Alan Waxman - Private Credit and the Modern Financial System - [Invest Like the Best, EP.466]

0:02 And welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. If you enjoy these conversations and want to go deeper, check out Colossus, our quarterly publication with in-depth profiles of the people shaping business and investing. You can find Colossus along with all of our podcasts at Colossus.com. Mm-hmm. Patrick O'Shaughnessy is the CEO of Postative Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Some.

0:36 This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum may maintain positions in the securities discussed in this podcast. To learn more, visit psum.vc. Um This is a unique conversation. It's my second with Alan Waxman, the founder and leader of Sixth Street, one of the largest private capital investment firms in the world. Him and I have been going back and forth about the history of financial guidelines and incentives and how those systems through time shape the system that we live in today and shape outcomes in the financial markets. We thought it would be a neat opportunity to walk through in great detail what he calls system one, two, and three, going all the way back to nineteen thirty three and the initial regulation glass Steagel, which kicked off system one.

1:24 We then go through system two from two thousand to two thousand and eight in the global financial crisis. And then go into great detail for the system that we're living in today. The reason all this history is interesting to me. is that ultimately it's about The incentives and the ways that investors and investing firms make money.

1:42 We have this great conversation about what Alan calls the factory model of investing, defined by the industrialization of both raising money and deploying money. sort of the opposite of the old school artisanal investment model that's entirely focused on earning outstanding investment returns. His historical perspective and lens on what's driving outcomes, I think, is useful information and history for all of us. As we try to navigate one of the most dynamic periods of creative destruction in capital markets history. Please enjoy my second conversation with Alan Waxman. We're facing one of the most interesting capital market setups of all time, alongside one of the most interesting just world environments, geopolitics, technology.

2:23 And you and I have talked a lot about the shaping forces. That will determine How things play out. From here. One of those things that I want to start with we'll talk about

2:33 A I will talk about geopolitics. Some other big things that might be shaping the world. But there's one that is probably under disgust that you are in a very unique position to teach us about. Which is what you call the guardrails and the incentives of the financial system itself.

2:49 The reason we're doing this today is So much discussion of private credit. direct lending. Things happening in private markets that's getting a lot of attention in the news. You can see it in stock prices of certain companies. And I think the whole world's grappling with this, trying to figure out what the hell is going on.

3:06 And what to expect. And you are a deep historian of this topic. And so I thought it would be a really cool opportunity just to have you teach us all about this important factor in what's gonna happen in the future. So What is your general frame for

3:21 The financial system and how it impacts the world. There's a lot going on in the news. What I'd say is What you're reading in the news today are the symptoms. But

3:33 not really the root cause and As an investor, when we try to figure out what's happening in a current moment. Which is we're definitely in a moment right now. We do two things. First of all, we think about it from The standpoint of the year.

3:46 How did this get here? What's the history of it? How do we get here to really figure out the current moment and also determine where we're going? So I think we'll talk about a little bit the history of how we got here. And then the second thing, and you hit this. is looking at everything through systems. And we think about systems, we think about The incentive system.

4:04 guard rails and market structure. First of all, I'm not an economic historian. What I'm gonna do is tell the story of history as it relates to the current moment. I think you gotta go back till pre nineteen twenty nine crash. And when you think about the American system, it's basically like the wild, wild west. It was pretty unregulated.

4:22 And There many causes of the nineteen twenty nine crash. There was Poor monetary policy. agricultural recession. Margin lending.

4:31 But one of the main parts that caused it. Is you had this idea of commercial bank. So think about commercial bank. So Individuals go put their money into a bank. As deposits.

4:42 Commercial banks Basically, we're in the same house as principal risk taking activity. So the investment bank. So these were all part of the same thing. As you can imagine, when that happens There's a massive conflict of interests.

4:55 So really the story starts for the current moment. Starts in nineteen thirty three, so this is after the nineteen twenty nine crash. This is after nine thousand banks. Phil. Think about that. Nine thousand banks failed.

5:09 Nineteen thirty three, Glass Steagle, probably one of the most important regulations that took place. And also the establishment of the FDIC, which we insurred deposits for individuals at banks up to a certain limit. And Glass Steel basically said these commercial banks, which was Deposit taking institutions from individuals just got really burned in the 1929 crash. They see become separated.

5:32 from the investment banks or at the time, think about principal risk taking. So think about in today's parley it's private capital. Investment banks. Those got separated. And that's kind of the first system. When I think about the first system that explains where we got to the current moment, let's just call it

5:48 System one. It's from Nineteen thirty three To nineteen ninety nine. And when you look at Post World War Two with the separation of commercial banks.

5:57 And invest in banks. You basically have to Post World War Two. Fifty a pretty stable system other than

6:06 The S and L crisis in the nineteen eighties, which was a big Event? It was a pretty good system. But The system wasn't optimized.

6:14 For economic growth. Because you only had a pretty conservative with a lot of guardrails commercial bank providing finance. Yeah, just low risk appetite. Yeah. So it's a low risk appetite. And again, because one the fixed income market hadn't developed, which is part of the story here. But also because investment banks they were more in the moving business. Than the storage business.

6:34 They were pricing securities to basically sell to other people. They weren't pricing it to hold for their own balance sheet. Now that changed as we get into the eighties, but again, broadly speaking, for this first system from nineteen thirty-three To nineteen ninety nine. It was working. It just wasn't Optimized.

6:52 The lesson from this is with really good guardrails, you can get long stability. You can get long stability, but again, you also have to think about job creation and economic growth. And I think if there's one criticism of the system, which is why the Glass Steagle Act got repealed in nineteen ninety nine. I can talk about why it got repealed. What like sort of the steps leading up to that is that it wasn't optimized and

7:14 As you go to a more globalized world and you're competing with Say European banks. You become less and less competitive. So in a non globalized world, it was probably okay. But as we got to a more globalized world, it wasn't really optimized to maximize economic growth for the country. Okay, so we get to the mid late nineties. What happens in addition to

7:35 new competitive pressures walk us through the transition into what becomes system two. So at the time again, we've got separation of investment banks and commercial banks. All sudden European banks Who weren't part of the same Class Steagle Regulation.

