The Canadian Investor - Is Private Equity Really Outperforming Index Funds?

Episode Date: December 18, 2023

In this episode, Simon explains how private equity (PE) works and why the returns are often not beating stock market indices like the S&P 500, despite what is broadly claimed by PE fund managers. Braden goes over the two main types of stock positions that Akre Capital Management focuses on. We finish the episode by talking about what does not qualify as a moat. Check out our portfolio by going to Jointci.com Our Website Canadian Investor Podcast Network Twitter: @cdn_investing Simon’s twitter: @Fiat_Iceberg Braden’s twitter: @BradoCapital Want to learn more about Real Estate Investing? Check out the Canadian Real Estate Investor Podcast! Apple Podcast - The Canadian Real Estate Investor  Spotify - The Canadian Real Estate Investor  Sign up for Finchat.io for free to get easy access to global stock coverage and powerful AI investing tools. Register for EQ Bank, the seamless digital banking experience with better rates and no nonsense.See omnystudio.com/listener for privacy information.

Welcome back into the show. This is the Canadian Investor Podcast, made possible by our friends and show sponsor, EQ Bank, which helps Canadians make bank with high interest and no fees on everyday banking. We also love their savings and investment products like GICs, which offer some of the best rates on the market. I personally, and I know Simone as well, is using the GICs, which offer some of the best rates on the market. I personally, and I know Simone as well, is using the GICs on a regular basis to set money aside for personal income taxes in April of every year. Their GICs are perfect because the interest rate is guaranteed, and I know I won't be able to touch that money until I need it for tax time. Whether you're looking to set some money aside for a rainy day or a big purchase is

coming through the pipeline or simply want to lower the risk of your overall investment portfolio, EQ Bank's GICs are a great option. The best thing about EQ Bank is that it is so easy to use. You can open an account and buy a GIC online in minutes. Take advantage of some of the best rates on the market today at eqbank.ca forward slash GIC. Again, eqbank.ca forward slash GIC. This is the Canadian Investor, where you take control of your own portfolio and gain the confidence you need to succeed in the markets. Hosted by Brayden Dennis and Simon Belanger. The Canadian Investor Podcast. Welcome into the show. My name is Brayden Dennis, as always joined by the graceful Simon Belanger. And sir, this is the definition today of the show goes on. We're about to do some back-to-back-to-backs

so that you, during the holidays, as the listener, get content coming out of both shows, all the hosts, all holidays long without a break. So expect a lot out of us and some fun episodes too at this time of year. Yeah, exactly. And that's why I'm going to be sounding the same probably for quite a few episodes where I'm like still feels like I'm a little bit sick, but I'm feeling pretty good. It's just kind of stuff. So people are wondering. Great timing for the marathon of content. Yeah, exactly. Five episodes and recording in two days. It's a bit of a marathon, but three today is not too bad. Yeah. Well, folks, today we have a regular Monday release. Just Simone and I here today.

The next two episodes are going to come out are going to be a year interview and bold predictions for 2024, which is going to be the three amigos. It's going to be myself, you, and Dan Kent on the show. So today I'm going to talk about the Accra Focus Fund. I basically have two short segments and you have one long segment about private equity. And then we're going to talk about moat traps at the end, which is something I've been thinking about a little bit lately. So I'll explain what that is. I'll kick us off with the Accra Focus Fund. I'll explain what that is. I'll kick us off with the Ackrey Focus Fund.

You've heard me talk about Chuck Ackrey, and I feel like a fraud because I called him Chuck Aker for probably like three or four years. I would say he was like one of my favorite investors, and I couldn't even say his name right. That brought me deep shame once I realized I had been saying it wrong on the podcast. It's okay. I called Warren Buffett and Warren Buffett for the longest time.

Just kidding. I'm just trying to make you feel better. Yeah, the all-you-can-eat Warren Buffett. Dude, so the Acre Focus Fund has been a monster led by Chuck Ackrey and his firm. And they've popularized something called the three-legged stool. They talk a lot about qualitative stuff. And they're the original Compounder Bro portfolio. I think he's owned American Tower for like 25 years,

which has been like a 200 bagar during that time, something absurd. He's owned Constellation software for like a hundred beggar at this point. And so I'm going to go through the portfolio and then I'm going to talk about something that they call core positions versus work bench positions. So the top 10 holdings as of September 30th quarter ending, MasterCard at 16%, then Moody's, Constellation Software, Visa, KKR, American Tower, Roper, O'Reilly, and CoStar. So a lot of free cash flow, words are tough, per share growth type businesses. The real high conviction, mostly wide moat, grow free cash flow, grow steady through acquisitions and organically. And so this portfolio, they say they have two things. They have core positions and workbench positions. All of those names have been in the portfolio for a really long time. And those would

