Episode #382: Dan Zwirn, Arena Investors – A Stoic Approach to Investing
Guest: Daniel Zwirn is the Chief Executive Officer and Chief Investment Officer of Arena Investors LP, a $3 billion global investment firm with offices in New York, London, San Francisco, Dublin, and Jacksonville focusing on global special situations, asset and credit investments in corporates, real estate, structured finance, and corporate securities.
Date Recorded: 12/15/2021 | Run-Time: 54:37
Summary: In today’s episode, we’re diving into the private credit market. Dan walks us through the process of sourcing private deals, the intricacies around structuring, and his framework for hedging currencies and commodities on a deal-by-deal basis. Then Dan explains why he thinks the CLO market is looking a little bubbly and the impact of COVID on his portfolio. Of course we talk about some examples of his recent deals, including one you’ll love hearing about with the AC Milan soccer club.
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Links from the Episode:
- 0:40 – Intro
- 1:26 – Welcome to our guest, Dan Zwirn
- 2:26 – The benefits of stoicism – Meditations, The Enchiridion, The Three Lives of James Madison
- 5:12 – Overview of Arena Investors
- 11:59 – Overview of investment and portfolio themes
- 15:46 – Dan’s view on diversification within credit markets
- 17:22 – How Dan finds opportunities in a world with so much liquidity and cash
- 19:29 – Why is there so much friction in the mortgage process?
- 23:11 – Structuring loans
- 24:13 – The secret sauce that allows Arena to scale their business
- 27:39 – Case studies of recent deals
- 30:43 – Risk management
- 33:37 – Navigating the pandemic
- 38:31 – Dipping his toes into sports franchise ownership
- 42:31 – What has been his most memorable investment
- 46:09 – Barbarians at the Gate, The Caesars Palace Coup
- 47:07 – Dan’s thoughts on the next decade
- 49:08 – Wisdom for the younger generation writ large
- 51:57 – Learn more about Dan; arenaco.com
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Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: What’s up, everybody? We got a fun show. Today our guest is the CEO and CIO of Arena Investors. A firm focused on global special situations in asset and credit investments. In today’s show, we’re diving into the private credit market. Our guest walks us through the process of sourcing private deals, everything from lending to fine art, airplane financing, real estate, oil and gas, litigation finance. Talk about the intricacies about structuring and his framework for hedging currencies and commodities on a deal by deal basis. He then explains what he thinks about the CLO market and how it’s looking a little bubbly, and the impact of COVID on his portfolio. Of course, we talked about some examples of recent deals, including one you’ll love hearing about with the AC Milan Soccer Club. Please enjoy this episode with Arena Investors’ Dan Zwirn. Dan, welcome to the show.
Dan: Thanks for having me.
Meb: Where do we find you at the end here? Happy Holidays, by the way, at the end of 2021.
Dan: Thank you. I’m in Manhattan, where things are slowing down quite a bit, both in business and in the schools and everything else. But the hatches are battened down. And we’re variously busy as investors and doing our business as you can imagine. So it’s a very interesting time.
Meb: Before we dive into all things investing, I had to hit you up your Twitter account, there’s a treasure trove of books, movies, things you like. What have you been consuming lately? I need some for the holidays to escape my family. My family doesn’t listen to this. So I can say that except for my mom. So, something I can read, movies I can watch with mom. What do you got for me?
Dan: Well, I would say I’m not actually holiday focused but if I’m talking about some of my favorite books of all time, they might be things like “The Meditations” by Marcus Aurelius and “The Enchiridion” by Epictetus. More new and recent, certainly, I just finished a fabulous biography of James Madison, which might seem a little long, but I would say, relative to this environment and this stage of where we are in the United States, it’s incredibly relevant.
Meb: Who’s the author on that one? Do you know?
Dan: A guy called Noah Feldman, who is a constitutional scholar at Harvard Law School.
Meb: We will add the show note links. I have that “Meditations” book on my bookshelf, and I’ve narrowed it down… I only have like 10 books left. My wife is a book hoarder. And I’m the opposite. Like, if I read something, I give it away to someone. I donate it, unless I’m going to reference it but I try to narrow down the books I’m actually going to read, otherwise, they just stack up for me. And so, that’s on the shelf. But my son who’s four, the other day, I said, “Anton,” I said, “I need a new book. Go grab me one.” And the little shit came back with Warren Piece. So, I said, “I promise. I’ll read whatever you bring back.” And it’s like a 1,000-page book. So I’m committed next year to read that sucker. Interesting. You were actually talking about, was it Epictetus? How do you say that? In one of your letters, weren’t you?
Dan: Yeah, well, certainly. I think I referenced on this, Epictetus or Epictetus, depending on what you prefer but “The Enchiridion,” which is just basically a manual, was put together by a student of his. And it’s a very thoughtful, short, but very insightful series of thoughts, encapsulating his view of stoicism and how it’s applied. Fundamentally, it is very good to live by, as well as guiding a lot of how we think about investing because in both instances, it’s very focused on being very crisp on differentiating those things that are under your control versus those things that are not. And quite frankly, most things are in the latter category.
And so, if you are very crisp about that, very refined in your thinking about it, hopefully, you’ll be precluded from either thinking that you know things that are not knowable or being too happy or too sad about things that are out of your control in the first place, and that are random, or a product of fortune, as he would say probably. It’s one that you can kind of go back to over and over and over because the messages never really stick in, in one shot. They need to be kind of repeated.
