Jeff Aronson – Building Centerbridge Across the Capital Structure (EP.468)

Jeff Aronson is Co-Founder and Managing Principal of Centerbridge Partners, a $43 billion alternative investment firm he started in 2005 after two decades at Angelo Gordon. Jeff's career spans forty years of investing across credit and private equity through multiple market cycles, giving him a front-row seat to the evolution of the alternatives industry. Our conversation covers Jeff's path from law school to distressed investing, lessons learned under mentors John Angelo and Michael Gordon, and the founding of Centerbridge with Mark Gallogly to bridge the worlds of private equity and credit. We discuss the firm's distinctive model of investing on both sides of the balance sheet in sector teams, building culture and compensation systems to reinforce collaboration, and adapting strategy through changing credit environments. Jeff also shares his perspectives on late-cycle market behavior, the shifting dynamics of private credit, partnerships with insurers and banks, and the challenge of staying differentiated as alternatives become mainstream. From our sponsor, Morningstar Embrace the global language of investment data https://www.morningstar.com/business/campaigns/where-data-speaks?dclid=CMTbg_DasI8DFaE6aAgdWtUfiw&gad_source=7&utm_campaign=crp_gl_n_n_en_2509_tf_n_wds_capitalallocatorsscript2&utm_content=audio_240530177&utm_medium=audio&utm_source=capitalallocators&utm_term=420544243 Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (⁠ https://thepodcastconsultant.com/https://thepodcastconsultant.com https://thepodcastconsultant.com/⁠ https://thepodcastconsultant.com/)

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  When you're on a hot streak like that and you think you can do no wrong, risk is rising, even though mentally you're thinking, oh, I must be good. I got this. I got it covered.

• 0:17Ted Seides?

  I'm Ted Seides and this is Capital Allocators. My guest on today's show is Jeff Aronson, co-founder and managing principal of Centerbridge Partners, a $43 billion alternative investment firm he started in 2005 after two decades at Angelo Gordon. Jeff's career spans 40 years of investing across credit and private equity through multiple market cycles, giving him a front row seat to the evolution of the alternatives industry. Our conversation covers Jeff's path from law school to distressed investing, lessons learned under mentors John Angelo and Michael Gordon, and the founding of Centerbridge with Mark Gallogly to bridge the worlds of private equity and credit.

• 1:03Ted Seides?

  We discuss the firm's distinctive model of investing on both sides of the balance sheet and sector teams, building culture and compensation systems to reinforce collaboration, and adapting strategy through changing credit environments. Jeff also shares his perspectives on late cycle market behavior, the shifting dynamics of private credit, partnerships with insurers and banks, and the challenge of staying differentiated as alternatives become mainstream. I hope you enjoy the show, and if you do, this week, why not reach out to your parents? If they're anything like my folks, they probably aren't that technologically inclined and might need to learn how to use the podcast app on their phone. Reach out to them, send your love, and show them how to use the app,

• 1:47Ted Seides?

  and then tell them you might want to listen to Capital Allocators. Thanks so much for spreading the word. Capital Allocators is brought to you by AlphaSense. Every allocator sits at their desk for hours preparing the work around investment decisions, getting up to speed on a new theme, prepping for the next investment committee meeting, and tracking what changes across an entire portfolio. AlphaSense just launched something built to help. It's called SuperAnalyst, an always-on agent that works like a power user on your behalf. It draws on over 500 million premium sources, including broker research, expert transcripts, company filings, and earnings calls, and keeps working long after you've gone home for the day.

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• 5:14Speaker 02

  Please enjoy my conversation with Jeff Aronson. Jeff, excited to do this with you.

• 5:21Speaker 00

  Me too.

• 5:22Speaker 02

  Why don't you take me back to your upbringing?

• 5:24Speaker 00

  I was raised in suburban Boston, a town called Needham, Mass. My mom and dad were from Springfield, Mass., Western Massachusetts. That's why I don't have a Boston accent. My dad was an educator. He was a teacher. He was a coach. My dad taught gym, physical education, at junior high school in Needham. I remember when I was eight, we moved to Washington State and my father had a job there for a year, literally a town in the middle of nowhere. They were known for their rodeo. That was about it. Then we moved back a year later and my dad worked at Needham High School.

• 6:05Speaker 00

  Then he eventually got a job again in physical education at Lowell Tech, which became University of Mass. at Lowell. And we were a very middle-class family. We never had a lot, but we always had enough. And I have a brother who's five years younger than me. He also lives here in New York City. Very ordinary upbringing with a split level house and all that stuff.

• 6:31Speaker 02

  Were there any lessons you remember from your dad as a coach that he imparted on you guys as kids?

• 6:37Speaker 00

  He never pushed me, nor my brother for that matter, into athletics. He was highly, highly conscious of not doing that. My father had been a great athlete all his life. He was a boxer. He was a gymnast at the highest competitive level. He probably realized his sons didn't get that gene, but to his credit, he never pushed us. It's a lesson, but you don't push people beyond their capabilities. Put someone in a position where they can't succeed. And I suspect he thought, I would love for my son to be a division one athlete. It wasn't going to happen.

• 7:14Speaker 02

  So as you went through school, you got on the law track. What were your thoughts of your capabilities at the time?

