The Myth of Private Equity | Jeffrey C. Hooke | Talks at Google

It's obviously a pleasure to be here. I'm going to start by taking the survey about how many people have heard the fairy tale Jack and the Beanstalk. Well, most of you, as you remember, from that fairy tale. His mother asked Jack to make the decision. cow from the cow family to the market and sell it instead, he was mugged on the way to the market by someone who offered to trade magic beans for the cow and those magic beans were supposed to result in great wealth for Jack and his mother, so in that particular case, as you may remember from the fairy tale, the magic beans came back well.

He had to steal gold from the Giant on top, but that resulted in wealth for Jack and his mother, but when we talk about

private

equity

, they have the same system. We are promising some sort of magic elixir or magic beans for investors that are going to dramatically beat the stock markets and as we will learn today, that is simply not the case and that is why the topic of this talk is called a capital

myth

.

private

, so I like to start the talk by telling you exactly what we're going to go over, so today we have six topics.

We have my background. What is private

equity

? Is it a savior for institutional investors? I want to beat the stock market, we'll talk a little bit, as Pranay indicated, about private equity returns and the associated fees and then we'll close with how large institutions select a private equity fund and then I'll answer a few questions so my background is a little unusual. I've had a few different positions, so I was an investment banker in New York for 15 years. I was an institutional lender in both New York and the World Bank in Washington DC. I've worked in private equity in emerging markets for a very large private equity fund, as well as for the World Bank's private equity operation, as he put it.

I was an author. I was also an expert witness before judges on financial matters and, as he pointed out, I'm currently a finance professor, so I've had quite a few different positions when it comes to dealings. I've done mint deals all over the world, so I've done deals in the US and 10 deals in Asia, Latin America, Europe, I mean, probably there. It's not a deal that hasn't seen mergers and acquisitions, initial public offerings, large debt offering projects and ants. I've been in my career and that's led me to see things in various ways, you know, because I've been exposed to so many different transactions, as well as different cultures, how people in various countries and various institutions view transactions and corporate finance, so I've had a kind of tool, you know, a kind of intellectual inclination that you don't see. with a lot of Wall Street type people, so I've looked at things.

I don't think it's necessarily helping my career much, but it's been interesting and of course you may have heard the expression "unn, you know the thoughtless life." It's not worth living, so I guess I've lived by that kind of motto in some books, he pointed out Wall Street type books, but lately I've done some academic work as a professor and the professors and I've worked with us. I have written articles on privately held state pension funds and we have just finished an article that will be published in a magazine on private foundations and their investment techniques.

I do a lot of pro bono work if you don't know what pro bono means. It means free in Latin, so I have worked because I have experience in investment banking and finance. I have worked for citizen groups and taxpayer groups in these four areas. Tobacco lawsuit fees that ran into billions, like fifteen or twenty. Years ago, the legalization of casinos in several states, many of the legislators wanted to license these casinos for free. I thought it was wrong. I thought it was un-American, so I left a fight to try to get the states to charge a fair market value quote for these. licenses and we had some success in probably causing the casino industry two or three billion in fees from utility mergers where the utilities are not giving enough benefits from the merger to the taxpayers and then, like I said, I've done that too not just academic research but some testimony on behalf of state pension funds and investor employee unions to see that those things are handled correctly.

My pro bono work also extends to see if a society and big fan of the CFA Institute and therefore, when I sometimes travel for Sometimes business holidays, if given enough notice, I will contact the Local CFA Society, it's a global organisation, so I've been in front of audiences in places like Moscow and Thailand, so it's been interesting there too, so I know a few. Many of you are in the investment club here at Google, so you know that investment club often means that I like to buy and sell stocks, so I'll say a couple of words about stock picking based on my experience.

Tens of thousands of people participate in the selection. of stocks and many are extremely well trained at top business schools and have a lot of experience, so if you pick stocks personally, remember that you have a lot of competition to get it right and actually beat the market. the people who do it it's very difficult to beat the market, most professionals can't do it and these people work 24/7 trying to be in the market, they just can't do it those who can beat consistently to the market, it is a very small percentage if you look at the fund managers that compete with the S&P 500, less than 0.1% have consistently outperformed it over the last ten years, so they have the rare combination of skill and Extreme luck and, if you look at the statistics, we are guessing. buy or sell for ten years if it is a binary choice the chances of being right for ten years or one in a thousand, so it is difficult to beat the market.

