The traditionalism of the Union League Club of Chicago was the perfect setting for Scott Malpass, Chief Investment Officer (CIO) and Vice President of the University of Notre Dame, to talk about the Private Equity strategies of the institution’s endowment fund. Malpass talked about the planning and policies the University uses for its investments, and how the nature of investing has changed since he joined Notre Dame in the late 1980s.
Scott Malpass has served as CIO for the University of Notre Dame since 1989, and is responsible for the investment of the University’s endowment, working capital, pension and life income assets of $11.5 billion dollars. The Notre Dame endowment is the 12th largest in American higher education, and the largest of any Catholic university. Mr. Malpass is a 1984 graduate of Notre Dame, and received a MBA from the ND in 1986. After working briefly on Wall Street, he returned to the University when the endowment stood at $425 million.
Besides his investment work, he teaches finance at Notre Dame, and helped develop an Applied Investment Management course. In 2014, he helped to found Catholic Investment Services, Inc., a not-for-profit advisement group for Catholic organizations looking to comply with guidelines for socially responsible investing. Recently, Mr. Malpass was appointed by Pope Francis to sit on the board of the Vatican Bank.
Below are the highlights of the talk given by Scott Malpass on Private Equity investing at the University of Notre Dame, which took place at the Union League Club of Chicago on August 1st, 2017.
“When I began, I didn’t know anything about Venture Capital or Private Equity,” Malpass related. He then told of a chance meeting in 1990 with Don Valentine of the Sequoia Capital Group out of Menlo Park, California. Notre Dame’s investment into Sequoia’s  Venture Capital Group funds has netted the University over one-and-a-half billion dollars. That is where the Notre Dame involvement with VC and PE funds began.
“What this type of investing has done for big endowments has been extraordinary in the last thirty years,” Malpass continued, “and it will continue to be a significant part of our strategy.” He went on to talk about how although the industries are more institutionalized, and although Venture Capital is no longer a cottage industry it was, innovations and technologies are not slowing down. He noted there is still a lot to do, and Notre Dame will continue to be committed to the both the VC and PE asset classes, as much any other asset class in the endowment portfolio.
As a background, Malpass talked about the “Endowment Model.” This model was invented by Cambridge Associates in the 1970s, when 15 schools got together to invest in equities, and be long-term investors to get high yield returns. It was based on diversification and a smooth spending policy, because they would spend 5% of the returns per year in their institutions. Because of the spending, they needed to be conscious of risk. Diversification and building relationships with long-term investment firms evolved to become the ‘Endowment Model,’ which began with the Ivy League schools, and then became something that Notre Dame latched onto.
“Our investment objectives are the same as any other endowment fund,” Malpass went on to state. He gave characteristics of ambition, high-yield returns (goal of 5-10% per year), proper staffing and a steady stream of distributions, and there is a lot more integration with a spending policy. He went on to say that only 50 or 60 institutions worldwide can handle these types of objectives.
He described his portfolio teams... “Public Equity (40%), Private Equity (variable in different types) and a multi-strategy team (35%). And multi-strategy is more cyclical business like real estate commodities, credit and fixed income.” The reasons they have done it this way is more recent consolidation in those areas, he noted, because they don’t want to be in all those categories all the time. They know they want to be in Public Equity and Private Equity, because it drives their high-yield returns. The rest, as he related it, is just opportunistic.
To expand upon the Private Equity portfolio, Malpass pointed out the most important number in the presentation, “...the 27% net Return on Investment since 1980.” Our target with that is about 30% of the Endowment. They have 45 active partners across geographies, stages and sectors, with about a 150 active funds over 2,000 underlying companies, so it’s a broad range portfolio. “That has paid for a lot of scholarships, faculty chairs and programs,” Malpass said.
“I think investing is about people,” Malpass said, “particularly in Private Equity and Venture Capital.” He talked about the process for getting to know the people in association with their investment firms. He spoke of his beginnings in the arena again, and told of asking some firm representatives about hobbies, outside interests, etc., often getting a terse “that’s none of your business.” It was odd, he said, in his stewardship role that he wouldn’t want to know about them... with Notre Dame, it’s about values and ethics, and how they would manage the university’s money. Often when asked about a firm’s “Ethical Policies,” he found they didn’t have them. It’s not that they were unethical, it’s just that they didn’t spell it out in policy, or talked about it, he added.
