So Cindy Crawford walks into a bar and a swarm of dudes approach her, brandishing their best pick-up lines: "Was your father a thief? Was your uncle a robber? Well if not, who stole the sparkle from the stars and put it in your eyes?" or, "My, what a beautiful mole you have" and even, "Well, aren't you MILF-y tonight?"
Sounds like the beginning of a joke, no? Well, actually, welcome to my life! Well, not just my life, but actually the life of any LP . . . after all, being the cat with the checkbook can make you the most attractive girl in the bar. And being the hottie of the honky-tonk comes with a cost: an endless stream of pick-up attempts.
And the lines we hear from GPs can be remarkable for their homogeneity. In fact, when I hear a buyout fund talk about Proprietary Dealflow or Operating Partners, or a healthcare fund talk about the Aging Population or the Patent Expiration Timebomb, I can't help but think that I've heard this story several (hundred) times before. In fact, I've got a visual reminder in the form of my oppressive inbox of just how many times I've heard some such story. Here's a sampling:
As you can see, the leftmost column contains the folders I've created for funds that have sent me information since I started at my current employer in mid-2004. In this view, you can see about 30 of the 452 VC firms with whom I've corresponded. I have a similar LBO/growth capital folder that contains another 377 firms and an international folder that contains stuff from about 275 additional fund managers. Add in the 75 managers that are in my "active" bucket (running the gamut from the latest GP over whom I'm breathless to the oldest, most tired fund that 's in run-off mode) and that's close to 1200 funds from San Francisco to Stockholm to Shanghai. Throw in my tenure at Old Ivy and I probably saw another 300 incremental funds over and above those 1200. And compared to some other folks on the LP side, that tally of 1500 seems like a rookie's breakfast.
Speaking of Old Ivy, when I was just starting out as an apprentice in the craft of PE investing I asked an Old Timer in the office about the early days of institutional investments in PE — I mean, this guy was my Hubble Space Telescope back to the cottage industry-era of the PE universe. And one thing that he said stuck with me all these years: "in those days, we kind of figured out what kinds of strategies we wanted to back, looked around at the four of five managers who were doing those kinds of things and then invested in about half of them." Remarkable . . . when I think about my "funnel" today, the line we used in my Old Ivy days seems to ring ever more true with each passing day: "It's harder to get into our portfolio than it is to get into our college."
And I believe that all the competition has to be challenging for overall returns. Or maybe, paradoxically, overall returns won't suffer as tradecraft generally improves, but instead the dispersion of those returns tightens as the industry professionalizes and best practices are copied and losers fade away and become exemplars of survivorship bias. In that vein, I'm reminded of a great Stephen Jay Gould article I read about 25 years ago in which he talks about the maturation of an endeavor (in that case baseball) and the disappearance of outcomes that are several standard deviations (positive or negative) off the mean:
"Variation in batting averages must decrease as improving play eliminates the rough edges that great players could exploit, and as average performance moves toward the limits of human possibility … Declining variation arises as a general property of systems that stabilize and improve while maintaining constant rules of performance through time. The extinction of .400 hitting is, paradoxically, a mark of increasingly better play."
What if that's true? What if the fabled dispersion of top-to-bottom quartile returns starts to narrow, (like the pennant-shaped graphs exhibited by many styles of investing that show wide dispersions in the early, pioneering, wild west years on the left side and narrower spreads in more recent years)?
Well, one implication may be that the "better execution" story (i.e. "we're good at this") becomes commoditized while the "we're doing something different" story becomes even more compelling. After all, do I need an n-th mid market buyout fund with operating partners and a geographic focus? Or the m-th early stage Sand Hill Road firm? Maybe, maybe not. That's just post-heroic private equity and there's indeed a place for that in a portfolio as a return enhancer. But I fear that those types of firms in the aggregate are slouching toward an paradigm of little more than what the public market guys would call enhanced-indexing.
But what about someone who's doing something innovative in style? Structure? Terms? That might add some spice to the portfolio. That's where the true octane (on a risk-adjusted basis) might lie. It's definitely the higher volatility play, both in potential returns (for the LP) and in fundraising success (for the GP,) but to do something outstanding takes audacity. And indeed, private equity should be all about audacity. After all, heroic investing lives at the intersection of courage and conviction.