In this wide-ranging conversation, Jeff Malec sits down with Dave Morehead, CIO of Baylor University’s $2.2 billion endowment, to explore the unique challenges and strategies of institutional portfolio management. From his early days trading derivatives in Chicago’s financial district to overseeing one of Texas’s prominent university endowments, Morehead shares invaluable insights on risk management, alternative investments, and maintaining intergenerational equity.
The discussion covers Baylor’s innovative approach to portfolio construction, including their successful deployment of volatility strategies during the 2020 market crash, their current cautious stance on equity exposure, and their philosophy on private investments. Morehead explains why they’re shifting away from cyclical assets in private markets and focusing on secular growth trends in healthcare, technology, and consumer sectors.
Particularly timely is their analysis of recent market volatility, bond market dynamics, and the broader implications of trade policies on institutional investment strategies. The conversation provides a rare glimpse into how a major university endowment navigates market uncertainty while maintaining its core mission of supporting education and student scholarships.
Whether you’re an institutional investor, family office manager, or investment professional, this episode offers valuable perspectives on long-term portfolio management and the evolving landscape of institutional investing. From helium gas investments to long volatility strategies, learn how one of the industry’s thoughtful practitioners approaches risk and return in today’s complex markets.
You want to learn how institutional portfolios really work? You want to understand how endowments think about risk? You want to hear from someone who’s traded it all and now manages billions? SEND IT!
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Follow along with Dave on LinkedIn and X and also be sure to check out Baylor’s endowment for more information!
Check out the complete Transcript from this week’s podcast below:
The Endowment Playbook: Balancing Long-Term Goals with Current Market Volatility
Dave Morehead 00:07
Our purpose is to support academia. So everything on the endowment side is first, like do no harm, and tends to be risk mitigating, and then within that, you’re trying to do the best returns that you can get.
Jeff Malec 00:25
Welcome to The Derivative by RCM Alternatives, send it!
Dave Morehead 00:30
Hi. This is Dave Morehead CIO of the Baylor University endowment, and we’re here to talk alternatives and institutional investing on the derivative.
Jeff Malec 00:49
How are you? Dave, fantastic, good. You’re down there in Waco? Yes, I have never been give us the quick, down and dirty on Waco? Yeah, Waco
Dave Morehead 01:01
is 100 miles south of Dallas and 100 miles north of Austin. So in my wife’s vernacular, we’re about as far away from civilization as we’re allowed to be.
Jeff Malec 01:14
That isn’t that whole Austin to San Antonio is just becoming one big megalopolis, right? Like you think the same thing will happen in 50 years of that whole all the way out to Waco, and it
Dave Morehead 01:26
is, yeah, Austin to San Antonio, as you mentioned, is is pretty built up all along. I 35 the there’s in Texas, we talk about the triangle. It goes from Dallas to San Antonio, over to Houston, back up to back up to Dallas. We think our office thinks that what has gone on from Austin to San Antonio is likely to occur from Austin to Dallas, and Waco is right in the middle of that. Got it
Jeff Malec 02:00
and what your Texas? Born and raised, no,
Dave Morehead 02:03
Chicago area, not at all raised, moved to Texas in 2011 to take a job here with the Baylor endowment, and have been here since where?
Jeff Malec 02:16
Where’d you go to high school? Wheaton north. Wheaton north. All right. I thought, you know our partner, Paul Rieger. I thought you might have been a Saint Ignatius, guy, like Paul and my son’s there now.
Dave Morehead 02:29
yeah, my wife and I were both Falcons. Wheaton North Falcons. Love it exactly. We were. We were part of the DVC. So it was always the DVC versus the
Jeff Malec 02:38
Catholic League. What was the DVC, I don’t even know DuPage Valley Conference got it.
Dave Morehead 02:44
DuPage Valley Conference versus the Chicago Catholic League and a lot of basketball and football events. What
Jeff Malec 02:50
was your, what were your What was your sport? Uh, tennis, tennis. Um, so how did you make it down to there? They were looking for someone smart came calling up. Here
Dave Morehead 03:02
it was. It was more an inquiry from me to actually endowments, kind of across the across the country. My wife and I had grown up, lived work, gone to school in the western suburbs in Chicago, and when my daughter was my eldest daughter was in second grade, she was asking if she was going to see me in the morning. The answer was no. I was working at hedge funds at the time, and we were off to work and whatever, before the kids woke up. And that started a line of inquiry, of like, did I want that to be the case. I want to do something else and and that sort of, you know, snowballed into, you know, at that point in time, I think I’d been on the for profit investment management side for 1718, years, and the question was, Do I want to hit the repeat button on anything that I had done up to that point, or did I want to do something new? It wasn’t anything particularly that I’d done that I wanted to do for like, the next 25 years. And so we opted for something new. Investigated the endowment space broadly, and ended up here. If you had told me 15 years ago that I would be living in Waco, I would have said that you need to get your head checked. But yeah, the first time, the first time that we were here, was the first time that my wife had been to Texas. She saw the inside of our house here one hour before we closed. Wow, still married. So yeah, that worked out. Apparently I did something right,
Jeff Malec 04:43
and my warped brain doesn’t hear the sweet story about spending more times with your kids. I hear like, oh, hedge fund. Which hedge fund? So, which hedge funds? What were they doing?
