Episode #442: David Rubenstein on Private Equity, Politics, Parenting, & The Art of Investing
Guest: David Rubenstein is the Co-Founder and Co-Chairman of The Carlyle Group, one of the world’s largest and most successful private investment firms. Established in 1987, Carlyle now manages $325 billion from 26 offices around the world.
Date Recorded: 8/24/2022 | Run-Time: 49:11
Summary: In today’s episode, David walks through the evolution of the private equity industry during his career. Then we spend some time on his new book, How to Invest: Masters on the Craft, which gives unprecedented access to legends in the investment industry, including the likes of Dalio, Klarman, Simons, Fitzpatrick, & more.
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Links from the Episode:
- 0:39 – Sponsor: Masterworks
- 1:36 – Intro
- 2:11 – Welcome to our guest, David Rubenstein
- 3:37 – How To Invest; David’s background in private equity
- 6:16 – Is alpha being squeezed in private equity?
- 8:06 – David’s thoughts on the convergence of public and private markets
- 10:19 – David’s most memorable investments are the ones he never made (Facebook & Amazon)
- 12:51 – Can private equity be replicated in public markets?
- 15:30 – Why did David start writing books recently?
- 19:02 – Common characteristics of the greatest investors David’s observed
- 22:38 – Some of his favorite stories from writing the book
- 28:20 – David’s thoughts on how to recruit and find good talent
- 29:04 – Thinking about improving, public education, financial literacy and income inequality
- 31:10 – The Meb Faber Show: Tim Ranzetta
- 34:09 – Lessons from David’s career in fundraising
- 37:48 – How to raise well adjusted kids in a wealthy family
- 39:43 – David’s take on the political divide in the US & how to get people to be more involved in the government
Transcript:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Welcome, my friends. We got a spectacular show today. Our guest is David Rubenstein, co-founder and co-chairman of The Carlyle Group, one of the largest private equity firms in the world now managing over $300 billion. In today’s episode, David walks through the evolution of the private equity industry during his career. Then we spend some time in his new book, “How to Invest: Masters on the Craft,” which gives unprecedented access to legends in the investing industry, including the likes of Dalio, Carmen, Simons, Fitzpatrick, and more. Please, enjoy this episode with David Rubenstein. David, welcome to the show.
David: My pleasure to be here. Thank you for having me.
Meb: We got another Dukie on the show. I’m a cavalier, we just had on Professor Cam Harvey, who is one of my favorites from Duke on the show this past week, talking about inflation, how he thinks it might not have peaked yet, but we got to start with Duke basketball. Give me a favorite Duke basketball moment in person, not on TV. One you saw, perhaps. Are there any that come to mind?
David: Well, I was at the final game for Coach K. and Cameron, and it was going pretty well until we got collaborated at the end by UNC. Yesterday, sadly, I was at the funeral of Grant Hill’s mother. And I remember I was at the game when he did his one-handed dunk before he passed the shot.
Meb: Man, you got a couple up there. Grant’s an interesting guy because a lot of athletes, I feel like we’ve turned the corner from, maybe 20 years ago, 30 years ago, athlete and celebrity. If you were to say their name was on a business or on a cap table, I should say, it was often a sign of, “Oh man, you got to watch out for this.” But I feel the world has changed really in the past 10, 20 years, where all of a sudden you look at the lines on the cap table, whether it’s Kevin Durant, or Dr. Dre, or Beyonce, or George Clooney on and on. These athletes and celebrities are wising up, and Grant’s one of them.
David: Look, he’s very, very successful in many different areas, but he’s one of the few NBA stars and superstars who has a college degree these days.
Meb: Let’s rewind. You have a new book out that I want to get to in a minute called “How to Invest.” I loved it. But for those who don’t know a little bit about your history in the business… I went to high school in North Carolina and the name of the high school I went to was R.J. Reynolds High School. So, when I heard the word private equity, it meant one thing, it meant buyout, which happened, I was pretty young. I would’ve been like 10 or 12 or 14 or something, but that had a very strong impression as a kid in my town. Tell us a little bit about the origin story with you guys and private equity, what it meant then and what it means now?
David: When I first got into the business, I started Carlyle in 1987. And it became one of the larger private equity firms in the world. But the phrase was not yet invented. Firms were then called leveraged buyout firms. And then the word leverage became odious. So, they went to management buyout firms, implying it was friendly. Then the word buyout became odious. So, they came up with private equity. Private equity in the United States means really, on my view, all types of private investments, which would be buyouts, venture capital, growth capital, you could say real estate, distress real estate, distress debt, opportunistic real estate, and so forth. Outside the United States, the phrase private equity means buyouts. It’s just different the way it’s used in the United States. But in my view, private equity means all private investments where you’re really investing equity.
Meb: When you started, the buyout industry was still, infancy being the wrong word, buyouts have been happening forever, but really the mainstream. What was the inflection point for the private equity industry? Was it things like RJR, the big-name deals? Was it the 80s, 90s bull market? What propelled it into the common lexicon? Was it endowments investing?
