Roadmap for Private Credit from Australia – Frank Danieli of MA Financial Group (EP.511)

Frank Danieli is Head of Global Credit Solutions at MA Financial Group, an ASX-listed alternative asset manager that oversees A$15 billion ($10 billion) across a broad range of private credit and lending strategies and A$179 billion ($125 billion) in a lending ecosystem platform. Frank began his career in restructurings, the self-described 'dark side of credit', and has used the lessons from special situations and distressed loans to build a performing credit platform across asset backed finance, direct asset lending and corporate private credit. Our conversation discusses what global investors can learn from the model of private credit in Australia. We explore the evolution of private credit in Australia and why it developed differently from the sponsor-backed lending market in the U. S., the regulatory shift that pushed lending off bank balance sheets, the role of Australia's pension system, and MA Financial's strategy for building proprietary origination across the lending ecosystem. We then turn to MA Financial's investment process, including the separation of investment selection from portfolio management, red teams, war games, and rigorous stress testing. Along the way, Frank shares why sourcing - not fundraising - will define long-term winners, why private credit requires diversified balance sheets, and why portfolio management and risk management are the largest sources of alpha in the asset class. 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/)

• 0:00Speaker 00

  What you don't want is the moral hazard, which you're seeing in some parts of the global private credit market at the moment, especially with the exposure to sponsor-backed direct lending for software companies, where people are saying, well, hang on a minute, I lend in this particular area, that's my job. So I'm going to find ways to rationalize that the next leveraged loan of this type is good. How do I do that? First, I'll start giving up on price. I can shave some pricing away. Once it gets to a point where there's not a lot of alpha left, you can't keep giving up price. So you have to look for something else to give. That's when you give up terms. And that's how you end up with 85% covenant lending in some of these markets. But once you've given up all your covenants, then what do you do? If there's still competition and you can't do anything else, you can either call up to your clients and say, take the money back,

• 0:45Speaker 00

  which usually money managers aren't in the business of, or you keep doing that activity. Then you give up sacred rights of lending, your documents become Swiss cheese. You have to still find ways to rationalize it. They then say, well, hang on a minute, I've got Swiss cheese. I'm not getting paid that well. I better only lend to quality companies. And that's how you've ended up with concentration to a whole bunch of software companies, because they actually did sound like really high-quality companies.

• 1:15Speaker 01

  I'm Ted Seides and this is Capital Allocators. My guest on today's show is Frank Daniele, Head of Global Credit Solutions at MA Financial Group, an ASX-listed alternative asset manager that oversees $15 billion Aussie dollars across a broad range of private credit and lending strategies, and $179 billion Aussie dollars in a lending ecosystem platform. Frank began his career in restructurings, the self-described dark side of credit, and has used the lessons from special situations and distressed loans to build a performing credit platform across asset-backed finance, direct asset lending, and corporate private credit.

• 1:57Speaker 01

  Our conversation discusses what global investors can learn from the model of private credit in Australia. We explore the evolution of private credit in Australia and why it developed differently from the sponsor-backed lending market in the US, the regulatory shift that pushed lending off bank balance sheets, the role of Australia's pension system, and MA Financial's strategy for building proprietary origination across the lending ecosystem. We then turn to MA Financial's investment process, including the separation of investment selection from portfolio management, red teams, war games, and rigorous stress testing. Along the way, Frank shares why sourcing, not fundraising, will define long-term winners,

• 2:41Speaker 01

  why private credit requires diversified balance sheets, and why portfolio management and risk management are the largest sources of alpha in the asset class. Before we get going, longtime listeners might remember my discussion of the lived experience of Joseph Campbell's Hero's Journey, created by Michael Mervosh and described in episode 402 two years ago. Well, after an eight-year sabbatical, I'll soon return to the mountains of West Virginia for my next journey. I'll take leave of my familiar surroundings and electronic devices to go on a week-long adventure, meeting allies, facing ordeals, and encountering the so-called belly of the beast, after which I'll return transformed by the experience.

• 3:27Speaker 01

  Like my past journeys, I have no idea what I'll find or learn once I arrive. And that is the essence and beauty of the experience. If you also feel the call to adventure, there's still time to engage and sign up. Hop on heroesjourneyfoundation.org to learn more about the upcoming journey. Hope to see you on the mountain. And thanks for spreading the word about the Hero's Journey and Capital Allocators. Please enjoy my conversation with Frank Daniele.

