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Interview: CIO Scott Richland on sports investing and business due diligence

The California Institute of Technology's CIO, recently retired, shares his knowledge on due diligence for sports investments from having bought a major sports team, ways to increase the value of private businesses from having inherited an aerospace business, and lessons learned on emerging markets and investing in mortgages after a downturn.

The California Institute of Technology’s CIO, recently retired, shares his knowledge on due diligence for sports investments from having bought a major sports team, ways to increase the value of private businesses from having inherited an aerospace business, and lessons learned on emerging markets and investing in mortgages after a downturn.

By Christine Giordano

Not every chief investment officer has the experience of buying and owning a sports team. Or growing a private aerospace business by 10x.

Scott Richland, the recently retired chief investment officer of The California Institute of Technology (Caltech) started there in 2010. It was during a time when Caltech had frozen 30% of its investments in cash following the Great Financial Crisis. He developed a way to get things moving again. He also became a surprise aerospace business owner when Caltech received a random inheritance of a business that was valued at $10 million. During this interview, we’ll discuss how Richland brought the value of that business up to $100 million before he sold it. We’ll also talk about his experience as president of a family office and buying a major sports team, and his advice on due diligence to sports investors. We’ll also discuss his lessons learned with investments in distressed mortgages, and with Brazil as an emerging market in his portfolio.

Note: Scott Richland is about to win a Lifetime Achievement Award at Markets Group’s Southern California Institutional Forum on June 12. Allocators are encouraged to come and cheer him on.

Christine Giordano: Welcome Scott. Thanks for being here.

Let’s talk about your career. Now, since you’re about to get that Lifetime Achievement Award in LA, how did you actually wind up at Caltech as the CIO for 14 years?

Scott Richland: That’s an interesting story. Actually, getting a Lifetime Achievement Award at this point is interesting because I’m not sure my life is quite done yet. Hopefully, I’ll have a few more achievements along the way. In any event, in 2009, I left the family office, which I think we’ll talk about a little bit more later. A trustee of Caltech with whom I had worked in the past and with whom I was very friendly approached me and suggested that I look at the opportunity at Caltech.

I really had never done anything in higher ed, didn’t know very much about Caltech. I certainly had never visited Caltech before. I was a little bit hesitant, but he twisted my arm and I interviewed. Next thing I knew, there I was sitting behind the desk. I never expected to be there for 14 years. It’s such an amazing place. It was such an incredible opportunity to work for a storied institution that it was just a fantastic experience.

Giordano: At that time that you took the helm, 30% of Caltech’s investments were in cash following the Great Financial Crisis. What’s the first thing that you did?

Richland: The first thing we did was to figure out how to restructure the office. Just a little history is warranted. In the GFC, the investment committee, and somewhat understandably decided to liquidate some of their more liquid investments, particularly their fixed income. Of course, what we all know is that when you raise cash, you actually have to make two decisions. One, when to raise the cash, and two, when to reinvest the cash. The second decision is actually much more difficult. They raised the cash in 2008, but they really weren’t able to pull the trigger on when to reinvest the cash.

I showed up in late 2010, and that cash was still sitting there. The first thing we did is identify some liquid investments, so public equities, that we could quickly put the cash into work. Then develop a plan on how to, over time, invest into more illiquid assets in the private equity, venture capital, real estate, energy, and so forth. Of course, those take three to five years, at least, to get deployed and can take 5 to 10 years to actually generate any returns, but that was what we had to do in order to get the portfolio back into an asset allocation that made sense for our endowment.

Giordano: During your time there, you had a random inheritance, a surprise business landed in your lap. Can you walk us through the story on that?

Richland: Yes, it was actually quite amazing. We had a donor who, actually, the school was not aware that he had made a bequest for his entire estate to come to Caltech. Even more interesting, he was not an alum of Caltech. He lived in Southern California, was a successful businessperson. He was an engineer and had built an aerospace parts company, albeit small, but somewhat successful, in the Burbank area. When he passed away or after he passed away, we were notified that he had donated his entire estate to Caltech.

The estate was relatively complicated, actually. It consisted of probably a dozen pieces of real estate spread from Hawaii to the East Coast. We had a fishing ranch in Idaho, or I guess a fishing lodge in Idaho. We had a very large home in Southern California. We had a large home in Hawaii that, unfortunately, required $2 million of capital expenditures to upgrade a wall in the ocean to prevent more erosion of the beach on which this house was located.