I think it's a good hobby, so I do it even though I don't think my results are fantastic. I think it's a good hobby. It's easy to measure your performance against the market. You know it's objective. I don't like being a baseball hitter or anything, but if you're anyone like the people in this room, you know you've probably done it. In a full-time job you won't be able to effectively research stocks in front of a professional, so I'd say you've reserved some of your portfolio for fun, picking stocks for the most part, so let's get to today's topic.

Let's talk about what private equity is and why it's a

myth

. I'll describe private equity for a minute, so the way a private equity fund works is that you have a number of large institutional investors, 10 or 15, sometimes 20, who put in tens of millions, sometimes hundreds of millions. of dollars in a fund, so it's a lot of money and the fund is run by investment bankers like me, so the fund buys companies for the most part and will have a portfolio of, say, five or ten companies and then these companies will then be sold after a certain holding period, so it is like a mutual fund, except the number of investments is very small and you control each one, so the fund really is in control and helps guide companies.

So the interesting thing I find in private equity, as opposed to a mutual fund, is that investors have a much longer time horizon, so if you're going to buy companies and then sell them you have to find them first, so finding a agreement in itself is a full time job. then you have to negotiate and close the transaction, so if you have a fund of, say, a billion dollars, it will take three or four years to invest that billion dollars, so in the next few years you will try it as a private equity fund. manager to work with the management teams of the various companies that you own, you're trying to improve the companies much like if you buy real estate, you can say, well, I'm going to paint it, I'm going to put an edit on it. and then I'll turn it around so they try to do the same thing except in a corporate world where they have a few years to try to improve the company's profits, improve sales, and then prepare the company for sale. in this company ready for sale and liquidation, then they have three or four years after the holding period to sell the companies.

Now most of them are selling intellectual property in M&A deals because there are very few IPOs in the United States, there are only a few hundred each year where there are 15,000 M&A deals each year, so they then sell the companies. at the end of the ten years and hopefully the investors have made a good profit, so if you look at it from a narrow perspective The way these managers pick stocks is almost like picking stocks in a portfolio, so They're very focused, but they're essentially picking stocks, except they're buying the whole company, so that's how the PM does it.

Now this chart doesn't show up, but there are three categories that dominate private equity, the biggest one would be leveraged buyouts and I'll talk about that in a minute. Venture capital and growth capital would be around 20%, but LBOs would be over. 60% of the money and what is that? What is a leveraged buyout? Well, a leveraged buyout fund. You have a basic strategy here, which is to buy five or ten low-tech companies. They have to be non-cyclical and they have to be profitable to be able to borrow a lot of money thanks, like loans to companies that make money, so the idea is that the LBO will have much more debt than a similar publicly traded company like the of Russell 2000 and the idea that you know basically is that the more debt you have go for a conservatively managed low tech company the lower the cost of capital if the market goes up the stock market goes up as does the merger market and acquisitions at the same rate the internal rate of return of the private equity portfolio will be higher than that of a similar portfolio of publicly traded stocks because it has more debt, more debt would mean a higher rate of return for the shareholder, of course, If the stock market falls, the opposite happens, so you will have more losses compared to the public market if you own a lot of stocks. leverage, so private equity fund in theory should have more volatility, it should go up and down more than the stock market due to higher debt, but returns will improve whether up or down, now equity funds venture capital you know, we're here in Silicon Valley venture capital is a little different, but it's the same principle: you buy five or ten venture capital investments.

They are generally the private equity fund or venture capital fund that does not control the company. They do not have a majority stake. They are buying companies. They are already in business for the most part, so they are not working in a garage or something and not all venture capital investments are high tech, so the companies here are much younger than the business. of acquisitions, so the venture capital fund already knows the venture capital. The partners not only provide cash but also guidance and advice, so it's a little bit different than the LBO business because I think there's more involvement with the management team, so the fundamental goal of the private equity industry is that They would like to beat the stock market because If they are not beating the stock market, the investors, the big institutions like Harvard or the Singapore sovereign wealth fund will say why do I need them.

