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Talking through the big questions defining private capital.
Brought to you by Affinity Presents. Public conversations in private capital.
THE CAP TABLE — EPISODE 4
Guest: Mark Shoberg, Partner & Chief Investment Officer, Capital Creek Partners
Hi, I'm Mark Shoberg, and this is The Cap Table.
Affinity passed along these questions, so let's get right to it. This is about a day in the life. What does a normal week look like as a CIO of a modern multifamily office? How do you balance high level macroeconomic asset allocation with the granular work of vetting individual fund managers? Really good question.
There's a lot of things we cover in a given week. We make sure we understand what everybody's working on, where people may need help in the given week. And then importantly, we have so many managers that come through our offices that we want to make sure we have the right team and coverage for each of those.
So that's our kickoff to the morning. Secondly, it's more a client facing — we do a lot of our asset allocation work. In our advisory meeting we talk about each of our prospective clients that we're talking to and what their needs are and what we might need to do to prepare for them. And then, as well, and more importantly, cover our existing clients and any means that they may have.
Across their portfolios, through that. And something we do from an asset allocation standpoint is we have a what we call our CAM. It's a client asset allocation model. And basically for each of our clients that may have a distinctly unique asset allocation plan, we monitor that against the existing portfolio, address any shifts or movement outside of our portfolio, and discuss trades and rebalancing activity that we may need to do.
And then lastly, and most importantly, we also have our investment committee that runs the entire afternoon that week. And that is where our entire investment team gets together. Everyone's very involved in that process. We talk about all of the meetings that we've had, assess new opportunities, decide if we're going to put them through our process or not.
And then any formal voting that we do on actual investments also goes through that investment committee. So with that, let's move to the next question. You've spoken before about the optimal size for an endowment being between 5 and $10 billion. Why does performance actually get harder to generate once funds grow past this threshold?
I think this is a really good topic and really important. I like to say we want to build a program that is optimal for investment. And through that, I think it's very important to be of size. So there is an economy of scale that you get where you can be a meaningful partner and also support the resources and talent you need to be really proactive as an investor.
So that brings you to this minimal threshold that is needed. And I will say, I think that you can quickly hit this economy of scale by growing too much. And in the blocks there are that typically just investing large sums of capital limit your universe of what you can do. At my prior shops, I think I witnessed both being in a more sweet spot and then growing to a point that made it much more difficult where we're having to deploy hundreds of millions of dollars with any given investment, and that just gets more difficult.
And there are fewer things to be able to look at. So I think in that 5 to $10 billion range, you can be really nimble. Where do you get that number? It's basically driven by venture capital — probably the biggest constraint. But we think if we can do 10 to $30 million per investment across alternatives, that's probably about 20 funds a year, with an additional 20% that we put in co-investments and directs.
You get to about a 5 or $600 million a year program of investments that grows in a steady state at about six times that. And if you think about a 30 to 40% allocation to alternatives, you kind of quickly get to something in that 5 to $10 billion range.
All right. Next question. With macro uncertainty and growing national debt top of mind for institutional investors, how should sophisticated allocators protect their portfolios against long term debasement without sacrificing yield? Yes, this is a really difficult question to answer. I would say that because there is a lot of uncertainty out in the market today that we're navigating and rates going up, rates going down.
There's pushes and pulls to that issue for sure. And growing debt and putting a lot more monetary capital into the markets drives a lot of that. I will say I don't think there's a single solution. It's a broad portfolio topic. And really there's a lot of things you can do within your portfolio to hedge against this in some regards, from a stable value perspective — fixed income.
It's about duration. So maybe pulling back your duration risk to alleviate risk of increasing rates at the long end of the curve. Secondly, within their more on the private credit side, the opportunity to invest in more floating rate debt, where you're basically making a trade for duration risk for credit and illiquidity risk.
