# How Sovereign Wealth Funds Create Alpha w/Peter Madsen Markdown copy of https://realalpha.app/v/-atCCMK1GYw/ on Real Alpha, the best minutes from long interviews with the people building AI. Cite and link the page, not this copy. Peter Madsen argues that factor-aware allocations, smaller venture funds and lower-fee structures can help a small sovereign fund pursue alpha. - Show: How I Invest - Hosts: [David Weisburd](https://realalpha.app/people/david-weisburd/) - Guest: [Peter Madsen](https://realalpha.app/people/peter-madsen/) is CIO of the Utah School & Institutional Trust Funds Office (SITFO). - Published: Dec 12, 2025 - Length: 33 min ## The best minutes - [2:01](https://realalpha.app/v/-atCCMK1GYw/?t=121) [Passive benchmarks can concentrate risk as small caps change](https://realalpha.app/s/passive-benchmarks-can-concentrate-risk-as-small-caps-change/) (5 min) - [15:55](https://realalpha.app/v/-atCCMK1GYw/?t=955) [Smaller venture funds have a more achievable path to high returns](https://realalpha.app/s/smaller-venture-funds-have-a-more-achievable-path-to-high/) (4 min) - [23:00](https://realalpha.app/v/-atCCMK1GYw/?t=1380) [Co-invest structures can reduce private-market fee drag](https://realalpha.app/s/co-invest-structures-can-reduce-private-market-fee-drag/) (4 min) ## Also worth watching - [7:41](https://realalpha.app/v/-atCCMK1GYw/?t=461) [SITFO used equal weights, then shifted small caps to private equity](https://realalpha.app/s/sitfo-used-equal-weights-then-shifted-small-caps-to-private/) (4 min) - [11:41](https://realalpha.app/v/-atCCMK1GYw/?t=701) [Factor analysis reveals risks hidden across asset classes](https://realalpha.app/s/factor-analysis-reveals-risks-hidden-across-asset-classes/) (4 min) - [27:11](https://realalpha.app/v/-atCCMK1GYw/?t=1631) [AI gathers manager diligence while investment decisions stay human](https://realalpha.app/s/ai-gathers-manager-diligence-while-investment-decisions-stay/) (5 min) Skip the two-minute career origin, the venture-education and sourcing discussion, and the brief sovereign-fund mechanics and closing. ## Full analysis: Peter Madsen says SITFO shifted small caps over about five years - SITFO has moved small-cap exposure toward private equity over about five years. - Madsen is unsure today’s small caps still resemble the companies behind the old premium. - The shift is a thesis to test against private-market costs, access, and distributions. Its 7 sections, what it means for you and what to watch are on [the page](https://realalpha.app/v/-atCCMK1GYw/#analysis), free with an account: - [5:44](https://realalpha.app/v/-atCCMK1GYw/?t=344) Today’s small-cap index may not hold the old premium - [3:46](https://realalpha.app/v/-atCCMK1GYw/?t=226) Passive benchmarks can concentrate the risk they mute - [9:35](https://realalpha.app/v/-atCCMK1GYw/?t=575) SITFO shifted small caps over about five years - [14:15](https://realalpha.app/v/-atCCMK1GYw/?t=855) Factor analysis tests whether diversification is real - [18:46](https://realalpha.app/v/-atCCMK1GYw/?t=1126) Smaller venture funds make large outcomes more plausible - [25:54](https://realalpha.app/v/-atCCMK1GYw/?t=1554) Co-invest terms matter most where returns are capped - [28:48](https://realalpha.app/v/-atCCMK1GYw/?t=1728) AI can clear diligence work, not make the call ## Summary Peter Madsen is chief investment officer of the Utah School & Institutional Trust Funds Office (SITFO). He joined as its first investment hire after running hedge fund portfolios in London at Cube Capital and working with similar state entities at RVK. Madsen says SITFO has shifted capital from small-cap public stocks into private equity as he questioned whether today's small caps retain the old premium. He argues that mean reversion makes out-of-favor markets worth investigating, while passive benchmarks can become concentrated and rules-based strategies offer a middle ground between passive and discretionary active management. He favors smaller venture funds and collaborative partnerships, including co-invest structures that reduce fee drag, and uses AI to organize manager diligence rather than make investment decisions. He says SITFO's permanent capital, school beneficiaries and land-revenue inflows shape how it plans distributions. ### Minute by minute - [0:00](https://realalpha.app/v/-atCCMK1GYw/?t=0) **Leaving hedge funds opened a new path.** Peter Madsen said he left Cube Capital after investors increasingly preferred private markets to hedge funds and the firm decided to wind down. A recruiter later connected him with Utah, where he became the first hire in a new effort to professionalize the trust's investment operation. - [2:39](https://realalpha.app/v/-atCCMK1GYw/?t=159) **Mean reversion favors out-of-favor markets.** Madsen said mean reversion remains real, particularly in active management, where results can come in waves. He recommended investigating managers and markets that have been out of favor or are down. - [3:24](https://realalpha.app/v/-atCCMK1GYw/?t=204) **Passive benchmarks make an active choice.** Madsen said passive benchmarks can become more concentrated over a market cycle and may mainly mitigate career or benchmark-relative risk. SITFO uses some passive investments for liquidity, but also uses rules-based public-equity strategies that combine factors such as value, momentum and quality. - [5:08](https://realalpha.app/v/-atCCMK1GYw/?t=308) **Madsen questions today's small-cap premium.** Madsen said he expects value to return but sees its performance as cyclical, with monetary policy and AI excitement extending the current growth cycle. He questioned whether today's small companies resemble those of the past, noting that fewer strong companies go public at a small size. - [7:16](https://realalpha.app/v/-atCCMK1GYw/?t=436) **An equal-weight start shifted toward private equity.