Lawrence “Larry” Kochard is the chief investment officer and CEO at the University of Virginia Investment Management Company, which has $8 billion in assets under management. Previously, Kochard served as the chief investment officer at Georgetown University and the managing director of equity and hedge fund investments at the Virginia Retirement System. Kochard holds a B.A. in economics from the College of William & Mary, an MBA from the University of Rochester and a Ph.D. in economics from the University of Virginia.
In this interview, Kochard discusses how UVIMCO sticks to its strengths to avoid a herd mentality, the difficulties of scaling a co-investment program and the evolution of his approach to markets and institutional investment over his tenured career as an asset allocator.
Kochard was recently named to Trusted Insight’s Top 30 Endowment Chief Investment Officers. He graciously spoke with Trusted Insight on February 24. The following interview has been condensed and edited for clarity.
Trusted Insight: The Yale Endowment model is ubiquitous throughout the industry. How do you see that strategy evolving over time?
Larry Kochard: It's a good question. First of all, most people think the endowment model is as simple as just having a lot of illiquid alternatives, but I would view it a little more nuanced than that. We, more than most asset owners, have an ability to think and act like long-term investors. So many investors have become increasingly short term, and as a part of that means you can handle more liquidity risk. I would agree with that, but I don't think it's as simple as saying we have a high degree of illiquid alternatives. It's more like we have this edge in being a long-term investor. Between the needs of the institution and the way most institutions are governed, that's attractive.
In terms of how that results in a lot to private investments, the challenge is as more money is allocated to private strategies, the prices that are paid by some of those private managers are going up, and we’re later in the economic cycle. Now this becomes tough.
There's now a better appreciation on the part of most investors that we're in a lower return world. Fees take a disproportionately larger part of the gross return. Private investments have continued to go up in terms of commitments. Managing that is difficult.
What does it mean for us? Where you saw many large endowments looking relatively similar over time, there might be more of a parting of people that have slightly different asset allocation strategies.
Trusted Insight: There is a finite amount of investments being pursued by near-infinite capital, which creates a herd mentality. How do you go about differentiating UVIMCO?
Larry Kochard: I'm a firm believer in playing to our strengths. Some of our allocation may be the result of some views that we have in terms of where there might be a lack of capital, and where there's relatively attractive pricing, which is getting harder and harder to find.
A big chunk of where we are, in terms of how we allocate, is playing to our strength. Across every strategy, there is a distribution of median performance for managers to bottom quartile to top quartile, to possibly top decile. We will have a greater or lesser allocation to something to the extent that there are certain strategies in which we have more of an advantage to understand that space, get access to the top managers, be able to identify upcoming managers early in their life cycle. Some of our allocation is influenced by that capability, which could change over time.
You don't want to say “Over the last year, or last five years, the top performing endowment had allocation of 10% or 20% to X and we only had 5%. Let's boost ours just because others were successful.” That's kind of exact opposite of the way it works here.
We are looking to find those areas where there are managers that have the ability to deploy capital in attractive prices and have an ability to make good investments, and we are better suited for identifying who these managers are and getting access to those managers. That strength will wax and wane over time and is influenced by the institution and its alumni.
Getting back to the endowment model, an advantage that endowments have relative to other asset owners, is the fact that we have alumni. It really helps us identify interesting opportunities and get access to those opportunities by leveraging that alumni network.
Trusted Insight: With the maturation of private markets, there is a push to various investment structures. Is there a fundamental change in private markets away from the two-and-20 model?
Larry Kochard: At an extreme, the way to get away from that is to just build that capability in house to do direct investing. It is unlikely we will be able to attract and keep people who are as good as those who work for top private equity firms. If they're that good, they probably would go out on their own and charge two and 20.
There have been other asset owners that have been more successful doing direct investing. Some of the large Canadian pensions have done a good job of building in-house capability on the private side, where they have the ability to write big checks. Again, getting back to the notion of playing to your strengths.
What we do instead, in order to cut into those fees, is look for opportunities to co-invest, or develop relationships with fundless sponsors. That way you can invest directly, but not within a high-fee fund structure. However, you must assess if there is an adverse selection problem. So, it’s about making sure you can get over that hurdle.
We look at co-investments, but it's hard to scale. We do a little more co-investments now than we used to, but it's not as though it’ll be a large percentage of what we do. I think if you try to scale it, it would not be additive to returns.