Next he talked about diversification. “The United States is still the default market,” Malpass said. “It still is the biggest, richest and most interesting economy in the world.” He spoke of global expansion, with a office in London for a couple years, but still the focus is on the United States for investing. He noted that they are long term investors, which sounds like a cliché, but those principles resonate with what Notre Dame tries to do in their investments. Even through the worst market cycles, like 2008, there was no panic. There is temptation to alter strategies during a down time, but if there is a philosophy, a focus, good governance and a long time horizon, he explained, you can play offense during the down turns.
He went on to say that the endowment focuses more on compounding and multiple of invested capital. “It always turns me off when we’re in a pitch or a meeting, and the first thing they show us is their ROIs Malpass related. Basically, he wants to know how much the University will get back, and ROIs don’t mean much to Notre Dame when selling him on what a firm is doing. That ‘what-are-we-getting-back’ strategy and mentality, he added, has always been healthy for the University.
On VC, he said, “In Venture Capital, we’re pretty much seed and Series A investors, heavily in the information technology space.” The endowment strategy in that arena is seed investing, he went on to say, and even though the VC space overall is more fragmented and deals are being done more broadly, in every cycle the same firms always emerge as the “goliaths.” He also said that Notre Dame loves Venture Capital, and is always looking for ways to expand allocations there.
“With buyouts,” Malpass explained, “we’re very much focused on lower and middle markets.’ That was qualified as $50 million or less, with funds in the $200-$300 million range. Notre Dame hasn’t done any mega-funds, he further expounded, with a longer timeline horizon they simply have a different approach.
“The depth and breadth of the U.S. Private Equity market sets the bar high for investing elsewhere.” Malpass went on to talk about the time the endowment representatives spent in China, with a first visit in 1989, and more than 40 trips between then and 2003, when they first invested there. That footwork set them up nicely in China, which is the bulk of their overseas emerging market investments, both in PE and VC funds. The breakdown is 65% United States, Europe is under 20%, and other emerging markets the rest, which is mostly China.
“The big picture is that we’re very late in this cycle, and who knows how long it will go on,” Malpass opined. It’s hard to predict what’s next, he went on to say, but certainly the valuations are stretched everywhere. In VC it’s leveling, and the ratio from investments to exits are at a record high. Fundraising is still robust... $20 billion raised on the first half of the year on 120 funds, which means continued discipline in Notre Dame’s point of view, at this point in the cycle.  PE buyout activity has slowed, according to Malpass, with deal values and deal accounts down 20%. High valuations persist and leverage ratios are where they were pre-the 2008 financial crisis, which led Malpass to state that the bad behavior that happened before that crisis is back.
“We can’t market-time these factors in building a PE portfolio,” he said, “but we will do lower commitment amounts or pass on things at this point in the cycle.” Notre Dame tends to be more dynamic and interactive than they used to be, depending on partner and strategy, he added. He gave an example of middle market portfolio investments in Europe, with their current banking situation... it’s been particularly interesting for Notre Dame to fund some new partners there, because of their need for capital. There is a lot of opportunity, he said.
“We have a commitment to our core partners, and we will continue that,” he expressed in talking about strategy, and added that dynamic portfolio management means the right people and the right strategy. Lately what they’ve done different is a one-off fund, or multiple funds with a partner over a long period of time. GPs have changed rapidly, and life cycles have been compressed, so there is a constant need to be aware of those changes and be flexible regarding them. Concentration is a goal... bigger commitments in fewer funds, but he added that everyone wants to do that and often it doesn’t happen, but they are making progress in that area.
“We’re doing more co-investing and more first time funds than we’ve use to, he concluded. “When we co-invest, we can watch our partners in a different and more dynamic way. It helps my team to evolve and learn, which is great.”
“Our convictions in the PE asset class endures,” he added, “it started out as a cottage industry and now is one of the most popular asset classes. It will continue to play a key role in the larger endowment portfolios... innovation is accelerating, and owner/operators will always have an inherent advantage over public companies. We will continue to try to differentiate ourselves, and to evolve as we stay in front, so we’re still open to different approaches, and we’re still excited about the future of this asset class.”
Q:  What percentage of the Notre Dame overall budget is supported by the endowment?
A:  30% percent now, and it was at 5% when I first started. That is comparable to larger endowments overall. That’s a good place to be.
Q:  As a larger endowment, you mentioned you invest in smaller funds. Do you think other endowments will do the same, or keep moving toward larger funds?
A:  I do see it, with the larger Ivy League funds, because we’re all having the same conversations. It’s about building an edge, looking at the next ten years, and how do we earn those high-yield returns for the campus. They want to capture it, but they’re not going to get as big a piece as they’d like, although they’re trying it more now than ever before.