** Madsen said SITFO began asset allocation from an equal-weighted portfolio, then used optimization and stress tests while accounting for its resources and incoming land revenues, mostly from oil and gas and real estate development. As its private-equity program matured, it reduced small-cap exposure and redirected it to private equity over about five years. He argued that optimizing for Sharpe ratio can rely too heavily on historical inputs and that a portfolio can accept volatility when it needs higher returns. - [11:41](https://realalpha.app/v/-atCCMK1GYw/?t=701) **Factor analysis reveals portfolio-wide risk.** Madsen described SITFO's approach as purpose-driven: broad categories give the team flexibility, while factor analysis helps it understand the risks across public and private holdings. He said the team wants either intentional factor overweights or neutral exposure with a high residual. SITFO moved from MPI to Venn, which he said offered a more user-friendly interface for its small team. - [15:55](https://realalpha.app/v/-atCCMK1GYw/?t=955) **Smaller venture funds can target larger outcomes.** Madsen said SITFO initially set venture aside because it expected strong performance to require access to well-known firms. He later favored early-stage managers and smaller funds, arguing that smaller checks and deals can make a 5x outcome more attainable. He said a $100,000,000 fund may need five unicorns to reach 5x. - [20:12](https://realalpha.app/v/-atCCMK1GYw/?t=1212) **Fund-of-funds partnerships can build access.** Madsen said SITFO's small team found it difficult to build venture exposure and select managers on its own. In hindsight, he said it could have used a fund-of-funds or collaborative model earlier, then built its own capabilities over time. SITFO later worked with fund-of-funds as scout or sourcing partners. - [23:00](https://realalpha.app/v/-atCCMK1GYw/?t=1380) **Co-invest structures reduce fee drag.** Madsen said commercial partnerships can provide research, data, software or advisory support and free SITFO to focus on less conventional investments. In some private-market co-invest accounts, he said SITFO avoids management fees, carry and fees on committed capital. He described the resulting reduction in fee drag as structure alpha. - [27:00](https://realalpha.app/v/-atCCMK1GYw/?t=1620) **AI can accelerate diligence, not decide.** Madsen said confidentiality concerns initially kept SITFO from using ChatGPT with manager materials. Its newer AI workflow does not make investment decisions; it gathers and organizes diligence information, including ownership, fees and terms that may be red flags. He said this gives the team more time to assess a manager's culture and investment philosophy. - [31:42](https://realalpha.app/v/-atCCMK1GYw/?t=1902) **Permanent capital links returns to school payouts.** Madsen said SITFO has perpetual capital and serves K–12 public schools, with payments going directly to the schools. The team also has to forecast land-revenue inflows and manage cash flows so that distributions are not disruptive. ## Transcript How I Invest, hosted by David Weisburd, with Peter Madsen. From the transcript How I Invest publishes with the episode. [0:00](https://realalpha.app/v/-atCCMK1GYw/?t=0) Peter, before SITFO, you ran money in London via pension plans. What drew you to building a sovereign wealth fund in Utah? Well, candidly, the the last dying breaths, if you will, of the fund to fund industry, were taking place. And we although where I was working prior, Cube Capital, we had a strong track record, strong team. When I joined, we were managing about 1,000,000,000 across some direct funds and fund to fund strategy, And but after about five years, we were still at about 1,000,000,000, you know, money coming in, being raised as part of our expansion into North America and some other markets outside of just, The UK. [0:39](https://realalpha.app/v/-atCCMK1GYw/?t=39) And the, but at that same, there were a few, like closely linked investors that all decided they'd rather be in private markets than hedge funds. And so we, the partners decided to wind down and that gave me a nice long runway of, you know, where to spend my next half of my career, so to speak. So I went to the headhunter person and I said, Hey, I'd like to be CIO in like a mountain town or beach town at a college university or foundation. And she literally laughed in my face and said, and everyone else. And then it just a month or maybe not even two months after she reached back out and said, you know, you're not gonna believe this, but Utah has, the sovereign wealth fund and they're looking, you know, the money's old as I like to say, but either there was no office, so that the effort was new in terms of professionalizing it. [1:26](https://realalpha.app/v/-atCCMK1GYw/?t=86) And I would be the first hire if I were lucky enough to get it. I had, while I was at RVK, I had, we had clients that were this very same type of entity or structure, and I worked really closely with the state of Oklahoma, You know, even worked lobbying to try and help them amend their constitution to help, you know, modernize that trust. So I had a lot of experience with the potential and, you know, how it could grow or be structured, especially if it was going to be brand new. And, you know, sure enough, it's, you know, it's ten years later now, but it worked out that it was an entrepreneurial endeavor, though, you know, in, you know, being part of the state of Utah, still quite entrepreneurial, still a huge challenge. [2:02](https://realalpha.app/v/-atCCMK1GYw/?t=122) At theCUBE, you seem to have a good fund in a bad market. Now on the other side, as a CIO, how important is being in the right market for a fund manager, and how do you assess that as part of a fund manager success? I don't even know if I'd say it was a bad market so much as just people were deciding they were skilled enough to pick their own hedge funds, but then when they were picking their own hedge funds, they were kind of sorting by AUM or brand name and starting from