The Exchanges

Q What were some of the key milestones of your trajectory of the business, say, from those early days till more recent times?

A We got interested in sovereign debt at one time, something we flirted with and then got out of. First, the Asian crisis came in 97 or so, and we did a great job at completely avoiding that, and we did a good job on the corporate debt that we were buying and the value equities and other things, so we sailed through that very well. Then, of course, the Russia crisis happened and we got killed on the Russian paper. We basically swore off things where we couldn't really handicap the odds. Better than the marketplace could, or even if we thought we could. It's a lot easier to do that in corporate settings where you understand the rules of play than it is in sovereign settings. That was an interesting bit of trauma. I remember we had hit a billion dollars in assets and we dropped back down to 500 and something. One of our young associates who had just joined us was looking at our pitch materials. She said, it says you have over five hundred million dollars. I thought it was a billion dollars. It was. We tried to repot ourselves in the lower volatility part of the world, and I think did a pretty good job at that and figured out enough varieties of strategy within credit oriented and arbitrage oriented strategies to avoid things that were more global macro in nature. So that was a pretty big wake up call for us. We also over time have realized that you have to be a business person and …

AI assessment note: “First, the Asian crisis came in 97... Then, of course, the Russia crisis happened”

Q Which two people have had the biggest impact on your professional life?

A I think my dad had tremendous influence on me because from the time I was little, my dad said, you have to have your own business. Don't work for other people. And you have to go to business school and law school, but then you have to have your own business. So my dad had a lot of influence. He gave me the confidence and the sense that it was okay to be an entrepreneur to others. I think the Whitehead Weinberg combination at Goldman Sachs were just such a model of style and integrity, and they did a great job. And I think that Mike Milken and Peter Ackerman We're such extraordinary models of entrepreneurial creativity and client service. I've been very fortunate. I've had a lot of good people to follow. You just have to make sure you're paying attention.

AI assessment note: “I think my dad had tremendous influence on me because from the time I was little”

Q So if you start with credit and distressed, as an example, there's a lot of cyclicality in the opportunities. It could be across industries. It could be across distress cycles. How do you keep a team together for such a long period of time that has that industry specialization when the opportunity set for the complex, most attractive investments can come and go?

A Yeah, that's a very good question. You have to reward people for not investing, as well as for investing, because there's a time when their areas are not particularly attractive, and you don't want to push people to invest, so you want them to own a piece of the overall firm carry, if you will, as opposed to just their own, so that they're not hoarding assets at a time when their area is not interesting, and they're just taking risk because they have upside and not downside. We're very careful about what the incentive schemes are, and generally speaking, people at the senior level are paid by how the firm does, not how they individually do. Although we make provisions so that we can recognize unusual contributions, but it's a challenge. And right when you think there's going to be no opportunities, all of a sudden they show up. We've just lived through a decade of declining interest rates where yield got lower and lower and lower on almost every instrument. So the yields were dropping. You weren't getting rewarded for becoming a more junior lender because you were only getting paid a tiny amount of incremental yield for going deeper in the capitalization. So prior to say the first quarter of this year, we were in a market where what you're describing with distressed was not just with distress. There were some ninth inning distress things to play, like the last chapter of Puerto…

AI assessment note: “You have to reward people for not investing, as well as for investing”

Q What types of opportunities are you seeing outside the US?

A Obviously China, the property sector has had more than its share of significant stress. For us participating in that kind of a market is difficult because it's non-transparent. The rules of engagement and the practices aren't completely clear, but it has reverberations in other ways. So for example, we made a loan that was a first lien real estate loan on a project in London where the developer was a Chinese developer who was having refinancing problems for exactly that reason. We looked at it just as a UK property loan on a partially constructed building. We just got taken out of that loan, but it was take one step to the left or one step to the right to try to figure out a way to take advantage of the fact that there's some disorder going on in one part of the world, but you don't have to really be right in that part of the world. Europe has been a very interesting place for making direct loans as well, because it's probably a little slower and looks a little weaker than the US. There are more companies that are closer to the edge that need our kind of money or other special situation type of capital that can solve an important problem they have in their balance sheet. It's a less of a plain vanilla market. We like the UK, we like Western Europe, but we're being very cautious in those environments.

AI assessment note: “Europe has been a very interesting place for making direct loans as well”

Q I'm curious if you put this together. You had this extraordinary leadership, all this incredible talent, the incredible imprimatur at Goldman, the path to partnership pre-IPO, which was the hottest thing to do. And as you mentioned, no one for the most part had left when you did. With Goldman's culture, what was it that got you to be one of those early leavers?