It was a crazy effort. Of course, my office was responsible for liquidating all of the assets. One of the assets was his business. This was, as I mentioned, an aerospace parts business, and he specialized in switches and sensors. It was a very specialized, highly engineered business. He supplied the switches and sensors to suppliers, to Boeing and to Airbus and to Lockheed, and to other large aircraft manufacturers. The business actually was losing money at the time. The gentleman had been ill for several years and, unfortunately, had not been able to pay the attention to the business that was warranted. It was losing a few million dollars a year when we acquired it. It was appraised more or less for its real estate value, which was around $10 million when it was donated to us.

I looked at this little business, and it happened to be located 10 miles from Caltech. It was convenient to actually drive over there and talk to the management team there. I recognized that we might actually have an opportunity to make something bigger of this. We decided, rather than liquidating the company right away, that we would hold on to it and try to turn it around. I had the great fortune of having a trustee, John Cutler, who specialized in aerospace and in aerospace parts throughout his career. I asked him to join me in working on turning this little company around, and he agreed.

Between the two of us, we spent two years working with management, replacing some of the management team. I became chairman of the board, and I worked with the CEO to renegotiate certain of their contracts that had been money-losing contracts. We sold off some of the real estate that they didn’t need. Ultimately, we started to generate profits. After a couple of years, we hired an investment bank to market the business.

That business that was originally valued at the real estate value went from losing $2 million to making about $4 million. We were able to sell it through a marketing process for $100 million. Actually, between the selling of the real estate and the sale of the business, we went from a $10 million valuation to something closer to $115 million over a three-year period. It was a very successful transaction. If you go to the Caltech website, you’ll find many, many faculty members have a named chair or a named fund behind their name is called the Allen BC Davis Fund, which was created as a result of this fantastic donation that Mr. Davis made to Caltech.

Giordano: Wow. What does that fund do now? You mentioned faculty behind their name. How does it fund?

Richland: The way the fund works is it’s actually awarded to faculty and gives them extra funds to use for their research that may not be funded through federal research grants or through other sources at the school. Mr. Davis has made an incredible impact on science and engineering at Caltech.

Giordano: Beautiful. I’m pretty sure that’s how he intended it.

Richland: Absolutely.

Giordano: As an engineer himself. Congratulations on that, by the way, chair of the board. You also, as a family office president at one point in your career, a lot of people are getting into sports investing. It’s becoming very topical, but at one point in your career, you actually bought a major sports team and became something of a president over it. Could you describe that experience and maybe some things that sports investors might want to know?

Richland: Yes. That was a very interesting experience. I wasn’t president. We had a president, but I was certainly involved in the governance of the team. It basically started when the patriarch of the family office I worked for indicated he was interested in acquiring a sports team. It turned out that he was a big soccer fan or football fan, I should say. He had actually played tennis and soccer as a young man. We looked at many different sports, but ultimately concluded that Major League Soccer, which at that time, this was in the mid-2000s, was really starting to grow. It had had some stumbles prior to that, but it was getting back on its feet, no pun intended, and was starting to grow again.

We started to dig into Major League Soccer and what the economics of it were. At that point, once we decided that it was something that we wanted to get involved in, we actually reached out to the commissioner of Major League Soccer. It was a gentleman named Don Garber, who was actually still there, and indicated our interest in becoming a part of MLS. He actually suggested that we start a new franchise in St. Louis, which was a big soccer town, but didn’t have a soccer team there yet. We indicated that while we really were interested in getting involved, starting a team from scratch, given our little family office situation, probably wasn’t amongst our capabilities.

In addition, they were required to have a stadium built. They didn’t even have a soccer stadium there. Again, that was probably more than we wanted to take on at that time. We indicated to him that we were really more interested in buying a team that was already established. There were none explicitly for sale, but he suggested to me that perhaps we could reach out to Phil Anschutz, who owned a company called AEG, which at that time– and he was actually one of the co-founders of Major League Soccer, and he owned three teams, which is a little bit unusual in Major League Sports for one owner to own three teams, but he actually owned Chicago, Houston, and the LA Galaxy, which of course was the most famous of his teams and the most successful of the teams.

