna be
(04:05):
suboptimal.
So the pieces that's missing is the strategy.
You said something that I wanna double clickon.
So what does it mean to have good managerselection and bad asset allocation strategy?
Give me an example of that.
Well, you don't have a specific strategy andyou're not targeting particular segments within
(04:31):
an asset class, then you're just left withfinding the best managers available.
And so if you're hunting in the most prevalentsegments of the private equity market, say the
middle market and the upper market, there's alot of really bright people and great teams
(04:58):
that can, you know, talk a good story.
They can walk you through a very rational sortof model of how they invest.
And you're left, you know, thinking that, youknow, this is a high quality group.
They would be great stewards of our capital.
(05:22):
And then you select on that basis.
And my point is that you could end up with abunch of, you know, quote high quality firms,
you know, of competent people, but you're gonnabe exposed to the segments of the market that
(05:44):
they're investing in.
And those might offer good returns, but theymay not offer the best returns.
You mentioned private equity.
You have upper middle market, core middlemarket, lower middle market.
In venture you might have growth or pre IPO,traditional venture and then pre seed and seed
and it's before you even pick which manager,picking what part of that market makes most
(06:07):
sense as an overall portfolio strategy.
In my opinion, it's very important to do that.
And it's not just that there's a right or wronganswer, although you you probably argue in
private equity there is one.
There's also a portfolio construction questionwhich is what is your overall diversification
of your portfolio?
(06:28):
Perhaps there's tax strategy if you're just aregular high net worth investor, not an
endowment investor.
There's other factors beyond just taking theright answer.
You're certainly, you know, wanting to considerhow the strategy is gonna fit within the
overall context of your portfolio.
(06:49):
And, you know, as an endowment, it's a multiasset globally diversified portfolio.
And so you're really looking for private equityand venture, you know, to drive returns.
You're shooting for high returns.
Whereas in other asset classes, you might beseeking diversifiers or strategies that might
(07:11):
hedge against inflation, or in the case of cashand fixed income to provide liquidity to a
fairly illiquid pool of capital.
So yeah, all these asset classes have a role toplay and the role for private equity and
venture venture is to help increase returns.
So you love the lower middle market of PE.
(07:35):
Before we go into why, how do you define lowermiddle market?
What does that exactly mean?
This is a great question and there is noconsensus.
So you'll find people, you know, talking aboutsub billion dollar funds or, you know, sub, you
know, dollars 300,000,000 funds or you'll hearpeople talk in terms of EBITDA levels.
(08:03):
To be a little bit provocative, it doesn'treally matter in the end.
I guess it matters from the sense that a labelhelps one, know, talk about what's important
about the market.
But what I would say is it's much moreimportant to think about it philosophically and
(08:26):
what it means in terms of strategic value.
You know, allow me to kind of expand on thatpoint.
And so the easiest way for me to talk about itis in terms of EBITDA level.
So let's say I go out and I buy a $6,000,000EBITDA company for seven times.
(08:53):
So that's $42,000,000 of enterprise value.
And let's say I put two turns of leverage onit.
So two times 6,000,000 is 12.
So 40 two minuteus 12 is $30,000,000 of equity.
And let's say I make eight of those investmentsin the fund.
So now we're talking about $240,000,000.
(09:14):
So this is very typical of what we do.
Now, if I have one 8X outcome on 30,000,000 ofequity, I have now just returned the fund with
one investment.
And it just so happens that the preponderanceof those types of outcomes of that quantum
(09:38):
happen in smaller funds rather than largerfunds.
And the way you get into the top quartile inprivate equity is not by printing these steady
3X returns on all eight of your investments.
You have one or two large outcomes that drivethose returns.
(09:59):
And so the question is, you know, how arereturns generated?
And it's very important for us as investors tounderstand how returns are generated.
And so if you look at a value bridge and thatvalue bridge, you know, the drivers are cash
(10:21):
flow accretion, debt repayment, and multipleARB.
And so now if you really study each of thesethree variables that drive value, drive
performance, you begin to understand thedifference of the opportunity offered in the
lower middle market versus upper markets.
(10:42):
And of course, job number one is to drive cashflow.
We're all doing that.
We're all trying to do that.
And that's a big determinant of performance.
Debt's a bit different in the upper versus thelower market.
In the upper market, debt is very available.
A lot of these investments resemble leveragedbuyouts.
(11:04):
So you start with a lot of debt, and then youpay the debt down.
And as you pay the debt down, that's valueaccretive.
So it's a value driver.
In the lower middle market, you can't get muchdebt.
And if you're doing a buy and build and you'reacquiring small businesses and adding them to
your platform, you're typically increasing yourdebt over the hold.