A It was really my dad's voice whispering in the back of my mind. My dad had always said, you have to have your own business. You have to be an entrepreneur. And I wasn't brought up in New York. I was brought up in Boston. My dad certainly didn't know what Wall Street was or know anything about that whole career path. And because I was enough of an outsider, I probably didn't ascribe sufficient value to this extraordinary position I had at this extraordinary firm. Maybe that was a good thing in the end, but I didn't. I really wanted to be an entrepreneur. And when I got the call from Mike, here was this entrepreneur who the senior people at Goldman Sachs, by and large, hadn't heard of him at the time. This was a brand new thing. I knew all about Mike because I was keeping track of all the financial bootstrap people, the guys doing what they called leverage buyouts back then, the early buyout firms of which they were very few, the people who were acting more as principal as merchant bankers as opposed to investment bankers. One of my friends and I were keeping track of all of these firms because they seemed like they'd be much more interesting to work at. Than to simply be an agent in the middle of transactions. And here one of them came knocking at my door. Mike was carving completely new paths in the financial world. There was no such thing as a new issue high yield bond before …

AI assessment note: “It was really my dad's voice whispering in the back of my mind.”

Q What was the core investment philosophy underpinning the pitch once you got past that cyclical opportunity and we're presenting a fund?

A We were trying to do something different from conventional capital markets investing. So we were trying to buy things that were complicated, that would eventually become simpler. And generally, though not always, do things that were driven by credit markets. So Distressed is an example of a perfect asset class that would fit in our type of operation that wouldn't fit with a lot of the conventional players in the market. Although by 1994 and five, Distressed had largely run its course, at least for a while. We were doing arbitrage from convertible arbitrage to risk arbitrage to other types of arbitrage. We would do stressed total return debt. We would make direct loans to people who were in a complicated fix and needed money quickly. And if we couldn't have enough capital ourselves to provide that entire tranche that we were pricing, we'd share it with a few friends. And we did that many, many times back in the old days. What characterizes everything that we did? Generally, we did value-oriented situations. This wasn't Incomprehensible valuation growthy stuff where you really didn't know what it was. It was mostly value orientation. It was usually something that was complicated and disliked because some change had happened and it was being rejected by the world at large, or it was complicated and new issue oriented, but didn't fit into the normal boxes in the capital markets. Th…

AI assessment note: “We were trying to buy things that were complicated, that would eventually become simpler.”

Q How do you organize this investment team where the core concentration of your activity was to find these complex opportunities in different areas? How did you arrange your team to be able to capture these opportunities?

A There are two broad ways to do these things. One is you arrange them by product. So you have a separate distress team, a separate high yield team, a separate team to do real estate. And the other way is you arrange them by subject. So you have people in different industry groups. One person covers retail, one person covers industrials, energy, whatever. We've generally started out with the idea that we would have a common pool of analysts specialized by industries. That's different when you get to particularly Highly specialized types of securities, like say, securitized products, whether that's RMBS or CMBS or student loans or consumer loans or car loans. Anything that's put in a structured, securitized package is usually quite specialized, so we have separate professionals work on that from the ones who work on other things. CLOs are a particularly specialized type of product, so we have a dedicated CLO team, but The dedicated CLO team, one of the reasons why I think they have such an outstanding track record is that they communicate extensively with and get the credits that they recommend approved by the broader credit team, so they have access to the same pool that the hedge fund analysts have access to. That's evolving, but we've organized it generally in most cases by industry, but where we need specialists for something specific like trading the CLO portfolios or trading…

AI assessment note: “we've organized it generally in most cases by industry, but where we need specialists”

Q What was the internal culture at Drexel like on Mike's team on the West Coast?

A Mike was very inspirational and positive thinking. That personality really pervaded the organization. The culture was don't be afraid to be inventive, figure out how to get to yes, don't figure out how to get to no. Peter Ackerman, the guy I worked for, one of the very senior partners at Drexel, was unbelievably creative at breaking log jams. In every major transaction that we were doing and figuring out a way to get deals done. So it was a very positive get things done culture. It was a creative culture where you were encouraged to design new securities and to just figure it out. We were all young. We didn't know what we were doing, but no one else did either. So we were free to figure it out. And Mike was an extremely empowering boss to all of us in that department and to all of us at the firm.

AI assessment note: “The culture was don't be afraid to be inventive, figure out how to get to yes”

Q What are the biggest risks that are keeping your alarm bells up on that caution?

A You always have to be careful in certain markets that you know the jurisdictional rules, but we've been down that path for 33 years as a firm. We know the difference between working on a bankruptcy or a distress situation if things go in the wrong direction in England versus France versus Spain versus Italy, et cetera. Those you do have to always watch out for. What I worry about more is that we don't have our arms around in a highly confident way of exactly how deep a recession will be in Europe. The energy situation is complex, a change of regime in the UK, the war in the Ukraine. These are exogenous things that just come from left field. I don't think five years ago anyone would have expected any of these things, or even a year ago. You have to expect the unexpected, and then say, how is that going to affect what is already a significantly weakening economic picture?

AI assessment note: “What I worry about more is that we don't have our arms around”

Q What have you learned from sitting in those seats that caused you to think differently about investing than you had before you served in that capacity?

A Much more about the equity world and positive optionality part of the game we're doing with debt securities is, in some respects, debt is negative optionality because the best thing that happens is you get paid off and the worst thing that happens is you lose all your money. You'd rather flip that around so you have unlimited upside and limited downside. That's what equities are theoretically, but that can be a bad game too because there's a price to it. We've always thought of distress debt as an interesting trade-off because you have that kind of upside optionality that you don't have on par securities. The same with stress debt. And one of the things that's great when you're on one of these boards, if you're looking at a broad array of other types of financial instruments, including equities, including venture, including private equity, you get a real sense for what the liquidity versus upside versus downside trade-off should be. I think it helps you identify when in the cycle it's most attractive to be doing what you're doing.