be core positions. So businesses about which we have the highest conviction regards to quality, business risk. I like how they say business risk, not risk, because so much of Wall Street calls risk like volatility and beta against the market. No, business risk, reinvestment opportunity and valuation. B, the workbench position, businesses which are typically new to us. This is the key part here. Or where valuation has precluded greater accumulation. So instead of selling the names, they just don't add to them if they don't think the price is right. And I feel like I finally have a framework for thinking about this when I read that, because I bought ASML earlier this year

and I was all excited about it. I thought the next few months is probably going to be rough for the company too. I was expecting to add to it, but I timed it up really well when the valuation was nice. And it basically ran back to where it was trading in like a month. And it was at the humming and hawing price. So for me, it's just on the workbench. I've seen better opportunities in my core positions that I own. Like this year, I've added a lot to Visa and MasterCard. I've added a lot to S&P Global. I've added quite a little bit to Constellation and some of these names, some big tech names. So I've added to the core names. And the workbench positions, I feel like I have a good name for them and I just wanted to share this slide on portfolio construction. You can go to ACRI's website and portfolio construction is one of the

links and you'll see exactly what I mean and their portfolio. I highly recommend you check out his letters, his work. I think he's done a couple of podcasts through the years as well. Yeah. No, I think that was good. uh wasn't sure that you were stopping right there so i was raising my desk so if people are wondering yeah exactly so there might be that in the background but i think it's a good way these mics that we have now are so legit i don't even think it picks up any of that stuff yeah they uh they definitely just um they're great for voice only vocals if you want to start a band do not get these mics because you won't hear anything else just just hear this perfect for us face radio thousand dollar podcast mics here we go

yeah and i think what i really like what he said is it really puts it into words i think that's almost like i think a lot of people have that same, but he puts a little bit of a visual to it. And I think that's definitely interesting. Yeah. Yeah. This and the three-legged stool are kind of abstract thoughts that have a gigantic influence on the way I think about investing. So go check it out. It's all available on their website. All right. Let's talk about private equity. You got a pretty big segment here. And dude, if you're in the business of investment and you're in private equity, of course you know what it is. But if you walk around the street and you say, what do people in private equity do? You probably won't get a very concise answer. It's like, what do consultants do it's

like yeah i don't know what do they do yeah and the more i read it the more i researched it and read about it and read especially some not fluff pieces that were supposed to pump private equity because unfortunately as people will see they're very good at marketing and making it sound like it's this unicorn that produces much better results than the public markets all the time. It's lower risk than the private markets. These are all things that you'll hear when people talk about private equity. Well, as I'll show, there's been a lot of exponential growth in the amount of funds for private equity. And I'll just say that Wall Street definitely likes it because, you know, it makes them a lot of money. But sometimes I think it's or actually a lot of the times it's questionable whether it's

the best type of investment for investors. And typically we're talking about institutional investors here. So that's the typical people that will be accessing those type of funds. So institutions, just as a reminder, it's banks, pension, sovereign wealth funds, endowments, foundations and hedge funds will typically be like what's considered institution. You'll also be able to invest in private equity if you're an accredited investor in the U.S. and Canada. Typically, you'll need, well, you'll actually need $200,000 in income per year or $300,000 if you and your spouse or have a net worth of a million dollars, excluding the value of your principal residence. So for those who may not meet the previous requirements and thought they had the network because they bought a home 20 years ago and an increase in value. Well, it's actually it excludes that. And there's different type of private equity, but I'll definitely focus more on the leverage buyout type here. So whenever I talk about this, I'll be talking about LBO, which is a leverage buyout. So what's a leverage buyout? So I'll start off with that. LBO is what most people will refer to when they talk about P.

And like I said, it's not the only thing in P, but I'll focus on that. And the private equity fund will identify a company to buy. Then they'll use a bit of equity, then finance the rest to buy out with debt. So by doing so, you have the potential of supercharging your returns because of leverage. But and it's for people to wrap their heads around that is the same as buying a house, right? So if you buy a house for a million dollars and you put 20% down, so $200,000, it means you finance $800,000 with debt. If the home appreciates 20% in value, it's now $1.2 million. So you've now doubled your initial investment because you still have that $800,000 debt. Let's just assume you haven't made any payment happen very quickly. But now your equity

in the home is $400,000. So you've only put $200,000. You've doubled your investment. So that's how you can really supercharge your investments with using leverage. But the other way around is also true. Like a lot of people are finding out right now in the Canadian housing market, if this home drops 20% and is now worth $800,000, while your initial investment is essentially wiped out and you still have that $800,000 in debt, whereas if you bought it all in cash, you know, I know not a lot of people would be able to do that, pay a million dollars in cash. Well, you would have still 800,000 worth. You'd only be down 20%. So I think that's a cautionary tale of using leverage. And a lot of people in real estate, especially before

