The Exchanges, every show

Q 30. Everyone's looking to invest in the market, trade the market, start a business, Building something from the bottom up. So we are speaking to them. So most of today is around that. Can we start with a little bit about you and how your own journey began from Queens to Wall Street? Maybe like a, how do you describe your story in your words? Your story, your origin story.

A Well, um, you know, I was born in Queens, New York, as you know, one of the, one of what are called the outer boroughs, uh, middle-class upbringing. Uh, neither parent, uh, went to college. Um, but my father was a very intelligent man and, and, and an accountant. And I think he did His job well. And so we lived a, uh, comfortable middle-class, uh, existence. Um, I went to the public schools of New York at a time when you could get a good education in the public schools of New York. Uh, and I think I got one. Uh, and, uh, oddly enough, uh, uh, Ended up taking courses in business law and then accounting in high school and really connected with accounting with the orderliness and the symmetry. Uh, it, it just clicked for me. So I decided to go to a business school. I applied to Wharton as the best business school for undergraduates in America. Uh, I was told I wouldn't get in, but I did. Uh, went to Wharton as an accounting student, switched my major to finance. Uh, uh, then went on to get a, an MBA in accounting from the University of Chicago business school. Uh, and, uh, between years of business school, I had a job in the investment research department of Citibank. Liked it, went back. That's my, that's my background.

AI assessment note: “I was born in Queens, New York... went to Wharton... That's my background.”

Q Can I ask, on the element of inflation, when we think about kind of the government stimulus packages and the quantitative easing that we've seen, how do you think that plays into the theory of, you know, rising inflation rates?

A You know, the, the canon of economics says that if the government runs deficits and otherwise stimulates the economy, prints money, as we say, that will add to the economic vigor and eventually bring on inflation. But our government's been running deficits since the global financial crisis, And this was the slowest recovery in post-war history, and it didn't kindle any inflation. And I'll add one other thing. For roughly 60 years, the inflation, the creation of inflation, was believed to be tied to something called the Phillips Curve, which was taken to mean that the lower the rate of unemployment, the higher the rate of inflation. That is to say, when more and more people got employed, that would take the slack out of the economy, allowing workers to negotiate higher wages And bringing on inflation. And, you know, as of January, the unemployment rate in this country was three and a half percent, the lowest in 50 years, and still no inflation. So now I think the Phillips curve is being disregarded. As I say, it's mysterious, and I wouldn't want to put a bet on what the inflation will be in, in, uh, 24.

AI assessment note: “our government's been running deficits... and it didn't kindle any inflation.”

Q wait on this one, and so they're fundamentally quite scary times. We've had the dot-com, we've had the tech bubble with the lack of business fundamentals, and then in 2008 obviously with the liquidity and housing crisis. The thing I've been thinking about constantly over the last few days, and excited to hear your thoughts on is, What in your mind is the fundamental economic crisis that's occurring here today?

A Well, we have a couple of things. Number one, depending on the ultimate severity of the disease, the present time we have a total stoppage of the economy. You know, stores are closed, restaurants, movie theaters, nobody's going to entertainment events, nobody's on airplanes traveling, hotel occupancy is very low, no business trips, no pleasure trips. So the economy is in a deep freeze. And then, in addition to that, given the fact that we had 11 years of prosperity and declining interest rates in the world, people used more and more debt to buy assets of lower and lower quality to lever them into palatable returns. But the combination today of the high leverage and the low asset quality has come home to roost, and a lot of companies are over levered, and a lot of investment entities are as well, and they may not survive. And in the meantime, They are having their liquidity withdrawn by lenders who need the money back, so there's on top of an economic freeze, we have a withdrawal of liquidity, and the combination is very serious.

AI assessment note: “combination today of the high leverage and the low asset quality has come home to roost”

Q Can I ask you, as you mentioned that, the incredible 60 years that you spent in the industry, is there an analogy that you can point to where you draw lessons from this time, or do you see this as fundamentally a completely new paradigm?

A Well, it's similar in some ways to oh eight, And it's different in some ways. The main difference is that this is life and death. This is a health crisis. That was a financial crisis. And the other difference is that that crisis came off a bubble in which the banks were levered 32 times their equity, and many highly levered entities had invested in subprime mortgages, which had no real substance. This time around, we are not coming off a bubble. The banks are much less leveraged. And there's no analog as deficient in substance as the subprime mortgage. So those are the differences. The similarities are that it's a financial problem for highly levered entities which own assets that are declining in price.