7:50 They started to unite with each other, so commercial banks. And investment banks in Europe started to come together. Would start to put The American commercial banks At a big disadvantage.

8:01 And not only were they coming together. But they were also taking on more leverage than what was allowed with the guardrails Uh American commercial banks. Це за результата, аз you can imagine.

8:13 All the commercial banks and many market participants are saying, Hey, we can't really compete. Against some of these European guys in nineteen ninety eight. Do it your back. Bought Bankers Trust, and that was definitely a moment. Citibank announced that it was merging with travelers.

8:29 Which at the time when they announced the merger. It actually wasn't allowed under Glass Steagle under the current regulation. So that's what sort of wet up to it. So I think it's A couple things globalization. Now all of a sudden you're competing against Europeans who have think about they can provide services and balance sheet and capital, you're at a pretty big disadvantage. So the system one started to get

8:51 less competitive as we move into a globalized world, and that led to nineteen ninety nine. When Glass Steagle So what comes in its place? It's basically just deregulation. It's deregulation and literally after that you saw a wave of mergers of

9:06 Combining commercial banks. An investment bank. So you saw JP Morgan Chase. There's many others, but With everything, there's knock on effect. So that came together, created these powerhouses that could compete with what was going on in Europe. But now you had all these investment banks that weren't commercial banks. So think about my own firm, Goldman Sachs, and many others.

9:26 Now they had to start competing. They didn't have access to cheap capital because they weren't a commercial bank. They had to compete with combined investment banks and commercial banks because a lot of the commercial banks both in Europe and the US they started to use their balance sheet to get investment banking business.

9:41 So what did all the investment banks do? they started to leverage up. And that's one of the other stories is leading into the system is the development. of the fixed income market. So think about corporate bonds, mortgage backed securities, asset backed securities, sovereign debt. That went literally from the eighties to the nineties went from seven trillion dollars.

10:02 to fourteen trillion. These are all financing mechanisms that could finance the investment banks to basically allow them to leverage up. And that's what started to happen. So literally from The time of Glass Steagle being repealed. You had

10:16 Commercial banks uniting with investment banks both in US and Europe. You had leverage going up. Leverage went up for commercial banks in some cases twenty, thirty times leverage. And all the investment banks were operating with leverage because they had to take on leverage to be able to compete with the combined commercial banks, investment banks.

10:35 And then Nine years later, what happened? You had the GFC now. Just to be clear. There's a lot's a polarizing debate of how much attribution

10:47 The repeal of Glass Steagle Pat on the GFC. What do you think? Well, I think like everything it's nuanced. There was definitely some attribution to it. I think that was clearly not the only reason.

11:00 My view, it's some combination, but ultimately it had to do with the system and the set of incentives. In that case, after putting all this together, a lack of guardrails that existed In sort of the first system we spoke about. And in system two is the lesson that it's the combination of Liquidity or asset liability mismatches and leverage.

11:22 that basically is the cocktail for every historical financial crisis. One of those two or both are involved. Leverage always plays a role. And they're all connected, but just The mismatching.

11:34 Of assets and liabilities. You could be the Best investor in the world making the best illiquid investments. But if someone comes and asks for your money In a quarter when you haven't had time to actually have that investment play out the way that you underwrote it to do. You're gonna be a bad investor, you're gonna get caught out of your option and you might have to sell it at a deep discount. So there's a few things. I think it's one, anytime you bring

11:58 retail or individuals. So think about people depositing into a bank. Next to principal risk taking activity. I think that's one thing. The second thing is just anytime you mismatch assets and liabilities. And then the third thing, again, going back to what we talked about earlier, is what are the incentives? What are the guardwells? And what's the market structure?

12:18 Okay, so then what happens? So obviously we know about global financial crisis is terrifying and the reaction is many things, but What is installed post GFC That sets the seed for I guess what we'll call the current system system tree. So in two thousand ten.

12:32 Two things happen. First is Basil three. was passed by G twenty nations. And I'll explain what that is. And the second thing is Dodd Frank. When you think about basel free, so this applies across all commercial banks.

12:45 And by the way, a number of investment banks that were not commercial banks were forced to become commercial banks. As a result of this Those commercial banks And this is really a basel free thing, had restrictions on capital, which For your audience, think about that as leverage. So the amount that they could be levered up so they didn't get levered up thirty to one or forty to one like they did create GSC.

13:08 And the second thing is restrictions on liquidity and liquidity is basically Through a bunch of shock scenarios, a bunch of things going wrong, do you have enough liquidity to meet all your obligations? That was a key part of it. Dodd Frank was more aimed at in the Volcan role that that didn't really last that long, was really aimed at the principal investing activity.

13:27 I would say it's more For the commercial banks, it was more Basel three, but Dodd Frank played a big role, certainly in the short term. How would you explain just system three and its guardrails and incentives to people out there? System three In my opinion.

13:44 It took like a hundred twenty five years to get here. Has the potential To be the best system American finance. Because when you think about commercial banks to deposit taking institutions

13:56 By the way, that are basically back stop by the governor, insured by the government. Through the FDIC. So think about GFC, there was a bailout the taxpayer belt. That's not good for society. That's not good for the middle class. That was not a good outcome for America. For those institutions having restrictions on capital or leverage and liquidity. where they're doing lower risk taking activity.

14:19 To finance a system. That's a good pillar of any financial system. Converse on the other side. And this is where the current movement starts to come in. Is now you've got private capital in coming in. So when you think about private capital, think about

14:35 Pension funds. Sovereign wealth funds. Endowments, insurance company. Providing capital In the beginning

14:43 of this period so called system three. post Basel three, post GFC. That's what resulted in the growth of the private capital industry because it was filling in the gap. So think about Principal risk taking activities. private capital was filling in the gap.

