[REPLAY] Sachin Khajuria – Two and Twenty, An Insider's Take on Private Equity (Capital Allocators, EP.285)

0:00Capital Allocators is brought to you by my friends at WCM Investment Management. WCM has the courage to back future histories not evident today, informed by their unrelenting focus on mode trajectory and elevated by insights on corporate culture. WCM's deep roots in public markets set the foundation for its approach to private investing. They didn't just want to enter the private markets, they wanted to improve the investing model itself. Build something better aligned, more thoughtful, and truly long-term. As a firm owned by its people and grounded in Laguna Beach, WCM is built for alignment and independent thought.

0:46Rather than chasing a scoreboard, WCM invests with a partnership mentality to build meaningful relationships with founders reimagining their industries. They show up earlier, stick around later, and let value compound over years. WCM's style is their edge. Authenticity over formality, two-way learnings over checklists, and stories over slide decks. To learn more, visit wcminvest.com. This testimonial will be provided by Ted Sides and Capital Allocators, who have been compensated a flat fee by WCM. This payment was made in connection with Capital Allocators' testimonial and production of podcasts, and does not depend on the success or level of business generated.

1:28The opinions expressed are solely those of capital allocators and may not reflect the opinions of others. Investing involves risk, including the possible loss of principle. Past performance is not indicative of future results. Please visit WCMInvest.com for WCM's ADV and further information.

1:45Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators.com. My guest on today's show is Sachin Kajuria, a former partner at Apollo and 25-year veteran of private equity who recently authored 2 in 20, a fantastic insider's account of the private equity industry. Our conversation covers Sachin's rationale for writing 2 in 20, the strengths of private equity, areas for improvement, and needs for change.

2:34We discuss the defining traits of the industry across the sourcing process, depth of research, use of operating executives, ability to pivot, and democratization of alternatives. We close by discussing opportunities and risks going forward and Sachin's application of his insights to investing at his family office. Before we get going, we're just two episodes away from the end of season one of Private Equity Deals. If you're an allocator, private equity manager, banker, or a student of deals or businesses, this show is for you. Search for Private Equity Deals on your favorite podcast player and subscribe.

3:14As soon as you do, you'll get a chance to listen to Advent International's star, Trisha Glenn, discussing a corporate carve-out. Please enjoy my conversation with Sachin Kujuri. Sachin, great to see you. Great to be here. Thank you, Ted. Well, why don't we talk about your background that led you to writing this book? So I'm an investor, 25 years as a partner at Apollo. I'm now a limited partner at a number of firms managing my family office. And prior to that, I spent a few years in investment banking at the start of my career, but mostly an investor for most of my life. And it struck me that a lot of my friends who are doing great in their own professions, medicine perhaps, or academics, or what have you, started to invest as they progressed in their own careers for their retirement, for their life goals, and so on.

4:06And yet, for some reason, they didn't really understand or have heard much about private equity, even if they came across it in a professional context. And so it occurred to me over the years, we should try to get more people with a baseline level of understanding of private equity, not necessarily from an academic, technical point of view, and probably not even taking sides, but more about what is it really like on the inside as someone who's in the GPs, as well as an LP, and now, of course, an LP across multiple firms. And that's what led me to the idea of writing this book, which really should be for everybody who either has a pension or a retirement plan that may be going into private equity or may meet private equity in their business.

4:52So from taking your experience over those years into writing this book to show the inside of how these work, what was your perspective going in? Constructive, because I believe in what I'm writing. So constructive, but realistic. And the way I would describe it, Ted, is trying to hold a mirror to the industry. What are the good things you see as we all look in the mirror? Hopefully a few good things. Probably a lot of things that we wish were better. And maybe a couple of things that we wish just weren't there. And so when you look at it from that kind of lens, holding a mirror to the industry, much like the industry does when it looks at a target, looks at a company to invest in.