AI assessment note: “Well, it's similar in some ways to oh eight, And it's different in some ways.”

Q I would love to quickly dive in, though, and for those that maybe missed our first episode, how did you make your way into the world of finance and come to found Oaktree in a very succinct one to three minutes?

A In other words, 60 years in three minutes. I went to college expecting to be an accountant. I switched my major to finance. I took a graduate degree at University of Chicago, and while in school, I had a summer job at Citibank's Investment Research Department, and I enjoyed it. And when I got out of school, I had several choices, but having had a favorable experience, that's what I chose. I was an equity analyst at Citibank for several years, unit head, and then the director of research from six, 75 to 78. In 78, I was asked to start a high-yield bond fund, and high-yield bonds have been the, shall we say, epicenter, although it's an advised word today, for almost everything that's happened, interestingly, in finance in the last 40 years. So I went from Citi to TCW, and there, with Bruce Karsh, I started the distressed debt investing activity, which is very important to us today. And in 95, Bruce and I and three other colleagues left to start Oaktree. So we are within a couple of weeks of Oak Tree's 25th anniversary, and that's the short version.

AI assessment note: “In 95, Bruce and I and three other colleagues left to start Oaktree.”

Q Wouldn't you benefit from calling it junk so you have a higher Margin because more people would stay out of it?

A Yes, if they listened to me, if I was that influential, but, and, and that's the right kind of, kind of, uh, counter thinking, but, On the other hand, a big part of our business now is making loans to companies that need what we call rescue loans. They don't like to be associated with the word distress. So we're more likely to get their business if we call it opportunistic. So, uh, you know, in the performing credit area, we lend money to companies that the world thinks has a, let's say three, four, five, six percent of not paying us. Probably three, four, five, six percent probability of not paying us. We lend them money if we think it's one or two percent. So if the world thinks they're five percent likely to not pay us, and we conclude that they're only two percent likely to not pay us, then the world requires them to pay an, a rate of interest which is commensurate with their five percent probability of non-payment, which means if we're right, and it's only two, we're getting something for nothing. And that thing is called excess return. So, So that's what we do. That's the essence of lending money. I mean, why would you lend money to a company that has a non-zero probability of paying you back? And the answer, Mike Milken's answer was you can demand the rate of interest, which is compensatory or more than compensatory. And when you get, when you get payment in life for doi…

AI assessment note: “Yes, if they listened to me, if I was that influential, but”

Q I'd love you to take me back. I know you grew up in Queens, but would love to hear what part of your childhood would you say has most impacted where you've come since?

A Well, it's hard to say. Number one, my parents were intelligent, And kept a good home, not educated, neither went to college, but still good citizens. I went to the public schools at a time when I feel you could get a good education. I think I got good preparation for college, even though we were on triple session and very crowded, but I had a great choice of courses and that included business law and accounting, which I took and really enjoyed. So that set me on my career direction. But the other thing that I want to mention is that I make a distinction. My parents were adults during the depression, not alive during the depression, adults during the depression, which meant you had to be born, I would say, before 1910, and mine were. If your parents were adults during the depression, they were traumatized, and you grew up hearing things like, don't put all your eggs in one basket and save for a rainy day. I think, if nothing else, that may be a rather, I would say, cautious person.

AI assessment note: “included business law and accounting... So that set me on my career direction.”

Q As you go through your career, I know you started in equities, turned to fixed income. What were some of the most important lessons that you learned in those early years about the structure of the markets?

A I started work in September of 1969. The bank and the rest of what we call the money center banks were nifty 50 investors, which meant they bought almost exclusively the stocks of the 50, what they considered the 50 best and fastest growing companies in America. This was a serious mania, a bubble. The ruling dicta where these were companies that were so good, nothing bad could happen, and so good that no price was too high. So the real lesson I learned was that there's always a price that's too high. If you held the stocks for five years from the day I got there, you lost about 95% of your money in great companies. Well, some weren't so great, but what were believed to be great. So the lesson I learned was it's not what you buy, it's what you pay. In successful investing is not a matter of buying good things, but buying things well. As time passed, I rounded that into a belief that there is no asset so good that it can't become overpriced and dangerous, and very few assets which are so bad that if it's cheap enough, it can't be a good idea. That really has summarized what I've done since then. I wrote a memo earlier this year. I talked about moving from the equity department to the Fixed income department. I would actually say, in the nicest possible way, I was banished to the bond department, which was Siberia at that time, because I was associated with the nifty 50 strategy, …

AI assessment note: “So the lesson I learned was it's not what you buy, it's what you pay.”