David: Well, I think in 1978, the Carter administration’s Department of Labor said it is okay for ERISA funds to invest in what was then called alternative assets, which is to say private equity or venture capital. Up until then, the only investors who were able to invest were high-net-worth individuals, some banks, and some insurance companies. So, the private equity and firms, like mine, were now able to get money from the biggest source of capital, then in the United States, which was pension funds. Today, obviously, the universe of investors is much larger. But the reason the industry has gotten so much larger is that the rates of return have just been better than anything else that you can legally do with your money over the last 5, 10, 15, 20, 25 years or so. Even through bad markets, privately people have figured out how to make money. And that’s probably, in part, because they’re highly incented, they typically get 20% or more of the profits. And when you have that kind of economic incentive, you tend to work harder and probably do better.
Meb: The flip side of that, too, is that as you see the success, certainly that invites competition. There weren’t that many firms 30 years ago, whereas there’s probably a lot more 2010 and now.
David: In 1987, when I started Carlyle in the entire world, there might be 200 or so so-called buyout firms. Today, there are roughly 10,000 private equity firms in one type or another.
Meb: That’s a lot. Have you seen an impact on alpha getting squeezed or opportunities being more sharp-elbowed?
David: In the early days of buyouts, take the RJR deal as a classic example, that was done in 1989. That deal was 5% equity, 95% debt. Of course, it didn’t work out so well. But if you borrow 95% of the purchase price and things work out, you’re going to make a staggering amount of money because the leverage is working in your favor. Today, the average equity components are probably closer to 50%, not 5%. For that reason, alone, rates of return have come down. But secondly, there’s more competition, so prices are much higher. In the early days of buyouts, the buyout EBITDA multiples or cash flow multiples were probably seven to eight or nine times at the peak. Today, they’re probably 13, 14, or 15 times. So, you’re paying a higher price, you’re using watch leverage and returns are coming down. But why is that still appealing to people? Because rates of return have still been better than anything else you could probably do with your money. And secondly, with interest rates being so low, for so many years, if people are looking at their cash accounts, they’re getting 1%. If that, and the buyout people are still getting net internal rates or return of 15% or 16%, it’s obviously easier to go with buyouts. And they’re not quite as risky as they used to be because, not only you’re borrowing less money, but the debt has what’s called covenant-free situations. It’s very hard to default on the debt, even if you aren’t doing so well, particular quarters or even a year or so.
Meb: There’s been a bit of a shift in the past decade, maybe two between public and private markets. Part of that has started to get a little more blurry, where you have these late-stage private companies and a lot of the VCs moving down and funds, like =. What sort of impact is that having and continuing to have on the ecosystem?
David: To put it in context, traditionally, when somebody was managing money for somebody else, they would traditionally have what’s called a 60/40 ratio, 60% equity, 40% debt, more or less. There was no alternatives. Today, anybody managing money for somebody else, endowments or the pension funds, and so forth, typically will have as much as 25% to 30% of alternatives, which is, say, private equity, venture capital, growth capital, and so forth. Therefore, you have a lot more money going into the business and a lot more competition for deals. In my view, it’s at the point where people are still putting money in these funds because if you can outperform on average, public market returns between 300 and 500 basis points on average, you’re still going to get a fair amount of money. Now, 300 to 500 basis points may not seem that much. But when you’re managing a lot of money, 300 to 500 basis points can mean a lot.
Meb: I was thinking, as you’re talking, the origins of the 60/40 portfolio, was this kind of a Markowitz sort of invention? Like, how did it end up being 60/40? Why not 50/50? Why not 40/60?
David: When the investment world really first started, let’s say in the 1700s, 1800s, people only put their money into corporate bonds or government bonds. When the equity markets came along really in the late 1800s and the early 1900s, people began to go into equities. And the reason was this, on average debt returns, probably over the, let’s say the 20th-century average, maybe 4%. Public market returns, probably average 6% to 8%. So, people began to put more and more money into equities. And then the 1960s, there was a phenomenon where Merrill Lynch and others began to tell everybody that anybody could be an investor. You didn’t have to be wealthy. So, anybody could put some money together and buy stocks. And therefore, more and more people got used to it. And then when the 401(k)s and the Roth IRAs came along, more and more people had money in programs that were really largely equity-based.
Meb: We did a poll the other day on Twitter. I was asking investors, what percentage own stocks, what percentage own bonds? I was actually surprised. Because 90% said they owned stocks, but only about half said they own bonds. I don’t know if that’s just the revulsion to lower interest rates, or if it’s a younger crowd, or what. But to me, that was a little surprising. So, as we think about private equity, do you have a most memorable buyout you were involved in over the years? Could have been good, it could have been bad. Is there any that comes to mind? You’re like, “Oh man. That one, that’s son of a gun, that was memorable.”
David: My most memorable investments for the ones I didn’t do. When Mark Zuckerberg was at Harvard, I knew about it and I didn’t invest in Facebook. When I had a chance to really get a big stake in Amazon. I didn’t do that. I told Jeff Bezos, just wasn’t going to make it. I guess he didn’t listen to me.
Meb: It’s funny because Bezos is famous. We talk about his quotes for regret minimization. That’s the perfect example, David. You got to go back and say, “Okay, I’ll invest, but I’m not going to invest much.” One of the insights you guys had, I think, earlier than most, I think it’s proof beneficial at Carlyle was, any asset class or strategy can go through the fallow periods, whether it’s stocks, whether it’s gold, whether it’s bonds, whatever, or even an active strategy like value or private equity. At what point did you guys start to diversify strategies and offerings? Was that from the get-go?