But I think that is also a means of getting some enhanced yield in your portfolio. In equities, this is true across all the time that you'd want to accomplish this, but in this environment, finding opportunities in businesses that have the ability to pass through cost to their consumers is paramount, because then they don't take — they can pass along some of those inflation cost as well.
Similarly, find things that have very low operational costs or things that may be less susceptible on the cost side can be helpful. So that would be more on the equity front. Really importantly is real assets — natural resources, scarcity of different natural resources can be a great hedge in an inflationary environment as well.
Royalties, where you're getting an income stream without having the operational burden and those costs that increase can be another way to play that. And then real estate that you have to be careful with. But in the real estate environment where you do have supply in check and growth and demand for leasing activity, that can pass through as well and provide a good uplift.
All right. What are the key risks in the market as you see them today? That's another good question. A lot of things that we look at around the inflationary environment, what rates are doing, what the impact of AI may be — both good and bad. Productivity on the good side, challenges to unemployment potentially.
So a lot of different moving parts. Tariffs, globalization, all those things are elements that need to be considered. And I will say though, for us and over the last several years, what we have deemed as the biggest uncertainty and biggest risk in the market is really geopolitical. And we've seen it rear its head in a lot of different ways.
With Russia and Ukraine, now the US with Iran, tensions with China — all these things are hotbeds that can have dramatic impacts on the market.
All right. Next question. Spotting the next elite VC — with tens of thousands of venture capital and private equity funds globally, what specific under the hood signals tell you that an emerging manager or a spin out fund is actually built to outperform?
Another really good question. I think a core item for us is that we really think a lot about understanding a manager's investment judgment. And more importantly, what about their process helps their success be repeatable? And so often we see a manager talk more about just investments they've made and not really giving us an understanding of how they think, how they really process investments.
So that's a key item. I also like to say in VC, I always think of myself as the entrepreneur sitting across the table from whatever venture capitalist, and I really think about that — do I want to work with this person, right? I may have a seven, ten year relationship here, and I spend a lot of time thinking about that.
Is this somebody who I want on the other end of the table, who I want alongside me and making and working through tough decisions? And I think that's a really instrumental, important part. A lot of VCs talk about access, following other great VC managers. We really think about what these groups are, how they're going to be helpful to a venture capital firm.
And that's how they can really build a lasting brand. The anchor LP dilemma. Venture funds are always hunting for an anchor investor. From an allocator perspective, what are the true pros and cons of anchoring a new fund? How do you negotiate an economic arrangement that makes sense? Pros. Definitely.
That you can get sizable investment early with a manager so you can get a meaningful position. You're able to help influence, discuss the structure of the firm and ultimately terms within an LPA for the investment. And then, arguably, you also are much closer to the manager, so you get to be a part of how they think.
You get more information. You're in a closer position that when they do have co-investment or they see dislocations, that you're able to be more responsive with that manager. So I think those are pretty critical elements of it. The cons are there. They are a lot of work. There's a lot of heavy lifting involved.
I personally really enjoy that part of getting to help firms get started and being a part of that. The second is thinking about economics. This is probably a really controversial topic. There's a lot of groups that take a large economic interest when they anchor funds.
But for me, and I think also coming out of the more of that Swensen approach, I think much more about setting up that firm for success and negotiating more on the behalf of all of the partners. So entering into something that's a true partnership, I think is really important. And arguably, if you do take too much out of the economics early, you maybe are putting them in a weaker position, right?
They don't have the same funds to support great talent. And there's a couple of things that happen. Either they can't perform in the same way because they're not able to retain the same talent, or they're going to arguably go out and raise more capital than they probably should in order to compensate for that.
Those lost economics. The myth of the endowment model. Many family offices try to copy the Stanford or Yale model of investing heavily in illiquid alternatives. What is the biggest mistake families make when trying to replicate institutional endowment strategies?