• 4:02Speaker 01

  Frank, thanks so much for joining me.

• 4:03Speaker 00

  Ted, good to be here.

• 4:04Speaker 01

  Why don't you take me through your background that led to your path in the seat?

• 4:08Speaker 00

  My background was in a combination of funds management and consulting. I come from the dark side of credit. I was a restructuring or workouts banker advising special situations, hedge funds and companies, banks that had got themselves into a capital structure that needed to be fixed. I met the founders of Mollus Australia. Mollus Australia was a 50-50 joint venture between Mollus and Company, the global firm listed on the New York Stock Exchange, and the local Australian staff, which is today MA Financial Group listed on the ASX. I was doing that, and in particular, in the post-financial crisis era, the platform in Australia had about a 50% market share advising on these situations,

• 4:50Speaker 00

  the recapitalizations occurring from that post-GFC era through to today. And I've parlayed that into building a performing credit business where the whole goal is to try to limit the chance that we're going to be in one of those situations. The reason for that structure was that the objective was ultimately to build more than just an advisory business, in particular, an asset management platform. About 85% of the business today is in various forms of asset management. I lead the credit platform, where we're investing across a range of different strategies in that market. We also have created this lending ecosystem, which is a large piece of financial infrastructure platform on which there's about $179 billion or $125 billion US dollars of managed loans on platforms.

• 5:35Speaker 01

  I would love to hear your thoughts on the region, all the lending strategies in private credit.

• 5:41Speaker 00

  The Australian market historically was a very concentrated banking market. There's the big four banks in Australia. And if you go back, they controlled 80% of lending. If you think about systemically important, these banks are important in that market. There's an empowered regulator in Australia in the banking space that, post-financial crisis, wanted those banks to be unquestionably strong, started to impose a lot of the regulatory and prudential changes that have come out of the GFC much earlier and much more conservatively than what happened globally. At the same time, there was a range of market structural changes, the rise of intermediaries and brokers for loans, technology, and other factors that led those banks to change the way they do a lot of business. They exited a whole series of areas,

• 6:26Speaker 00

  certain types of home loans, car loans, business loans, equipment and asset finance, changed the way they do those loans. Rather than doing them directly, they do them by partnering with institutions like us and providing asset-based finance facilities to specialist companies that then do the end activity. In our region, private credit looks different to globally. Globally, this term, private credit, is almost synonymous with sponsor-backed direct lending. Our book is 60% asset-backed facilities, 20% direct asset lending, and then 20% in the direct corporate lending, which includes sponsor-backed direct lending. It's not saying there's a certain type of leveraged loans that were better done in credit funds.

• 7:08Speaker 00

  It's saying there's a whole bunch of things that banks used to do. They either don't want to do them anymore or can't do them efficiently from a capital perspective, and there's a different way. It's a wider definition of the term, and that's what's occurred over the last 10 to 15 years.

• 7:23Speaker 01

  When that pivot post-GFC came from the bank balance sheets, the inception of private credit and the asset management side, what capital came in that supported?

• 7:34Speaker 00

  In Australia, there is a pension system called superannuation. You have to compulsorily put a certain amount of your money every month into a pension. That's about $4 trillion today. It breaks down about 75% into large institutional-style funds and about $1 trillion in self-managed funds, which are for high-net-worth individuals or high-income-earning professionals. You've got these two sectors in the local market that are large and growing, that have participated in that space. That capital is pension capital. It's looking for a long-term investment. It's able to trade off a degree of liquidity for a premium, if it can exist. It's also looking for something that's more of a fixed income alternative, rather than I want to get equity returns through debt.

• 8:19Speaker 00

  It's seen a system gravitate to something more investment-grade oriented or a blend of investment-grade and sub-investment-grade compared to what you might see in other parts of the world. The other thing about Australia is that it is part of APAC. It's close to Asia. We've seen a significant amount of capital all through Asia invest in these areas.

• 8:37Speaker 01

  With these two sides of the need, starting GFC on the lending side, and this capital that needs to find a home with this type of strategy, how did you think about what you wanted to put together in the asset management business?