Meb: It’s a struggle for those of us who’ve been in markets long enough to know that humility ends up being a really core feature you have to have with markets. And we often say, to be a good investor, you have to be a good loser, meaning, whether your positions are in drawdowns or whether just that things don’t work out, you have to be able to deal with that. You know, that’s just a part of things. And I think a lot of people that crave certainty in that world, it’s hard for them on that side. All right, well, let’s start with investing, man. We haven’t done as many shows on your particular world of expertise. So I’m excited. And we’re going to go deep on a lot of different areas. Why don’t you guys give us just a broad overview of what you guys do at Arena. The other Arena was in the news this week that the stock just got acquired by Pfizer, I saw, but you guys are not that Arena. Tell us what about Arena Investors does and what’s your focus?
Dan: Sure. So we are an investment manager now closing in on $3 billion assets under management. We actually are connected to a public stock called Westaim that’s traded in Toronto. And that has some assets that we manage as well as the stake in our company, as well as a controlling ownership in a specialty PNC insurance business called Skyward that does very well. But within our core business, we fundamentally refer to ourselves as a global chaser of illiquidity. We want to in our main flagship funds, that’s the combination of, again, trying to put together a book that is collectively as uncorrelated with the overall market as possible and is as protected from idiosyncratic risk as possible through a combination of position diversity, as well as making sure that the things that we do are as uncorrelated with one another as possible.
And so, we have a pretty good ability to make sure that any given problem out there can’t hurt us too much. We can gain that diversity because we have a global network global enterprise, where we’re looking at virtually every permutation of industry, product, and geography. So we have a wide purview of things that we can look at. We have a whole series of probably 40 plus joint ventures with several 100 people around the world to give us very particular sourcing expertise to do these things. And they could be as much alone as buying of merchant assets as a quick trade or whatever it might be. And then we have a very extensive servicing infrastructure, a combination of people and processes in IT that allows us to kind of control all this in one shot.
And so it gives us a pretty good sense of what’s out there. And unlike most investment managers, who tend to know how to do a thing and want to promote that thing, and subject their investors potentially to some level of moral hazard, we have no a priori view on things because we’re not motivated to sell a particular thing. We just say we like to do with things the things that make sense and avoid those that don’t. And so we have absolute skin in the game and absolute alignment with our investors.
Meb: Easier said than done, of course, but it makes sense. And essentially, your business comes down to lending and finding recipients that will be good investments. And so, walk us through a high level, where you operate in this space. And eventually, and not just yet, I would like to walk through maybe a couple of examples because it’s fun. We pull up your position sheet, and it’s like 100 investments but it’s everything from something in North Carolina to something halfway across the world in different types. And I’d like to dig into a couple of just broad examples of, like, what it is. But just give us a broad overview of where you guys sit in this world?
Dan: I would step back to be a “lender” myopically is not necessarily a great position to be in because there are a very limited number of markets in the world where you can do an original issue per a loan, and assure yourself that you’re taking less risk than everybody else in the capital structure. So I would say we do lending but what we really do is we create convex situations. And sometimes we use the construct a loan to do it. And sometimes we might buy an asset that’s liquidating, or partner in various ways, that position are such that other people have, as or much more kind of skin in the game subordinate to us in some way, not whether it’s through a loan or not but we’re going to be in a position where if things go well in the situation, we’re going to be fine but if things go not as well on the situation, either for a micro or macro reason, we’re going to be just as fine or maybe even better. And that notion of convexity is a very big part of our business.
Meb: And it broadly aligns with concepts of sort of like trying to find a margin of safety, you know, where you picture the downside and actually think about it. And so many investors I think, struggle with this that mentally as they walk through the actual worst-case scenario, a lot of people think well, you know, this may not happen but like okay, let’s say this does happen specifically, what then transpires. And I think you kind of have to, right, and particularly in your situation?
Dan: Well, going back to stoics, there’s a term called Premeditatio Malorum, which means a kind of premeditate the downside, the bad stuff, and think it through. And when you combine that perspective with what is really deep value investing, the key differences is I can see that I’m buying that dime for a nickel or lending a nickel against a dime. But I can use structure, whether it’s a loan or something else to actually be able to capture that disparity. The problem that pure stock investors have with deep value is they can just be value forever. And thus, it’s kind of more like a roach motel.
Meb: I was laughing now, I wouldn’t have been laughing as much about a year ago. That reference is funnier now after values had a good run this past year. But for the prior 10 years, was probably a little too painful to even laugh about.
Dan: In addition to not doing macro, and in fact, for us not doing very mathematical investing, very quant stuff, we also don’t do things that require greater fools to save us. And so when you think about any PE, I think we have a pretty good sense of what the E is, when an asset or enterprise can produce in a series of earnings that you can kind of have a view as to the present value of. But with regard to what others might think of that, and whether they might be in the mood to take it off our hands at a higher price, it’s way outside our circle of competence and we have no edge on that. And so, we don’t do any investments that need that to happen.