14:58 And with the exception of hedge funds and really REITs. Those were matched assets and liabilities. So you think about private equity, private real estate. private infrastructure. Private credit. They never had someone that could literally ask for their money back or they didn't have depositors saying

15:13 They need to get their money back. They can't get it back because of the liquid assets. So that just to put it in context. private capital from pre-GSC to post GSC is about two trillion. Pre GFC, it's grown. to around fourteen, fifteen trillion.

15:29 Private credit, which is in the news today. Grew from Five hundred billion to about two trillion, what is day. So massive growth. And this filled the gap for that. principal risk taking capital, provide risk capital to all parts of the American, which is a good thing. І I would say up until two taus and eetin.

15:47 The system was working great. Commercial banks. deposit taking institution effectively backstop by the government doing safer things. And then you had matched assets and liabilities where you An investor, a set of assets couldn't get caught out of eroption, providing the risk capital. That's a pretty good system.

16:06 Until We start to see behavioral changes in Two thousand eighteen. Just to put a pin on an elegant, well designed system of guardrails and incentives.

16:16 the commercial model where it's lower risk. And protected or backstoped. And higher risk seeking capital where the assets and liabilities are matched. Is a good system. It's a good system. Yeah. All crises generally are caused from

16:30 Not credit issues or other is they might start in other issues, but it's mismatch assets and liabilities. So you mentioned this year twenty eighteen as being a pivotal point. I wanna explain that transition, but It feels important you and I have talked about this notion of yours of the factory model before.

16:45 We're gonna go into that in more detail, but just to plant the seed in people's mind. Define the factory model just briefly, and then I want to talk about what happened to get us transitioned and the incentives. towards that model. So The way

16:58 that we define the factory model in our industry. Is There's Two parts to it and then there's an output. First part is the industrialization.

17:08 of the fundraising process Say liability gathering. Literally raising as much capital as you possibly can. As fast as you can. So that's the industrialization of the liability side or the fundraising side.

17:22 That comes first. And then what comes second Is then А за результатализа Of the asset side, so think about investing. So

17:31 If you're on an investment team and all of a sudden your firm has A lot of money to invest and It's just sitting there. And maybe there's a time stamp on it. All sudden your behavior has to start to change because you have to deploy that money.

17:46 Much quicker. And what's the best way to raise a lot of capital quickly? Make it very simple. Make it very narrow because if it's wide That's too hard to explain. So you want to make it as narrow as possible.

17:57 And you're also willing to take Let's say make concessions on the type of capital you raise. So Meaning Maybe it's got a term where they can ask for your money back. So instead of perfectly mass assets liabilities.

18:10 Maybe you're wanting to start to not have perfectly matched assets and liabilities because you want to raise it. As fast as possible. And again when people cure this, they're gonna think I'm only talking about the bigger firms in our industry. But

18:23 It filtered down to mid-sized firms, smaller firms for a whole bunch of reasons, but this whole factory model behavior started to reveal itself. In twenty eighteen. The visual that's coming to mind on the asset side. And again, we'll come back to both these ideas in more detail, but I think of an artisan making a horse saddle or something by hand, and then I get an order for a hundred thousand horse saddles. I can't make it by hand. I gotta make a fact. That is the exact way to think about because it's a different model when you're building that horse saddle versus you get a massive order. But one point's important is that It starts always on the liability side.

18:58 And then it goes to the asset side, and then you get the current moment that we're in that I know we're going to talk about. It starts on the liability side because why? Because If you just all sudden go to that example, it's a really good example of the horse saddle.

19:13 All sudden if you don't have a factory that can produce a hundred thousand on the artisanal side, you're not ever having to think about it. You could have an industrialization of the assets, but if you're liability constrained, you're not gonna change behavior because You don't have the capital to go do that. You'll run out of money and Five days.

19:31 So it's gotta start on the liability side where you raise all the money, then you have it. Then the behavioural change starts. These two things, it's first liability side, it starts the industrialization, and as a result of that. It goes to the asset side. Which is interesting because if you add up every conversation I've ever had with an investor, ninety eight percent of the time spent is on the asset side.

19:52 What are you investing in and why Exactly. By the way, that's okay. If you have perfectly ass match assets and liabilities, it's okay. But Let's imagine a world where every investor you spoke about had a term in their agreement after three years, the investor had the option to call their money back. That would probably be something you want to be talking about a lot.

20:09 And by the way Prior to two tausin eight. Конь Бактиншол систем. The private capital po was pretty perfectly Mass has assets and liabilities.

20:20 It would seem if everything was frictionless and I was a GP I would of course have matched liabilities. If I could just snap as much capital as I wanted into existence. Yeah, of course. I wanna have no problems. So what's the series of events starting in twenty eighteen? What were the first

20:34 examples of this and then how has it evolved. The first signal is underwriting. Because investing or lending You can invest

20:45 As much money as you want, you can win as much money, that's not the skill. The skill is Investing that artisanal Behavior. Everyone talks about private credit, but we started to see it in every asset class. We started to see it in real estate.

20:58 We started to see it in infrastructure. We started to see it in private credit. It wasn't actually bad, but we started to see behaviors like turns that You would never do Because obviously when you lower your underwriting standards Guess what happens? Your deployment pays can go up. You have an origination engine.

21:17 You're sourcing all these deals and let's you're an artisanal, you might have a Hit rate of half a percent you look at if you lower your underrating standards, your hit rate on deals that you might do might go to two percent or three percent. It's literally all in your control. So I think we started to see it, but it was just like something we started to notice changes behavior, but it wasn't full fledged. factory model industrialization.

21:40 Covid happened. And then post COVID. It was Game on for the factory model. Both on the liability raising side.

21:48 And also on the asset side. Literally that behavior Starting to accelerate In incredible ways, right after Covid. the capital, the liability has come from lots of different pockets. But my mind goes to like the wealth channel that everyone's talking about now.

22:03 Institutional channel as well. Maybe put a little more colour on where it actually Came from where he's coming from. What started to change in two thousand eighteen is There are these things called SMAs, so separately managed accounts.

