Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy, Alan Waxman
[00:00:00] S0: What's the range of so what's here? I can imagine one so what is like, "Tough shit, you can't have your money back," and the world keeps spinning. Another is something dangerous and scary and systemic because past financial crises have tended to be downstream of some domino, like private BDCs or whatever it is. Each time it's different. What do you think the range of implications of all this is? [00:00:00] S1: I don't think this is a systemic issue yet, for two reasons. One, 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 I don't think this is systemic. It could turn out that way, but that's actually not what I think is going to happen. I do think there needs to be a major recalibration of behaviors, in the way that people approach this wealth channel, because if you go back to what we talked about earlier, any time society or finance system puts wealth or retail individuals next to principal risk-taking, if you look throughout history, 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 it's starting to become more asset liability mismatched. But when you look at the quantum of the problem, at least as it specifically relates to this, it's pretty small in the grand scheme of things.
· Alan Waxman, Patrick O'Shaughnessy
[00:00:00] S1: I don't think this is a systemic issue yet, for two reasons. One, 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 I don't think this is systemic. It could turn out that way, but that's actually not what I think is going to happen. I do think there needs to be a major recalibration of behaviors, in the way that people approach this wealth channel, because if you go back to what we talked about earlier, any time society or finance system puts wealth or retail individuals next to principal risk-taking, if you look throughout history, 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 it's starting to become more asset liability mismatched. But when you look at the quantum of the problem, at least as it specifically relates to this, it's pretty small in the grand scheme of things. [00:00:00] S0: So what's going on is, in private markets, in the wealth channel, very small allocations to private investments, historically one to two percent. And that channel is smart. They see that value creation and returns are happening without them in private markets. They want access to it. Seems fair. That two percent is expected to go wherever, 10 plus percent in the decade to come. So I guess the question is, how can we do it responsibly?
· Alan Waxman
[00:00:00] S1: If you are going to raise a narrow strategy, just direct lending 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. But again, because flows come in in procyclical times, if you only have a $100 million vehicle, maybe it's always a good time to invest. But if you have a much larger vehicle, it just gets really hard because maybe it's a good time to invest, maybe it's not. And that's why I think where this will go responsibly, I think you're going to 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 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 a pretty good time to invest. And it oscillates within each ecosystem all the time. So I just think you want a wide aperture. But if you're going to do that, you can't just all of a sudden show up, which is probably what's going to happen after this week. Everyone's going to show up and say, oh, I'm a multi-strategy private capital fund. I'm going to do whatever. Well, yeah, you got to be able to do it, but you also got to have 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. And I think those are the key attributes that 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 2008 crisis, 1929. And if you're comfortable keeping it invested, then you're probably a suitable investor.
· Patrick O'Shaughnessy, Alan Waxman
[00:00:00] S0: You said before that maybe System 3 could be the Goldilocks scenario. I was always interested around financial crises and 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. 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 going to take advantage of the ability to raise more money forever, unless the responsibility is mandated or regulated or more clearly laid out. Do you think we have some evolution still to do to create the Goldilocks scenario? [00:00:00] S1: I think that's what really needs to be thought about. I think that's going to 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 it's not the right guardrail and it's not good for competitiveness and it creates the next crisis. The best answer is a market mechanism, like you have with institutional investors, where if you do irresponsible things or you're not a good investor, if you change your business model, they're going to punish you by not giving you money for your next fund.
· Alan Waxman, Patrick O'Shaughnessy
[00:00:00] S1: I think that's what really needs to be thought about. I think that's going to 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 it's not the right guardrail and it's not good for competitiveness and it creates the next crisis. The best answer is a market mechanism, like you have with institutional investors, where if you do irresponsible things or you're not a good investor, if you change your business model, they're going to punish you by not giving you money for your next fund. [00:00:00] S0: 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 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 maintain an underwriting standard that's extraordinary or however you want to define it. Any other major advice that you'd give to people running investment firms, or just principles you have from building Sixth Street that flow from all this history and thinking?
· Alan Waxman
[00:00:00] S1: First, what's your clarity of purpose? What's your day one clarity of purpose? Does that say consistent over time? Is your clarity of 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 is something we talk a lot about at Sixth Street, is that if you look at all the great companies that have been around for a long time, they got one thing right. They never forgot what their purpose was, which is to serve their customers. It's enticing to raise a bunch of money. It's enticing once you raise it to invest a lot of money. That doesn't mean that you have to do it. Sixth Street, we're a 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 track records. We've been here longer than – in direct lending, I started the direct lending business in 2001 when there was only two of us. So we've watched this and we could have gone to the wealth channel and raised all the same vehicles because of our track record. And we have – you know how many dollars of perpetual private BDCs we have? Exactly zero. 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 got to block out that noise and it always comes back to first principles of 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 going to be here for a long time, not short-termism.