Q How do you and your team go about trying to ensure that you maintain your discipline when you see more and more people willing to pay 2000 dollars for the painting you think is worth a thousand?

A You just constantly go on and on about the importance of risk control. We have a investment philosophy, which we wrote down when we started. April the 10th will be our 30th anniversary. We started in 95. We knew what we believed in and how we believed money should be run and how we wanted to run money. So we wrote out an investment philosophy, which covered everything we would do. And it has six tenets. The first says that the most important thing is risk control. I think that's the mark of a professional. Not that you don't take risks, but you take them intelligently. The second is consistency. Our clients don't want us going from the top of the distribution to the bottom, and neither do we. The third is less efficient markets that haven't been thoroughly picked over, where not everybody knows everything and understands everything. Number four, specialization. We don't try to do everything, just we try to do a limited number of things well. Number five, non-reliance on macro forecasting. And number six, non-reliance on market timing. But the first one, risk control. That's really the key. People who work at Oak Creek get battered with this all the time. I describe myself as the CCO, the chief culture officer. And when I write the memos, it's not just for outside consumption. When it's in the water, you don't have to do it overtly. It's just insidious every day that the culture…

AI assessment note: “You just constantly go on and on about the importance of risk control.”

Q What do you think happens when there is so much money that continues to come into the space? We haven't, at least on a headline basis, had a default cycle, but companies are certainly having problems from time to time. How does this play out? Are we going to see a default cycle again?

A When I was a boy, that's what we used to call the 64 dollar question. Then with inflation, it became the 64,000 dollar question. You remember the TV show. But I think we'll have another recession someday. I think cyclicality and in a person driven thing like the economy can't be avoided because you have excessive optimism and then corrections. So I think we'll have another recession. I think when we have a recession, it'll get harder on some companies. And then the question is, will they default? I would assume so in the public bond market, they can come in and ask for an exchange To push the problem down the road, and they often get it. When we do what Sheldon Stone called a remedial exchange, we mark that down as a default. And then what's going to happen in the private credit market when the companies go to the loan holders and say, look, we can't pay you on time. And the loan holder says, that's fine. You're a great guy. I think you're terrific. Take another year. And then what happens if they can't pay after another year? Let me just put one thing on the table. What happens if Oaktree has two investments in a company and public bonds and private credit, and the company has some difficulties in a tough period, and the public bond gets marked down from par to 80, and the valuation guy who works on the private side says, well, I think it's not worth 98. Then you have two loan…

AI assessment note: “And then the question is, will they default? I would assume so”

Q Well, you write in the memo about how this came to be of the two of you collaborating over the pandemic, but maybe here to recap on the podcast, how did this amazing thing happen of a father son writing this incredible piece of work together?

A Well, Nancy and I came to California on March the sixth of 2020. Oaktree was scheduled to have a conference for its clients on the 11th. Although we canceled the conference, we did record it at the conference venue. For live streaming, and so we were in L.A., which of course is Oaktree's headquarters. Andrew and his family came out on the 13th and moved in with us, and we stayed that way for, I think, until June. So we were incarcerated together, and first of all, we have fun talking about what we do and kidding each other, and we have a lot of differences. We're not the same person. Andrew's business is different from mine, and his General mindset is different. What he learned 40 years after I learned what I learned initially, hopefully still learning, both of us. So there were a lot of instances of differences, and that made for a very spirited period, and I hope a spirited memo.

AI assessment note: “Andrew and his family came out on the 13th and moved in with us”

Q One thing I've certainly learned in my career is that being a great investor is a very challenging proposition and an activity that can easily be one's life work. Building a great investment firm is a very different challenge. It's very rare that people can be great at both of those, and it's also not a Second challenge to take on lightly. How did each of you think of this?

A Well, having spent my first 17 years at Citibank, which is a management intensive bureaucracy, I was pretty good at those things. I was not a guy who started in a garage, you know, and so processes and deliberateness were right up my alley. But on the other hand, we started Oak Tree at a time when the quest for alternative investments was extremely strong. The demand, I think, outstripped the supply. Most people kind of gave up on getting the returns they need from stocks and bonds. So we had a big tailwind, and what Bruce and I did for the most part is create a culture. We didn't ever have a macro managing, micro managing mentality. We were too busy. It was not our day job to run the company. We did that as a sideline and it wasn't management intensive. So we weren't great on the profit margins, but they kind of took care of themselves and we were haphazard about compensation. You know, we kind of respond to the last person to walk in the door, but the right culture at the right time With I think some exceptional people was enough to make the company a success, even though it was largely an unguided missile in terms of management.