Dave Morehead 04:52
Yeah. So let me take you back a little bit further, because you’re in the Chicago area. So yeah, some of these. So I worked at. Stress right out of school. And then from there, did derivatives risk management at the old CRT. At the time, it was nations bank. CRT, yeah, that subsequently merged with Bank of America, of course. And so I was sitting on their derivatives platform, which was in the Sears Tower at the time, and and then went from there to William Blair was doing sell side equity research on transportation, logistics and then especially retail. Went from there to Richie capital, working for a fellow that I had worked with at the bank. And then, after four years there. I think there was a group of us that spun out and started our own firm called high view capital, where we were trading energy, specifically and and I was there for about six years before moving before moving south. So you
Jeff Malec 05:59
were on the whole you were on Prop firms, option traders, equity firms, and there
Dave Morehead 06:05
wasn’t, there wasn’t a plan there that was just, you know, kind of where my interests LED. I will say that being in this seat where you oversee all of those types of strategies and trading practices has been extraordinarily helpful. So I haven’t traded metals, I haven’t traded softs, but I’ve traded almost everything else in the marketable space. So I cover market rules here. My colleague Renee covers private investments for us here at Baylor. And we have, we pretty much have, like, a sibling relationship. So we talk a lot. We’re always talking about marginal dollars. What you know, should it go to the public side or the private side? What? What return characteristics or potential does she have versus what I’m seeing? And so, yeah, she prosecutes the private side, and I look after the public stuff
Jeff Malec 07:06
you’re showing your age with first trust and Sears Tower, two names that technically don’t exist anymore, but we still got our office is right across from what we still say is Sears Tower. Come on, Willis, whatever Willers tower, they, I think they lease two floors and get to call it the Willis Tower, right? That doesn’t seem right. Um, so, and what was your favorite part of all those stops, the energy trading seems the most I mean that that I to you were hanging your own shingle a little bit. Yeah,
Dave Morehead 07:38
to me, um, trading the energy space is the hardest thing that I’ve done. It’s, I mean, you basically have to keep track of three different things that are going on. You have to know what the economy is doing. You have to know what the market’s doing, and then you have to know what individual companies are doing. And so if all of those things are aligned and headed up, then energy tends to go up. But there, there are more variables that come into play. There I found then, then say, especially retail, where that’s really a US economy thing, right? How are consumers feeling, and are they buying more? Are they buying less? That one, to me, is a little bit easier to to fair it out. I would say the thing that was interesting with all of it was, was the ability to do new things and learn new things. My kids, sometimes I don’t know I like. I’m always last to sort of figure out what’s going around, what people are saying, but sometimes they’ll be like, so what’s your toxic trait? If I had one, it would be that I get bored easily. Your kids ask you what your toxic trade is, yeah. Or they’re like, in the comments, those kids, they’re like, they’re like, Yeah, my toxic trade is this. They’re like, yeah, what’s yours?
Jeff Malec 08:58
Well, I’ve got, oh, they don’t mean it like a trade. They mean it like you’re in your life. Yeah, right, got it
Dave Morehead 09:03
so, yeah, in all of those it was beneficial to me to step into something new that I didn’t previously have experience with. Learn it, develop, grow, conceptualize it and and basically when I kind of get to that point that I’m ready for the next thing.
Jeff Malec 09:32
So Baylor comes Colin, you get the job there. That’s interesting me. So you guys think of the world in marketable and privates totally, even if there’s asset class overlap,
Dave Morehead 09:45
we do, because our view is that things are better prosecuted on one side or the other. I don’t subscribe to the seems to be a belief. For a practice that if it’s private, it’s necessarily better than on the public side. I think that there are a lot of issues, potentially on the private side that haven’t yet gotten, you know, brought to the fore or sorted out, and sometimes people neglect to consider and so private to us is something where you have to think long and hard because you’re giving up liquidity and and it’s not really the liquidity that you’re giving up that is the problem. The problem is, is that you’re giving up your optionality going forward. So once you make a commitment in a drawdown vehicle that’s a contracted cash flow that when they call, you have to send it. But of course, whenever they’re calling capital, that may not be the best use of capital at that point in time, and so necessarily, whenever you are signing, you know, subscriptions, papers, for a private investment, you’re selling a strip of options. And I think that most people don’t think about it that way,
Jeff Malec 11:13
and that short, like an opportunity, yes, call, exactly, right, right? Yeah, so,
Dave Morehead 11:17
so, and then you end up a little bit over your skis, and then you’re in a liquidity situation, and you can’t take advantage when you should, and, etc, etc, etc. It takes, you know, three to five years to sort that out.
Jeff Malec 11:30
And then we could argue, right, that there’s a there’s not just a premium anymore. There’s a discount, right? Like, for the privates, right? Well, I was going to save that for later, but we could dive in now, like, what Cliff Asness calls, right, volatility, laundering, right of, hey, we’re going into privates because we know they don’t give mark to market. We know the marks are a little smoother. So we’re going into that on purpose. I think that’s what drove a lot of private equity and the Yeah.
Dave Morehead 12:01
I mean, if, if that’s certainly not something that we think about. We’re doing it for returns period. Yeah, people are getting into an asset class for that purpose, then, yeah, you’re, you’re sort of asking for trouble, because that’s not the point of investing in privates. Investing in private should get you higher returns, but you need to take into account all of the kind of sold options,
Jeff Malec 12:27
yeah, that you have. But do you think they they maybe not explicitly, but implicitly in the numbers, and look at the Sharpe ratio, or whatever the volatility is lower, this is a better investment for what you were saying before. We don’t really think of it as better or worse. It’s just different. Just different.
Dave Morehead 12:43
Yeah, yeah, it is different. And our threshold is to the tune of like 500 basis points annualized over whatever the public market comp is. So if it doesn’t meet that, we don’t do it.