• 8:52Speaker 00

  We came from a restructuring background. What we wanted to do was to make sure that we embedded the learnings of what goes wrong in credit, not just around the credit risk of your loans, but also around the structures that you're investing in, the structure risk, some of the other pitfalls that can happen through lending. So you put yourself in a good position if something inevitably does go wrong. The other thing that we saw through the restructuring business was the importance of empowered process, good team structuring, good portfolio management, not just good credit selection. We spent a lot of time designing the infrastructure around the business as to how we were going to approach the market.

• 9:37Speaker 00

  The other thing that we thought was important was that if we were right on the thesis, that you were going to see a significant amount of capital move off bank balance sheets or in a world where banks were going to partner with institutions to provide capital, was that it's going to be a large space. It's not going to be a couple of trillion dollars, it's going to be tens of trillions of dollars. Your problem was not going to be AUM gathering. Your problem was going to be sourcing good quality loans and the ability to produce those loans through cycles. That's why we went down a path of proprietary origination. Everyone says they have proprietary origination and what people often mean by it is,

• 10:16Speaker 00

  I've got some great professionals with lots of relationships in the market and that's part of proprietary origination. We felt it was important to have platforms, that's why we have the non-bank lending business, our own lending businesses that can lend in certain areas of the economy and produce assets that our funds can own. That financial infrastructure business, not only a source of access, but a huge source of data or intelligence, lifetime access of what's happening in the markets, touches 350,000 customers in the Australian economy. It's a bit like how banks might use credit card data to have a real time pulse on the economy. You can see where the lending standards get better and worse and we wanted that. Finally, we always believed in partnerships.

• 10:58Speaker 00

  We've done a range of strategic partnerships with banks and other specialist financial firms and asset managers around accessing deal flows. The idea was have this proprietary source to have a wide funnel, tens of billions of dollars a year of potential lending opportunities, and then have a disciplined process to filter that out. We're trying to avoid losers, not pick winners, trying to basically filter out credit that's going to go wrong or at least make it a very small incidence when it occurs.

• 11:28Speaker 02

  I'd love to dive through those various aspects of how you do it. You mentioned origination, the importance of platforms and relationships. What does your team look like at that level of the investment process?

• 11:42Speaker 00

  We split into two basic cohorts. Then there's a whole series of support functions around them. The two main cohorts in the asset management business are our investment team and our portfolio management team. The investment team by their nature, they're there to source investments, underwrite loans and positions. They're not originators, we ban that word. We don't want them to just originate, throw it over the fence and it's someone else's problem now. We want them to own those positions for the life of them. That's their job. The thing about the incentives that people have, if you grew up in a commercial bank, you think about your client in that bank as the borrower, the CFO or the sponsor, MD or whatever.

• 12:23Speaker 00

  You do the deal, when you're bringing the deal in, next thing you do is you're beating up credit to get the deal done. Then you fund it, it's over a treasury's problem now. Then, oh no, it's gone bad, well, it gets moved from you to the bad bank and you're out. And then the bad bank guy comes out and he's dealing with the workout. Never in that value chain do you think about your job as being a fiduciary of the deposit holders. I hear a lot in so many firms, this idea of I'm an originator there, I've got to get deals done. How do we get this deal done rather than should we do this deal? Then you have this other cohort called the portfolio management team. They're the fiduciaries of capital. Their job is credit strategy, portfolio construction,

• 13:07Speaker 00

  thinking about the correlations between different parts of the portfolio and what they should look like. Things like treasury liquidity as well. You've got these two cohorts that collaborate, but they also have a natural tension between them. That tension could be, I'll give you a real example. An investment person's found a really good loan. It was a senior secured corporate loan to a childcare business. It was low leverage, it was in regional parts of Australia, it was market leading position in what it did. The structure was tight, this was just a fine loan, portfolio management team objected. Why would they object? Well, the reason they said is we actually already had a couple of childcare positions. They thought that it was enough exposure. The idea was, well, hang on, because it's a good loan, do we need another one? Now, that goes the other way sometimes.

