E171: SBIC Funds: How to Raise $175 Million for Private Equity & Credit Funds

This episode is a masterclass on one of the most powerful — and under-the-radar — capital structures in private markets: Small Business Investment Companies (SBICs). I’m joined by Brett Palmer, President of the Small Business Investor Alliance, and David Demeter, who helps manage Davidson College’s endowment. We dive deep into the SBIC program — a unique public-private partnership that lets private equity and credit funds access 2:1 fixed-rate, non-recourse leverage from the U. S. government. The result? LPs can access equity-like returns for credit-like risk, and fund managers gain scale without sacrificing strategy. Most people haven’t heard of it. That’s exactly why we did this episode.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Weisburd?

  Today, we're unpacking how SBIC funds work and what it takes to raise 175 million for private equity and private credit strategies from the government. My guests are Brett Palmer, President of Small Business Investor Lines, and David Demeter, Managing Director at Davidson's College Endowment. We'll cover why SBICs consistently outperform other funds, how government leverages amplifies returns for both GPs and LPs, and what makes the lower-middle market so attractive. Without further ado, here's my conversation with Brett and David. Brett, tell me about the Institute for Private Capital Study done by the University of North Carolina.

• 0:38Speaker 01

  Sure. The Institute for Private Capital is a nonpartisan consortium of universities, Duke University, UNC, Stanford, Chicago, a whole bunch of them, that get together and study finance issues. It's a phenomenal organization. And last year, they did a study on small business investment companies and their performance. And their performance that they found was surprising to them, not to us, but just how much better SBICs perform because it's not very well-known, they're relatively small, but they really do perform better than most everything else they see out in the market.

• 1:18Speaker 02

  SBICs represent a variety of different investment strategies, but once they were benchmarked against their appropriate strategy, SBICs outperformed non-SBICs by about 4% on a net of IRR basis, net of the IRR basis.

• 1:35Speaker 01

  And on MOIC basis, they outperformed by about 0.68x larger. So it was a meaningful outperformance from the Burgess benchmarks that they looked at for several hundred funds.

• 1:52David Weisburd?

  .68 X is certainly no small number. Talk to me about who's outperforming.

• 1:58Speaker 01

  SBICs are small business investment companies. So they're private equity and private credit funds. They raise private capital from institutional investors. They go through a licensing process at the government. Then they can access leverage at the, from the federal government, from the Small Business Administration at the fund level, not an individual deal level, but at the fund level. That's very attractive leverage as far as the terms go. There's no guarantee on the performance of the SBIC. If you invest poorly, you lose money. If you invest wisely, you make money. But leverage is an amplifier. And so the government has this program to have small business investors amplify the capital where the private capital leads.

• 2:41Speaker 01

  This SBA leverage follows, and that is incredibly beneficial to the LPs and to the GPs as well. Let's small funds get scale and it gets, lets LPs have leveraged returns on their investments.

• 2:54David Weisburd?

  Tell me about the function of leverage in SBIC. What kind of quantity of capital are we talking about?

• 3:00Speaker 01

  These are smaller, tend to be smaller funds because as funds scale up larger, they have to write bigger checks and small businesses would love giant checks, but they really can't use them. They need check sizes that really are fitting to their scale. So the amount, total amount of leverage that an individual fund can borrow is $175 million. And it's generally done on a ratio of two to one, $2 of leverage for every dollar of private capital. So the fund sizes are generally below $350 million, but some are significantly larger. But these funds also can have multiple funds in succession. And so you have, like all funds, you have an investment period and then you have a harvesting period and you never want to be out of the market.

• 3:41Speaker 01

  So when you finish or finishing up your investment period of one fund, you start another one. So the total amount of outstanding leverage that a small business investment company can have outstanding at any given time is $350 million across all of its funds.

• 3:58Speaker 02

  I'd just add these strategies, these strategies range across asset classes. So there's a lot of direct lending in SBICs, there's senior lending, there's even venture debt, but they also go down into equity, buyouts and growth equity. And now with a newer program that's focused on equity strategies, you're seeing even some venture in SBICs.

• 4:20David Weisburd?