David: When we first started in 1987, we just wanted to pay the rent. And that was the struggle. But after we raised our first buyout fund, a $100 million, I began to say to my partners, “What about if we try to build a T. Rowe Price or a Vanguard of private equity,” which is to say have multiple funds and take advantage of our brand name, which wasn’t that big at that time. After we raised our second fund, which is $1.1 billion, I think I then said, “All right. I’m now going to embark on the strategy of multiple funds, I’ll recruit the people, and then I’ll go raise the money. And my partners will make sure the money got invested well.” So that was in the early 1990s. And obviously, Blackstone, KKR, Hollow, among others have followed a similar strategy of diversifying and globalizing.
Meb: We’ve come full circle because after Bogle’s passing, I saw recently that they made a big splash the last year or two. The Vanguard was trying to make some inroads into the private equity world with a fun launch, which I don’t know if it’s out yet, but it’ll be interesting to see how they do.
David: Well, remember, Vanguard is famous for very low margins, and therefore it’s very inexpensive. Private equity is not considered inexpensive. So, it is surprising that it would be counter to their culture, you might say.
Meb: There’s been a couple interesting things they’ve been doing. They even have a market-neutral fund, which I think surprises a lot of people. As you look at the evolution, and obviously, things change over the years. Some of the academics and quants out there will look at the private equity space and say, “You know what? I think we can run a fancy regression and try to come up with the characteristics of private equity companies and public markets.” You mentioned the seven times EBITDA versus maybe a 14 times. Do you think that’s something that can be cobbled together? You talk about a few of these quants in your book. Is that something you guys spending time with, thinking about, looking into?
David: For those who are listening, it was always thought that humans were smarter than machines. And then when Jim Simons and others came along, they used quantitative methods to look for market inefficiencies, typically in public markets, currencies, commodities, stocks, and bonds, and so forth. Not in private equity, because it’s harder to trade in and out of private equity. I think that the quants have basically been looking for ways to replicate what private equity does in their format. And I would say, you can probably do it. But the biggest challenge is this, most investors get out of the market when the markets are going down and get into the market when the markets are going up. And if you have that freedom to do that, that’s probably what the average investor will do. The advantage of these private equity funds by locking up money for a long time is you can’t trade in and out of it as readily as you might want. You might be at a replicate the returns of private equity through some quantitative strategy, but the chances are you’re locking people up for a long time is less. And therefore, I think maybe people will get out of the market in the wrong time and get in the wrong time.
Meb: You hit on a point we’ve talked a lot on this podcast about, where, as a public fund manager, we have over 125,000 investors. I struggle with what you just mentioned, trying to align the best interests of our shareholders with their outcome. And we’re all emotional humans and many to their detriment, like you just said, when things go on sale, they run out of the store, the opposite of what they should be doing. I used to think of, when I was younger, the lockups and illiquidity of certain strategies to be a negative. But now I think it’s a feature, you know, not a bug. One of the things I spend a lot of time… I haven’t figured it out yet, David, I’m close, but trying to figure out a structure that will both incentivize and deter retail investors from trying to light themselves on fire. The annuity, obviously, and things like Social Security are in the right umbrella. But often, annuities and things like that come with huge tolls as well with all the middlemen. We’re working on it. If you got any good ideas for me, you can let me know either on the podcast or later, but we struggle with it.
David: Well, okay, but it sounds like you’re doing pretty well without my advice. So, I don’t know if I could give you any good advice.
Meb: Let’s kick it over to the book. I’m going to spend some time there. You got a new book out. You’ve written a bunch. How many books you got under your belt at this point?
David: This is my fourth book. I didn’t start writing them until I was in my late 60s. And I’m kind of wondering what I was doing in my 20s, 30s, 40s, and 50s. Why I couldn’t do these then, I don’t know. But now I’m trying to churn out a book a year. Have you written books yet?
Meb: Yeah, man. I have the opposite problem though. I write one, and every time I write one, I say, “I’m never doing that again.” And then I feel like I can’t not say what I have to say.
David: So how many have you written?
Meb: That’s a good question. I just blanked on that because I’m working on one this summer, five. We’re neck and neck. Although a couple of them were really short. They could have been pamphlets, I think.
David: It’s okay. “Common Sense” was a pamphlet.
Meb: Yeah, there you go. So, the book is fun, and there’s a few jumping-off points I really want to get to. The funniest I’m going to start you with is I was reading through it and got to the Seth Klarman chapter. Listeners, Seth, if you don’t know, from Bow’s post, one of the most famous value investors in the world. He’s also an author, except he’s smarter than us. He’s only written one book, and he introduced the concept of scarcity. This book, “Margin of Safety” regularly goes for $1,000 or $2,000 on eBay. And as a cheap young analyst, cheap bastard, I read the PDF version for free online a long time ago. But Google last night out of curiosity, there they were on eBay for a $1,000, $2,000. Except I found one on Alibaba that was $13. And I said, “Okay, there’s three outcomes here. One is, this is a real copy. And the person in China or wherever who has this, just doesn’t know that it goes for $2,000. So, I’m going to buy it.” In which case, I owe David dinner because he just made me $2,000. Option B, I just gave all my information to a scammer somewhere and my identity’s going to be stolen. So, David owes me dinner. Lastly is I’ll just get the PDF. Someone’s just like, print it out the PDF. They’re like, “No, you didn’t buy the book. You bought the PDF.” I’ll let you know, we’ll do a follow-up in like a week or two.