I think a big one is that it's definitely not just about adding alternatives to your investment mix. There's a lot that goes into that. And I think a common pitfall is the approach of, "Hey, let's copy that asset allocation plan," but they don't devote the same amount of resources to be able to go out and exercise and find investment opportunities. So I think that's a big one. Secondly is probably around spend discipline.
A typical endowment or foundation is going to have a fixed distribution rate annually, which makes it a little easier to plan illiquidity budgeting and forecasting cash flows. I think oftentimes you'll see families that may have sporadic spending. So big ticket items that come up, they can definitely throw off your liquidity and roadmap.
So that's definitely something really important to consider. I'd also highlight that endowments don't have the same tax consequences in the same way that high net worth do. And so just following, maybe active managers in public markets as an example, that have heavy trading activity would be much more impacted on a net after tax basis.
So those are things that also need to be considered. The last is I think to do alternatives well, you have to be very proactive. It's important, particularly in venture, to be with top quartile or even decile managers to get the alpha performance you need. A lot of those managers don't really market, right.
You have to be proactive. You have to court. You have to find these opportunities. And really that requires some devoted resources and people to go out and find those relationships. So that kind of gets back to the resource need.
Okay. Next question. The CPI and liquidity crunch. LPs across the board are feeling the pain of slow distributions. How has the current liquidity environment changed how Capital Creek builds its private markets pacing schedules?
Thankfully, I think we've been in a really good place on this. We have a pretty long dated approach to commitment budgeting for how we invest in alternatives. So we think about a 5 or 6 year roadmap to get to — as we model to get to our asset allocation plans, it's really important you want to stay consistent over vintages.
I've seen the other side of it where if you chase returns when liquidity is high and you're getting a lot of capital back and you have to redeploy a lot, you may tend to overcommit. And when the markets turn, you're in a position to have a lot of unfunded capital and liability on that. So I think it's really important to have a very smooth long term approach for how you commit across the alternative space.
Next question. What is the number one thing venture capitalists and private equity managers misunderstand about how institutional allocators actually view risk? I think I'd probably highlight two things here. One is around portfolio construction. I think oftentimes we don't see enough thought go into how portfolios are put together on the alternative side.
So you may embed and see a lot of concentration risk in certain themes, as an example. So that's maybe one — just thinking more about, talking through your portfolio construction process. And then secondly is teams are everything. That is what we see as the core important thing. And who we invest with, it's about the team and the talent that they represent.
And so often managers spend more time about their strategy and the underlying investments or track record. And the reality is early in the cycle, we want to get to know you, the manager. We want to know about your team, your culture, your vision for the company. Because we do think about this as a long term relationship.
And I do think a lot of managers don't quite understand that. Fill in the blank. What's a piece of data or qualitative signal that you value more than almost any other when evaluating the team dynamics of a new fund management team? It's a great question, I think. One thing I like to say is very simple about what we do.
The idea is if we can find the best talent at whatever it is they're doing and get our alignment right with them, there's a lot of good things that happen. There is a lot of great talent in the industry, but then the flip side is it's difficult to really get great alignment. So we really strive to get both those elements right.
And within that, we do think a lot about understanding the investment judgment of a team and then the processes they go through, the incentives they have in making their investment decisions, as really crucial elements of making decisions on anybody we invest with.
All right. Next question. Looks like we've entered the lightning round. Venture capital or private equity? Which has the better risk adjusted alpha over the next decade? I will say I oftentimes refer to the Goldilocks theory. Usually nothing in its extremes is ever the right answer. And I do think these two are both great asset classes and probably are where we put most of our capital across alternatives.
And the reality is venture at certain times is going to have outstanding performance. But private equity is more consistent. On a median basis, I don't think you really see a huge delta there. But if you can find top quartile and top decile managers, I would put that in the venture capital camp.
Probably the safer bet and more consistent would be on the private equity side. All right. Emerging managers or established brands. Where are you placing your bets? Again, I have to go with both. We love emerging managers. We love the alignment. We get. They're very hungry, and establishing new firms, which is amazing.
