How do we build our Venture Portfolio? | AWM Insights #155
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Episode Summary
Private Markets, and specifically, Venture Capital, appeal to investors as they offer outsized returns for those that can accept illiquidity and risk. After we work through those factors for a client and build a dependable financial structure, how do we invest to maximize your opportunity for success?
We are always present in the Private Markets, meeting with fund managers and business operators to identify the best opportunities and stay top of mind for future ventures. Our annual fund structure, presence, and persistence keep us relevant.
There are also segments of the Private Markets that have tactical advantages that we leverage. Known and successful operators have access to the best deals, smaller funds are more agile and can snap up opportunities quickly, and earlier-stage companies give us better entry valuations and hopefully longer runways for capital appreciation.
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Episode Highlights:
0:00 Intro
0:55 Our systematic approach to investing in Private Markets
3:10 Applying our methodology
5:20 How do we build our Venture Portfolio?
8:10 What factors do we look for and how do we structure our fund?
9:51 Text us!
+ Read the Transcript
Brandon Averill (00:02): All right, Justin, part three of our little Venture series here. Obviously in that first episode we really got, hopefully got everybody pretty excited about the opportunity that Venture private investing in general really provides. And then part two, we went through, hey, this is so exciting and makes so much sense. Why doesn't everybody do it? Kind of walk through a couple of the main criteria why we think, hey, this should give you a little bit of pause. And then we talked about or set up this part three episode is, okay, great, I'm super excited about it. I think that it definitely belongs in my portfolio. I've overcome the potential reasons why I wouldn't do it, liquidity, resources, access, and I'm ready to actually participate. And so when we get there with clients that are listening and we start to build out the Venture part of their portfolio, I'd love to just walk through how systematic we are, how we think about it, how we go about it. Maybe get into a little bit of why we think that's so important.
Justin Dyer (01:07): So even starting with the portfolio itself and the custom nature, let's go there and then build. And we hit on it in the last episode and we've touched on the customized way in which we build portfolios. But if you check all these boxes, how do we start to identify what amount? The starting place is basically a 10% floor of your portfolio. And then if there's substantial projected excess resources for the next generation, that's kind of the ceiling. And then depending on your unique circumstances, maybe it could be somewhere in between. But then once we figure out what that target actually is, to your question, we know based on history, based on data that there's cycles within markets in general. But certainly that's the case within Venture as well. And really what that means is there's going to be good years and there's going to be bad years.
(02:04): The amazing returns and the numbers that we threw out in the first episode of this series doesn't happen each and every year. It's not just this nice linear relationship. And so we want to make sure we're systematic and really, what that term means is it's repeatable. We're getting access year in and year out so we have a higher expectation, a better likelihood, higher probability, whatever phrase you want to use to see that higher expected return over long periods of time. What that actually means in practice for us is taking your target, your unique specific target to Venture and saying, "Hey, we want to build this into a repeatable process. We're not just going to take that entire mountain and put it into a fund this year", and then we'll wait until the liquidity comes back. Whenever that is down the road, potentially 10 years as we've talked about. We say, well let, let's participate over a minimum of five years.
(03:02): So we hopefully get a recycling effect at some point in time through this program. And then you're participating not only over the next five years, but then year six, you're seven, year, eight, you're nine, and then it just kind of feeds on itself and becomes this really, really nice systematic process to capture those higher expected returns that we've talked about.
Brandon Averill (03:25): I think that's really helpful, and maybe even for people listening to put some numbers to it, and I'll keep it pretty simple, but let's assume that we have a new client that comes in to keep it really simple and they've got 20 million and no access or no allocation to Venture in their portfolio, how we would think about that is, okay, 20 million dollars. Let's assume that you're not going to earn a whole lot beyond this. Our starting point's going to be about a two million dollar allocation. And assuming that this client doesn't have the priorities that build up to much more than say 10 or 15 million dollars of need for those resources in their lifetime, then we're going to implement that. We're going to take that two million dollars. And I think, well, I know what you're saying is we're not going to take that two million dollars and plop it in the [inaudible 00:04:17] market this year, right?