That really keeps us in a position where when we’re making bets, so to speak, we’re betting on things that are under our control to resolve one way or another. And so, that is a very, very big difference from just being able to recognize a value disparity. It’s how do you recognize the value disparity and go get it and crystallize that delta. And that’s what we do. Whether it’s in a loan, or whether we’re liquidating from airplane engines or hypothecating tax liens or buying nonperforming loans in Southeast Asia, it’s all the same thing, lending a nickel against a dime, buying a dime for a nickel, and then catalyzing the capture of that spread.
Meb: Yeah. So at its core, it feels like “a simple business” but obviously, it’s not. Maybe walk us through some of your annual letter, which is great. We’ll post in the show notes links if it’s public. There’s like maybe five or six broad categories you guys are looking at when you’re thinking about themes. Maybe walk us through the categories and then also, we could probably dive into a few of them just to give some listeners actual concrete examples of what you actually mean, when we’re talking about some of these ideas.
Dan: We try to group these things into bucket, just as a way to kind of communicate what they are. And so our business really runs across corporate property, commercial and industrial assets and finance, structured finance, consumer assets, and securities of all kinds. And so, in each of those buckets, it’s our job to know not only what’s interesting but what is not interesting and to have no attachment to those circumstances changing, you know, even by 180. And so, right now, I would say in corporate, we’re focused on things like energy-related and commodity-related, corporate investments and corporate debt lending. We’re focused on smaller entrepreneur-owned businesses that need finance that can’t access cheap bank finance or cheap finance from BDCs or other kind of more asset management type product investors.
We’re focused on creating originators of credit of various sorts, idiosyncratic credit in corporate form, and things of that sort. What we don’t like is things like middle market lending to financial sponsors, leveraged buyout firms that’s been very over-competed. We don’t like the CLO space, either the left side or the right side of the balance sheet. Leveraged loans are one of the most overheated areas in the world. And the securities that finance them through the securitization markets are also terribly overpriced and badly structured in too long a duration and all kinds of unappealing stuff.
In property, we finance folks who need the money real quick, either from a defensive posture or an offensive posture. Folks, for instance, in COVID, who are building a new multifamily property near a research university. It’ll house biotech workers as they build. Or on the other side of it banks who say, “Nobody’s paying the rent, I got to get out of this loan before the end of the year, and we’ll buy that. And we’ll either extend it at a new price or we’ll foreclose on it or…
Meb: Go send over Fat Tony and collect.
Dan: Well, we are proactive as servicers and workout folks. Never gratuitous, and we always give the other person a chance to do the right thing. There’s a guy called Chuck Zito, who ran the Hells Angels. And he once said, “I never hit anybody who didn’t have it coming.” And so, we’ve always preferred someone to do the right thing, but if they don’t, then we’ll enforce.
Meb: I was laughing as you were talking about this because we had Nathan Myhrvold on the podcast and he was talking about some of his patents and he was joking with a friend and the guy’s like, “I’m worried you’re going to sue me.” And he goes, “Why? Are you stealing from me or something? Like, there’s a line that was just so on point that I thought was so accurate. But anyway, okay, keep going.
Dan: In commercial industrial, we do factoring, trade finance, entertainment finance, aviation, all manner of different ways to kind of lend against loans, lend against equipment, do leasing, things of that sort of all kinds. And so that could be things like, we’re very active in liquidating and converting aviation equipment with different partners. We’re a leading lender to filmmakers in Puerto Rico, where we are advancing against the tax credits that they’re issued without having exposure to the consumer adoption of the content, so to speak. We buy nonperforming pools of loans all around the world. We do various forms of insurance finance and we’re very active in litigation finance of all kinds around the world. So there’s a lot of stuff out there.
Meb: I should have asked you, when I preface this question, I sort of said, “Dan, what do you guys not invest in?”
Dan: Well, it’s the big three, Macro, Quant, and things that require a greater fool.
Meb: Is there a situation where someone, whether it’s y’all or one of your partners, and they surface a loan that’s like esoteric, I mean, is it like you guys have kind of looked at almost anything, it sounds like?
Dan: Well, we’re fortunate in that we have partners who have very unique collateral or geographic experience, all around the world. And so, it’s pretty likely that we know somebody who knows the arts, the film, the tax credit, you know, the country, whatever it is, who’s willing to write a check right with us in a hyper-aligned manner and frequently, someone who has decades of experience in a given type of thing that we’re going to partner with when those kind of more esoteric things arise. And furthermore, a lot of great investments arise when you need a combination of what otherwise would be very disparate capability.
So our securities folks might work with our energy folks to do a mineral rights related or royalty trust transaction in a small public company internationally or our structured finance people might work with our real estate people if there’s a combination of as there was recently of different forms of film production equipment leases mixed with a film studio, and, you know, financing both of those in a combination. So, a lot of these interesting investments come with these dueling capabilities that we may bring jointly to a situation to kind of understand it. But whatever we do, we’re always going to be the home team, not the tourists in the given situation. And if we don’t have some edge of that sort, we’re not going to be involved.
Meb: I’m going to play devil’s advocate, ask just like a very basic question. It feels like in a world of money washing around, maybe, I don’t know less so now than 6 months, 12 months ago, but where seemingly, money is available to most people and companies at pretty low rates, how do you guys find opportunities? You know, how are these companies not calling down to some local lender and finding something that, you know, 2% loan? How does this end up on y’alls plate and somebody from the University of Chicago or somebody would probably say is like, How is this not efficient to the point where you guys even have a reasonable risk-return, where you’re not just getting these hairballs that no one else wants, and it’s nasty?