the top. And so if you had a small hedge fund or a fund of funds is you're neither, and so that, you know, the industry kind of went went the way it did. [2:37](https://realalpha.app/v/-atCCMK1GYw/?t=157) And now now that we're here and we're you know, we've developed our beliefs in advance of making investments, we iterate on our beliefs. And one of our beliefs is that, you know, the the I mean, I guess two of our beliefs come to mind, but one is that mean reversion is real. It may not seem like it, and public equities, The US stock market, etcetera, but especially active management, you know, it comes and goes in waves for the most part, especially if it's a meaningful in size, you know, very low small numbers, very low vol that might be persistent. But everyone wants higher returns, tends to come with some vol, and it tends to come in waves. [3:12](https://realalpha.app/v/-atCCMK1GYw/?t=192) And so you should be looking at or investigating either managers or markets that have been out of favor or are down and out. And where do you sit on this active versus passive debate, and what are the variables that you're looking to ascertain the market, whether you should be more active or passive? We we have some passive that can be useful for, you know, liquidity sleeve. But if you don't have a huge concern around tracking error and you are, what I'd like to say is, like, you know, people refer to the total portfolio approach or, you know, being outcome oriented unless benchmark driven. You look at passive benchmarks. [3:48](https://realalpha.app/v/-atCCMK1GYw/?t=228) **Peter Madsen:** They're sort of a active decision and that you chose to participate in passive. They tend to be momentum in nature, and each cycle, they tend to become more and more [3:58](https://realalpha.app/v/-atCCMK1GYw/?t=238) concentrated or less diversified. And if the idea is that it's, supposed to be mitigating risk, I think the only real risk it mitigates is, maybe career risk or, you know, benchmark relative risk. And, but it you know, on the other hand, it may give you back some bandwidth or spare you the headaches of active management. We kind of took a middle ground approach where we do have some passive, but we have a lot of what we call rules based strategies in especially in public equity. And that, for example, what, you know, you think of, like, value, momentum, quality, weight those a certain way, hold a certain number of names. [4:35](https://realalpha.app/v/-atCCMK1GYw/?t=275) You're getting broad market exposure. You're getting a beta of one. You're screening out, you know, bad companies, including companies that aren't terribly expensive and have some momentum. And that seems to me to be a a low cost kind of reasonable approach to diversification that while it does include some tracking error or career risk, I think it's from a total portfolio perspective, it's a better trade off. And Fama French came up with this three factor model. Ken French was my professor in business school, which basically weighed at small in value stocks versus, I guess, the opposite is growth large in growth stocks. [5:09](https://realalpha.app/v/-atCCMK1GYw/?t=309) Do have philosophical stance on where the future of the public markets are? Some people say value is a thing of the past. What do you say? I I think value is will make its way back, but I think it's, you know, it's something that isn't you know, it is mean reverting. It is cyclical. We're in a really long kind of odd cycle, I think, in terms of the value versus growth. It you know, what happened in the nineties, it was pretty long. But sit post GFC with monetary policy and then now with the AI and, you know, the excitement around AI, I think it's just extending that cycle. Something I'm more convinced of is that the small cap premium, I think the market structure has changed, and I'm not sure the small caps of today are the same as the small caps of years past. [5:54](https://realalpha.app/v/-atCCMK1GYw/?t=354) There's been decent amount of ink spilt on this, And I think that's one area where I've we've changed our minds on thinking that, you know, because small cap has been out of favor and because valuations have been more attractive, that that should be a, you know, a long term overweight. So in small cap land, we're looking for things that can do that, and that means, you know, concentrated, you know, micro caps that you hope get taken out or, for example, we have biotech hedge fund exposure as part of our small cap exposure. The CIO of Hurdle Callahan, Brad Conger, and he actually believes that small public companies are fundamentally different than they were a decade ago. [6:33](https://realalpha.app/v/-atCCMK1GYw/?t=393) What does that mean? A lot of them are fallen angels. They were SPAC targets or direct listings that fell down or they're public companies that are now small. And then to to the second point of that is there's some companies that should never be public companies via SPACs or other metrics that are that constitute the rest of some of these small cap companies. So it's not truly smaller companies. The true smaller versions of the large public companies are actually still private companies in their middle market or large buyouts. I agree with that. And another maybe way of saying the same thing is companies used to go public earlier, so they were small cap ish when they went public on average, and they might have been great companies that grow over time. [7:12](https://realalpha.app/v/-atCCMK1GYw/?t=432) And that that's just not the case as you highlighted it. There's just fewer of those strong companies with momentum going public at small size. They go public at massive scale. And our focus in private markets is really, you know, along the same lines that maybe the small cap premium is actually in private equity in very small micro lower middle market and lower type names. I was gonna ask you that exact question, which is if you believe