  So let's talk brass tacks. So if you raised 80 million in equity, you could now borrow 2X that 160. So you're basically going around with a $240 million fund. Let's say that $240 million fund returns 2X net to investors. Tell me about how the different parties benefit from that structure.

• 4:40Speaker 01

  The fund managers, general partners benefit from getting scale. They have a larger fund to work with. They get to do more deals, they get to write more checks. And yes, that also means that a bigger fee because the SBICs generally, not always, but generally get management fees on the projected leverage as well as the private capital they have. And the LPs get levered returns. And so for, say, an SBIC is going to be making a $9 million investment, they'll pull 3 million from their LPs, they'll pull 6 million from this SBA credit facility at a very low cost and very, very attractive terms, and then they make that investment. And so, you know, you really get significantly amplified returns for the LPs.

• 5:21Speaker 01

  And so in many cases, you get sort of equity-like returns for debt-like risk, which is a different model than you can get anywhere else because the way this leverage works is it's a fixed rate leverage. You know, you have for a 10-year period, it's basically the 10-year treasury plus a, you know, 50 to 80 basis points. And there's no prepayment penalty, it's non-amortizing, and so it's very attractive leverage that you could never get anywhere else in the market. And so that's really advantageous to the LPs. And that's how, you know, endowments like Davidson Colleges Endowments and others get really attracted to this, this model because one, it's a very inefficient market in the lower middle market, and two, you get this leverage amplification, which is really attractive.

• 6:05David Weisburd?

  Right before the podcast, you mentioned that it had grown from 2 billion to 50 billion. Double click on where that growth has come from.

• 6:13Speaker 01

  So I've been president of this trade association for about 17 years. And in 2008, the SBICs were about 2 billion in assets. And today, they're north of 50 billion. And there's probably 15 to 20 billion more coming online in the next 18 months or so, I would imagine. You know, you really have a significant growth in the private credit markets during that period, which this dovetails with. You also have significant regulatory changes in the banking world where the banks aren't allowed to do a lot of things they used to be able to do. And so the SBICs are filling some of that gap. I think there's also been a significant discovery of the lower middle market and the opportunities for a relatively inefficient market.

• 6:57Speaker 01

  Once you get to the upper, you know, middle market, it's a very efficient market, even if it's still a private market. The lower middle market is still very inefficient. There's still lots of value to be created. There's still a lot of growth to be had. And so you've really seen a very significant influx of investors that are all, that are performing well and LPs that are getting interested in. The biggest challenge to further growth really is just the scale. You know, these are relatively small funds. And, you know, a lot of the big platforms with, who have the huge dollars, can't write check sizes that small to a fund. And so for some of them, that's limiting, but for smaller platforms, it works, family offices, you know, smaller university endowments. It's really attractive.

• 7:41David Weisburd?

  Brett, the SBIC funds are not only for private equity funds, but also for private credit funds. Tell me about that and how do managers use SBIC funds for private credit?

• 7:54Speaker 01

  You have to have a track record of investing this way. And you have to propose to the Small Business Administration that, hey, we're going to continue to invest the way we were. You have to have an analogous record and we're going to raise private capital and then we're going to amplify that with your leverage. Now, if you can't raise your private capital, if the market doesn't trust you with your capital, the government's not going to either, and that makes sense. But most of these fund managers have really, you know, come in and they've said, hey, look, this private credit opportunity is very significant.

• 8:25David Weisburd?

  David, you're at Davidson College, you're an LP in a lot of these structures. Walk me through the structural alpha that you achieve through investing in an SBIC fund, both on the credit as well as on the equity side.

• 8:40Speaker 02

  The most quantitative way to answer that is to refer to the IPC paper, which found across all strategies SBICs outperformed their Burgess benchmarks by about 4%, but it's an amplifier. So if you have lower gross of fee returns, unlevered gross of fee returns, you're going to have less magnification from the leverage. One anomaly you find with SBICs that people don't always pick up on is the net of fee levered returns are frequently higher than the gross of fee unlevered returns. Just to say that again, the net of fee returns would be higher than the gross of fee returns because of leverage.

• 9:19David Weisburd?

  Give me an example of that.