David: It might be that the version is the Chinese translation, which nobody else has. Who knows?
Meb: There you go. All right. So, you wrote this book concept, is sort of a similar vibe to a couple of your other books. Give us the inspiration. You got some friends and just wanted to chat during the pandemic? What inspired you to write this one?
David: Well, the idea is to interview the best investors in each category or among the best investors, and distil what made them great investors. And then I wrote the book for three different audiences. One is great investors who want to see the absolute best investors, what they do. So, people that are really in the investment business, like you, who are really good investors, see what the absolute best people think about various categories and how they got where they are. Secondly, for people who are thinking about becoming investors who maybe want to invest in a fund or directly, how they should think about it and what the lessons are for them. And the third, students who might want to get into the investing business. And I try to point out that investing is not a matter of just being a greedy person trying to make a lot of money. It has that impact, you could say people make a lot of money in the investing business if they’re successful. But I do think it helps a country’s capital structure because if people can allocate capital the right way and do it well, as we’ve done in this country, you can build a country that’s quite wealthy. I don’t think people who go in the investment world should be considered as doing something that’s not patriotic. They are patriotic, in some ways, not just quite the same as giving your life in a military confrontation, but they are doing something that I think is useful for society. And I try to convey that point.
Meb: There’s extremely varied profiles in this book, you have everything from Ray Dalio of Bridgewater who runs one of the largest hedge funds in the world, to we mentioned Seth Klarman, to Jim Simons, to endowment managers, index providers. We’d love to hear your thoughts on some commonalities because their approaches are very different. Is there anything you can kind of tease out from all these different hugely successful individuals across the board?
David: The great investors have these characteristics in common that I have observed. And I would say that in any profession, the greatest people in it probably will have certain common characteristics. But in this profession, investing, the ones I observed were they tended to come from middle-class families, not poverty-stricken families. They tended to be reasonably well-educated, many had graduate degrees. They tended to be very good with numbers. They may not all be Jim Simons, a great mathematician, but they’re pretty good with numbers. They all tended to have enormous amount of self-confidence, not arrogance, but self-confidence. They like to make the final decision on an investment, they don’t like to delegate it to somebody else. They like to read an enormous amount, even if it’s not directly relevant to their day-to-day job because they think that, at some point, information in their head will come out and be useful to them.
They also tend to be, and this is most important, willing to defy conventional wisdom. In any given area of life, and certainly, in the investment world, there’s always the conventional wisdom, “You should do this, you should do that.” These very people are willing to defy it. And that’s how they made their success, basically doing what other people told them not to do. I also tried to point out that everybody who’s a great investor is not a white male. The book has a number of people that are women, and then are minorities. And I think increasing, you’re going to see that in the investment world, as the investment world diversifies much more than it has historically done.
Meb: One of my favorite takeaways from the book, there was a quote talking about the investor who said, “They’re able to admit a mistake, cut their losses, proceed with the next opportunity largely without looking back on dually.” One of the things you see, particularly with young investors, and I was talking about this over the last year when a lot of very speculative investments are now down 60%, 80%, 90%. And I said, “Look, the older of us that have been through a few of these cycles, have the scars.” You made plenty of losing trades, many of which were painful. And you learn from it. A lot of people, particularly younger, only want to talk about the winners, only want to talk about the things they got right. But that’s part of it, that comes with the territory of losing. And so many of your profiles talked about that.
David: Look, I would put it this way. I don’t have that ability. I’m not a great investor. I talk about the mistakes I made for 10 or 20 or 30 years later. These people tend to forget about it. They make a mistake. They go into the next thing, but they’re willing to talk about their mistakes. And why is that? I do think it provides a certain sense of humility. If you’re Seth Klarman or you’re Stan Druckenmiller and say, “I made this mistake,” it shows you’re not arrogant. It’s hard to imagine an arrogant person liking to talk about their mistakes. Many of these people have a fair amount of humility because if you know, if you’re in the investment business, you’re going to make mistakes every day. And it requires a certain amount of humility. Warren Buffet is not an arrogant person, he’s humble. And I think that’s a really good trait for investors to have and great investors certainly have it.
Meb: There was a good quote from, I believe this is Don Fitzpatrick in the book… So, there’s a great story about Soros, when he was making a bet against the British pound, one of his trading heads turned to him and said, “You know we could lose everything on this.” And they turned back to him and said, “That’s okay. I can make it all over again.” The football analogy, I said, “You got to be like the Eli Manning. You can just throw interception after interception, come right back and get back into it and start slinging again.” You have the losses, but you have the fortitude to kind of stick with it. Any favorite stories resonate from the book where you’re chatting with somebody?