• 7:22Speaker 00

  I went to college at Johns Hopkins. I was always interested in government and public policy. And I liked the fact Baltimore is close to Washington, so I thought that was cool. I knew nothing about being a lawyer. I thought if I was interested in government and policy, law school made sense. I got into a bunch of law schools. I got a big scholarship at NYU, so I said, that sounded good. Law school was enjoyable. I made a lot of great friends there. I said it was another three years of college. I learned what it was like to understand the law, but I had no idea what it was like to practice law. I found myself in a job at a big law firm. This is in 1984 and it was like, oh, it wasn't what I thought. I had this vision.

• 8:07Speaker 00

  I was going to practice international law. I thought I would fly to London and I would negotiate a deal and stay in a beautiful hotel. I learned international law meant staying up all night in an office building downtown, poring through a stack of documents, looking for typos. This was not for me.

• 8:25Speaker 02

  So what'd you do?

• 8:26Speaker 00

  I spent the first year working incredibly hard. I spent the second year working incredibly hard at both my job and looking for a new job. I found a job in the legal department as an in-house lawyer. At a small investment bank, it was called LF Rothschild Unterberg Tobin. I was in my mid twenties, I didn't know anything, but my job was to effectively be the in-house counsel to the team that managed the firm's proprietary capital. That team had a couple of strategies. One was, it's now called merger arbitrage, it used to be called risk arbitrage.

• 9:08Speaker 00

  They also invested in bankruptcies, event-driven. They also had a convertible bond hedging strategy, buying converts, shoring stock against it. And the two people who ran that department were John Angelo and Michael Gordon.

• 9:21Speaker 02

  Familiar names.

• 9:23Speaker 00

  I really liked working with them. I tried to befriend them, even though I didn't want to be a lawyer. I consider myself a super lucky person, although I don't have a superstitious bone in my body. The stock market crashed in 1987. That led to the demise of LF Rothschild, eventually went bankrupt. So I'm thinking, I'm an in-house lawyer, I don't want to be a lawyer. The firm that I worked at just went broke. I was newly married and I had student loans up to my neck. I'm screwed. John Angelo and Michael Gordon said they were going to start their own firm. And I said, give me a chance, I want to become an analyst. Michael Gordon joked, but maybe a little half-serious, well, you're a lawyer, you don't know anything about math.

• 10:07Speaker 00

  And I said, I'm decent at math, just give me a chance, I'll work for free. They took a chance on me and it all worked out.

• 10:14Speaker 02

  What was notable in your path from knowing some math to the decade and a half you spent with John and Michael?

• 10:23Speaker 00

  I was a hard worker. I went to NYU at night, not to get a degree, but literally to take accounting and corporate finance and security analysis. And it was the first time I had ever gone to school to learn something as opposed to going to school to get an A. Very different. I was really into it and my wife would tease me. I remember this book, it was called Principles of Corporate Finance by Brilliant Myers. It's like Samuelson for macroeconomics, like a pleasure book. I was really, really interested and I immersed myself. I read as much as I could. I asked a thousand questions.

• 11:02Speaker 00

  Of my coworkers. And when we started Angelo Gordon, end of 88, beginning of 89, there were maybe a dozen people, 15 people max. I didn't want to be a pest, but I was always asking questions, including dumb questions. Unlike law, I enjoyed it. I had an aptitude for it. I always describe investing, it's like doing puzzles. People say, well, what else would a good investor be good at? I said, like an investigative journalist. You're always asking questions. You're looking under rocks. You ask a question one way, you listen, listen, listen, then you ask the same question, but you rephrase it to see if you get a different answer. It was like being a journalist and investigating and learning. And I really liked that.

• 11:48Speaker 02

  As you look at the building blocks required to go from the basics of corporate finance to investing, how would you describe that progression from when you started to when you were ready to go out on your own?

• 12:03Speaker 00

  To be a good investor, you need a lot of skills. Being a good listener is hugely important. You have to be inquisitive. You have to be naturally curious and never willing to accept conventional wisdom. I would watch carefully the people around me. I tell people that John Angelo and Michael Gordon, they raised me professionally speaking. Michael Gordon taught me how to invest. He was a brilliant investor. I saw how he did it and I adapted it to myself. And John taught me how to deal with clients and how to build a business. Over time, I was always observing, always listening, always asking questions. I was successful. Sounds crass. I was a moneymaker. I was doing really well. And what happens

• 12:47Speaker 00

  in firms is when you see talent, they saw something in me. They kept giving me more and more responsibility over time. First, Michael had to approve every investment. And then he only had to approve the larger investments. And then he didn't have to approve any investments. That takes time. I mean, I was there late eighties. I left 20 years ago. I left in February of '05.

• 13:15Speaker 02

  What was the breadth of investment activities at Angelo Gordon?

• 13:19Speaker 00

  My focus was exclusively credit. I helped build and start our real estate business, but that was also a function of credit. This was now in the early nineties, there was a recession. Drexel had imploded and the savings and loan crisis. And as part of our investment strategy, so it was principally focused on distressed securities and special situations, all with a credit bent. There was a lot of real estate credit around. Learn the real estate business and that led us to start eventually what turned into be a huge real estate platform at Angelo Gordon. Putting that aside, my mandate was to focus on our credit businesses. It's funny, nomenclature change. It used to be investing in bankruptcies. That sounded too harsh.

• 14:04Speaker 00

  Then it went to distressed debt and securities. That sounded a little kinder. And now it's called opportunistic credit. Leveraged buyouts are now buyouts. Risk arbitrage is now merger arbitrage. But things don't change. It was investing in credit, but trying to generate, I'll call it an equity-like return as opposed to a credit return.

• 14:25Speaker 02

  What did the various credit cycles look like in your time at Angelo Gordon?