22:16 Prior to two thousand eighteen, for the most part, the private capital ecosystem was basically funneled through. Funds. So think about commingled funds. Lots of investors come into one fund. To pursue a certain strategy. And all of a sudden they started to be

22:29 Every conversation With every LP was basically We want an SMA. We want more fund of one.

22:37 Just to do XYZ for us. You go to an LP. You basically say, Hey, we're gonna raise five hundred million dollars or a hundred million dollars and we're gonna do direct lending or we're gonna do private equity or we're gonna do real estate.

22:50 And all of a sudden there started to be a proliferation where literally three years prior it was Not in any conversation. Every conversation was SMAs and what it is, it was just The industry showing to raise capital from the institutional channel, so not wealth, the institutional channels, so pension funds, sovereign wealth funds, to some extent endowments. Rais as much капітал as possible. In the simplest form.

23:13 Taper off. The next place where the industry started to go. Was the wall space. And the well space in general, just from a historical perspective.

23:28 It is typically the Easy Therese, the simplest Therese. It's typically the cheapest. That doesn't mean that they're not smart, just the cheapest. But the other characterization of the well space was that

23:41 It's always easiest to raise in the procyclical environments when things are going really well. But When things start to not go well. the wealth space or retail where individuals want their money back quickly. I just want a level set on that's an important concept.

23:57 And that's where it started to go. And that got us to one of the symptoms that are here today. But the one thing I wanna point out and we'll talk about the current moment. Is that the SMA was a symptom. What's going on in the wall system?

24:11 The well system is a symptom. When you think about some of the stuff you see in stuck private assets where there's so many assets around the world and Private real estate. private infrastructure, private equity that literally

24:24 were companies or assets that were bought in really post COVID of sort of twenty, twenty one, early twenty two, paid way too much. Their stuck assets all that stuff is symptoms the root cause of this. Із чанбер паттерн. of the factory model that's the root cause in

24:41 Again, one of the things that's Not frustrating, but Unfortunate is that Everything that is covered in the media is just talking about the symptoms and not actually getting to the root cause.

24:53 And again, when you think about history People talk about the symptoms, but when you start to diagnose what happened and how we got there It had to do with the root cause. And I think that's something that hopefully this conversation provides some greater clarity on. So if I think about this model And we've talked about maybe you can mention the multiples.

25:12 that markets had been putting on asset management companies that we can look at public markets and see everything transparently. How much markets were willing to pay for the equity. In multiple basis. What the multiple is of that drives the incentive to raise money.

25:27 The story of the factory model starts to correspond with FRE multiples. What is FRE? FRE stands for fee related earnings. fee related earnings is basically your management fee profit. So You raise a fund.

25:42 got a management fee on it, you got a set of expenses and what's left over, that is your fee related earnings. These things for our industry started traded between Let's say early two thousand ten, call it Ten to fifteen times FRE?

25:57 In two thousand eighteen, when all this started, it stepped up to call it fifteen to twenty times. Obviously depends on the comp set. Before this current moment. We're at twenty five to Thirty times plus That's where it is. And by the way.

26:11 If you go back to the early passing of Basel III and Dodd Frank, there was a massive secular opportunity to fill the gap. That was left from commercial banks being constrained Then The system found its sort of stay state place, but in order to keep growing

26:28 And again, it's the whole industry. What do they do? Many participants adopted the factory model. And is maybe the crass way to say this in the factory model, the GP, the founder of the firm stands to make a lot more money from the equity of their GP than from the carry they would earn through investing or something like this. What I'd say is that

26:46 Look. To be a CEO of One of these larger it's hard. You have a lot of different constituents. It's really hard.

26:56 As an investor firm, sometimes it's good to grow and Sometimes it's not good to grow. It depends on what's the investment environment. What's quality of your liability structure? What's the flexibility of your investment model to sort of migrate to where the best opportunities are? It just depends, but I think it boils down to

27:14 What's your clarity of purpose? There are a number of people that are public that I would say have not adopted a factory model. There are a number of people that are not public that have adopted a factory model. Maybe because they want to get bought by one of the larger guys, or maybe if you're a mid sized fern and you want to be one of them. The issue is just because you're large and

27:34 Just because you're public, it doesn't mean that you've adopted The factory model. It's like What is your clarity of purpose? Now, if your clarity of purpose is to be an investment bank. Then maybe that is what you wanna be a factory model, but if you're gonna do it You better have really good

27:48 Risk management. That's why If you look at commercial banks Jamie Diamond is probably one of the best risk managers. Of all time. What he can do from a risk management perspective, and you saw it in GFC and he's seen other times in his career.

28:01 He's a better risk manager, but the rest of the industry that follows suit because they want to be Jamie Diamond. They might not be as good a risk managers as him, and it's the same thing Over here, so it's not just the larger guys because members the industry always follows. The larger guys but it's not certain that just because you're public, just because you're large, that you've actually

28:19 adopted the factory model. What are the most common in your mind telltale signs of a firm that's in this model? What does a firm that's adopted the factory model look like that's distinct from an investment model? Base firm.

28:33 First of all, you know it when you see it. You can see it in the underwriting We're in a bunch of different ASA classes, you can see it. Particularly like if you're a fixed income investor or credit investor because you have capped upside, there's terms you just don't give. A lot of those terms have been

28:48 Given to facilitate deployment. You should not do those terms because it's all good when you're in a post cycle environment, but If You have capped upside and you're earning a ten percent return in all the collateral. that your ten percent is based on can literally be taken out of your quadl package overnight. Or

29:06 For that 10% return, you can be levered up because let's say there's an AI disruption and some software company needs to reposition their business and they can basically lever you up. So you go from fifty percent loan to value to 120% loan to value. Those are just things that You shouldn't do for a ten percent treatment. The first time we did this, we talked a lot about

29:26 return per unit of risk. It basically sounds like the thing happening in the factory model is that that has fallen out of whack. The objective function becomes more deployment. of capital because that ties to size of my business, multiple on the business, how much money I'm making as a shareholder or whatever. And it's fundamentally divorced from the investing equation, which is return units per unit of risk or something like that. So map this onto like the news cycle today.

