Educational Alpha: S3E3 – Conversation with Andrew Akers, Lead Quantitative Research Analyst at PitchBook

Release Date: February 19, 2025

Introduction

In this enlightening episode of Educational Alpha, host Bill Kelly engages in a deep dive with Andrew Akers, the Lead Quantitative Research Analyst at PitchBook. The conversation centers around private equity, private market replication strategies, and the intricacies of measuring and replicating private market returns in the public domain.

Guest Background: From Traditional Finance to Quantitative Analysis

Andrew Akers shares his professional journey, transitioning from a traditional finance background into the realm of quantitative research:

• Early Career: Started at Vanguard, working on the retail side before moving into institutional consulting focusing on strategic asset allocation and portfolio management.

  Andrew Akers [02:07]: "I started probably a more traditional finance background... spent a year working for Vanguard on the retail side."

• Strategic Research: Delved into performance reporting and strategic research, examining capital market assumptions and portfolio construction for institutional investors.

• Shift to Quantitative Analysis: Eager to enhance his quantitative skill set, Akers joined PitchBook, where he now leads quantitative research, focusing on private markets.

  Andrew Akers [02:20]: "PitchBook was a great opportunity... combining the data side with the market side as well."

Understanding Equity Risk Premia in Public vs. Private Markets

The discussion begins with a foundational concept: equity risk premia and its applicability across public and private markets.

• Theoretical Consistency: Akers emphasizes that, fundamentally, equity represents the present value of future cash flows, irrespective of a company being public or private.

  Andrew Akers [04:37]: "If you just go back to like the very basics... you're trying to use that capital most efficiently."

• Risk Assessment: Both public and private equities carry inherent risks related to cash flow uncertainties, aligning their risk premia despite the market's structural differences.

Private Equity Replication: Challenging the Status Quo

Akers challenges the traditional narrative surrounding private equity (PE), particularly the notion of operational alpha as a primary differentiator.

• Operational Alpha Myth: Contrary to decades-old beliefs, Akers' research indicates that operational improvements (like margin increases) aren't consistently driving PE returns.

  Andrew Akers [06:27]: "What we've seen from the data... has been driving buyout returns has been multiple expansion, revenue growth."

• Systematic Security Selection: PE managers' returns have been more attributable to systematic security selection—identifying undervalued companies—rather than unique operational strategies.

  Andrew Akers [09:59]: "The security selection component is the one that stands out... buyout managers may be more systematic than I think people realize."

Building the Buyout Replication Portfolio (BRP)

Akers outlines the construction and performance of the Buyout Replication Portfolio (BRP), a key focus of his seminal paper.

• Timeframe and Benchmarking: The BRP was tested over a 10-year period (2014-2020), compared against the Russell 2000 index.

• Return Decomposition:

  • Security Selection: Dominated the outperformance with an 830 basis points gain, emphasizing the importance of selecting undervalued securities.
  • Sector Selection: Contributed 150 basis points, highlighting the strategic overweighting in sectors like technology.
  • Leverage: Slightly detracted from returns, indicating the complex role of leverage in performance.

  Bill Kelly [08:39]: "Security selection was 700... underscoring how different your portfolio is from the Russell 2000."

• Alpha Sources: The BRP's success underscores that systematic security selection and sector tilts, rather than managerial operational changes, are primary drivers of PE-like returns.

Leveraging Machine Learning for Private Market Insights

Akers delves into the application of machine learning and neural networks in identifying patterns that predict private equity investments.

• Predictive Modeling: Utilized quarterly financial statements and stock price data to train models predicting the probability of a company being taken private within 18 months.

  Andrew Akers [14:11]: "We're outputting the probability of a certain publicly traded company gets taken private within the next 18 months."

• Data Utilization: Focused on companies with available financials, enabling the identification of systematic tendencies in PE managers' investment choices.

  Andrew Akers [16:37]: "There are certain characteristics that these firms are looking for which then kind of leads into... a systematic framework to copy that."

Performance Metrics: The Public Market Equivalent (PME)

The conversation transitions to performance measurement tools in private markets, with a particular emphasis on the Public Market Equivalent (PME).

• Challenges with Traditional Metrics: Metrics like Internal Rate of Return (IRR) and Multiple on Invested Capital (MOIC) have limitations in accurately assessing PE performance.

  Andrew Akers [33:07]: "IRRs... have some extreme limitations."

• Advantages of PME: PME accounts for the timing of cash flows and provides a relative performance measure against public benchmarks.

