The Exchanges

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 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”

Q So as you describe different forms of cycles, where we sit today with private credit, and you've just written this memo about this, how do you start thinking about how investors should consider both the opportunity and the potential risk?

A Well, of course, the risk is the flip side of the opportunity. In my experience, and you can trace the narrative, you get the times when nobody wants to do something. I wouldn't touch that with the 10 foot pole. Usually, if you're willing to do it, nobody else is, you can get a pretty good deal. And I was lucky because that was high yield bonds in. Then I was approached by a guy named Bruce Karsh who wanted to partner with me and started the stress debt fund. And I think we were a TCW at that time. And I think we started one of the very first to stress debt funds from the financial institution, even emerging market stocks in. Which we went into. As I say, if you do things nobody else wants to do, you can usually get a good deal. But then eventually other people figure out that it's a good idea. They flock in. It becomes more popular. And then of course, like everything, it gets overdone. Then the opportunity is gone and all you have left is risk. So it's the swing of a pendulum. It's very pronounced. It was the subject of my second memo, which was written in 1991. I called it the pendulum. I think the memo was creatively titled second quarter performance. But to me, if you're interested in the short or even the medium term, this is the most important dimension. Do they like them or do they hate them? Buffett puts it very succinctly, first the innovator, then the imitator, then …

AI assessment note: “So where are we on that continuum? And the answer is in the early years”

Q This gets back to this question of what else? In the past, when equities and bonds in the 2002 1002, it turned to alternatives, later turned to private equity. Private equity doesn't look so great. Credit markets aren't at the cheapest. Where do you think people are looking in terms of what else is going to be attractive to meet their spending needs going forward?

A I don't have that fertile mind. I'm lucky that I've been able to adapt to the changes, but I don't think I predicted or even caused any of the changes. I just don't consider myself a futurist. And one of my favorite oxymorons, Ted, is that we're not expecting any surprises. Surprises are by definition unexpected, and I don't feel that I anticipate the changes. I think that there are so many bright people on Wall Street. You have these fertile minds, they'll think of something. However, I wrote a memo in around October about asset allocation, and I said in there that I think there are really only two basic forms of assets, ownership and debt. I don't think Wall Street's going to be able to think of a third, but they'll certainly try. Wall Street has a very good record of accommodating people's desires to put money to work.

AI assessment note: “there are really only two basic forms of assets, ownership and debt”

Q challenges in the business. And one of those is when the pendulum has swung to an extreme that looks very good, you can get excited and buy. When it's an extreme that's tough, you want to be very, very cautious. Most of the time you spend in the middle. How have you gone about sustaining an organization that for the most part isn't playing at one extreme or the other?

A It's a very important question. There's not always something exciting to do. I wrote a memo in October of 22 called What Really Matters. We had a conference, and everybody was asking me, when is the Fed going to start cutting rates, and how much, when's the recession going to start, and which month? I said, these are all short-term questions, and they don't matter. What really matters is, can you buy interest in companies that grow, and can you lend money to companies to pay you back? It's not always something exciting to do. The memo got very little attention, as far as I can tell. I see what people write me, and I didn't get many notes on that one, and I think it was really important. I listed five things that I think don't matter, Ted. Short-term events, short-term trading, short-term performance, hyperactivity, and volatility. These are not things that matter. What matters? Are you better than the other person at finding growing companies and finding companies that will repay their debts? I think I said in there that when I was a kid, there was a saying, don't just sit there and do something. Well, in the investment business, I think a lot of times what's important is don't just do something, sit there, sit there and wait for your ideas to work. If yesterday you did what I said, which is to say you bought interest in companies that'll grow and made loans to companies that'l…

AI assessment note: “Now, you asked how you keep a business together, and it can be tough.”