Jeff Malec 12:59
And you’ll see that. Do you ever come in and you’re like, hey, we’ve got an private energy investment. We’ve got a on the public side energy stocks. And those have kind of a horse race internally, of which one are we going to invest in? We
Dave Morehead 13:11
do do that to some degree, at different points in time. Typically, we’ll pick we either want a particular category in privates or we want it in public. So give it. Give you a for, for example, like Yeah, 1010, plus years ago, you could give money to a private equity energy midstream manager where they’re developing pipelines, you could develop that for three to four times EBITDA, and then you could turn around, take it public, and the market value it at, you know, 13 or 14 times EBITDA, right? So that was basically a private, public market arbitrage. And so you should just do that. That doesn’t exist today, but to the extent that it did, you should be doing all of that on all of your midstream energy on the private side, right? Because that’s just free money. Yeah. So you know, when situations like that exist, then we’ll allocate all of the capital either the public side or or the private side to take advantage of of that arbitrage, if you will, between private and public markets. Right now, what we’re doing is we’re we’re really moving a lot of the cyclical assets out of our private book over to our public book. And the reasoning is because when you’re signing up for private markets, you’re signing up for getting cash flows back seven to 10 years in the future. And none of us know what the economy is going to look like. We definitely don’t know what crude price is going to look like 10 years out. So. Same could be true with real estate, anything that’s cyclical and we don’t, because our purpose, our goal, is so meaningful to the university, we’re trying to help students go to school. You know, higher ed costs are going up. We’re trying to create returns faster than the school is growing, so that we can ultimately get to a point where, you know, tuition increases stop and potentially go the other way, because that’s our goal, allocating capital to a strategy and then having a macro variable affect that eight years from now, and so therefore we get 0% return on it through no fault of the manager. Yeah, that’s an opportunity cost that we simply can’t take. And so we’re on the private side. We’re allocating to categories that tend to go up into the right over time, and then we’re putting, you know, the manager expertise on top of that, so
Jeff Malec 16:07
or private credit, or, what
Dave Morehead 16:09
do we know for your for your listeners, that would be like we’re allocating to healthcare, tech and consumer. We’re not doing real estate, we’re not doing energy. We’re not doing anything that’s cyclical, because we don’t want to be standing there eight years from now. This is metaphorical, but, yeah, we want to be standing there eight years from now. Explain to a student why they have less scholarship dollars. Because, you know, crude prices ended up at 30, right? We can encyclical
Jeff Malec 16:43
to me, you’re saying, I would call it more like
16:48
as correlated with secular trend,
Jeff Malec 16:50
Yeah, or like correlated to the economy or Yeah, right. So we’re trying to allocate
Dave Morehead 16:54
to things that have big secular trends, like healthcare. Are people going to spend more money on healthcare globally in 10 years from now than they are today. Yes, of course, right. Is technology going to advance over the next 10 years? Yes, of course. Is biotech going to solve more diseases over the next 10 years? Yes, of course, right. So like we want to allocate to those things where the underlying is yes, of course, and and then we have the manager expertise sitting on top of that.
Jeff Malec 17:27
But surely I could get 25 people, 2500 people on here to be like, Oh, we’re short on housing. Housing is going to go up to the right, of course, right.
Dave Morehead 17:38
You could. And that’s why there are markets. And exactly they can, they can run their own program.
Jeff Malec 17:43
But to me, you’re saying not only, like, sure, that’s a factor and of course, but that’s got all these dangers to a slowing economy, higher interest rates, yada yada yada, that the others are little more insulated from
Dave Morehead 17:56
Correct. Yeah, we’re not. We don’t want to take a risk that we can’t forecast well
Jeff Malec 18:03
and go back, because I’ve never. Do you think what the model you explained? So the endowments there to drive returns, to help cover all sorts of costs, or mainly to provide that tuition assistance. Give me a little background on what, yeah, I mean, Taylor is doing. And then maybe, if you can, I don’t know how much you know how much you know about other endowments, but how that contrasts with others. Sure,
Dave Morehead 18:23
all university endowments, but almost all of them, the largest portion goes to scholarships, whether that’s 30% 40% 50% almost all endowments like fall into that category. And then there’s another big wedge of the pie that goes to professorships. So if, if a professor is has a named chair, for example, the yada yada yada chair in, you know, sociology, or, you know, finance, or whatever, philosophers are backed by endowed dollars. And so programs too are sometimes funded by endowed dollars. I think, I think that there are some schools that have actually taken this into the athletic realm where perhaps coaches salaries are funded by endowed dollars. So at the end, yeah, well could be, yeah, I don’t think, I haven’t heard a whole lot about that happening. I think it’s new enough, and the future direction of that is uncertain enough that everyone is doing that on a expendable dollars basis, as opposed to an endowed dollars basis, right? Because if, if the industry, or if the approach to paying players changed over three or four years, then your endowed account would need, yeah, what are you doing, writing or something. So yeah, most, most university endowments. Basically it breaks down to most of it is scholarships and professorships. There is some that is programmatical. And then the balance is general use. The general use tends to be 20% or less of the of the distributions to the university. And
Jeff Malec 20:16
you just said the key word I was going to ask about the distribution, so we’re not talking right, what? What’s the size of Baylor’s
Dave Morehead 20:23
so Baylor’s endowments, 2.2 billion. Okay? There is a legal requirement across which all universities operate, that there that the operators of the Endowed assets maintain intergenerational equity. It’s a legal term that means that the same benefit has to accrue to the students today and the students in the future and over time that has generally been assumed to be about a 5% spending rate. If you earned 8% in the stock market over time and you spent 5% sending those dollars back to scholarships and programmatic funding, then you would have 3% left to grow the endowment and inflation. You know, prior to the last couple of years, was kind of two to 3% for the prior 30 years. And so that 5% spending rate is, is generally where people gravitate to. Is
Jeff Malec 21:35
another name for that law, the anti Chicago Illinois law, right? They’re like, Okay, we’ve made negative 4% Let’s spend 40% and see how things work out.
21:49
Yeah, that that
Jeff Malec 21:49
doesn’t really work, yeah, um, and this is who was telling me the Princeton, I think, can cover their entire I mean, how many endowments, I guess I’ll form it in question. How many endowments out there are actually covering that entire desired Alpha? Yeah,
Dave Morehead 22:05
not a lot, right? Yeah. Because basically, you would have to, you would have to have donors that gave 20 times whatever the expense was to properly endow it and take it, you know, off, off of the college’s books, right? It was fully covered by by the endowment. So it’s, it’s a lot of dollars, the people generally ask me, and it would hold true for Baylor. It would hold true for, you know, any other school Northwestern I went to University of Chicago for grad schools and hold true there. Do, Do you know, for some of these schools, Northwestern University of Chicago, the Ivy’s, you know, the the endowments are in, you know, 10 to $20 billion does it matter if I you know, the next donor created an endowed account. And the way that I always respond to that is I would ask the student, who’s, you know, receiving the scholarship from your endowed account? I I would guess that to that student, it matters a whole lot. Yeah, and so, and that’s
Jeff Malec 23:18
the difference between just putting it into the general endowment, versus, I’m endowing, I was a philosophy major at Union College. I’m endowing a philosophy scholarship,
Dave Morehead 23:28
right? You can use particular you can do that, right? So you, I couldn’t, I couldn’t endow a an account specifically for you, because then, then I’m getting around, you know, the gift tax thing, right? So that’s not allowed. But I could say, for any, for any union student who is pursuing philosophy as a major, you could even make it more particular. In Chicago came, you know, from a place east or west of the Mississippi River that that is actually ends up being a contract between the donor and the university. They legally cannot use those dollars for something else.