David: Jim Simons is somebody that, maybe others listening don’t know, but he was the first person who really built a great quantitative investing business. He’s a mathematician of great international repute. And he got into this business kind of by luck, in terms of investing. He’s unusual, in the sense that he never wears socks. So, I’ve interviewed him once in a black tie dinner and he showed up with no socks. He’s got this thing about no socks. He’s also got a thing about cigarettes. He smokes two packs a day, and he’s obviously managed to get this far without having lung cancer. So, I don’t know how he gets away with it, but he’s an incredible smoker. And he brings his ashtrays with him.
Meb: I’m not going to say much about correlation causation because I don’t smoke. But look, no socks today in the office.
David: Yes, but you’ve got shorts on and you’re wearing athletic wear. If he wears a suit, he has no socks.
Meb: That’s fair. This is California formal out here in Los Angeles. The biggest takeaway I had from the book, because I don’t want to spoil it. Listeners, you got to go check it out. The biggest correlation to me was that if you were interested in building a multi $100 billion or even trillion asset manager, you need to get your start in the Carter administration. First interview of the book was with Larry Fink? Also got started there?
David: His partner, Ralph Schlosstein, and worked with me in the White House. And I was surprised, as I noted when they went public with their first bond fund that, he had worked in the White House, I had worked in the White House. Ralph didn’t, neither of us knew anything about investing then. Sometimes good things come out of the Carter administration, despite what people say.
Meb: One of the things in the book that I thought was really interesting was this concept of, you have to have asymmetric information and be able to set up some of these asymmetric trades. One of my favorite interviews was with Paulson, of course, the famous credit default swap trade where he said he had a billion dollar check to the IRS, to the U.S. government for that trade. They’re hard to find and they’re rare.
David: That was one of the hardest interviews because I was trying to boil it down into understandable pros. What he was trying to explain was very complicated. But the essence of it is, what do you say? He had an asymmetric trade, which he thought was very rare. You can make a hundred times on the upside, and if you only lose one or two times on the downside. It was very rare, he said. And I take his word for it, but it’s rare to find somebody to do that. And that trade was the most successful one, I think in Wall Street history. In one trade, he more or less made $20 billion.
Meb: And that ends up being one of the big takeaways from all of investing. For me, has been the appreciation of these outlier trades and power laws, whether it’s on an individual trade basis or within a portfolio. I think the venture capital world gets this intuitively, where if you have a hundred investments, a few of them make the portfolio. Stock investors maybe do. But often, I feel like people get rid of their winners too early on the path to 10 or a 100 bagger status. It’s easy to sell. And think about the new condo, you’re going to go buy. But every a 100-bagger was once a 5-bagger or 10-bagger, at one point.
David: I didn’t put it in the book, as I focused on us investors, but I did interview a Chinese investor, Neil Shen. Neil Shen has built the Sequoia China business. He used to work at Carlyle in one of our companies, that was a Expedia of China. And we made two and a half times our money. When we sold it, we thought we’re geniuses. The company we sold at a market cap about $3 billion is now about market cap of $25 billion. So, we sold it too soon. And then he left when we sold it and he built the Sequoia China business, which is the most successful business in all of China of any venture capitalist. And he’s by far one of the wealthiest Chinese investors now.
Meb: There are a couple other topics I want to hit on. But before we leave the book… All right. So, you’re chairing various committees and organizations. Let’s say a new one comes up to you tomorrow, says, “Okay, David, got a $100 million bucks. And guess what? Due to your connections, four of the managers from your book said, they will let us invest with them. Who are you going to give money to?”
David: Diversification’s one of the keys to success. So, I would take four or five of them. But many of these people are hard to get into their funds. You can’t just get into Sequoia fund just by calling up.
Meb: So one of the books we did write that I don’t think anyone read because it was wonky, but I liked it, which was, “Invest with the House.” It looked at all the top-long-only equity guys. The original thesis was, can we just copy Buffet? And what if you just bought what Buffet bought? Because the 13 F’s come out once a quarter. And even after the delay, well, it turns out you do great. It’s a great investing strategy. It doesn’t work for like the Jim Simons of the world, because they’re doing other stuff. But for the equity guys, because a lot of them are closed, you could actually replicate their long book and think about it that way. But that book’s like seven years old. So, I haven’t updated it to see how they’re doing now.
David: What’s the advantage of doing that over the spine, the stock?
Meb: Oh, so versus Berkshire, it actually does very similar. You could theoretically, you don’t get the private businesses, which could be good or bad. But for the other 20 managers that are hedge funds, you can invest in them, like you mentioned. So, if you want to get in Appaloosa or Bow post, you can’t so you can invest in what Klarman is investing in. You also don’t have to pay two in 20. That’s a big one.
David: Okay. You’re talking about doing it with lots of people. But with Warren Buffet, you could just buy stock.
Meb: A long time ago, we had a idea and a ETF that we were thinking about doing it. And we, to me, humorously titled it, the Omaha ETF, because the concept was following these great investors. The SEC said, “You can’t name it this because people are going to think you’re investing in companies in Omaha.” And I said, “No one’s going to think that, but whatever. I don’t want to pick fight with you guys.” One of the things that you said you enjoyed/had a little value add over the years as a founder was recruiting. Did I hear this right? Give some help, man, because I don’t think I’m particularly good at it.