this, how do you operationalize that strategy in the market? You would essentially shift some of your allocation from publics into privates, into private equity. [7:46](https://realalpha.app/v/-atCCMK1GYw/?t=466) Yep. We actually did that. So we're earlier on, we were I think one of the ways of thinking about asset allocation is yeah. I had the good fortune of hearing, Harry Markowitz present at a really small conference when he was presenting on something about the four zero one k, how to, like, optimally use your company stock in your four zero one k, but he started out his presentation by saying, I don't want any of you young whippersnappers here to ask me about mean variance optimization and why, you know, it's so naive or whatever. He's like, I did that fifty years ago. It's how you guys are the ones who are supposed to be improving on it. [8:18](https://realalpha.app/v/-atCCMK1GYw/?t=498) And he said, in fact, the best, you know, the the best diversifying portfolio or the best diversification is just to go fifty fifty. And that's the naive approach, and it tends to be, like, from an academic perspective, the best, diversification, if you will. And the so we you know, I I thought about that, and then I read another author put together something kinda similar, but and then you look at risk parity and what Bridgewater's done, and it it's kind of the same concept of, you know, the naive portfolio is to not, you know, be concentrated in one thing if diversification is the goal. So when we started our asset asset allocation, we kinda started from an equal weight perspective, and, you know, we used optimization techniques and, you know, made sure that we were being quite quantitative in the end to stress test our decisions. [9:00](https://realalpha.app/v/-atCCMK1GYw/?t=540) But we started with, what if we were equal weighted? What would our expected returns be? And then what dials should we turn to get our expected return up based on, you know, the size of the portfolio, the size of our resources, the fact that we have money coming in from, you know, land based revenues, you can call it, mostly oil and gas and real estate development. So we thought we put all that together and we were we were more or less an equal weighted portfolio. Like it was pretty close and it was, you know, a terrible experience for the first few years. And as we kind of lived with that and tweak with it and evolve, one of the decisions we made was to take down the small cap exposure and move it into private equity. [9:39](https://realalpha.app/v/-atCCMK1GYw/?t=579) That's been about five years or so in the making. It it finally was and being newer, you know, we didn't have enough private equity to have a 20% target when you're, you know, just pacing in your first dollars. It's kind of ridiculous. So it made sense as we evolved over time to pull down our small cap exposure and direct it towards private equity. The truly diversified portfolio, to me, is a very interesting thought experiment, which is if you worship at this altar of diversification, this is your model portfolio. You start with that, and then you kind of tweak it from that. But you guys literally did that. [10:09](https://realalpha.app/v/-atCCMK1GYw/?t=609) Yep. Yeah. That's how we started the conversation. Yeah. And are you not just trying to and and why not just optimize on Sharpe ratio and come up with this super efficient portfolio that is optimized on this one variable of Sharpe ratio? I like to say things that are kind of controversial, and maybe I end up just putting my foot in my mouth most of the times when I do. [10:30](https://realalpha.app/v/-atCCMK1GYw/?t=630) **Peter Madsen:** But one of the things I like one of the the things I like to remark is that the Sharpe ratio is a perverse indicator. So I think if you're optimizing on Sharpe ratio and you're assuming distributions are normal [10:42](https://realalpha.app/v/-atCCMK1GYw/?t=642) and you're assuming your inputs are more correct than they probably are, and if there's any mean reversion, you're you're sort of top ticking, you know, with your optimizing on Sharpe or targeting the high Sharpe investment based on historical experience. So if you really look out ex ante and by the way, like, know, as being a consultant and having working on a lot of institutions and a lot of asset allocation exercises, it's really hard to take a lot of risk when you have all the different asset classes available to us. If you have some exposure to those and you're, you know, thinking about it pretty clearly, it's pretty hard to have a really terrible experience that you can't survive even in August 2022. [11:23](https://realalpha.app/v/-atCCMK1GYw/?t=683) I mean, those are really dark and terrible periods. I had clients that had a lot of problems to to deal with, but, you know, they in the end, it was it was fine. No one missed a benefit payment. No one had to go out of business. It is fine to have a decent amount of volatility ex ante, and it is fine to optimize on the return and not the Sharpe ratio. Like, if you need a higher return, you're not gonna have a great Sharpe ratio, and that's So as part of your investment philosophy, you avoid investing from buckets, instead you focus on facts or factor exposure. Tell me about that, and how do you do that from a bottoms up? [11:56](https://realalpha.app/v/-atCCMK1GYw/?t=716) Yeah. So the we actually I like to sometimes refer to it as purpose driven investing. So we do have, you know, we do live in a kind of conventional world, if you will, with, you know, you never really we can't pick our trustees, and just thinking through that and again having that experience of sitting across from all types of trustees over a decent number of years, Wanted to make sure that we were having good conversations with stakeholders as well. So we do have categories and asset classes, but they're pretty broad and vague. And so for example, we have growth, and within growth, we have