Another way you can try to cut into the fees is to develop relationships with groups early in their life cycle. This way you can be one of their cornerstone investors until they get their footing and carve out attractive fees. Again, I don't want to overemphasize that.
I think there's been a lot of asset owners that have talked about renegotiating fees. The challenge you come up with is that oftentimes those that are most willing to renegotiate are the funds that you may be less likely to want to be invested with. I don't want to overstate that either, but I think you are seeing some movement on that front, very little but some, and then, some co-investing.
Trusted Insight: You’ve been with UVIMCO for six years. With respect to your long-term perspective, in what nuanced ways has your approach to the portfolio changed over that period?
Larry Kochard: In terms of what's changed, it is pretty nuanced. A) Our total allocation to private investments has been slowly going down. B) I have a greater appreciation for the need to, when something is less liquid, have it be appropriately sized as a smaller part of the portfolio over time. C) There are a number of active managers that we've used historically to add value net of what you could get from a passive exposure. When you really properly account for that, I don't think the alpha may be quite as strong as what people may have believed, historically.
We stick with our managers for a long time. There’s a constant replenishing. Sometimes when managers get too big, we replace them with managers that are smaller and earlier in their life cycle. That constantly evolves. I don't think there's any big dramatic change that I've seen.
Trusted Insight: What are the private market allocations being replaced by over time?
Larry Kochard: That's a good question. What has replaced that over time are more concentrated public managers. These are managers that take a friendly approach to activism and take a private equity approach to investing in the public market. Some of those strategies are still relatively high fee and are also relatively illiquid versus a typical public equity manager. They're also relatively low turnover, meaning they're holding their positions for years. They develop close relationships with the company and are able to truly act like a long-term shareholder in a constructive way, as opposed to just being a passive shareholder.
It's about looking at companies and being able to try to add value to companies in a similar way to private managers. Although there's a lot more in the way of activism today than in the past, it's still attractive relative to what has become an increasingly competitive environment for a lot of private strategies.
But again, has that been a big change? No. It's been a very small change.
Trusted Insight: What topics are you and your staff grappling with right now?
One of the things that we try to stay focused on is not getting paralyzed or fixated on our inability to forecast those things; sticking to our knitting of partnering with great managers for long periods of time; and making sure we can find new ones and know when to trim existing ones.
With that said, are there other long-term themes in which we can really make an overweight to and stick with that for a long period of time? And again, it's been harder to find some of those more recently. I think the big thing is to just not become paralyzed with a lot of these macro fears.
Trusted Insight: There's been an increasing number and sophistication of institutional investment offices. Does that present a challenge in differentiating from the herd?
Larry Kochard: The number of additional competitors has been a growing concern. That makes our ability to get access to great funds that much more difficult. Not only has it been an issue, but it will continue to be an issue for us.
That's why we need to, in addition to trying to find those managers, think of some themes that we can capitalize on. What are ways to differentiate ourselves from some of those other investors, as we are long-term partners with some of these great managers? Without a doubt, that creates a challenge for us.
Trusted Insight: I’m in the process of reading your book, where you interview a number of CIOs. If you were to conduct a similar CIO interviews today, what would you ask them?
Larry Kochard: Wow, that's a really good question. I think some of the questions you asked are really good. How have your views changed?
Getting back to that question of how I’ve changed, I laid out the different asset classes in the first few chapters of the book, whether it was private equity, hedge funds, real estate, etc. The evolution that I've made from then to today, which started at Georgetown and has continued here, is the notion that endowments should not be filling up buckets.
Instead, we have an overall level of market risk, which is influenced by these three broad asset classes, which are public equity, public bonds and public real estate. Equities, bonds and real assets. That sets a certain level of market risk that we want to attain, but then we manage to that level of market risk by finding what we think are the best assets across an array of different levels of risky assets. The riskiest are venture capital, and the lowest risk being cash, in terms of just volatility. That sets a market risk budget.
Then we separately have a liquidity risk budget that is a maximum amount of illiquidity we're able to handle, in terms of unfunded commitments, as well as percentage of our pool that can be turned into cash within a certain period of time. When we assess whether we should allocate to a real estate manager, a resources manager or a buyout manager, they’re all competing for this unfunded commitment capital. This is a certain cost to us.