5:39It's not just looking at all the bad stuff or the good stuff. It's trying to get to the truth of what do we really see? Do we see a business that has strengths? What are they? What are the things that could be done better? What are the weaknesses? And is there anything drastically wrong that needs to change more urgently? And what are the opportunities? And so I try to look at the industry from that perspective, constructive but realistic. Well, let's break that down. Let's start with the good. from the inside, what do you see as what the good things are about private equity? The good firms that I've been involved with and I invest with now, they really do think like principals, not like advisors.

6:20They really are in it with an alignment. And this is rare. It's easy to say. It's very, very hard to do day in, day out, good deals, bad deals, return of capital, potential loss of capital, they're really thinking about it as if they had all the money in the deal, as opposed to them having a fraction of money in the deal, and most of the money coming from retirement systems, sovereign wealth funds, what have you. And so that alignment is really powerful. When you see people really feel it, Ted, They really feel it, which is like, this is our deal. Or if it's a mess, this is our mess and we're going to clean it up.

7:05It really means that they're fighting for you. They're in your corner. Of course, they're making a great profit out of it if it works out. Of course, there's nothing to hide about that. But if it doesn't work out, they're not consultants. They're not just walking away. And the best firms, they're almost better on defense than they are on offense. So that's number one. Number two, the firms that have gained a certain critical mass, they have what I call in the book, the library. They have an amazing network of data, executives, knowledge, know-how. And this gives them a fantastic edge. Even before you look at things like size and scale, they have great information and they're able to capitalize on it.

7:52That's not something you can just replicate by hiring a bunch of folks. You could hire 20 smart investors from five different firms, but you wouldn't be able to replicate the knowledge base that's inside those firms. So that's number two. And I think number three, and we talk a lot about this in the book, the best firms have temperament. They are very good at pivoting when they need to pivot, sticking when they need to stick, and really looking at the long term. It's not a trader mentality. It's not buy low, sell high. It's not like, oh, what's the hot piece of information we can trade on? It's nothing like that.

8:30It's very much like we could own this for 10 years or more. What is going to get us to the outcome we want? How do we recalibrate that outcome continuously? And how do we then reverse engineer into what we have to do today to be able to get to that outcome? And that takes temperament. That takes a sort of the ability to leap when there's chaos, the ability to freeze when you need to freeze. That takes a certain long-term perspective. So those three, I think, are the key things that I've come across. On alignment, you said there are only a few firms that really kind of get this right. You could look at the economics, you could look at the structure, and firms generally have variations of a theme, but the same economic structure as it relates to, say, alignment with their LPs.

9:19So what is it about those few that get it right that differentiates the ones that don't quite get it right? Well, in a rising market, you're going to find all private equity firms or most good private equity firms doing well, whether you're looking at their buyout strategy, their credit strategy, infrastructure, real estate, and so on. It's when things get difficult that you start to see bifurcation, you start to see the tide going out, et cetera. And that's when the culture at the firms, which absolutely has to come from the top, is really witnessed. That's when they have to bare their teeth because things are difficult.

9:54It's not easy to just buy a company, put some debt on it, wait five years, make a double, and then move on, right? And I agree with you 100%. Most firms have two in 20 or some variation thereof. How come some can't beat the S &P, whatever timeframe you look at. And some can. Some continue to provide 500 basis points, 1 ,000 basis points above the S &P for long, long periods of time. How is that? And it absolutely goes to the culture. And it's such an overused word. It's almost like you can dismiss it like, oh, culture. Yeah, okay, whatever. But what I mean is it's really the day-to-day, Ted. It's the blocking and tackling.

10:30It's not the sixes they're hitting. It's not the home runs. It's the day-to-day, are they really living the deal. And that comes from the folks at the top who've probably been around a long time or they've been trained by the founders of these firms. They breathe it, really. That is what makes the 2 in 20 work. You can have the formula, but it doesn't mean you can actually make it work. And that's why I go to the fact that this is really a people business. There's nothing automated about it. There's nothing that a supercomputer can replicate. There's no ETF version of private equity or private markets more generally.