I approached Mr. Anschutz’s president, a gentleman named Tim Leiweke, and asked if he had any interest in selling any of his teams. He originally indicated no, they were perfectly happy with their teams, but with a little persistence and calling him every couple of weeks and asking if he had changed his mind, we eventually got to the point where he said, “Well, we might think about selling Chicago, make me an offer.” We did, and we did a little bit of negotiating, and we were able to acquire the Chicago Fire in 2007. It turned out to be an incredibly successful investment.

I was only at the family office for a couple of years after we acquired the team, but it was quite fun being involved in sports. There’s a lot going on in terms of figuring out your ticket sales and running the stadium. We were even involved in trying to get other uses out of the stadium. Get attracting concerts and other events at the stadium. Of course, the player personnel side and bringing in international players, and so forth. It was a great learning experience for me. The team ended up being sold by the family office. I think it was in 2018 or ’19. As I mentioned, I was long gone at that time, but I can tell you that they generated more than a 10X return on that sports investment. It turned out to be very successful.

Giordano: Congratulations again. What was key to making that team profitable? I know you were president of the whole family office. I’m guessing you had enough on your plate. You were handling everything from the investments to the staff of that family office. Now, all of a sudden, you owned a soccer team. What was key to being in your role and making this a successful team?

Richland: We hired a president, and actually we hired a person in the family office who directly oversaw the investment. He did have a background in sports and in soccer. He was more involved in the day-to-day running of the team. I was sort of at a higher level on some non-team-related things. I was not involved in player personnel and ticket sales and things like that, but I was involved in running the business. For example, we took in all of the back office operations. The accounting and the payroll and receivables and payables, and all of that was brought into Los Angeles from Chicago. We managed all of those back office operations out of LA.

In terms of your specific question about the profitability, I can’t actually speak to that because the team was not profitable, as was the case with most of the Major League Soccer teams, and not all. I think there may have been one or two teams at that time that were actually generating a profit. I think, as most people know in sports, it’s not the annual profitability that necessarily drives the valuation. It’s the popularity and the interest in the sport that drives the valuations from a lower level to higher levels. That was certainly the case for Major League Soccer.

We acquired the team for a surprisingly low price. As Major League Soccer expanded, as it got more TV revenue, as it collected new franchise revenue, so every time a new franchise was opened, the new owner had to pay in a new franchise fee, and that was split among the existing owners. That new franchise fee kept getting higher and higher and higher. More new franchise revenue was split among the existing owners. That made the teams more valuable as well.

Christine: Fascinating. Just some key points. If you’re talking to other people who’d like to invest in sports, what should they look for? How should they kick the tires on that?

Richland: You have to look at the trajectory of the business and where their future revenues are going to come from. I think for most Major League Sports, the majority of the revenue comes from TV and other outlet rights. Some amount comes from ticket sales. As you know, there are some teams that are sold out every season, and so their ticket sales are very strong. There are other teams that don’t attract quite as much. Ticket sales are less important, but TV revenues are more important.

What was interesting about Major League Soccer, TV revenue was, at the time we acquired the business, there was virtually no TV revenue. In fact, I’m a little embarrassed to say we actually had to pay to be on local TV to have our games broadcast. We were able to get them broadcast, but the local outlet said, “But you have to sell the TV advertising, and if you can’t sell the TV advertising, then you need to pay for the TV advertising.” Understanding the economics of the team and of the league is obviously incredibly important. And where it’s going, when does the next TV contract come up? Obviously, payroll is a big thing.

We had one international player on our team who was very expensive. You have to make a trade-off. You have to assess what is this very expensive player going to do in terms of our attendance and in terms of our ability to win games. In our particular case, would it attract a certain community? This particular player was from Mexico. He was a very popular player in Mexico. Would we be able to attract the Mexican-American community to our games as a result of having this very popular Mexican player on our team? Understanding those dynamics, of course, is critical.

Giordano: Fascinating. Great. Shifting gears a little bit, you’ve also had some lessons learned. I know emerging markets are becoming more of a discussion point. You’ve had some experience with those. Can you talk about your experience in Brazil?

Richland: Sure. As most people who’ve been in this business for a while know, emerging markets go in and out of favor. The opportunity to make money in emerging markets obviously goes through cycles. In the 2000s, I’d say 12 to 15, emerging markets was very popular. Of course, China was ripping at the time, was getting very popular, and was growing very quickly. We made some investments in China. Some worked out well, some didn’t. We also were looking at investments in South America.