I buy public stocks, so the idea is to have a higher rate of return with less risk. sales pitch, so if you look at that sales pitch, it would put the private equity business at a higher rate of return, the sp500 with lower risk now, some of you may remember if you've ever taken a finance course that challenges all financial theory. since the 50's supposedly if you are above this market line the market will go in everyone will invest in this and therefore reduce returns to what is at this stock market line so that's the theory , so it greatly contradicts the theory.

PE investors say not only do I want the S&P to outperform the private equity fund, I want to outperform it and that's because you can't sell these funds, you can't sell your port as part of a private equity fund. private capital as it can be sold. stocks and you also don't get instant feedback on what the price of your private equity portfolio is because there is some uncertainty about the value of a private company so there are thousands of funds available, like I said, I used to work for one and the The idea since The fund managers perspective is that I want to start funding one by getting fees from investors and hopefully making a profit and then as long as this fund is four or five years old,I'll start the next one because I don't need much. extra management to start a new fund so I'll start this fund next I'll get fees from that while I sell part of one and then just as fun as two start investing I'll go fund three so I'm capitalizing the gains and now I have economies of scale with management, as I said, it would be nice if investors could beat the market with these funds, but before they were, say, before 2005, as you can see, the funds that were started before that were consistently outperformed "yes" at p500, but then people started dipping into these funds because these funds got much bigger, there was more competition for deals and as you would expect when there is more competition for deals the cost of deals mergers and acquisitions increases and, as a result, returns. has declined, so over the last 12 years or so, you know the returns haven't been very good relative to the S&P 500 and if you look at it, these are buyout funds, if you look at venture capital, there are a similar performance pattern where people were piling into these funds and So the returns haven't been that fantastic, so if we look at the fees as an element of the whole private equity equation, they're pretty high, so the fees on an index mutual fund you could buy at Vanguard Fidelity could be five basis points per year.

There's almost nothing and in fact you know there's been some news that Fidelity is starting to offer funds for nothing, so I would invest in them without paying any private equity, on the other hand, it's about 300 basis points a year, so the fees are sixty times higher, so the private equity fund manager has to beat the S&P by 3% every year just to compensate the investors for the fee, so it's pretty difficult, so if you do you look at like this type of chart, I mean you know getting into this part of performance is so difficult you know, only a small percentage of people can do that in the public markets and as a result, with the high fees, you're not investing investors' money 100 percent, maybe you just know that private equity funds only invest 80 percent of investors' money, so there are many obstacles that PE funds managed to conquer in trying to surpass the stock mark and I looked at a fun, you know, a lot of states, a lot of universities and a lot of large institutions don't do it.

They know what their storage fees are, they don't ask, so they are not billed a storage fee, the fees are deducted before investors see their returns, the only fee that is disclosed on an accounting basis is 1.8 %, unless the state of the The university asks that they do not receive the Decarie fee. New Jersey is one of the few states that actually asks for it, so I put it here on the slide to show you that the rates are about 3% from last year. Now the interesting thing about private equity funds. Performance is positive and really dominated by the top quartile, meaning the top 25% of funds are doing very well, the second quartile is around the stock market and the third and fourth are below, so that you have half the people I have.

I don't have a very good batting average and if we look at venture capital, we know the graph would be very similar. The thing about those performance numbers is that a lot of the performance numbers are based on transactions that haven't been sold but in other words, company P has bought the company hasn't sold it yet, so how are they measuring well its performance? They have the ability to value their own investments in the market. Nobody is actually double-checking like the auditors, the investors, the limited partners. don't check and you know it's kind of an honor system that always surprised me maybe I'm a little harsh and cynical but you know I was surprised that billions of dollars come in and no one really checks it so I like it overall. process a third grader, you know, grading his own homework, which is a little strange for this type of business, so here's the evidence, so if you look at the purchase funds, you know this was like 10 years and these are statistics or reasonably recent.