11:09It's a people business. And therefore, you have to understand the traits and DNA of those people because it's those people that are going to make the two in 20 work or not work. I'd love to hear an example of something you came across, whether it was somewhere you worked, somewhere you didn't work, someone on the other side of the table, where you saw something that was revealing of the opposite of what you just talked about, that they weren't doing things for the right reasons? I'm not going to name names or firms, of course, and I've worked at several firms, so we shouldn't make assumptions where this is from.

11:45There's a deal at Investment Committee and a number of the partners are against it because the data doesn't support the thesis, or at least there's enough doubt in the thesis that at the purchase price that's mooted, there's not enough room for error in that purchase price to be as wrong as one could reasonably be wrong, if that makes sense. Unless there's like a Hail Mary solution that comes out from nowhere. But because of relationships of the partner or partners involved leading the deal, they get it through. The comment being, well, we're doing this, or we're going to make so much money. We're going to do this.

12:22And that did reveal to me, huh, you're basically bypassing the best bit of the firm and the culture to get the deal done. Now, fortunately, I must say, extremely rare. But Orsino, equally, unfortunately, in both cases, resulted in a very poor outcome and in fact, capital loss. I'd love to touch on this relationship between the library, as you said, all these resources, and just the size of the firm. Sure. It has multiple dimensions. So first, let's look at not necessarily size, but scope and scale. If you do one strategy, if you're a one trick pony, even if you're amazing at it, you're going to limit yourself in scale until you start to do other things.

13:15We've seen that. Go back to the beginning of my career. You had TPG, you had KKR, you had Apollo, you have Blackstone, you have so many amazing firms. Not all of them were the same size or had the same CAGR 25 years later. And so when you look at that, you see one of the reasons that some of the firms grew much more powerfully than others did was, yes, their poor strategy worked out well, but they also diversified. They went into other things that they either knew and did more of, or they hired great talent from the outside to merge with their own culture and pursue a new set of strategies too.

13:55So they may have gone into life sciences or infrastructure or more credit. And the more products you have on offer, the more there's on the menu, the more you learn about the ingredients, the more you learn about the flavors, if you will. And so the more strategies you're running, the different kind of information you get, but also the different lens of information you get. You could be a supplier to a particular industry in your credit business, but in the equity of a competitor in your buyout business. You could be the infrastructure of a particular company in your real estate or infrastructure fund.

14:33And then you could be the debt provider to the services aspect of that company in another fund. or maybe you have a social impact strategy that's investing in that too. So you can see that the more games you're in, the more information you're going to gather. So that's number one. The second dimension to it is, of course, many firms are very careful as they should be with information walls, but you are going to have opportunities where strategies can either work together, because let's say they're tackling a complex situation that requires more than one fund to look at that strategy. Or you could have certain individuals that are above those information walls because they're particularly senior and they have to take a certain leadership view.

15:16And when you have that ability, that flexibility, I would say, to either look at multiple strategies on the same deal or involve people who sit above the wall, that also gives a different kind of learning and perspective. The third dimension I'd put to it is, of course, that even after you've sold a business, I think some of the best firms continue to monitor those industries. Not necessarily that same business that they've just sold, but certainly that industry. So if they pop back into that industry at some point in time, it's not like the best they can look up is a deal from three, five years ago.

15:52they'll still have folks analyzing the significant trends in that industry long after that business has been exited. And where it really gets powerful, Ted, is when you add it all together. It's not one of these things. And when you add it all together and you combine it with size, so you're not just able to do the billion-dollar deal, but you can also do the$5 or even$10 billion deal, then suddenly you get into a class of your own. You're like in, to use a soccer analogy, you're like in the Champions League of private equity. And that's what we found now, that there's a handful of these firms that are able to look at information, cut so many different ways, so many lenses.