public and private equity. [12:30](https://realalpha.app/v/-atCCMK1GYw/?t=750) And for us, we're like, okay, that's the high risk, high return part of the portfolio. So for something to be in that portfolio, we don't really care what the structure is, what the vehicle is, what the liquidity is. It could be public. It could be private. You know, obviously, very you know, like a venture fund traditionally structured wouldn't go in public equity, maybe a crossover hedge fund that has 25% private markets that could be in a public equity, an evergreen private equity fund. We could put that in public equity or private equity. But as as we try and keep that generalness or that vagueness that allows us to be really opportunistic or open minded about how we invest and what we invest in, we have pretty healthy ranges and and latitude that our trustees have afforded us. [13:13](https://realalpha.app/v/-atCCMK1GYw/?t=793) But at the end of the day, we run a factor model that and we have we try to have straightforward benchmarks that also represent the factors. So, obviously, you have ACWI for public equity. For real assets, we use S and P real assets index. For income, we use high yield one to three because we don't want duration in that portfolio. We want credit risk. And so as you're as you're thinking about that and communicating that with stakeholders, that's pretty straightforward. Then when we go behind the scenes, so to speak, we're looking at that benchmark, the set of factor exposures, and how we can add value from it. [13:44](https://realalpha.app/v/-atCCMK1GYw/?t=824) And we either want to have intentional overweights across factors, that we think will be rewarded, or we want to neutralize the factor exposure but have a high residual. We're not necessarily trying to have our factors beyond the benchmark. We just want to know that, for example, we have equity beta coming from high yield. We if you desmooth and interpolate private market returns, you know, you have equity beta risk coming from private debt, from private real estate. You might have interest rate exposure coming from infrastructure or private real estate, etcetera. [14:15](https://realalpha.app/v/-atCCMK1GYw/?t=855) **Peter Madsen:** So we just wanna make sure that we have a holistic view of the portfolio, what risks we're bearing, and whether or not we want to bear them or whether or not we think they'll be [14:24](https://realalpha.app/v/-atCCMK1GYw/?t=864) rewarded. And that's and a, you know, sophisticated regression type analysis with factors is cheaper and easier to do than implement than, say, a a risk system that looks at all of your holdings and then tries to, you know, give you the sector weights, geographic weights, etcetera. And even still, I'm like, I'm not sure how much my equity beta really actually is just seeing of, you know, how much tech exposure I have when, you know, I also have data centers in real estate, for example, and and are those correlated? Well, the holdings based analysis doesn't tell you that, but a factor based analysis can. [14:57](https://realalpha.app/v/-atCCMK1GYw/?t=897) And what what tools are you using to to break it down on a factor basis? Originally, we were using MPI, Markov processes. I remember can't if it's international incorporated, but, that's a great system, very sophisticated, very robust. It's a little more technical for the average user. And given that we're a smaller team and some turnover at the smaller or, I mean, at the at the younger level where, you know, you would want people running the systems. We switched from that system to Venn, which is, you might be familiar. It's it's a software company started by Two Sigma, the hedge fund group. And they're they have a really robust suite of factors and a user friendly interface based on the web, and it can connect with your custodian, for example, and just a just an easier way when you have, you know, interns and people with couple years experience kind of helping you with analysis. [15:51](https://realalpha.app/v/-atCCMK1GYw/?t=951) Let's talk about your private book. You go pretty far down the risk curve on the venture side. You like funds under a $100,000,000 oftentimes. Super angels are funds one and funds two. Why play in that part of the market? What's the risk reward like for you? We first started as we were first building out our portfolio, like I said, we have these broader categories and we have private equity as one, and then it's left to us to iterate on our allocation between, you know, buyout, growth equity, venture, etcetera. And we put venture to the side initially at first and we, because the conventional wisdom and the experience I had working with larger institutions and being a consultant is that if you can't access the really well known brand names, then you're probably not going to do well in venture. [16:42](https://realalpha.app/v/-atCCMK1GYw/?t=1002) And, you know, that that our trustees agreed with that kind of sentiment and I met some local investors here who were seed stage investors, running smaller funds and and you're doing it in Utah, and they've kind of made their case, had some data to back their story up, and so we worked on our philosophy for venture and decided that we probably don't have the connections or the bandwidth or the time or energy to try and get ourselves into, say, you know, Sequoia or whatnot. If they're actually gonna be capacity constrained, then you would want that. And if they're not going to be capacity constrained, they're gonna raise many different funds and kind of push you or or, you know, require you to invest across all the different strategies and not just be in the early stage funds. [17:27](https://realalpha.app/v/-atCCMK1GYw/?t=1047) That that wasn't ideal either, but perhaps there are, in our initial philosophy was early stage, meaning pre seed, seed, maybe series A, and kind of off the run markets that might feed up into the food chain of venture or some