But conversely, there is more risk that we have to spend a lot of time on and evaluating a new manager. Established brands — consistent long term performers when they stick to their knitting and maintain their strategies. Those are great places to be as well. Next question. Solo GP or team led fund.
Which organizational structure has less inherent risk? Great question. I think team led probably has less inherent risk. I think solo funds have a place though. Solo GP that can be more nimble, make decisions quickly, can generate really great returns. I think the challenge for them is they have to kind of address that team dynamic, succession, key man risk.
And I have started to see some formations of groups that help identify ways to manage succession should something happen to that GP.
Real estate — is it an inflation hedge or a value trap right now? Both, I'd say. I think it really depends on the underlying real estate. The only way you really are going to get the inflation hedge is that costs go up for development, supply drains, so you can drive rents. The trick is you have to have demand, right?
If you don't have the demand, it doesn't serve that purpose. So there are definitely places to get good inflation hedges. Conversely, there are a lot of value traps out there. Obsolescence is real. You have to be very careful about that. The ability, the need to reinvest capital to bring in new tenants can also be a big drag on performance.
So it can be both depending on the underlying class. The ultimate metric — net IRR, TVPI, or DPI — which one tells the truest story? These are all super important. I am starting to feel like a consultant now, hedging my bets on how I answer these questions. But net IRR and TVPI together are important. Ultimately, it's all about DPI and what that return does.
I just don't want to ever see a manager feeling like they have to produce DPI in order to get that next fund invested — if they truly can compound an investment by maintaining and holding it, I'm definitely in favor of them doing that. So being disciplined in that approach, not selling their winners if there's still room to run, is important.
But then, at the end of the day, DPI is what you can eat, right? The AI question — AI hype or reality here? I think there's a little bit of both. I'm extremely excited about everything going on in AI. I am, throughout my career dating all the way back to the .com era — I don't think I've ever seen an adoption curve like you see in AI, it's across everything, right?
Demographics, geographies, industries. There really isn't a place to look that isn't somehow embracing it and starting to adopt it in a pretty rapid fashion. There will surely be winners and losers. Valuations are high. Some of these companies won't make it, or they'll be made obsolescence by new technologies.
So you have to tread lightly. But I think long term it's a really interesting, exciting place. Are there any key themes you're focusing on today? I think a few. Some we've been in, but we've spent a lot of time in the space, environment. As we saw launch activity growing dramatically.
We just felt like innovation was coming into space. So we got very active there. Fast forward, it's become a very hot sector. And so we have some great companies that we have early positions in and are really excited about what's happening there. Secondly, I think in the health and wellness, longevity economy, we have been spending time there and have some really interesting things that we've invested in.
And then last, and I'd give this credit more to our managers than us, but we've seen a big shift in a lot of the underlying investments across our private equity book that have more of this halo sort of concept — heavy assets, low obsolescence — and those have been faring very well and seem to be a really good opportunity.
Lessons learned over your 20 years of investing? I think the two things I would probably highlight out of the gate — one, trust your gut. You have to do the work. You have to do the diligence. But ultimately, when something doesn't feel right, you gotta sort of take that into heart.
I'll give an example. I think early in my career, met a manager, had a tremendous track record, literally had never lost money on an investment. I was in awe of what they had created. But in hindsight, there were signals, things that they had scaled pretty dramatically. Missed a couple meetings, or just didn't quite have that organization you felt like you'd normally want to see.
That gut feeling was there. But we did the investment and it did okay. But it definitely had its challenges along the way. So I think that's one big one. And then the second is I think the compounding of relationships over a career are vastly important. That is the source of all the opportunities that we see.
It's those trusted networks that you have. So I push to my team and suggest for everybody to just be out there, get to know people, share ideas, communicate, and build really strong, lasting relationships that I think will be very helpful in your investment career. All right. With that, I want to thank Affinity for having me on today.
I've really enjoyed it. And we'll see you on the next one.