David: Look, I’ve made a lot of mistakes over the years and recruited the wrong people from time to time. But I generally recruited reasonably good people and they perform well, but you have to interview the person and make sure they have the kind of values you want. You don’t want people that are too arrogant. You don’t want people that think they’re too smart. You don’t want people that are trying to do this for the wrong reasons. They just want to buy yachts as opposed to really loving the investment game. Again, you know, I’m sure you’re doing pretty well. And I doubt that you have a hard time recruiting people.
Meb: Well, we’re hiring, listeners. So, hit me up, if you want to live in Cali. I have one child. Today was my son’s first day of kindergarten. So, not too many dry eyes, me and my wife. But two of the topics that I think are really interesting that I want to chat a little bit about, that I know you have an interest in. One is education. So, thinking about where America is in 2022 and thinking about, particularly in our world, the wealth and income gap, how do you think about some of the best ideas on what we could be doing as a nation to sort of improve that, close it, fix it, all that good stuff?
David: If I knew the answer to that, I would be in the Iowa caucuses and the New Hampshire primaries, because there’s no great answer to that. And in my view, we are managed to have the finest higher education system in the world, we’re the envy of the world. But we have one of the worst for a developed nation K to 12 systems for the average person. Obviously, they’re very wealthy people. K to 12 system doesn’t work very much. If I had one suggestion, it would be to really focus more on getting people to be able to read. A large percentage of people in this country, relatively speaking, can’t read at all. Fourteen percent of adults are functionally illiterate. It means they can’t read past the fourth-grade level. And we allow people to drop out of high school at relatively young ages. If we could keep people in high school and make certain when they graduate, they actually could read, that would do more than any other one thing to reduce income inequality, in my view.
Meb: One of the topics that’s a little more niche than that, but we talk a lot about how schools also don’t teach money in any form or personal finance. You get to 18-year-olds today, the administration is talking about some student loan forgiveness. But even asking an 18-year-old to take on tens or hundreds of thousands of dollars of debt, many of which don’t necessarily have the guidance there for them, is a pretty life impacting decision.
David: We don’t teach financial literacy in high school. And people can emerge from high school with a high school degree and not know how to balance a chequebook or how to do anything with money. They tend to squander it.
Meb: That’s sort of my white whale. We talk a lot about it on this podcast. And we had Tim Rand, who runs a charity, listeners, old podcast alum. He’s been trying to work tirelessly over the number of years to get personal finance and money into high school curriculums. And I think the number was as low as 12% of high schools had it. But he said, “We’re now up to almost 40%.” And there was like four states within the past, I think, year. Florida was one that or starting to mandate that topic. So, hopefully, things are moving in the right direction. This young generation, and maybe it’s just bull market and everything else, social media, but seems to be interested.
David: You can go to any high school and graduate and go to any college and graduate and not be required to take a course in financial literacy, not know anything about stocks, and bonds, and investments, even though eventually in life, you’re probably going to have to know something about it.
Meb: While we’re on that topic, any other things you’re kicking around your head about how to think about that literacy, personal finance literacy, any other ideas that are particularly interesting worth trying?
David: There are places that do try to do financial literacy. And Junior Achievement often tries to do it. And they are doing it in the Washington area. But it’s considered too commercial, I suppose. But we tend to teach people ancient Latin more than we teach them modern finance. Latin is a wonderful language, but may not be as relevant to learning how the stock market works or whatever investment is. And most people, if they have a reasonable lifestyle and income, will probably have to manage their investment someday. And how do you do that is not something we teach in high school or in college even.
Meb: I’m hopeful that the public government states start to get it right. Maybe they’ll be a private market solution. I think there’s probably a billion-dollar idea in the education. I mean, so many of these educational organizations can scale to very large size. We don’t want to do it. But, listeners, I think there’s Rosetta Stone for personal finance or investing that’s probably multi-billion dollar company at some point, and doing it the right way. To me, not leading you to your gallows and casino that some of the companies do.
David: For example, did you go to MacIntyre?
Meb: No, I was an engineer. I was a nerdy bio guy. But certainly, spent some time there as an undergrad.
David: I often think that in American education, we ought to teach people one other thing we don’t teach them, which is this, to get a PhD, you have to have foreign language skills. That’s the original concept of PhD when it was invented in 1066, was you have to have two foreign languages. It’d be better if they got rid of that and said you had to learn how to raise money, fundraise. Most people in their adult life will be asking people for money for political, or philanthropic, or investment decisions, or being asked. But people don’t really know how to ask and people don’t know how to fundraise, but it’s an important part of life, increasingly. For example, how many times in the last month have you been asked for money for some venture or political thing or philanthropic thing? Or have you asked me before? But where did you learn it? You have to learn it basically by teaching yourself more or less.
Meb: For those who are more engaged, which you kind of have to be, to be a listener of this show, gets wonky pretty quick. But we talk a lot about, even if you’re not going to put money to work, I think it’s hugely informative. There’s websites like AngelList and others that lets you look into early-stage startups, pitching ideas, and start to get a feel for the jargon and lingo, but also tactics and ideas. And you can start to review dozens and hundreds of these deals that many of which become world-changing companies. And also it’s fun because it’s optimistic. The public markets can be so much negative information and flow versus the startup world. Give me some tips. If someone was going to come pitch you to ask for money, or you were going to go talk to a big institution on…or better yet, you’re going to go teach the course. So, down the road, NYU, or back at Duke, they say, “What do you teach? What’s in the syllabus?”