• 13:50Speaker 00

  You'll see the PM team saying, well, from a strategic perspective, we need exposure to XYZ in the book to keep it balanced. That's something to have. And the investment team on the ground, looking at the intricacies of the credit, might say, well, that's good from a macro or top-down perspective, but the nuances of these deals don't stack up. We had a real example of that a couple of years ago as we were doing more corporate lending because we liked the dynamics that were emerging in that space. If we're going to be increasing our exposure to corporate, it makes sense to have exposure to defensive industries, which is true, such as healthcare, also defensive aging population in Asia and so on. A large position came up, but the investment team, having looked at the intricacies of it, they objected and they said, hang on a minute, insurers putting the squeeze on, costs are going up.

• 14:35Speaker 00

  You've got rent ceiling to inflation, inflation was going through the roof. The structure was pretty loose and so objected and that became quite a distressed structure. You want this natural tension and the job of myself, the others on our investment committee is not only to provide the governance environment for these groups, but also help to manage that tension for the benefit of our capital. We've designed our credit philosophy around an approach we call what you have to believe. And that's all about saying, every time we do a loan, we want to know where it breaks. Every loan, we want to know where you do lose money, even if it looks like a remote set of circumstances, because that will mean we can go and monitor for those things in the real world we've thoroughly stress tested.

• 15:18Speaker 00

  We've tried to build these things into the nature of our process. A lot of it comes from having worked in the distress, the restructuring business and applying it to performing credit.

• 15:29Speaker 02

  On the investment team that's doing the selection of the credits, how do they go about deciding when to dive in on something relative to that portfolio team that may say, well, that's great credit, but we already have a lot of exposure there?

• 15:43Speaker 00

  We like the process to be fluid. We're having regular dialogue. You want everyone to be around to be able to share those views. We've got regular forums where people can talk about the opportunities that they're seeing. We can have that dialogue and debate. Then we can leverage the fact that we've created this lending ecosystem out there to go and produce or access those loans into the market to get the access. What we don't want to do is to be waiting for an auction to occur, say, hey, now you can participate or not. We'd rather be able to go out and create the opportunity on a bespoke basis. That's how we're creating the opportunities in the first place. Through a one to three month process, we're then doing a series of processes throughout that,

• 16:28Speaker 00

  which is leveraging the network we have at MA as far as we can, cross pollinating IP across the whole group, all the different businesses we run, the relationships that the firm has into the market, things like expert networks and other ways we have access to industry expertise. We've built a lot of data infrastructure to do this too. We want to be able to run loan books at large scale. Flagship funds that we run might have 246 positions. For the positions that are the asset-based finance, which I think is today 98 different facilities, there's 1.4 million underlying loans and receivables that represent the collateral of those loans. Excel's out the window, you need to be able to use data or infrastructure to visualize these loan books,

• 17:09Speaker 00

  to stress them up and down and to focus on what is important, to know how this credit will perform through different cycles.

• 17:16Speaker 02

  What are your rules of thumb for the portfolio management team in building a credit portfolio?

• 17:24Speaker 00

  We've developed ways to think about units of risk. How risky is a particular position that we have exposure to, based on some qualitative factors that we've been able to observe historically, but also some judgment factors that we've seen out there in the world? They don't just relate to credit risk, loan to value ratio against the enterprise or an asset. They relate to structural features of the loans, how wide or loose the covenants and baskets are, how extensive they are. Some of the qualitative factors about the management of the counterparties and so on. You're trying to break these things down into what's my actual risk? Not in volatility terms, but in probability of facing a problem.

• 18:07Speaker 00

  Then determining what are the correlating factors? What things cause that probability for each of these different segments? How do we create a book where the correlations are low? Something that's going to impact our exposure to, say, home loan portfolios. In our flagship book today, about 14% exposure to many different types of home loan lending. They're driven by interest rates and unemployment. And you've got the security of the asset if things go wrong. We have other exposures like our specialty finance books, legal dispersment funding, insurance premium funding, that have almost no correlation to interest rates and unemployment. They're driven by totally different things. The idea is through a cycle, yes, there'll always be some ups and downs,

• 18:48Speaker 00

  but if you have enough different sectors, you've balanced your exposure to those sectors well, you can deliver a consistency of both income and capital.

• 18:57Speaker 02

  What does your portfolio construction look like compared to your peers?