• 9:20Speaker 02

  I always try to make this argument, to try to hit a 3X net return in a private equity fund is a very difficult thing that a lot of us aim to do. Only about 8% of private equity funds from 2000 to 2020 have done that. And even then, a lot of that was luck. Sometimes you just picked a great vintage year. To do that in a traditional fund, you probably have to earn something like a 3.5X gross of fee return, something a bit higher. In an SBIC, you probably have to hit about a 2.5X gross unlevered return to hit a 3X

• 10:01Speaker 02

  net levered return on an MOIC basis. When you actually look through it, fund returns are a bell curve, right? And that 3X net return fund is way out on the right tail. If all I have to do is hit a 2.5X gross, which in a traditional fund would be like a 2X net, well, something like 40% of funds, private equity funds in the lower middle market did that from 2000 to 2020. So that increases your odds of picking by like 5X. Now, I'm not trying to pick this outlier that's way out on the right tail. I actually have a fighting chance inside an SBIC to hit a 3X net MOIC.

• 10:43David Weisburd?

  Private equity, the returns are much more banded than maybe a venture capital or a biotech fund. So the difference between a medium, median returning fund and a top, top 10%, in this case, top 8% fund could literally be 1X.

• 11:00Speaker 02

  And this can really help you get there without taking enormous amounts of risk or trying to grow companies too exuberantly, too aggressively.

• 11:10David Weisburd?

  Last time we chatted, you said that you had a bias towards lower middle market, even without the SBIC structure. Why do you like lower middle market so much?

• 11:19Speaker 02

  In the lower middle market, there's just more inefficiencies. And a lot of the things our GPs do, it's not rocket science. It's building out management teams, installing new accounting software, establishing KPIs. They're really, most frequently, building out these companies that have never had institutional investment before. And it's a great place to do that and sell it on to the next private equity owner.

• 11:47Speaker 01

  Now, that being the first institutional capital is a really great place to be. One, there's huge amounts of value to be created. You know, simple technologies, simple, you know, human resources tools that really amplify it. It also, from a lot of the LPs I talk to, it takes away some of the reputational risk. The only way to make money in the lower middle market is to grow the business. You know, you're not talking about, hey, we invested in something, they had to slash a bunch of jobs, or they shipped stuff offshore. The only way to make, make money is to grow it. And you can grow it. And there's, it's a proven business model, very, very low strikeout numbers. You know, it's, it's unusual to have a failed investment, very unusual, because these are proven models that just haven't been professionalized

• 12:32Speaker 01

  in some cases. And so it's a win-win reputationally, it's a win-win from a financial standpoint. And there's frankly, a lot more choice as far as the number of deals. I mean, these, these funds are looking at 400 to 500 opportunities for every one they, they actually invest in. It's that, it's that inefficient of a market.

• 12:52David Weisburd?

  Thank you for listening. To join our community and to make sure you do not miss any future episodes, please click the follow button above to subscribe. We like to romanticize small businesses in our culture, but there is a reason small businesses stay small. They may be operating on clipboards, literally. They're not even in Excel, let alone AI, not have a CRM. They might just have a file with their customers or just know them by name. So coming in and picking up those low hanging fruit could be a great source of alpha versus the upper middle market. Oftentimes, you have to rely on leverage and other kind of more riskier investment strategies than just fixing the business.

• 13:30Speaker 01

  And you've also squeezed out some of those profits and those efficiencies early and you've sort of what you paid for as you've gone along. As relates to small businesses, I mean, most small businesses in the United States, the vast majority, it's over 90% of small business in the United States have zero employees. And that's not what we're talking about here. We're not talking about, you know, some guy who's alone and just a consultant. These are businesses that are meant to outlast the founder. And so it really is making sure that it maintains itself as an ongoing enterprise. And so it really is taking sort of the cream of the crop and then making sure that it just, you know, they keep ramping up and going. So the bigger platforms that have sort of stretched down to the smaller part of the market are sometimes surprised about

• 14:12Speaker 01

  the professionalization that's needed. No, your sister can't be your auditor. Your girlfriend cannot be your secretary. You know, they, you know, these small businesses have, you know, real human components to them that need to be professionalized. And that's why I say like HR components are a really big thing with these smaller platforms. These smaller platforms are so busy, you know, operating, they're often growing, but they don't really have time to think strategically or don't have the networks across the industry, across geographies to go from a, you know, small player to a regional player, maybe even a national player. And that's what these fund managers do, not just with money, but also with expertise and networking.