Q:  As you invest in smaller funds, and then suddenly the next ones are increasingly bigger, do you stay smaller... in the sense of staying with what you know?
A:  Yes, you’re right, that became a typical pattern, and we always we’re talking the University out of it. We lost some battles earlier, but we’re winning more of them now... the overall board is much more willing (to invest in) much more incremental fund size growth. The economics are better.
Q:  There are so many different fund structures today – ten year funds, six year investment lives, two & 20 structure on economics. Is that still the right model for you today, or are you seeing more discussion for shorter funds, especially with fees with money on the ground and carried interest. What is your take?
A:  We have all those conversations with all of our Private Equity groups. With hedge funds we’ve had more more success in alignments with fees and terms, but that hasn’t been the case with Private Equity, that hasn’t changed much. We’re happy to pay up for performance, but it has to be real performance. It’s been tougher to get real change in that asset class.
Q:  As you look at your portfolio holistically across the private and public asset classes, is there anything you’re doing differently today to try and integrate that data to assess overall portfolio risk?
A:  There is definitely a lot of risk analysis in the total portfolio... geographies, definition of risks and currencies are all looked at over the total fund, both at the manager level and as a look through. Even though we work in three teams at Notre Dame, and they are integrated and collaborative, we’ve embraced specialization. Other funds are generalists, and that can work, but our culture is collaborative in exploration. I think Private Equity thinks differently than Public Equity, and definitely differently than cyclical commodities like real estate. I like the fact that they are willing to specialize and have interest in becoming an expert in what they do. 
Q:  When you look at first time funds and managers, what are you looking for and what is your vetting process?
A:  The good news is that in today’s environment they do have some kind of deal record. They’ve been at previous places where we can reevaluate what they brought to that firm. But we do a lot of due diligence... and a lot of learning is asking the right questions, and it takes a lot of meetings to do that. Ultimately, it’s about what business plan they have and what experience they do bring to bear – maybe they’ve worked in and have expertise in the sector, but this is their first Private Equity deal. We wouldn’t do sector deals in the past, but were doing more now. Many former operating people are moving into this space, and there is great potential success there.
Q:  The University of Notre Dame is strongly rooted in their Catholic faith. How does the university balance their desire for return on investment with integrity in their mission? And with your new role on the Vatican board, how would you answer that question as well?
A:  The Vatican side is a whole other lecture. You may need another lunch. However, on the first part, our investments have to reflect Catholic social teachings. In our research into companies, we have a whole process associated with the U.S. Bishop’s guidelines on social responsibility. The core of it is restriction, but that has been in place before I was even CIO.
We have a restrictive list we give our managers, but we also asked ourselves, how are we going to expand and maintain our compliance with those policies? The companies we restrict are not in the Private Equity space. We can get a ‘opt out’ in all of our funds for each individual deal. PE has been the easiest to comply with, we’ve had only one violation in 30 years – and that was 20 years ago – and we carved ourselves out of that deal. And just to quickly mention the Vatican side, they do have the same compliance standards, they just don’t have as big a staff as we do, and it’s also mostly fixed income.
Q:  If you were starting a Private Equity firm now, for example a family office with a billion dollars, how would you think about staffing such an office?
A:  It would be tough to start today, it would be a huge challenge. I certainly wouldn’t say don’t do it, but you’d have to be very patient. There will be connections to GPs, and you can start with that, and at the right time you might buy some secondaries to add to that, but basically spend some time getting to know people. Eventually, here will be an opportunity to get into better funds, and at a better price. You can’t market-time it, but you also don’t want to get into everything during the peak of a cycle.
It’s about taking a long term perspective, which is a lot of ‘blocking and tackling.’ There is nothing magical about it, we didn’t have any particular intellectual property when we started doing this, but it was just having the right mind set, taking the longer time horizon and just a willingness to wait for the right people to come along. That might be some of the ways that I would get started.
Q:  There is a perception in the marketplace that you are the preferred LP, and that you get into a lot of oversubscribed funds that other folks can’t get into, so it would be hard to replicate what your returns are. But what kind of time frame would you estimate it would take to build what you have built over the years?
A:  At least a decade, maybe longer. It’s going to take some time, so you have to take that perspective. Unfortunately the short term-ism in markets today are what investors are thinking about, it’s at the worst point I’ve ever seen. It’s exacerbated by the financial media, the social media and our overall culture. Everything is now short term, but investing can’t be, if you do it right. You just have to have that mindset. So yes, it’s at least a decade.