E91: How Elite Endowments Invest in 2024

Episode Summary

Executive Summary: Baylor’s endowment team explains a disciplined, contrarian allocation approach built around a permanent 55/45 public-private split, strong liquidity management, and concentrated bets in only the private strategies they believe can clear a 15% net return hurdle. They favor smaller, earlier venture funds, spin-outs, and concentrated managers, using size, governance, and GP relationships to outperform larger peers.

Main Topics: Endowment asset allocation framework (Priority: 5/5): Baylor manages a roughly permanent 55/45 public-to-private mix, guided by an annual allocation budget and a clear return threshold rather than short-term macro timing. Why Baylor invests heavily in privates (Priority: 5/5): The private book grew as legacy positions were cleaned up, liquidity improved, and the portfolio became self-funding, allowing more capital to be allocated to higher-return private opportunities. Return hurdle and asset selection (Priority: 5/5): Baylor only allocates to private categories that can plausibly exceed a 15% net return hurdle, favoring sectors with secular tailwinds such as enterprise software and healthcare. Liquidity, IRR, and duration trade-offs (Priority: 4/5): The team distinguishes among shades of liquidity and evaluates venture and buyout strategies by both IRR and MOIC, arguing that duration and opportunity cost matter to institutions. Venture capital strategy (Priority: 5/5): Baylor prefers smaller venture funds, fund one-to-three managers, and high-conviction teams, believing this structure improves alignment, loyalty, and probability of outsized outcomes. GP diligence and relationship model (Priority: 4/5): The team emphasizes deep qualitative diligence, including many references, personal references, and ongoing feedback loops with GPs, portfolio companies, and spin-out teams. Institutional advantages and mission alignment (Priority: 4/5): Baylor believes its smaller size, Waco location, governance, and Baylor-affiliated team provide nimbleness, contrarian thinking, and strong mission alignment with the university.

Key Arguments: The 55/45 public-private split is treated as a durable strategic choice, not a macro-tactical trade. Private equity is justified only when expected returns exceed the illiquidity cost and opportunity cost of being unable to rotate into public dislocations. Baylor’s private portfolio grew because legacy positions were sold and the book matured into a self-funding structure, reducing liquidity strain from capital calls and endowment spending. The firm does not seek diversification within private equity for its own sake; it seeks return-rich pockets within the overall portfolio and uses public markets for diversification trades. Venture is evaluated as a long-duration asset where MOIC and IRR must both be considered; a faster 2x can outperform a slower 3x over time due to recycling and compounding. Smaller venture funds and spin-outs can offer better alignment, stronger motivation, and higher-return potential than larger platform funds. Concentrated managers are preferred because Baylor wants GPs with conviction and believes over-diversification can dilute returns and attention. Extensive qualitative diligence, including references from friends, neighbors, and long-term contacts, is used to assess character, culture, and succession potential. Baylor uses its board and governance structure as an advantage, enabling faster execution and better decision-making than larger institutions. The endowment’s relative size and location let it be nimble, contrarian, and less exposed to social/information pressure from coastal investor networks.

Data Points: Endowment size: $2 billion - Baylor University endowment at a high level Portfolio split: 55/45 - Approximate public/private allocation today In-house investment professionals: 5 - Number of internal investment staff Private allocation target: 45% to 50% - Desired private-investment range within the overall portfolio Net return hurdle: 15% - Minimum return Baylor seeks before committing to private strategies Endowment spend rate: 5% - Annual spending sent back to the university for scholarships Public equity return assumption: 6% - Used in Baylor’s private-equity return hurdle math Required private premium: 350 basis points - Premium above public equities Baylor wants from private investments Opportunity cost assumption: 5% per annum - Added to account for foregone public-market opportunities Implied hurdle before rounding: 14.5% - Baylor’s back-of-the-envelope hurdle leading to a 15% line in the sand Venture ‘good fund’ benchmark: 3X net - Party-line benchmark cited for venture funds Venture IRR example: ~14% IRR - Approximate IRR for a 3X net fund over 10 years Alternative venture example: 2X over 5 years - Illustrates how shorter-duration funds can match or exceed IRR outcomes Lower middle market commitment example: $10 million - Illustrative commitment size for an early-stage venture relationship Standard commitment comparison: $20 million - Typical larger commitment Baylor contrasted against smaller venture checks Portfolio company concentration guideline: $3 million or greater - Target underlying position size outside of venture

Pivotal Quotes: "We're only investing in categories where we think can clear our net return hurdle, which we define as 15%." — Renee: Explaining Baylor’s private-investment selection discipline "We think that private equity at the end of the day is long-only equity, it's levered, it's illiquid." — Renee: Describing how Baylor frames private equity versus public markets "We want GPs who are investing with conviction and willing to make outsized bets." — Renee: Explaining why Baylor prefers concentrated managers and smaller funds

Implications: Baylor’s approach suggests disciplined, liquidity-aware institutional investing can outperform by prioritizing return hurdles, manager quality, and agility over broad diversification. For GPs, it rewards transparency, focus, and alignment.