David Rubenstein is the Co-Founder and Co-Chairman of Carlyle Group, and the author of "How to Invest: Masters on the Craft."
Rubenstein joins Motley Fool senior analyst John Rotonti to discuss:
- Lessons from Warren Buffett, Larry Fink, and Seth Klarman.
- Genius and luck in investing.
- Happiness and expectations.
- Investing with a margin of safety.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Dec. 03, 2022.
David Rubenstein: What Ryan would say is, when you hold onto assets, you give the entrepreneur, the CEO, some real-time to make improvements and really grow the company. But you also have two other great advantages. One, you can avoid taxes because if you're not selling, you don't have a taxable income. Secondly, you can compound a bigger amount of money. If you're not selling you are therefore don't paying taxes, you're compounding on a bigger corpus.
Chris Hill: I'm Chris Hill, and that's David Rubenstein. He's the co-founder and co-chairman of the Carlyle Group, a global investment firm that happens to run one of the biggest private equity funds out there. He is also the author of How to Invest: Masters on the Craft. It's a book about what the most successful investors have in common. Motley Fool Senior Analyst John Rotonti caught up with Rubenstein to talk about what makes a realistic rate of return and the common themes among great investors like Larry Fink, Stanley Druckenmiller, and Warren Buffett.
John Rotonti: I want to jump into the interviews you conducted for the book, but first I have a few questions about your own investing in a business career. Carlyle has generated 26 percent annualized returns in its private equity funds over a more than 30-year period. That's truly incredible. What are Carlyle's investment criteria and what are the secrets to your firm's investing success?
David Rubenstein: Well, that's not easy to answer though so succinctly, but essentially in private equity, we do many different things other than private equity. But in private equity, we generally tend to be not at the cutting edge of the most novel thing. We tend not to be a venture capital investor, we tend not to be an early stage investor. We tend to do more classic buyouts or significant stakes in companies even though we might not be a classic buyout. We generally are big believers in debt pay-down and making certain that we don't pay EBITDA multiples that are hard to sustain. We basically are not likely to get a lot of 100 times our money deals, but we generally avoid a lot of zero times our money deals. Classic bread-and-butter buyouts that are well-financed in industries that are understandable and that have pretty good CEOs.
John Rotonti: I love that the first rule of investing is don't lose money. In the book, you say that successful investing is ultimately about predicting the future. In fact, you say that Warren Buffett is the best long-term investor of all time and so he could also be considered the best long-term predictor of the future. But as investors, we are constantly hearing that the future is impossible to predict on a consistent basis. Which one is it? Is predicting the future futile, or is it the essence of long-term successful investing?
David Rubenstein: Well as I tried to say in the book, all of life is really about predicting the future. Should you marry this person, should you go to this school, is it going to work out? You don't really know where things are going to go, but you're trying to make your best guess about the future. We don't have perfect ways of measuring how successful you are in predicting the future. But in business and investing, we do have a perfect way. That's profit and loss, internal rates of return, multiples and invested capital and so forth. Warren Buffett has been, but maybe the greatest investor of all time in the sense that he has averaged about a 20 percent return a year for 60 years. That's pretty long time. He's pretty good at predicting the future. I would say not perfect, nobody is, I would say nobody is perfectly going to be able to predict where the world's going two years from now, five years from now. But generally, good investors have a pretty good nose for where the world is going to go. They generally would reasonably work for, and they would really take some risks, but nobody is perfect of course.
John Rotonti: You write that, "The investment guys do not reward those who hope good luck will provide superior investment returns on a regular basis. As with casino gambling, good luck at the outset of an investor process or career can actually be bad luck. One will think that genius rather than good luck was involved and will repeat itself so a doubling down on the next investment will probably occur, typically result in losses greater than the initial gains." Do you think there are a lot of investors in the market today that had some good luck in the markets in 2020 and 2021 that see themselves as geniuses today?
