The Exchanges

Q You work through that process. You're making whatever decisions you are. What does your portfolio look like?

A So we target 15 longs. We want to be concentrated. We think that's a way to sort of generate alpha over time, and also it allows us to really engage meaningfully with the companies. We think about risk on the long side in our portfolio in three buckets primarily. Valuation risk, which can be distressed or equity, but it's where you're taking fundamentally a view on the valuation of a company. Total return credit, which is credit where there's both A carry component as well as a capital return component where we're expecting effectively the spread to tighten over time and then low LTV credit. So those are the three buckets, but the portfolio has been moving pretty rapidly. We really were mostly equity in that valuation bucket and taking it down in January and Feb as we reached price targets and some names, but then as we got worried about the pandemic, we had very little total return credits. We just weren't seeing value in total return credit, but We quickly went in March and April to that being by far our largest allocation. Buying a lot of mostly investment grade that had reached kind of 99 percentile in terms of historical spreads and long duration of the curves really flattened and the long duration stuff we thought had a lot of total return upside and also you were starting to trade significantly below par in some instances where you had bond floors. So I think as the year…

AI assessment note: “So we target 15 longs. We want to be concentrated.”

Q And then what was it that sparked your departure to start Anchorage at the time?

A It was, as I said, I really enjoyed the people in You know, a lot of aspects of that job. It was an offer that was really too good to pass up. A colleague of mine was running the bank debt business, and he had come up through the ranks as a salesperson, a trader, and then ran that business, ran risk, and I was on the distressed bond desk, more focused on bonds and capital structure arb, and he had been in touch with Reservoir Capital, Dan Stern, about seeding opportunity, and came to me and asked if I wanted to be part of it, and The upside downside was really too compelling to pass up and we would never imagined it would turn in and become what it did. Sometimes you can see people early on, definitely want to have their own thing and definitely are leaving. That wasn't the case for me. It was more that it was an opportunity that I felt like I kind of had to go pursue.

AI assessment note: “It was an offer that was really too good to pass up.”

Q Why don't we just start at the very beginning of your path and your initial interest in investing?

A It wasn't really till I got to Wharton. I didn't grow up in a household where we talked about Wall Street at the breakfast table. It was all about education, get educated, and I went I'd studied engineering and physics, and I was about to take a seat for a PhD in biomedical engineering, and I had to change a heart at the last minute and joined a consulting firm as an analyst for two years. But after that, I went to Wharton, and I was attracted to Wharton for a couple reasons. One was the quantitative bent and brand of the institution. I think, secondly, the Lauder Institute, which is a joint degree that they offer in international studies. But once I got there, of course, there was lots of talk of Wall Street. I remember the first time I went up to New York on an informational interview and I took not the Amtrak, but the local transit to Penn station and then the subway down to wall street. I remember climbing the stairs of the subway and kind of stepping outside and just feeling the energy and the intensity and thinking like, I want a piece of this. I want to be part of this. So that's kind of how the, you know, the initial interest was spawned. That informational interview was, in fact, with Goldman Sachs, and then I applied for a summer internship, and I was really humbled. I didn't get any of the interview slots that I had applied for, and I thought I was a little bit cocky…

AI assessment note: “So that's kind of how the, you know, the initial interest was spawned.”

Q As you started to tackle each of those for inherent the business, why don't you start with the investment strategy piece in that you've trafficked in, obviously in credit and equity and privates with your own stuff and some earlier, what product did you decide to put out and bring to market?

A We led with a product that is across the capital structure, long and short. We wanted to be able to go where we saw the best risk reward. I mean, I think another one of the lessons you talked about from Anchorage, we were, I think, very good at being able to invest across the credit spectrum from distress to IG, across the capital structure, from equity through bank debt and across geographies. And we were always asking ourselves, where are we seeing the best risk reward today? And so we wanted to have that flexibility. The other thing that we designed it to be able to do is to be, you know, in moments like coming to this year, we had very little net exposure, but we want to be able to have communicated to our investors that when things are really for sale, we're going to get much longer. So that ability and flexibility to get long when we feel like risk is really on sale was a key design element. The other I'd say is really time. There's a time Arbitrage perhaps in the markets today. I think if you're trying to compete quarterly against the machines, that's a tough place to be. So you need to be able to take a longer term view. And so we structured it so that the majority of our capital is longer term capital and, you know, in exchange for that, what we offered was lower fees, a hurdle, and we pay ourselves at the end of three years. We really want to make sure In terms of cor…

AI assessment note: “We led with a product that is across the capital structure, long and short.”

Q How do you think about the short side of the book?

A So shorts, one, I would say we like to be able to short because we think being able to be market neutral or closer to market neutral certain, some periods of time is really valuable. So first I'd say we look for companies that are overvalued. Generally, we're looking for shorter term catalysts. So We find a lot of these companies that are on the wrong side of these SDGs and we think are facing operational headwinds. And then we find also companies where we think they're laggards on ESG. So I'll give you an example of one screen we run called the cult of personality screen. So we look for companies where the CEO has been in the seat, 15 years or longer, and where NSCI or Sustainalytics gives them a bottom quartile score on governance. And we've just seen over and over in our career that And sometimes the CEO is there because they're just like that good, but oftentimes it becomes a personal fiefdom and ends up badly.