of these other shops that you need to write bigger checks. And as we spent time on that, philosophy, you know, we we deviated from it a little bit. You know, we got in the in the heyday, you know, we got nudged into some bigger funds that an opportunity funds and so forth that, you know, we call them, you know, stapling on. And but we really honed the philosophy after we worked with a group called Sindana, a fund of funds, and they run an Michael, okay. [18:06](https://realalpha.app/v/-atCCMK1GYw/?t=1086) I'm a two time guest. Okay. Yeah. So you know the you know the story. So we we were drinking the Kool Aid from, Michael and his team, and then we also ran across another, you know, group of individuals that run a venture fund, a fund called Pattern, and, you know, you read some of their work, look at some of their data. Moonfire also has a great website with a lot of data, And if you think about, not just fund size, but also portfolio construction, and you think about relative ownership early on when valuations are arguably cheaper and you have the ability to size up your ownership, you know, early on and your check sizes are, you know, smaller, the deal sizes are smaller at that stage of the market, then your ability to generate a five X or higher, you mathematically [18:51](https://realalpha.app/v/-atCCMK1GYw/?t=1131) **Peter Madsen:** should be easier if you have a, you know, if you, even if you have a $100,000,000 fund, you kind of need five unicorns to get a five X, right? [18:59](https://realalpha.app/v/-atCCMK1GYw/?t=1139) And are you reliably going to get five unicorns each, each fund, each vintage? That's, it seems a lot easier the smaller the check size, the smaller the fund size, the smaller the deal size. It it's it's similar for us in private equity. So all things being equal, you'd love to access the Sequoias and and the other capital constrained strategies, but knowing that you can't access those instead of going to second or third tier brands in that same space, you decide to go down market where you could get similar returns maybe with some more vol, but you actually had a shot to get those kind of great venture returns that you could get in the name brands. [19:38](https://realalpha.app/v/-atCCMK1GYw/?t=1178) Yeah. I think I I I agree with that, summarization or simplification. And and another interesting thing to us is, you know, you wouldn't you wouldn't think of it as, we didn't think of it as a good way to invest. But if you're if you're a solo GP and you have a small fund, you're really well networked, really well connected, you're, you know, able to add value one way or another to the ecosystem, people will, you know, invite you or allow you to write what's often called a collaborative check, and those funds tend to do really well. And that, you know, those so it's it's just us trying to make sure that when we're investing in venture, we're not just doing venture for diversification. [20:15](https://realalpha.app/v/-atCCMK1GYw/?t=1215) We're doing it for, you know, as large of outcomes as we can. Taking a step back, how did you go about educating yourself in the venture space? Is this through the fund to fund construct, and what's some best practices for an LP that wants to educate themselves on a new space? Yeah. Regrettably, we didn't start out with a fund to fund adventure. I think in hindsight, you know, we're a small team. We're trying to be clever and implement our ideas, and we work with a a mid sized consulting group, and it's really hard to, try and build out a portfolio across all the potential opportunities for investing. [20:46](https://realalpha.app/v/-atCCMK1GYw/?t=1246) And arguably, we should have started with like, I speak to kind of the collaborative model we use now at, you know, maybe a later point in the conversation, but either a a more collaborative model or just allocating to a fund to fund to make sure you're in the market, you know, getting some decent exposure, getting your diversification from those, you know, asset classes that are harder to implement, and then over time, building up your experience and capability of I think that's how most people do it. That's how we should have done it. We spent, you know, it's kind of a funny story. We we one of the fund to funds we did was China, venture in China, it's early stage, met all our criteria, except we were like, you know, we'll never get to China in terms of being good at selected venture managers. [21:30](https://realalpha.app/v/-atCCMK1GYw/?t=1290) So the fund to fund was a pretty kind of a no brainer if you wanted China exposure anyway, and it was supported by our consultants. That was something we did at twenty seventeen ish or, you know, plus or minus, and at that conference, met someone who I was describing, you know, this conversation we're having, and he said, oh, you need to meet this guy, Michael Kim, and I couldn't find it. I could, I spent a decent amount of effort trying to get in touch with Sindhana and it wasn't until a few years later that we actually synced up and ended up, you know, partnering with them, but the, the amount, the, the venture community, the GPs there, the fund to funds and some of the advisors, there's a lot of data that they're working with. [22:08](https://realalpha.app/v/-atCCMK1GYw/?t=1328) It seems, you know, maybe it's just, you know, my, you know, a familiarity or recency bias, but it seems like since Sondana has grown in size and garnered attention, there's been a lot more thoughtfulness around fund size, portfolio construction, and now when I'm on LinkedIn, I often see a lot of data driven analyses around these topics, and it'll always all point to the same thing, but just back to the the actual question of how you educate yourself, I think there's a ton of stuff online that's data oriented in nature that that makes, you know, that that lays all of that out for you. The manager selection part really difficult. [22:45](https://realalpha.app/v/-atCCMK1GYw/?t=1365) We