David Rubenstein: Well, there's no doubt that some people that did very well in the run-up of tech multiples a couple of years ago and growth capital multiples a couple of years ago, and crypto technology for awhile and so forth. Tech people though, hey, I really am smarter than people thought I was. I really am smarter than all those people that got better grades than me in college and law school or business school. I am pretty smart. I have a knack for this that nobody really recognized before. There's no doubt there's some of that hubris, and some of that, I would say self-deception. But generally, the most grounded investors recognize that there's luck involved. They don't just say, because I did well in one year or two years, I'm really a genius. I think the really good investors are always nervous about the world falling apart and always worried about protecting their downside. That's one of the reasons why I tried to point out in the book. The really good investors have a certain amount of humility because they know the markets can go against them and they're not really going to be able to do anything about it. Therefore a really good investor say, when the markets are moving against me, I'm going to get out. I'm not going to say the tape is wrong, the markets are wrong. Everybody else has an idiot, I'm smart. They tend to make a willingness to get out of bad decisions and go onto the next thing.
John Rotonti: You also say that overpaying for an asset or company rarely has a pleasant outcome for the buyer. What are your thoughts on current valuations, either in public stock market or in private market buyouts?
David Rubenstein: Well, there's no doubt that the stock market has adjusted and probably appropriately so. I'd say a correction is considered to be a 20 percent decline from more or less the peak. I suspect in the stock market averages, we're now probably down a little bit more than 20 percent from the peak over a couple of years ago. Private market valuations have not come down as much. That is something that some people wonder about. Are the private market valuations really meeting the test of the market? Or they really are some self-deception by the people who are doing these markets? Because in public markets as you know, the public is, everybody in the world is really in fact making that decision about where the market is or the value is of the stock or the other asset. In private markets, you tend to be having an outside consultant. You might have your accounting firm and you have your own professionals, and whether the market is as tough on the value of the asset as possible, some people question. But I do think the private markets have not come down quite as much as public markets. Some people think there will be a further diminution in some private markets. I think the private markets are probably reasonably accurate. Private companies are generally better companies than public companies in many ways. I don't think the markets are going to go down appreciably from where they are now.
John Rotonti: In the book, you say investors with realistic expectations of rates of return tend to be more successful. Investors who are chasing rates of return that are unrealistic based on historic norms, will generally be disappointed. What do you think is a reasonable expectation for required rate of return for a good stock market investor, let's say over the next five years?
David Rubenstein: Over the last 100 years or so, public market stock averages above average shown roughly six percent a year so the stock market goes up on average about six percent a year. Obviously some years higher, some years lower. If you're a stock market investor, you should probably be looking net of inflation. I'm not talking about taking into account inflation. Assume inflation zero for a moment, six percent or so. If it's inflation is one or two percent then that's obviously lower than that by four or five percent is what you're talking about net of inflation. If you go into the stock market thinking you're going to do much better than that on average over a long period of time, you're probably fooling yourself, unless you're Warren Buffett or you have some unusual talent. That's why for most people I think it's probably a good idea to take Index Fund. If you're a doctor or a dentist, well, they're very good professions, you're probably busy doing something other than looking at stock markets and assessing companies. Probably get somebody who's a professional to do that for you and probably meeting the market averages is probably what you should expect.
Now if you're in fixed income, you're obsessed with not taking this stock market risk, you just want steady income, then you're probably looking at a lower rate of return. As we know historically, fixed income returns probably you're averaging two or three percent on average. Now because the Fed interest rate is on higher now, you can probably get three and four percent rates of return on fixed-income instruments for some period of time. I would say on your private markets, you're looking for double-digit rates of return. It depends on whether your infrastructure, your real estate, core real estate, opportunistic real estate, venture capital, growth capital buyouts. But on the whole, all of these so-called alternative assets, I think people are looking for double-digit multiples. Sometimes maybe 10 or 11 percent in infrastructure, maybe 15 percent in some opportunistic real estate and private equity, maybe 16, 17, 18 percent net internal rates of return. If you have realistic expectations, you won't be disappointed. If you think you're going to get 25 percent net internal rates of return on a consistent basis, you're going to be fooling yourself.