• 14:51Speaker 02

  We have to remember the, this program exists for job growth. We romanticize small businesses because that is where a lot of American job growth comes from. These groups need capital and then this program provides that without a cost to the US government.

• 15:06Speaker 01

  There was a study done by the Library of Congress a couple of years ago, a nonpartisan research division, Library of Congress. And for SBICs, the equity-oriented investments added, I think it was, the number was north of 350 new jobs per, organic jobs per investment. And the debt-oriented ones were 175 or 180, I think something along those lines, per investment. Those are big numbers for small businesses. You know, that's not going to be GM. And that's not going to become Tesla. Though Tesla was an SBIC investment back in the day. That's sort of an outlier. You don't have to go public to make money with these. But, you know, there really are meaningful growth that in both in revenue and earnings

• 15:47Speaker 01

  and in employment that really is something that takes away some risk for the LPs from a reputational standpoint.

• 15:56David Weisburd?

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• 17:22Speaker 01

  You go, you raise private capital, you go through this licensing process, you get approved by the SBA. Then when it's time to make investments, you draw it just in time. You don't get all the money at once. So if you have a fund where you're borrowing, you have 150 million dollars of leverage capacity. You don't get that 150 at once. You're doing, you get it on a deal by deal basis. And you pull the leverage from the Federal Home Loan Bank of Chicago. At the same time, you're pulling leverage from your LPs. And so that money comes from the Federal Home Loan Bank of Chicago. And then every six months, it gets put into a trust certificate and auctioned off.

• 18:02Speaker 01

  And when it gets auctioned, the buyers are, you know, fixed income funds and insurance companies and hedge funds and all the big financial players, because these trust certificates have the full faith and credit of the United States behind them. So they're not guaranteeing any individual performance for the SBIC, but they'll guarantee that that trust certificate will perform. And it's generally the 10-year treasury plus, you know, 45 to 85 basis points. And then again, the nature of that leverage is really attractive. No prepayment penalty. You can pay it back whenever you want. You know, it's a fixed rate. It's not going to go up or down.

• 18:43Speaker 01

  You know, it's non-amortizing, so you're just making interest payments for 10 years. Then you have a big slug at the end. And that's how it works. And so the pool sizes generally are around $2 billion plus or minus every six months.

• 18:59Speaker 02

  I would add, the most attractive feature of the leverage is that there's no refinancing risk. It's 10-year leverage. There's a lot of investors that are wary of leverage, and rightly so. I always remind people that, you know, Warren Buffett, fundamental value investor, you know, rightly argues that, you know, margin debt is dangerous because it can be pulled from you at any time. But I also remind people, he has an insurance float. It's also very special leverage that is low cost and has no refinancing risk. When you take away the refinancing risk from leverage, you take away a huge portion of that risk. And so this leverage is very special in that it does not have refinancing risk if you manage it properly.

• 19:41David Weisburd?

  And David, you're essentially a buyer of these type of funds at Davidson. Why do you think this hasn't become a bigger program?

• 19:50Speaker 02

  Well, it has become bigger over time, but these are smaller funds. You know, they typically only raise 50 to 200 million in LP capital. That's usually below the threshold that most placement agents are willing to work. These funds, historically have been the largest LP base is from banks. Banks get special treatment under Dodd-Frank to invest in these, and they get community reinvestment act credits that they need under regulation. So banks don't talk, as LPs don't really exist outside of SBICs, so there isn't a lot of cross-communication between that investor base and other investor bases. So there just isn't a lot of people talking about it. I mean, that's why we're here today on your podcast to try to get

• 20:34Speaker 02

  the word out, because this program really is growing, and we see a lot more GPs coming into the market.

• 20:41Speaker 01

  Yeah, I'd add to that, David. You're not the only one asking that question. We gave a presentation to a group of 75, 85 family offices down in Texas late last year, and that was the first question, like, if this is real, you know, if this isn't just some brand-new flash in the pan, why haven't we heard of it before? And this has been around since 1958. This has been around for a long time. It just really has been reinvented and really grown dramatically since, you know, the financial crisis and Dodd-Frank alongside, you know, the private credit markets growing. And so it's, you know, getting the attention of folks is hard when you're smaller platforms, but it's getting a lot more attention from family offices. It is getting more attention from university endowments.