One of the investments we made, which on its face was very unique, very niche, and actually relatively safe. It was in Brazil. It was an interesting strategy where basically payroll loans were being made to government employees, and the loans were repaid out of the government employee’s paycheck. To the extent that the person remained a government employee, we were quite confident that we would be repaid on these consumer payroll loans. They were denominated in local currency, however, and so the way we thought to control that risk was to hedge the local currency back into dollars.

What we learned, however, unfortunately, is that hedging, currency works well if, A, the assets and the liabilities are exactly matched so that when you’re going to get your foreign currency, you have a hedging contract that is tied to that time frame where you’re going to get the money and you can exchange your foreign currency that you’ve received back into dollars and everything works. If it’s not exactly matched and, more importantly, if you have a very large devaluation, as we happened to have in Brazil during the time we had this investment, then currency hedging doesn’t really work because it becomes much too expensive to actually do the currency hedging. Even if you did the currency hedging in our case, we were locking in a loss on the transaction.

It turned out we lost money on that transaction. This is one of the few investments I made during my 14 years where we actually lost money on a transaction. The lessons learned were to avoid what I call a stroke of the pen risk. That is a risk where you can wake up one morning, and find that your currency has been devalued by 20%, 25%, 30% or find out that a new tax has been put on your business that you weren’t expecting or find out that your business has just been regulated out of business. That can happen in emerging markets.

Another example, of course, we weren’t hit by it, but people will recall the private education business in China was regulated out of business overnight. If you had investments in private education, which was a very popular sector, you woke up one morning and found out that you lost all your money in that business. It’s really important to look at the sorts of businesses you’re invested in and what the variety of risks are, and how you can potentially hedge them or avoid them. If it turns out you actually can’t avoid them, if you are subject to, as I said, stroke of the pen risk, it’s probably best to avoid those types of transactions, and that’s certainly a lesson I learned.

Giordano: Now, there’s some practice in tying the currencies to collateral, and as far as the emerging market investments, was yours tied to collateral at all at that point?

Richland: It was tied to the loans that were creating cash flow, as the loans were being repaid through these payroll contributions. When the currency was devalued, the loans were still being paid in the same amount and the same foreign currency. However, they weren’t worth nearly as much in dollars as they had been the day before. When we went to hedge again, to convert those new cash flows back into dollars, the number of dollars we were going to get, that we were locking in, was much lower than what we had gotten before, and so it basically destroyed the investment.

Giordano: Had there been further collateral in real assets like buildings and such, would it have mattered?

Richland: Probably not. The way to make sense is if you’re a dollar investor, if you are investing in an emerging market that has dollar revenues, and you have a match there, then it may make sense. Because they actually have dollars coming in, and then they can potentially pay you dollars from the dollars that are coming, they can pay you back in dollars, so you don’t have to worry about the exchange rate.

Even emerging market debt, you have to be very careful, because even if they’re dollarized, unless they have dollar revenues, or they have dollar-denominated assets, you’re still subject to that emerging market having to take their existing currency and convert it into dollars, and if they have to do that, and their currency is greatly depreciated, they may not be able to afford or they may not even have enough local currency to convert that currency into dollars. You have situations, for example, in Africa, where from time to time, the currencies have become virtually worthless, and so it didn’t matter how many of those local currency units you had, you couldn’t have enough to convert those into the dollars you needed to repay dollar debt.

Giordano: Interesting. That was fascinating. You also have some experience with mortgages and credit markets. Can you talk about that?

Richland: Sure. We were involved in the mortgage market and, throughout my 14 years at Caltech, continued to be involved in mortgage markets in one way or another. One experience that was particularly successful was when we had the mortgage-backed security disruption in the early 2010s, I think it was probably around 2012 or 2013, and we saw a pretty significant disruption in the MBS market, and we determined that this was a great time to go in and buy some of these mortgage-backed securities that had fallen dramatically in price.

We actually went to a couple of different mortgage-backed asset managers and asked whether or not we could form a separate account for them to invest on our behalf. We found a great partner in Canyon, and they agreed that they would start a separate account. They concurred it was a great opportunity to invest. As you may know, Caltech is a medium-sized endowment at the time. I think we may have been just under $2 billion, and so we were looking to invest $40 million in a separate account. Canyon came back to us and said, “This is a great opportunity, but instead of doing just a small separate account where you’re going to have to incur a lot of expenses, not just the fees, but the expenses of setting up the separate account, why don’t we use your $40 million to anchor a fund, and we’ll raise more money around your $40 million investment?”