(04:18): We're going to take it and say, okay, over the next five years, so we're going to do 400,000 this year, 400,000 next year, and so on until we get to that two million dollars. And then where we might violate it is we've got a client with a hundred million dollars. And let's say their total need of those resources in their lifetime is 40 million dollars. We have this excess resource bucket up 60 million. So what we're talking about is, okay, great, how do we steward that 60 million in the best way possible for the next generation? It probably means that we should go above that 10% floor in Venture. So we may double that to 20 or 25% potentially once the client really has a great understanding of how we go about this. Is that accurate kind of benchmarking?
Justin Dyer (05:05): That's spot on. That's 100% correct. And every single client's unique. You could even see a hundred million dollar clients with differing approaches, but you're spot on. We want to customize everything to their situation.
Brandon Averill (05:18): So building on that a little bit, okay, we've got this allocation, we're participating over five vintages. Maybe talk a little bit about are we investing the exact same funds and same opportunities year in and year out, or how do you think about actually building that portfolio each year as we go along?
Justin Dyer (05:39): So I'll start high level on our general philosophy with respect to Ventures specifically, there's the art of Venture. I've talked about it being a craft and really it being a relationship driven endeavor for the most part, the skill in which a manager has the repeatability of that skill. These are all more of the qualitative side of Venture, the art, if you will. And then there's the pure science, the data. When you take everything together within Venture capital, what does the data actually tell us? Well, outliers can be random. It does follow something called a power law distribution. And then even more granularly, what type of funds outperform, what size of funds outperform? And when you put all that together, well, first of all, there is persistence within manager's skill. So we want to get access to the best. That goes back to access and repeatable access to the top tier. There's evidence that they will continue to win.
(06:45): But on the science side of things, when you look at the data, you see the earlier stage funds actually outperform and smaller funds outperform. They're more nimble, they're arguably taking on more risk, but you're getting a higher expected return as a result. To your question, specifically because of the nature of how funds actually deploy capital and when they fundraise, that doesn't happen each and every year. There isn't this marketplace that I get to go to and say, "I want to buy the same five funds each and every year." That's just not how Venture or private markets at large work. So we have a platform of our relationships, of our preferred funds. They're all raising on different schedules. And that's actually a good thing. I don't mind that because what it gives us, not only are we talking about what's called vintage year diversification when we talk about deploying over a five year cycle, but we also want manager diversification as well.
(07:39): And there's just the inherent need for that because of when funds are raising we would probably do that by design anyway. So our vehicles, our annual funds are investing in different managers each and every year. The idea is that these managers are outperforming, and when they come back to raise, we are going to participate with them again. So there is some repeatability, but it's going to be staggered out over many, many years. But the underlying focus is going to be a majority deployed into early stage smaller Venture funds with top tier managers. And then the rounded out piece of it will be a little bit later stage to give a little bit more, let's say, predictability to the fund and also shorter term liquidity needs.
Brandon Averill (08:27): And I think that's important for clients to understand is it's a huge advantage to be in market all the time. And you get to have access to the best opportunities when they do make themselves available. And most of these underlying funds, they fundraise on a two to three year cycle. They raise a bunch of money, they deploy it, they go invest in companies, they're out of money. They got to go raise their next fund to do it the next time around. So what it allows us to do is by being in market all the time, we see everything. And if we were raising, were doing that every two to three years, there'd be this kind of trying to line up the opportunities. And I think you would find yourself being extremely product driven like we had in previous sessions. But you know what this allows is for the development of relationships.
(09:20): And people know that, hey, AWM Ventures is there. They're always willing to write checks if the opportunity presents itself. So guess what? Guess who gets the calls? They're going to call us because they know that we have the capital to deploy. And it's why you meet with, specifically meet with so many different fund managers year in and year out and do the due diligence on them because we never know when the opportunity might exist to take advantage of that for you guys that are listening.
(09:47): So hopefully this gave you a little bit of a flavor for how we actually systematically think about your allocations to Venture. And maybe we'll get into in future episodes a little bit about, Hey, when we actually go to look at a specific fund, I think it'd be fun to hear just your process, Justin, for, "Hey, we just got this introduction via somebody that we trust and we got our first meeting." It would be interesting for you to kind of break down, hey, what are we looking for? How long does that cycle take? How quickly can you get comfortable? All those different types of things and really talk more specifics about how we go about making the investments. And then I think also portfolio construction would be good to focus on and future episode, how many funds do we put in, how do we look at that, et cetera. But for today, we'll wrap up and as always, own your wealth, make an impact, and always be a pro.