David Morehead – Top Down Allocation at Baylor (EP.381)

Episode Summary

Executive Summary: Baylor CIO David Moorhead explains his contrarian, top-down endowment approach: prioritize downside protection, use liquidity to shift capital across regimes, and rely on managers as implementation partners. He contrasts endowment styles, details his manager-selection process, and argues that portfolio structure, valuation lag, and cash-flow discipline matter more than rigid asset-class labels.

Main Topics: Moorhead’s career path and Baylor’s fit (Priority: 5/5): He moved across fixed income, derivatives, equities, hedge funds, and energy, which gave him broad market fluency and led him to Baylor partly for work-life balance and proximity to family/community values. Three models of endowment management (Priority: 5/5): He outlines three approaches: diversified manager selection, direct/co-investment dealmaking, and Baylor’s top-down regime-based allocation that follows market conditions rather than fixed weights. Top-down, contrarian allocation framework (Priority: 5/5): Baylor allocates based on cyclical signals like spreads, volatility, and opportunity cost, scaling into dislocated areas and keeping dry powder for larger drawdowns. Risk management and portfolio construction (Priority: 5/5): The portfolio starts with downside protection, quality exposure, and stress awareness; the team accepts relative underperformance in euphoric markets if it helps protect capital in crashes. Private markets philosophy (Priority: 4/5): Private allocations are driven more by secular growth and valuation-lag considerations than by blind diversification; cyclical exposures are often better handled publicly where they can be traded. Manager selection, culture, and turnover (Priority: 4/5): He emphasizes humility, flexibility, stability, and family fit in manager diligence, and says turnover is often driven by portfolio redesign rather than manager failure. Scaling the institution and team development (Priority: 3/5): Moorhead discusses learning from larger endowments, building funds of one, and gradually delegating responsibility to a younger team while maintaining accountability.

Key Arguments: Endowment management is less about broad asset-class labels and more about liquidity, regime awareness, and the ability to reallocate when conditions change. A top-down framework can outperform by leaning into dislocations such as wide credit spreads, low volatility, or beaten-down sectors that are unlikely to disappear. Downside protection is central because Baylor’s mission depends on preserving and growing distributions for students, faculty, and programs. Quality matters because in existential or valuation-driven selloffs, strong businesses tend to survive and preserve capital better than lower-quality exposures. Private markets should emphasize secular growers, because long lockups make cyclical sectors dangerous when timing is uncertain. Manager relationships should be explicit partnerships; Baylor is willing to withdraw capital when managers are hot and add when others are exiting, with advance notice. Humility is essential in managers because the right answer is only known a little more than half the time; insecurity is a hidden organizational risk. Portfolio turnover is often healthy when it reflects improved structure or better use of capital rather than dissatisfaction with managers. Cash is not a failure of deployment if the opportunity cost of investing is unattractive; waiting can be rational. Baylor increasingly sees concentration, funds of one, and selective exposure as ways to offset the downside-heavy tilt without sacrificing discipline.

Data Points: Baylor endowment size: $2.2 billion - Current size of the endowment David Moorhead oversees Career length before Baylor: 18 years - Time Moorhead spent in investing before joining Baylor Time at Baylor: 13 years - How long he has served as CIO at Baylor Industry style share: ~70% - His estimate of endowments that try to win by manager selection rather than market timing Diversified endowment outperformance: 200 to 300 basis points per year - His estimate of the excess return diversified manager-selection endowments can generate over the benchmark Deal/co-investment style share: ~15% - His estimate of endowments pursuing bottoms-up deal-driven approaches Credit spread example: 300 over - Current-ish high-yield spread level at which Baylor would likely avoid high yield Credit spread stress example: 2000 over - Spread level in 2008 that would make Baylor likely participate in high yield Market move framework: 10% increments - Baylor stages capital deployment by 10 percentage point market moves Large drawdown add points: 20%, 30%, 40% - They want capital available to add at each deeper decline Potential return opportunity: 20% annualized - Target return level used to assess opportunity cost over a multi-year horizon Opportunity cost hurdle: 5% per year - Illustrative cost of capital used in decision-making when treasuries yield around that level 2019 cash and vol holdings: $100 million cash and $80 million long vol - Held because attractive opportunities were scarce Private/public sizing heuristic: ~50-50 - Moorhead’s evolving view of a balanced public/private mix for Baylor’s size Equity names in portfolio: 750 individual names - Example of how much hidden diversification existed before a shift toward concentration Manager allocation range: $250,000 to $100 million - Range Baylor may allocate to individual managers depending on conviction and strategy Baylor team size: 5 investors - Moorhead plus four other investors across private and public work Question on learning from larger peers: $20 billion / $40 billion - He says he does not know how to run a $20 billion portfolio and wants to learn from larger peers such as those around $40 billion Facility/property example: $5 billion - Scale of property/plant/equipment at a very large university endowment example used to explain private capacity

Pivotal Quotes: "We start with the perspective of how do we avoid big downside events? And then we construct the portfolio from there." — David Moorhead: Explaining Baylor’s risk-first portfolio construction philosophy "The categories are just communication devices. You can't really boil a portfolio like we're all running into four headers and have it accurately describe what's going on." — David Moorhead: On why internal portfolio analysis goes far beyond standard endowment buckets "We don't come at it and say over a long period of time, high yield has done well versus equities versus whatever on a risk adjusted basis. And so we're going to have 6% allocated to high yield at all times." — David Moorhead: Describing Baylor’s contrarian, regime-based allocation approach

Implications: Listeners should view endowment investing as a dynamic risk-and-liquidity exercise, not a static allocation game. The episode suggests larger value comes from discipline, selective concentration, and manager partnership than from rigid diversification.