(11:27):
So it's actually value destructive in the lowermarket.
But the single largest determinant of value orthe most distinguishing one when looking at the
upper versus the lower market is the thirdcharacteristic, which is multiple arbitrage,
(11:48):
valuation arbitrage.
And I would argue based upon my own experiencethat there is materially more value arb
opportunity offered in the lower middle marketthan the upper market.
We've been at this ten years.
Our own experience across our realizations,more than two dozen realizations out of one
(12:14):
hundred and one hundred and ten smallbusinesses in the portfolio, we've been able to
increase the multiple from entry to exit byseven and a half turns.
And that surprised us.
And we certainly don't forecast that we'll beable to generate that when we go from a couple
(12:40):
of dozen realizations to 100 realizations, butit does illustrate the quantum of value
accretion you can add in the lower middlemarket by buying at a lower valuation, growing
the company, and then serving it up to thatnext rung of capital that has a massive amount
(13:06):
of dry powder, unfunded commitments, where it'sfar more competitive and they're willing to pay
higher prices.
Unpack that seven and a half.
How much of that is due to increased cash flowor increased profits?
And how much of that is due to multiplearbitrage?
Yeah, so I want to be clear.
(13:26):
So when I talk about a seven and a half turnuplift from the entry valuation to the exit
valuation, we're only talking about multipleARB.
So not to be confused with like a multiple oninvested capital, right, which we can talk
about.
But those three variables, you know, cash flowaccretion, you know, you're hoping to add one
(13:52):
or two turns of MOIC, you know, through thatactivity, and you're hoping not to destroy too
much of that with the use of debt, right?
As I mentioned, the debt is typically going upfor us.
We've averaged about 2.9 times EBITDA ofleverage at entry, and that will tend to go up
(14:18):
a bit.
But it's rare that it would exceed four turnsof EBITDA at exit.
But that third component is pure valuationmultiple ARB.
For us, when we look across all the sectorsthat we invest in and we're single sector
(14:40):
investors for the most part, we blend in atbuying these companies at eight times and we
have sold them at 15 and a half times.
That's the seven and a half turn up with thatI, spoke about.
So in that example with 8x you're doubling themultiple of which you're selling them at.
(15:04):
Almost.
And then you also have the increase the one to2x increase from the cash flow and then you're
paying some of that is being paid back in debtand the leverage that you put on the deal.
That's exactly right.
And so to frame this in terms of MOIC, becauseI think people are, you know, interested.
(15:28):
I mean, ultimately people are going to select astrategy that hopefully delivers better
outcomes.
If you look at the private equity markethistorically, and I should qualify that I am
talking about, for the most part, controlequity and growth equity transactions.
(15:51):
I personally don't invest in venture.
We have another colleague that's far better atthat than I am.
So when I refer to private equity, it's reallycontrol equity and growth equity.
The broad market has historically delivered atwo and a half times gross MOIC at the deal
(16:15):
level.
So that's kind of the private equity market.
And we've been doing this for ten years andacross the realizations I spoke of, we've been
able to generate a return that is two turnshigher than the market.
So it's been a pretty compelling segment of themarket for us to focus on.
(16:43):
Basically, going from a two and a half averageto four and a half for UCLA is great
performance.
Why are there not more endowments like UCLAgoing into the lower middle market?
I think there are a lot of reasons.
At the end of the day, the stars have to alignin terms of the AUM you're managing, because
(17:08):
that dictates what kind of team you cansupport.
And you need a large enough team so that youcan devote sufficient time to develop a
specialization to a particular strategy, thisbeing one that we pursue.
(17:32):
And then on the other hand, if you write$50,000,000 checks and if you're worried about,
you know, being too large a percentage of thefund you're entering, then it becomes very
difficult to invest in small funds.
And if you reduce your fund check size, then itreally is not moving the needle for very large
(17:56):
endowments.
Then you're not putting money behind partnersand managers that have a very strong brand
recognition.
In many cases, you're meeting managers for thefirst time as you get to know them.
(18:19):
And therefore you need the right governanceframework.
And so it's extremely helpful if the team ismaking the decision on manager hires, as
opposed to say a board that you're reportingto.
And I'm very fortunate to have very strongsupport from my CIO, who appreciates the
(18:50):
performance potential that this strategyrepresents and believes we can manage the loss.
And that also holds true for our board.
And I would also add that we have a strongcapability in operational due diligence, which
is important when you are diligent managersthat really don't have a brand name.
(19:16):
And, you know, probably 12 of the 15 managerson our roster, entered at Fund One.
So there's very little in the way of trackrecord.
So for all these reasons, you know, size, youknow, governance model, and then, you know,
(19:38):
capability in terms of specialization and ODD,all this kind of factors in to what kind of
firm can focus on this end of the market.