interest rates started going up, they were essentially saying, well, you know, why wouldn't you be in real estate? You can use leverage and become rich, but it also goes two ways. It's nice when you're in a bull market, but when you're in a bear market, the other way around can be quite painful. Same thing when you invest on margin. And what happens with PE, and this is where I start being very critical of PE, is they tend to sell this as being very low risk, when in reality, there's always increased risk when using leverage and this is where a lot of PE funds I think personally and you know I'm not the only one will say that and I'll quote give some Warren Buffett quotes a bit later well they definitely mislead and I would go as far as sometimes they just outright lie to investors by promising or saying things that are not really all that true

in reality. And honestly, there's a lot of shenanigans that happen in that world. Now, how it works, the PE fund will raise capital from institutional and accredited investors. The capital will be locked in, meaning that investors cannot withdraw until the end period. The lock-in period will typically be between 7 and 10 years. And once the capital is raised, the fund starts looking for LBO deals, leveraged buyout deals, like I mentioned earlier. Now, the fees, this is where it starts getting really fishy. So if you like to get, you know, to pay fees, this is definitely the investment for you.

Personally, I like to save on fees. Yeah, I mean, I know, Brayden, like you've been pretty critical when it comes to mutual funds. This makes mutual funds look cheap. I'll just say that. In terms of fee structure? Yeah. Yeah, the fee structure is something else. So there's actually more than one fee.

That's one of the big issues here. So the fund will typically... Go ahead. That's typically where I am so critical of fee structures is actually not the nominal percentage management fee, like net-net, the entire management expense ratio. It's how you actually get to that is so convoluted, so confusing. Their clients are not able to explain it. They're hardly able to explain it. And guess what? That's by design, right? It's completely by design. And that's where I have such a problem with fee structures is actually not even the nominal amount. While those are ridiculous as well, it's actually the structure and added complexity for the benefit of the manager, not for the benefit of the customer. And that's where I have an issue. Yeah, it's great business for the fund managers.

As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free so that you can choose

the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com. That is questtrade.com. on there, I am shocked. The engagement is amazing. This is a really vibrant community that they're building. And people share their portfolios, their trades, their investment ideas in real time. And it's all built on the concept of transparency because brokerage accounts are linked. And then once you link your brokerage account, you can get in-depth portfolio insights, track your dividends,

and there's other stuff like learning Duolingo style education lessons that are completely free. You can search up Blossom Social in the app store and join the community today. I'm on there. I encourage you go on there and follow me, search me up. Some of the YouTubers and influencers and podcasters that you might know, I bet you they're already on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead, Blossom Social in the app store and I'll see on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead, blossom social in the App Store and I'll see you there. Now, the ongoing fund management to me.

So that's the first one. That's the kind of fee that people might be a bit more used to that you'll see in mutual funds, for example. So the fund will typically charge an ongoing fee of 1.5 to 3%. 2% seems to be pretty common here. But where it gets really shady is the fee. And this is one of the things that Warren Buffett actually criticized back, you know, he's criticized it multiple times because they had been approached by PE funds and I'm pretty sure he just ripped them to shred and they never went ahead with that. But he's been very critical.

And I'll give you a couple of quotes in a second here. But the fee is charged from day one, even if the PE fund hasn't found a deal yet. So I'll give an example for this. So, for example, say a fund raised a billion dollars from different investors. The one billion is actually not contributed to the fund just yet. It's a commitment from investors to provide this money to the PE fund once the first deal has been found. So if the fund only finds the first deal a year after the start date of the fund, they'll still charge the 2% management fee from day one, even though they aren't producing any returns. And that could

potentially be acceptable if you start calculating the returns from day one before you've actually found a fee. But of course, that's not what they do. They actually start calculating the returns once the first deal is done to make essentially the fun and the returns and also hit some targets, to make essentially the fund and the returns and also hit some targets, make it easier to hit. So that's one of the things that Warren Buffett has been extremely critical of, how these funds actually calculate returns. It's the two and 20 structure too, right? That's what this is. Yeah, exactly. And essentially what Buffett mentioned regarding private equity firms at the 2019 Berkshire shareholder meeting. And I'll quote here, we have seen a number of proposals from private equity funds where the returns are really not calculated in a manner that I would regard as honest.