• 21:26Speaker 01

  But again, there's this that scale issue that David touched on a little bit is just large check sizes. If you don't want to be more than 10% of a fund and you have to cut a minimum, you know, $50 million check or $25 million check, that just excludes a lot of the very large institutional LPs that get a lot of the attention.

• 21:41Speaker 02

  That is a big problem. So investment offices that have the staff and sophistication to go do the work on the space generally cut larger checks and then they don't see it as an opportunity. Smaller groups like myself, you know, we're very time constrained. Trying to get a small investment office to go look at something new is difficult. But we've at Davidson find, you know, that's our competitive advantage. You know, we're a smaller group. We're going to use our size to access interesting investments like these.

• 22:16David Weisburd?

  Would there be anything that keeps an emerging manager from utilizing this capital for their first couple of funds and then going off this capital as they get bigger?

• 22:26Speaker 01

  That people do that all the time. But a lot of funds, so, you know, these are not rookies that are running these funds. And I think that's one of the things in the larger private equity, private credit space, when you look at smaller funds, like, oh, you're just emerging, you're just starting out in your career. These are really established people that are professionalized at this level. And some of them have grown and some of them have grown to multi-billion dollar platforms. But a lot of them actually just like this part of the market. You know, they really know this part of the market. They like having the choices they have in this part of the market. And so, you know, you can grow up and there are certainly some funds that have grown so large that it just stops being a meaningful portion of them. And a number of the, for example, a number

• 23:08Speaker 01

  of the BDCs, the business development companies started as SBICs like Main Street Capital, I think, I don't know, they're an eight or nine billion dollar BDC and they still have a couple SBICs, but they started as I think a $50 million SBIC and they took it and they grew. And there are a number of folks who have done that Hercules Capital, big venture lender in Silicon Valley. Similar and there are others. But you know, the program has grown both in the in the amount of institutional investment coming in as well as the leverage caps themselves. Now, Congress controls those leverage caps. And one of the things I do that's kind of unusual in finance is I regularly talk to the government, whether it be the Treasury Department, the White House, the SBA, the

• 23:48Speaker 01

  people writing laws in the House and Senate to, you know, help them on understand private credit and private equity policy. And, you know, we're trying to work with them to raise some of these leverage caps to let the market, you know, really fill because there's a lot more demand for slightly larger checks. And this program works very well. So I think we're going to be successful in getting that a little bit bigger and making it so that funds don't have to leave the program because it is so attractive to them and to the job creation across the country.

• 24:21Speaker 02

  Generally speaking, I think the managers that enter the programs send a great signal to LPs because they're willing to do the work to go get one of these licenses, but also that, you know, their fund growth is probably going to be a little bit more moderate than you would see outside of an SBIC because they want to keep that leverage relevant to their fund size.

• 24:40David Weisburd?

  There's a licensing process. How difficult is it to become an SBIC-backed manager?

• 24:46Speaker 01

  You have to have real experience and real successful experience investing in the strategy that you're going to pursue with the with the SBA. So if you're going to form an SBIC license and you'll be doing private credit, you've got to have private credit experience in a similar size. You can't say, hey, I've got a private credit experience, I'm not going to go do venture capital, like not not going to happen. They're looking at it from both the financial return standpoint to make sure that the taxpayer is protected, that these loans are paid back. But they're also looking at it from the reputational side. You know, if you've made lots of money, but you've left a train, a trail of lawsuits and wreckage and companies going bankrupt behind you, they're not going to license you.

• 25:30Speaker 01

  It's just not going to happen. It doesn't mean doesn't mean the companies can't go bankrupt that you've invested before. That happens or there can't be a lawsuit. That happens. But if there's a negative pattern, they just don't want to deal with it and they're not and they're not going to. And so. That is a limiting factor. It also takes some time. It takes the better part of a year for a first-time fund to be able to do this. And it costs a lot of legal fees. We're trying to do some things to take those costs down a little bit. But it is a barrier. But that being said, we have currently north of 50 new platforms that are in the advanced stages of getting licensed right now.