29:51 What is happening where are their assets? Liability mismatches. What are the nature of them? What's the implications? Again, go back post Covid, that's when the wealth space took off so the democratization of alternatives or private capital which

30:05 Just to be clear. Not against that. Some of the factory models that Are out there. Have

30:12 Raised capital. From the wealth channel. And Irresponsible ways. So first of all

30:20 In general, you're taking an illiquid asset And you're giving investors an ability to get their money back quarterly. They say semi liquid. There's no semi liquid. Okay, there's no such thing as semi liquid. Anyone that's an investor that's been through a bunch of cycles, there's liquid and then there's illicit because again, going back to the

30:40 history of the Wall Channel or individuals or retail. The one thing we know it's very post cycle. We're a pro cycle environment. It's easy to raise money and when you're not, and when there's problems or dislocation like there's today, they want their money back. So you basically had mismatching of illiquid assets. And liability. So that's one part of it. The second thing is that they would raise these very narrow

31:04 What I mean by narrow is it's just direct limit. So it's not like you can invest in direct lending and Real estate and infrastructure or an asset based finance. No, no just very narrow. just direct lending or just asset based finance or just this strategy. That's a narrow strategy. And maybe that's okay if you raise the right amount of capital, but if you raise an unlimited amount of capital where your investing is dictated not on good investments in the market. But basically dictate by how much money you can raise. There's never a governor on how much money to raise. And the thing about these wealth vehicles.

31:35 When they raise it, they have to invest it right away. We call it info investing. They have to invest it right away. So they raise as much money as they can. And if they don't invest it right away, it dilutes the return of that vehicle. To ground this in actual reality as much as possible. We've talked about all these guardrails, all these incentives. The three problems.

31:54 All this stuff where the system structure begins to determine. What is fate? What is actually happening today. What's happening today is

32:04 There are these vehicles called perpetual private BDCs. These have been raised in the Walt Channel. So individuals wealthy massiflone They've been raised and again In some cases, not all cases.

32:18 in very narrow strategy, so just direct line or Just private equity. And really the catalyst was software in AI. And also some of the market volatility, but started to question the quality of their portfolio.

32:32 Or it could have just been market volatility. Because of what's going on outside of this. Where people want their money back. There's a limit on how much Money.

32:41 people can ask for in Basically a lot of in the per petrol private BDC space. The amount of money people have asked for has exceeded What is the five percent limit?

32:53 And That's creating all the noise that you're reading about. What's the range of so what's here? I can imagine Once a what is like

33:01 Tough shit. You can't have your money back. And World keeps spinning. Another is something dangerous and scary and systemic. because past financial crises have tended to be downstream of some domino, you know, like private BDCs or Whatever it is.

33:17 Each time it's different. What do you think the range of implications I don't think this Is

33:25 A systemic issue yet for Two reasons. One, it we're only five years into this, so it's early. And the second thing, at least for now There's a pretty strong economic backdrop. There's definitely risk to it. So

33:37 I don't think this is systemic. It could turn out that way, but that's actually not what I think's gonna happen. I do think there needs to be a major Recalibration. Uh

33:49 Behaviors. In the way that people approach this wall channel, because if you go back to what we talked about earlier. Any time society or finances then puts Well for retail individuals next to principal risk taking. If you look throughout history.

34:05 That's where problems start to happen. Most of it's been with commercial banks, because that's been the primary pillar of the finance system. But now with this new pillar in private capital. It's starting to touch risk capital. And

34:19 It's starting to become More asset liability mismatch, but when you look at the quantum of the problem. As at least it specifically relates to this. It's pretty small in the grand scheme of things. So

34:32 What's going on is in private markets in the wealth channel, very small allocations to private investments historically one, two percent. And that channel is smart. They see that value creation and returns are happening without them.

34:47 In private markets. They want access to it. Seems fair. That two percent's expected to go wherever, ten plus percent in the decade to come. I guess the question is How can we do it responsibly?

34:57 If you are gonna raise a narrow Strategy just direct money or just private equity, you need to govern The amount of inflows That come in. So sometimes you just say no, maybe you have a waiting list.

35:10 But Again. Because Flows come in. And

35:15 Pro cyclical times. If you only have a hundred million dollar vehicle Maybe it's always a good time to invest. But if you have a much larger view, it just gets really hard because maybe it's a good time to invest Maybe it's not, and that's why I think.

35:29 Where this will go responsibly, I think. You're gonna have to have very wide apertures because Ultimately, in every ecosystem, whether it's direct lending or private equity or real estate or infrastructure, they go through supply-demand dynamics. Sometimes there's supply of capital. Is really high and demand is low, that's probably not a good time to invest. And sometimes demand of capital is really high and supply of capital is really low. Again, not certainly, but probably pretty good time to invest. And it oscillates within each ecosystem all the time. So I just think you want a wide

35:58 Aperture. But if you're gonna do that, you can't just all sudden show up, which is probably what's gonna happen. After this rec everyone's gonna show up and say, Oh, I'm a Multi strategy private capital fund. I'm gonna do whatever well Yeah, you gotta be able to do it, but you also gotta have

36:12 The capabilities to be able to do that and there's a number of people that do But You can't just all sudden do it. It's like a style of investing. I think Those are the key attributes that

36:23 will make up responsible investing, but I think the biggest thing is just being very upfront. When you want your money back, you have to assume it's a two thousand eight crisis, nineteen twenty nine. And if you're comfortable keeping it invested, then you're probably suitable investor. You said before that maybe system three could be like the Goldilocks scenario. I was always interested in around financial crises. moral hazard as a topic. And the socialization or spreading of this risk that one person takes to make more money and they'll be bailed out or something like this.

36:52 It seems like this mismatch, this asset liability mismatch. is something that In the current system maybe it's cyclical and it waxes and wanes, but selfish people are gonna take advantage of the ability to raise more money. Forever.