AI assessment note: “what Bruce and I did for the most part is create a culture.”

Q Can I ask, on the element of inflation, when we think about kind of the government stimulus packages and the quantitative easing that we've seen, how do you think that plays into the theory of, you know, rising inflation rates?

A You know, the, the canon of economics says that if the government runs deficits and otherwise stimulates the economy, prints money, as we say, that will add to the economic vigor and eventually bring on inflation. But our government's been running deficits since the global financial crisis, And this was the slowest recovery in post-war history, and it didn't kindle any inflation. And I'll add one other thing. For roughly 60 years, the inflation, the creation of inflation, was believed to be tied to something called the Phillips Curve, which was taken to mean that the lower the rate of unemployment, the higher the rate of inflation. That is to say, when more and more people got employed, that would take the slack out of the economy, allowing workers to negotiate higher wages And bringing on inflation. And, you know, as of January, the unemployment rate in this country was three and a half percent, the lowest in 50 years, and still no inflation. So now I think the Phillips curve is being disregarded. As I say, it's mysterious, and I wouldn't want to put a bet on what the inflation will be in, in, uh, 24.

AI assessment note: “the canon of economics says that if the government runs deficits”

Q see DoorDash soaring at the rates that it has done. I just have to ask you, it often doesn't seem to correlate. How do you evaluate the state of kind of the public markets today, companies IPO-ing, given what we've discussed in some ways in terms of the fragility of the macroeconomy and the situation that we're in? How do you think about and evaluate your public market performance today?

A Well, number one, everybody wants to know if we have all these problems with the disease, how can a Stock prices be at an all-time high. That's the main thing. And what I would say is, number one, for complex reasons, the prices of stocks and other assets are highly influenced by the level of interest rates. The lower the interest rates, the higher the asset price is justified. We have the lowest interest rates in history. That justifies, for example, the highest P.E. ratios in history. So when you look and you see that the average P.E. ratio in the post-war period has been 16, and today we're in the 26 or seven region. You say, well, that's, that's tremendously overpriced, but it's, it's makes perfect sense relative to the level of interest rates. Now we spent a lot of time before talking about inflation and interest rates. If interest rates go up, prices should be expected to go down. But today's asset stock prices for technology companies, for example, I think are not inconsistent with today's level of interest rates. And then the other thing is great tech companies like Amazon and Microsoft and so forth were icebreakers. They led the way by performing extremely well coming out of the pandemic. They're up substantially for the year, while non-tech is not. Their great relative performance kind of cleared the way for phenomena like you're seeing in the IPO market. The fact tha…

AI assessment note: “for complex reasons, the prices of stocks and other assets are highly influenced by”

Q we look at the Toolkit that we have at our disposal to reengage the economy when the health crisis does subside, you know, one hopes as soon as possible, but we've used all the tools at our disposal. Do you think that's a fair concern given the fiscal and monetary policies that we've used over the last seven to 10 years, meaning we have little to enact such growth again?

A Well, it is a concern. The main areas in which we have exhausted our resources are, uh, interest rates, which historically interest rate cuts have been the central bank's main Tool for stimulating economies. The problem this time is that the normal regime of interest rate cuts in the past covered approximately 500 basis points, which is what investment people use to say mean five percentage points. So interest rates in the past might have gone from nine to four or from seven to two or something like that. Or in the global financial crisis, they went from five to zero. Well, the problem is that in this instance, the interest rates At the beginning of the problem were one and a half percent. So clearly if it's one and a half, you can't cut by five. So that's a problem. And then the other problem is that governments, as opposed to central banks, government's main tool for stimulating economies has been deficit spending. And thanks to the Trump tax bill that was signed in December of 17, we were already running a trillion dollar deficit in times of prosperity. So further deficit spending then is Similarly, unpalatable. So the ability to do deficit spending should be limited in some way, and obviously the ability to cut rates is limited. There are other things that the Fed and the government can do, and they'll do them all to try to bring the economy back.