like I said, we ended up partnering with a couple of fund of funds as scout funds or sourcing, partnerships, if you will, just because of the sheer volume and difficulty in in taking care of of the portfolio while also trying to find, you know, fifty, seventy five million dollar funds, you know, run by a single person or a couple of people. Tell me about this collaborative model that you alluded to. So working with consultants is having been one, think it's okay for me to say, and we still work with consultants. We appreciate the value they bring. They're an extension of staff. They have a lot more resources than we do, but they need to, their business model is such that they need to serve the, I don't know if you'd call it the largest common denominator, but it is kind of a, a business of solving for a lot of clients. [23:27](https://realalpha.app/v/-atCCMK1GYw/?t=1407) And if you're, if you have a custom approach or a niche approach or a niche interest, that's a one off for them. It's, you know, it takes away from, from their bottom line. And when you're working in a more collaborative model where, you know, consultants would collaborate on the sense that, you know, you're sharing ideas and you're asking for services or getting certain, you know, some stuff off the shelf provided. But if you enter into more of a commercial relationship where, for example, you're, you know, we're anchoring some evergreen funds and with some advisory type firms, and we're receiving in exchange either revenue share, discounted fees, or advisory services, or database access, or other software, one or more of those in each case. [24:14](https://realalpha.app/v/-atCCMK1GYw/?t=1454) And now we have this commercial kind of relationship where we, you know, we are in business together, so to speak, and when we want access to XYZ researcher database, if it's, if it's, if that work is done, by them, then we, you know, can roll that off the shelf and we don't need to roll up our sleeves and do as much due diligence or underwriting because those very capable people with a lot more resources than we have, and in some cases, a lot more experience have done that underwriting. So that frees us up on what you might call more conventional type exposures, and then we also have, the ability to bring, either bring to them what you might call like satellite or niche type fund or strategy, and they're, you know, they're obligated to work with you in some capacity depending on the nature of your of your collaboration, commercial collaboration, and we or we just have that extra bandwidth to work on that ourselves and on those kind of satellite exposures, if you will. [25:11](https://realalpha.app/v/-atCCMK1GYw/?t=1511) And in addition to that, we're able to, in certain areas where we think the upside is more limited, like private, we call it private income, call it private debt, private real assets, which includes real estate infrastructure, all kinds of natural resources, maybe some other things, you'd be really hard pressed to get like a two X net or three X net from those strategies right there. Odds are really good that if that, your downside is really well protected, but your upside is pretty capped. I think that's like the diversifying benefit. There's partially that those types of strategies bring, but in order to really drive returns there, we looked at the structuring and, you know, fees on committed or how long it takes to deploy, or both. [25:54](https://realalpha.app/v/-atCCMK1GYw/?t=1554) **Peter Madsen:** And we've, as part of our collaboration, we're able to structure co invest accounts that are, with minimal expenses. [26:01](https://realalpha.app/v/-atCCMK1GYw/?t=1561) So we're, you know, we're not paying management fees, we're not paying carry, we're not, you know, when the cap, we're not committing capital, paying fees on committed capital. And so that kind of call it like structure alpha, if you will, from the nature of those relationships and how those deals are packaged, we have that uplift of being, you know, we're going to pretty easily get median gross returns, if not better, but then we're adding back all of those fees, that fee drag over time. And that allows us again, more bandwidth for putting private markets money to work or hedge fund exposure to work where we can really focus on making sure we're picking the right strategy or the right manager that might be a little more difficult to require a little more heavy lifting. [26:43](https://realalpha.app/v/-atCCMK1GYw/?t=1603) Professor Steve Kaplan, who was on the podcast a few months ago, they he came up with this Kaplan Shore Index, and he figured out that two and twenty on a per year IRR basis was actually six percentage points. So to your point, if you have half of your funds in a two and twenty half in a co invest was zero and zero, you're actually getting 3% alpha across the entire portfolio. It was pretty significant alpha when it comes to co invest. 100 agree. You're also using AI tools to screen decks. What what are these AI tools, and how are you using them strategically? We tried to be early adopters of AI when ChatGPT first came out, but then we realized the confidentiality concerns and we weren't really able to put, you know, manager material in there. [27:29](https://realalpha.app/v/-atCCMK1GYw/?t=1649) You know, you could obviously have it, you know, proofread a memo that doesn't contain any confidential information or all the other things we might use chat GPT for, but we really thought we were going to be able to, you know, adopt it early on. We had a working group we called Skynet, but each time we met, we were like, I, like, we're kind of locked out because the, you know, because of our confidentiality provisions that we agreed to with managers and, put it to the side. And then we finally, you know, got our hands around the corporate for lack of better term, you know, subscription chat