He added, if I were running a pension fund, I would be very careful about what was being offered to me. And this is what PE funds do, right? They go to pension funds and like various institutions, endowments. And a lot of the time where, you know, there might be a committee, whether they're well-versed investment or not. Sometimes there are, sometimes they are not. But even then, I mean, they are sometimes reluctant to question the returns of the PE funds. And one of the things that Buffett pointed out is exactly what I just talked about. So they charge that management fee from day one on committed capital, but only calculate the return once the capital

has been deployed. So it's like having your lunch and eating it too. Like to me, it's okay, you want to charge the fee from day one, then your return should be calculated from day one. Makes no sense. Very misleading to investors. And I don't think a lot of investors actually realize that they're in these funds. So it's good business for the fund manager because if you're looking at the management fees, if you have $1 billion committed in capital for 10 years and you charge 10% in management fee, then you're getting a sweet $20 million a year regardless of what happens. So for 10 years, that's $200 million in fee. So I'm going to say, obviously, that's no wonder that Wall

Street likes these funds because you can get some sweet fees, but there's more. So don't worry. These are not the only fees they charge. I was going to say, not just to your thunder, but that's just the two part. We haven't talked about the two and 20 part. There is an and 20. Just to back up a little bit here, right? Like we're talking about a few things here. So you mentioned the risk piece here. Yeah. A few things here. So you mentioned the risk piece here.

Yeah. This goes back to my first segment. How do you quantify risk? Because if all of a sudden this instrument is less risky because it doesn't trade on public markets and get marked every day, does it actually have anything to do with inherent risk? have anything to do with inherent risk. This has been my criticism of the word risk in financial markets since I have ever been an investor. There is increased risk. It's the Charlie Munger three L's, liquor, ladies, and leverage. That's that third L. Look, an asset is not less risky because it doesn't get marked every day. It just means it's less volatile. And that is a key, key difference between how I see risk and how a lot of fund managers sell risk. This goes to my second point. You just mentioned how they

sling these things to pension funds, endowments, collect nice two and twenties off them. This is a sales business. This is a relationship business. It's a sales organization where their side hustle is managing money. That's how I've always viewed these things. The people that are managing the money and making these decisions for the pension funds and endowments, you bet your ass they're going to fancy dinners with the fund managers. They're doing everything that you would imagine in a sales process because that's what this is. It is a sales-led business. And I want to be involved with fund managers who are in the investing business, not the sales business. If you look

at Berkshire Hathaway, it's publicly traded zero fee private equity. That's what these roll-ups and capital allocators like Berkshire Hathaway are. But they're in the investing business. They're not in the sales business. Warren doesn't try to sell you his stock. He tries to sell you a story about all the businesses they own. He's very good at marketing. He's in the investment business, not in the collecting management fees business. So if you can differentiate those two things when selecting management teams, it's pretty obvious. It's actually really easy to tell. And your results will be vastly different when those operations are done differently. Yeah. And even the largest pension funds, I'm talking CPP here, for example,

because I've gone through, you know, not the whole thing, but, you know, some important areas on on PE. And they're always like kind of, you know, showing like, oh, you know, we have PE and it provides really good return. Well, CPP and I don't know what percentage it is that's divided between in-house private equity and PE funds, but they do both. And I think it's around 30% of everything that they have that's in private equity. And essentially you read and it's the same kind of structure here. They say, oh, we give performance fees, which I'll just go over now, that kind of 20 portion, but they have to attain targets and things like that. And, you know, I would be very surprised if I talk to, you know, CPP investment board, if they actually really know how the rates

of returns are calculated, because I'll, like I'll mention a bit further on, there's the estimated investment return rates that are provided by manager. And these are self-reported, by the way. So, you know, that's another issue. And they're also the final rates of return, which tend to be adjusted down when you actually close out. Because the whole point of leverage buyout is you buy a company, you put it, you know, sometimes you'll take it public to private, but you put it under your fund with the idea of selling it for a higher price, you know, 10 years or close to when the fund winds down. And you actually don't know what your returns will be until then. So they provide the estimated IRR, internal rates of returns until then. Now, the second performance, so performance fee, it's also called carried interest fees. So the percentage of the

fee will vary, but it's going to be in excess of 10% can be as high as 20%. And it's done on a deal per deal basis. So in order for them to get that fee, the deal has to achieve a certain rate of return, which is typically 8%. Unfortunately, PE funds have been known to do some creative accounting when it comes to this. So what they do is once they find a deal, they might actually borrow from a line of credit to close the deal and only request the investor funds several months later. By doing this, the PE fund is able to calculate the IRR, so internal rates of return, for the deal from the time that the investor put the money into the deal, not from the time that the deal was actually done. However, they will use the initial purchase price of the LBO that was done several months earlier. So essentially, they're shrinking the time period, which increases the IRR. And that's really fishy that they're doing that,