AI assessment note: “Well, it is a concern. The main areas in which we have exhausted our resources”

Q wait on this one, and so they're fundamentally quite scary times. We've had the dot-com, we've had the tech bubble with the lack of business fundamentals, and then in 2008 obviously with the liquidity and housing crisis. The thing I've been thinking about constantly over the last few days, and excited to hear your thoughts on is, What in your mind is the fundamental economic crisis that's occurring here today?

A Well, we have a couple of things. Number one, depending on the ultimate severity of the disease, the present time we have a total stoppage of the economy. You know, stores are closed, restaurants, movie theaters, nobody's going to entertainment events, nobody's on airplanes traveling, hotel occupancy is very low, no business trips, no pleasure trips. So the economy is in a deep freeze. And then, in addition to that, given the fact that we had 11 years of prosperity and declining interest rates in the world, people used more and more debt to buy assets of lower and lower quality to lever them into palatable returns. But the combination today of the high leverage and the low asset quality has come home to roost, and a lot of companies are over levered, and a lot of investment entities are as well, and they may not survive. And in the meantime, They are having their liquidity withdrawn by lenders who need the money back, so there's on top of an economic freeze, we have a withdrawal of liquidity, and the combination is very serious.

AI assessment note: “on top of an economic freeze, we have a withdrawal of liquidity”

Q the incredible firm that you've built with Oaktree, but, you know, it had to start somewhere, and a little birdie told me before Before our conversation about an investment banking job that you maybe didn't get coming out of college, so I'd love to start with that. Why did you not make the job, and how did you make your way into the world of finance as a result, Howard?

A Well, a little over 50 years ago, when I was graduating from University of Chicago Graduate School of Business, I didn't really know what I wanted to do. I applied for six different jobs in six different fields. One of them attracted me more than the others. It seemed more glamorous and more exciting, and it was what everybody wanted, all my peers. So I was hoping for that one, but I didn't get that one, and instead, I started work at Citibank in the Investment Research Department, and about 30 years later, the guy from that firm, who was the campus recruiter, did something very good for the school, so I wrote him a letter, and this was in the days of letters in the late nineties, and I congratulated on what he was doing, and I said, I don't know if you remember me, but you were the recruiter, and I was a job applicant, and you know, in those days, it took a while, so a couple of weeks later, his Letter appeared, and it said, yes, I remember you, and I followed your career, and if you ever want to know why you didn't get that job, give me a call. So, of course, I gave him a call about 10 seconds later, and after some pleasantries, he said, well, we hired the wrong guy. It's weird of you to say that, and he said, no, I mean, the recruiters had decided to hire you, and instead, the partner in charge came and hung over that morning and called the wrong guy, and they actually gave …

AI assessment note: “the partner in charge came and hung over that morning and called the wrong guy”

Q Howard, I want to finish on, on a final one, and it's not a forecast at all by any means. It's more a forward look And that might be a forecast in some respects, but what does the next five years look like for you and for Oak Tree? What does that roadmap ahead look like for you, do you think?

A Well, my goal is to continue to operate as we have in the past. I don't think this is a time to increase our risk, as I suggested in my answer to the last question. When I say we could have had more risk in between, this is not a time for more risk. We're going to continue to keep the risk off and prepare for the next downturn, and we're hoping there will be one. We need one. We make our biggest money In connection with downturns and their resulting recovery, we're assuming that there will be a cycle as in the past. The bull market is 11 years old. If there's not one in the next five years, that means we'll have gone 16, which would be a record by a wide margin. So my guess is that in the next five years, we'll have a period of distress, and my hope is that Oak Tree will distinguish itself as it has so many times in the past in distress.

AI assessment note: “in the next five years, we'll have a period of distress”

Q cycle. I guess the big question for me is It's really a case of insertion point. I know at points in 2008, OCHE were deploying close to maybe six hundred million per week for 15 weeks running. I guess then, how do you think about when's the right time to be really aggressive versus when to pull back, given the kind of probability distribution returns being maybe more modest now?

A Well, again, you said, what the insertion point? What is the time to buy? I would try to get away from that phrase. There is no the time. This is a time. There may be several. And we never know when it's the top or the bottom, but we can have a sense whether it's a better time to increase risk or decrease risk. I think it's a better time to decrease risk for the reasons that I've been discussing, the extended nature of the expansion, the bull market, the above average valuations, the investor behavior. Frankly, investors in a low interest rate environment with the market roaring ahead as it did in, in Best return since 1997, that's 22 years. People are afraid of missing out, so they're engaging in what I call pro-risk behavior in order to get their share. All of these things taken together tell me that this is A time precaution, not B time, A time, that I believe that an investor should have less risk currently than they usually do. Now, people always wanted me to say, buy or sell, in or out, and those judgments are too black and white. It should be more nuanced. Where on the speedometer between zero and a hundred should you be today? And my answer is that whatever your normal risk position is, today I believe you should have less, not zero. I don't think we're in a massive bubble. I don't think this thing is gonna collapse anytime soon, but I do think that there is more risk t…

AI assessment note: “we can have a sense whether it's a better time to increase risk or decrease risk.”