16:34And as an LP, you can look at it and you can say, how amazing is it that some of these firms can have a flashcard or a CEO survey of sentiment, or they have the heat map of what's happening in each pocket of the industry ahead of what you read in the press. And so they can tell what's happening. And of course, they're not the only firms. I mean, investment banks would have this too for their clients and other things. But I think the perspective is a little bit different as a principal as opposed to an advisor. And so this, I think, is a huge information advantage because not only does it help you scout for new opportunities, it also helps you, I think, defend your existing investments better if you know what's coming down the road.

17:18I'm curious to ask what your view is of, let's just say the mid-market, because a lot of these advantages you're espousing accrue to larger players, get more breadth, more scale, more resources, more information. What's your sense of the investment prospects of the larger mega caps with all these resources compared to say the mid-market? So I think the ones that do things really well, in my view, are able to adapt very quickly to changing environments, whether it's higher inflation and interest rates, slower macro, dislocation, one in 100 year events like COVID. And so I think that although they'll find blips, they'll find certain investments don't do well.

18:07In general, across a particular strategy or fund, they're going to do quite well. And this is why with the previous question, I started with the strategies they run rather than necessarily the size. I think it's not necessarily just size is the driver. I think it's the people, Ted. If you have amazing people who leave one firm and start their own firm that's, let's say, 5 billion of assets or 2 billion of assets, as opposed to 50 or 100 or 500, it doesn't mean that they're not going to be able to replicate the success. It's because it's, again, it's a people business. It's the individuals. So I tend to look at, okay, who's doing that mid-market strategy, as opposed to the fact that it's a mid-market strategy.

18:50But digging into that another layer, historically, some of the best returns have been found in smaller pockets of the market that have been less mined than the larger pockets. Now, I think there's an argument to say that they're harder to find these days, but it's pretty ripe at all size levels. But I think you can scale it. So for example, if you were a mid-market specialist and you specialize in, let's say, five, six different industries, right? You've been doing that for a fairly long time or you're staffed by great people that have left larger firms or other firms who have done that in their careers.

19:28It's not that hard to scale up or down in size. It's probably easier to scale up than down. I think that's right. But it's not that hard if you've got the right people. And so I'm quite optimistic. In fact, some of the things I'm looking at to invest in for my family office right now are actually a lot smaller than the mega funds, simply because the numbers are out of this world. I mean, they're producing incredible numbers. And so it deserves a lot of investigation. I will say, however, that in the mid market, I think you ought to be more careful because there are a lot of copycat kind of funds, which do exist in the mid market that you do find at the higher end, but I think is perhaps more prevalent in the mid market.

20:10I'm But I look at the people and I look at the numbers and I think all those things are applicable at the mid-market if you've got the right folks involved. As you were writing the stories in this book, what occurred to you that you said, look, there are things that are good with private equity, the things that could be better and the things that aren't there. What's some things that you see that you think could be better? It has so many aspects. I think number one, and we should just get it out there because I saw that in the reaction to the book. We had generally some very good reviews, but we also had some comments from people that were reputable publications, but they just hate private equity.

20:45I think, number one, the industry can do a better job of presenting itself. I think, in general, the industry has done a much better job in recent years of emphasizing the positives it does for communities, for diversity, for all the right things, for the environment, social investing. But I think it could do an even better job. And I think the reason that would be helpful is that there will be less noise around the industry so they can kind of get on with the jobs, right? So I think that's number one. Number two, I think it's not unfair to say that although the industry has gone a long way in spreading some of the returns, and you've seen that on specific deals quite explicitly, where the returns are not just given out of the C-suite, they're kind of spread across the companies that are invested.

21:29I think we need to see a lot more of that. I'm not sure you want to get into a world where you sort of necessarily regulate it or force it. It has to make sense and it has to fit with the culture of the firm and all those things. But I think it's so good when you see it being done, when you see so much profits made and it's spread not just amongst the C-suite, but it kind of passes all the way. I think you need to see more of that. I think that's fair. And then equally, if you look at the size and scale of this industry, 12 odd trillion on its way to 20 trillion across private markets in the next decade, this is an important part of the economy, period.

