Every portfolio -- and at a more granular level, every investor -- is comprised of differences in strategy, thought process and ideology. It is these nuances that lead a portfolio in one direction over another. In Trusted Insight’s extensive interviews, we asked LPs to describe their investment philosophy, both in terms of their personal philosophy and the philosophy dictated by the needs of the institution. One key theme, regardless of the strategy, was to stick to your beliefs -- no matter what.
We have interviewed over 40 institutional investors. In this week's edition of Trusted Answers, we look at different investment philosophies:
The most impactful lesson that I took from my time at the Yale endowment was the value of a consistent philosophy. The value of having a set of rational beliefs regarding investing and sticking with a consistent set of principles over time.
We tend to have a little bit of a contrarian streak to us. We also, because of the vision of helping to find investments and fund ventures that help to create a world of peace, prosperity and sustainability, end up liking a lot of technologies or sectors that others may be very bearish about.
For example, we continue to be heavily focused on clean energy. If we want to invest in great opportunities, and we want to take advantage of the long-term nature, one of the technologies that may be more controversial that could have a huge impact if they are successful is nuclear fusion. We have one company that’s focused on nuclear fusion.
Basically, we continue to like complex engineering problems that may at first be a stretch and feel too ambitious, but may end up solving some of the world’s biggest problems at the end of the day. In that case, many of the investments that I quoted you earlier, such as Tesla or SpaceX, are ones that fit this type of criteria very well.
...Staying mission aligned is important, which for us means making investments that we think will solve big problems in the world, but also benefit all of us and of course the capital behind us financially. When you make good choices, sometimes you don’t have to give up financial returns. When you make good choices for the world, and when you find opportunities and investments that can potentially solve huge world problems, sometimes things work out financially as well. That is also a great way for one to stay passionate about your work. Find a way to feel very passionate about your work, and it’s a great way to wake up in the morning.
As I often describe, our mission alignment is a great way to get me up in the morning and get me excited about the day ahead. The endowment-style portfolio allocation approach gives me the “sleep at night” insurance.
Over my career, I’ve compounded assets by using a value-investing philosophy. Investing on a bottom-up basis in strong cash flows results in better downside protection. If we win in the declines, we will compound returns ahead of our benchmarks with lower volatility.
I have lived the benefit of value investing. Let me give you an example. The pension fund I was running in the late 1990’s dot-com era was invested in a great portfolio of cash flows, while the dot-com investors were invested in pieces of worthless paper. While the portfolio lagged the tech stocks, we did pretty well. But the real benefit came later. In the subsequent bear market from 2000-2002, our assets actually appreciated while the markets were in sharp declines. Obviously this doesn’t always happen, as we learned in 2008, but it shows how value investing can compound over time with lower volatility. In 2008, our assets certainly fell, but by a lot less than the benchmarks. We can win by losing less. The key to doing this right is in keeping the foundation’s board of trustees educated on this philosophy. They need to understand that, at times, the portfolio may perform very differently than the markets.
People often say portfolio construction is more art than science, but know what each investment in your portfolio is bringing to the table...
Do the work, do the reference calls, look at the data, trust but verify. It's very easy to get caught up in trends or flashy investments.
People often say portfolio construction is more art than science, but know what each investment in your portfolio is bringing to the table and understand how the different pieces work together.
You don’t have to be right all the time. You just have to be right 51% of the time. And you have to be more committed to your winners than your losers.
I would say that my philosophy is to look for inefficiencies, to be a value investor and to take advantage of the fact that we have really long-term capital. We really look for opportunities where people who have a short-term mindset can’t play effectively. I think that’s the only thing that really differentiates us. Also our size. We are big enough to be relevant, but small enough that we can go into esoteric markets.
That’s fundamentally how we invest. We analyze inefficient assets, assess how they compare to each other, their risk-reward tradeoffs and we focus a lot on manager selection.
We understand very clearly that we are in the business of taking risk, and we know that we have to do that. Our job is to take risk and mitigate it. That’s the philosophy on this team and we try to impress upon the team that everything is not going to go well.
It’s something I learned once I got to the Ford Foundation, because the woman I reported to said to me ‘You don’t have to be right all the time. You just have to be right 51% of the time. And you have to be more committed to your winners than your losers.’
That’s the philosophy we have here. I tell people all the time, “If you are afraid to take risk, then we are never going to make money. There’s not a problem if we make an investment and it doesn’t go well. There is a problem if we make an investment and something happens that we did not price into our underwriting.
So if a risk happens that we had no idea about and we are caught off guard, then the team has failed, because the team is supposed to identify potential risks. If something happens and we knew it was a risk, that’s just what investing is. We underwrote to that, and the return potential hopefully compensated us for that. There is a real push for us to identify risk and be able to decide for ourselves how much money it’s going to cost to take on that risk.
It’s tough to encapsulate an investment philosophy in just a couple of sentences.
A couple key takeaways that I can share: It is very difficult to time markets. It is important to come up with a strategy that is independent of being able to successfully time markets because it’s so challenging.
...I would argue that one of the great strengths of endowments is the ability to withstand illiquidity. It’s probably the perfect investment vehicle from that perspective. When we are looking at markets and people are clamoring for liquidity, it’s usually the endowments that are in a position to say “We don’t need liquidity. We need long-term returns. We need to maintain the purchasing power of the portfolio over long periods of time.”
The starting point for investing is to consider the financial model for the organization whose funds are being invested. What are the objectives? What are the cash flows in? What are the cash flows out? How much predictability is there, and how much control do you have over those flows? That is fundamental to determining your risk tolerance.
My investment philosophy is basically to have a long-term view, find the highest quality managers you can, have a concentrated portfolio so that you fully understand what your managers are doing, and what assets are in your portfolio underlying your manifest.
We are an investment thesis-driven company. We're about 80% thesis-driven and 20% opportunistic, meaning we study the market and identify profit pools that can be disrupted or created. Then, we look for winning business models, compared to just looking at a thousand deals and only picking a handful.
We look at company team first and foremost—having a strong team with a track record of success is a critical hurdle for us. We have a strong philosophy around people. As a corporation, GE is renowned for identifying talent and developing it. We also keep in-house several EIRs (Entrepreneurs In Residence) that we work with to identify markets, and even start new companies.
We also look for the ability for business models that create a sustainable and first-mover competitive advantage. We study the friction points of market value chain. We also understand where there are arbitrage opportunities, and where incumbent business models are more likely to be disrupted. From a technology perspective, we're big fans of protectable solutions, whether a trade secret or IP-based.
Lastly, we like to look for ways that we can put a finger on the scale. If we have competitive advantages that benefit a portfolio company, we use that to our advantage.
Noah Lewis, Managing Director, GE Ventures
Read the full interview here.
Trusted Answers is a weekly series that delves into some of the most pertinent issues within institutional investing, and shares some of the insightful responses from the 40+ institutional investors we have interviewed in the past year. Take a look at some of our other Trusted Answers.