I can see even in 2010 2011, most of the returns that they are guaranteeing have not yet occurred in terms of cash, now these deals have not been sold, so you have funds that are seven eight nine years old that have not been sold half. the things they own still, so you might know I'm kind of questioning whether they're worth as much as the managers say, so if you want to dig a little deeper into the weeds, I mean, are they really worth as much as? I said, "You know," I did a study with one of my colleagues and we looked at what the market valuations were experienced during the crisis.

A company with more leverage, such as the portfolio companies of a leveraged buyout fund, would now be expected to decline. more than the stock market for the reasons I mentioned above, but if you look at the way they reported it, the leveraged buyout industry said, guess what our results were better than the stock market despite our higher leverage? , so again it would seem to me that Totally the opposite of what financial theory would tell you, so we call that expression yield smoothing so that you have the flexibility to put your own brands in your portfolio. Obviously it will do it a little bit in your favor if you are a rational person to look better sooner of course like I said the sales pitch is not only that we have higher returns in the stock market but we are also less volatile anyway , the sales pitch has made many large institutions believe in them.

I looked again with one of my colleagues, we analyzed the returns of the pension funds in the big states like California, New York, Maryland, we analyzed their pension funds and they know that they have dedicated much more to alternative assets such as private equity funds. fund, but that Stampede into private equity and all its alternatives didn't really provide a higher level of return, so if you just compare your average state pension fund or endowment to the 60/40 ratio you can buy it at , you know at Vanguard or Fidelity, there's a big difference, 60/40 beats that by a significant margin now people who don't really know Matt say well it's only 1% what's the problem, but if you have a pension of 50 billion dollars and it's 1% every year, that's 500 million a year, you know sooner or later you're going to be talking about a lot of cash, so how do these institutions choose private equity funds?

They are trying to do the best they can. They are trying to find private equity funds that are at the best level. top quartile, how do they do it? There are two ways to do it: One is to look at a fund that was previously in the top quartile, so that fund comes out with, say, a fun number two so that the investor says, "Okay, they did well." fund number one I assume they will repeat the performance in fund number two, our fund number three in this case, so what is the statistical probability that the third of the second fun will outperform the previous fund?

It's about 30%, so it's almost random, so in Wall Street terms, that's called mean reversion, now you may be doing well for a while, but then gradually, as you As time goes by you can tell it goes back to the average it's the same as everyone else so with LBO it's about 30% so it's almost random with VC there seems to be more staying power as VC companies are more Experts in repeating their performance now, that's an option, so you try to go to your top quartile funds and hope they repeat the performance, unfortunately most of them don't.

What about option number B? That would be where you say: I'm going to play it safe. I'm going to pick a big fun brand, so I'll go with Goldman or Carlyle Group or Kohlberg Kravis, they have, you know, six. or seven funds from that story, they are big names, I will just invest in them, the problem with that is that if you look at the big fund families like Carlyle, Apollo or KKR, they don't outperform the no-name funds, so strategy o B doesn't seem like a good option. I mean, B obviously gives the pension fund people in his endowment some air cover.

They can always say, well, it wasn't my fault the fund went belly up. I went with Goldman Sachs. We're supposed to know what they're doing, so there's an old saying that you can't get fired if you go with IBM; it would be the same in the private equity business, now the portfolio patterns, what does it look like with these funds? So if you have 10 companies in a fund as an average buy you have about three that will go bankrupt due to high debt you know sometimes it doesn't work when you borrow a lot of money it will be fine in terms of performance 3 will be how this works well you could have a 20 or 30% rate of return these C's are a little bit different you know they are more of a gamble you are dealing with younger companies many times their technology so you know they are not developed and you don't know the customer base or the technology, so you know you have a lot more bankruptcies when they reach outperformance, it could be very high, you know, just great returns.

