Jul 22, 2024 · 1h 4m · capital-allocators
Rob Small and Anil Seetharam - Public Equity Adjacent to Private Equity at Stockbridge (EP.397)
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gold bands on the timeline = statements, start to end. Hover to read, click to jump. CC turns on captions
In this episode of Capital Allocators, host Ted Seides interviews Rob Small and Anil Seetharam of Stockbridge at Berkshire Partners about managing a concentrated $5 billion public equity strategy within a $20 billion private equity firm. They discuss their outside-in research methodology, dynamic conviction polling, collaborative board governance, and key lessons from seventeen years of long-term compounder investing.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 20.9% of the talking time here. How this is scored →
Ted as informed peer 5.0 Guest teaching 4.8 Guest disagreement 0.4 Ted pushing back 1.2
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 49:55 Anil explicitly rejecting hype around owning Nvidia
Anil candidly admits that despite Nvidia's stellar market run, Stockbridge refuses to own it because it falls outside their circle of competence and they would lack conviction during drawdowns.
Hardest push from Ted ▶ 47:41 Ted challenging the omission of mega-cap tech winnersTed presses the guests on how a private equity mindset in public equities could justify missing the Magnificent Seven tech companies that drove the bulk of market returns over the past decade.
Biggest teaching moment ▶ 15:05 Anil's puzzle box analogy for private versus public researchAnil educates the listener and host by framing private equity diligence as a timed puzzle box with full data versus public equity as missing ninety percent of the puzzle pieces thrown in the woods with no clock.
Ted holds their own ▶ 10:37 Ted frames the historical failure of PE-to-public crossoversTed demonstrates deep allocator knowledge by pointing out that over the preceding twenty years, most private equity firms attempting to run public market strategies failed due to conflicting cultural mindsets.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Professional Backgrounds of Rob Small and Anil Seetharam | 5 | 4 | 0 | 1 | Ted guides the biographical narrative smoothly, asking how Berkshire Partners evaluated adding public equities as a distinct product. Rob and Anil explain their career paths and the firm's three-part acid test for launching new initiatives. | |
| Designing a Long-Only, Concentrated Public Equity Strategy | 6 | 4 | 1 | 2 | Ted brings historical industry context about how past private equity crossovers into public markets largely failed. Rob details how Stockbridge rejected standard long-short hedge fund models to stay concentrated and long-only on advice from David Swensen. | |
| Building Public Market Muscles and Achieving Conviction | 5 | 6 | 1 | 1 | Ted asks how the team developed public market investment muscles from a private equity background. Anil offers a vivid analogy of comparing private equity diligence to a timed puzzle box and public equity to missing puzzle pieces scattered without a clock. | |
| Inside-Out vs. Outside-In Research and Private-to-Public Diligence Gaps | 6 | 5 | 0 | 1 | Ted probes the operational research gaps between private and public market diligence. Rob and Anil explain that while inside data is necessary for restructuring theses, outside-in research is just as telling for stable compounding businesses. | |
| Navigating Potential Conflicts and Sharing Insights Across Teams | 6 | 5 | 1 | 2 | Ted asks how Stockbridge navigates material non-public information and potential conflicts when both teams evaluate similar companies. Anil explains that the firm trades in industry insights rather than non-public information, resolving conflicts through co-investment. | |
| Deep-Dive Diligence in Practice: Pediatrix and Vulcan Materials | 5 | 6 | 0 | 1 | Ted inquires how deep-dive research manifests practically relative to standard public equity analysts. Anil provides concrete case studies, describing demographic modeling on neonatology for Pediatrix and mapping every quarry in the US for Vulcan Materials. | |
| Filtering the Investment Universe and the Discipline of Passing | 6 | 5 | 1 | 2 | Ted asks how the team quickly filters ideas to avoid getting bogged down in extensive research, and how consensus decision-making works. Rob explains the firm's conviction polling system and the psychological discipline of distinguishing passing from declaring a stock bad. | |
| Sponsor Advertisement: Ridgeline Investment Management Tech | 0 | 0 | 0 | 0 | Host mid-roll sponsor advertisement read for Ridgeline investment technology. No guest interaction or substantive discussion. | |
| Strategic Philosophy on Public Company Board Participation | 5 | 5 | 0 | 1 | Ted asks about the cost-benefit trade-offs of public company board seats. Anil and Rob emphasize that they never seek board seats to impose activist changes, but rather to support management and strengthen holding conviction in compounders like TransDigm and ADS. | |
| Weathering Volatility, Short Attacks, and Operating Discipline | 5 | 6 | 1 | 1 | Ted asks how Stockbridge handles inevitable stock drawdowns and bumps in the road. Rob recounts how a short attack on TransDigm prompted rigorous outside-in verification that enabled them to aggressively buy more rather than panic. | |