AI assessment note: “Much more about the equity world and positive optionality”

Q that seems to come and go a lot is every couple of years, someone throws a warning shot about the potential mismatch in liquidity with credit instruments and say the ETF world most recently, or the mutual fund world before that. As we go through these pockets of downdraft like we have earlier this year, have you seen any of these potential mismatch issues cause real problems in the markets?

A The entire history of the financial world is one of crises that are born of exactly what you say, where you have a combination of illiquid assets held by a firm that has liquid liabilities, like a bank, and is leveraged. So leveraged and a mismatch is always the disaster. Always. That was what happened in the thrift crisis the first time around. Very illiquid real estate loans Funded by daily deposits from depositors to take them out. Commercial banks that had a combination of commercial paper and deposits and all sorts of very short-term liabilities, buying all sorts of securities as principle that were not really marketable, plus not keeping track of what their real liabilities were because the derivatives market had gotten so overblown without careful compliance and regulation. There are so many stories out there of institutions that have failed that are highly leveraged And have a mismatch. And if it pervades the banks, which are the absolute center of the financial world, then it becomes systematic risk. That's a very dangerous system. We don't have that right now. The banks are not leveraged up to crazy levels, and they don't own tons of illiquid securities. A lot of those securities have gone to other balance sheets in the shadow banking system. So the worry is the shadow banking system somehow full of mismatch and leverage. I don't think so. I think that most of the pri…

AI assessment note: “We don't have that right now. The banks are not leveraged up to crazy levels”

Q When you're sharpening your pencils on credit analysis, how do you either react or respond to what you're seeing on the inflation side?

A A lot of time we try to use historical analogies. So when we're looking at some of these securities that we talked about, and we're looking at how bad can it get? And we start saying, how bad did things look in 2008 in terms of default rates and credit losses on cars? That's serious recession. Not necessarily the inflation part, but the recession part. So we try to look at a lot of scenarios that we build from prior episodes, either of inflation or recession. And we try to say, how much can we tolerate? What's different this time, of course, is that unlike the COVID-induced problem where the Fed was there to the rescue, the Fed here is the cause. They're not rescuing you. They're doing this purposely because they're trying to deal with inflation. We try to look at all these scenarios. We try to prepare ourselves as opposed to predict. That's one of the mantras we repeat often here is prepare, don't predict. And you have the ability to hedge. You have the ability to protect your positions. The nice thing about the format of most of our money is you can do that. So that's what we try to do.

AI assessment note: “we try to look at a lot of scenarios that we build from prior episodes”

Q One of the benefits of the old system you hear about is the market making that went alongside of bank's ability to hold assets on their balance sheet. What are you seeing in the liquidity of the instruments that you trade?

A Liquidity has always been fleeting in some of the things that we invest in. Even when we started the business, Drexel had a disproportionate share of the trading in the secondary market of high yield. So when Drexel went away, liquidity went away in many respects. And then other firms all showed up because if there's no liquidity, there's usually a lot of profit in making liquidity. So market makers showed up, often competitive firms that refused to go into the industry, but then hired someone from Drexel to run their department the next minute. So that's what happens. Banks used to hold a disproportionate percentage of the high-yield universe, like pre-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-'-' Which means when a mutual fund wants to sell, at least at this particular moment in time, the bids can be pretty disappointing. And that's a good thing if you're a buyer, but it's not necessarily a great thing if you're a seller because liquidity is challenging. And it's not always great as a buyer either because you might s…

AI assessment note: “Liquidity has always been fleeting in some of the things that we invest in.”

Q So if you think through the trajectory and the business at the highest level, you get started in that first decade, you get to a billion and maybe back to half a billion. Where did it go if you take the late nineties to 10 years after that to more recently, both in assets and people?

A We've always had a fairly people intensive approach to life. We were one of the very first firms of our sort to register with the SEC. We chose to do that because we thought it would project a certain level of transparency and compliance that would serve our business. And a lot of our clients are endowments and foundations and sovereign wealth funds and other clients to whom those things are quite important. And I also think that no investor will always do a great job at every point in every cycle. So you may as well give people a second reason to stick with you if you happen to do a poor job on the investing side, and I think having good transparency and compliance and being a resource to your investors is quite important. We had a heavy component of personnel who were oriented around transparency and compliance and communication. It started out with a few of us in a little room at somebody's law firm, and then it grew and grew and grew, and now we have about 222 130 people. And the investment staff is probably at 65 or 70, and the rest are all sorts of very important functionality that supports that. And they're very important. You have to do those at the highest levels. But we also expanded geographically. We opened an office in New York a very long time ago. That was essential just because we're in New York constantly. The street is in New York. A lot of our colleagues and …

AI assessment note: “now we have about 222 130 people. And the investment staff is probably at 65”