And I think that's why you see less in the wayof, you know, institutions investing in this
(20:04):
part of the market.
And back to my earlier point, if you don'tformulate a strategy and you're just left with,
you know, know, quote selecting the like worldclass managers, you're not likely to focus on
this end of the market.
(20:26):
I believe that you always have to invest inhighly competent people and teams, but I don't
like to use words like world class or, youknow, rock stars or golden boys or girls or any
of this nomenclature that you hear frequentlytalked about when people are talking up a
(20:54):
manager.
So there's this paradox where you need somebodyhighly technical, very experienced in the
space, but also you can't be this megaendowment that has to invest billions and
billions of dollars in every strategy.
So you need almost this like Goldilocksendowment with precision asset allocation, also
(21:17):
a board and a governance that supports thisprecision like strategy.
That's fair.
At least that's how I approach it.
And you mentioned something that triggeredanother thought.
Just as important as, you know, pursuing thesespecific segments because you think they offer
higher potential, it does another veryimportant thing for the team, and that is it
(21:43):
allows you to completely ignore large swaths ofthe market.
And that's not only important to help us findthe better managers in the small market, but we
also have to manage a few other asset classes.
And so we have also developed pretty nuancedstrategies in those nuance, I'm sorry, those
(22:10):
asset classes, which help us ignore largeswaths of those markets, because time is the
most precious resource that an LP has.
Just given that most of the time these arefairly small teams managing large pools of
capital.
Presumably you're becoming more skilled inwhatever you spend time, effort and turns on.
(22:35):
So you're building your competency within thelower middle market versus if you were to
dilute it across all of private equity, youwould become a generalist across those
Absolutely.
That's true in spades.
I mean, we take it further and we invest in twostrategies within private equity.
(22:59):
If we're buying performing companies, highquality companies through our partners, we're
doing that through a single sector format.
And, you know, the other strategy we pursue isspecial situations.
And we sort of relax that single sectororientation because we want them to cast a
really broad net because it's more of a bottomsup hunting exercise.
(23:23):
But, you know, it's the lower middle market,then it's single sector or specialist sits.
So it gets very specific.
And that level of specialization allows you tohave a degree of pattern recognition whereby,
one, you're taking far fewer meetings, and thenthe meetings you're taking are highly
(23:47):
productive, and you're using that patternrecognition to diligence different aspects of
their activities and business.
And it just helps you.
It's a much more efficient exercise than havinga group come in that says, hey, by the way, you
know, we invest in these four or five privateequity sectors, you know, consumer, tech,
(24:16):
industrial, financial services.
It's very sort of discombobulating for me totake that kind of meeting today and spend
fifteen minutes on each of those sectors.
Don't find it very productive.
I would even further strengthen that in thatyour value as an LP to the GP is also your
(24:38):
focus and that you're able to see because youcould only invest in so many funds and managers
and so many managers, you have much morevaluable insights across your GPs that you
could share with your GPs versus if you werespread thin it'd be more difficult to bring
value as an LP?
It's very important.
Like, you know, it's important that anendowment team be the partner of choice with
(25:10):
the GPs that you're targeting.
And I think in their view, you know, the moreknowledgeable the LP is about their business,
the more likely that LP is gonna be able toride through the rough patches that are
invariably going to occur because we're allequity investors.
(25:33):
We're just taking lots of risk.
And so it's never sort of a straight line to a,you know, a three or four or five X outcome.
And so that intimacy with their business, Ithink makes us a better partner.
You mentioned you do a lot fund oneinvestments.
I've had TIFF and Inatai Foundation on thepodcast talking about they even go earlier.
(25:59):
They do independent sponsor deals.
Do you look at independent sponsor deals?
And what are your thoughts on?
Yeah, let me even back up further and helpflesh out this market and where it sits sort of
like downstream and upstream.
So we talked about what is downstream in termsof the middle market, the upper middle market,
(26:21):
the large market.
And we can get into it, but effectively there'sso much dry powder in those segments that we're
trying to play underneath that wave of drypowder.
And we're taking, yeah, we're taking theexecution risk of doubling or tripling the size
of a small business and graduating it up over acertain EBITDA threshold where the buyer
(26:48):
universe opens up, the debt capacity opens up,debt pushes value, competition of capital
pushes value.
And that's where you get that multiple ARP.
Whether it's two times, three times or sevenand a half times, you can count on some level
of multiple ARP.
Now, upstream from the market that I've beentalking about is I would not define it.
(27:14):
I think you have to separate size versuscapitalization.
You know, so we talked about the independentsponsor market.
That's really a capitalization lens to lookthrough.
