Invest Like the Best with Patrick O'Shaughnessy
· Henry Ellenbogen
[00:00:00] S1: It was such a prominent view in what I was trying to do. We talked a little about the investment philosophy. I mean, the investment philosophy is really simple. Let's invest in small companies that can compound over time and become large companies. And what's our advantage that we bring over other investors? We think we're great at people and understanding change. So, basically everything we do at Durable, because we're an investment-driven firm, is in support of that investment mission. First of all, we essentially with a clean sheet of paper said, if we were gonna go purpose-build an investment vehicle to allow us to do this, how would it actually be structured? Essentially, the percent of capital that we put in the public markets and the private markets is aligned against that. And then the second thing we talked about is organizationally, how are we gonna go align against this? The way we think about people is very purposeful. We really believe that very few people actually operate the way we do. We think Durable is just different. It's different because my partner Kathryn, who worked with me when we first underwrote Figma in 2020 and also when we led the investment round in '21, was the same person who was at the all hands meeting with Figma when Dylan announced to the company that they were going public, and is still the person that basically looks at the company when they announce their public earnings. I mean that's just different. So you have to have people who can work with companies that are valued at 2 billion and they're private and have 30 million of run rate revenue. And now Figma is a $1 billion revenue company, a public company and can continue to work on that. And investment firms aren't structured that way. So if you want to have people who can do that, you gotta develop them internally. Second of all, it's time allocation. In general, at any point in time we probably have 10-15% of our capital in the private markets and the rest in the public markets, but we have to be willing to spend the appropriate time on new ideas. So when we look at Duolingo and the right decision for Duolingo and maybe the right decision for us is only to invest $20 million. We don't look at it as a $20 million investment on a $15 billion vehicle. We don't look at it as 10 basis points or 12 basis points.
· Henry Ellenbogen
We actually look at it as our future compounder. Our investment memos are just fundamentally written different than other investment firms. When we look at an early stage growth company that is not already competitively advantaged, we write the memo that says if Duolingo does what we think it can do over the next three years, not only do we make a fair return for the risk of the company, but at that point in time we would want to buy more at these higher prices. And if we can't write the memo that we want to buy more at higher prices, we can't buy the shares and our thesis can't be, it gets bought. Or our thesis can't be it'd be a great talent acquisition by someone. So that has to be aligned. And then the investors we're in business of, we have incredible investors. We have to be transparent with them that in order to pursue this philosophy, we're gonna have what people would say is monthly or quarterly volatility in our performance when they look at our performance. And that sounds so obvious, but increasingly the market has changed where capital is short cycle, so many people are on one month basically incentive models, not even yearly, one month. And so we have to have been very transparent with our investors and told them what we're trying to do, deliver on those promises, but deliver on those promises over the right period of time.
· Patrick O'Shaughnessy
[00:00:00] S0: I'm so intrigued by this dollar cost averaging up concept that you're not willing to invest in the first place if you're not excited to, if it goes well invest more at higher prices. Is that the right way to think about it, that the way you build a position over time is investing more as the price goes up to build your fulsome position?
· Henry Ellenbogen
[00:00:00] S1: Yes and no. So there's really two parts of our portfolio. When we're looking at what we call early-stage growth companies, and it could be Duolingo as a private company or it could be Duolingo after it goes public. But it's still not competitively advantaged at that point in time, it didn't have cash flow, it didn't have PE ratios. We still view that as an early-stage growth company we're saying in the future there could be competitive advantage, the operating culture could be clearly established where we could look back and see the excellence of it and the adaptability of it, and then we could look at the growth formula and really understand it. And obviously along the way we've really believed these are our kind of people who could scale organizations. So when we look at something like that, we have to believe that when we look at the three plus three, we're underwriting it on a three-year basis in general, not always. If it does what we think it can… not like, it will, and I'm gonna speak to that in a second. We would then wanna buy more as it, in our lexicon gets bigger, but also de-risks and then proves to be a competitively advantaged business, and shows more resilience, and shows the ability to financially balance growth, profitability, innovation. Basically prove its ability, in the case of Duolingo, to become more of a power app, teaching speakers a foreign language for more self-improvement. Then it starts to do it for learning, that basically increases educational ability to participate in the economic world. They're obviously going to different subjects with chess. So as you progress as a business more towards what we view as a competitively advantaged business that's for lack of better word big, but still has growth, we underwrite those with a view that if it does that scenario, we would want to buy more. And if not, we just can't get involved. Now of course in my career I've invested in over a hundred private companies and I think I've been involved in over 50 IPOs. How many of them do we still own? Well, we probably still own more than anyone else in the markets. Even if I look at Durable, among our largest positions in the public markets are DoorDash, Affirm, Toast, now Figma, Warby Parker. And we led those last private rounds, they persisted and we bought more at different points on the curve.
· Henry Ellenbogen
I would say on a durable growth company, because of market volatility and this agency principle that I think about that's forcing people to have short-cycle views of the public markets, actually probably you're buying more of them when they're down. One of our favorite entrepreneurs is a guy named Jay Hennick who essentially is CEO of Colliers, but he was also the founder of FirstService and we own both of them. We're actually involved in a private investment with him also. Back to Act 2 entrepreneurs and also our belief that we do business with people and we're really good at people, and good people do sometimes multiple things well. And look, in the case of Colliers, I think it's a very misunderstood company. I think for sure the brand suggests it's a commercial real estate broker. Commercial real estate brokers don't do well in general when interest rates are high. That was the case last year. But I think what's misunderstood about Jay, and he has done this time and time again, is because of his understanding of—he was really a disciple and his mentor was Peter Drucker—his understanding of local incentives and his sharpness of capital allocation, and the way he sets up the partnership model when he buys people. What people haven't realized is he's built an incredible business, both in asset management on the real estate side and Harrison Street, and also he's building a terrific consulting platform. I think our insight there is it starts with Jay, but it starts with understanding actually the asset quality of Colliers is not the quality of a commercial real estate firm that's cyclical. It's actually a really good real estate asset manager, emerging really strong consulting firm. So last year when people were worried about the weak commercial real estate market and interest rates, we bought a lot more of that company. It sold off based on short term macro concerns. So in that part of the portfolio, probably we're buying more of the companies when they go down.
· Patrick O'Shaughnessy
[00:00:00] S0: You said something really important and interesting that I'd love to dive into, which is the principal-agent problem. And my question is a market structure question. We've talked before about some crazy percentage of just marginal volume that happens inside of the platforms, the Citadels, Millenniums, Balyasnys, Point72s of the world. How do you feel that, and I'm curious just for your thoughts on changes to market structure in general since you've been doing this, how it contributes to that volatility, what opportunities it creates, what dangers it creates?