Jeff Malec 24:16
But then how does that confusing? On your guy’s side, there’s as a practical matter, of like, to me, if you’re, like, a huge hedge fund of funds, managing all these SMAs, right, right? Of like, this has to stay in the sleeve. And I can’t have that in some super illiquid thing where I might need to get that out if,
Dave Morehead 24:33
if you’re right, if I had to keep track of all of those things, that would be very confusing. Thankfully, I don’t. So how it works at most endowments, certainly the large ones, is there’s development staff that calls people and asks for money. That money comes in if an account is formed. Treasury, the accounting departments at the university keep track of at Baylor, there are 5000 light item one. Line items that make up the environment. They keep track of all of those. It gets unitized, so like a mutual fund, yeah. And when dollars come in, they buy units in the main of of the main we call it the Baylor University fund got it. And then on the flip side, when we’re sending dollars back those is that’s just a distribution, just like it would be from a mutual fund. X number of shares are redeemed, and then Treasury takes responsibility for making sure, yeah, those dollars get to the right account and to the right place. So, so
Jeff Malec 25:38
is there a little bit of a hack there? Right? If you were in some venture capital fund that’s going to pay a big distribution? Next year. And I came in this year and endowed something. I’m going to get that distribution from that without having lived through the 10 years of investment period, right?
Dave Morehead 25:52
You? You that’s true. You would we, of course, mark everything to market. Yeah, as so there would have to be a little bit of you would have to know things on your side, yes, yeah,
Jeff Malec 26:09
but go ahead, hey, hack it away. People send, send a billion dollars in and get that next distribution exactly, generally, what’s your guys sort of return target, risk profile, all that good stuff. Yeah, we don’t portfolio composite. Yeah, right,
Dave Morehead 26:30
of course. Let me. Let me give you some perspective on how we think about the endowment. Philosophically, we’re a little bit like and most endowments are a little bit like doctors and like first, do no harm. The the the distributions that we provide this year for Baylor about $100 million Baylor’s budget, on an annual basis presently, is about a billion dollars. So the endowment is covering 10% of Baylor’s budget. So from that standpoint, no endowment is going to be all equity, right? Because if you and if we just take the current environment, we if we talked about tariffs that are going on, we’re unclear. You know where that’s going to sort out, but let’s just say that there was a full blown trade war, and everyone just stopped trading with each other. Then in that situation, the market could be down, what, 50% so yeah, if that were the case, and if you had 100% of your dollars in equities, then, you know, the go forward years instead of, instead of me being able to give the university $100 million a year, now I’m giving them $50 million a year, right? So, so to the extent that endowments take on a great degree of volatility, they’re putting the future tuition at risk for, you know, for the students who are going to attend the university in the future. And so almost all endowments come at the risk side of things first, right? We’re trying to, in fact, in our spending policy, to even make it a finer point in our spending policy and what governs the distributions that are sent to the university. Not only is there a smoothing function that sort of like over the last three or four years, it’s looked back, but we can’t send less to the school the next year than we did this year, right? So there’s a floor built in. There’s a floor built into the spending policy that kind of keeps floating up, and it’s in essence, like in hedge fund land a high water mark, yeah? So once, once, we’ve given the school $100 million regardless what happens in the equity market over the next year, we’re still going to give the school at least $100 million and and the reason for that, of course, is because academic, academia doesn’t move at the speed of the markets, and our purpose is to support academia, right? And so if you think about that, and it could be the case if, if you rolled back and you went through, you know, the 60s or the 70s, and there was a lot of volatility, and the equity market just kind of went sideways and something like that. And then you had, like, a tariff type thing and a big down draft. You could get yourself into a lot of trouble if you were just yeah, you know, now you’re drawing down principle Exactly, yeah, right. And so. And then at that point, you would ask again, Chicago, see Chicago, Illinois, exactly. And at. That point you’re actually going against the legal framework that these endowments are set up for, because then you’re not being true to the intergenerational equity between today’s students and tomorrow students. Today’s students would be benefiting at the expense of the future students. So so everything on the endowment side is, first, like, do no harm, and tends to be risk mitigating. And then within that, you’re trying to do the best returns that you can get. And so this is why some of the stuff, like, when you comparing stuff, you know, I could have just been in the s, p, you know, 100% and that that speed all the end up, well, it’s like not
Jeff Malec 30:42
2 billion in Nvidia, and could have solved all the exactly, all right, Texas’ problems, yeah,
Dave Morehead 30:47
and it could have, until there’s a tariff there, and then it’s down 15% and then the school’s at risk. So I think most people on the endowment side who sit in my seat, just don’t comment when, when those things come up. But not only are they laughable, but they’re, they’re, we actually can’t do that, right? Yeah? So like, if I put the entire endowment in Nvidia, I would go to jail, yeah? So,
Jeff Malec 31:17
as you said, Yeah. And so what is right to me that lends itself to, like, we should just be in T bills, but then you get the zero rate environment, then you’re in that problem too, right? So that’s, that’s
Dave Morehead 31:30
originally, that’s where all endowments were. So it’s only been over the course of the last 80 years that endowments have migrated to. They it used to be stipulated legally that you could only be in fixed income. And then over time, what’s happened is that equity allocations have increased, and then alternative allocations have increased, right? And so over the industry is changing right as things do. And so I would say there are different schools, of course, that have different levels of risk tolerance, kind of obviously, right? Yeah, is everyone?