| Navigating Large-Cap Winners and the Circle of Competence | 6 | 5 | 1 | 2 | Ted presses the guests on why their private-equity style public equity approach initially overlooked the mega-cap tech stocks driving index returns. Anil and Rob discuss owning Amazon and Microsoft based on circle of competence while deliberately passing on Nvidia. | |
| Selling Discipline, Modeling Limitations, and Behavioral Lessons | 5 | 6 | 0 | 1 | Ted asks about sell discipline and operational errors. Anil discusses the pitfall of overly rigid spreadsheet IRR modeling that causes managers to sell compounders prematurely, and Rob recalls a 2016 emotional sell mistake. | |
| Avoiding the Endowment Effect and Evaluating Analytical Conviction | 5 | 5 | 0 | 1 | Ted asks how they distinguish stubbornness from conviction when an investment goes south. Rob illustrates this using a coin-flip probability model, while Anil explains doing continuous work to avoid the endowment effect. | |
| The Blurring Boundaries Between Public and Private Markets | 5 | 5 | 0 | 1 | Ted asks about the blurring line between public and private valuations. Rob and Anil reflect on twenty years of compounding and note that the biggest lesson is making a very small number of consequential, high-conviction decisions. |
Statements from this episode (37)
Small: Private companies traded at higher multiples than publics in 2005-2007
“For the first time, we did comparable sheets with public companies, and we were seeing private companies go for more than public companies. So the control premium was higher than the liquidity premium.”
Small: Berkshire Partners Is Largest Investor in Its PE Funds and Stockbridge
“We're the largest investor in our private equity funds, and we're also, as a group, the largest investor in Stockbridge.”
Small: PE firms must build public market teams internally for effective collaboration
“Building it internally was important because the relationships of the people were a key to making it work. It wasn't just saying, Geez, Berkshire partners should have a public firm. Let's go hire a team to go do it. That would not get the collaboration that we…”
Small: Stockbridge is essentially long-only and has rarely shorted
“We're essentially long only. We have a right to short, but we've done it only a couple times in our history”
Small: Short selling consumes too much time and rarely makes sense
“Very, very few people were good at it, and it took up most of your time. To get shorts. Plus you were in some ways leveraging your longs in order to justify your shorting. So it just seemed to us to make no sense to do that.”
Seetharam: Stockbridge abandoned short selling after a one-week trial
“For the first two years, I think we invested exclusively internal capital and tried a lot of things. So like Rob mentioned, we tried to short. The first short, I think, lasted a week. And we realized we were not going to be good at it. We didn't want to do it,…”
Seetharam: Public investing gives less data than PE but no time constraints
“In the private equity business, the way it works is you have access to a data room. And you have a certain amount of time to understand as much as you can about a company with full access to the information and the management team. So if you were to use an ana…”
Seetharam: Stockbridge matched private equity diligence conviction on Skillsoft
“There was a business that we were invested in at Stockbridge, a company called Skillsoft. It's an education software business that Berkshire private equity ended up taking private. And we got to see what public information would allow us to understand about th…”
Small: Internal data is necessary for operational change theses
“The private data would be great if you had an enormous change thesis. If you thought management was doing the wrong thing on major operational issues and you thought you could do better, I don't know how you make that decision without internal data.”
Berkshire maintains no internal walls between its PE and public equity teams
“Across the firm, we chose not to have any walls between the two businesses.”
Rob Small: Stockbridge embeds members into Berkshire PE industry teams
“The private equity side is divided into industry teams. We put one of our people on each one of their industry teams, so that way they can learn about what they're learning about the industry.”
Seetharam: Berkshire Private Equity Targets Smaller Businesses Than Stockbridge
“Berkshire private equity tends to invest in smaller businesses has always invested in smaller businesses than we tend to invest in. So there's very little direct overlap in the companies we're looking at.”
Seetharam: Stockbridge Rarely Encounters MNPI from Berkshire Private Equity
“So we found it's extremely rare that we end up with MNPI on a company and the places where we've run into issues They've tended to be opportunities, not conflicts or issues. We've co-invested in things.”
Small: Stockbridge avoids biotech approvals and commodity-driven businesses
“So we don't invest in things like, is the drug going to be approved, or where commodity prices will ultimately drive the answer.”
Small: Investors must be cautious expecting management teams to pivot
“And we found that managements, ah, are really good at executing, continuing to do what they have done in the past, and that you have to be really, really careful before you're asking a management team to do something different.”
Small: Stockbridge models 5 years out and targets mid-teens returns
“We build a five-year model. Which tends to make you have to think at least 10 years out because someone's gonna buy the business from you, and we want mid-teens or better returns.”