It leads to a very different way of thinking about investments, as opposed to just saying, we're gonna have a certain target allocation to real estate, a certain target allocation to buy-out, a certain target allocation to venture. We try to allocate and commit to a level that gets us to that target. It allows us to be a little more thoughtful and play some of those opportunities against each other.
Getting back to your prior question, I would actually turn this question to each of the CIOs: How have your thoughts evolved over time, in terms of how you think about what influences the way you allocate to different strategies? That's why I call them strategies and not asset classes.
At an extreme, there've been some institutions that have gone even further than this. Ultimately, the big risk that I have in my portfolio is equity market risk, and I manage to an equity market risk that is equivalent to a beta of about 0.7 to public equities.
At the extreme, the other institutions that take on the smart beta have said, "We're gonna have a target to equity risk, and then a target to these other factor exposures -- say value, or small cap, or quality. Maybe we'll match 'em.”
The reason I don't go quite that far is in that all of our investments, for the most part, are in commingled funds with varying degrees of transparency. I don't think I have enough data to truly understand what those factor exposures are. It's hard to estimate with any degree of confidence. I think it gives people a false sense of precision.
Your exposure to equity market sensitivity or risk, since that really drives most movement in returns, is easier to get your arms around. That's why I have this middle ground, versus others that have gone even further of managing to these factor exposures. We just manage to one factor exposure: equity risk.
I would ask some of the CIOs how their thinking has evolved. Are they just trying to fill up buckets? On our team, another thing that's changed is I've moved to more of a generalist approach, where people have their specialty, but people on the team actually have an ability to get involved outside of that specialty. Everything is very team oriented, in terms of the way we approach thinking on any one investment. That way you just don't have the real estate person finding more real estate to fill up a real estate bucket.
I would ask the other CIOs: has their thinking evolved on that front, both in terms of the way they think about those asset classes, as well as the way they've organized their teams to manage on a day-to-day business?
I think there are more people that use that now than if you go back ten years, when we wrote the book. You can tell by writing the book, that it wasn’t the way I was operating. It was shortly after writing the book that my thinking on the matter actually evolved.
See the full list of Top 30 Endowment Chief Investment Officers here. View Trusted Insight's full library of Q&As here.
In this interview, Kochard discusses how UVIMCO sticks to its strengths to avoid a herd mentality, the difficulties of scaling a co-investment program and the evolution of his approach to markets and institutional investment over his tenured career as an asset allocator.
Kochard was recently named to Trusted Insight’s Top 30 Endowment Chief Investment Officers. He graciously spoke with Trusted Insight on February 24. The following interview has been condensed and edited for clarity.
Trusted Insight: The Yale Endowment model is ubiquitous throughout the industry. How do you see that strategy evolving over time?
Larry Kochard: It's a good question. First of all, most people think the endowment model is as simple as just having a lot of illiquid alternatives, but I would view it a little more nuanced than that. We, more than most asset owners, have an ability to think and act like long-term investors. So many investors have become increasingly short term, and as a part of that means you can handle more liquidity risk. I would agree with that, but I don't think it's as simple as saying we have a high degree of illiquid alternatives. It's more like we have this edge in being a long-term investor. Between the needs of the institution and the way most institutions are governed, that's attractive.
In terms of how that results in a lot to private investments, the challenge is as more money is allocated to private strategies, the prices that are paid by some of those private managers are going up, and we’re later in the economic cycle. Now this becomes tough.
There's now a better appreciation on the part of most investors that we're in a lower return world. Fees take a disproportionately larger part of the gross return. Private investments have continued to go up in terms of commitments. Managing that is difficult.
What does it mean for us? Where you saw many large endowments looking relatively similar over time, there might be more of a parting of people that have slightly different asset allocation strategies.
Trusted Insight: There is a finite amount of investments being pursued by near-infinite capital, which creates a herd mentality. How do you go about differentiating UVIMCO?
Larry Kochard: I'm a firm believer in playing to our strengths. Some of our allocation may be the result of some views that we have in terms of where there might be a lack of capital, and where there's relatively attractive pricing, which is getting harder and harder to find.
A big chunk of where we are, in terms of how we allocate, is playing to our strength. Across every strategy, there is a distribution of median performance for managers to bottom quartile to top quartile, to possibly top decile. We will have a greater or lesser allocation to something to the extent that there are certain strategies in which we have more of an advantage to understand that space, get access to the top managers, be able to identify upcoming managers early in their life cycle. Some of our allocation is influenced by that capability, which could change over time.