So you have to a lot of times those folks arebuying middle market, upper middle market small
(27:38):
market companies.
So you can't just say that independent sponsorsare buying smaller companies.
They're not, okay?
And then, of course, upstream from them is thesearch fund market.
And those break down into funded search orunfunded search.
And the funded search, know, you know,committed capital vehicles, you know, those
(28:04):
folks typically going after larger companiesthan the unfunded search.
And we can run into those folks.
And I prefer the risk in the lower middlemarket to funded search because the team is
just far more resourceful and has a lot morevalue creation levers to pull because the
(28:28):
portfolio tends to be more concentrated,whereas funded search, they're doing, they
could be doing, you know, two dozen deals.
It's hard for them to really add a lot of valueas say a GP.
The unfunded search, we can't touch it.
It's more just one off.
It's just some person that has found a companyand then they're passing the hat looking for
(28:52):
capital.
We're not set up to invest in that opportunityset.
So back to your question on the independentsponsors, you know, of course, there's always
one off co investments to be made there.
(29:13):
We have not done that.
And then, of course, now you see funds beingraised that would invest in independent sponsor
transactions, either one off, you know, sortof, you know, partner by partner or
programmatically where they're funding maybethree or four deals for the partner, preparing
(29:35):
them to launch a fund, you know, at a latertime.
And, you know, we haven't had to consider thatbecause our performance has been sufficient.
I don't see any performance advantage right nowin pivoting our focus to that end of the
(29:58):
market.
So you've chosen not to be in the middle marketand upper middle market private equity funds,
but as an endowment, you do have to bediversified.
How do you think about it from a portfolioconstruction side, not having exposure to that
part of the market?
Back in the old days, when we first launched,we were much more opportunistic than methodical
(30:19):
in deploying our private equity.
And so there might've been years where we madeone investment or two investments in private
equity.
I personally don't think that's enough.
I think private equity is probably the bestbeta out of any asset class, if I'm defining
(30:40):
beta as just the market return.
And so through cycle, you know, rolling fiveyear periods, rolling ten year periods, private
equity is the best performing asset class inour portfolio.
And I think it's probably the best in most.
And so I like to think that you wanna, when youhave a great beta like that, this is getting
(31:08):
into portfolio construction, which you askabout, you want to make sure that you're
harvesting that beta.
And so if you're making one or two investments,the return dispersion within private equity and
venture is so wide that, you know, you might belucky enough to, you know, have participated in
a first quartile fund or you might haveparticipated in a fourth quartile fund.
(31:32):
So in my view, four is kind of like the idealfour per year.
And I think a good range to think about isthree to six commitments per year.
And that's going to diversify you sufficientlyso that you're harvesting that return.
But through manager selection, you stand achance of outperforming the market.
(31:57):
So you're adding the alpha.
So three to six funds per year, which may havehow many positions under?
My preference is for five to nine positions.
You know, in the old days, you'd see a lot ofthese groups, again, were, a lot of them were
multi sector.
And so they had, you know, teams working inconsumer and fin services and software and, you
(32:20):
know, industrials, and they were all expectedto populate the portfolio.
So you'd see 12 to 15 positions.
I think the other thing that's changed is thecommitment period.
You know, in the legal docs, it's still fiveyears.
In the old days, people were using five years.
Today, they're not.
(32:40):
I think it's shortsighted not to think in termsof like the value of the optionality that
you're given with the five year commitmentwindow, but you rarely see that today.
It's What's the typical deployment in lowermiddle investment?
(33:00):
I don't think it's, I don't think it's toodifferent across a lot of other asset classes.
I think it's probably gravitated to closer tothree years and that, you know, that creates
its own vagaries because if you're a serialinvestor and you're trying to invest, you know,
we like to say arbitrarily where you would loveto get three funds out of a relationship.
(33:26):
You know, I've been here twenty two years andwe still have a group that's in the portfolio
that we put in the year in which I joined.
So there's, you know, three serial funds isarbitrary, but you can imagine that if you're
on a three year cycle, by the time you get tofund two, more likely than not, there's been no
(33:50):
realizations in fund one.
And by the time you get to fund three, youknow, maybe you've seen a few.
And so it puts a lot of pressure on the LP.
And so you have to start looking at thefundamentals at the portfolio company level and
you have to start to, you know, evaluate whatthe company has done in actuality along the
(34:19):
lines of revenue, EBITDA margins versus whatthey underwrote for a company that might be,
you know, three, four, five years into its holdperiod if it hasn't, you know, been sold.
So you have to start looking at the fundamentalperformance.
And the investment period may be similar acrosslower middle market, middle market, and upper
(34:43):
middle market.
What about where the value is from the GP side?