John Rotonti: One of the things I love about the alternative asset manager model is you got infrastructure where you're expecting 10-12 percent, you've got some other things where you're going 12-14 percent and in private equity above that. You're investing across that growth spectrum. You'll like that some of the wealthiest individuals you've ever met are not really happy people. It's not necessary to be a world-class investor to have a world-class life. What do you think brings happiness?
David Rubenstein: That's the most elusive thing in life and I think from the dawn of civilization, people have been trying to achieve happiness and some people get it and some people don't. What I said in the book is that some of the wealthiest people I know are some of the unhappiest people in the world that I know. That's because they have higher expectations. They want people to say they're great, they want to get more satisfaction from their children or their spouse, and they don't get it, or they don't think that people recognize how talented they are, or they don't find the pleasure in buying the art and the houses and the yachts that they thought they were going get. I think the greatest way to get happiness is to be grounded and have realistic expectations of what you can achieve in life, and then you get the greatest pleasure in my view from helping other people. That's not a novel comment, but I think people that help other people in philanthropy or other ways feel more fulfilled in life than people that don't. Generally, some people that are not wealthy, but have a modest expectation of what they want out of life and do help other people are among the happiest people I know.
John Rotonti: Larry Fink, founder of BlackRock, is known for having an extremely thoughtful and comprehensive view of the macro factors driving markets and economies. He says that he built up this ability by traveling the world and talking to government leaders, and clients, and then using those conversations and lessons to build his view of the investing landscape. He says, "It's all additive. It's like sedimentary rock, a layer here, a layer there, and soon enough you'll have some substance." David, how important do you think it is for great investors to be very macro-aware, similar to, but obviously not to the same extent as Larry think?
David Rubenstein: I saw Larry about a week or so ago. He took his entire board of BlackRock throughout the Middle East and introduced them to many people there and so they get a sense of what's going on in the Middle East. Larry obviously was getting a pretty good set of information himself from that trip. I do think it's important to be as aware if you can of what's going on around the world, and the more information you have about what's going on around the world, I think there'll be a better investor. I think it's one of the reasons Larry has been so successful. He's been willing to travel the world, get to meet people all over the world and hear what they say. Then obviously take his own perspectives and blend that with what he's learned. I do think it's important to travel or to get information from many different sources. The best investors absorb enormous amounts of information before they make a decision.
John Rotonti: Larry Fink says that investors may be making a mistake right now, thinking that we're going to return to the Go-Go years of benign inflation, very low-interest rates, and QE, and massive liquidity injections anytime soon. What do you think about this?
David Rubenstein: I agree with him. I think that we're not likely to see two percent inflation for quite some time again. I think that the Go-Go era that we went through in terms of technology and so forth, I think it's probably in abeyance for awhile. I think we're going to have to suffer through probably some negative quarters and recession type of environment for maybe a couple of quarters next year. Not a deep recession, but some modest recession. I think for a while, people are going to be nervous about where the markets are going and whether the valuations we saw years ago for technology companies, whether that can be seen again in the next 10 years or so, I'm skeptical.
John Rotonti: Ron Baron's partner fund has generated low to mid-teen returns since inception. Since 1992, it's the best performing mutual fund out of more than 2,000 funds that it's measured against. His firm has generated over $50 billion in profits for its clients. What do you think are the keys to Ron Baron success as a public stock market picker and portfolio manager?
