E261: How Sovereign Wealth Funds Create Alpha w/Peter Madsen
Timestamps are as accurate as they can be but may be slightly off. We encourage you to listen to the full context.
Podcast Summary
Peter Madsen, Chief Investment Officer of Utah's School & Institutional Trust Funds Office (SITFO), shares his unique journey from managing hedge fund portfolios in London to building one of America's most sophisticated sovereign wealth funds from scratch. (01:00) He discusses how he transitioned from the declining fund-to-fund industry to become the first investment hire at SITFO, transforming Utah's endowment with a modernized approach to investing. The conversation explores SITFO's contrarian philosophy around mean reversion, their shift from small-cap public equities to private markets, and how a small team competes with massive institutions through factor-based investing, collaborative models, and AI-powered due diligence. (02:53) Madsen reveals why he believes small caps are "broken" in today's market structure and how SITFO uses innovative partnerships and co-investment structures to generate alpha while managing a perpetual capital fund that directly benefits K-12 public schools in Utah.
- Core themes include mean reversion investing, the evolution from active vs. passive strategies, private market opportunities in micro-VC and small buyouts, and leveraging technology and partnerships to punch above their weight class
Speakers
Peter Madsen
Peter Madsen serves as Chief Investment Officer of Utah's School & Institutional Trust Funds Office (SITFO), one of the most sophisticated sovereign wealth funds in the United States. Prior to SITFO, he managed hedge fund portfolios and fund-to-fund strategies in London at Cube Capital, overseeing approximately $1 billion in assets across direct funds and diversified strategies. He also worked as a consultant at RVK, where he gained extensive experience with state trust funds and helped lobby for constitutional amendments to modernize trust structures, including work with the state of Oklahoma.
Key Takeaways
Mean Reversion is Real and Should Drive Investment Decisions
Madsen emphasizes that mean reversion is a core investment principle that extends beyond just public markets into active management strategies. (02:53) He argues that while it may not be immediately apparent in US stock markets, active management performance comes and goes in waves, especially for strategies with meaningful size and volatility. This belief drives SITFO's contrarian approach of investigating managers or markets that have been out of favor or are "down and out." The key insight is that investors should be looking at underperforming areas when others are avoiding them, as these cycles eventually reverse and reward patient capital.
Small Cap Premium Has Migrated to Private Markets
The structure of small-cap public companies has fundamentally changed, making the traditional small-cap premium less reliable. (05:29) Many small-cap companies today are "fallen angels" - former SPAC targets, direct listings that declined, or companies that should never have gone public in the first place. (06:59) True high-quality smaller companies now stay private much longer and go public at massive scale rather than small-cap size. SITFO operationalized this insight by reducing their small-cap public equity allocation and redirecting that capital toward private equity, particularly micro-VC and lower middle-market buyouts where the authentic small-cap premium now exists.
Start with Equal Weighting, Then Optimize Thoughtfully
Rather than beginning with complex optimization models, SITFO started their asset allocation from an equal-weighted portfolio approach, inspired by Harry Markowitz's observation that naive 50/50 diversification often provides the best risk-adjusted returns. (08:05) They used this as a foundation, then made specific adjustments based on their resources, cash flows from land-based revenues, and expected returns. This approach proved more practical than optimizing solely on Sharpe ratios, which Madsen considers "perverse" because it can lead to top-ticking investments that performed well historically but may mean-revert going forward.
Collaborative Models Provide Scale Without Internal Resources
Small investment teams can compete with larger institutions by developing commercial collaborative relationships rather than traditional consultant arrangements. (24:24) SITFO partners with advisory firms through revenue-sharing, fee discounts, and co-investment structures that provide access to databases, research, and pre-underwritten opportunities. This frees up bandwidth to focus on satellite or niche strategies while getting "off-the-shelf" access to conventional exposures. The collaborative model allows them to achieve median or better gross returns while eliminating fee drag through co-investment accounts with minimal expenses.
AI as a Due Diligence Leverage Tool, Not Decision Maker
SITFO uses AI tools strategically to handle data gathering, collation, and objective scoring in their investment process, but explicitly not for making investment decisions. (30:06) The AI system processes meeting notes, manager materials, and legal documents to extract specific criteria like ownership structures, fees, and red flag terms according to their predetermined frameworks. This allows the investment team to spend more time on qualitative aspects like culture and investment philosophy rather than administrative tasks, essentially providing leverage that allows everyone to read memos before meetings rather than spending time writing them.
Statistics & Facts
- SITFO manages assets where beneficiaries are K-12 public schools across 22 Western states that have or had sovereign wealth funds, with distributions going directly to those schools. (33:29)
- When Peter Madsen worked at Cube Capital in London, they managed approximately $1 billion in assets across direct funds and fund-to-fund strategies, but remained at that level for five years despite expansion efforts. (00:21)
- For a $100 million venture fund to achieve a 5x return, they would need approximately five unicorn companies per vintage year, making smaller fund sizes mathematically more feasible for generating high returns. (20:03)