We agreed, and we structured the fund, what I thought was pretty interesting, which was a two-year investment period and a one-year liquidation period. One of the risks you have in being in a commingled fund, particularly in what can be an illiquid asset class from time to time, mortgage-backed securities being one of those, is that when you’re in a commingled fund, you have the risk that your partners or the other people that are in the fund may want to pull their money out at an inopportune time, leaving you, the other limited partners, left holding the bag, if you will, holding the less liquid underlying investments. That’s one of the reasons we wanted a separate account, because we knew we didn’t have that risk.

By structuring this fund as a two-year investment period and a one-year liquidation period, there was no commingled fund risk. There was no opportunity for anybody else to get out. Everybody was going to get out after three years at the same time, and so we were comfortable with joining other partners in this fund as long as we were all on the same terms. It turned out to be immensely successful. I think we generated over a 30% annualized return over that three-year period, which was more than a double over three years, and so it worked out well for all parties.

Giordano: Considering that our economy is raising a lot of credit funds, what would be some key takeaways from that experience?

Richland: In private credit, I think people need to be very cognizant of liquidity mismatches. I know right now there are some, shall we say, less liquid asset classes that are launching into retail products where there are opportunities to withdraw money in timing that is not directly correlated with the timing of the return of those underlying investments. I would be very concerned about a potential run on the bank or run on the fund that would leave the remaining investors in a perilous situation, or might result in gating, not allowing investors to redeem their money.

We already saw that, by the way, with BWheat and some other funds, where there have been some mismatches between retail money and the underlying assets. Obviously, as well, in credit, we’re going through right now a very uncertain time in terms of business strategies, both on the buy side in terms of supply chain, companies that need to bring in, whether it’s raw materials or finished product that they then sell, great uncertainty about what those materials are going to cost or whether or not they’ll even be available.

Just recently, we heard that China has now restricted the sale of some rare earth metals, that obviously is going to have an impact on many businesses, many manufacturing businesses that require those rare earth metals. Tariffs will have an impact on the cost of importing materials for manufacturing here in the US. The flip side is the selling of your products. If you’re an exporter, if you’re dependent upon foreign markets for selling your products, one needs to be very aware as you’re making loans to these companies about what is the status of those foreign markets. Will those foreign markets be there to continue to purchase these domestic products?

We already know that many countries have, in retaliation or for one reason or another, have already decided that they’re going to stop importing certain US products. The one that’s been in the news over the last month or two, most famously, is Canada not allowing the import of US liquor. Obviously, that has an impact on the liquor business. There’s many other examples where US companies who are dependent upon foreign markets, whether it’s agriculture or manufacturing, or any of our other businesses, are potentially going to be dramatically impacted by what’s going on right now.

You won’t necessarily see a lot of those impacts immediately. Inventories need to be sold down. It’s when you have to go through the next cycle of importing your raw materials when you’ve run out of your current stocks that’s when we’re going to see the real impact. That may be a month, two months, six months away, but certainly you’re going to see an impact over the next, let’s call it, three to six months.

Giordano: Of course, this is going to be an ongoing discussion, I’m sure.

Richland: Yes.

Giordano: Still shaking out, as we can see, as each country reacts to our tariffs, and we react to theirs. Looking back and running through your whole lifetime of experience, Scott, what would you like your legacy to be? What would you like to be remembered for?

Richland: I think I would like to be remembered for my loyalty, my dedication to my craft, and to my various employers. I’d like to be remembered as a great mentor. One of the things I’m most proud of is watching the success and seeing the success of various people that I’ve worked with, who I’ve hired over the years, and watch how successful they’ve become. One of my first hires at Caltech recently became the chief investment officer at a large hospital system in Southern California.

Even though she left the nest from the Caltech office, I couldn’t be prouder of the fact that she’s now CIO at a great hospital system. I’ve had others. There’s a gentleman who worked for me back at the family office who became CIO of a large wealth consultant, and he’s been CIO there for many years. I hope, as a mentor, I had some small part in helping those people become successful. I’m terribly proud of the success they’ve had.

Giordano: Great to hear. Honestly, in sending out the invitations for your celebration, there was a resounding, “Yes, I’ll be there. I want to speak for Scott.” Congratulations on that, Scott.

Richland: That’s nice.

Giordano: Thank you for this interview. I have greatly enjoyed it.

Richland: Thank you. Thank you for having me.

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