• 26:13Speaker 01

  And at your average fund size of 200 to 300 some odd million, that's a pretty big number as far as what's coming on. And that's just already what's in the process, you know, and gone through the interviews, gone through the FBI background checks. Because that's the other thing from an LP perspective that's different. Not only I've had the LPs done the diligence and the fund managers and the government's done the diligence, the managers. They've actually run the applicants through the FBI to make sure, hey, are we good? You know, and if the answer is no, you're not getting a license. And so that gives a number of LPs an added layer of comfort in investing in this space. But it takes the better part of a year to get one of these things. But the return ultimately is very attractive.

• 26:55Speaker 01

  And once you've had one, the second and third and fourth and fifth and sixth and seventh licenses are moving much faster than they have in the past. And now running around three or four months to get your follow-on license.

• 27:08David Weisburd?

  What's the main reason that an otherwise qualified fund typically does not become eligible for SBIC funding?

• 27:14Speaker 01

  There are a couple of reasons. One, some people just don't like the idea of working with the government. And where the government's going to be a creditor, a lender to. Two, a number of platforms like to invest internationally and you can't. So the investments you make via the SBIC, 100% of those businesses have to be primarily inside the United States. And so a number of funds will say, hey, we want to do 20% in Canada. Can't. You can do a parallel fund and do that, but that's just not an option. So when you're investing in these businesses, they have to be small enough to qualify. This isn't going to, if you're focusing on 20 to 25 million dollar EBITDA companies, it's just too big.

• 27:55Speaker 01

  And this is called the Small Business Investment Company Program, not the Medium or Middle Market Business Investment Company Program. So you have to be really focused on this part of the market. You have to be willing to invest exclusively inside the United States. Again, those businesses might have sales offices, other parts of the world, but you have to have at least 50% of the employees inside the United States. And then you have some folks who just frankly have a lot more lawsuits on some ugly stuff that can be hindering. And so when they discover that, hey, they can't get, they might not get through because of some previous, you know, unpleasantries, we shall say, you know, they just don't go in. But I think the government aspect of it, the international aspect of it,

• 28:39Speaker 01

  the size aspect of it, and the deeper diligence is one that are things that sometimes steer people away.

• 28:45David Weisburd?

  Taking a step back, Davidson has a barbell approach to investing. Talk to me about the Davidson Endowment Investing Strategy.

• 28:54Speaker 02

  We invest like a lot of endowments. But I'd say where we differ is we tend to have a larger hedge fund program. Today, that's about 35% of the endowment. And within that hedge fund program, you tend to have, we tend to have a lot less market risk, a lot less beta, and a lot more, a lot lower cross correlation among funds. That allows us to take a lot more risk on the private side. Today, about a quarter of the endowment is in venture capital and another 20% is in other private liquids like SBIC funds. We really want our capital on the private side to deliver, you know, high returns.

• 29:37Speaker 02

  We want all of those liquid commitments to compete for capital so we can get the best returns. And like we said earlier, you know, there's a wider standard deviation of returns in the private markets. There's a much greater ability to add value there. And so we want to emphasize that.

• 29:57David Weisburd?

  So you also invest 25% into venture capital. Given that you have the SBIC part of your portfolio, why also invest in venture capital?

• 30:07Speaker 02

  In venture capital, if you can... You know, through luck or skill, pick the best funds, you will have the highest returns. It's the highest returning part of the private markets. On average, venture returns have typically equaled private equity returns over a long period of time. But there's a much greater, you know, tail, positive tail in venture capital where if you get in the best ones, it can be truly extraordinary returns.

• 30:37David Weisburd?

  And you mentioned 35% of your money is in hedge funds. That's a pretty high number and hedge funds are these kind of black box instruments, at least to the outside world. Double click on some of the strategies in your hedge fund portfolio.

• 30:50Speaker 02

  As a smaller investor, we have a little bit of an advantage investing in hedge funds. We can invest in smaller ones where there can typically be more alpha.