Dan: Yeah, I’m not a big cap M fan. It’s a nice notion. It’s just not really what I see in the world. It presumes that the bounciness of security is a proxy for its intrinsic risk. But it may or may not be and there may be many other factors that drive that. And so what fundamentally happens in the world is yes, there’s an unbelievable amount of liquidity, we’re in probably one of the greatest bubbles that there had ever been. But ultimately, there’s a high correlation between the availability of that bubble money and size. The big driver of that wave of cash is, can that cash find a way to deploy itself in size?
And so that bias as alternatives become not alternative but mainstream and the deployment of capital and the aggregation of assets becomes the objective versus the quest for optimized return per unit of risk. It leaves in its wake all these opportunities that if you just want to make a great return per unit of risk, are just sitting there to be had if you can gather themselves up and gather them out. And then in the conventional financial system, right, banks, I don’t know when the last time you tried to get a loan from a bank was but it is brutal.
Meb: You are hitting on a topic we haven’t even talked to on the podcast recently that was, like, I tweeted this out, the mortgage process was quite possibly the dumbest experience I’ve ever been through in my entire life. And not to mention, like, the number of hours spent just sending hundreds probably of documents, not just like one or two, like hundreds of documents buying a house. And the quick summary was like wanted to get a mortgage, now own this house and wanted to not put down much because interest rates are so low on the mortgages. And they’re like, “You’ve been rejected because you own your own business and it’s a hedge fund. I was like, “Whoa, whoa, first of all, we don’t have a hedge fund. Second of all, we’ve been around for 15 years.” And I was like, whatever. I was like, “Can I talk to the people?” And they’re like, “No, it’s illegal to talk to the people doing that.” And I was like, “Well, they clearly don’t understand that we’re not a hedge fund.” So, who can I talk to? They are like, “Well, like no one, really.” And I was like, “Oh, my God.” I’m like, “All right, tell you what, how about we put half down?” And they’re like, “That doesn’t matter.” I’m like, “75% down?” And they go, “That doesn’t matter.” I’m like, “Isn’t that the only thing that matters?” I’m like, “What are you guys talking about?” It was just so dumb. I just could not believe in 2021, that this was the status. So every employee in my firm can get a mortgage, but I couldn’t.
Dan: Yes, well, many, many distortions of that exist. And so, as an example, we had several years ago post the GFC, we had a business lending to folks in Florida. And this is before salt was reduced and people started flooding into Florida, who were not U.S., citizens who are coming from Latin America and other places, and they were willing to put up significant capital. And so, instead of 80% loan to value and 10 to 30-year loan at 4%, we said, “Okay, how about 60% of value in a one to two-year loan at 13%?” And they were happy to take it because we could produce that in a couple of weeks. And it was vastly easier than what otherwise they would be facing for completely silly reasons.
And so, that aspect of what banks had become because, you know, look, they’ve learned lessons. If you were managing a credit institution with hundreds and hundreds and hundreds of billions of dollars and thousands of employees, you can’t leave it up to an idiosyncratic investor to make every credit decision. And so you have to use these very, very broad rules that nobody can veer from under pain of death, that effectively govern the way you provide credit. And knowing that on top of that, they’re going to be criticized in every possible way by regulators that kind of never leave your side.
And so, effectively, what it means is banks can’t lend to anybody who actually needs the money and a whole different world needs to be there to service. And that whole world, that alternative world is highly levered towards stocks and meeting $100 million, $200 million, $250 million opportunities to make it worth the while of the institution to kind of do the work and make the decision. So the question is, can we come in there in the middle and do these idiosyncratic decisions and make our business as efficient as possible in the way that it operates and is variable cost-efficient as possible in order to kind of go in the middle there and actually, properly price all that risk or actually, well, properly price it and then charge a premium for the service that we’re providing.
Meb: First of all, what’s the range on? Is it like a million on the low end, 100 million on the top end? Like, what are the traditional loans y’all package and what sort of duration?
Dan: Across the board in a very general sense, we’re exposing ourselves that kind of in a first position and assets, whether it’s a loan or not down to 65%-ish with a two-year duration, and an unlevered return of something like 17% to 18%. But it could be lower than that or higher than that as the risk changes. And frequently it comes with cheap optionality as extra in various forms.
Meb: But how big are the actual like…? Are these like…? What’s the size of these?
Dan: In an individual position, it could be, you know, call it 5 to 10 million up to 30 to 50 million but there’s a lot of things that we do, where we’ll find an area where we’re putting out half a million to a million at a time, but every couple of weeks in a kind of programmatic form with the right partner who is appropriately aligned with our interests.
Meb: What would you say is.. Special sauce may be not the right word, but when it comes to kind of the two… It feels like in my head, the two levers of really getting this right, the first being sourcing it, so actually finding the right opportunities because a little bit it is we talk a lot about this, like, frustration arbitrage where you’re finding something that doesn’t fit necessarily the normal mold of where all the money’s washing around. And then so there’s the finding it and sourcing it, but then also the structuring it. So creating a deal that is created in the right way that really drives, I assume the big risk of just not having something that goes to zero or having someone who’s not as worthy as you thought. Are they equally as important as one, like, much more of a challenge? Does it vary?