37:05 Unless the responsibility is mandated or regulated or more clearly laid out. You think We have some evolution still to do. To create

37:13 The Goldilocks scenario. I think that's what really needs to be. Thought about. I think that's gonna happen as part of this recalibration process, but that is a much better outcome. There can be good legislation, but there's a risk that

37:27 It's not the right guardrail and it's not good for competitiveness and it creates like the next crisis. The best Answer is a market mechanism like you have within institutional investors where if you do irresponsible things or you're not a good investor for you change your business model. They're gonna punish you by not giving you money for your next fund.

37:47 If I turn all of this into ideas or guidelines for people running investment firms or who want to launch an investment firm or something. What are the right principles to take away? Obviously, one is keep your liabilities and your assets well matched. That's a major one that's Anyone can do and maybe you have to work a little harder to raise money, but you'll be thankful for it. A second is

38:06 maintain an underwriting standard that's extraordinary or however you want to define it. Any other advice that you give to people running investment firms. Or just principles you have for building six street. that flow from all this history and thinking.

38:21 First, what's your clarity of purpose? What's your day one clarity of purpose? Does that say consistent? over time, like is your clarity purpose to raise a bunch of liabilities or is it to drive good returns for investors. Maybe it's both. Maybe you can do that. Maybe some firms can do that. But What is your clarity of purpose? This is something we talk a lot about at Six Street is that

38:40 If you look at all the great companies that have been around for a long time, they got one thing right. Is They never forgot what their purpose was, which is to serve their customers. It's

38:52 Enticing to Raise a bunch of money. It's enticing once you raise it to invest a lot of money, but doesn't mean that You have to do it. Six street. We're multi-strategy private capital firm. We do a bunch of things. One of the things we do is direct lending. We have one of the best

39:06 Track records. We've been here longer than in direct winning like I started the direct line business at two thousand one When there's only two of us, so we've watched us in We could have gone to the wealth channel and raised all the same vehicles because of our track record.

39:21 And we have You know how many dollars of perpetual private BDCs we have. Exactly. Zero.

39:29 It's not that we couldn't have, we just didn't think it was the right thing and we didn't think it was consistent. With our clarity of purpose. And that's why we didn't do it. It's easy to get FOMO. I just think you just gotta block out that noise and it always comes back to first principles of

39:44 Clarity of purpose. What are your values? And if you stay consistent with that, judging by the best companies that have been around for a long time. That's your pathway to building a great company that's gonna be here for a long time, not

39:57 Short Termism. Again, back to the news cycle, there's s this thing of Firms that manage lots of private credit strategies, SMA exposure, et cetera. Some of their stock prices are really hurting.

40:08 And we've talked about all the reasons that nauseum. for the mismatch, et cetera. What do you think happens in private credit? Land. I think And hope.

40:17 That This is gonna be a recalibration. People are going to readopt. Underwriting.

40:26 I think People in the industry Will change behaviours, and by the way, in some cases the market. Will change your behaviors because you may not be able to raise More capital, so the market mechanism, I think, will work.

40:39 And then obviously, and this is a hopeful I think it'll stabilize and hopefully the best thing about the current moment. Is that this happened? Not in a deep recession. that happen when the economy's pretty relatively helpful. I mean, there's definitely risk out there to be worried about But this would be a much different if you think about redemptions on a lot of these wealth vehicles, if it were

40:59 A distressed environment. The redemptions will be two three X what they are. So to me, this is a gift to the industry to recalibrate. And there's a lot of smart people in our industry, a lot of great investors, and I think The industry where we calibrate.

41:14 And then if you think stepping back from the American financial system. commercial banks, you could have a really powerful system supporting economic growth with Commercial banks providing one pillar, safer, good guardrails, and private capital providing the risk capital. That's a pretty good system, and I think if we get that right. It's really gonna set up America to be really optimized.

41:36 Economic growth. That's what I'm hopeful about. You alluded to AI and software being one of the early dominoes that got this whole discussion rolling and people's redemptions and reactions and things. It seems like if you think about creative destruction as a force driving the US experiment since its inception. Talk about facing a tiger. We are facing a hardcore period of creative destruction.

41:58 How do you think about that? Given the open wide mandate of six street, your ability to go put your capital and your customers' capital in so many different places. Just talk through like the opportunity set today. Of course, I want to hear what you think about like AI and software. I can't help myself.

42:12 This just feels like such a time to be alive, but also Opportunity and danger. There's lots of opportunity. I mean, I I live on Vell Limbs. I play with them. Actually my wife makes fun of me because I'm constantly playing with my friend Claude or my friend Chad or my friend Jim and I.

42:30 I'm always not your friend Rock. I actually play with them all because I like to ask them the same question to see how they answer it. Differently and just to try to get a feel for it, but big believer on the productivity opportunity. There's a lot of good with it, but there's definitely Risk on the transition.

42:50 You mentioned software. That was one of the catalysts that got us into the current moment, but everyone's so focused on software. I think having lived in Silicon Valley, I know you spend a lot of time there, this is not just software, this is every industry. Because once one company in any industry figures out how to actually use it as a tool and really figures out how to use your agency capabilities and

43:11 Drive higher margins. If you're one of the companies that's a slow adopter And you're not active you're gonna Have some of the same problems that

43:19 People perceive The overall software industry to have today. So It's not just software, it's across everything, but look, it's One of the best things about the American project is crave destruction because it allows for prudent allocation of capital.

43:34 to the right places that are gonna drive the right outcomes. If you think about the unfolding set of opportunities that it creates One of the categories that you and I always talk about that I'm so interested in is one's own development. And the highly adaptable people seem like they're gonna be set up for lots of success in this environment.

43:52 How do you think about your team? And I know you have a team that's very long tenure that tends to be at six street for a career. How do you think about their development and new things that you can do as the leader to make sure that they are all dynamic? as things change really fast. Like I know you're playing with the LMs all the time, but This is an important part of your job. Your team, how are you thinking about it?