I'm like, let's say, a boring low-tech company and the acquisition business a couple of case studies for those of you who are interested in venture capital. I'm sure you've all heard of this one. Darah knows it. I guess once you're in Forbes magazine it's like the end. You know that always. I used to think that when a CEO writes a book, you know the stock is going to crash because I've seen a lot of cases where a book comes out and then the company's stock crashes, so you know that this story It is quite well known. invented what people thought was a unique technology for doing blood tests by just pricking your finger instead of sticking it in and you know, a needle in your arm and people were believing the story.

He invested hundreds of millions of dollars from Silicon Valley, which still has a lot of knowledge. investors, it received a lot of publicity, most of it was pretty good, the value of the company when on a private basis reached up to nine billion dollars until the roof collapsed and the magazine started picking up rumors that the technology really wasn't what she and others said it was and of course I guess the company just announced it was going into liquidation a couple of weeks ago so us equity investors are totally out, how about a good one? Why talk about that?

Let's talk about a good one. One, there are a lot of good ones, yeah, Roku is a real success story, so it's about ten years old and ten years old they invented the first streaming box for Netflix and then they developed some other products and you know, it followed the normal process. I would like to see a high tech company increase its venture capital and gradually get a higher value and then go public in large numbers and everyone would get a great rate of return. Now Roku is still losing money despite all this success, so we're just going to have to wait and see, in a few years, if it turns out to be a really solid business entity that can commit and can maintain its momentum, so it could be say why people still invest, why big institutions invest in private equity, right?

I've seen these statistics, I'm a bit of a student of human nature, and I've come up with some kinds of theories about it after talking to a lot of people, so I think there is a category of investor who can be a true optimist. I know people always like to think they can do better than the stock markets, they say. I think I have a plan for us to do better and you know, I think private equity is the way to go so these would be the true believers and I was working on behalf of the New Jersey employee unions and I looked at the private ones looking the private equity portfolio and I remember hearing the head of the investment committee speak and he said, "Mr.

Hook doesn't know anything, you know, we only invest in the top quartile private equity funds, so I looked at the top , they invested 200 different funds and I looked at it and I looked at their performance in a private equity database and they were They were not in the top quartile, they were not in the bottom quartile, but they were not superior if you took the hundred together, they were exactly in the middle, so they were, let's say, between the second and third quartile, which is what would be expected if the funds were selected at random, but there were people who simply believed that now the other group would be institutional investors who listen a lot to their consultants, so every large pension fund, most endowments, would have a consultant who would tell them what their portfolio allocation is. you should allocate some of the shares to the bonds and others toalternatives, so they are always pushing alternatives, these consultants, and if you listen to them, you yourself will be an alternative.

Now a cynic might say why they are pushing alternatives if you have looked closely at these statistics, if you are a consultant, you get paid millions of dollars a year. Well, why would they continue to pay if you just walk into the office and say, I think I should index the entire portfolio? So they say: Well, what? Do we need you for C? I think it's probably the most applicable and it's unfortunate, but if you're working on a large endowment or if you're working on a large state pension fund, you're in the Investment Office, you know that.

Typically you'll be tasked with choosing managers, so you're not investing the money yourself, but rather you're choosing managers in stocks, bonds, hedge funds or private equity, so you're unlikely to look at all the numbers. and say well our strategy is wrong, we have ruined it in the last ten years because we are not exceeding 60-40. Those people's jobs depend on one having many different investments to manage and oversee, so if they ended up walking into the board director's office and saying, "We can't produce any return premium on an index, so I hand over my resignation. You know, not many people are going to do that, so that would be called.

Well, in finance, that's called an agency problem where the investors are using the managers as agents in the hope of getting a good return. and the last one is really what I call the Stockholm syndrome. Now the Stockholm syndrome is based on people like 20 or 30 years ago who were kidnapped by a gang in Stockholm, Sweden So, over time, while they were held captive. , they started to sympathize with their kidnappers, believing what the kidnappers told them and it was a very interesting kind of psychological experiment or situation, so if you talk to people in the business, I mean, a lot of them go to conferences and they're all talking about how good private equity or hedge funds are, so if you interact with people and they talk about these things, you started to believe it, so that could be the fourth theory, but again, like I said, I think that probably the sea could be the predominant theory for why you know we still see a lot of private equity.