GPT. [27:59](https://realalpha.app/v/-atCCMK1GYw/?t=1679) And then we were like, you know, individually using it with, you know, everyone's working on their own different prompts and with more or less success. And, you know, it's actually a lot of work to get, you know, those prompts right and to get get it where you needed to be. And meanwhile, we were working with and looking at software providers. You know, there were quite a few out there, but the, we spent about a year looking at names because each time we looked at a new name, things were moving forward, things were evolving, and each time we had a question or like, well, we're looking for a CRM solution as well, they'd say, oh, give us a month and we'll have that, you know, programmed in and we'll, we'll talk again and sure enough, you know, people are coming back and so it took us a while, we were pretty patient, And then more recently, you know, we've we've adopted a group or, you know, we've we've subscribers signed on, implementing it. [28:48](https://realalpha.app/v/-atCCMK1GYw/?t=1728) And the idea is, I think, you know, maybe to state the obvious that it does not make investment decisions for us. It doesn't make any decisions for us. And I I'm and not yet. Yeah, I used to say the, the interns were cheap AI, now the interns are expensive AI, but, you know, that kind of level of work that you might have an intern or an administrative person do, you have to gather the data, then you, you know, winnow it down somehow with criteria, you collate the rest of it to make sure that you've got all the pieces you need to underwrite in, in one place and you do your best to score it and, you know, maybe it's after lunch or maybe you had a, didn't have a good night's sleep or you're mad because you didn't source the deal and now you gotta work on it anyway and all these things, like, oh, that's a low score, you know, and we've always tried to have objective metrics to look at and point to when we, you know, in our templates that we're underwriting and it's just really hard to be objective and score certain things. [29:46](https://realalpha.app/v/-atCCMK1GYw/?t=1786) But now we can say, you know, take the first path, like get all the data, put it all in one place, make sure you're giving us the good and the bad. You don't just say like, man, you know, you're being simplistic, the prompt should be pretty [29:58](https://realalpha.app/v/-atCCMK1GYw/?t=1798) **Peter Madsen:** specific on, please don't give me an answer to a decision, but please highlight what the ownership structure looks like, what percent, you know, of this firm is employee owned and [30:09](https://realalpha.app/v/-atCCMK1GYw/?t=1809) how is it distributed amongst the team. And if it's greater than x or smaller than x or whatever, then that gets a certain score. And when you point the system at a, it's, you know, say a folder or data lake with all your stuff in there, your meeting notes, your manager notes, all the man of the collateral paraphernalia, all that stuff that comes along with doing the due diligence and investigating managers, you can take your criteria, your philosophy, your criteria, and your own framework and your own template and have it be, you know, delivered to you as you want to know ownership, here it is. [30:45](https://realalpha.app/v/-atCCMK1GYw/?t=1845) You want to know fees, here it is. You want to know what terms are in the LPA that you'd set are red flags? Here they are. You can do that more or less, you know, or you can do a lot of the due diligence kind of data gathering and assessment really early upfront if you have all the materials, including legal due diligence, operational due diligence, before really spending the time to do the softer work around culture and, you know, how do they generate, like, do I buy this philosophy? Is this philosophy going to persist? And it's just such a times, you know, it's a, it's a, it's a leverage for the team. [31:19](https://realalpha.app/v/-atCCMK1GYw/?t=1879) We're, it affords us time to think and discuss and actually have everyone read the memos before a team meeting versus, know, you're trying to write your own memos, let alone read everyone else's. And, you know, a good example is, you know, someone has to go through the LPA to or something to look up exactly what the fees and operating expenses are when it really should just be in a table somewhere. It's pretty exciting. It's pretty early days, so we'll you know, we have no real kind of success stories yet other than people are pretty excited about the leverage that's supporting us. What practically is different about investing out of a sovereign wealth fund versus, say, a pension fund or an endowment? [31:58](https://realalpha.app/v/-atCCMK1GYw/?t=1918) Each entity is going to be different, right, in terms of at least marginally different. But for us, we're a permanent capital or perpetual capital. And, you know, all sovereign wealth funds are, but our beneficiaries, like a lot of other Western states are 22 Western states that have had, or still have sovereign wealth funds and the beneficiaries are K through 12 public schools. And in our case, you know, that check goes directly to those schools. And so that's one aspect is thinking about the distribution and thinking about it all the way to the end beneficiary. And then the other part of the ledger is the capital coming in from land revenues. [32:36](https://realalpha.app/v/-atCCMK1GYw/?t=1956) So we have to monitor or try and forecast or manage those income and cash flows, and then think about making sure those distributions are not disruptive. Well, Peter, this has been an absolute masterclass in how to invest like a sovereign wealth fund. Thanks so much for jumping on the podcast. I'm looking forward to continuing this conversation live. appreciate it. Thanks for the invitation. Good conversation. That's it for today's episode of how I invest. If this conversation gave you new insights or ideas, do me a quick favor.