because essentially, it helps them achieve that 8%, where in a lot of cases they might not achieve it if they would get the investor fund. So this committed fund, they would get them as soon as their deal is closed. So that's another way that it's a little bit fishy how they do things. And that's one of the big criticism of PE is there is a lack of regulation around that. Anything you want to add there before I go on to how the returns are calculated and the opaqueness of that? No, it's just important to recognize there how big of a difference the performance fee

can make on your total returns if you look at them in aggregate. If you do a calculation on the difference with performance fee and without it is out of control. And the problem with performance fees, and by the way, I'm going to have to talk about this in a second. You and I are both investors in Brookfield Asset Management. This is how they make their money. Oh yeah, I know. We're very critical of it. At least they're offering something unique to the marketplace, which is being a unique owner and operator and asset manager of alternative assets that are hard to get exposure to if you don't use them. So this is me giving them the benefit of the doubt.

Where was I? Oh, it's just the performance fees. So is that hurdle rate? You said what? It's typically 8%? Yeah. That's the most common one I've seen. Yeah. Yeah. 6%, 8% I've seen. Sometimes they'll benchmark it to the benchmark that they're following or even the S&P 500 in some rare circumstances as outperformance versus that. But if you have a flat, let's say 8% hurdle, and in most cases, not private equity, but say I'm managing equities and I'm running a mutual fund, and I say, okay, anything over 8%, I'm going to collect 20% of that as a performance fee. If the market does 20% that year and I did 16%, I underperformed the benchmark and I collected 20% on 8% outperformance. So I outperformed some arbitrary number, which the market almost never does. We've talked about this extensively. Markets typically can return on average around 8% to 10%, but almost never return 8% to 10%. It's usually up big or down big, a la the last few years. That is actually normal market behavior,

if you look at the last 100 years of the market. And so that's also a flaw, and in my opinion, dishonest by picking an arbitrary single digit number rather than a moving benchmark. No, I think that's a great point. I put that in my notes. So that's a great point. And the returns, I've always been a bit skeptical about PE, how they valued investment. And it's been quite a while, but it really started bugging me about last year when I was preparing for a REIT episode with Dan Foch from the Canadian Real Estate Investor. And I came across some data from NARREIT, which is the National Association for Real Estate Investment Trust in the US. And although I've mainly talked about LBOs here, leverage buyout, there are tons of private real

estate fund, which are another form of PE. And in a report, Nareed pointed out that discrepancy between REIT index in 2022 and private real estate fund was a whopping 41%. So in 2022, estate fund was a whopping 41%. So in 2022, REITs had been totally crushed by rising rates. But somehow, you know, the sector, somehow private real estate was up, I think it was like close to 10% for the year, whereas REITs were down close to 30%. So I mean, that's where it really became a bit of a head scratcher for me, because you're talking about the same exact asset class. So how the hell is one down, you know, 30 percent and the other one 10 percent is up? And they'll probably say, well, there's no comps and, you know, there's all these different excuses. But at the end of the day, I think it's a whole lot of BS.

I won't say the whole thing. I want to keep it friendly here. And first, P, don't know their, like I mentioned, the IRR, the internal rates of return until all the deals have been exited. So what they'll do until then is that they provide an estimated IRR. And they might use public companies for comps for that, but they can also get creative. Maybe there are 10 comparables public company. Nothing really prevents them from only choosing the top two that are the highest valuation in terms of comps, because there's really no regulation behind that. So they can definitely use that. They might use private market comps, but those can be hard if there hasn't been

any recent deals. And I think that was one of the excuses that a lot of these private real estate fund were using is they, oh, there's no deals happening in private real estate. So it's very hard. So we'll go back to like 2019 comps or, you know, they would have all these kind of excuses. So what ends up happening is they will often overstate their estimated ir only to reduce them down the line when the returns are final and they've actually done their exit strategy and sold off the companies and somehow you know these funds sell themselves as to be immune to market corrections they'll say that it's because they are long-term investors and that the value of their investment should be calculated the same way as public markets.

And, you know, sounds like they'll definitely use public market comps when it suits them, but not when it doesn't. So it's a bit like, okay, with the markets doing well, you know, clearly the PE fund will be doing well. When it's not doing well, the PE fund's still doing well. So it's, yeah, it's a bit, you know, if you want to be consistent,

be consistent. Not all firms also get independently audited. And when they do, it can be hard for auditors to fully validate their calculation. And oftentimes auditors will have to trust the fund managers to some extent. That's another issue here. And they'll also use benchmark that tend to be favorable to PE funds instead of using something like you mentioned, the S&P 500 or a Vanguard or BlackRock index ETF that would be 60-40 equity and bonds. Oftentimes it'll be 60% S&P 500 and 40% just a broad-based bond index. Or at least a moving benchmark of the asset class that it's tracking. Yeah. index. Or at least a moving benchmark of the asset class that it's tracking. If equities is not the right benchmark, which in many cases for these funds, it's not, that's okay. But there are moving benchmarks that can be used for the asset class, but that's not very convenient.

