Private equity firms like Blackstone, Carlyle and KKR have been hugely successful over the decades. They have used corporate control and financial leverage to deliver equity returns envied by many public market investors. Yet, competition for deals in private equity and the presence of informed, rational sellers have made it difficult for large private equity investors to find true bargains. Nonetheless, for those of us active in public markets, applying private equity principles can lead to better returns.
In the exclusive interview below, Australia-based value investor Adrian Warner provides valuable insights into private equity-style investing in public markets. Adrian is the Managing Director and Chief Investment Officer of Avenir Capital. His background is ideally suited to this topic, as he enjoyed a successful career in private equity in Australia and the United States before setting up Avenir Capital. Immediately prior to Avenir, Adrian was Managing Director and part-owner of Catalyst Investment Managers, a mid-market Australian private equity firm with $900 million of assets under management. Prior to Catalyst, Adrian was Managing Director of CVC Asia Pacific, one of the leading private equity groups in Asia with US$2.75 billion in assets.
Path from Private Equity to Value Investing in Public Markets
Adrian Warner’s evolution from private equity to public equity investing is quite fascinating. Having learned about the efficient market hypothesis early on, Adrian viewed public markets as devoid of major inefficiencies. He went on to a profitable career in private equity investing. As his experience grew, he started noticing greater inefficiencies in public markets as well as greater competition for deals in private equity. At some point, he realized that the nature of markets actually made some public securities susceptible to mispricings some of the time. Listen to Adrian describe his journey toward value investing in public equities:
Public Market Success Through Private Equity Principles
Adrian Warner’s extensive experience in private equity inculcated in him several principles that have served him well in public markets. Here are the three pillars of his approach to value investing, each of which has been strengthened by the application of private equity principles.
Emphasis on What Can Go Wrong
Private equity investors use financial leverage to drive greater equity returns, necessitating an intense focus on downside risk. When leverage is at play, small changes in enterprise value cause disproportionate changes in equity value. As a result, private equity investors typically seek out stable, cash-generative businesses with recurring revenue models. Keen awareness of downside risks can improve public market returns by making large drawdowns less likely. While Adrian Warner does not seek out highly leveraged public companies, he continues to focus on finding companies with fundamentally low downside risks.
Bottom-Up, Deep Investment Research
Private equity investors take control of businesses, relying on the performance of those businesses to generate investment returns. By contrast, many public market investors prefer to engage in Keynes’ “beauty contest”, constantly guessing which securities other investors will like in the foreseeable future. Application of private equity principles can make public equity investors more focused on the underlying business rather than the stock price. As Ben Graham has stated, the stock market is a “weighing machine” in the long term. As a result, investors who focus on the fundamentals should outperform over time.
Focus on Absolute Long-Term Returns
Private equity investors do not benchmark their performance in the same way many public market investors do. In private equity, the goal typically is to generate absolute investment returns over a long period of time. By adopting a similar focus, public equity investors gain an edge over fellow market participants who make decisions based on short-term results or emotional swings. The increasing “short-termism” of many investors has created an opportunity for those willing to apply private equity principles to the public markets.
Adrian Warner cites the private equity principles that have helped Avenir Capital outperform in public markets:
My full 45-minute conversation with Adrian Warner on applying private equity principles to public equities is available in The Manual of Ideas Members Area.