• 14:30Speaker 00

  When we started, it was a pretty exuberant time. Things started to crack and the cycle was getting old in the tooth. And then Drexel and executive life and savings and loans. And there was a recession. It wasn't a steep recession, but there was a recession. What had happened in the eighties was that leveraged finance really came to the fore and high-yield bonds, junk bonds and leveraged buyouts with using a fraction of equity and things like that. That was probably the origin of the phrase "good companies with bad balance sheets", which became terribly overused. Defaults skyrocketed. And you had a lot of owners of these instruments. First, it wasn't their mandate to hold something that was defaulted.

• 15:15Speaker 00

  It was credit, it was supposed to be a yield. All of a sudden, no yield. That led to more sellers than buyers. The buy-side was not well-defined. There were a handful of buy-side investors in the space. And the banks were sizable players for their own balance sheets. So Bear Stearns in particular. Goldman raised a third-party fund called the Water Street Fund back then. It was not an institutionalized market at all. Most of our investors at Angelo Gordon in the early days were high-net-worth individuals, family offices, only a handful of institutional investors.

• 15:53Speaker 02

  In that type of environment, how would you define the skill set that you needed to succeed?

• 15:59Speaker 00

  A lot of investors in credit are former lawyers. I don't think that's surprising because understanding how something works from a legal perspective is critical to investing in credit, particularly in situations where something has gone awry. Company isn't performing. Maybe there's a big litigation judgment. Having an understanding of how credit agreements work and legal processes and bankruptcy processes is really important. The way I describe it is I put in the context of a company's balance sheet, the classic T, and that the alpha of a credit investor, particularly in a special situation credit investor,

• 16:43Speaker 00

  opportunistic credit, call it what you will, the alpha's on the right-hand side of the balance sheet. Understanding how things work, relationships, and you get into court, litigating and all those things. What I learned back then, and it remains true to this day, no matter what anyone else may say to the contrary, credit investors do not know companies as well as private equity investors. And no one will ever convince me otherwise. And the reason for that is simple. Credit investors don't own companies. They're not supposed to own companies. They'll never know a business as well as a true owner of a business and someone

• 17:26Speaker 00

  who is trained over years and over decades to understand how do businesses work from the inside, not how the capital structure works, how to identify first-class management, not understanding who's the smartest lawyer, who's going to do the best job litigating in bankruptcy court. It's a completely different skill set. That skill set resides with private equity investors on the left-hand side of the balance sheet, but they'll never know the credit stuff as well as the credit people. That's not their thing.

• 17:58Speaker 02

  How did you decide to leave Angelo, Gordon?

• 18:01Speaker 00

  I had been there a long time. I loved it there. I loved my bosses. By the end, I really didn't have a boss. I did my own thing. I raised the capital. I built the team. I was doing all the investing. I really enjoyed working there. We never argued over money or compensation. I always got paid fairly. It made me wealthy. I returned the favor many times over, but I was happy to do so. What I wanted was a chance to do my own thing. I wanted to drive the bus. That was something that they were not prepared to do. When I left, my heart was racing and I told them that I wanted to leave and build my own business.

• 18:46Speaker 00

  And John Angelo, who's a larger-than-life Wall Street personality, he stood up, he hugged me, he always called me Jeffrey. He said, Jeffrey, we've thought of you as our son. And I'd been with these guys forever. It was a super nice thing to say, but as I told my wife that evening, and she said, how was the day? I said, that was exactly the problem. In their minds, I was still 25, but I was 45. So it was time for me to do my own thing.

• 19:13Speaker 02

  So when you go to start Centerbridge, what did you want to do differently?

• 19:19Speaker 00

  I left in 2005. Around year 2000, I met my to-be-business partner, a fellow named Mark Logley. Mark was at Blackstone. Mark ran Blackstone's private equity business. That was when Blackstone was a much different firm. There was no real estate, there was no credit. Mark ran the private equity business and the current leadership of Blackstone. They all worked for Mark because they were all in the private equity business. And Mark, like myself, had joined Blackstone in the eighties. We were introduced by another partner at Blackstone, a guy named Art Newman. Passed away a while ago. Art ran Blackstone's financial restructuring business.

• 20:00Speaker 00

  So they had an advisory business, which they spun out 10 years ago, which became PJT. And Mark and others at Blackstone, they were interested in credit. But they were also quite self-aware. They knew it wasn't their thing. So Art suggested to Mark, you should meet Jeff. You'll get along. You look at the world summarily. So we met, we became friendly and we decided that we should partner on some deals together. Fifty-fifty on a handshake, no document, no nothing. And we will combine our investment teams effectively. One of Mark's analysts at that point was David Blitzer. And Blitz was like one of the team members, working on all of these joint projects.

• 20:43Speaker 00

  The name of the project was called Project Spock, as in Mr. Spock from Star Trek. And the idea was for where no man had gone before. Because usually companies don't partner together. But we did, we were open books. And it was relatively simple. Mark and his team, they were experts on the left-hand side of the balance sheet. And our team, we were good on the right-hand side of the balance sheet. And it was a huge success. We invested a lot of money. We made a lot of money and we did it together. Mark, like me, had been there from the eighties and he also aspired to drive the bus. We got to talking because we both decided the likelihood of us driving the bus anytime soon

• 21:27Speaker 00

  wasn't high because the founders were in charge and they were doing a great job. And they enjoyed it and continue to. And we said, maybe we should go do our own thing. And so we left. Mark also left in '05 and the idea was, let's build a business together. The name Center Bridge, even though it sounds like just one of those other names involving a direction or a structure. There was some thought to it in that we were taking two strategies.

