Value investors have just a few fundamental rules they follow religiously in the hope of beating the market: buy low and sell high; maintain an investment portfolio concentrated in relatively few companies; and take contrarian bets. Warren Buffett says that when he buys a stock, he thinks as if he’s buying the whole company. Private equity figures often claim to act like value investors also. Perhaps that used to be the case. But nowadays the big buyout houses are breaking all the rules laid down by Buffett’s mentor, Ben Graham.
This year, the equity markets have touched all-time highs. Renowned value investors, like Seth Klarman of the Baupost Group, are holding back. But private equity firms are spending their huge war chests at record pace. Nearly $500 billion in private equity deals have been completed this year. That’s more than double the amount in the same period last year, according to Dealogic. Blackstone has bought over 30 companies since January 2006, covering a variety of sectors from technology firm Freescale Semiconductor to Michaels Stores, a craft retailer. The firm now has around 55 companies in its private equity portfolio, up from 36 in 1999. Still that’s nothing compared to Carlyle, which owns hundreds of companies. John Maynard Keynes, another pioneer of value investing, warned against excessive diversification. The British economist claimed that as an investor he was personally unable to understand more than 50 companies at a time. Sure, Blackstone has hired more people to watch over day-to-day operations at their portfolio companies. But the founder, Steve Schwarzman, is said to be the man with the magic touch, who oversees all its investments. With Blackstone’s IPO around the corner and the firm rapidly raising new funds, there’s a danger of investment overstretch.
Still, there is at least one private equity firm which has found a way to grow quickly while sticking to the value-investing rules. Recently, Cerberus placed a large contrarian bet when it bought Chrysler for $7.4billion. True, the firm’s portfolio now consists of 54 companies, but many of them are in the auto business. If Detroit continues along its abysmal path, Cerberus’s investors will be disappointed. But at least Stephen Feinberg’s outfit will have conformed to the value investors’ maxim, expressed so eloquently by Mark Twain: “Put all your eggs in one basket and watch that basket.”