So we talked about you do less leverage and youhave more multiple arbitrage, but are the top
GPs, the top quartile GPs, are they topquartile pickers, negotiation, you know, all
that?
Or are they top quartile value add andoperational people?
(35:06):
You know, like I think most investors, we werevery focused on, you know, operational value
add.
And I mean, really the quantitative metric isgrowth of cash flow.
And I'd throw in margin there, so revenuegrowth and margin.
(35:28):
And so that's the ballast of the return.
And I think everybody is focused on that.
But back to the value bridge, I think what alot of people downplay, and you'll hear general
partners make comments like, well, you know, wedon't underwrite multiple expansion.
(35:55):
And I think that's fine.
You know, that expresses a view ofconservatism, which I think is healthy.
But I think on the other side of that coin,it's also a illustration that they believe that
(36:19):
multiple ARB is fleeting, meaning that it comesand goes over the course of a market cycle.
And I'd like to make a comment about that.
So when you look at the price at which themiddle market and the upper market are buying
companies, know, a high, it's not only is it ahigher, you know, sort of relative sort of
(36:50):
multiple than the lower.
So if the lower middle market is down here, theupper middle market's up here.
But the other fascinating thing that you findabout that market characteristic is that
through time, the amplitude of the purchasemultiple in the upper markets, that amplitude
(37:13):
swings more than the lower middle market.
The lower middle market is pretty steady.
You don't take a lot of market risk buyingsmall companies.
You know, the multiple might flux, you know,one turn over or under its historical trend
line, But you can see really massivefluctuation in the middle and the upper market.
(37:36):
And the reason you see that is that there's alot more capital washing around that market as
represented by unfunded commitments.
And there's a lot more debt capacity.
You can put on a lot more leverage.
And as the interest rates fluctuate, you know,we came out of a really low interest rate
(37:59):
environment up until a few years ago, thatreally pushed those multiples quite a bit
higher.
And then when those rates go up, you see themultiples, you know, come down because those
partners, know they can't get as much debt andthe debt isn't as accretive.
(38:23):
So they got to make their return more, youknow, from a higher amount of equity.
And so they recognize they have to pay less forthat in order to get their return.
So that's another really interesting dynamicabout the lower versus the middle and upper
(38:44):
market.
Upstream you have the interest rate.
The interest rate goes down.
Private equity managers are able to eitherraise, probably raise bigger funds and also pay
more because now less of that is equity andmore of it is debt.
So now that drives up pricing.
Is that a lagging indicator?
(39:05):
In other words, if interest rates go down in2026, will it take a couple years for that to
flush out in the market?
Or is it more like an efficient market where itbasically the prices go up almost immediately?
The way that we get impacted in the smaller endof the market, it's not on the buy, it's on the
(39:26):
sell.
So if our manager's done their job and they'vetripled the size of a company and they've
graduated up into this, you know, this higherrung of, you know, higher valuation segment
where all these middle market firms are, youknow, they're trying to find the best new
platform, right?
(39:47):
Or they might even be trying to find an add onto a larger platform and and our platform
becomes their add on, right?
The way we get impacted is they might comeback, you know, if rates go up as they did,
this did happen to us, you know, rates shot upand that buyer came back to our partner and
(40:08):
said, Hey, you know, I can't get the debt Iused to get.
I can't pay as much.
You know, I'd have to re trade you and I wantto offer a smaller amount.
And, you know, our partner just pulled the dealand decided just to kind of wait it out to see
(40:29):
if things would improve.
And I think it happens pretty fast.
So if, I don't know, I'm not gonna be aprognosticator of where rates go, but if they
do go down, then I think you'll find peoplejust, you know, putting on more leverage.
(40:49):
Because the leverage essentially is on a dealby deal basis, not on the fund basis.
That's right.
Yeah.
Double clicking on that GP, on the ideal GP,the ideal GP avatar.
If you had to choose between somebody that wasreally good at picking and negotiating versus
(41:11):
somebody that was very good at operations,which one would you pick and why?
The way we've evolved, David, is, you know, Imentioned when buying performing high quality
companies, we come at it through a singlesector orientation.
So we're big believers in this.
(41:34):
In other words, they may do nothing butconsumer or fin services or gov services or
industrial or business services or healthcareservices.
So we have exposure to all those managers andwe're probably one to three deep in each of the
(41:55):
sectors.
You know, so the question is, why do we dothat?
We want the manager to have the best odds atbuying the highest quality companies at the
lowest possible price.
So we want their value proposition to theprospective portfolio company to be
(42:18):
overwhelming.
We want the portfolio company to meet with themanager and reflect on that meeting and come to
the conclusion that they don't even want to goon it.
A lot of times these sellers are wanting toroll equity and stay involved, take some chips
(42:38):
off the table.