I like to say in my college classes that private equity M&A is a business for optimists, so you have to think you're going to do better than average and human nature tends to do so. being optimistic in many cases and the investment business in a nutshell, you know that if you think you can get higher returns, you will be optimistic relative to many others, so there is a bit of a circular facet to this where you have got the claims of the funds. of PE and like I said they can basically value their own businesses at market prices, a lot of PE fees are secret so people don't know what the states pay.

Accounting doesn't require fees to be disclosed, so it's a self-perpetuating cycle and it's been very effective, which is why if you believe in efficient market theory you'd say wait, wait a second time, you know you shouldn't. There is a private equity industry as large as it is, but you know that the markets are not entirely efficient. Because the information is simply not available to many investors, so I'll stop and answer a few questions. Anyone who has a question would like to ask. Thanks chef. I appreciate the talk. I was wondering if you have the same type. point of view towards private equity funds that say they specialize in a particular asset class like real estate versus infrastructure funds or versus I guess so, I mean do you have any thoughts that you know about those types of funds? how do they compare to funds that buy businesses like LBO versus you know we invest in roads or whatever, well infrastructure funds are too new and to be analyzed in that way where you can look at a long term track record.

The other problem with infrastructure funds is that there tends to be no public equivalent that is easily definable in the same way as a private infrastructure fund, so it would be difficult, on the other hand, the real estate sector has a long history , so private real estate funds would do. pretty much the same as publicly traded REITs, real estate investment trusts which are publicly traded vehicles that buy real estate and if you look, I mean, I haven't studied much about this, but if you look at the private real estate funds, they also tend to be less volatile than publicly traded REITs, which has raised some questions about you know your market value ability, you have one here, go ahead, it's clear, you know these are these people who They're running a business, I mean you know they're running a business obviously benefits their investors, but they also benefit themselves as owners of the business or the private equity funds, so the trend for the larger ones is We've done everything we can in DC, we can't grow. much bigger in that market because there just aren't enough good investments, so it's not unusual for them to say that some of the skills are very similar to private equity, so we'll take what we've learned in venture capital and transfer it to growth capital or maybe not purchases, but growth capital and I agree with them.

I think there are many similarities. Deal closing evaluation accompanies evaluation, management and markets, so it is a natural progression and it has been seen that some of the largest buyout companies are not only going into growth capital, not so much venture capital , but you see them investing in hedge funds, you see them making loans or they say, well, we've done a lot of buyout deals as equity investors, we can also make loans, so it's just about diversifying their business. make earning patterns more stable and predictable. I was wondering if, like you, you know of any differences in, for example, the attitude to investing in cultures like, for example, I can do it in other countries like Asia versus the United States.

I got into Asia quite a bit, I mean, from the REIT standpoint, you know, I think there's a distinction between listing to a retail investor and an institutional investor, so if you go into retail in Asia, I think they're much more interested in speculation. They tend to be more analytically inclined and they might look at the company's P/E ratio and how it compares to others and what the growth record is and all that kind of stuff, but I think the Asian retail investor you know would say, " Oh yeah". I heard it's a hot stock, I'm going to go buy it, I won't do much analysis, so I think it's not that they don't do that here in the US and Europe, but I think they would be a little more speculative.

From an institutional point of view, I haven't noticed much difference between, say, a large Chinese sovereign wealth and, say, a large university. I think they tend to travel in the same circles and use similar investment techniques. See you later, Curt. Hi Jeff. Thanks for talking about the previous question if you see that retail investors in certain countries or places tend to be more musical or at least have you seen in your studies a similar sort of correlation, we would say that PE is successful in some areas versus not? or some emerging markets versus not, there are factors like these that confound the factors that basically make them a little bit more successful or not, there are PE and a lot of emerging markets now, and you know, it's a relatively new phenomenon of private equity and, for example , India. or Malaysia, or you know South Africa, so I don't think there is enough data to measure whether they are emerging market PE funds or expired.