• 21:55Speaker 00

  Private equity, and now it's called private credit, but that phrase didn't exist 20 years ago, and bridging them to the center. And that was the idea.

• 22:03Speaker 02

  What was it about bringing those two sides together as you looked back or getting ready to form the business that you felt made it a success in a way that might not have if you weren't working together?

• 22:16Speaker 00

  A couple of things for us as people. There was no, don't copy my homework. Everyone was an open book on both teams. It was really productive and there was no tension or jockeying for credit or anything like that. We wanted to win collectively. So culturally, there's a lot of merit to it. And then combining the skill sets. Good investors are inquisitive. Blacks, they're really interested. Well, how do you look at this crazy capital structure? And what's going to happen? And the game theory behind it? You had avid students on both sides. And the fact that we're 50/50.

• 22:51Speaker 02

  So when you go to form this strategy, pretty novel to combine those two parts of the capital structure 20 years ago. How did you think about what product to put together?

• 23:03Speaker 00

  Our first product was a private equity fund, but it was designed to do more than buyouts. So of course, it was going to do buyouts, but it was also going to do distress for control, which is a lost art these days. But distress for control is just a buyout. The only difference between a distress for control transaction, buying debt, converting it to equity to own a company, is that in a traditional buyout, you're using leverage to acquire a company. Distress for control, you're delevering to acquire a company. But that's just the means to the end. The end of both is you own the company. So it is truly a private equity strategy.

• 23:47Speaker 00

  And we were also doing structured equity. But we told our clients that we don't have a set bucket. We can be 100% buyouts, 100% distress for control. We were indifferent. And then, talk about luck. We raised our first fund in the spring of '06. It was a very large fund. And then for the first year, we didn't do much because we kept bidding and losing. 06 through the beginning of 07, there was no distress. Most people forget, most distressed companies are distressed for a reason. They're lousy, you don't want to go near them. So there's nothing good to do there and we kept losing in buyout space. And then the world toppled. We had a huge pool of capital. We did some buyouts, which were hugely successful.

• 24:31Speaker 00

  We did some distress for control deals that were hugely successful. It was a big success.

• 24:37Speaker 02

  I'd love to pick apart some aspects of the investment approach with those sides. When you went to source, on the credit side, the paper is already existing. Private equity is a big world. How did you think about where to look for the opportunities?

• 24:53Speaker 00

  When we started the firm, we had two strategies. Typically, a firm with multiple strategies will have multiple teams. You have private equity team and a private credit team. Rarely did the two interact. From day one, we didn't do that. We said, we'll have one team. We'll follow certain industries, but if you're within the industrials vertical, you will invest up and down the capital structure within industrials. As opposed to having a team of investors focus on industrial buyouts and a completely different set of investors focused on industrial distress or credit. We said, just have one team.

• 25:38Speaker 00

  Invest up and down the capital structure. Everything from distressed debt to buyouts and everything in between. We've continued that to this day. It's our single biggest differentiator in terms of the way our investment team operates. I thought back then, and I continue to think today, it leads to better thinking. Because if I were to overly generalize, the private equity investors think everything is going to the moon. The credit investors think everything is going to zero and it's good to have some balance. We also thought, and it remains true today, it would lead to differentiated sourcing. Because you could source through different networks that weren't available to a traditional buyout investor

• 26:22Speaker 00

  or a traditional credit investor.

• 26:24Speaker 02

  I'd love you to tell me more about how the team operates and what you felt special about it.

• 26:31Speaker 00

  So let's stick with industrials. That's one of our verticals. Things evolved over time. Initially, our hope was that every member of the investment team, you're going to be a pure switch hitter. Doesn't matter. You could do equity, you could do debt. What we learned over time, it's rare that you find someone who can hit 300 from both sides of the plate. People who are natural lefties or natural righties. So we evolved that terminology of being a switch hitter to having majors and minors. So you can major in private equity and minor in private credit or vice versa. But the idea was, we wanted people to be deeply involved in both, in terms of their day-to-day work, as well as in terms of compensation.

• 27:15Speaker 00

  We eventually raised credit funds. We wanted to make sure that everyone was properly incented. Back to industrials. The entire industrials team meets weekly. That team is comprised of private equity majors, private credit majors, who may focus on opportunistic credit, but industrials, or direct lending, a big direct lending business now, the people within our direct lending business who focus on industrials there at the meeting, and our leveraged loan and CLO businesses, the analysts who focus on industrials there at that meeting. We may have someone from real estate at that meeting, to the extent they're doing industrial properties or warehouses.

• 27:59Speaker 00

  They talk about everything under the sun, from what's happening in the portfolio, across the entire firm, to what are they seeing in the market, to what's happening in terms of sourcing. It sounds pretty simple. Took years to develop that operating model, but it really works because there's so much intellectual capital in firms like ours. We have just over 300 people here, and we have 130 investment professionals. We have private equity, private credit, and real estate. We're not unusual. There are lots of firms with multiple strategies. How do you figure out a way to harness all that intellectual capital and get everyone moving in the right direction?

• 28:41Speaker 00

  Sure, compensation is important, but it's also culture. Young people, for example, who come here, it's a bit of a self-selecting crowd. If you only want to do buyouts, that's it. You're probably not going to even send us your CV. And the same thing with credits. People who are curious and know what they're signing up for. It's just a different experience, not necessarily better, just different.