22:06It's not just important to know if you're on Wall Street. It's important to know even on Main Street. And therefore, I think if you look at the way the industry responded to assist in Corona and assisted with donations, with community service, with all those things, I think that's certainly a lot better than potentially it was in prior national or even international crises. But I think there's a ways to go. So I think this is an industry that's an important part of the economy. It's almost a steward of significant parts of the economy, certain significant industries. and I think once we start to recognize it as kind of like these are sort of modern industrialists in a financial sense, I think there's a certain responsibility that goes with that, that things, we're seeing a lot of great things.

22:51I think we should celebrate that. We should be very honest and positive about that, but I think there could be more. And what are the aspects that you think just aren't there? This is changing. So if you look at who invests in this industry, it goes back to the first question we had about the perspective and the reason for writing the book. Not many people know about private equity as much as they should. Not many people invest in private equity as much as they could benefit from. So some folks still see this as, oh, private equity is only for people of a certain wealth or only for certain kinds of institutions.

23:25Whereas actually you and I both know that a lot of folks' pension plans are invested or retirement plans are invested in private markets, they probably don't know about it. And so what we don't have, being honest, and I think it's getting increasingly urgent, is a very good baseline understanding of private markets for everyone in the same way that people know about public markets. Why should you only know about the acronyms that make up Apple, Amazon, Microsoft, Alphabet, Google, etc.? You need to, as somebody with a retirement account, know about Blackstone, Carlyle, etc. You should, because these are kind of the equivalent of those big tech names that I talked about.

24:13It's big finance, or it's what I call, you know, mainstream active asset management. And so that is just missing. Because if you asked most folks who maybe dabble a bit in their pension, or they keep an eye on their pension, or maybe even they're slightly active investors, they do a little bit of stock trading, they'll have a sense of like, should I be buying Disney? Should I be buying Apple? Should I be doing this? And then you say, well, what about private equity? Like, no, got no idea. But the check sizes are getting smaller, Ted. It's not just multimillion dollar tickets. There are$50 ,000 tickets.

24:47There are$20 ,000 tickets. There are now$10 ,000 tickets coming out. And it's not fully available to retail, but it's coming. And so I think ahead of that, there should be education for everybody. And again, I think that what that will do in addition to better public relations, better communication, it'll lower the noise and it'll help people find private equity more accessible. And that's what I think is missing at the moment. I'd love to dive into some of your thoughts being inside the industry on aspects of the process. So on sourcing of deals, you hear a lot about the word proprietary. Everyone wants a proprietary deal.

25:28What did you see being inside the industry of how deals actually get sourced? It's a fantastic question. I think the reality is that firms of a certain reputation, so firms which are well-known, of which there are many, many firms, and certainly firms of a certain size. as soon as you start to do deals which are like a billion dollars per deal or more, right? It's hard to say that no one else will ever look at that deal other than you between the time the idea comes up and you closing the deal. No one's ever going to look at that deal ever. It's going to be totally under the radar screen and no one is ever going to even have any idea that it's happening.

26:13It's a total surprise, okay? That's very difficult. Why is that difficult? Well, well, let's start with the seller. The seller probably has some obligation to stockholders, to their investors, to actually check that the terms are good terms. And so at some stage, they will probably need to hire an investment bank or themselves or some other broker or something to check that what they're doing makes sense. We're carving out this business. We're selling it to a unit of Carlyle or whatever. Is that the right price? Is that, well, then their advisor will be where have you checked with anyone else?

26:47And they say, well, no, we decided not to check anything with anybody. I mean, that doesn't really fly. And so I think there's a certain recognition that you're going to have competition at some stage. But if you have competition at the stage where you have been sufficiently ahead of the game, you've followed that industry for a long time, you've possibly looked at that industry through multiple lenses, the credit lens, the infrastructure lens, the real estate lens. Maybe you owned the business before or its competitor. Maybe you looked at the business and backed away, or maybe you were beaten at buying business because somebody else paid a higher price.