I shouldn't say if they won in the stock markets of those countries. I just don't think there is enough information there, yeah, thanks for the lecture. I couldn't help but notice that if you look, you've presented a great slide that was either the history of performance relative to SP or it was a 60/40 it wasn't very clear which and it seemed pretty clear that it was performing relative to SP for quite a while. time and then stopped. Do you have any theories as to why yes, of course I do, sir? I wouldn't be here if I didn't, yeah, I mean, I think and I talked to a lot of people in the business about it, you know, I think when there was a lot of success, as this chart points out, people just investors started buying these. funds based on their historical track record and like I said, you know I kind of suggested as people stack up on these funds the target prices because there are a limited number of targets that meet the requirements to be a candidate for buy, for example, so the price of the targets therefore rose, so as the price of the targets rises, the corresponding return for the LBO investor falls a little, not reaching zero, but falling a little bit, so the difference you can see is illustrated here, you know, once people started looking.

In this history, you know, oh five, OH, six, oh seven, they were some of the biggest years for new funding, so there's a lot of competition for deals and I realized that when I know because I work part time. in an investment bank. and I see the competition for transactions where for an LBO candidate we might get six and seven bids so you know who the winner is, the one offering the highest price, where the winner is and then it could be the loser because you know they're paying a price too high. then you have supply demand because there is a lot of money trying to find the same transaction, the other aspect would be the fees, you know the fees are high, so if you have a fairly high level of fees, that will be a drag on your return at any time. other questions, I have whatever in recent years there has been a lot of discussion about the value of going down that path and so a lot of money is flowing that way now and do you anticipate that there will be some kind of similar effect What actually was it?

After seeing the PE returns, the good thing is that a lot of money came that way and eventually the returns are non-existent. Is there any potential for the same thing to happen on the index side? Now I will only invest directly in index funds. I think at some point, if too much money goes into index funds, there will be more opportunities for stock pickers, people who study and then pick individual stocks because many passive funds will lose price, You know, they're just buying. stuff based on market cap, but if you look at the retail mutual fund market, it's about 30 percent indexed and institutionally you know the big pension funds or endowment universities.

I think the indexing is only around 15, so it's a lot. small, so when I've thought about it and talked to people whose opinions I respect, I think the indexing part can probably get to 75 or 80 percent before the indexing returns are surpassed by those people who are not indexing, but you know, there's a long way to go, a long way to go, the other thing is maybe I should correct myself, there are a lot of people who manage money who could do what's called closet indexing, so they're managing a large large cap fund for some money manager or for some state pension fund, so they are trying to adjust their results to the large cap index so that they are current, although they claim that they are picking stocks and doing all kinds of analysis , they are trying to stay close to what the stocks are in the index so that they don't overperform or underperform by any significant amount, so you know, you could say it's a very conservative strategy, but I think if you include the locker indexing, my percentage is maybe doubles what is indexed.

Right now, thanks for the chat, Jeff, I have a question. Do you think the competition from private equity actually trickled in? Oh, you know, it affects the public market, for example, for the reason that for years it seems like the initial public offering (IPO) surprised you. The way I look at the whole IPO valuation is that it is quite high and there is not much juice from the IPO, so part of yes, then the question is whether the private equity market competes with the public market for new listings, I would say absolutely. So there are a lot of companies that you would think would be good IPO candidates and they say there's so much private equity money out there, why should I do an IPO?

It's a pain to be a public company. We have everything laid out there for everyone to read. You have so many regulatory issues that you have to address everything you talk about on TV or in press releases. This can be put under the microscope by a lawyer, so for many companies I think it's a better idea to invest in private equity, which is why there is so much private equity. I think they are really delaying the number of IPOs and I don't see that process beingslow down. Personally, I would like to see more IPOs so that public investors have a chance to get into many growing companies, but there is too much private equity money available right now and I'm sure you see it a lot here in Silicon Valley, you know you see a good small company and you say, well, it's a good IPO candidate, but I know it's just not happening, the other factor that you don't often hear mentioned is you know the investment banking community has shrunk considerably, so So now you probably know five or ten companies that really dominate the business and would also dominate IPOs. so they tend to want to see bigger deals, they're big companies, it's economical for them to do big IPOs, so with the disappearance of a lot of smaller banks that they've acquired or just closed down, you don't see as many smaller D's there.