Q the incredible firm that you've built with Oaktree, but, you know, it had to start somewhere, and a little birdie told me before Before our conversation about an investment banking job that you maybe didn't get coming out of college, so I'd love to start with that. Why did you not make the job, and how did you make your way into the world of finance as a result, Howard?

A Well, a little over 50 years ago, when I was graduating from University of Chicago Graduate School of Business, I didn't really know what I wanted to do. I applied for six different jobs in six different fields. One of them attracted me more than the others. It seemed more glamorous and more exciting, and it was what everybody wanted, all my peers. So I was hoping for that one, but I didn't get that one, and instead, I started work at Citibank in the Investment Research Department, and about 30 years later, the guy from that firm, who was the campus recruiter, did something very good for the school, so I wrote him a letter, and this was in the days of letters in the late nineties, and I congratulated on what he was doing, and I said, I don't know if you remember me, but you were the recruiter, and I was a job applicant, and you know, in those days, it took a while, so a couple of weeks later, his Letter appeared, and it said, yes, I remember you, and I followed your career, and if you ever want to know why you didn't get that job, give me a call. So, of course, I gave him a call about 10 seconds later, and after some pleasantries, he said, well, we hired the wrong guy. It's weird of you to say that, and he said, no, I mean, the recruiters had decided to hire you, and instead, the partner in charge came and hung over that morning and called the wrong guy, and they actually gave …

AI assessment note: “the partner in charge came and hung over that morning and called the wrong guy”

Q that you've written about, it was actually in your memo from 1993, but you said, being right does not lead to superior performance if the consensus forecast is also right, lending to the contrarianism that we just mentioned there. So, if we kind of double-click on that, can you expand on your matrix of right and wrong, and then consensus versus non-consensus, and how do you think about that matrix?

A Well, the most important thing about the matrix And, uh, that, you know, even though it's, uh, 26 years ago, it still attracts pretty good attention as you're witnessing. One of the most important things to take away from that matrix is that if you engage in conventional behavior, that is, you follow the crowd, if good things happen, you'll have good conventional performance, and if bad things happen, you'll have bad conventional performance, but either way, your performance will be conventional. If you want to distinguish yourself from the crowd, If you want to be an above average performer, by definition, you can't engage in conventional behavior. So if you instead deviate from the crowd, and contrarianism is one way to deviate from the crowd, if you do, and you get good breaks, you'll have unconventional above average returns, and if you get unlucky breaks, you'll have unconventional below average returns. But the attempt to produce above average returns Has to start with unconventional behavior. You can't expect to behave conventionally and have returns which are unconventional. That's really what that matrix is all about.

AI assessment note: “One of the most important things to take away from that matrix”

Q How important is that ability to look stupid? In terms of outperformance.

A It's essential. It is one of the most essential ingredients. And again, I wrote a memo back in, uh, well, in oh six, I think it was, I wrote one called dare to be great. Um, and I said, in order to be great, you have to dare to be great. And then in 14, I updated it, dare to be great too. Uh, and I said, everybody dares to be great. The question is not, do you dare to be great? The question is, do you dare to be different Because clearly by, you have to, to diverge from the, from the pack is required if you're going to be a superior. In anything. And number two, do you dare to be wrong? Number three, do you dare to be look wrong? Do you dare to look wrong? Because even things which are going to be right in the long run, maybe look wrong in the short run. So you have to be willing to live with all those three things, different, wrong, and looking wrong, in order to be able to take the risk required and, and the, and engage in the Idiosyncratic behavior required for success.

AI assessment note: “It's essential. It is one of the most essential ingredients.”

Q What's the, the government's role in the economic cycle?