AI assessment note: “we look for companies where the CEO has been in the seat, 15 years”

Q If you're investing the asset side of your balance sheet into these things that also serve the core of the foundation, others would make the case, oh, that's a narrow investable universe, so you're sacrificing return that you could then use to make more grants on the liability side. How have you thought about that holistic math?

A So most of the endowment Is in what I would call MRI, mission-related investments, where we expect, they're aligned with our mission, but we expect commercial rates of return. And then there's the grant making, which is a hundred percent concessionary. It's this in-between space that people get hung up on. Like I'm investing in something that I think has a great social impact, but for the risk I'm taking, I'm earning 300 basis points less than what market rate of return risk would be. And I think that Some of those organizations are just more efficient in allocating capital and tackling social challenges than if you asked a pure, purely nonprofit to do it, or you asked a government program to do it. And so we try to kind of do that calculus in our minds and just say, look, for the 300 basis points that we're giving up is the social return So great that this makes sense for us. And often the case is yes. I mean, relative to a pure grant, even if you can just get the capital back and recycle it and use it again. And there's also something about this blended finance models that also, I think there's a governor accountability effect that there is an expectation of return of capital, let's say. And so it does sometimes cause the receiving organization to have to be a little bit more aware perhaps of their expenses and efficiency and how they use that capital.

AI assessment note: “for the 300 basis points that we're giving up is the social return So great”

Q Is there an example of one of your investments in the fund that's been really emblematic of what you were hoping to accomplish by opening up the outside capital?

A Maybe without mentioning specific names because that might cause a compliance issue for our people, but we did write a paper last year for the Journal of Applied Corporate Finance and talked about ESG is a tool in active management. We gave an example of a specialty chemical company that was off sides of the EPA on nitrous oxide sulfur dioxide emissions, and it was our view that they should spend the money to comply with the EPA today, and that that would put pressure on their smaller competitors to comply, further tightening supply demand, and that the price increase alone would cover their cost of capital investment, and they've moved down that path, and Have since released a sustainability report and become real leaders, I think, and, and how they're approaching sustainability. But the kicker in all that was that they were trading at a 20% PE multiple discount to their closest competitor. And we felt like by fixing these issues and some others, they would be able to really trade in line with their closest comp, which has happened. So that's one example of really ESG integration. I think if you think about just ESG more thematically or SDGs, when you look at how energy has been performing, You know, any company with long dated reserves has been called into question. Healthcare. My whole career, the trade in healthcare was buy the company with the highest moats that's earning …

AI assessment note: “We gave an example of a specialty chemical company that was off sides of the EPA”

Q I'm sure that the Anchorage could be a whole show in and of itself, that experience over, you know, whatever it was close to 20 years. But why don't we just touch on some of the key things you learned at Anchorage that you sort of embraced and didn't know at the time when you started?

A There are a few big lessons. I mean, one, we approached it as a business. I think a lot of people start funds and think about like, I'm smarter than everyone else. I'm going to put up better numbers. But I think our approach was to say, really focus on the customer, the client. What do they want? What of their needs are we solving and design products around that have multiple products so that it creates some stability of revenues to the GP and management company and allows us to invest in the business and infrastructure and people over time. From an investing standpoint, the biggest sort of takeaway was just make sure that you're in a position to go on offense when the markets are under pressure. And so that's really informed how we think about managing the portfolio risk here at inherent as well. But you want to make sure when the market's offering really, really good risk return, you want to be in a position to buy it. And when it's not throttle back, don't try to take on Bad risk to put up great numbers and make sure you don't use leverage unless it's really well thought out and termed out, et cetera. Clearly, I think the lesson that was hammered home to is you're only as good as your people in this business. How do you attract and retain great people? We have just a wonderful team. They continue to have a great team at Anchorage. I'd say those are some of the key lessons th…

AI assessment note: “There are a few big lessons. I mean, one, we approached it as a business.”

Q There's a lot of noise around what is a good company. There are indexes and things like that. What available data or information is in the market that you find useful in your analysis?

A There's a lot of good data on governance, and there's increasingly good data from CDP, TrueCost, and others on the environmental side. And I think we talked about the challenges around scope three. That is an issue in the data today, but people are trying to figure out ways to address that. Social is much more difficult today. Let's start with the fact that the data is self-reported, unaudited, and stale by the time you get it from those corporates. So I think that's going to improve. Mandatory disclosures are going to improve. Different frameworks for taking that data then and figuring out how to use it in a useful way are going to improve. But for now, it's early days. I think you have to do your own work, and we're able to do that because we run a small, concentrated portfolio. It's a much more challenging problem, frankly, for Very large allocators with hundreds of internal positions, hundreds of potentially of external positions or many managers externally. How do they roll it all up into a dashboard that's informative and relevant for their investment committee? It's not easy.