44:14 When we hire someone, we're looking for a lot of things, but two of the things that we're looking for Are they an open architecture person? Like can they Play tennis, what we call playing tennis. bounce different ideas even when you disagree with someone, and the second thing is are they a warner? Surprisingly we track all the

44:32 AI usage on the L models. Our usage across our entire firm is Off the charts. One because of the types of people we hire, but I just think in general in stepping away from six street is that

44:45 If you're not adaptive in this environment and you're not a learner. literally committed to learning every day and improving yourself every day, you have the risk of getting lost And what's happening and about to happen in a more accentuated way. I have a off the wall one for you. It's been deeply impactful on me.

45:03 Can you explain this paper one sheet system for how you get Everything done and Track what you do. I actually did a presentation to our entire firm

45:15 On personal organization systems because I think As an investor, as a business person. The scarcest thing you have is time. And one of the most important skill sets is your

45:26 dynamic priorization of that time on the highest impact things. That's why we always talk about return on time. And what My personal organization system does, I call it the brain. Is I literally try to get the way my brain is structured.

45:41 on one sheet of paper Said all my Important priorities people Businesses, investment themes. I made changes over time based on what's needed for me because my job changes every year. Because I have to evolve.

45:55 I try to get my brain on paper. And it allows me to dynamically prioritize where the highest return on my time is. That's number one. And the second thing it allows me to do is I capture So that I never have loose sense.

46:09 I try to always follow up on everything. Be proactive about things. I just think proactive is the key thing. It's very clear what my top five strategic priority is, all the tactical stuff, and I'm constantly looking at it, updating, and I do it all by hand. Cause for me, I have to actually put pen on paper. Once my sheet fills up of all my tactical stuff, the small stuff I have to do, I start a new sheet.

46:34 And then I write literally all then. It takes me like an hour. I generally do it on a Sunday. And there's never a time I actually go through that process on a Sunday where I don't connect Two or three dots or think of a new idea. That's my left brain. And that's why on the second sheet, which I can't remember if I should have a Yeah, we had the right brain, right?

46:51 And then I'm my right brain sheet, which is the second page, which is all my creative Ідея, стім. Business building ideas, people better leadership just whatever comes to mind Thinking about the current moment.

47:04 And when we start thinking about why are we here? How do we get here? That's kinda how I start to really dive into history and I just write stuff down and I track it and I've done that for twenty five years. So I have all my right brain thoughts over twenty five years, and what happens is I'll go back. And I'll look at'em.

47:23 Every year at the end of the year, I go back and read all my right brain thoughts and sometimes there are ideas that I had. From ten years ago, from fifteen years ago. That surfaces today and become relevant today. So I try to get my left brain on the first page, my right brain on the second, and then I try to Get'em working together. And again, it just helps me see things.

47:42 I want us just to clear thinking on so I can try to see the world not only for what it looks like today. What it's been But also where it might go and how can six streets be part of that. One of the things that stuck out to me seeing the actual sheet, I'm thinking about the left brain sheet where there's different boxes. I'm curious what the different boxes are. And one of the things that I

48:03 found very powerful was that One of the segments is a list of people to call. It was a crazy list. It was like a shitload of people and then like tons of strikeouts. And when you run out of space, you then copy it to another page, but you also copy over all the stuff that is lower turnover, I guess I would call it. And that act is like a big part of just embedding it in your brain.

48:24 The process of that So looking is part of it, but the best ideas come out of actually the process when I'm writing it all. So what are the other segments of that first page? So there's a list of people to call. There's like five or six boxes. I can't remember what they are. What are those boxes?

48:39 I think I told this last time. We have everyone affirmed our personal business plan. My personal business plan at the end of the year I've done for I don't know twenty five, thirty years. It takes me three weeks to do my personal business plan. And that's why I was said to you last time We spend all this time evaluating, do they have a business plan or not? And then most people do you have a business plan for yourself, they don't have one. That's why we make everyone in our firm do personal business plan. But from that personal business plan I do at the end of the year. I get a lot of clarity just from reading, going back to stuff I've read. What are my top five priorities of how I can drive the most impact?

49:11 Two Our firm, our investors, what are those absolute Complete clarity on what those five things are. And I have a box for each of those five things. So that's five boxes on each of those things. Then I have high priorities because again, those have different cadence to them. Everything has a different cadence, which is why I think you have to see everything together.

49:31 The boxes on the page. Change every year. Just like our themes every year change. Everything has to change everywhere because it goes back to adapting because the world's always changing so quickly. If you're not adapting yourself, then you're gonna get lost in this world.

49:46 So I'll have my five strategic priorities of my time. I'll have people I really want to focus on. Those could be internal, external. I also have on there my health because despite drinking this, I think about'cause I actually think I have to be healthy to be able to do my job. What would be an example of something that gets written down in health? I've got on there Vitamin D, I'm very focused on vitamin D.

50:09 I've got My left hip, I've had an old soccer injury, so I'm focused on left hip mobility. But it's something you just see every day. And it's constantly. Like there's different things it's also the personal side so I keep Balance.

50:23 It is an intention system, but it's also a return on time system and an ability to dynamically prioritize. Do you talk to younger people? Who are just coming up through the business, even some older people still don't know how to prioritize their time. It's really hard to do because you literally could spend all your time on one thing. So how to manage the time and just being able to see that in your brain or in the matrix. That's kinda how I think about it.

50:47 Another thing that Last time we talked really stuck in my head was I just turned forty and we were talking about the opportunity you have from age forty to fifty, which got me wondering about twenty to thirty and thirty to forty. If you think back on the major eras.

51:01 Of building and managing a life's work and a career. Tied to specific ages. What have you learned? Twenty to thirty for me was

51:10 Education. Morning just as much as I could. Asking as many dumb questions as possible. twenty three you think you know stuff, but if you haven't been through cycles or made a lot of mistakes and Seeing other people make mistakes and see people make good decisions and good long term decisions, short term decisions. You don't really know anything from your twenty to thirty.