A The most direct is the actions of the Fed, and of course that's in, in, in theory that is independent of government, but the, the Fed's central banks, which is what the Fed is, have for more than a hundred years basically been charged with controlling inflation. That is the number one job. Keep the economy on an even keel so that it grows But not overheats causing inflation that has to be reined in. In the more recent years, maybe 30, 40 years ago, the Fed was given another responsibility, which is to support employment. Now, this is problematic, because employment growth comes from economic growth. That's good. Too much economic growth , you get rising inflation. That's bad. So they, they, they have two goals, which are in opposition. And, of course, that requires, uh, particularly adroit management. Which is, by definition, not so easy. Um, and, um, so, well, you know, sometimes the Fed is too positive, and you might get inflation, or you might get, you know, I think, I think that in, in, in some ways, the Fed contributed to the global financial crisis by being too accommodating. And, you know, uh, I think that, uh, Greenspan was so accommodating of the need of the economy to grow that, uh, And, and kind of a, kind of a cheerleader that he permitted the perception of something called the Greenspan put. Which is, anytime the economy looks like it might have a problem, the Fed …

AI assessment note: “The most direct is the actions of the Fed”

Q Polarize everything. I want to come back a little bit just to investing. One thing we didn't talk about that I really want to get your thoughts on is, uh, what is risk? Like, how do you define risk? Not only in investing, but risk in general.

A Well, risk in general, what is it? It's the probability of bad outcomes. You know, in academic investment theory, they say it's volatility. The volatility of prices, the volatility of returns. Now, I believe, and that was a view basically developed in the new theory of investing, and I would say basically at the University of Chicago in the early sixties. And I was very, I talked before about my luck. One of the things I was lucky about is I went to Chicago in 67, and I was among the first classes taught the new theory. And anytime you're at the front of the line, it's an advantage. And that put me at the front of the line. But in the new theory, they, there are all these processes and equations which concern risk and return, and how you optimize risk, return relative to risk. And you have a formula, you need to plug something in for risk, and they plugged in volatility. Now, I don't think volatility is risk. I think, I think risk is the probability of bad outcomes. But Why did they use volatility? Because it exists. You can say, how volatile was this asset or, or, uh, asset class in the past, and we'll extrapolate to add to the future, and if, if you don't use volatility, there's no other number available, because there is, there is no number that you can observe historically for the probability of bad outcomes at, at various points in time, but I think that risk is the probab…

AI assessment note: “Well, risk in general, what is it? It's the probability of bad outcomes.”

Q So in a way, are you saying the psychology of people, mass mentality in a manner remains the same, and that can be modeled for more so than events can be?

A Well, of course, events are largely The things that people do, which is largely the result of their psychology. But I do think that, that events in the future are somewhat predictable because B, because The implications of past behavior are somewhat predictable, and future behavior is somewhat predictable. The things that have happened, for example, in the economy and the markets are likely to induce certain behavior in the future, and you can know a little bit about that. And, but when, when the history and the past behavior has been extreme, the ability to infer from that rises. In other words, I wrote a book about, uh, cycles, and that's the one where I refer to my experience traveling in India. And, uh, Cycles are induced primarily by behavior. By, you know, uh, uh, the upcycle is exaggerating, overgeneralizing. The upcycle, there's a trend line. Let's say it's GDP growth. There's a trend line. But sometimes, uh, the economy grows more than that. Why? Largely, I think because of optimism. Because people are optimistic, so they spend a lot of money. Producers are optimistic about demand for their product, so they build new factories and hire labor and buy machinery. And the sum of these things produces a period of above trend growth. But then when Producers have more than prepared for the coming growth, and consumers have been sated by consumption than The, then things will …

AI assessment note: “events are largely The things that people do, which is largely the result of their psychology.”

Q Any last words, Howard, to our audience? Any piece of advice?

A Well, I, I, what I, what I always say to people about investing, Nikhil, is that investing is a puzzle. Challenging puzzle investing. I define as positioning your capital to take advantage from few of future developments. But I also say that future developments can't be predicted accurately. So you need superior insight to get it more right than most people, but you're not going to get it right all the time. If you have to be right all the time, if there's something in your makeup that recall, that says you're going to be unhappy if you're not right all the time, don't become an investor. Uh, Taleb in his book fooled by randomness, uh, talks about the difference between investing and dentistry. He says, if you go to dental school and you learn how to fill a cavity and you fill the cavity that way every time you'll be successful every time. So if you have to be successful every time, become a dentist or, or an engineer. A civil engineer, you say, I want to build a bridge from here to there. He does his calculations. How much steel? How much concrete? Every time the bridge stands. But, but, but it's not that interesting in my opinion. And so investing deals with this fascinating puzzle that you're trying to solve To a better degree than others, even though there are no laws that work absolutely. Fascinating. And I love it. Um, it's still a puzzle. It's still a puzzle. I'm trying …

AI assessment note: “if you're not right all the time, don't become an investor.”