Jeff Malec 32:16
Different state laws, the whole game,
Dave Morehead 32:18
right? Well, all each endowment is governed by state law. State law has generally trended to be similar in this regard, and so they’re basically, they’re everyone’s basically governed by the same laws. But it might be the case that a school particularly needs to get their endowment higher, and so they are willing to take more risk to make that happen. Or it could be that the school you and this is the same thing with a lot of ultra high net worth individuals, we have a lot of money, we’re just trying not to lose it, right? And so you get, yeah, I mean, we do kind of compare school returns. But that’s also specious too, right? Because there’s a whole range of risk tolerances and preferences and needs, etc, for each different school. So in general, annualized volatility runs in a range from sort of like 10 to 15% so it’s not, not too different from the equity market. I think equity market, kind of, over time, is 14 ish, yeah, the last, think, last 10 years, the top endowments probably high, 9% 10% returns type thing, but we’re like our I can’t speak to everyone else’s, although I think, I think it’s very similar. But to give you some perspective on how diverse our pool of capital is. We’re way, way more diverse than the S, p5 100, like it’s not even close. And we own all sorts of things. We own makeup brands, we own beverage brands. We particularly own, like helium gas, you know, in addition to the energy stuff and and what have you, what we
Jeff Malec 34:31
own, you’re saying, like, actually have ownership on the cap table of those, or own the own in the public markets.
Dave Morehead 34:38
And the helium case, it’s a private company that produces helium gas
Jeff Malec 34:45
and which is running out, or there’s a shortage or something, right? Which is why
Dave Morehead 34:49
we own it, yeah. So one of our sort of core tenants, one of the things that we try to do is we kind of look at things from a top down. Own perspective, and where are the shortages, where are the bottlenecks in industries where demand is growing, and then we try to own either the companies, the assets or the inputs around those bottlenecks or shortages, right? And all we’re really trying to do is set ourselves up in a situation where the wind is at our back, right? And typically, like in the helium case, like, that’s not that doesn’t move around very much based on what the equity market is going to do, right? Helium goes into MRI machines. It’s used in semiconductor manufacturing. It’s used in rocket launches. So semiconductor usage is going up. Rocket launches are going up. MRI machines are going up. Therefore, I want to own the thing that is in short supply. And we try to do that broadly across the broadly across the portfolio.
Jeff Malec 36:08
I thought it was just huge kids birthday demand for the helium balloons. It’s got industrial you. But you’re talking just in the equity sleeve at the portfolio, right?
Dave Morehead 36:26
This would be in the marketable side of the portfolio. So we divide it into, you know, the private side would be venture capital and private equity and buyouts and anything that has, like a seven to 10 year draw down fund structure around it. On the marketable side, it’d be fixed income equities and what we call as marketable alternatives hedge funds would would fall into that category, anything that was hedge fund equity like, but wasn’t like a drawdown function, drawdown structure, and was shorter dated. And
Jeff Malec 37:07
what do you mean by drawdown structure, where they can ask for more cap, correct? There’s capital calls,
Dave Morehead 37:11
so in our in our fund, privates, end up being about 45% of the assets in some of the bigger endowments, you know, those, yeah, like it was 60% upwards of 60% what, what we have found is that that, or what we believe is that the equity market doesn’t always go up, and the ability to move the flexibility to allocate capital into opportunity sets when the market is down is is kind of critical. And so we’ve stayed right around that 45% level. Because what we found is, if you go beyond that, then when the equity market goes down, then you have this denominator effect, then the total private side light kicks up to close to 60% people are still calling capital. It’s contractual. You don’t have an alternative there. And so in that situation, you end up selling of your, some of your public holdings to fund these private but you’re selling it in the hole, and that’s what we’re trying to avoid. So I would say at any end in time, we probably have more liquidity than we probably need, but then in situations like we’re in today, that that’s very beneficial, and
Jeff Malec 38:40
then out of that whole pie, right? So the marketable versus drawdownable. What is the alt look like if we put, and I guess I’ll ask you marketable
Dave Morehead 38:52
side, right? So on the marketable side, it’d be about 50% sort of typical traditional fixed income and equity type funds, and about 50% would be alternative,
Jeff Malec 39:09
got it, which might be, or they still might be, have a beta to stocks, oh, or third one, yeah, okay, third one, yeah. So it could be some energy hedge fund, some correct specialty, China tech, or something correct. And then what and what I would call true alternatives, like macro or managed futures or long volatility that would do well in a market downturn. What is, what does that allocation look like? If anything? Yeah, so
Dave Morehead 39:36
that depends, and that’s varied quite a lot for us over time. I can take you back through it a little bit going into 2020 I mean, we didn’t know that there was going to be a pandemic, but going into 2020 we had about 15% of the endowment in cash and long volatility. Hmm. And that really came about, because 1718, volatility was basically the cheapest thing on the board. And so the warehouse then, yeah, we were buying it. We owned it. We probably went into the pandemic with about 80 million in in long vol products, which was up about 60, 65% over that. You know, the second, I guess, March, April, yeah, May of 2020, at which point we sold it and rolled that into equities that were down 30% right? So fantastic.