• 19:04Speaker 00

  The main difference from a lot of our peers is that we have exposure to asset-based finance, direct asset lending and direct corporate lending, sponsor and non-sponsor backed in one place. We have 38 different sub-sectors of lending that we're exposed to. The reason is because we're trying to create that fixed income alternative style product where we're saying choose your risk tolerance, we'll do the product that will deliver that same profile as far as we can, but with a premium for the fact that there's some complexity, there's less liquidity and there's a proprietary element of what we do. The difference is that we're not monoline. As a result, we've got this broad-based book and we're weighting up and down all the different sectors we're exposed to.

• 19:49Speaker 00

  That idea comes from the workout's history. It's about saying, at some point in the cycle, the marginal loan in a particular space isn't going to make sense. What you don't want is the moral hazard, which you're seeing in some parts of the global private credit market at the moment, especially with the exposure to sponsor backed direct lending for software companies. Where people are saying, well, hang on a minute. I lend in this particular area. That's my job. So I'm going to find ways to rationalize that the next leveraged loan of this type is good. How do I do that? First, I'll start giving up on price. I can shave some pricing away. Once it gets to a point where there's not a lot of alpha left, you can't keep giving up price. So you have to look for something else to give.

• 20:34Speaker 00

  That's when you give up terms and that's how you end up with 85% covenant lending in some of these markets. But once you've given up all your covenants, then what do you do if there's still competition? And you can't do anything else. You can either call up to your clients and say, take the money back, which usually money managers aren't in the business of. Or you keep doing that activity. Then you give up sacred rights of lending. Your documents have become Swiss cheese. You have to still find ways to rationalize it. They then say, well, hang on a minute. I've got Swiss cheese. I'm not getting paid that well. I better only lend to quality companies. That's how you've ended up with concentration to a whole bunch of software companies, because they actually did sound like really high quality companies. Maybe they are.

• 21:15Speaker 00

  They're mission critical system of record, recurring revenue, high margin, high cash generation businesses with high valuation. So I should have a good margin of safety. And then, oh, no, Claude is arrived and it could disrupt this entire business. The fundamental problem isn't lending to software. The fundamental problem isn't doing sponsor backed loans. The fundamental problem is that in the business of lending, you need a big diversified balance sheet, not only scale or diversification in the sense of lots of things. You need lots of different things.

• 21:46Speaker 02

  In a business that you'd like to continue growing, how do you balance that idea of if you're a little smaller, you may have a more fine tuned selection on a credit, but you're in a market that's competing. You still have the same body of opportunities to look at than others.

• 22:04Speaker 00

  It is a challenge. That's why you have to invest heavily in proprietary origination channels. This ecosystem that can produce loan opportunities so that you're not forced to just participate in auctions. It's not to say we won't do something more syndicated or cloud, because we do. But you want to have that tension and that flexibility that you can keep producing assets. We've spent hundreds of millions of dollars of our own money building out that ecosystem. On top of that, we've invested heavily, $240 million of firm and staff capital in the funds to show alignment, skin in the game in what we're doing. If you think about those two things, that's a lot of capital.

• 22:47Speaker 00

  It's capital that's got to come from your own balance sheet or from your firm. That's one of the challenges in it. What you'll see is that if you roll forward 10 years, 20 years, this industry of private credit will be all about that model of proprietary styles of origination, not that dissimilar to what a bank looks like. You're just doing it with a slightly different capital base and capital structure.

• 23:10Speaker 02

  I'd love to hear more about the acquisitions that you've done to build that origination platform.

• 23:17Speaker 00

  One of the early acquisitions we made in that space was a small non-bank mortgage lender in Australia. There's been times where we've built organically. Our specialty finance platform is one. We found the opportunity. We secured it. We use firm capital to lock up the first of the lending opportunities. And then we went and got the right credit licenses to do the direct financing, facilities, the tech, the origination process, the credit documents. It is helpful when you go to that granular level and you see what the production of credit looks like. Some of the trade offs that are made. We've done both. On top of that, we made an acquisition of a business which became the financial infrastructure business we have today, the Finshore platform. We acquired it out of a small Australian bank.

