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Capital Markets have been an interesting place over the last 200 years to understand humans, emotions, psychology, fear and greed. Nowhere else in history does one have emotions, engineering, data and psychology combined into one – these typically tend to happen when money gets involved because there is no concept of ‘sufficient’ with money.

There are two periods of immense learning that we as humans need to pay attention to over history: these typically happen around periods of easy money – where one gets to see greed at work – and around periods of tight liquidity – where one gets to see rationalization and discipline at work. While I will aim to talk about the former here the below chart put up by Social Capital neatly summarises the latter (around why some of the best companies get built around periods of tight liquidity).

Education has been a fascinating subject since time (a little over 5000 years to be precise). Today with capitalism at its most chivalrous display, this becomes more important, because this is the only repeatable business that has the largest global TAM (Total Addressable market) and one can make a case for the business to last across ages (from a 1-year-old to death). The only other business that comes close is food, but unfortunately, the preferences change too fast and has a risk of going obsolete with a limited shelf–life (problems that do not affect education).

Education has a potential path to wealth generation and in turn, freedom of time. More importantly, with the advent of the internet, access has become democratized. However, there is an issue with democratization – it leads to standardization, and put together with the context of business, that is the quickest way to scale, thus creating perverse incentives. The other interesting thing about education is, while everyone aspires for it, everyone wants the best too, both for themselves and the kids, and this is where things get complex – how do you define the best, and how do you know what works? Especially in a world where ed-tech companies are spending billions in attracting eyeballs and inundating you with daily offers with the lure to learn at the lowest prices. To understand this, once again must go to first principles, meaning – if one agrees that if we can find patterns among the best minds through history and observe if there is a pattern to their education and life, there is a high probability that it should be the best way to build a process around education. Fortunately, there has been a wonderful article written here, on studying history and patterns around the childhoods of exceptional people.

For those who do not have the time to read the article (though I would highly recommend it), the 3 key patterns the author saw were :

· The parents created environments for the children so that learning was through experience and from other experts.
· The learners had time to roam about and practice self-directed learning.
· There was a significant 1-1 tutoring through their learning.
· They had cognitive apprenticeships.

While it is hard to create such an environment today, it’s clear that the current education system is not geared toward this. To rephrase my statement, it’s hard because it takes time to build this – potentially over 20 years (which external capital in the form of a fund structure cannot support due to the longevity we are talking about).

One of my strong beliefs in building the next generation education system would be around the above factors discussed in the article (and yes, this cannot be funded through VCs or PEs). While the internet and technology will support this, the constraint around creating this will be the supply (tutors, experts, creating apprenticeships) and creating a slow but more thinking-driven exploratory environment.

So, what does this have to do with Private Equity?

Over the last few months, my conversations with founders of multiple private equity funds were predominantly around them looking at aggressively raising capital to deploy in India. Two years back, during the peak of the liquidity cycle, they were aggressively raising capital as their NAVs and marks were going up, and they had to do follow on rounds in their investments. Two years hence, the liquidity cycle has tightened, and the story revolves around aggressively raising capital to deploy into new companies as there are ‘exciting opportunities’.

Today, the benchmark of success of a private equity or a venture fund is around the number of funds they are managing, which means the partners are fundraising in perpetuity. Now, fundraising in essence is not bad, but the question to ask is about the opportunity set of companies or businesses that build value over time. Here again, I resort to history and data to help –

Since we do not have a deep history and market in India, we go to the US for a potential solution. The last 25 years in the US has helped create a total of 1,500 funds (which have successfully managed to raise USD 1bn and above (the benchmark for a viable and sustainable fund today that the GP aspires to build). Out of this, a sum total of 23 have generated a DPI IRR (meaning IRR on payouts – not paper MTM gains) of 12% and above post fees and expenses. The odds of successful investor returns are stacked against the investor when one delves into the numbers.

Private Equity and Venture as a source of capital have continued to fuel innovation and entrepreneurship. This has happened over the last 40 years and will continue to happen for the foreseeable future. However, just as education has a supply problem, the same issue exists with private equity and venture. It is important to realize that less than 1% of the companies that are built past the growth stage end up creating a sustainable IRR for the PE funds. This necessarily means that the opportunity set for PE funds to invest in companies can never be an eternal tap (in terms of fundraising). However, while much of this is widely documented – so why do we still have this constant desire to invest in PE funds? The answer lies in the difference between the marketed IRRs (which are theoretical returns vs DPI returns – Dollars paid back to investors. In the journey of investing, the theoretical returns can be significantly higher along the way, which always makes the fund look good and in turn, benefits the desire to constantly fundraise). More importantly, the fees charged make the probability of returns to the investor trivial across the asset class.

Is there an answer to this? I have always believed that there is an answer to all problems – the issue is, does one want to take it ? The answer has been provided by a fund called Benchmark capital, which has managed money for 24 years with one of the best track records the industry will aspire for. They have done it with a lean team and raising capital opportunistically. They have successfully raised a USD 500mm fund today, after 24 years of fund management, you can check how many would term that successful, but their investors would as their DPI returns on average has exceeded 25% net across funds.

Both Private equity and Ed Tech as a business have significant opportunities as they have significant scope for innovation, growth and building a better tomorrow. However, both are anti-scale industries and the best ones will scale around time and not capital.



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