But they do want to roll equity and they wantto stay involved.
And so they want to find the right partner togo on this journey with.
And so, you know, if we're talking about theindustrial sector, generally speaking, we want
our managing partners to come from not onlyinvestment backgrounds, but it's very common
(43:02):
that there is a former PE backed CEO involved.
And, you know, why is that important?
Well, it gets to exactly what you're talkingabout.
I'll come to value creation, but just stayingon the purchase opportunity for a moment, the
(43:23):
way you get to really strong returns is you buya company at a lower price than it is
prevailing in the market right now.
Okay.
So if that sector is trading here, you'rebuying at a turn low or whatever.
Then once you purchase it, you're you, youembark on your value creation initiative and
(43:47):
you grow cash flow.
And then you graduated up into this higher rungof capital that's willing to pay a higher
multiple.
So all those things come into play in producingyour return.
And I would just add one more thing.
You're professionalizing the company and you'reimproving the quality of the earnings.
(44:10):
And although that may not show upquantitatively in growing cash flow, it will in
the margin and it will absolutely result in ahigher multiple.
So all those things are important.
But back to single sector, you know, wantingoperating executives and investors on the team
(44:37):
and just sticking on that topic for a moment,you can just imagine if you're going to a
meeting with a potential seller who wants torule some equity in a sector like in
industrial, and your partner is a former PEbacked CEO that had three successful outcomes
(44:59):
in industrial, you know, he or she can sitacross from that owner and, you know, sort of
reminisce about their shared experience.
And ultimately, what you hope happens is, youknow, you have several factors that the
(45:21):
seller's considering when selling that company,Price being one, but, you know, you know,
potential partnership is another.
Terms might be another.
You know, I think about this as a key buyingcriteria.
It's a marketing term where, you know, ifyou're pitching your product to a customer that
(45:44):
that customer has, you know, four or fivecriteria that they're considering when deciding
to buy your product or service over another.
So, you know, hopefully, hopefully through thatkind of dynamic, you know, you're you're able
to persuade that that seller to deprioritizeprice amongst their criteria of selling the
(46:14):
company to the right partner.
And so that's how, you know, that's why it'simportant on the buy.
And that's the value that a single sector fundthat has operating capability sitting inside
the partnership brings to the table.
I gave you a false binary.
I said, do you want the lowest price or do youwant the most value add?
(46:38):
Your response was the most value add will leadto the lowest price and also lead to multiple.
You want the lowest price and you want thehighest value add.
There's a circular aspect to it in that thelowest price will also get you the highest the
highest return on highest absolute return on itas well.
(47:00):
So you might buy a $20,000,000 company for$15,000,000 because you have the value add and
because of the value add you could now increasethe value by 3x versus by 2x.
So you get this multiplicative.
A very excellent formula to think about is, youknow, to buy a company a half a turn or a turns
under the comp set that's prevailing in themarket, double the cash flow and sell it for
(47:27):
three turns higher, right?
And use modest leverage.
That's gonna lead to a very attractive outcomethat every private equity investor is gonna be
happy with.
And so that is, I think it's extremelyimportant for people to understand the value
drivers and how you generate a return and howmuch each of those value drivers can flex and
(47:53):
therefore how much they're contributing to thereturn.
And then you can start, you know, puttingtogether your diligence sort of process based
upon trying to answer those questions.
So let me try to break this model.
So let's say you have three operating partners,best in class operators, and you have either no
(48:16):
investment people or maybe some junior partnerthat has been at one of the top PE firms for
ten years.
Could that work?
Only operating GPPE fund work or does it alsobreak if you don't have enough investment
acumen?
I think it's helpful to have both.
You know, I think both backgrounds bring animmense amount of value to the table.
(48:44):
And I'm trying to think, so we have apartnership where there's three operators and
one investor and the investor's the juniorpartner.
We have another one with, you know, twooperators and one investor.
And then you see an awful lot where there's oneinvestor and one operator.
(49:05):
The investment acumen is important, you know,for a couple of reasons.
I would just say, generally speaking, fundmanagement, you know, portfolio construction,
governance.
You know, I think another really importantvalue they bring is capital allocation of
(49:30):
making, you know, because the operators, theycan dream up all kinds of value creation
initiatives to embark upon once you own thecompany.
But the best teams know that their time islimited and they need to prioritize those value
creation initiatives.
(49:52):
And there's no better way to do that than interms of thinking about return on time and
return on capital.
So that gets to capital allocation.
And generally speaking, the folks with theinvestment background are better at that, have
more experience at that.
(50:12):
Thank you for listening to join our communityand to make sure you do not miss any future
episodes please click the follow button aboveto subscribe.