Dan: The sauce is really the freedom of mandate because you can’t scale this activity unless you can bring in as many variations of that disproportionate return per unit of risk situation as possible. It’s the sourcing, as you say, but sourcing that is enhanced by alignment of interest. Everybody will source for it but you say, “Well, how much are you putting in, and then suddenly, everyone gets alligator arms.” And so, we want folks who have extreme domain capability and are willing to really bet their personal circumstances on their ability and domain capability.
And then the last piece is that servicing function, and that can mean structuring things the right way that puts you in a position to be able to recover your investment or deal with it if it’s not the right thing or how we monitor, how frequently people have to deal with us. We like you to pay every month. It’s something. We like you to report every month. We like to have a lot of discretion as to how things are going to go, which per your quote from Nathan Myhrvold should be no problem as long as you’re delivering the goods. In some ways, it’s a little bit like running a casino. So we have cameras kind of everywhere. And we’re very, very focused on the details. But if you’re executing appropriately and we’re doing our job, it’ll be great.
Meb: How do investors access? Is this institutional only? Do you guys have any public funds or give exposure to any of the work you’re doing?
Dan: Today it is primarily institutional. We have a series of funds, some of which are kind of flagship go-anywhere types. So for institution, some are drawdown structures, some are open-ended but still has a liability match. We also have funds that we call excess capacity where there’s an area that’s particularly compelling and there’s so much to do relative to our resources that we need kind of extra money just for that. And then there are things that we call stable income, where we’re able to deliver edge, but not at the return level on an absolute basis that would warrant full alternative fee structure. So we do things in commercial mortgages and ABS, etc. where we’re kind of able to gain an edge.
The only real as a kind of retail investor, we obviously, one has exposure to both assets that we manage, as well as our manager through Westaim stock. And that reports quarterly on the TSX. And we have our all day, which makes you think, Southside coverage, and we do our annual shareholders meeting and things of that sort. And so, certain people who get it sometimes actually do both. They are institutions that invest in our funds, but they also go, “Wait a second, I can be your partner, too and buy the stock of Westaim as well.
Meb: And so let’s say there is an institution listening, what’s the minimum? Million, 10 million, 100 million? What gets you in the door?
Dan: It depends. It depends. Our marketing guys drive that process but, you know, it’s typically 5 million.
Meb: I always like hearing specific examples, and you don’t have to mention the names of the parties, but would love to hear… Because this is not an asset that most investors can actually participate in. Like, if I want to go lend to an aircraft company that’s not really available. The coolest part about y’alls, listeners we’ll post this show note links there, some of the positions sheet, it’s like the dream of uncorrelated sort of stuff everywhere, aircraft engines, fine art, oil and gas, venture loan. I mean on and on, sports team. I was trying to talk the other day about someone to buy my Denver Broncos so that they can have some new ownership.
Maybe walkthrough, and I’d like to hear an example of both maybe traditional, something that worked out or just like a normal or abnormal investment, what you thought about at the time, how you protect your downside, how you guys do the modeling. So you mentioned something like having some of these, like, when it doesn’t work out, like, you have to actually go deal with it. To me, that’s not a trip, I wouldn’t ignore. But again, then on the flip side, maybe one that did get hairy and how it kind of played out and how you guys actually kind of had to deal with it. It’s easy if people were just paying you but if they’re not, it gets a little more work.
Dan: Well, so as one example, we were in the oil and gas space where there’s a lot of opportunity. A lot of people have traditionally, both lenders and owners get pretty passionate and start to think that they know where oil and gas prices were going. And as soon as they think that is really when things get ugly. And there was a large bankruptcy in Colorado over an oil and gas company. And there was a kind of pass it in there that was interesting. And we said, “Okay, it’s going to face a bankruptcy auction. Maybe someone will want to buy. We’ll lend a certain amount on it.” And based on hedging the commodity price, so we’re not really taking commodity price bet at all, there’s just kind of a by the pound amount of commodity there that can be sold forward, we’re using derivatives. And we’re happy to lend X on it to make, you know, call it 15% to 20%, a one or two-year transaction that enforces hedging.
And over a weekend, it turned out, it didn’t look like anyone was showing up. And so we said, “Okay, well, we’ll just buy this at a level that we would otherwise happily lend it with.” And then we kind of get all the upside too and do the hedging. We brought in a couple of guys who could administer it more efficiently than it had been before. And we changed its name and we kind of cleaned it up a bit. And then out of the bankruptcy with a new name and a new manager, etc., we then went around to the banks and said, “Hey, we got a nice oil and gas company, who wants to lend. It’s now a clean, no bankruptcy, new name.
A couple of banks were interested and we basically borrowed our whole bases out and ended up owning the company for nothing. And so, you know, we’ll find things like that, you know, to your point, there’s a lot of hit somebody rules that couldn’t be in bankruptcy, and there was no operator, and all these other things. We kind of clean those things up that had nothing to do with intrinsic value. And then people said, “Oh, now it’s a company and I want to lend to it.” I was like, great.