51:30 Thirty to forty, you're incredibly ambitious, you're still learning, but you're trying to prove yourself. I started six street with my partners when I was thirty three or thirty four, so I didn't know what I didn't know. I mean, I knew a lot, but it's like You're going through that, but you haven't made enough mistakes. Yeah, to like refine everything.

51:51 And you get to forty or fifty, and forty or fifty it's like If you've spent time Learning, again, continue to learn. You've made enough mistakes. You really know who you are at that point, know who you are as an investor and how you approach things. It's prime time. You get to fifty and then you're trying to really focus on

52:10 being a mentor, developing the next generation. And just trying to provide that voice in the room, not only in terms of investing, but also Leadership, management, and really just trying to be a teacher to your team. But also a warner,'cause I still learn a lot from them. But forty to fifty

52:27 Let's go, Tom. In Go time, one of the questions that I've been asking everybody, because I'm just selfishly curious about it at this age feels like the right time to ask. is around the measurement of success. Kevin Kelly. one of the founders of Wired magazine has this amazing

52:41 idea which is like your success definition should be extremely bespoke to you. Traditional measures of success. our traps, money, power, fame, et cetera. And I heard a founder recently say something like He measure success through the degree of radical self respect.

52:55 Success means complete self respect. And obviously that then means lots of other things. But I'm so curious how if I'm going into prime time or something, I don't want to waste that. So the objective function of prime time needs to be success. That's good wisdom. Let's hit the mistake that

53:12 People fall into is this whole idea of money, fame. Fortune. What's you start To prioritize that, that's a cup that will never get filled. keep trying to fill the cup and the cup keeps getting bigger and bigger.

53:24 That cup never gets full. So I think that's one of the problems I think people make in our industry is that they think the cop even people say oh it's easy for you to say where you are now. This is something my dad taught me when I was Ten years old. So this is not new.

53:39 Was never the thing. For me it's like I just wanna do great Things be excellent and do it with great people that share my values. And do things the right way.

53:50 That's on the business side. And I want to do all that. In a way and be excellent. Not competing against anyone else, competing against ourselves. But do show in a way where On the best dad.

54:01 The best husband. And it's Getting one without the other. I just think you're gonna be eighty years old, you're looking at your mirror and what was the purpose of life? There's no purpose The purpose of life for me, and again

54:13 It's certainly not about the Cup. That's definitely never been it. It's about all those relationships you form and those experiences you go through with people. When you're eighty, eighty five years ago, you're looking back, hopefully I'm healthy because I've looked at my sheet. A lot of times and

54:28 It's those relationships and those experiences that I think drive to a fulfilled life and obviously it starts with your family, but I have a lot of Hawaiian friends, you're Huey. Hui is good for your group, your posse. having those experiences of climbing up the mountain together and that's

54:44 To me, what it's all about. And if you are around the right people, you have the clarity of purpose, you have the right values, you have the right culture, and you're going up the mountain together, it's so fun. And you never have to question first principles, how you're gonna do business trying to do the right way, and it's what we call clean living. But again, doing that at the expense of not spending time with your family, I think

55:05 That would be pretty unfulfilling to me. Last time I got to ask you my traditional closing questions, I have to come up with a new one this time. One of my favorite things from our first discussion, when you sent us the visual, which I love is the concept of facing the tiger. Maybe you can remind us what that means. I thought you were kidding in the conversation, but like literally off the elevator is a giant tiger in your office, which is so funny. I like the principle a lot, but I'm also curious what it means to apply that principle for you and Six Street.

55:31 Today in this fascinating dynamic environment. Face the Tiger, it's one of like the core ethos of Sixth Street, which is There's hard things in this world. We're gonna make mistakes, we're gonna have problems. But

55:46 When those problems happen, instead of pointing fingers We have just a scene from day one of our firm. Is that We look at the problems head on, we look at them together and we don't run from them. We run to them. We run right at them.

55:59 And that's what Face the Tiger is. For the environment we're in And this is what I Told our entire firm. Is that

56:08 We're in a world that The pace of change. Is Rapidly accelerating. And if you think the pace of change is accelerated now, it's gonna just continue and it continued to so which is why by the way from an investing standpoint going back to we said earlier, the idea that you're gonna have a narrow investment strategy when the world's changing so much.

56:28 You're gonna have oscillating supply demand dynamics of good time, bad time, like it's just crazy to raise it. or too narrow strategy unless you put a governor on the amount of capital raises. But I think the biggest thing when you look at the human being is human beings in general don't Change. There are small percentage that thrive in chaos and love it and step up like Michael Jordan. He love chaos, his heart rate's low and hit a game winning shot, but most human beings don't like change. And as we start to go through This pace of change, there's obviously a lot of anxiety, is AI is gonna take my job, is it not?

57:01 And our whole thing is You can sit there and be anxious about things or worry about things, you can be like, Hey This is what it is. The world's changing. We got to face the tiger. It's going to change. Whether we like it or not, it's going to happen. Yeah, there's stuff from AI, but what are you going to do about it? And that's what we say to people, it's like look, we gotta face the tiger and just remember you get

57:20 One life. Do you want to be average or do you want to be excellent? And that's how we talk to our people. You keep talking about it enough, and they get in the right headspace. So when change happens or their disruption or something goes wrong. They've got the tool that they can use. Let's say face the tiger to be able to approach it and we try to just get that in our firm.

57:39 I think I said this last time when proms happened, we're like good, let's go. Game time, let's go. And that's the way we've been since day one, and I think to some extent the way we are as people. I wish I could do this with you every year. I hope we do. Thank you so much for your time. Thank you so much, Patrick. Appreciate it. If you enjoyed this episode, visit Colossus.com. You'll find every episode of this podcast complete with hand edited transcripts. You can also subscribe to Colossus, our quarterly print, digital, and private audio publication featuring in-depth profiles of the founders, investors, and companies that we admire most. Learn at Colossus.com slash subscribe.

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