Do you find that in the lower middle marketsince a lot of those companies are owned by the
original founder the family operator they tendto have more rapport with the operators versus
maybe if a private equity fund bought thecompany, they have more rapport with investor
(50:34):
types.
Is there something to that?
Absolutely.
Like there's no question.
I had a really interesting diligence call acouple of weeks ago with a seller and he was a
rolling equity.
So this was the founder of a small business inthe industrial space.
(50:57):
And you could tell this gentleman was extremelyreticent to sell to take on an equity
investment.
And it was a controlled transaction, but he wasrolling a very substantial amount of equity.
And you could tell that he had so much pride inhis business.
(51:18):
It was so important to him.
And he had kind of a chip on his shoulder andhe was a little wary of how much value the
private equity firm could offer him.
And he said repeatedly throughout the call, youknow, whether or not he thought they would add
any value.
(51:39):
But you, of course, you know that he hoped theywould add a lot of value, but I think it gets
back to the idea that he had a lot of pride.
It dawned on me during that call that thatcompany would never sell to the vast majority
of private equity firms, even though, you know,that company was for sale and it was
(52:01):
represented by a broker and anybody, you know,could have thrown in a bid.
Anybody could have potentially meted with themanagement team.
It dawned on me that the vast majority of themwould have no chance at any price to sell to
that gentleman.
(52:21):
So double click on that because I want to putnumbers on that.
So let's take it to the extreme.
Let's say it's a 100% sale of the company.
When founders found the company, have you everseen a founder take less money because they
thought the company would be in better hands?
Oh yeah.
I mean, that's almost the formula.
(52:41):
That's an emotional belief in what you've builtand wanting it to be in good hands.
So not a quote unquote rational decision.
So you're bringing up a very important point tomanaging risk.
You are very hopeful that your manager isn'tbuying 100% of the equity.
You know, you're, these are small, we haven'ttalked about the risks of small businesses,
(53:05):
but, you know, there's, there are risks.
And, you know, of course the founder of a smallbusiness is, is potentially very important,
particularly through a transition.
And so one way to manage your risk is not tobuy all the equity, but to make the transaction
(53:29):
very meaningful for the founder so they cantake some chips off the table and they have a
nice pool of capital that they can diversifytheir lifestyle with.
But they're rolling equity.
And, if the manager has done their jobcorrectly, they have shown, to the founder what
(53:57):
the potential is for them on that amount ofequity rolled.
And many times, the potential at the ultimatesale five years later can result in, you know,
a higher amount of capital flowing into thepocket of the founder than the initial
(54:17):
transaction amount that they take off thetable.
And so if that's the dynamic, then you canappreciate the importance of selecting the
right partner to go on that journey with,right?
That individual has to really trust the peopleinvolved and they have to buy into the business
(54:45):
plan, the value creation plan.
And if they don't, they're never gonna sell tothat partner.
What advice would you give to youngerprofessionals that are looking to get into
private equity and maybe this part of theprivate equity market, the lower middle market?
What's the best approach to to land in thatpart of the industry?
(55:07):
My answer is the same across all asset classes.
I think it's really important to, you know,just, you know, bring a lot of independent
thinking.
You know, the term gets overused, but firstprinciples, take a fresh look at asset class.
(55:30):
And I think immense value for investors andyoung people in particular to really get
familiar with the variables that are that aredriving the returns in the asset class.
So what are the what are the components thatare driving the returns?
(55:51):
There's no better way to do that than to builda model, an Excel model from scratch, you know?
So build a, I call it a J curve model.
It's really a fun model that, you know, you'dbuild it quarterly, you'd deploy it over five
years, you'd define some hold period.
You would add a variable that grows cash flowfrom entry over the course of the quarters in
(56:17):
the hold period.
You would make some assumption about whereyou're gonna sell that at on some EBITDA
multiple versus entry.
You'd add leverage to the model.
You'd add a waterfall.
And once you have all this, you can start playwith these variables and you can understand the
relative importance of each on the totalreturn.
(56:42):
And then once you're comfortable with that, youcan look at the dynamics of the asset class.
And in private equity, I personally think oneof the most interesting things is just where
all the dry powder sits.
And so if you look at this mountain of drypowder and you start stratifying it by fund
(57:03):
size, you'll find that it all sits above fundsthat are $500,000,000 and larger.
So that was the original basis for our strategyin the lower middle market is, hey, once you
strip out all that dry powder above500,000,000, you're basically left with this.
Like if you were to take like a fat tip blackFelty and just draw it on the zero line, that's
(57:30):
the dry powder in the lower middle market.
And then of course, there's far more targets inthe lower middle market than the large market
in terms of the number of portfolio companiesto buy.