Meb: As you think about, you mentioned the Macro side earlier but, you know, obviously, there are some tides that affect… I mean, you have a diverse portfolio, and most of the risks are very specific to the individual company or situation. However, there are some broad trends that happen with markets over time, bear markets and bull markets, high valuations, low valuations, everything in between. I’ve heard you mention before, and you can kind of talk to this, and you just actually referenced derivatives a little bit too. Is there any ways you think about the portfolio where there are risks that permeate across the entire book, that were you? Do you ever think about hedging any of that or is that just not an idea? How do you think about things that maybe not that you can’t control, but that are outside of the specific deal parameters that may affect it? I mean, my God, we just went through one last year, I guess, a pandemic. So, maybe just talk to that whole general concept of how you think about that macro and some of these risks?
Dan: Well, in any given situation, if we had rate risk, we would hedge it, although, given our duration, we really don’t. But we do hedge currency and we do hedge commodity because we don’t have any kind of differentiated view of those things. There are situations where I would say we are aware of what I would call semi-systematic risk. So as an example, in Puerto Rico, at the same time, we were investors in distressed residential mortgages, distressed consumer, distressed corporate, film finance as I mentioned against tax credits, as well as some businesses. And so, among those things, there was relatively little correlation. But at some point, the viability of the entire island starts to matter to you.
And so when it got too much past, call it mid-single digits percent cumulatively, even when we had more to do in those areas with great partners that we respected, it was kind of enough. And so we’re kind of always on the watch for what we would call semi-systematic risk arising. It starts to look like a Macro exposure. And so we’re going to make sure we keep spreading out by geography by product type, by partner and counterparty in every which way we can. No one’s ever fully immune but hopefully, we are the last man standing when some Macro tidal wave occurs. And furthermore, within all those structures, as I mentioned, there’s typically 20% to 50% of somebody else’s capital beneath us or value beneath us. And so that can really put you in a position to absorb a lot of shock, whether it’s idiosyncratic or Macro. And so that stacking of risk protects us quite a bit as well.
Meb: So what was last year like? Because I imagine, you know, there obviously, were entire industries that were extremely stressed. Was that a hard year to navigate? Was it specific to certain setups? Was it something that you guys kind of waited through? What was the experience?
Dan: Well, offence and defense. You know, on the offensive side, we had a lot of convertible and credit arbitrage that was set up effectively as a structured, long put option that would have worked had not Jerome Powell interfered so much in the late part of March 2020. So that didn’t work, but it was well set up. But then what we had when the markets really kind of had the issues is that in a number of instances, there was suddenly for the first time in a long time, within original issue convertible structures, there was a lot of cheap volatility to be monetized through a providing credit, backed in various ways by the stock of big public companies. And so that was very interesting.
I would say in terms of the mortgage market and leveraged loans at ABS, it didn’t get more than a third to halfway down to where it would have been had it been left untouched by the Fed. And when you look on an apples to apples basis, at 2020, and put it against the 08, 01, 02, 98, 94, we weren’t really close to where we were going and where we may very well end up again. On the defensive side, we certainly had some borrowers or counterparties that had issues. In most of those situations, basically, things turned out okay. Didn’t turn out great for some of those folks who had that subordinated risk on because we needed that value in order to make sure we were covered.
But we didn’t end up actually taking anyone over or anything over that we otherwise weren’t on track to take over anyway. So, we had some great operator partners who needed a little bit of wiggle room to kind of maneuver. And they had shown us that they knew how to maneuver and we gave them the ability to kind of get that done and be successful. We had others who were like, “Yeah, it’s a tough situation and we don’t want to bear any of this. We want you to bear it.” And we said, “No, we’re going to have to do something else.” And we went down that path as well. So, it was certainly labor-intensive, certainly in the first few months after COVID really hit, but certainly could have been a lot worse for the world in the markets. And the seeds of future issues may have very well been sown in response to March 2020, as it occurred.
Meb: As you kind of like look around the world today, and at the end of 2021, look out to the future, what does the world look like? And I guess my question, particularly is thinking about, like, do you see more opportunity abroad because you guys tend to be a pretty global shop or is it particular sectors that seem interesting, or worrisome, or just any general thoughts as we roll the calendar over?
Dan: As I mentioned, a lot of it is sighs no matter where you are. And when it’s kind of that sub 100 million at a shot area, it can get very interesting because not many people care. I would say, Japan showed us that you could have bad monetary policy for an extended period of time and kind of muddle your way through for years and years, and maybe decades. But when you combine that with really poor fiscal policy, and you create inflation, and more importantly, the expectation of inflation, which we have now, you’re in a real tough position because arithmetically, either that inflation is going to escalate and kind of trigger what ultimately will lead to stagflation and/or there will be a monetary response, that itself will potentially reduce the inflation but cause other issues.
And so, in a world where, as an example risk-free went up 300 basis points and credit spreads went up 300 basis points, which not so much, really, it’s not like a crazy number, and they’re correlated, you would be talking about trillions of dollars of equity loss. And I think we are more at risk of that, than we have been in a long, long time since the late ’60s and how they created the ’70s. And I think a feature of all inflation driven pre-panics is the proliferation of investments whose sole source of perception of value is that someone else will buy it from me more expensively. And from crypto to NFTs, to leverage loans to parts of real estate, to art and to many other things, I don’t think we’ve ever seen the volume of things that I hope someone will buy from me at a higher price ever exist. And so, from our perspective, that means we want to do things that stay right in our box in terms of risk-reward that don’t have access to those big and easy dollars so that when and if the tide goes out, our opportunities say goes from large to large square.