Q You've become super well known for your memos. Before we get into this most recent one on credit that I'm excited to explore, what's your process for writing these memos?

A I just have to get an idea, but I get ideas all the time of something that's worth writing about. It might be something in the news. And a lot of them come from discussions with clients because their questions tell me what's on their minds and I want to be responsive to that. If I can figure out a way to answer their questions, which is helpful, then I got the start of a memo. That's what happened with the credit memo, but it happens very often. Now, it's not always that. For example, I've written memos on big picture topics like risk and cyclicality and leverage and things like that, which did not stem from questions, but that was just because I thought I had something to add. The basic Thing is, I have to think I have something to write, which not everybody else has been writing or talking about, or I have to see something differently from everybody else. The last thing I want to do is put out a memo that says, me too.

AI assessment note: “I just have to get an idea, but I get ideas all the time”

Q What are you seeing in current underwriting standards of how far the pendulum has swung towards lots and lots of interest and deteriorating of underwriting standards?

A It's not a bargain. It's not languishing cheap. If the pendulum swings from hate them to love them, I would say that where the credit standards are on the somewhat to the undemanding side, not terribly. In oh, five, six, seven, the reason we knew to pretty much avoid the markets in most regards was that They were just giving money away to anybody who wanted it for any purpose. Standards were extremely low. I don't think that's the case today. Standards are lowish. That still presents a big problem because if you want to apply high standards and somebody else has lower standards, then they can bid more for a given deal. Think of it as an auction for a painting. You want to pay a thousand dollars per square inch, but somebody else wants to pay 2000 a square inch. You're not going to get it. That's the same with investing. I wrote a memo in February or seven called the race to the bottom. I said, the race is on too many people have too much money and they're too eager to put it to work. Bad things happen. So it's on today, but I don't think it's terrible today. It's just, the markets are a little bit generous today.

AI assessment note: “credit standards are on the somewhat to the undemanding side, not terribly.”

Q and wealth management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. When you're sitting on an investment committee and people are talking about private credit, what are your views about how investors should think about these challenging issues?

A Well, the people who run these funds Pretty much like the fact that they don't mark the market, because then in the bad times when the headlines in the papers are so negative, they don't have to go to the treasurer of the organization and say, we're down 10%. They can say, oh, great news, we're only down two percent. So it's just reality, but the point is you shouldn't deceive yourself. If they're at 98, you should not feel that you've taken the full pain. In a way, it's a really interesting question, Ted, and I'm glad you're exploring it. It kind of relates to the old question we used to say when we were kids. If a tree falls in the forest and there's nobody there to hear it, did it make noise? Noise is sound waves hitting your ear. If there's no people there to hear it, maybe it didn't make noise. Likewise, if there's no public market, Price things at, and you ignore the psychological swings. Is there anything wrong with that? I wrote in the credit memo that in the public markets, stock market, bond market, you can accomplish the same thing. Just don't read the paper. If you get your statement from the broker, just throw it in the drawer. And then you say, well, I'm glad my stuff didn't go down because you didn't open the envelope. But that's, in a way, what private credit investors are doing. When the statement comes, not from the fund, but from the economy, they don't open …

AI assessment note: “it's just reality, but the point is you shouldn't deceive yourself.”

Q What have you found in being a public company?

A We were semi-public from O seven to 12, and then public from 12 to 19, and people would say, how is that? I'd say, well, it's fine, except that every day you get a report card from somebody who doesn't know your business that well, called the market. They say your stock's up a buck or down a buck. It sounds like it should be a commentary on how you're doing, but the people who are making that decision, as I say, don't know your company that well. It's okay. Look, first of all, there's a lot of paperwork, legal work, and all that stuff, and that's onerous, but if you go public to get liquidity, that's a reasonable price to pay. So you get the liquidity and hopefully you can use your stock for hiring and stock options and maybe acquisitions and so forth. So maybe that's a good idea. And then you have to see it go up and down. But if you're not thick skinned, you shouldn't be an investor anyway. But I didn't mind when Brookfield invested in Oak Tree, they took out the public. And I didn't mind being non-public again.

AI assessment note: “every day you get a report card from somebody who doesn't know your business”