• 24:02Speaker 00

  We thought it was a misunderstood asset. We thought that the broker channel, that people would get their loans through intermediaries, whether they're home loans, car loans, business loans, whatever they are in Australia, would grow and grow. That's certainly been the case today. 75 to 80% of loans in Australia don't go by someone going to a lender directly. They go through an intermediary, a broker. Those brokers use infrastructure like our platform to access the loans. We like the business for its infrastructure characteristics. It's important for data and intelligence around what's happening right now, live time in the market. You're seeing eight or 10 billion of loans go through it every month. You can see what's happening. Also creates a real halo effect for us in origination, especially around asset based finance,

• 24:46Speaker 00

  because we are more as a group than just a provider of capital. We're a true partner. We're a source of origination for counterparties and we're a source of access. Then you do it through contract as well. Some of those strategic partnerships we've done. We've done one with Major Aussie Bank going back in 2021. We've done some with a bank and asset managers over here in the US. We've done some things in Europe. We're constantly looking for ways to do this where partnership is the right model.

• 25:11Speaker 02

  When you add that up today, how many people and platforms do you have across asset backed lending, direct lending and corporate lending?

• 25:20Speaker 00

  Across the total MA financial group, all the employees and all the businesses and things we run, there's probably 900 people. We're all through Australia, Asia. We have presence now here in the United States. We have two offices here in the US. We're doing asset based finance here. We have a lot of different access points. There's about 30 different platforms that we're working with regularly. Some of them within our group, some of them third party platforms. The direct people in the private credit investment business is a team of about 40 investment and portfolio management professionals with 100 people around them doing various functions. Then we have an asset management platform of 250 people and the people in those separate platforms. So it's quite a large operation.

• 26:00Speaker 02

  When you developed this with this expertise in the region, what was the decision process to expand globally beyond the APAC region?

• 26:10Speaker 00

  The history of Australian platforms going global isn't that good. We thought that because of the inverse development of private credit in Australia, where it started in these other areas outside of just sponsor backed lending, that we could take some of those learnings and some of that expertise and apply it in a global sense. We did it by finding the right people. It was through the Mollison Company connection. Through that connection, we were introduced to a group here. We worked with them in a partnership model originally, providing co-investment capital in some of the origination here. We acquired that platform. They became part of our business and fully integrated into the global team we run.

• 26:49Speaker 02

  How do you think about those trade offs of having a partnership where there's deal flow to acquiring the team?

• 26:57Speaker 00

  It's horses for courses. There are times where it makes sense to be in a partnership model. If it's smaller scale or if there's something unique that that partner can bring particular access that it wouldn't make sense for us to develop. You usually want that to be complementary. Ideally, we can bring more than capital. We might be able to bring certain types of our data analytics, some of our credit frameworks, some of the terms and structurings that we put into our deal flow that might be different from what is standard in that particular sector or market. And we can do something together. That's how we've thought about it. We want the partner to bring something we don't have usually access to a certain part of the market that we don't have directly and it wouldn't make sense yet for us to own.

• 27:43Speaker 02

  You mentioned credit frameworks to use. What are some of those frameworks?

• 27:46Speaker 00

  I mentioned this what you have to believe framework earlier. The other thing that we like to do in our process is every time we're taking a deal to an investment committee, we assign some people to be our red team. This is basically taking someone from the investment portfolio team, importantly, not working on the deal. They haven't met the management, worked all weekend, stayed up all night, haven't fallen in love with the deal. They're going to look at this deal before the investment committee. They're going to go through all the raw information, the data, all the credit docs. They've got to come to IC and articulate the contrarian perspective. Why would you not do this deal? What's been missed? Is there something that we're not properly calibrating? Are we thinking at scenario X is more remote than it actually could be? Sometimes this might feel belligerent.

• 28:31Speaker 00

  It's not intended to be. We want to thoroughly elicit where the risks are so that we can then monitor for those things in the real world. Once we've made the investment, because we're in the private markets, we can't exit our positions as easily. You want to make sure you've understood that downside framework upfront. The other thing that it does is that it sharpens your thinking about origination when that person who was the red team yesterday is now doing their own deal flow. So you get a symbiosis out of this. We've done a whole bunch of other things in the process. We do these things called war games now every quarter where we simulate recessionary scenarios, moderate, severe and a crisis scenario on all our loans in our book. It's a huge piece of work.