It is unlikely we will be able to attract and keep people who are as good as those who work for top private equity firms. If they're that good, they probably would go out on their own and charge two and 20.
You don't want to say “Over the last year, or last five years, the top performing endowment had allocation of 10% or 20% to X and we only had 5%. Let's boost ours just because others were successful.” That's kind of exact opposite of the way it works here.
We are looking to find those areas where there are managers that have the ability to deploy capital in attractive prices and have an ability to make good investments, and we are better suited for identifying who these managers are and getting access to those managers. That strength will wax and wane over time and is influenced by the institution and its alumni.
Getting back to the endowment model, an advantage that endowments have relative to other asset owners, is the fact that we have alumni. It really helps us identify interesting opportunities and get access to those opportunities by leveraging that alumni network.
Trusted Insight: With the maturation of private markets, there is a push to various investment structures. Is there a fundamental change in private markets away from the two-and-20 model?
Larry Kochard: At an extreme, the way to get away from that is to just build that capability in house to do direct investing. It is unlikely we will be able to attract and keep people who are as good as those who work for top private equity firms. If they're that good, they probably would go out on their own and charge two and 20.
There have been other asset owners that have been more successful doing direct investing. Some of the large Canadian pensions have done a good job of building in-house capability on the private side, where they have the ability to write big checks. Again, getting back to the notion of playing to your strengths.
What we do instead, in order to cut into those fees, is look for opportunities to co-invest, or develop relationships with fundless sponsors. That way you can invest directly, but not within a high-fee fund structure. However, you must assess if there is an adverse selection problem. So, it’s about making sure you can get over that hurdle.
We look at co-investments, but it's hard to scale. We do a little more co-investments now than we used to, but it's not as though it’ll be a large percentage of what we do. I think if you try to scale it, it would not be additive to returns.
Another way you can try to cut into the fees is to develop relationships with groups early in their life cycle. This way you can be one of their cornerstone investors until they get their footing and carve out attractive fees. Again, I don't want to overemphasize that.
I think there's been a lot of asset owners that have talked about renegotiating fees. The challenge you come up with is that oftentimes those that are most willing to renegotiate are the funds that you may be less likely to want to be invested with. I don't want to overstate that either, but I think you are seeing some movement on that front, very little but some, and then, some co-investing.
Trusted Insight: You’ve been with UVIMCO for six years. With respect to your long-term perspective, in what nuanced ways has your approach to the portfolio changed over that period?
Larry Kochard: In terms of what's changed, it is pretty nuanced. A) Our total allocation to private investments has been slowly going down. B) I have a greater appreciation for the need to, when something is less liquid, have it be appropriately sized as a smaller part of the portfolio over time. C) There are a number of active managers that we've used historically to add value net of what you could get from a passive exposure. When you really properly account for that, I don't think the alpha may be quite as strong as what people may have believed, historically.
We stick with our managers for a long time. There’s a constant replenishing. Sometimes when managers get too big, we replace them with managers that are smaller and earlier in their life cycle. That constantly evolves. I don't think there's any big dramatic change that I've seen.
Trusted Insight: What are the private market allocations being replaced by over time?
Larry Kochard: That's a good question. What has replaced that over time are more concentrated public managers. These are managers that take a friendly approach to activism and take a private equity approach to investing in the public market. Some of those strategies are still relatively high fee and are also relatively illiquid versus a typical public equity manager. They're also relatively low turnover, meaning they're holding their positions for years. They develop close relationships with the company and are able to truly act like a long-term shareholder in a constructive way, as opposed to just being a passive shareholder.
It's about looking at companies and being able to try to add value to companies in a similar way to private managers. Although there's a lot more in the way of activism today than in the past, it's still attractive relative to what has become an increasingly competitive environment for a lot of private strategies.
But again, has that been a big change? No. It's been a very small change.
Trusted Insight: What topics are you and your staff grappling with right now?
The number of additional competitors has been a growing concern. That makes our ability to get access to great funds that much more difficult. Not only has it been an issue, but it will continue to be an issue for us.Larry Kochard: The thing that everyone grapples with are a lot of the geopolitical risks right now, but I don't they're any bigger now than they've ever been. People always think the current geopolitical risks are higher than ever, but, whether it's what is happening in Europe, or what's happening in China, or what's happening with the politics in the U.S., there are too many people that try to predict some of those outcomes and fail.