• 29:05Speaker 02

  What'd you figure out about what in particular is complex from that simple idea of bringing the people together?

• 29:12Speaker 00

  It takes a lot of practice. It's natural, I'm going to go do my own thing and I'm focused on what I'm doing. I'm focused on the deal I'm doing as opposed to, yeah, I'm sure I'm doing my own thing. I'm running a deal, I'm doing diligence, but a big part of my job is working with my colleagues and making them better. And a big part of their job is working with you and making you better. That's a learned behavior. Takes time.

• 29:37Speaker 02

  Are there any ways you tried to manufacture that to work better?

• 29:41Speaker 00

  Process is important. I talked about these weekly sector meetings. You just can't wing it. You actually have to have process. We talk about how we compensate people with the appropriate incentives. Team building is important here. We do a lot of team events as a firm. We have a foundation that we started the firm before it was a thing. Now it's a thing. Everyone has a foundation, but everyone participates in the foundation in terms of making grants and things like that. We have an open floor plan, very few offices. I didn't have my own office until maybe six years or so ago. I sat on the floor with everyone. Remember, my parents once came here. Where's your corner office? I'm that chair. That's by design, all to encourage communication.

• 30:24Speaker 02

  How do you structure the compensation to keep everyone aligned?

• 30:28Speaker 00

  We have private equity funds, we have private credit funds, we have real estate funds. We make sure that people have meaningful components of their compensation come from across the firm. You still may have a major, which is perhaps a majority of your compensation, but a substantial minority, and I mean substantial, will come from other areas in the firm. You feel it culturally and your economics reflect it. You are truly part of one team.

• 30:56Speaker 02

  How do you cross fertilize information across the different sectors to connect the dots?

• 31:02Speaker 00

  It would probably be more at the senior level, but that would be a bit more ad hoc. There's no formal process for that per se.

• 31:10Speaker 02

  What have you seen on the differences in underwriting from the concept of left-hand side of the balance sheet? They think about the growth and the right side's downside protection. When that gets into the underwriting of individual positions, what's subtly different in the two?

• 31:25Speaker 00

  There are different ways of approaching the same investment. People will look at investment through a different lens. And that is one of the great things about our firm is that we can look at one particular company. But because we have investors around the table with different backgrounds and different skillsets and different experiences, it becomes a really interesting and vigorous conversation. What about this? What about that? That's what investing is. It's pushing each other and challenging, not in an aggressive way. But even our investment committee process, it's not that a deal team goes away for six weeks and then they show up with a beautiful deck. It's iterative, multiple investment committees and workshops and pushing and prodding and things like that.

• 32:11Speaker 02

  When it comes to owning positions on those two sides, credit, distressed side, there's a lot now of the game theory of the different participants, LMEs, all that stuff. Private equity, totally different. What are the lessons you've pulled out from when you bring those two things together?

• 32:27Speaker 00

  Well, hopefully the two never meet. We've had tough deals, like all buyout firms. I am quite confident in saying that if we have a tough deal, we know what to do better than most. Not just in terms of thinking about how to improve the value of the business, but what do we do with this capital structure? What's the best way to preserve value and grow? The tenure of partners here is very, very long. People, they get it. They know enough to ask questions because it's so collaborative.

• 32:57Speaker 02

  In the last 20 years, you've had a bunch of different types of cycles, from GFC, sector cycles, pandemic rates now. Also, there aren't really legal bankruptcies, or haven't been a long time the way there were. I'd love you to take me through what you learned in these different cycles and how you adapted the investing approach.

• 33:21Speaker 00

  All cycles, they're different and they are few and far between these days. I do believe in cycles. Predicting the timing of cycles is impossible. As I look at the world today, there are lots of manifestations of what I'll call late cycle behavior and signals. But as the cycles have progressed, so the last big cycle was really the GFC. Covid was brief. And what happened as a result of that? If I think about opportunistic credit, for example. Opportunistic credit, investing in credit to make an equity-like return. It's been around since 19th century. There was a speculator named Jay Gould who bought up railroad bonds post-Civil War. So it's been around through the 20th century, through the Depression.

• 34:05Speaker 00

  And it was always marked by two things. One, it was a strategy focused on markets, secondary markets, that you bought a defaulted bond, a fallen angel, or even a loan from a bank, but you bought it in a market. And second, it was a total return opportunity. Not yield, because companies bankrupt, there is no yield. So it's buying something at 70 that you thought was worth par. And what happened after the GFC? We know the story. Banks retreated. Wall Street hates vacuums. Non-bank banks came to the fore, this notion of direct lending. Credit started shifting away from banks to non-bank lenders, principally lenders

• 34:50Speaker 00

  that were financing buyouts. What did that mean for opportunistic credit? Which, again, had focused for a long time on secondary markets and trading and total return. We started evolving our opportunistic business post-GFC, particularly in the early to mid-teens, 10, 11, 12 years ago. In addition to keeping that traditional playbook of markets and total return, we started getting into the origination business. It was an evolution from pure secondary market focused to now focusing on primary origination. And from a return perspective, migrating from a total return strategy to a strategy

• 35:34Speaker 00

  that was focused on yield. So we started lending money, but we weren't lending money at LIBOR, predecessor to SOFR, LIBOR plus 350. We wanted to do it at, how's LIBOR plus 900 sound? With all types of bells and whistles and covenants and structural protection and call protection, the result of which was to generate the same equity-like rate of return. And that was really a sea change in opportunistic credit investing to the point that it's more than half our business now as opportunistic credit investors were lenders. And not just LMEs. In fact, LMEs are only a small portion of it, but it's transitional capital. It may be capital needed for growth. It may be capital to non-sponsored businesses.