• 29:14Speaker 00

  It's not that we can predict all those economic indicators, how they'll actually affect every loan in the real world. It's getting people to think sometimes the world becomes a bad place. Sometimes things don't go your way. Another lesson of the restructuring business. Normally when that happens, people aren't thinking straight. They're frozen. We want people to say, I've thought about this. It hasn't gone the way it should. Here's the break the glass now plan to go fix things. It's things like that that have been core to our credit framework, more than just saying we'll only lend at four and a half turns of leverage or never more than five and a half X. We don't have those hard heuristics. We do have this framework for risk thinking

• 29:55Speaker 00

  and this philosophy that risk is everyone's responsibility because we're aligned. We're all investors and we have that philosophy of co-investment, not just at the senior team, but through the entire team.

• 30:07Speaker 02

  On that red team, blue team exercise, it always sounds like a great idea. We'll just take contrarians and throw them in the room. What have you seen work in the weeds that allows people on the red team to have as much drive in getting at their side of the answers than they were the ones on the original deal team promoting the deal?

• 30:30Speaker 00

  The team's quite collegiate. You get to enjoy that process and learn from it. What it elicits is not so much, wow, we should never have even looked at this deal. It's a failure of process. If we've gone and done three months of work on a private deal and then we don't do the deal. When that happens, we're saying, hang on, what went wrong along the way? What's normally coming out of the red team is we've got a good view on the credit risk side. We might need to tighten the structure. If it's in asset backed, maybe there's an eligibility criteria allowing a certain kind of lending that we shouldn't include, or we'll need to adjust a covenant, a portfolio parameter to limit exposure to that. Maybe we need to tighten the baskets in the corporate deal.

• 31:14Speaker 00

  In a direct asset, do we need more equity in from the borrower? We need some change in the structure of the loan. Finally, maybe we need to do some checks or embed some controls for the third risk in credit, which is fraud risk. We are always thinking about credit risk, which you need to manage, structure risk, which you need to control, and fraud risk, which you need to avoid totally. We've seen a couple of egregious examples of double pledging recently. Are we making sure we've got consistent custodians or trustees across all the facilities of a counterparty? Are we doing the right audit, AUPs, cash checks and so on? Have we required that of the borrower in our facility so we can go and do those when we need to?

• 31:56Speaker 00

  It could be things like that, which don't eliminate deals, but make them safer or more sustainable through different market conditions.

• 32:05Speaker 02

  As you've done that with your team over the years, they've sat on both sides of different credits and gotten sharper and better. How often does a credit that you're looking at at that investment committee level change today because of inputs from the red team?

• 32:21Speaker 00

  The changes happen regularly around deal structures and terms. It might be 25 to 30% of the time, pretty regularly, that that's causing changes to the structure. It's rarer that it's totally eliminating the deals. We're doing 5 to 10% of the deals we see through the funnel, but it's the broader process that's eliminating things mainly rather than the red team. The structural tightening happens a lot. What it also does is that it creates a lot of cross pollination of IP, that we're making sure things we've seen before, terms we used in other facilities are being applied. It's a good cross check to give comfort to what we're doing.

• 33:00Speaker 02

  What are some of the phrases that you use internally to allow the blue teams and red teams to have that vigorous debate, but then still be on the same team without egos getting involved?

• 33:12Speaker 00

  One of them I really like is the only certainty is uncertainty. You always hear this idea that Trump did this, something happened in the UK, there's a lot more uncertainty now. I always laugh, last week, before you knew that there was going to be war in the Middle East, you might have felt comfortable, but that was an illusion because there was huge uncertainty, you just didn't know it. I've always believed that the future is a constant level of uncertain. What you're grappling with is always investing under uncertainty. How do you do that? How do you avoid, especially in credit, taking these high conviction views on one thing, where you expose your investors, your LPs to catastrophic risk of loss because you believed you knew you could predict the future?