Jeff Malec 40:39
What did that look like? That was predetermined monetization, or it was just, hey, this is crazy. Let’s, let’s do a emergency meeting and come out so we
Dave Morehead 40:50
have the wherewithal, the staff has the wherewithal to move money around within, you know, percentage guidelines for each fund. And so, like, we all know that, you know, vix doesn’t stay at 80 for very long. So if and when it’s, you know, north of 60, you better be getting after it. So yeah, that’s, that’s, you know, I’ve, I’ve traded vol before. And yeah,
Jeff Malec 41:17
it’s just kind of, and was likely going outside your band anyway, right? So if you were, I wasn’t, we
Dave Morehead 41:23
didn’t have that much. I think we were, I think it was zero to four or 5% that we could allocate, and at the time it was probably, we’d probably allocating, I don’t know, 3% two to 3% at that. And then as 2021 rolled on, and stocks were going straight up. We sold equities, we bought long vol again, we started stockpiling cash. 2022 happened, which was the tech meltdown, because it wasn’t an existential thing. Vaul didn’t rock it up like it did during the pandemic timeframe, but it was a 15% we sold that we bought equities, and then, yeah, we’ve been pretty long equities up until about the fourth quarter of last year, and we took equities down by five, six percentage points. So at the moment, at the moment, we have the least amount of long only equity exposure that we’ve ever had. So we’re fairly sanguine about, you know, what’s going on in the market these days that doesn’t meaningfully impact us. We have, over the last two to three years, been allocating a lot more to idiosyncratic type things like helium, right? That doesn’t move we own via another manager, we own three Class B malls across the US and one in the UK, right? So there would be another example of endowments being much more diverse than than you know, just what the S, p5 100 is doing. So, yeah, I mean, we’re involved in all sorts of things as it relates to our exposure right now we have the least amount of equity that we’ve had. I’m kind of happy to maintain that lower equity exposure. For the time being. We have a number of things that are more idiosyncratic, that are doing quite well and kind of bolstering our returns, outside of what the equity market is doing,
Jeff Malec 43:41
and any trend following managed futures exposure. We
Dave Morehead 43:45
do have some, not a lot. We actually have it paired with some of our tech long only exposure. So we think about where our risk lies, and then, of course, we’re trying to mitigate risk, and so let’s see on the long only equity side, we probably have about 10% where we’ve hedged it. In addition to just having not a lot of long only equity exposure, about 10% of our equity exposure is hedged. Some of that is hedged with trend following. Some of it is hedged with long vol. So we’re trying to, we’re trying to mitigate both the 2022, scenario, where it’s just the valuation, drip, drip, drip, you know, for the whole year. But we also want to mitigate some of the oh my gosh, existential risk. You know, pandemic happens, yeah, and so the combination of trend following and long fall serves that purpose.
Jeff Malec 44:54
And how do you personally, over the years deal with trend following drawdowns, which. We’re in a pretty good one right now hasn’t delivered. It’s been way too choppy and whip side Right
Dave Morehead 45:04
exactly. Well, we don’t own things. We are not a set it and forget it shop. So we started adding trend following, actually Jan one. So we’ve had it in our book before in the past, but then there’s a long period of time where we did not, and we’ve just added it back because equity valuations were high, we didn’t know how they were going to come down. And to your point, over the last quarter, trend following hasn’t worked to mitigate that down move that we’ve seen in equities, but the long vol bit has
Jeff Malec 45:47
and so you’re you would get in or out of it, not based on its own performance, perhaps, but based on the greater picture for you. Correct, now, equities super cheap. We’re going to get rid of that hedge. Correct,
Dave Morehead 46:01
exactly. In other words, not everything needs to be hedged all the time, right? Right. In general, our view is the endowment can withstand a 10% down move. It gets really difficult for us if the equity market, we’re down 40% and so we hedge things, uh, sort of 10% and beyond, we’re not, we’re not. If the market’s down 5% we could really care less, yeah.
Jeff Malec 46:38
So let’s talk. We’re recording this. Had a super crazy week last week, which we’ll say for the listeners this week, recording on Friday. But what? Not losing sleep at all. Just of interest. Are you staring at your screen, going, This is crazy. Like, what? What were your money? I mean,
Dave Morehead 46:58
it’s, it’s, it’s historically Crazy, right? The vol that we’re seeing, you know, up and down 5% in a day is about 10x normalized vol. So, like, it’s for sure, crazy. We were very attentive over the weekend as to what was going on. It wouldn’t have surprised me. Of course, the markets open Monday down another 5% and then rebounded. But you don’t know. I mean, when the when futures were closed, we were watching Bitcoin, because it trades around the clock, of course, and it was down five 7% so on Sunday, I was touching base with all of our managers saying, like, if we’re down 10% tomorrow morning, how do you do and and then preparing for if that was the case, who would we allocate to to take advantage of those lower prices?
Jeff Malec 47:56
But you’re not thinking, Where am I ditching risk and this kind of thing, and de leveraging and thinking, Where am I? Where can I get into things? No,
Dave Morehead 48:05
and, and the the endowment itself is not leveraged, right? So the individual managers can take on leverage. If they were de risk, I should have said is not, no, we tend to do the de risking bit like I mentioned in advance of a lot of these things. So if, if something doesn’t make sense to us, we we lower our exposure, right? If you know the mag seven being that, you know 30 times earnings, that doesn’t make sense. So you know, we have very little exposure to those, to those names. I don’t think we’ve ever owned Nvidia, for example. So that helps us avoid divots, which, if you go back to, you know, the central thesis of what an endowment is about. That’s the primary thing that we’re trying to do, we’re trying to avoid divots and then invest after the dust clears. And so it’s worked so far over the last 10 years. So we’ll see if it continues to work, but we try to get out of the way of things that don’t make sense, and then allocate quickly in behind them when they trip and stumble, fall on their face.
Jeff Malec 49:23
Any as you were watching the screen, any major concerns that bonds are in big trouble. US dollars in big trouble like that. The US is in trouble, right? If that’s no matter of flight to safety, I don’t know what, yeah, that’s duration is on your fixed income side, but, like, kind of how you think about that whole piece of this new puzzle,
Dave Morehead 49:46
right? I think what’s going on here on the bond side, rather than anyone sort of manipulating, you know, bond yields is, if you think about it, we basically had. Let’s just say that the scenario that I gave before, it’s metaphorical, but we can work with it. Say everything that is imported costs 100% more, right? And that’s the way things were going to be. Then the stock market in that scenario was down, what I don’t know, 35% and that would make sense. Then you had a 90 day pause. You’re just going to hit pause, except for China, which is, what, 20% 15, 20% of our trade, at least value, yeah, yeah. And it’s a, you know, the tariffs on that are 125 now they’re 125 I don’t know they could be 150 whatever, right? Let’s say all the other ones come to some sort of agreement, and then you divide that 125% by 20% and so, like, basically, on average, everything that you buy, that’s imported is, you know, cost 20% more. Well, that’s clearly inflationary, right? And I think that that’s what long I think this expected value of inflation is what the bond market is doing, right? So I think that the administration was able to keep sort of 10 years locked down, if you will, until this tariff bit, and then people just start doing expected value math, which is not very difficult, and are going like, yeah, pencils out to be up 20% for everything, right? So, so then the back end should lift, and that’s kind of what we’re seeing, yeah.
