My guest on this episode is Andy Ellis, a managing partner of Localize Capital in Pittsburgh which, as the name suggests, focuses on investing in companies and entrepreneurs around the Pittsburgh area. Little known fact about me, I used to live in Pittsburgh as a young kid and was extra excited for this conversation because of that. Andy grew up in Pittsburgh, worked in Southern California, and eventually moved back to Pittsburgh to help form Localize.

Andy and I talk extensively about the structure of Localize and how they choose to invest in companies over a very long term, with a core idea being to look for owners who think not just in years, but generations.

You may have heard of the concept of finite and infinite games, a concept written about by author James Carse. A finite game has known players, a beginning and end, and set rules, whereas infinite games have known and unknown players, no end, evolving rules, and the goal is to perpetuate the game. If this concept sounds interesting, this conversation is for you as we discuss this concept in the context of private equity and entrepreneurship. Please enjoy the episode.

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https://www.thinklikeowners.com/podcast/2019/7/11/andy-ellis-localize-capital-tlao-ep-8




Part 1 of our transcript:



Went to school in Cleveland, Ohio, returned home to Pittsburgh after school and started with an investment management firm here in Pittsburgh. Was on an internal sales desk here in Pittsburgh for a few years before having the opportunity to move to an external sales position in Southern California. So was able to stay with the same company, continue to work with all the people that I had been working with, but was able to move across the country, live in a new place, and meet new people. Spent a little over six years in Southern California in a few different beach towns when I came up with the idea for Localize, which is the current thing that I'm doing, and Pittsburgh was a natural place to come and test the thesis. And I can dive into that if you'd like. Being from Pittsburgh it was convenient, easy, and comfortable. And moving from a place that was very high cost and prohibitive toward taking risks, moving back to a place that we were very familiar with and that has a comparatively very low cost of living, put us in a position with the amount of money we had saved, take the leap and to take the risk.

When I was working at the investment management firm I had made friends with a gentleman who did a lot of macro-credit analysis, and he was a short seller. And he typically ran his portfolio from about 70% to 100% net short. I found this very intriguing for a few different reasons. One, it provided us with a product to sell to people that wanted to hedge equity exposure, which was a nice thing to have because what I was doing was I was a wholesaler of mutual funds, and it enabled me to open up a lot of doors that otherwise would have been difficult to open. So I was drawn to it from that perspective, but more than anything I was drawn to the analytical framework of my mentor who ran the portfolio, that he was able to be 70% to 100% net short the market at all times and was able to withstand raging bull markets.

So you think about it, in order to do that you have to have a high level of intellectual honesty and really be able to build out an analytical framework and very stringent risk parameters. So I was really drawn to the way he viewed the world, the analytical framework or prism through which he viewed what was going on in the world. So I started to follow that pathway and he was very gracious with his time. I asked a million questions, a ton of very simple questions, trying to get to the root of a lot of different things, and he very frequently was recommending books to me that were extremely difficult to read. And I think that might have been one of the ways that he weeded people out whenever they would ask him questions potentially. But I read the books. I read some of them multiple times and highlighted and took notes and came back with questions.

I was really drawn to his analytical framework and the way that he thought about the world and how he managed portfolio risk. I had thought about potentially getting into short selling and trying to join his team, but I also saw that it was a really tough job and he, most of the time, was thought of as a pariah or an idiot, and he was very frequently alone doing his analysis and running the portfolio. Then when the market hit the skids, he was the most popular guy in the building. So the life of a short seller can be very lonely and that would be very, very difficult for me. So I didn't want to be a short seller and at the time I was learning from him, that was mainly through my 20s. I guess that I was mature enough to know that I didn't know anything. I was learning a lot from him, but for every one thing I learned there were 15 things that I uncovered that I just didn't understand, that I had yet to learn. So I didn't have a clear pathway or understanding of what it is I was supposed to do with the knowledge and thought processes that I was learning from him.

It took quite a long time to come up with my own thesis and take. One of the things that I really admired about him too was, he writes every week. When you go to his blog, he wasn't just reading Austrian economics and saying, "I subscribe to the school of Austrian thought." He took bits and pieces of their analytical framework and would weave it into his own analytical framework. So everything from Canes, to the Austrian school, to George Soros's Alchemy of Finance, to Henry Coffman, to Kindleberger, to you name it. The list goes on and on. It was nice because I could read the books but then also read his commentary and his thought process on it, which was really interesting. So here I'm learning his analytical framework and his view of the world, learning about how his view of the world was informed by these things, and trying to figure out well, what's my take on that? His portfolio, like what he does, is a manifestation of all of these things that he's learned. What is that thing going to be for me? It took a long time to come to that and I'm happy to say that I think I've found something that I can be bullish on as opposed to be a short seller and be thought of as a bear.