• 31:00Speaker 02

  About half of our capital and half of our relationships in the hedge fund book are with fundamental long short hedge funds. These are typically lower net funds with, and higher gross exposure funds. Our goal across all of hedge funds is to hit something like a low double digit net return on a five-year plus time horizon. If we can do that, we can keep up with long only public equity markets, I feel, and do so with much more diversification, you know, providing liquidity in times of stress to the portfolio.

• 31:34David Weisburd?

  And why is there more diversification in these strategies?

• 31:37Speaker 02

  Just because you emphasize stock picking and you get away from the market risk. You know, just keeping that net exposure low and, you know, using your gross exposure to take on more idiosyncratic risk. Within long short, you're taking on idiosyncratic risks related to the individual companies that you're going long or short.

• 31:58David Weisburd?

  So you're, you're long part of the market, you're short part of the market. So what remains is manager skill.

• 32:03Speaker 02

  Yeah, and hopefully you picked right. We don't always do that, but the goal is to get the whole portfolio in that sort of low double digit net return area. So we can, like I said, keep up with public markets in the long run. So this diversification doesn't drag our long-term performance down. And I failed to speak earlier, the other half of our hedge fund book tends to be more quantitative, doing similar things, but in more quantitative manner.

• 32:29David Weisburd?

  Talk to me about portfolio construction of quant strategies within your portfolio.

• 32:33Speaker 02

  We tend to pick managers that are smaller, that we can have a trusted relationship with. And we do that across all asset classes, and that's a little tougher in the quantitative space. We've specifically looked at managers that are typically under $5 billion in AUM, where we can have that better relationship. You know, we're never going to fully understand what all the algorithms are doing. We'll have some sense of it, have some logic behind it. But we're not there looking at, you know, the daily numbers or anything. We're trying to find really experienced professionals that we can trust and have an open dialogue with, where everything isn't just a black box.

• 33:17David Weisburd?

  Why do you think a lot of your peers in other endowments have much less allocation to hedge funds?

• 33:22Speaker 02

  As your asset size increases, the number of different hedge funds you can access decreases. And then you start getting into problems over, you know, how much are hedge fund fees capturing the alpha versus how much alpha is coming through in net returns? I think it's very difficult to run a hedge fund that's sort of 50% to 80% net long with a 2 and 20, or just a 20% performance fee, and not have a lot of the alpha captured by the managers opposed to the LPs. So, you know, you typically see as AUM increases, hedge funds are also going to be going up market away from small and mid caps.

• 34:07Speaker 02

  And you know, it just becomes a much tougher game.

• 34:10David Weisburd?

  Perhaps it's obvious, but why are small hedge funds more likely to outperform larger hedge funds?

• 34:16Speaker 02

  Just a greater range of investment opportunities in small and mid-cap stocks. It just becomes more unwieldy to deal with large amounts of capital in the manner I'm talking about with a high gross exposure. So it's as much tougher game as you go up market.

• 34:31David Weisburd?

  And there's more sophisticated competitors as well.

• 34:34Speaker 02

  Oh, totally. Yeah.

• 34:35David Weisburd?

  Brett and David, this has been a masterclass on SBIC funds. If a manager is considering adding SBA funding into their fund, what's the best resource for him or her to go to to find out more?

• 34:50Speaker 01

  www.sbia.org, Small Business Investor Alliance.org. You know, we're the trade association that started that way. We're both GPs and LPs. So if you have LPs that are looking to invest in these, we do a lot of matchmaking and help them find the funds that match their criteria. As well as, you know, for funds that are thinking about forming an SBIC fund, whether it be a buyout fund, a MEZ fund, whatever structure they want to be, we're, there's a lot of information on that website and we can also talk to them and help them get them pointed in the right direction.

• 35:22David Weisburd?

  David, any parting words?

• 35:24Speaker 02

  Thanks for having us on. We really appreciate it. It's a, it's a topic that might be a little bit dry, but you know, we love it and are always happy to talk about it.

• 35:32David Weisburd?

  We were joking that it's a special type of person that finds this very exciting. And thankfully our audience is that person. So thank you for jumping on and I look forward to sitting down in person soon.

• 35:43Speaker 01

  Thank you, David.

• 35:44David Weisburd?

  Thanks for listening to my conversation. If you enjoyed this episode, please share with a friend. This helps us grow. Also provides the very best feedback when we review the episode's analytics. Thank you for your support.