Jeff Malec 51:38
And I was on a pod last week, theorizing maybe it’s the end of trust in the US markets, and especially the US Treasury market. Of like, I don’t know which way these guys are going there. Yeah, that again, off again. Is there maybe a little bit certainly,
Dave Morehead 51:53
that’s, you know, the, the foundational requirement for the function, you know, financial markets is trust, right? And that’s why economists, of course, are saying that the damage has already been done. Because if I’m a CEO, and I’m making $20 million a year, making whatever it is that I make, and I have the ability to ask my board to spend half a billion dollars building a new plant in the US. Am I going to do that? No, because it’s going to take three years to build that plant, and in year five, we might have a new administration that changes the rules again. And so then I get fired because I spent half a billion dollars on a manufacturing site that now has no use in the most expensive spot in the world. Yeah. So, so our, our is manufacturing coming back to the US? No, of course not. Right now will it go to other countries, like other than China? Yeah, it will, and it already has, right? Hence Vietnam being a being a target, right? Yeah, so that that will continue to happen, I would not want to be a supply chain Vice President right now. I think that’s realistically the point of the spear. But yes, when you have, when you’ve sort of had the rug yanked out from under you, and the decision makers are people that are making, you know, 1020, $30 million a year at the at the top of these big companies, do they want to risk their income to potentially spend, you know, 200 million, 500 million, to build a factory in the US? No, of course not.
Jeff Malec 53:38
That’s a good I haven’t heard that take before, like, not because it’s bad for the shareholders, but probably also bad for the shareholders, but they’re, like, looking after their own skin, of course, yeah, um, right. They got to pay that, the homeowners fees on that house in Jackson Hole or whatever. They can’t. They can’t be getting rid of that $20 million a year, right? I I talk for a minute. We touched on a little bit. Is it hard for you or hard for endowments to write all everything we just talked about is kind of short term, but you have this super long term view. So right, like you have to transact and you have to act in the short term, but you’re having a, as you said, seven, eight year view, right? Like, is that mentally difficult for you guys?
Dave Morehead 54:28
I think it takes or helpful to me. It works very well so and, and let me give you some perspective around that I would be a terrible floor trader like in the pits in Chicago, my I simply can’t process the change that fast and make a decision I’d be I would be penniless and hungry if I had to be in the pits in Chicago, right? That’s not my stick. Likewise. I’m not a very good trader as it relates to what our next quarter’s earnings going to be. There are a lot of the pod shops that are like, really, really good at that. That’s not kind of my stick or the or my strength. I prefer to think in a top down manner over the course of six months to three years, and and the the endowment space actually suits that type of thinking very, very well, because we can lean on longer dated we don’t have to have returns today, right? Like pod shops have to have returns today, right? Otherwise, literally leaves. I don’t have to do that. We own our capital. Our capital isn’t going anywhere, and so I don’t have to worry about making money today. And therefore, I can lean into things that are dislocating and might take, you know, six to 30 to 36 months to work out right for myself, once you get beyond sort of three years I I, like, who knows, right? Like, like, I don’t know if, if Israel and the countries around it are still going to be at each other’s throats. I don’t know if Russia and Ukraine are still going to be at war, like, it’s like, that’s too far for me to see, but over the next two to three years, I think, I think it’s, it’s not too difficult to ferret out, like, where things are headed, and then we invest around that. If we were good at predicting where things were seven or eight years in the future, then we would do the cyclical bits on the private side, because we would be able to really, like, I know that in seven years, crude is going to be at 30 or 120 and then we would invest that way. I don’t, and so therefore we don’t
Jeff Malec 57:08
the and do you think right, this kind of leads, I guess, to why an individual, there’s a lot of family offices, are trying to adopt endowment models, even some individuals. But is that a mismatch, right? Of like, if I put an endowment model in my 401, K, maybe that works, but in my COD’s kids college account, probably not, because I’m going to need all of that money, right, six years or whatever. Family
Dave Morehead 57:31
Offices are interesting, because the families themselves actually play quite a big role in how the investing goes now it depends on one family to the to the other, but the central thesis with all family offices is that obviously the family has done something, right, yeah. So whether it’s in energy or real estate or owning a company, etc, the family has been involved in business previously. They know how to make money, and they’ve actually been extraordinarily successful at whatever it was that they were doing. And so a little bit by definition, you, in that case, are working for someone who, to some degree, is potentially better at the money making, but then you are and so from that sort of foundational underpinning, family offices, often the professionals, the investment professionals that work There, tend to have more of a dialog with the patriarch or matriarch of of the family, who has gotten the family to that point, to that financial position, more so than exist in the endowment space, right? So we know Mr. Baylor, correct. We meet with our board quarterly, and in between those times, they’re available if we have a question or a concern or need some assistance with something, but otherwise they leave us to implement the plan that we’ve talked with them about previously. I
Jeff Malec 59:17
push back a little on sometimes the family office, uh, Patriarch, whatever is, has the like entrepreneurial trap, right? They think they’re good at all this other type of investing because they’ve had all the success. But it’s doesn’t correlate necessarily.
Dave Morehead 59:33
Yep, that’s true. You get that a little bit with doctors as well, right? Yeah, doctors actors are used to being the expert in the room and saving people’s lives. And that doesn’t necessarily translate to finance.
Jeff Malec 59:47
And then my experience in Texas is you got a lot of family, a lot of oil money that wants to just keep doing oil money, yeah.
