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Turtle Creek Asset Management

Private Equity Q&A: Andrew Brenton, Turtle Creek Asset Management

Investment management firms have been in the private equity replication game for years now, with varying degrees of success. Greg Winterton spoke to Andrew Brenton, Founder & CEO of Toronto-based Turtle Creek Asset Management, to get his views on the approach.

GW: Andrew, the private equity replication approach has not caught on in the sense that traditional private equity fundraising has been on a tear in the post-GFC period. Why do you think it hasn’t been as popular as its proponents might have thought?

AB: I think we need to start off by differentiating between traditional private equity replication and what we do, which we are calling synthetic PE. Traditional private equity replication is basically a specialised index fund with leverage. It starts with the premise that you can establish what kind of firms private equity invests in, you come up with a list of criteria, and then you invest in those companies through an index structure which you then leverage up in the same way private equity would.

That’s not what we do. Ours is a company by company approach. We do the hard work on each individual company as if we are going to buy the entire company, in the manner of private equity investors. We value them in detail according to their future free cash flows - we’re not using simple metrics like P/E multiples. We get to the know the management, the company, we look at the whole picture. The only difference with traditional private equity is we’re not taking the companies private, they stay public, and we add leverage at the fund level to replicate, in aggregate, how PE would leverage each company’s balance sheet.

GW: So, what can be done, or should be done, differently, so that this approach gets more attention?

AB: We’re not necessarily defending or attacking the traditional private equity replication model. It’s just not what we’re doing. We’re active managers, they’re taking a passive approach. They’re specialised index funds with leverage, we’re more like private equity in a public equities structure. We take an intensely valuation focused approach. We think you can't value companies based on a screen of traded multiples. This is because earnings are all over the place and there are so many accounting variables. You need to do the work company by company.

GW: Your background is actually in the traditional private equity space. What are one or two of the lessons you learned doing ‘normal’ PE that has informed your current view?

AB: If I had to try to pick one thing, it would be really good companies don't need to raise equity. They earn good enough returns on their capital that even if they're growing they can fund that growth through issuing debt. And so, in a similar vein, as we turned to the public market over 20 years ago, we don't own any public companies that need to raise equity capital to run their businesses. We never want to be invested in companies that are hostage to their share price, where they may not be able to achieve the forecast we have for them because their share price is really low, and if they issue equity at that price, it's dilutive to the shareholders. There's a common view that the purpose of the stock market is to raise capital for companies. But, in fact, there's a more powerful purpose of the public stock market, which is to provide diversification for the current owners. Being public is a way for those owners to sell the company in pieces over time.

Another learning was that in private equity there was rarely an opportunity to improve upon a buy and hold. You did your work, you made the investment and then, years later, you sold the investment. The public market provides us with endless opportunities to improve upon a buy and hold approach – and we have taken advantage of those opportunities over the years to meaningfully enhance a buy and hold return, holding by holding.

GW: What’s your response to those that say that PE replication is ‘muddying the waters’ – i.e., public equities belong in the public equity bucket, and private equity belongs in the PE bucket? After all, public vs private companies are exposed to different risks.

AB: I understand many investors like to bucket things, they like strict silos. But good investing is finding opportunities. And so I don't view PE replication as muddying the waters. I'd actually argue it triggers a conversation about what exactly is private equity accomplishing. You know, there is an argument which is that private equity is less risky than public equity. But you can only make that argument if you think measurable share price volatility is risk, which we don’t believe. Of course public equities are by definition more volatile than private equity because in the private market there’s no ‘price discovery’, the share price isn’t moving around when you’re private. Fundamentally, a company’s a company, and is exposed to competition and all the things that they face, and whether a company's public or private, that doesn't change. The real risks are business risks, not share price volatility.

GW: Lastly, Andrew – private equity is experiencing something of a cyclical retreat at the moment, as higher interest rates are impacting deal making and fundraising. What’s your message to investors on your synthetic PE strategy in the prevailing macroeconomic environment?

AB: People have asked, 'isn’t your synthetic PE fund in a challenged environment because of higher interest rate?' And I have explained that, in fact, the companies in the fund are in a stronger competitive position, so this is a great time. The companies in this fund are platform companies that have always competed with private equity owned firms to make acquisitions. And think of the advantage of having companies that are public that only have senior debt. And yes, of course senior debt costs have risen, but they are borrowing at a much lower cost than buyout funds. And then the incremental borrowing we incur at the fund level, to match private equity debt levels, company by company, is roughly at the overnight bank rate. Combined, the interest costs are much lower than what buyout funds have to pay, assuming they can even access the leveraged loan market in the current environment.

Andrew Brenton is Founder and CEO at Turtle Creek Asset Management

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