Stockbridge built a database of every US quarry and surrounding population trends
“And one of the things we've done is assembled a database of
Every single quarry in the United States and what the ownership is of that quarry and the population trends around that quarry.”
Stockbridge makes only two to three new investments per year
“We invest in two to three things a year. We probably look deeply at 10 to 20 things a year with a pretty big team, and so the several hundred that we look at, we're putting them down very quickly for one of those reasons.”
Small: Passing on Investments Means Lacking Conviction, Not Predicting Failure
“Our no is not that this isn't going to be a great investment, it's that we're not going to get to high conviction that this is going to be a great investment, and that makes it a little easier.”
Stockbridge has entire team vote on admitting portfolio investments
“As an entire group, we discuss every idea that's making its way into the portfolio from a very early stage, which we call our tear sheet stage, where we're just introducing the whole team to the business to a final investment memo. Everybody from the newest an…”
Small: Sizing public equity positions purely on modeled IRR is suboptimal
“We were religious about keeping our five-year internal rate of return models up to date and trading off that. The higher the IRR, the bigger the position. We learned that wasn't the best way. We changed over time at that point to adding a conviction element”
Stockbridge limits its portfolio to 15 names, capping positions at 25%
“And so that ultimately leads to a portfolio of typically around 15 names. We've had a position become up to a quarter of the portfolio. That's more the exception. Typically the largest position will be in the 15%. And then a bunch of things around six percent.”
Small: Fast-twitch trading funds require single decision-makers rather than consensus
“I think if we were a fast-twitch Hedge fund making multiple decisions every day on trading, it wouldn't work. You'd need single points of decision, whether there's a number of them or one of them, but we don't make a lot of decisions.”
Seetharam: Stockbridge sells troubled holdings rather than pursuing activist board seats
“So the key is if we have a problem with the company, it's better for us to sell than it is for us to go on the board and try and change it.”
Berkshire Partners held Advanced Drainage Systems continuously from the late 1980s until 2010
“Berkshire Partners invested in the company in the late eighties when it was a small agricultural plastic pipe producer and held the business continuously until 2010 through multiple funds and then sold it to another P firm who took it public in 2014.”
Stockbridge and Berkshire PE acquired ~20% of ADS in 2017 after accounting restatement
“In 2017, we bought about 20% of the company after they were through their accounting restatement and then subsequently joined the board.”
TransDigm was Stockbridge's first investment and largest position through most of its history
“And so when we started Stockbridge, that was the first company we looked at and we invested, it has become and been our largest position through most of our history.”
Small: Public markets exhibit far crazier mispricings than private equity
“We've seen crazier prices on both sides by far in the public markets than I think you tend to see in the private markets.”
Seetharam: Stockbridge passes on Nvidia because it sits outside its competence
“While let's say a company like NVIDIA is an extraordinary business by all accounts and one we've looked at, we just don't think we would be a great owner of that business at this point in time. Because while I can tell you all the great things about NVIDIA, I …”
Small: Stockbridge Sells for Only Three Specific Reasons
“Well, there's three reasons that you sell. One is you lose conviction in the thesis, and you think you should move on. Two is it gets so expensive that you think the returns looking forward aren't acceptable, or at least certainly compared to what else. Or thr…”
Seetharam: Spreadsheet valuations fail to model great companies creating their own luck
“Excel-based valuation methodology doesn't really capture the full distribution of outcomes. A good business with great tailwinds and a great management team can create their own luck, and it's hard to model that.”
Seetharam: Selling Winners Too Early Is Stockbridge's Biggest Mistake
“Selling winners too early has been a constant source of frustration, one that you can just open up your Bloomberg and see it hit you in the face every single day.”
Seetharam: Long-term investors must track non-price markers to validate an investment thesis
“It's important to have evidence in a long-term investment that things are working. That may or may not show up in the stock price, but there's a set of markers along the way that give you confidence that your long-term thesis is right.”
Stockbridge does multiples more research after buying a stock to combat bias
“We do a lot of work up front, but we do multiples of that work after we own a company. And just ensuring that we're not holding onto something simply because we did a lot of work and we have endowment effect and it's in our portfolio.”
Small: Berkshire will not make macro-timing bets between public and private equity
“I don't think we will make market-based bets of now's the moment to invest in public and now's the moment to invest in private.”
Stockbridge requires unanimity among senior partners for new investments
“That's why we demand unanimity among the senior people to invest in something, because you're gonna get hit with a bump, and so when you get hit with a bump, you have to have enough information, enough belief to evaluate the new information, but be able to sti…”
Seetharam: A Very Small Number of Decisions Drive Portfolio Returns
“It's very easy in this to think about making a shorter term trade or adding a smaller position to the portfolio, but that's not really what we're set up to do. And when we do that, We're more likely to make a mistake, and so what we've really honed in on is ju…”