David: When you go to raise money, the most important thing is to not talk at the beginning about why the product, or service, or whatever you’re selling is so good. Let the other people talk about themselves. When you hear what other people think about, or what’s on their mind, then you can better make your presentation to them. If you let people talk, they generally will. People love to talk about themselves, as a general rule of thumb. That’s why I is the most favorite word in the English language. Let people talk before you make your pitch. That’s important. Secondly, when you’re done, follow up in an appropriate way. Because even if you are very effective in making a pitch, it’ll go in one ear and out the other ear in an hour or two. A good presentation has a half-life of about a week and a half. If you haven’t followed up appropriately in a week and a half, you might not have as well as even had that meeting, in my view. Also do not oversell by telling people something is the greatest thing since slice spread, because people won’t believe it and you lose your credibility. Know what you’re talking about. Make certain that you really are well-informed, and you can answer almost any relevant question.
Meb: I was laughing as you were saying that, because I can’t tell you how many startups I’ve seen in the past few years where the deal memo says, “This is the fastest growing Fintech in history.” And I said, “Even if you thought this might be true, how could you possibly validate that statement? There’s no way to know the claim you just made. Oh my goodness. Or this company will hit a $100 million in sales by the end of the year.” I said, “Man, you don’t live in the public world because SEC would be hammering me for that if I said something like that.” On that same note, as in the modern world, so many people neglect, particularly post-COVID, the human element. I open every single letter I get on my desk. I don’t get that many, but a handwritten note from somebody, well, 100% get open and responded to versus, I mean, how many emails most people get on a daily basis? Probably hundreds, if not thousands. Or a phone call, my God, crazy. A little bit of that is lost just because it’s so easy to hit send, reply, reply all.
David: When I first started practicing law, the head of the firm came in. He seemed like a doddering old man, but he was a very famous former judge. He came in and said, “I only have two words of advice for you. One, return your telephone calls every day. Be polite, get back to people. Secondly, don’t do anything that is ethically challenged because takes five minutes to ruin your reputation, a lifetime to build it. And all you carry around with you is your reputation.” I looked it up recently, and this doddering old man was a year younger than I am now. So, he wasn’t so doddering now.
Meb: Well, life expectancies have moved up, David. I think you got 120 in you. Popping back to the question, and I kind of skipped over a little bit earlier. We talked about education, but… All right, I got that kindergartner. How do you think about, as a parent, I think you got two, three kids. How do you think about raising well-adjusted kids that are not total turds? I mean, particularly in the investing world, thinking about money all the time. Any advice?
David: I should say the hardest thing in the world to do is raising children. It’s even harder though if you’re wealthy. Obviously, we all know people from wealthy families, children who are spoiled, they don’t really work hard, and they basically are going to waste their life. I can’t say I’m a perfect person, but I have managed to raise three children, all of whom have their own private equity funds. So, what more do you want than a child that has its own private equity fund and is an MBA? My kids were well-educated at Harvard and Stanford and so forth. So, I got lucky. But I don’t have any poets, no playwrights, no artists. They’re all in the private equity world. So, I don’t know. Maybe I did something right. Or maybe I did something wrong.
Meb: It’s something that’s front of mind a lot to me because so much of life, I think sports is a good analogy, is drive and grit, and everything is built from adversity or tough times. I mean, thinking about money management, reading some of the stories of famous managers that started and had terrible first three years. I mean, 99% of people I know that do that today, just fold. Or you see managers, they just close their fund and they reopen again and all these sort of behaviors. But so much of life is about that adversity.
David: Look, anybody that’s achieved anything, including all the people I wrote about in the book have failed at something. And they picked themselves up and got back into the game. And if you haven’t failed at anything, you haven’t tried very hard to do something.
Meb: There was a producer on a podcast that had done a lot of famous movies that was talking about failure resume as a concept, be like, “Look, start to keep a document that is like almost a journal of the mistakes made and failures.” All right. So, you’re a history buff, too. You have been engaged in politics over the years. What are you thinking about these days? You put this book out in the wild and you got a curious mind you’re involved in all sorts of stuff, TV show host, chairman of a bunch of boards. What else is on your mind? What are you thinking about?
David: Well, the country is obviously very divided. And I don’t think it’s going to change anytime soon. I think that it’s not as bad as it was during the civil war when we started killing each other. But we’ve had a lot of violence in recent years because of people that politically disagree with each other. I do think that it’d good to find a way to unify the country in some manner or fashion. But I don’t see it on the horizon right now
Meb: What was the movie, “Independence Day?” Other than a good “Alien Invasion,” which we can all unify against?
David: An alien invasion might unite people for a couple days, at least.
Meb: There was a chart I saw about political divisiveness and how it’s increased over the years. I mean, I think perhaps during kind of when you were involved, it was almost like a rugby or soccer match where the Democrats and Republicans, they might brawl, but then they’d go to dinner afterwards, or have lunch, or a beer, or something.