What you're describing here is what I call, you win, I win. You lose, I win. That's what it is. Yeah, exactly. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense, and with them, you can buy all North American ETFs, not just a few select ones, all commission free, so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service.

Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is Questrade.com. Calling all DIY, do-it-yourself investors. Blossom is an essential app for you. It has been blowing up with now more than 50,000 Canadians plus and growing who are using the app. Every time I go on there, I am shocked. The engagement is amazing. This is a really vibrant community that they're building. And people share their portfolios, their trades, their investment ideas in real time. And it's all built on the concept of transparency because brokerage accounts are linked. And then once you link your brokerage account, you can get in-depth portfolio insights, track your dividends. And there's other stuff like learning Duolingo style

education lessons that are completely free. You can search up Blossom Social in the app store and join the community today. I'm on there. I encourage you go on there and follow me, search me up. Some of the YouTubers and influencers and podcasters that you might know, I bet you they're already on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead, blossom social in the app store and I'll see you there. The last thing in terms of return is that you'll see things like the industry has outperformed the stock market and you know, blah, blah, blah. It's based on self-reported data. Lots of funds don't report, and those that do is self-reporting. So clearly, that also needs to be taken into account.

When it's self-reported, I mean, you know, some random person can tell you that they've tripled the market returns over the last five years, and they don't really give you any proof or show you anything much there. It's all self-reporting, right? So should you believe it? Should you not? I mean, it's hard to say. Now, it is also one of the issues, especially now, is that it's becoming a really crowded market. So it was hard to find data on this, but essentially there's been a rapid growth in private equity investment. It's more than doubled since the early 2000. Wall Street may say it's because of demand, and maybe that's true. But I think there's also really some good marketing on their part and making this this kind of unicorn with low risk, low volatility that always beats the market returns.

And I'm going to go on a limb here and say that the rapid growth is probably because there is a lot of money to be made via fees for fund managers. They're probably pushing that pretty hard along with that marketing. Obviously, not being the most... Yeah, I'm sure they are. They tell what the fees are. But oftentimes, I think probably people don't fully understand how these fees come into account and they're calculated. And that means there's more competition as well for P deals.

So because leverage buyouts are usually done with profitable companies. So if there is more competition from various PE firms, then good deals will be harder to find. So this can force a PE firm to get into deals for the sake of it, because that's the whole point, right? They have to get some returns if they want to get those performance bonuses. And when you do that, you increase the risk of not having great returns on that deal, which makes outbeating the market even harder when you're charging exorbitant fees like they are. Now, anything you want to add here? The last part here shouldn't be too long.

No, my only real general comment is, look, leverage buyouts and this model is fantastic. I'm not talking about for the fund managers or anything right now. I'm talking about as a business. There can be amazing value-creating compounding machines. Look no further than the list of the companies I listed in Accri's fund and the ones in my portfolio, look at like a Roper Technologies. It's just basically a tech PE firm that trades as a no fee PE company at your disposal. So the actual model, look at Berkshire. The actual model is, is actually really amazing. And it's worked for a really long time. The part that you and I are critical around is what it's being marketed as with these firms and the high fees.

That's what we're being critical of, not the actual model. Because the model has been around a long time and it works extremely well. Yeah, it works. I mean, it works well when done correctly. I think that's probably- When done correctly. Yeah, when done correctly. Obviously, lower rates definitely help there too. So when rates are higher, it's going to be a bit harder because you're going to be paying more on that interest for the leverage. But yeah, it's a good model. And that's also something to think about with these PE funds is saying, okay, really the majority of them are doing it correctly? That's also a question to ask, right? I think it's a valid point for it to be just that alone

to be critical. And the last point here that really is not great about PE funds and that is different from publicly traded companies that you're talking about is the funds are locked in. So because the money is locked in for extended periods of time, PE returns should provide at least, I would say, 2% better annual returns net of fees than the stock market. And that's clearly not the case. That's because you should be getting a premium for locking in funds. That's how it works. Take a GIC. Why are you getting a higher yield on a GIC? Because you're locking in the funds and you can't withdraw them.