Meb: Are you an Italian soccer fan yet? You’re going to go and see some games this year? What’s the story?
Dan: I have seen one, and maybe I should be embarrassed to say, one live. I’d see a lot on TV. But as was publicly mentioned in certain places, we helped arrange and partnered with a much bigger partner alone to one of the premier soccer teams in Europe called AC Milan, which is number two right now in the Series A, which is the national League of Italy, the highest level national league of Italy. And it had been purchased by a Chinese group of buyers, purchased it from the former prime minister. They put up half the money. It was over 600 million euros and they had some issues where they couldn’t close. And so we arranged a loan that other much larger partner joined us with and we effectively became their partner given their size.
And we said, “Okay, we’ll give you half the money in order to close and we’ll charge a very, very high rate of return and pardon the team and other things.” And the owner put in more money to kind of help support the team but it wasn’t that efficiently managed, other things. And so, kind of over a weekend, they decided they didn’t want to support it anymore. And so, our partner and we took it over. We’ve owned it since. And it’s now running on a much stronger footing. Everybody’s playing a lot better and with efficient player contracts. At headquarters, it’s been appropriately financed, and plans for a very significant stadium that are well-publicized in partnership with a crosstown rival, which is called Inter Milan.
And so, things are pretty good. And to my knowledge of the big five European leagues, that AC has the youngest team among those 100 teams in Europe, while competing at a very, very high level, in fact, having been most recently in the Champions League. So, we had a very, very large margin of safety there with our borrower that put us in a position such that we’ve been able to handle the vicissitudes of sports franchise ownership, which in a world like soccer, where you have the notion of promotion and relegation is a very complex one. And in my hometown, in Pittsburgh has a sadly very horrible baseball team called the Pirates.
Meb: But a beautiful stadium.
Dan: It is beautiful. But if there was relegation, they might be like playing high schools right now. Nothing forces them to really optimize the product they put on the field. Whereas in Europe, you are laser, laser-focused because if you blink, you’re in the minor leagues. It keeps everybody very sharp. And so, it’s been a successful investment, ultimately, but had the usual kind of convexity dynamics that we like to see, which is, if things go well, we make a nice return. And if things don’t go as well, we still make a nice return.
Meb: That was a little too close to home almost. My fantasy football league just adopted relegation and I almost got booted. I’m always terrible. So there are certain sports analytics, where I can use my quant abilities but the problem with fantasy football is you have to be too active. Like, I need to legally just draft the beginning and you can just never change after that. I feel like I would do okay, but having to like monitor and change lineup, it’s my nightmare. I’m too airheaded about tracking it, but I didn’t. So, I’m just a perennial loser on the other hand,
Dan: My 11-year-old just won the league against basically the fathers of his friends and he is training to be a GM, I think at some point.
Meb: That’s awesome. Well, it’s such a fun area. I mean, there’s so many developments and analogies and it’s fun to watch how things I mean, just Steph Curry just set the three-point record on how things change over the years and a lot of market analogies in there. Anyway, when I make it over to Italy, I’m going to have to hit up a game. I’ve only been in some pretty minor soccer games thus far. My wife used to live in Bologna. We may be there. I really want to get over to ski in the Dolomites. But travel this Christmas looks a little questionable an early part of this year. So, a lot of domestic U.S. skiing I’m hoping for, but would love to see a game. As you look back on your career, what’s been your most memorable investment? I mean, you’ve probably done I don’t know, certainly hundreds of investments.
Dan: Almost 3,000.
Meb: Geez, what stands out? You can tell a couple if you want. But any stories in particular that are super meaningful. I mean, my God, just looking at your position sheet, there’s probably 40 that are more esoteric than probably anything I’ve ever done. But what comes to mind? Anything stick out?
Dan: As an example, there was one where another party was buying apartments from the government of Germany, and they needed a partner very, very quickly. And I was at a larger entity at the time. And so we in very great haste provided them a backstop for 400 million euros, and for our trouble, took 100 million ourselves and ended up at post securitization and privatization, and then taking it back public again, we made quite a bit of money. But a lot of those things are these situations that really come up last seconds, come up out of nowhere, and where you need to move a lot of resources and a lot of intellectual property, and a lot of documentation, and a lot of capital very, very quickly.
But the reward is that you get a very, very asymmetric return being a risk opportunity. But I started writing the heat of the Asian crisis in ’98. And there was no trade to be had for five months, suddenly whole different of opportunity set arose. So it just really depends. But a lot of those situations really taught me the value of digging deep and doing your work and showing up. I mean, so many, many years ago, I was a debt investor in I think Panini, if your son collects those sticker books, you know, on the different team, and it was owned by Marvel at the time. And the company wasn’t really that responsive.
So, I spoke to the guy running Marvel at the time and said, “Hey, I’d like to just find out about Panini. I’d like to go meet the guys or whatever.” And he said, “Nah, we don’t feel like having to do that.” And so I said to my boss, “We are a creditor, we have a right. It feels to me like we should just introduce ourselves.” And so I just flew to Modena and showed up at their front door. What you learn is if you’re a stakeholder, you have either explicit or implicit rights. And if you knock on the front door and particularly without any issues around MNTI, etc, this is banked at land, it’s not public information, so to speak, I mean, you just ask questions, a lot of people will just help you if you just do the work, do the primary work, and are inquisitive and have done your homework already to kind of make sure you don’t waste people’s time.