AI assessment note: “increasingly good data from CDP, TrueCost, and others on the environmental side”

Q Usually when you talk about distressed opportunities, you don't really think about ESG in the same breath. They're almost opposite ends of the spectrum. How do you think about blending the two?

A I'd say two. One is, you know, the distress that we're going to be focused on are businesses that we think have a real role to play in society and can be long-term compounders and came into this either with over leveraged balance sheets, but are fundamentally good businesses or they're eye of the storm companies. This has happened to be in one of the industries that's being so affected by the shutdown. So trying to find those, I'll give you one example of a company that we really like right now, which is in the ambulatory surgery center of business. And it's a leveraged company. We've been buying bank debt and bonds. It's a company where it's one of the few times in healthcare that payers and physicians and patients all agree that they're good because they lower costs, they improve outcomes, and patients prefer to go in an ambulatory setting than into a full service hospital, particularly today with COVID circulating. So that's an example of the kind of thematic company that we'd like to own in distressed. The other thing I would point out is there is an opportunity in a restructuring to hit the reset button. You have this moment in time where you can completely rethink governance and put in place best practices in terms of governance and executive compensation. You have a chance to reset on culture and really say, look, this is what we stand for. And so I do think there is a r…

AI assessment note: “put yourself in a position to lead on ESG starting with governance.”

Q So as you started thinking about bringing in external capital and knowing everything you know about what this means in terms of a business and an investment strategy, where did you start?

A First, again, we wanted to make sure we were aligned with our mission or values. Like, you know, what's our North star here? So I'd say number one, it's very clear to us that as an investment organization, we have to put up great numbers because otherwise we're talking about these things, but we need to show great numbers. Our two big goals as an organization are to show that when you incorporate ESG into your investment process in a thoughtful way, at least a better investment outcomes. And as you probably know, there's still a lot of folks who the moment they hear ESG think confessionary, and we just don't think that we think it makes us better investors. And we want to demonstrate that and hopefully by demonstrating that, encourage more capital into the space. And the second big goal is to show corporates that when they lead on ESG integration, they can lower their cost of capital. And the basic rationale of that is you have two companies doing exactly the same one, but one leads on ESG and one doesn't. You're willing to pay more for the cash flows of the one that leads on ESG because those cash flows are less risky. They're less volatile. And if we can help companies to sort of internalize this message and believe it, then instead of folks like us and others begging them over the head to incorporate ESG, they'll just see it in their self-interest to go out and lead on these…

AI assessment note: “First, again, we wanted to make sure we were aligned with our mission or values.”

Q How do you blend a traditional DCF? You're looking at cash flow. You're projecting out the model for three to five years or whatever it is. And then these factors where, you know, on the emissions, you could quantify it. If you say we're going to price carbon on the S, maybe it's a little bit harder. How do you actually do that?

A Well, just as a side, I mean, one of the organizations we support, the Center for Sustainable Business at Stern is really tackling this issue of how do you quantify the benefits of sustainability? Because I would argue CEOs got the message because it was great for external relations and managing their people. COOs view it as an opportunity to really continue to push operational excellence and improve productivity, reduce costs. CFOs, maybe you're still getting the message. And There are different ways, of course, that these things manifest themselves over time in your financial statements, higher productivity, having an employee workforce that's engaged will result in better revenue productivity and better expense management over time. We often make the argument around cost of capital. And I guess the way that you would integrate that into your financial analysis is to lower your discount rate for a company that you think is leading on these issues. But it's hard to distill this into a single number. People do try to come up with frameworks and do that. I think that's part of the opportunity for driving Alpha still. Even the ratings agencies themselves often don't agree on whether a company is a good ESG company or a bad ESG company. I mean, just to use the Tesla example, some really like them because they're electric vehicles. Some really don't because of governance and work l…

AI assessment note: “integrate that into your financial analysis is to lower your discount rate”

Q What did you learn in your time at Goldman that stayed with you since?

A I had a really great experience there. And I worked with really smart people, very hardworking, very client focused, high integrity. And very competitive. And so I think all those things were great lessons to learn. Early in my career, I was asked to manage people. I kind of fell into this. It was right time, right place because I moved up to the distress desk and for a year mobility program. So to the fixed income division, and they didn't really know what to do with me. So they put me at the end of the desk and asked me to look at utilities. So, you know, at that point, I don't think there'd been a utility bankruptcy in two decades and lo and behold, We had Enron. And then we had Pacific Gas and Electric the first time around. And they were like, Davis, get over here. We need your help. And I had a great boss, John Savitz, who really tried to put his people first. And so every time, you know, we were advising the firm on their exposures, commodity exposures out of J Aaron and counterparty exposures. And anytime we had to meet with someone senior or the CFO, he would always bring me along and let me be the one to present. So I got introduced to Some of the senior folks of the firm early on, and we were able to navigate that well and make money off the desk. And that's really what gave me an opportunity to take on a leadership role there eventually. I mean, as it, as happens at…

AI assessment note: “very hardworking, very client focused, high integrity. And very competitive... great lessons to learn”