And the bank will give you... For lack... Yeah, liquidity needs to be factored in here yeah yeah you're paying you're essentially getting paid more because you're in a non-liquid investment that's what it is so you should be getting a premium for that versus a savings account you'll get less oftentimes it's actually probably around there two percent difference at least right now and so who in their right mind would lock in their funds for the same or lower returns with all else being equal? No one would. But unfortunately, you know, with

all the opaqueness of these returns, how the fee are calculated, I think a lot of people just don't realize it, don't know. And they'll argue that this is, you know, the fund managers will argue that it's actually a good thing that the funds are locked in because it's a long term investment. It'll prevent you from making any stupid decisions or things like that. But a lot of these institutions invest the money for long periods of time anyways. So I think that that argument, I mean, is pretty moot. It shouldn't be a reason to underperform the market or justifying the underperformance, although obviously they'll say otherwise. And for me, I look, the lack of transparency, the creative accounting when it comes to return,

the high fees, the illiquidity of the funds. And it's just, yeah, it's a pretty poor investment in my view. I'm sure some in reality do beat the market. I mean, there's always going to be some outliers. So obviously that's going to happen a bit like mutual funds. Even if they charge 1.52%, they may beat the market. But to do it on a consistent basis, I think that's going to be pretty unlikely. And I'll finish on this here.

Were you aware that Wealthsimple is offering this? I am because of you. Yeah, private equity. And I was chatting with Dan on this. And look, I think Wealthsimple has done a lot of good things for making investing more accessible for Canadians, lower fees. But this, I mean, they could do better, Wealthsimple. Like this is the page if you go and you type in Wealthsimple private equity and you just scroll down and then in big bold letter,

you have 100 billion assets under management, 18% annualized return, gross of fees with two asterisks, and then 25 plus years. I think they might need a couple more asterisks. Exactly. And then you have to actually drill down into the FAQ to look at how the fees are calculated. So Weld Simple charges a 0.2% to 0.4% fee for this service. And then on top of that, fee for this service. And then on top of that, the private equity group charges 1.5% management fee and a 12.5% performance fee calculated on a deal by deal basis, like I mentioned earlier, as long as the deal earns 8%. So, you know, it's not, I'm not critical necessarily for Wealthsimple

for offering this. I'm critical at how they're marketing it because most people will not drill into the FAQ they'll see this big bold letters oh my god 18% that's fantastic but in reality I'd be very surprised if this LGT firm is actually doing all that well if they use similar accounting to what regular index ETFs are doing. So I think this is just very misleading. And I think Wealthsimple, honestly, do better. You can definitely do better than this. Just be like, I know you're transparent in some way about the fees, but when it's in big, bold letters, people are going to see that and they're less likely to drill down and see what the actual fees are. It's that searching for diversification and diversification in asset class on your fancy

dashboard pie chart that has made the need for these things and the rise of AUM in these things explode over the last 20 years. If I'm managing Harvard's $50 billion tax-free pension fund, which is essentially a tax-free hedge fund, incredible business. I want to own that business. You can't just be 100% in equities. You can't just be 100. That's not sophisticated enough for us prestigious pension fund managers. We need to sprinkle in a little bit of venture capital. I'm going to sprinkle in a little bit of private equity, sprinkle in a little bit of fixed income, sprinkle a little bit of equities. We're going to get the whole gambit here for diversification sake so that my pie chart looks like I'm doing my job and meeting my mandate. That's as simple.

That's how I think about this. I don't think that there's anything really more to it than that. No, I think, I mean, I think you're right, unfortunately. But yeah, I think, sorry, I may have gone a little bit on the round there, but there's a lot of research for this. And I encourage people to read more on it. There's some good books out there and just be wary of the articles or studies that are really pumping private equity because

oftentimes they'll definitely have some vested interest in doing so. So I would say just caution that, but there's definitely some really good information out there for those who are looking to get in the nitty gritty of it. Look, there's lots of money to be made for the managers. And you and I on Brookfield, they're collecting, what is it, like 340 billion of capital that they collect management fees on. To bring it all the way back around, I'm here to make money. You're here to make money. You're listening to this podcast to make money. And this is a very good business asset management collecting fees on capital.

It's software-like. It has software-like margins, software-like recurring nature with those locked-in percentage fees. Oh, baby, it is a – it's capital light. The business of managing capital is in itself capital light. It's got all – it checks all the boxes. It does everything that you'd want. And so there's lots of money to be made here. And a lot of companies have made lots of money doing it, aka Brookfield.