So that was the basis of our original thesisis, Hey, like if we buy these small companies
(57:50):
that are trading at lower multiples and they'retrading at lower multiple because there's less
capital splashing around and we could take theexecution risk of double or tripling the size
and then selling them into this next tier ofcapital where all this capital is washing
around and where this debt capacity is higher,then you know that's a good formula.
(58:14):
You mentioned first principles.
I agree that's something that's overused.
One other way to say the same thing is top downthinking versus bottom up thinking.
Usually top down thinking you look at whateveryone's doing and you start asking why and
9095% of the time it makes sense.
It's an efficient market.
They're doing them.
(58:35):
They're doing things the way that they shouldbe done but sometimes five to 10% of the time
and it could be asymmetric that could be areally big opportunity they should they're just
following what everyone else has always doneand that's the wrong strategy and that's where
you could really generate alpha, which is justrisk free return or additional return that is
(58:59):
not commensurate with the risk, the definitionof alpha, so I think as an investor you could
use you could just keep on asking the questionwhy and why.
You can get some interesting answers and a lotthere's a lot of sacred cows in our industry
that nobody dares question why they're donebecause most of the time you have a question,
(59:19):
you have an answer and you look like an idiot,but sometimes you uncover something special.
This is absolutely true and you're spot on Andit makes me think of, I think, something else
that's important for me to say, particularly toyounger professionals.
You know, my team didn't wake up and just havethis epiphanyal moment and, you know, and just
(59:47):
sort of like envision this grand strategy thatthat we just hypothesized overnight.
It just doesn't work that way.
Right.
Like all, you know, this whole conversation iskind of capstone.
It's a capstone of ten years of effort.
Right?
And so hopefully you have some market insightinto one of the, like the very important basic
(01:00:14):
elements of market structure that is occurringin an asset class.
You know, for us that epiphanyl moment inprivate equity was where the dry powder sits.
In natural resources, it was, hey, you know,you're facing a real steep cost curve, so you
better be very low.
And then you just start pulling these threads.
(01:00:36):
And, you know, you're surrounded by reallysmart people that are contributing to these
conversations, and you're just iterating.
And you're pulling on these threads and you'redeveloping your, your, your, your strategy
evolves and you just put one step in front ofthe other, you know?
And, and, and in some cases it's two stepsforward and one step back, right?
(01:00:59):
Where you make a mistake, you make a mistake,right?
And then you course correct.
And then you take another step forward and thenyou ultimately end up with a really robust
strategy that, and I should say, well, I'll sayanother thing.
I'm not very tactical.
I used to think that it would be smart to getreally cute and, you know, make one or two
(01:01:27):
tactical investments per year.
Maybe do that, but I'm not trying to do that.
And that's very hard to do.
And so my point is that you want to think morestrategically.
And so you're hoping that whatever element ofthe market structure that you're focused on is
(01:01:49):
going to have some legs, right?
It's not going to be this fleeting six month orone year sort of trade, right?
I honestly believe, that we could be executing.
I mean, we've been executing this lower middlemarket strategy for ten years.
And if we don't get too big, you know, it'skind of damned if you do, damned if you don't.
(01:02:12):
You know, we want the endowment to be as largeas possible so we can have the biggest impact
to UCLA.
But on the other hand, you know, at some pointwe're gonna grow out of our ability to invest
in the most attractive segment of the market.
(01:02:32):
But I believe that we have some runway still,You know, back to, you know, young people and
young professionals, I would also say, youknow, really think about your personality and
your strengths and weaknesses.
And, you know, I happen to be a big believer inMyers Briggs.
(01:02:53):
And my younger years, I was never really thatfocused on, okay, what are my strengths and
weaknesses?
Today, I'm very attuned to what my strengthsand weaknesses are.
And I function better in private markets than Ispent my first ten years as a generalist.
(01:03:15):
So across the entire portfolio, public markets,hedge funds, etcetera, I am as a personality
type, much more better equipped to work inprivate markets.
And I would encourage people, you know, to, youknow, put one foot in front of the other, get
(01:03:38):
familiar with what drives returns, and thendevelop, you know, an approach.
And what comes with that development isconfidence.
And then with confidence, you're willing tokind of, you know, stretch the boundaries of
(01:03:58):
your strategy and your approach, and you'reable to take on a little bit more.
And then you're gonna find yourself, I think,in a spot where you can bring all that to bear
on behalf of your organization and really driveperformance.
(01:04:19):
Well, Michael, this has been an absolutemasterclass in the lower middle market.
Thanks for taking the time and look forward tocontinuing this conversation in person.
Thanks, David.
It's been my pleasure being with you.
Thanks for listening to my conversation.
If you enjoyed this episode, please share witha friend.
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