When reflecting on co-investment and direct investment strategies across Limited Partner types, it is interesting to compare and contrast how different LPs leverage the strategy to advance their institution. For fund allocators like pension plans and insurance companies, co-investments and direct investing are first and foremost tools to lower fees and increase exposure to sectors of interest. For LPs such as fund of funds, co-investments may also be a tool to build depth into their manager relationships and encourage continued collaboration and transparency.
Foundations separate themselves from other LPs in that their organizations are purpose built for the sole priority of driving charitable missions forward. Thus, the pools of capital managed by these organizations can be dually useful to 1) be grown to fund future charitable initiatives and 2) be used for impact investing to catalyze businesses that enhance the foundations’ missions as they scale.
The David and Lucile Packard Foundation is a unique LP to explore given their relative youth as an institutional investor and their progressive use of direct investments as tools for their mission just as much as their financial gain.
For background, when Packard’s current CIO, Kim Sargent, joined the foundation in 2008, its portfolio consisted of just five line items: HP stock and several index funds. Upon arrival, Sargent, a member of the ‘Yale diaspora’ under David Swensen, teamed up with then-CIO John Moehling to institutionalize the portfolio, adopting many elements of Swensen’s Yale Model, including a focus on long-term investing, concentration, sourcing top-tier talent, and forging deep manager relationships.
For Sargeant and Moehling, expanding the foundation’s portfolio in the wake of the Global Financial Crisis provided an intriguing entry point for building an institutional investment portfolio. Starting with a blank slate, the team had access to managers who had traditionally been closed to new capital and chose to first diversify the foundation’s equity-heavy focus by incorporating hedge funds. They then expanded the private markets allocation, initially through secondaries.
While Sargent and Moehling incorporated elements of the Yale Model into their portfolio construction, the Foundation has underscored the distinct differences between foundation and endowment investing. Namely, most endowments receive alumni contributions that partially or fully cover their payouts to universities, reducing their net liability and allowing them to take on more illiquidity risk. Foundations, however, face a different challenge, with 5% to 6% of funds going out annually and with no known incoming contributions, their portfolios must cover both payouts and capital calls. As a result, many have much lower private market asset allocations than their endowment counterparts to ensure adequate liquidity.
This said, the mission-driven aspect of foundation investing offers a unique contrast to the private equity co-investment strategies of larger pensions discussed previously. For example, while pensions co-invest or direct invest to reduce fees and drive higher returns, Packard finds value in the strategy for also investing in businesses that accelerate the Foundation’s mission. Today, the portfolio dedicates 3% of its broader institutional portfolio to mission-related investing (MRI). This enables the foundation to invest directly in companies aligned with its goals, even if there are complications with tax status, expected return, timeline to liquidity, and so on.
As of 2020, the program has funded 295 businesses with over $850 million that are programmatically aligned to Packard. While the Foundation naturally considers the same risk and return metrics when evaluating opportunities, they also have the ability to balance impact alongside those due diligence data points. This strategy is viewed by the Foundation as a catalyst to drive their mission as it allows them to play multiple roles in the capital stack (grants, loans, investments, etc.) and be a partner in funding mission-aligned companies as they grow into their projected scale.
To read more about other LP types’ relationship to direct investing and co-investment please continue here.
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