Meb: You know, Marvel’s a fun story. I remember there was a great book, we’ll add it to the show note links, I can’t remember the name of it. I love reading all the old vulture distressed debt books like “Icahn” and we talked a couple of podcasts ago about some of the tobacco. I went to high school in North Carolina. So the Reynolds was very close, the barbarians at the gate. But there was a Marvel book that talked about their whole battle. And there’s so much intrigue and just people involved in a lot of these situations. For a long time as a young guy, that was like my best performing investment ever was Marvel stock. It was like low, tiny single digits when no one wanted it back in the day. So I have some fond memories there too. But that’s fun to watch. And here we are with “Spider-Man,” everything else coming out this week that…
Dan: I would say if you like stories like that, I’m a bit of a geek for those kinds of things too. And there was a recent book called “Caesar’s Palace Coup.” I don’t know if you read that. But if you like barbarians at the gate, I would venture to say this might be better. And it was really, really well done and really thoughtful for both institutional and even retail investors. It gives a very good picture of what a kind of large scale restructuring looks like and feels like.
Meb: And the funny thing I just added that watching the show note links, I added it to my queue, it’s also so much work. It’s easy, just go listeners go online and buy a stock, right or, you know, do an angel investment even in these days, or to buy some crypto, or whatever it is, but, like, some of these really airy stories are so complicated and just like thousands of pages of legal and everything else. My God, kudos to them. And that’s one of the reasons that people can earn some outsized returns their…
Dan: Law firms definitely like us. They’re pretty excited. Quite a fee string.
Meb: Yeah. You’ve been around for a few different crises, you’ve seen the evolution of the hedge fund industry, in general. As you look to the future, we see a lot of seas changing with everything going on in the world. Any thoughts as we look out over the next decade thinking about your career and thinking about what the future looks like? What’s on your brain? Anything you’re particularly excited or worried about that we haven’t talked about?
Dan: I think investors will increasingly be in a position to have to demand Alpha. Price taking should be really a business service provided for at a cost-plus, whether that’s inequities, or debt, or anything else. It’s just meeting the market, ultimately, that’ll be competed down to an act of service provision. And I think you’ll see that more and more. On the other side, you will see able capital providers with increasing levels of nimbleness be on the other end, but you’re going to have to prove it. And it’s going to take a lot of infrastructure. It’s not just because I happen to be smart and I’ll out-think the other guy. There’s got to be a reason for your adjustments just like any other business.
And the things that govern what makes it good or bad business from a buffet-style perspective are going to be those who are successful in the price making versus the price taking business within asset management. And, you know, importantly, I think gravity still exists and panics are not going out of existence. And we’re going to see the results of what has been really, really distorted monetary policy now for almost a decade. And what is really unprecedented levels of spending at the same time, there’s going to be something that people are going to write books and dissertations about coming.
Meb: I think you are a fellow, well, engineer, undergrad, you did MBA too? Is that right? Computer science, was that right?
Dan: I did finance accounting in my own concentration and restructurings at Wharton. But I also went to the engineering school for computer science, and then later I went to Harvard for an MBA, a decent amount of schooling.
Meb: For the younger crowd listening in, any wisdom to impart, whether it’s career-related or whether it’s investing related? You kind of reference we haven’t really had much of an actual bear market in a decade. The financial crisis for many is a distant memory. The pandemic was so fast it feels like most didn’t even really get to experience much of the down and back up. Any general thoughts or anything you’ve kind of changed your mind of since the early days that you would reflect on?
Dan: Yeah. Well, I would say for younger folks, don’t be millennial in any way, and work extra hard, and be extra dedicated, and be extra focused. And I would say, don’t think it’s going to be this easy. This is a very, very strange time. And I think people take for granted how easy it is to get a great job, how easy it is to get great training, the need for schooling, in addition to kind of on the job training, I think there’s a lot of great education to be had. And when you have an environment like today, it’s easy to forget that.. It’s good to create what I call a pedestal of pedigree. If you can go to get great education, on the job and off the job, it’ll endure to your benefit, not only in terms of the practical skills you gain, but also your ability to take negative outcomes and kind of recover from it and be resilient. And so, in some ways, even living through COVID is there are worse things to live through. I mean, it’s not good, but it’s not showing up on the beaches of Normandy.
Meb: Yeah, our parents’ generation, it’s the opposite. One of my favorite memes during the pandemic was something along the lines of, like, we had to storm the beaches of Normandy like you’re literally just being asked to sit on your couch. This was when like quarantine was happening is like, I can just kick you know, can you do this? But yeah. Dan, this has been a blast. Where do people find out more about y’all, good place to go? Where do they catch more your views and what’s going on with your firm in the world?
Dan: Sure. We have www.arenaco.com and www.westaim.com, our affiliate in Canada, as well as our Twitter feed, and other social media presences that we have.
Meb: Awesome. We’ll post the links to the show notes. Dan, thanks so much for joining us today.
Dan: You’re welcome. Nice to talk to you.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.