There just aren't enough people to sell them, so you have those two factors. I think working against the public market having more listings at least for now. Thank you. General question about, you know, during Graham's time there was a lot of focus on price. -to-book and then the world moved forward as the economy changed and the nature of business also changed, if we look at price-to-earnings ratios and price to free cash flows, do you think there is another change of paradigm or is it rather here where you can find a good The idea is taken to the extreme in which of the two is where you have a very intangible economy, customers acquire now whose values ​​are realized over a long time and the p/e does not reflect that economy.

Remember when Graham and Dodd wrote that book? We were just getting over a big stock market crash, so the book was ultra-conservative and said, "Focus a lot on the balance sheet, that's your backup plan." You know if you had a strong balance sheet, it's unlikely that the company could go bankrupt, so that was kind of the starting point, look at the balance sheet and then let's look at the income statement, so now it's the other way around, you know. , people are looking at the income statement a lot more and I guess that's been the trend for the last 30 years and that's how it is.

More or less what my book was was a sort of update of Graham and Dodd's authoritative book and I don't think the paradigm has really changed. I think you know people today are still focusing on, as you pointed out, a cash flow, EBIT, no. Looking at the balance sheet a lot, unless you're a financial institution like a bank or an insurance company, which I think is the most notable thing in recent years and this is kind of a repeat of, say, 99 98 2000, you know ? People are more willing to accept a steering wheel. about the companies that know a good progression of sales without profits, so they have good sales profits, they will come later and I think now it is a kind of repeat, let's say 20 years ago, and I think people have learned their lesson.

I'm probably being a little more analytical than I was 20 years ago with the last Internet boom, but I'm still a little cautious about it and I'm still a little reluctant to recommend buying stocks of companies that have big losses even though they're raking in customers that you know could generate future profits for the business, yes any additional unit economic basis in the last combo companies were probably not profitable even in a unit economics, compared to today you could argue that they are losing money, but that is because the fixed costs right now are very high, but in unit economic terms they are still very profitable and if they have a scale, then you know that those fixed costs can be covered, obviously it is risky to know if they will raise fixed costs. scale or not, not really, you're absolutely right, I mean, if once you have the fixed cost established for many of these companies like Uber or Twitter or someone like that, you know, once you have the fixed costs established, a As the number of customers increases and the revenue increases, you know that you're going to make a lot of pure profits that will make it to the bottom line, but I think like you and I talked about yesterday, you know, predicting which ones can actually make it is a little difficult, people do it.

Have you tried in the past and you know that most of them choose 10 or 15 companies that are similar to the ones you describe, you know that will be the case. as venture capital, 2 or 3 will be absolutely fantastic returns, 4 or 5 will disappear and then you know three or four will be fine. I mean, sorry, that's how statistics work. I mean, it frustrates people, what you say, well, I guess. I can choose winners. I have all this training or I know the Internet business, but yeah, it's very difficult to do it consistently, so I had a question about the current low interest rates, Jeff, how do you think about what your discount rate should be? of the sea should be in the capital valuation, yes, so many predictions about future cash flow have to come back to the present if you are doing an analysis of a company, so here we have had seven or eight years of very low.

Interest rates by historical standards, you know, two or three percent for government bonds are very low compared to history, so what I do is and what other more conservative investors do is say, well , we are now in a period of unusually low rates, so if I am predicting cash flow 15 or 10 years from now, using 2% or 3% as my base is simply not realistic, so I think an approach more rational is what is the normal US Treasury bond rate for the last 30 or 40 years, it's probably around five or six percent, so I use that as a base rate for some kind of projection and then I add risk on top of it, so if you get your base rate of five, you add six or seven to invest in the stock. market as the stock risk you face and then you have to add one or two more points depending on the industry you're in or what unique attributes the company has, so for a common equity investment, I think you already knows. someone has to use a discount rate of say 11 or 12 percent to be fair and objective.

Thank you pronounced push thank you very much.