• 36:19Speaker 00

  That's where most of our business is. It may be capital to a sponsor that needs capital and doesn't want to part with equity because it's too expensive, but it's some hair on it. It's complex. So it's not a traditional direct lending solution. That's been a huge change in our business.

• 36:36Speaker 02

  As you've evolved before you were an owner, how do you think about the differences in risk reward, particularly when those loans themselves are complex? So maybe there's some hair on them.

• 36:48Speaker 00

  Investing in credit, you have to remember the three Cs. Capacity, which is the ability to pay. There is collateral, which is the guarantee, the backstop to pay. And then there's character, willingness to pay. Those are timeless. You still have to focus on all of those. I look at what we've done in our lending business, rate returns for a long period of time and dozens and dozens of deals, billions of dollars of capital with minimal losses. That's a function of just being careful. Think about safety, safety, safety, safety.

• 37:21Speaker 00

  There's less of a focus on safety today than there used to be. Again, another manifestation of late cycle behavior. But safety first. When you invest in credit, particularly when you're originating, you lend a hundred cent dollars, you have to get back a hundred cents because your return is purely contractual. There's no convexity on the upside. You only make so much money. So you have to be really careful to be good at this.

• 37:47Speaker 02

  I'd love to turn to where we are today. What do you mean by late cycle?

• 37:52Speaker 00

  Having seen past cycles, they're all different, but there are certain behaviors which always come to the fold. Cycles of tension between fear and greed, and we're very much in greed mode now. There's tremendous complacency. You see it in spreads. Spreads are super tight. They're tighter now than they were before the GFC in the investment grade world, which is mind blowing. Spreads tightened the tightest level since pre-long-term capital management in the late 90s. You see investors willing to accept opacity rather than transparency. You hear the phrase, got to put the money to work, deployment, deployment, deployment, far more than risk and safety. You see a spate of frauds.

• 38:37Speaker 00

  All of these are indications of late cycle behavior. It doesn't mean that things are going to turn tomorrow or when they turn, it's going to go kaboom. Who knows? But you just have to be really careful. And everyone has done well for a long time. It's ironic, but when you're on a hot streak like that and you think you can do no wrong, risk is rising, even though mentally you're thinking, oh, I must be good. I got this. I got it covered.

• 39:08Speaker 02

  What are you seeing in the operating performance of the businesses you're either lending to or owning?

• 39:14Speaker 00

  We have not seen softness. Any given company can go through a patch. We have some building products companies that we own. They're going through some stuff now. We haven't seen a particular sector of the economy start to keel over and we listen carefully to what banks are saying, what lenders are saying, and we have big credit exposure. We see it. We have multiple angles. We don't necessarily have to go to an economist at a bank to understand what's happening on the ground. We have our own private data set, our library. Talked to our portfolio companies, we talked to management teams. I'm always anxious because I'm from credit land. We don't see it. You wonder about subprime auto always blows up as long as I've been doing this for nearly 40 years. Always it's constant.

• 39:59Speaker 00

  People do dumb things. I like to say one of the best things about working on Wall Street is people can't remember what they did yesterday. People make the same mistakes. Everyone always says they're careful, but you got to do it. You got to say no to deals.

• 40:11Speaker 02

  How do you invest through this environment?

• 40:14Speaker 00

  Carefully, nervously. My role at the firm has also evolved over a long time. My role now, I'm just focused on risk from an investment standpoint. You have to trust the judgment of your partners and your colleagues. And we've been together for a long time and I know that everyone has strengths and weaknesses, including myself. I try to be cognizant of that. But my job really is, looks like we're going to drive into a wall. I'll say, don't do that. So be really careful.

• 40:46Speaker 02

  When you bring that down to your sector meetings, your investment decisions, how is that impacting the incremental decision in any of the portfolios today?

• 40:58Speaker 00

  I don't know if it's impacting individual decisions, but people will generally know that I'm going to approach things. I'll be very curious. What about this? What about that? Have we thought about this? Have you reached out to this person? You got to be creative in trying to get an angle. We're looking at some businesses in the UK which are regulated now. Well, how's it work in the EU? Even though the UK is not part of the EU, how's it work here? How's it work in Asia? What makes a good investor? I think it's the ability to see something before someone else. It's the ability to see something before someone else. And that's what we're always trying to do.

• 41:37Speaker 02

  Where does that vision come from?

• 41:39Speaker 00

  Some of it is learned and some of it is who you are. I always ask when we're interviewing someone or talking about someone, I'll say, do they get the joke?

• 41:49Speaker 00

  Do they really get it? Some of it is intuition. You gotta be a very hard worker. You have to be detail oriented, but you also have to be a good decision maker. And a lot of it is intuition, pattern recognition. It's how someone is built and it's years and years of doing it. So it's both learned and it's somewhat intuitive.

• 42:11Speaker 02

  I'd love to turn to talking a little bit about the business that you're in. That's also changed quite a lot. The last 20 years, the alt business, credit. Just love your perspective on where you sit today in that ecosystem.

