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The Private Equity Mindset: How to Find Success

The Private Equity Mindset: How to Find Success

When investors approach the markets, they tend to think they are going to find some magic button that unlocks the secrets of trading and investing success. They study chart patterns and dream of being Stevie Cohen or Paul Tudor Jones.

They want to find success trading the short-term market movements and catching the big trends on their way to millions. Individuals all too often come to the market with unrealistic expectation and hopes of quitting their full time job to become full-time stock traders.

The print media and internet are full of offerings to teach you the secret of trading and put yourself on the path to everlasting profits. The sad truth is that something on the order of all retail traders are unprofitable and that number has been consistent throughout almost three decades around the market.

Enter At Your Own Risk

When traders enter the market as a short-term or swing trade, they are competing against guys with their Ph.D. in math and statistics who have to install special air conditioners to cool the computers they use to trade. You think you have a great trade set up because of some chart pattern moving or oscillator oscillating? What traders all too often become is lunch money for a bunch of guys who cut their teeth trading in the pits at the CBOE or Merc and have an edge in knowledge and application that most traders will never be able to replicate or compete against.

The other mindset that crushes a lot of investors is the "I want to be Warren Buffett,” syndrome. So much has been said and written about Warren Buffet and his approach to the market that pretty much everyone thinks they can replicate his success. They can't.

Although Warren's mindset and attitude towards the market should be used by a lot more people, we are never going to see the type of privately-offered deals that Warren and Charlie see at Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B).

You will never be able to replicate what Buffett has achieved by cloning his portfolio of public companies because a lot of his cash flow comes from the private companies he owns and he gets paid to use leverage by his insurance float. The combination of Charlie Munger and Warren Buffett is a once in a lifetime pairing of brains and talent and while traders may be able to learn from them, you aren't going to be able to invest like them.

Wanna be like Warren? Good luck!

When you look at individual investor returns over time as a group, they tend to lag not just the indexes, but actively managed funds and even fall short of the inflation rate over the past 20 years. Individuals trade entirely too much, tend to chase hot stories and popular stocks and are too easily influenced by outside forces such as advertising and sales pitches.

Our brains work against us as the aversion to loss and comfort level running with the herd makes it almost impossible to earn a satisfactory return in the financial markets.

Warren's teacher Ben Graham once remarked that investing works best when it is most business-like. Investors should approach the stock market like a collection of businesses and adopt the mindset of the most successful business people in the financial markets. Private equity funds earn high returns by buying assets that are unpopular, holding them for five to seven years and selling them to the momentum minded herd.

How to Adopt the Private Equity Mindset

While individuals may not be able to exert the level of control that a big fund can exert over their portfolio, companies can adopt the 'Private Equity Mindset' by buying out of favor assets and securities and holding them long enough to recover and sell for many multiples of the original purchase price. This is a far more successful practice than trying to place bets on where the indexes will close tomorrow.

Private equity investors look at thousands of companies in the course of a year and narrow the list down to those that they think are priced cheaply enough to offer significant returns. Along with distressed investors, private equity investors are often vulture-like in their behavior and are more active buyers in an economic or sector downturn. These investors also take advantage of others panicking or even forced selling to obtain more advantageous pricing.

They hold the assets for several years until conditions normalize and begin to show signs of euphoria and irrational pricing to the upside and they cash in and collect their out-sized gains.

In addition to adopting the longer-term 'buy and hold it until it works' mindset, investors would do well to pay attention to what private equity funds are doing at any given point in time. The activities can hold valuable insights into what assets and sectors may be underpriced and set for substantial long-term returns.

What To See Right Now

Right now, we are seeing private equity funds like Carlyle Group (NASDAQ: CG) and KKR & Co. (NYSE: KKR) raise and deploy funds in the energy sector. WL Ross, Blackstone (NYSE: BX) and Apollo (NASDAQ: AINV) have become very active in the battered shipping industry. Brookfield Asset Management (NYSE: BAM) just raised a large new infrastructure fund. There are some sectors around that are cheap enough to attract widespread attention from the large private equity funds and individuals should be scouring these areas for attractive long term investment candidates.

However buying has not been the chief activity of most private equity funds this year. Leon Black of Apollo recently told an investment conference that conditions for selling assets were so favorable that his shop was selling everything that wasn't nailed down. Wesley Edens who heads up private equity for Fortress Investment Group (NYSE: FIG) recently said, “This is a better time for selling our existing investments than making new investments.”

Blackstone President Tony James chimed in that, “With credit markets hot and equities strong, this is a better time for selling assets than for buying.” A look at the forward IPO calendar shows that PE firms are lining up to offload past deals onto the investing public right now. This is probably not a precise timing mechanism is but is valuable information for long term investors when considering the stock market right now.

Most individual investors would be better served by not trying to be Warren or chasing pipe dreams of short term trading gains and adopt a private equity mindset.

Tags: Ben Graham Charles Munger Private Equity Funds tony james

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