The big difference is if you want to sell your shares tomorrow, you can. Yeah. And Brookfield's not charging me a management fee, but they are their customers. Their business, they are. Yeah. No, no. That's fair. But I think that's the biggest difference. But if the customers are going to them and they're not really reading their fees, maybe they should find better people to be committing those funds. hydroelectric power, ports, highways, large infrastructure projects from an owner-operator and manager. Where is that going to come from? And that's an actual offering that is unique to the marketplace versus, you know, I'm going to lever buy out some company that sells pumps to factories. No, that's a fair point. There's enough of those around.

Yeah. I think that the only thing I'll add to that is maybe push back a little bit is, I mean, some of these funds, my God, they have 30%, 40% allocated to PE. Is that really diversification? I mean, you can make a counter argument that you're concentrating a bit more clearly. Yes, you have a broader set of assets that private equity might have access to, but I think a lot of pension funds, especially the smaller ones, will end up doing quite well just investing in index funds and over private equity. But I get

what you're saying. How are we doing for time? I have a very quick segment. Should I bring it out here? Yeah, I mean, we could or not do it. It's up to you. That sounds like in between. We're going to go for it. It's quick.

It's called Moat Traps, okay? Dorsey Asset Management published this thing about moats. I'm going to go into more detail about other topics inside this presentation on future episodes, but it is called what's not a moat. They have three things here outlined that they believe is not a competitive advantage. That is, it got me thinking about, can we think of some more moat traps? Number one, dominant market share. So high absolute market share is not a moat. If I'm the largest player, that doesn't actually give me a competitive advantage. Sorry, it might give me a competitive advantage, but it is not a durable moat by having dominant market share. Technology, they say commoditization

and disruption are inevitable, absent consumer lock-in, a la GoPro and Fitbit. This has been on my mind a lot lately. Tech changes so fast and it's one of the hardest moats to maintain. It really is. Look at the last year of changes with AI models. Hot products, they typically generate high returns for a short period of time, but sustainable returns make a moat. So I think this is right. If you have a graph of moat and ROIC. It's that the wider the moat, the longer you can extract high returns on invested capital. It's a license to maintain high returns on invested capital. And that's why it's so important. That's why moats are so important. It's like a patent on printing high returns when you have a durable, intact moat. That's the way I think about that. If you were to graph that out qualitatively versus

like a numeric high return on invested capital, it is a license to maintain that printing of money. And that's what a moat is. But like all patents and all licenses, they eventually expire. And so it's important to think about what's not actually durable and what's changing. Can we think of any more moat traps? I'm really trying to think of some examples of what might come as thought of as super high moat and And it wasn't like, look no further than Kodak, than IBM, Dell. So many of those things were high market share and disruption that eventually became commoditized

without consumer luck. Yeah, probably like first to market. Yeah. I think that's commonly seen as like almost not commonly seen but i think a lot of people will see that almost as a moat by the end of the day especially if it's something not very hard to duplicate if there's money to be made there's going to be competition and if you don't innovate whatever it is right it could be something not even that technological if you don't innovate you you're definitely going to get your lunch eaten.

Yeah. And you can see that come out in margin profiles too as it starts to get eaten away at. I think when you look, that's why like with FinChat and with Stratosphere, it was so important for me to try to get visuals and tables of historic data going back further and further. Because it's a big difference between Visa achieving a 60% free cashflow margin that's maintained for 15 plus years versus

NVIDIA doing that in one quarter with the data center business. It's not a knock on NVIDIA. It's probably the most impressive business of this year. It's more so that that's a completely different assessment of durability. One quarter to 15 years, right? Those are entirely different things to think about. Anyways, that's today's show. So we got Motes, Ackery, and dunking on private equity. Yeah, I know. Maybe we'll get some hate mail from private equity. Oh, yeah. Oh, yeah. Bring get some hate mail from private equity fund managers. Oh, yeah, oh, yeah, bring it on. Bring it on.

You cannot hurt our feelings. Yeah, and if you do, like, by all means, you know, send me a detailed view of how you calculate your returns and when you start charging your fees. And, you know, maybe it's, you know, maybe you'll prove me wrong. We'll see. Hey, we like getting proved wrong on this show.

That's what it is. It's about pushback of ideas and being a free thinker, baby. The show goes on. Let's go record two more, Simon. Yeah, let's do it. We got this. We got this. Coffee, refuel. The three amigos are going to be live on the mics here for the next two episodes here on the pod

make sure you keep tuning in through the holidays and have a great time all right i know a lot of people are coming into uh you know time off for the first time and maybe months since the summertime you know kick back have a good time enjoy yourself over the holidays and we'll be here for you here now or we'll check back in the new year. We'll be back here too as well. So enjoy your time over the holidays. The Canadian Investor Podcast should not be taken as investment or financial advice. Brayden and Simone may own securities or assets mentioned on this podcast. Always make sure to do your own research and due diligence before making investment or

financial decisions.