David Rubenstein: Ron would say that he has two things that he does that make him very successful. One, he does a lot of due diligence very carefully and he does it himself. I remember when Carlyle was going public, we went to meet with Ron Baron's firm and he showed up and he was taking a lot of notes and he was very thoughtful. He asked very good questions. He does a lot of due diligence, he does a lot of work, and he knows what he's talking about. Secondly, he does intend to sale. He intends to like to buy in the companies where the entrepreneurs still owns a big stake in it on the theory that they're going to make sure it's going to work if they own a big stake in it. He intends to hold for long periods of time. He was an early advocate for Elon Musk and made a fair amount of money in Tesla and SpaceX by holding onto assets. What Ron would say is, when you'll hold onto assets, you give the entrepreneur, the CEO some real time to make improvements and really grow the company. But you also have two other great advantages. One, you can avoid taxes because if you're not selling, you don't have a taxable income. Secondly, you can compound a bigger amount of money so if you're not selling you therefore not paying taxes, you're compounding on a bigger corpus and so by not selling which he doesn't really sell that much that frequently. He tends to ride his winners quite a long way. He's a very smart person and while he came from a background as I did as a lawyer, like me, he wasn't really happy with the law.
John Rotonti: Jon Gray, president of Blackstone, I believe he's in line to one day become the CEO of Blackstone which is largest alternative asset management company in the world. He built Blackstone into the largest real estate company in the world and he helped orchestrate a $14 billion profit for Blackstone on Blackstone's investment in Hilton Hotels, which is the most profitable buyout in history. What do you think makes Jon Gray such an incredible real estate investor?
David Rubenstein: John is very smart. He got a good IQ, he's very hard-working, that's useful too, but he's got an engaging personality. There are a lot of very smart people that are hard-working, but John has an engaging personality, which makes people want to do business with them. You can't buy something if people don't want to do business with you, and you can't sell something to somebody if people don't want to buy from you, but John as an engaging personality is likable, he's modest on assuming not a big ego, and I think people just enjoy doing business with him. That's been a big plus as well. He's also been able to motivate a team of people around the world to build a really great real estate business. He built the largest opportunistic real estate business in the world by far and done some of the most successful deal. I think it's a combination of intelligence, hard work, and an engaging personality.
John Rotonti: In the book, he says that his best advice is to "Be a high-conviction investor." He goes on to say "When you dabble and just put a bunch of money on things you don't know or understand, it tends to work out badly." You have also built one of the most successful alternative investment firms in the world. What do you think of that advice, to be a high-conviction investor and not to dabble and things you don't understand?
David Rubenstein: Well, I agree with him because if you try to do a little bit of everything, you'll probably do nothing very well. What he means by high conviction is make sure you really know what you're doing. Spent a lot of time and energy in making certain you have all the facts, and then if you're convinced that you're doing right, then go in and basically make a significant investment. That's what George Soros has always said. When you have a great idea, dabble down and don't just think it's a great idea and put a modest amount in it, put a great amount of money behind the ideas you have high convictions in, and that's what I think Jon Gray's done. When he's done an analysis or his team has done an analysis as they did in the EOP transaction, which was the biggest real estate deal of all time, they really knew what they were doing, but they also knew that they should pre-sell some of the assets because the market could go down so they pre-sold, in that case, three-quarters of the assets and what they were left with turn out to be extremely successful for them.
John Rotonti: Yeah. This next question, I'm combining the advice from four or five people in your book because they all gave almost the exact same advice. John Rogers, founder of Ariel Investments, says "The best way to be a successful investor was to be contrarian, to not follow the crowd." Dawn Fitzpatrick, the CEO and Chief Investment Officer of Soros Fund Management says "In this industry, you make money by having a view that's not the consensus, and over time becomes the consensus view. You have to have the confidence to have opinions and be an independent thinker and then be willing to bet on them." Ray Dalio, the founder of the largest hedge fund in the world, says the most important thing is "The ability to be an independent thinker. You can never go with the consensus, the consensus is built into the price." Seth Klarman, who's done 15 percent annualized over nearly 40 years and has had only four down years in those 40, says that value investing is "The marriage of the calculator and a contrarian streak." He also says "Not drawn to hot areas or to what other people are doing." He has no interest in chasing things just because they're going up. David, do you think contrarian is a prerequisite for long-term out-performance, and how important was contrarianism to the success of the Carlyle Group?