One of the things that we try to stay focused on is not getting paralyzed or fixated on our inability to forecast those things; sticking to our knitting of partnering with great managers for long periods of time; and making sure we can find new ones and know when to trim existing ones.
With that said, are there other long-term themes in which we can really make an overweight to and stick with that for a long period of time? And again, it's been harder to find some of those more recently. I think the big thing is to just not become paralyzed with a lot of these macro fears.
Trusted Insight: There's been an increasing number and sophistication of institutional investment offices. Does that present a challenge in differentiating from the herd?
Larry Kochard: The number of additional competitors has been a growing concern. That makes our ability to get access to great funds that much more difficult. Not only has it been an issue, but it will continue to be an issue for us.
That's why we need to, in addition to trying to find those managers, think of some themes that we can capitalize on. What are ways to differentiate ourselves from some of those other investors, as we are long-term partners with some of these great managers? Without a doubt, that creates a challenge for us.
Trusted Insight: I’m in the process of reading your book, where you interview a number of CIOs. If you were to conduct a similar CIO interviews today, what would you ask them?
Larry Kochard: Wow, that's a really good question. I think some of the questions you asked are really good. How have your views changed?
Getting back to that question of how I’ve changed, I laid out the different asset classes in the first few chapters of the book, whether it was private equity, hedge funds, real estate, etc. The evolution that I've made from then to today, which started at Georgetown and has continued here, is the notion that endowments should not be filling up buckets.
Instead, we have an overall level of market risk, which is influenced by these three broad asset classes, which are public equity, public bonds and public real estate. Equities, bonds and real assets. That sets a certain level of market risk that we want to attain, but then we manage to that level of market risk by finding what we think are the best assets across an array of different levels of risky assets. The riskiest are venture capital, and the lowest risk being cash, in terms of just volatility. That sets a market risk budget.
Then we separately have a liquidity risk budget that is a maximum amount of illiquidity we're able to handle, in terms of unfunded commitments, as well as percentage of our pool that can be turned into cash within a certain period of time. When we assess whether we should allocate to a real estate manager, a resources manager or a buyout manager, they’re all competing for this unfunded commitment capital. This is a certain cost to us.
It leads to a very different way of thinking about investments, as opposed to just saying, we're gonna have a certain target allocation to real estate, a certain target allocation to buy-out, a certain target allocation to venture. We try to allocate and commit to a level that gets us to that target. It allows us to be a little more thoughtful and play some of those opportunities against each other.
Getting back to your prior question, I would actually turn this question to each of the CIOs: How have your thoughts evolved over time, in terms of how you think about what influences the way you allocate to different strategies? That's why I call them strategies and not asset classes.
At an extreme, there've been some institutions that have gone even further than this. Ultimately, the big risk that I have in my portfolio is equity market risk, and I manage to an equity market risk that is equivalent to a beta of about 0.7 to public equities.
At the extreme, the other institutions that take on the smart beta have said, "We're gonna have a target to equity risk, and then a target to these other factor exposures -- say value, or small cap, or quality. Maybe we'll match 'em.”
The reason I don't go quite that far is in that all of our investments, for the most part, are in commingled funds with varying degrees of transparency. I don't think I have enough data to truly understand what those factor exposures are. It's hard to estimate with any degree of confidence. I think it gives people a false sense of precision.
Your exposure to equity market sensitivity or risk, since that really drives most movement in returns, is easier to get your arms around. That's why I have this middle ground, versus others that have gone even further of managing to these factor exposures. We just manage to one factor exposure: equity risk.
I would ask some of the CIOs how their thinking has evolved. Are they just trying to fill up buckets? On our team, another thing that's changed is I've moved to more of a generalist approach, where people have their specialty, but people on the team actually have an ability to get involved outside of that specialty. Everything is very team oriented, in terms of the way we approach thinking on any one investment. That way you just don't have the real estate person finding more real estate to fill up a real estate bucket.
I would ask the other CIOs: has their thinking evolved on that front, both in terms of the way they think about those asset classes, as well as the way they've organized their teams to manage on a day-to-day business?
I think there are more people that use that now than if you go back ten years, when we wrote the book. You can tell by writing the book, that it wasn’t the way I was operating. It was shortly after writing the book that my thinking on the matter actually evolved.
See the full list of Top 30 Endowment Chief Investment Officers here. View Trusted Insight's full library of Q&As here.