Dave Morehead 59:55
And so in that from that standpoint, we we know a lot of family. Offices around the state, of course, and from and from that standpoint, the investment staff then are taking exposure that’s significantly different than what we’re doing, because they may have a company, a business, an asset, a sector that, like dominates the family’s wealth. It might be 50% or more of what governs that family’s financial situation. And so they actually then wouldn’t invest at all in energy on their own, because they already have this big, you know, oil asset over here,
Jeff Malec 1:00:46
way in the beginning, we mentioned some of the private stuff has issues. Want to elaborate on that? I think we touched a little bit on it, of the drawdowns and the and then to ask if, in this right, what are NASDAQ down 20% off. It ties. Are you starting to see some privates not do distributions,
Dave Morehead 1:01:08
all that kind of good so let me answer the first question. Yeah. You know you’ve seen this from from Congress or from the regulators, is that basically, there’s been more focus recently on the transparency of what the management company is paying for and what the LPS in private funds are paying for, and making sure that if the LPs are paying for something that that is then disclosed, right? So no, in the in the pod shops, for example, those are often sort of like costing 20 types of things. So, like, almost all costs can be rolled into
Jeff Malec 1:01:59
that. That is, there was a big article, is like 50% or something, right? The the
Dave Morehead 1:02:03
the private funds are not set up as cost in 20 but if, the, if the principals at the fund do consulting work for one of the companies in the portfolio, there’s a question of like, if that consulting fee, like where that goes, or does that get backed out against management fees that the LPS would be would be paying anyway, right? So there, I think that the just like any industry, as it grows and gets bigger it, it gets the attention of regulators, it gets the attention of lawmakers, and it wouldn’t surprise me if there were more transparency requirements around all the cash flows that are going back and forth between portfolio companies and the management company, for which is
Jeff Malec 1:03:12
weird. In my world of regulated futures and commodity pool operators, that’s already in place, there’s correct all sorts,
Dave Morehead 1:03:18
and that was and your business was around much earlier than you know, right? The build up and growth in the private fund universe. And so it’s not, it’s not a surprise, right? The the regulations and whatever that exist in your world at one point didn’t exist. And then there were some bad actors, whatever, and then there were regulations around that, etc. This happens in every industry, and so it wouldn’t surprise me if more of that is forthcoming on the private side, be
Jeff Malec 1:03:50
bad for the private jet industry. They can’t Well, I need this jet to fly out and see my private company. And yeah, Michigan, and how else am I supposed to get there?
1:04:01
Yeah, and
Jeff Malec 1:04:05
then, because you mentioned pod shops, are you guys invested in some pod shops? And there’s been a little bit of like, they’re getting too big. I guess it’s kind of what you’re saying. But what’s your thoughts on that as a strategy and where it fits kind of in a portfolio? Yeah,
Dave Morehead 1:04:17
there’s a number of things that we don’t do that doesn’t mean that they are bad things. They’re just we can’t do everything, and we have a particular strategy and approach to doing things. We don’t do private credit, we don’t do pod shops. At the end of the day, we are effectively running what the pod shops themselves are running, right? And we feel capable of allocating capital between managers and strategies on our own. So we don’t, we don’t feel like we need that additional help, if you will. You
Jeff Malec 1:04:50
don’t have a center book. Like, if one of them are on here, be like, well, the real strength and it is having a center book and offsetting risk in real time and yada yada. But,
Dave Morehead 1:04:59
yeah, I’ve. Think we, if you put, if you plot all of the endowments risk and return, I don’t believe that there are any endowments in the country that have our same level of risk and higher returns. So we’re doing just fine on the risk adjusted side of things.
Jeff Malec 1:05:19
Yeah, we don’t without a center, but we got it awesome. We’re gonna end I was, I forgot to say before, when you were talking about all the rankings, and you look at the other endowments performance every year, I can’t remember who puts it out, but they put out a graphic of the ivy League’s performance, and it drives me crazy because it’s not color coordinated. It has Dartmouth like red, and all the colors are different colors. I’m like, How easy would this be, to just put the school colors on each The
Dave Morehead 1:05:48
interesting thing is that in the Ivy Leagues, because the endowments are generally quite large, is that within the Ivy Leagues, every student newspaper up in the Ivy Leagues, yeah, produces that graph that is color coded, yeah, right, because they’re keeping track of how they’re doing versus the school up the road. Yeah. What
Jeff Malec 1:06:10
are the what’s the average in the ivy zone? 3545 Yeah, I don’t,
Dave Morehead 1:06:16
I don’t know. I think, I think Brown is the smallest at around eight so,
Jeff Malec 1:06:23
and Harvard’s like, 60, yeah, yeah. And what I was saying before I heard Princeton is has hit that place where just their distributions are covering the entire school. I think that’s I think that’s true. It was on a podcast. I can’t who’s the thinking fast guy, but he was saying, like, stop giving money. They don’t need any more money. He’s like, give it to your kids. Do something else. Stop giving them money. All right, let’s finish with something fun. Little do a little Mount Rushmore, um, and let’s ask your favorite bands. Who? What four bands would you put on your own personal band, Mount Rushmore. All right, so,
Dave Morehead 1:07:07
so you know, I grew up in the in the 80s, largely junior high and high school. So bands of choice at that time were, Van Halen, definitely, yes, you two, the cure. So the the 80s station on XM, or the 90s station is, is generally what my car radio is always on.
Jeff Malec 1:07:35
Got it? So that’s your that right there. That’s your four, Yeah, same again, was Van Halen definitely, you too, you too, for sure, that’s my number one, and the cure. And the cure, right? A lot of you two in there, I put the cure on there. Um, I went to see you two in the sphere in Vegas. Phenomenal.
Dave Morehead 1:07:58
My wife and I went to the 30th anniversary Joshua tour
Jeff Malec 1:08:04
in Chicago and soldier fans
Dave Morehead 1:08:05
up here in Dallas at the American Airlines center. All right, that was cool. It was at Jerry world. It was at the Dallas Cowboys Stadium. I
Jeff Malec 1:08:14
still haven’t been there. That’s super cool. Yeah, hopefully we’re getting one of those in Chicago soon. When they move the team out to Arlington Heights, I’d be fine with it if they build a big, huge, cool stadium like that. Yeah, of course, and get some better teams, right? Um, all right, Dave, it’s been fun. Thanks so much, of course. Thanks for having us keep fighting the fight down there. Yeah, we’re trying. All right. Thank you. Cheers.
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
