Pembridgecap

A Wealth Creation Journal

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Scribbles: KKR at the Goldman Sachs conference

  • 2X as much KKR investment professionals in RoW vs US.
  • 18 out of 22 investment strategy families less than 10 years old. Significant operating leverage on those (mostly) RoW people in young strategies
  • KKR Capital Markets: doing deals with third parties and being able to control the dealmaking and capture some fees, having a cap markets division is a competitive advantage that does not show up in typical alternative’s KPIs such as AUM, FPAUM etc
  • when KKR converted to C-corp, it stopped distributing 75% of distributable earnings. Today it is lower
    • Note I believe this is reason why KKR trades cheapish: the market prefers bird in the hand over compounding bird in the KKR stock bush, with supermajority voting stock etc.
  • KKR major player in Asia, biggest in terms of private equity funds, started in 2005
  • Most Asian investment professionals actually in India
  • Investing mostly in domestic consumption stories in Asia

 

Coming wave (next 1-2 yrs) of flagship fund raisings, chronologically:

  1. Asia PE fund
  2. Americas
  3. Infrastructure

 

Flagships will be additive to overall fundraising (last 3 yrs 90B of AUM raising without flagship wave, i.e. I believe only 1) and should be 30-40B USD in aggregate.  Everything else equal, 120B AUM raising in 3 years is possible (bull case environment maybe).

 

Odd lot split-off Danaher – NVST

If you buy 99 shares of Danaher through IBKR today at the US open, you’ll probably be able to tender these by the end of the business day (which is the deadline) for 5% more value in NVST shares. In two weeks you’ll get NVST shares delivered in your account.

Danaher is splitting off its 80% interest in NVST.

I am doing this unhedged, i.e. simply buying DHR and taking the volatility risk on NVST

Results may vary a lot, but 5% upside baked in is quite a high expected IRR for a few weeks of waiting.

 

 

 

 

Presenting a new blog post category: scribbles

The blog has been inactive for a while as the time hurdle to write down structured thoughts proves to be high.

From here we’ll post interesting notes, conference tidbits, thoughts in a more haphazard way under the post category “scribbles”.

We hope you’ll enjoy it.

Book review: Free Capital

I have never felt that investing is like working. It is more like playing ten parallel games of poker.

Peter Gyllenhammar

I recently read Guy Thomas’ excellent book “Free Capital: How 12 Private Investors made millions in the Stock Market” and learned a few things.

The book profiles 12 UK private investors who left their career to invest. I found the book an enjoyable and easy read.

The depth of the interviews is quite good. It’s easy to see the author is very knowledgeable in stock market investing (i.e. he’s an independent investor himself).

The book is agnostic on investment philosophy and there’s no larger narrative. Rather, the book is similar to the all-time classics Market Wizards or Inside the House of Money or John Train’s The Money Masters. The main difference is it profiles succesful non-“professionals”.

As the book does not have a big narrative, I’ll share some interesting concepts and quotes I picked up. The book is also full of “concept boxes” that explain certain touched-upon concepts. Even for seasoned investors, you will learn a few things. I will not share these.

Interesting thoughts, resource and quotes. Unsurprisingly, as an electrical engineer myself, the “hard science” investors’ thoughts resonated most:

  • most investors used the bulletin boards to share info with others ADVFN (which I find useful as well for our Dart Group plc position), Fool, iii.co.uk, stockopedia.co.uk

Investing is not like Olympic diving: there are no marks for degree of difficulty

Sushil
  • optimal betting size (i.e. Kelly Betting) is more cautious to downside risks than simply going by “expected returns” (i.e. probability-weighted return). Optimal betting uses logarithmic returns: while an investment with 50% chance of +25% return and 50% change of -20% has a 5% “expected return”, it has a 0% expected logarithmic return. Another way to see how an investor “gets” 0% and not the expected return is by continuously investing in the above 50/50 +25%/-20%-type of investments: +25%’s that are equally followed by -20% return 0% over time
  • Path-indendepent thinking: occupational identity can be a mental constraint. Don’t let your thinking be constrained by your identity.

I don’t seem to have very much influence on Walter. That’s one of his strengths: nobody seems to have much influence on him.

 

Warren Buffett on walter schloss
  • look for motivated sellers
  • better be right than consistent

The best decisions in the stock market attract no applause

Vernon
  • structuring your investments by writing down a brief 1) thesis 2) secondary factors 3) “hygiene factors” (absence of red flags)
  • investing is a game with negative scoring: avoid mistakes, learn from other people’s mistakes
  • optimal rate of error: it is not worth knowing everything about a company, because every point investigated has a time-opportunity cost. Your aim in checking “hygiene factors” is not to find out everything, but to reduce your error rate to an acceptable level

On talking to insiders and activism:

  • strategic naïvety: it can help to appear less sophisicated than you are. It helps persuade insiders to open up.
  • manage company meetings: at AGM’s, set expectations at the start of the meeting by informing insiders you have several questions to ask. Take note of who answers which questions and how they interact.
  • create a paper trail: putting your communication on paper makes it harder for directors to evade their fiduciary duties and ignore you

Another interesting – and complimentary – review can be found here.

TC

Small cap value works, especially when controlling for quality

Recently I read an excellent Cliff Asness (AQR founder) paper Size Matters, if you Control your Junk.  It is very comprehensive research on the size effect. Highly recommended.

First popularized by Fama & French, the size effect says small companies outperform large by a few percentage points per annum.

After Fama & French, the size effect got a lot of criticism from new empirical research however for not being statistically significant or being the result of data mining. The main pain points that make the size effect appear less statistically significant – than for example value or momentum – are basically:

  • small caps do not outperform consistently
    • over time (in the ’80-’00 period they underperformed)
    • globally
    • over certain stock characteristics (value vs growth, positive vs negative momentum)
  • small caps outperformance seem to be concentrated in
    • January
    • illiquid stocks
    • the most extreme size deciles (smallest companies and largest companies): the size effect does not exhibit “monotonicity”. In other words, the best performing decile might be the smallest companies’ decile, but the remaining deciles do not have monotonically decreasing returns toward the last decile

The authors then surgically show that all these criticisms are trumped by the size effect if you control for “quality” (defined by high profit margin, low leverage, high sales growth, good quality of earnings). In other words, small caps have not significantly outperformed globally, over time, over certain stock characteristics, in Feb to Dec, etc. because stocks in the smaller company universe tend to be more “junky”.

If you buy small companies that are on average as high quality as large companies, you actually get size outperformance that is consistent over all the above metrics (time, geographically, value and growth, liquidity, all year) and  the effect becomes monotonically decreasing with the size decile.

Now that we can rest assured the size effect is significant and robust over all these variables when we make an apples-to-apples comparison with large stocks in terms of quality, the cherry on top is that the value effect much larger in small caps. This great paper shows how much.

TC

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