David Rubenstein: Well, first I do agree with that view and I say that that is what all the great investors have in common. They defy conventional wisdom. The conventional wisdom says, the stock market is going down and you shouldn't invest. They tend to go in and buy things at discounts, but they have to have some independent judgment and they have to do their own research. But yes, if you basically go along with the pack, you will be the pack or whatever the market averages, that's what you'll do. Obviously, you have to do something different than what the average person is doing, and typically, people are doing something that's quite contrary, and many times people laugh at them when they're doing it, but they often turn out to be right, at least the very good ones too. Starting Carlyle was contrary, no one thought you're going to build a private equity firm in Washington DC, and then secondly, we tended to focus in industries initially that people didn't think you could make money in. We did a lot in the aerospace defense industry. Initially, we had Frank Carlucci, former Secretary of Defense in our firm, and we had some expertise of other people as well. We invested in some industries that people didn't think you could do. One of the biggest contrarian things we did where the two were contrarian at the time now they seem like common things. But in the early days of private equity, you are either a buyout firm or a venture firm or a growth capital firm or whatever, but nobody did everything. We decided we would have multiple funds and like T Rowe Price or Fidelity or Vanguard have multiple funds and try to sell the brand name of that. We did that and that hadn't been done before. Then secondly, we globalize the business by having a dedicated team in Europe, Asia, Japan, Latin America, Africa, and so forth. We had our own dedicated teams elsewhere around the world. Historically you didn't invest outside the country you were based in or you didn't have dedicated teams there, so we did those things that were contrarian at the time now they're not seen as that contrarian. We did things that were contrary and that helped us grow the firm.
John Rotonti: Yeah. In the book, you try to summarize these qualities that these investors share, but you write "No other characteristic of a great investor is as important to their success as their willingness to ignore conventional wisdom." That seems to be like the one that's common across all investors.
David Rubenstein: I think it's the most significant. There are other characteristics that are in the book, but that's the most significant one for sure.
John Rotonti: Yeah. Seth Klarman says the margin of safety concept is critical. Do you invest with a margin of safety?
David Rubenstein: Well, we hope to. Margin of safety is the title of course, of his legendary book, which is not in print and I think goes for a very expensive price on eBay, and he hasn't done a second edition. He took that title, I think from one of the chapters and another book that's very famous on security analysis. You always want something that gives you some margin of safety, so you don't want to think, well, if everything works out here, we're going to be great and we're going to get a three percent rate of return. You want to have a much higher rate of return because you need a margin of safety if something goes wrong, and so you don't want to be doing things just right at the edge where you think if everything works out, you're going to be OK, but you want to have a big enough margin so if everything doesn't work out, you might be better than just OK, but you want to have a big enough margin of safety so that if the world goes against you, you are not going to be in trouble.
John Rotonti: One of my favorite quotes in the book comes from Seth Klarman. He says "Risk aversion is crucial. The margin of safety concept along with a disciplined approach to buying and selling. A lot of people forget to sell, and it's important when securities or investments reached full value that you move on. Then there's the criticality of independent and sometimes contrary thinking." How important is having a sell discipline and knowing when to sell as an alternative asset manager?
David Rubenstein: Well, I think it's important. I know sometimes in our own firm, we have people that think that the deal was supposed to get a 25 percent net internal rate of return, it's now marked at 20 percent. They said, well, no it's going to be there in a couple of more years, let's wait. We often have to push people to say look, 20 percent net is OK, don't be piggish. As the old saying is, pigs get fed and hogs get slaughtered. I think there's another famous saying by a great investor from the 1920s Bernard Baruch. Who said, nobody ever got fired for taking a profit. If you can make a really good profit of good profit by anybody's measure, take it. Sometimes at Carlyle, we think that a company is going to make six times its money and we now market at four times his money and we are sometimes reluctant to sell. I think we should probably do a better job in that. I do agree with Seth. It's a good idea to remember that there's an advantage and selling when you're making a profit.
Chris Hill: As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy yourself stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.