That's a long-winded way of getting to the genesis of what we're doing now, but one of the things that I talked about a lot with my mentor was this notion of there being two economies, there being the financial economy and then there being the real economy. That was always something that intrigued me and I would ask him a lot of questions around that and talk about regulation in one versus the other. Like is the tail wagging the dog or is the dog wagging the tail? Because these two things work in conjunction with one another. Is there correlation, causation, how does that shift through time?

So one of the things that brought me back to Pittsburgh that I think is so interesting and it helped inform a little bit of what we're doing with Localize, there's a gentleman named Henry Hillman. The Hillman family owned an industrial empire. They owned many businesses. And when Henry Hillman inherited this industrial empire in the '70s, he liquidated a lot of the companies. He sold these businesses. These were real economy businesses. And one of the things that's so intriguing is a little known fact that Henry Hillman actually funded two very prominent ... He didn't fund, he seeded two very prominent private equity shops. He was 33% of KKR's first LBO fund, and he was 50% of Kleiner Perkins' first venture capital fund. The venture aspect is interesting because given that Carnegie Mellon is here in Pittsburgh, he wanted them to run Kleiner Perkins out of Pittsburgh and they told him hell no. They were going to California and it probably was ... I mean based on path dependency who knows if that would have materially changed anything, but they went to California and the rest is history.

Point being he was liquidating these businesses and turning them into financial assets. And that was decades ago, and now you look around and year after year more businesses are being turned into financial assets, as opposed to privately held businesses that are run for different timeframes, with different preferences, with different ... Essentially using this operating company to optimize for different outcomes, it's becoming more and more potentially uniform as a result of the capital that is buying and owning these companies looking more and more similar.


You're saying the financial economy is using the real economy for different means than the real economy might intend those to be? So, instead of the business owner running the business for themselves the way they'd like, there's a financial piece of the economy that comes in and manipulates it to a different set of means?

Yeah, and it's maybe less about intentionality or what this part of the economy wants or that part of the economy wants. It, to me, has just more to do with when you own a private asset and you're running a private company, you could ... People buy and run companies for different reasons. That might be one portion of your portfolio that you strictly bought and use to run a loss, to offset some sort of gain that you get somewhere else or something of that nature. But when people are buying up those assets for the sole purpose of using it in a traditional private equity fund, those traditionally have pretty similar objectives. The types of LPs that deploy capital into those funds typically have certain expectations about what type of risk it's going to bear and what type of return they can expect as a result of it, and what type of timeframe they can expect that in. So again, the podcast that you're doing is interesting because I don't know if this has existed all along or if it's just becoming more apparent as a result of Twitter and podcasts and things of that nature. To some extent family offices have been doing this forever. It seems that there may be some sort of a shift toward a longer term focus in having sustainability and survivorship and generation of unlevered free cash flow into perpetuity as a more attractive option.

So it seems like there could potentially be some sort of a shift. Maybe there's just more of an appetite from LP based to want to invest in that type of private asset. I don't know.



And is Localize specifically a vehicle that's backed primarily by the capital of your other various partners or are there investors who come in as well?

We're in the process of raising two separate funds, two separate strategies, that work in conjunction with one another. I come at it from a perspective of more of a macro perspective, it's called Localize for a reason. We want to localize assets. I'm generally a happy go lucky guy. Again, I didn't want to be a short seller. But I still find myself having thoughts about beautiful cash flowing assets that are owned for the purpose of applying leverage to them and potentially flipping them down the road that are owned by a private equity firm across the country. One example is just after moving back we took our kids to this really great amusement park that is for small children. It's not like massive roller coasters. It's called Idlewild. It's up near Ligonier, Pennsylvania. It's east of Pittsburgh. I think it was funded by the Mellon family. But it's one of the oldest parks in the country and it is a beautiful asset to our region. And I'm sitting there, I'm standing in line and looking around at all these people shelling out money for soft pretzels and slushies and buying their kids all these gadgets and having all this fun.

And given my previous work I got to see what people invest in for retirement, and I couldn't help business think here we are standing in this beautiful asset to this region that we all support and love, and we come here and we spend our hard earned money on, and I'm looking at all the people walking around spending this money and I'm thinking to myself that guy has T. Rowe Price, that guy's in Vanguard, they have all these different retirement accounts and I bet if I stopped and asked them they'd have very little clue what they actually own in their retirement accounts. Some of them would. Some of them might know a portion of the assets they own. But generally what they're doing is they're looking for income in retirement, yet here we stand in one of the oldest parks in the entire country that's in our backyard and it is literally owned by a private equity firm in Spain.

I know that we couldn't possibly repatriate all of our capital and invest it in all local assets, but it also seems to me that there's an opportunity to at least bring some of the capital home and to create a market whereby people who are seeking income from assets that they understand and can see and feel and it means something to them, it seems like there's an opportunity for them to seek a portion of that income for retirement within the region.


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