  Andrew Akers [33:49]: "PME takes into account those timing of cash flows which you need to."

• BRP as a Superior PME Benchmark: By aligning sector weights and leveraging similar to PE strategies, the BRP provides a more accurate PME, revealing that many PE funds perform in line with systematic replication rather than delivering true alpha.

  Andrew Akers [36:02]: "When you use the right measure, but if you use the wrong inputs, you're still going to potentially get to the wrong answer."

Volatility, Drawdowns, and Risk Assessment

Akers addresses the risk profile of the BRP compared to traditional benchmarks.

• Higher Volatility: The BRP exhibits an annualized volatility of over 30%, significantly higher than the standard Russell 2000 index.

  Andrew Akers [28:06]: "The replication portfolio has annualized volatility north of 30%."

• Deep Drawdowns: Experienced a 54% drawdown during the March 2020 COVID-19 crash, highlighting the strategy's susceptibility to market downturns.

  Bill Kelly [30:30]: "The BRP of 31 and drawdown was 54. How did that compare to the index?"

• Leverage Impact: Leverage amplifies both returns and risks, making the BRP more volatile and prone to larger drawdowns compared to unleveraged benchmarks.

  Andrew Akers [31:27]: "It's the fact that after you lever it up, that's just the nature of leverage that you're going to be adding risk and return potential."

Future of Private Market Replication and Institutional Access

The conversation explores the potential of the BRP and similar replication strategies to democratize access to private market-like returns for high-net-worth investors.

• High-Net-Worth Potential: With a global high-net-worth asset base of approximately $450 trillion, there's significant untapped capital that could benefit from private market exposure.

  Andrew Akers [24:44]: "There's a whole different level of sophistication... They're not familiar with how to build these portfolios."

• Product Development: Emphasizes the need for low-fee, scalable products that simplify the implementation of private market strategies for individual investors.

  Andrew Akers [27:36]: "To satisfy those investor needs and create more of a symbiotic relationship that's good for those companies in their AUM, but also beneficial for investor portfolios."

• Index Viability: While the BRP shows promise as a PME benchmark, its role as an investable index remains complex due to inherent risks and the necessity for tailored products.

  Andrew Akers [37:19]: "You'd have to craft that to the individual use case... Perhaps you'd include some hedging in the short term."

Conclusion: Measuring Success and Looking Ahead

Bill and Andrew wrap up by stressing the importance of accurate performance measurement in private markets and the BRP's role in enhancing transparency and evaluation of PE managers.

• Benchmarking Importance: Just as city metrics help evaluate mayoral performance, reliable benchmarks like the BRP are crucial for assessing PE success.

  Bill Kelly [36:02]: "How am I doing? I don't know."

• Future Webinars and Discussions: Announcement of an upcoming webinar featuring insights from Akers, highlighting ongoing efforts to bridge private and public market strategies.

  Bill Kelly [40:10]: "We have a webinar on a very similar subject and it's going to look at some of your research."

• Final Thoughts: Acknowledges the evolving landscape of private markets and the continuous need for innovative tools and strategies to meet investor demands.

  Andrew Akers [40:13]: "There's probably something there, but potentially you'd have to craft that to the individual use case."

Notable Quotes

• Andrew Akers [06:27]: "What we've seen from the data... has been driving buyout returns has been multiple expansion, revenue growth."

• Andrew Akers [16:37]: "There are certain characteristics that these firms are looking for which then kind of leads into... a systematic framework to copy that."

• Andrew Akers [24:44]: "The question is, do we currently have the products and the implementations to fit those needs?"

• Bill Kelly [27:36]: "If you accomplish that, Alfred Nobel will walk out of his grave and pin the Nobel Peace Prize for Economics right on your chest."

Key Takeaways

1. Systematic vs. Operational Alpha: Lee’s research suggests that systematic security selection plays a more significant role in PE returns than previously thought operational improvements.

2. Replication Portfolio Insights: The BRP outperforms traditional benchmarks primarily through security and sector selection, not just leverage.

3. Importance of Accurate Benchmarks: Utilizing tailored benchmarks like the BRP can provide more accurate assessments of PE manager performance via PME.

4. High-Risk Profile: Replicating private market strategies in public domains involves substantial risk, emphasizing the need for careful portfolio construction and risk management.

5. Future Prospects: There's a growing opportunity to create scalable, low-fee private market replication products for high-net-worth individuals, potentially democratizing access to alternative investment strategies.

For more insights and to stay updated on future episodes, visit CAIA Association and subscribe to Educational Alpha at kaya.org.