David: That’s right. They don’t do that anymore. They rarely socialize with each other. I host a dinner once a month for members of Congress from both parties and a couple hundred come, but they tell me that’s the only time that they ever can see each other in a non-political non-partisan setting. It’s very rare these days.
Meb: Why do you think that is?
David: This is the reason, in my view. Politicians love to stay in office. They hate to lose, even though the jobs don’t pay very much. So, to stay in office, they got to raise a lot of money. And if you raise money, you have four benefits from it. One, you’re more likely to win. Two, you’re more likely to scare off somebody. Three, you’re more likely to have money to buy a committee chairmanship or subcommittee chairmanship, which are not done by seniority so much all the time anymore. And four, you can keep the money after you leave office, more or less for political purposes, but you can pretty much do what you want with it. So, people are always raising money. House members spent about 40% of their time raising money. You raise money from people who you appeal to on the far left or the far right. You don’t raise money, generally, by appealing to people down the middle. You don’t say to people, “I’m going to be a bipartisan senator. I’m going to work with both parties.” If you try to do that, you won’t raise any money. It’s unfortunate. Right now, the amount of money that you can give the politicians is unlimited. Politicians know they can raise unlimited amounts of money, they just spend time raising it.
Meb: Is the solution there? You got to have some sort of campaign finance reform?
David: We tried that and it was struck down by the Supreme Court. The only way to really deal with it as a constitutional member, but that’s unrealistic to get done, I don’t have a good answer. But in other countries… I’ve met recently and interviewed the Singapore prime minister. And he told me he recently had won his reelection. I said, “How long was your campaign?” He said, “Four days. We only allow four days to campaign.” In our country, you’re campaigning for two years.
Meb: I like it. That’s almost like the old-school stock market. Let’s just have it open one day a week. While we’re on the topic of politicians, a lot of them have gotten some flack and heat this year, Pelosi and others, for actively trading during their time in office, which seems like an odd balance between liberty and freedom. Hey, you should be allowed to manage your investments, but also, hey, we don’t want politicians front-running legislation and making decisions that would be mostly compromised.
David: Used to be the case that there was no limit to what a member of Congress could do, and they didn’t have to disclose what they owned. We’ve made some improvements. They have to disclose everything. They have to disclose their trades. They no longer can use inside information in trading. So, what you’re referring to is that Nancy Pelosi’s husband, Paul, has made some trades, and that has to be disclosed. And people can judge whether it’s appropriate or not. I think it’s not a perfect situation, but I think that we have to recognize this. We pay our members of Congress so little that it is amazing that we don’t have more corruption in our system. Members of Congress haven’t had a raise in their salary in 20 years, they’re paid about $170,000 a year. Seventy-five members of the House of Representatives have to sleep in their offices because they can’t afford a second apartment in the city of Washington. They don’t have any money. Why we don’t have more corruption? I don’t know. But it is not a terrible thing if some of them can try to make more money investing legally and appropriately in the market.
Meb: What are we printing at, 8%, 9% inflation too? That salary in real terms is looking even lower than it was 10, 20 years ago. I would love to see a return to, and maybe this is just perspective, but it seemed like in years past, there was a little more of a concept of civic duty or a pride in people being involved in government or wanting to affect change at that level. Do you think that still exists? What’s the current vibe on trying to get the private citizens and sectors involved in the government?
David: John Kennedy famously asked his generation to go into public service, and many people did. Today, I think people go into government for different reasons. I don’t know if they want to solve problems as much as maybe get access to the people that they can make money from later on. I don’t think that’s true in all cases, but there’s no doubt that people think that going into government today is more than just a matter of public service. I think they think there’s some career benefit that’ll help them make money later on. Unfortunately, that’s not a good thing. But we do have public-minded citizens, I don’t want to sound like we don’t. Members of Congress, I applaud them willing to serve at very low salaries. To be a senator these days, you probably have to be a multimillionaire because by the time you get to the age that most senators get elected to the office, they’ve been in the business world for a while and they tend to make money. House members generally tend to be younger, and they don’t really have much money, in most cases.
Meb: Particularly today of social media, it seems a tough proposition to want to be within the crosshairs 24/7, on top of that, like you mentioned, have a lower salary for that effort and pain.
David: In Singapore, to mention Singapore again, they pay their cabinet officers what they would get in the private sector. So, they make $1 million or $2 million a year. Our cabinet officers are not allowed to make more than I think the members of Congress make. And as a result, we have cabinet officers who are not really highly paid.
Meb: I love that idea though. Like, you’re talking about looking for the best ideas from anywhere. I mean, whether other countries or even in the U.S., other states, like best practices always feels to me like, hey, let’s look around the world, see who’s figured this out and then see if we can maybe emulate or try to transition to that idea or system. Who knows? It’s a hopeful but tough ask. David, it’s been a blessing for you joining us today. We’re bumping up against time.
David: Thank you very much. I appreciate you taking time to talk to me and reading my book.
Meb: Listeners, “How to Invest” will be on the shelves. Check it out. Get a copy as well with some of his older books as well. David, thanks so much for joining us.
David: Thanks a lot. Appreciate it.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at [email protected]. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.