• 42:24Speaker 00

  We sit in the middle market. I'm happy we sit there. We have just under $45 billion of capital. It's a ton of money on the one hand. On the other hand, it's not compared to some of the giants out there and some of the public alternative managers. What we have decided to do is to stay focused on mid-cap, on middle market. But think about it in terms of full spectrum investing. We have fully built out private equity business, a fully built out private credit business, a fully built out real estate business. A lot of the giant managers of the world, the big public ones, they have the same. You'd be hard pressed to find another firm built like us in the middle market.

• 43:09Speaker 00

  That's how we approach it. That's our edge, obviously our people, but it's the part of the market we play in. It's our sourcing capabilities within that. It's all goes in the mixing bowl.

• 43:21Speaker 02

  What are some of the competitive challenges you face on both sides? Just start with you're in a market where there are much larger credit providers.

• 43:31Speaker 00

  I'm always thinking, how are we going to compete? If someone has $300 billion in credit, there are two principal ways. One, we either have to be better at it. We have great investors. That ultimately manifests itself in a record. Look at our track record and I feel pretty good about it. That means we have great talent. That's one way we can compete against someone with. Hundreds of billions of dollars. The other way we can compete is, and I use the phrase reluctantly because everyone uses the same damn phrase, is proprietary sourcing. I'm sure Ted, everyone you speak to has proprietary sourcing. I think we really do, and it's demonstrable. So we either have to understand something better than anyone else because we've got

• 44:14Speaker 00

  great investment talent, or we need a sourcing channel that just belongs to us and can't be replicated. The third thing that we do goes back to the beginning of the firm. Operating as a single team gives us an advantage, both in terms of the skill that our investors have, because they do have a broader perspective than, for example, someone who only does credit. And I think it gives us access to different sourcing channels compared to someone who does credit. It's those three things. It's talent, it's sourcing, and it's our operating model, operating as one team.

• 44:51Speaker 02

  When you're seeing that late cycle behavior, particularly in the credit markets, how does better talent end up translating into returns if someone's moves through an underwriting or willing to pay more?

• 45:03Speaker 00

  I'll give you two examples in the news. First Brands and Tricolor. We looked at both for years. People said, there's never been a picture of Patrick James. We flew to his office. We met him in person. We had the Tricolor management team at our office. We spent a lot of time with both these businesses. We didn't invest a dollar. How do you measure that? That's a good question, because we didn't do it. So how does that show up in our returns? Well, I guess we avoided a loss. That's a good thing. The fact that we didn't do it is real alpha. I think it's undeniable. I still don't know how to measure it, how to quantify it, but it's a real thing.

• 45:42Speaker 02

  And how about relative to smaller players in the credit markets? Competitive disadvantages?

• 45:49Speaker 00

  One of my acronyms around here is ROE, which is what I call return on effort. We won't look at something small because the ROE is lousy. Won't move the needle on our fund. The same way that Apollo or Blackstone or KKR may not necessarily look at a mid-cap investment size because it doesn't do it for them, doesn't move the needle.

• 46:10Speaker 02

  One of the things you mentioned earlier is IG spreads are tighter than they were pre-financial crisis and probably one of the proximate causes, the lower cost of capital of insurance subs at some of the big asset managers. How have you thought about the strategic activities that you've seen in accessing capital at some of your competitors?

• 46:28Speaker 00

  We've done the same. We have a longstanding relationship with MassMutual. We have a partnership with MassMutual where we're managing credit assets for a reinsurer called Martello Re that we put together with MassMutual and some other institutional investors. That's a perfect example because we weren't going to go build an insurance company from scratch. So we partnered with one. What we've done with direct lending, how are we going to compete with direct lenders who are focused on financing sponsor buyouts when that's an incredibly competitive business? And we know that business well because we're a sponsor.

• 47:10Speaker 00

  So we know how competitive it is and credit investors have a lot of capital to deploy. We partnered with Wells Fargo to focus on companies that have nothing to do with Wall Street, that are family owned. We've tried to do this with great intentionality, find partnerships that will enable us to compete at the highest levels. We're not competing with MassMutual, we're not competing with Wells Fargo, really important, but that enables us to compete with managers who are in the mega space.

• 47:39Speaker 02

  What do you think happens with the renewed interest from private wealth coming into private credit, potentially private equity?

• 47:48Speaker 00

  It's a question of when, not if. I think alternatives are perfectly appropriate for individual investors with one gigantic caveat. They have to understand what they're buying in terms of the risks, in terms of liquidity, and in terms of the fees. And there can't be any obfuscation on any of those things. If people go in eyes wide open and they know what they're buying, I think it's perfectly appropriate. The challenge will be is that they don't and they do it anyways. That's an area for concern. There's a regulatory pendulum. A lot of capital will come in from the wealth side. Inevitably, there'll be an issue. That's just the way it is. And I don't know what it'll be about, but there'll be something.

• 48:32Speaker 00

  If we're now dealing with small investors who don't have the sophistication level of a large university endowment or a big pension plan or a sovereign wealth fund, and it's perceived as the little guy is being hurt. Well, then you could see regulatory backlash even if the providers have done everything correctly. I think that's a known risk going in. It could happen. It wouldn't surprise me if it does happen sometime down the road. But that doesn't mean that a bad incident with a lousy outcome shouldn't impact an entire marketplace.

• 49:10Speaker 02

  Where do you think Centerbridge goes from here?

• 49:13Speaker 00

  Firms like ours, we're faced with a choice of do you want to remain small? Do you want to be in the middle or do you want to be large? Being in the middle, you're not going to shrink your way to greatness. You have to grow. We have decided to grow. We've grown a lot over the last five years in terms of strategies, mostly, but not exclusively, that are credit related because our view has been we should grow, but only in adjacencies. So are we going to start a longshore equity fund that focuses on stocks in Latin America? No, even if it's the flavor de jour, even if there's tons of enthusiasm about it, we're not going to do it. We have no edge, number one.

• 49:57Speaker 00

  And number two, it does nothing for our existing businesses. If you look at how we've grown, it's always been in adjacencies that we understand. And it's always been in businesses that will enhance our entire franchise. It broadens the funnel. We've been able to do that as opposed to let's just go do something because it happens to be topical today.

• 50:22Speaker 02

  If you could snap your fingers and fill asset capacity at whatever size you thought was optimal for what you do, where would you go?

• 50:31Speaker 00

  I like the idea of doubling our AUM over the next five years. Pretty ambitious. 15% CAGR between performance and growth. That'd be good.

• 50:42Speaker 02

  When you look at the evolution of the industry over the 40 years you've been involved, what most concerns you?

• 50:49Speaker 00

  I would say commoditization. At some point, alternatives are no longer going to be an alternative. And they're like mainstream. And when that happens, it means it will be harder to generate outsized returns. That's what worries me. I think about that in terms of influx of wealth capital. All that capital is going to come in. It's going to need a home. What does that do to returns? Usually, when more capital comes into a space, returns tend to be depressed or decline. So it could be harder to outperform unless you're doing something that's nichey, unless you have world-class talent, unless you do it differently. So I would argue, we do it differently, our operating model.

• 51:33Speaker 00

  Unless you've got sourcing channels that no one else has, there are lots of ways to address that. At some point, alternatives no longer be an alternative, which is the height of irony.

• 51:44Speaker 02

  What are you most excited about in the opportunity set for the next couple of years?

• 51:48Speaker 00

  The fact that it's changing so rapidly is intellectually quite engaging and exciting. How do we stay ahead of the curve? And we're not a mega firm, and we don't want to be a mega firm. But how do you stay ahead? How do you make sure that you don't become commoditized? Everything we do, we're thinking, what's our edge? So all those things that I just described, it's all about finding the right edge.

• 52:11Speaker 02

  And what are the things today that you think on the margin are new or different in how you're staying ahead of the curve?

• 52:19Speaker 00

  It's capitalizing on what we already know. What we've done with our insurance solutions business by partnering with MassMutual and now talking to other large insurers, that's different because we're not competing with them and we have no aspirations to compete with them. What we've done with Wells Fargo is pretty novel. There have been lots of copycats. That feels good. Imitation is the sincerest form of flattery. Those are two recent examples.

• 52:43Speaker 02

  So Mark retired a few years ago, and you are still full on. What do you think it is that keeps you going?

• 52:51Speaker 00

  I love what I do. I find it intellectually interesting. I love the people I do it with. As a group of partners, we've been together a long time. My son is also in the investment business and he used to work at a big bank. And one day, he was bellyaching to me and I said to him, did you ever hear the expression, work sucks? And he goes, yes. I say, well, that expression is there for a reason. Sometimes it does, but the most part, it doesn't. I like the notion of building. The past five years, that has been a new thing for me. In addition to investing, which I've been investing since the eighties, building is also rewarding intellectually. It's really been fun as we build some of these adjacencies.

• 53:34Speaker 00

  It's an opportunity for young people who work here to take a leadership role. I find that rewarding. And I don't mean financially. I mean, almost emotionally, intellectually.

• 53:45Speaker 02

  Jeff, I want to ask you a couple of closing questions before I let you go. What is your favorite hobby or activity outside of work and family?

• 53:53Speaker 00

  I love to ski and I love to cycle. I like both of those because when I'm doing both, I'm focused on saving myself and my mind is not drifting back to my office in Midtown. I'm just focused on the moment.

• 54:07Speaker 02

  What was your first paid job and what did you learn from it?

• 54:11Speaker 00

  It was an after-school job in high school. I worked at a high-end butcher shop. My job was to clean. I know how to make hamburger. To this day, I can wrap any type of deli meat or steak in the blink of an eye and it looks perfect. I remember that job vividly.

• 54:28Speaker 02

  What's your biggest investment pet peeve?

• 54:31Speaker 00

  Second guessing. I'm an even keel person, but when people get into the should've, would've, could've game, it drives me bananas because we all make mistakes. It's the nature of investing. If you're a professional, you don't need to be told by your coworkers, we should've done this, could've done that, I would've done that. The money is gone. It's lost. It's water under the bridge. You have to learn from that. If you're a professional, you know. You don't need to be second guessed by colleagues. That type of behavior is culturally corrosive. It's the only time I get agitated.

• 55:09Speaker 02

  Jeff, last one. How has your life turned out differently from how you expected it to?

• 55:14Speaker 00

  I am so lucky. My parents are elderly, but they still joke with me, "Why'd you give up law?" I said, "Well, first that was in the 80s and this other thing has worked out." I am incredibly lucky. I am fortunate. I've done really well. My wife and I were giving away all our money, which is fantastic. And for all the stuff in the country, and this is the greatest country, how did it turn out different? I had no idea I'd be sitting here. And I'm here, and hard work and luck, being in the right place, right time.

• 55:43Speaker 02

  Jeff, thanks so much for sharing your insights.

• 55:45Speaker 00

  Glad to be here. Thanks.

• 55:47Ted Seides?

  Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators.com where you can access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time.

• 56:02Speaker 03

  All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.