• 33:56Speaker 00

  The other one, it sounds like a buffettism, it's predicting rain doesn't count, building the ark does. It goes to this same idea of we can't crystal ball what's going to happen tomorrow. Got no idea where interest rates will go, what could happen, what could come out of left field that we're not thinking about today. We have to think about a spectrum, a distribution of risk. Build as much protection mechanisms as we can, types of security, asset backing, defensive features, things that give us the really long runway before a problem hits us when something goes wrong. And that's again, we're in the credit business, we're not in the equity business, we're not compounding returns, and we're not trying to do equity returns through debt.

• 34:39Speaker 00

  We're trying to deliver fixed income with a premium for trading off a bit of liquidity.

• 34:43Speaker 02

  What are some of the rules of thumb in your portfolio construction that allows you to build that arc?

• 34:48Speaker 00

  One of the core things is making sure that the correlations between different sectors are understood. In the portfolio management sense, we want to know what drives each of those different sectors of lending and be able to map the differences in them. Some of them are more basic. Do you have the right level of diversification? Not just, I've got low position sizes, but I have carefully thought about what my target ranges of different sectors, asset backed commercial, asset backed consumer, asset backed real estate, corporate, non sponsor, sponsor are within the book, how you're managing those up and down through a cycle. It's a balance of art and science.

• 35:30Speaker 00

  The important thing is that framework around, we need to understand risk. We need to be able to evaluate what drives credit performance, that we're building the right structural protection so we get what we think we're exposed to. When you've gone and restructured a debt facility and you've pulled these things apart, you get appreciation for here an indenture and a facility agreement now market. Why are things there? What's that clause for? There's a whole bunch of clauses people never think about. They, oh, I've got this covenant, I'm senior security, there's this basket, okay. But what are all the other terms? What do they say? We want to know that stuff and make sure that we, in our portfolio,

• 36:13Speaker 00

  have a range of different things that can't all go one way.

• 36:17Speaker 02

  How do you balance the realism or pessimism that comes from having work at expertise with the optimism required to make loans where upside's capped anyway?

• 36:29Speaker 00

  One of our founders, Andrew Priddam, likes to say, in our credit business, we have to be optimistically pessimistic. You can't do nothing. We want to be able to provide capital into the real world. The optimism comes from having followed a rigorous process. That gives you the conviction that my portfolio is constructed well and I spend all my time thinking about where risk is, what the downsides could be. I can be positive, I can be optimistic about how this capital will perform through different market conditions. We try to avoid having people in a team and developing people that you want to be the star loan picker. In my view, that's for equities.

• 37:13Speaker 00

  We get compound returns and you can have the 10 bag or upside. That's not our business. The people that thrive for us are the people that are good at process, that want to improve those processes when they can be enhanced. We have in our IC papers, a bunch of checklists. The checklists are all about saying, what are the things we've seen that have correlated with things that have gone wrong before? Some of them are amber flags, some of them are red flags, some of them are bright lines. If the borrower could steal the assets away, bright line is just not for us. There's some things that are, okay, this is a risk, we have to be cognizant of it, but we can live with that. We think about an airline pilot, they're about to take off.

• 37:55Speaker 00

  They sit there and they go through a bunch of checklists that say, what are all the things that have caused crashes in the past? Do they exist now? No, they're not in place, we take off. If they do, they stop, they check, they try to rectify those things. If they can't get comfort on some serious things, they just don't go anywhere. That's why air travel is so safe. We're trying to take that same philosophy. We're trying to make it a process and it's the process that makes you optimistic.

• 38:21Speaker 02

  When you bring those credits into the book and then you're running your analysis on things going wrong, what have you learned about running that effectively to improve the portfolio?

• 38:33Speaker 00

  One of the things that we've done is that we've had to make the war games process more than just the macro stress testing. The macro stress testing, we thought about it a lot at the time of deal inception. How far can things fall in the world or the bad things happen before our capital is going to face an issue? Has the underlying business collateral or asset changed so that that sensitivity has moved a long way? That's a good exercise, but it doesn't change that much unless there's been fundamental changes in the underlying borrower. The other thing that does change often and that comes up are these discrete risks. It could be behaviors of competitors, industry dynamics, changes in technology.

• 39:17Speaker 00

  We look at a range of these other discrete, non macroeconomic risks, fraud and intercreditor dynamics. If you see certain banks decide they're going to exit a market. We look at all those different things as well. We've also made it a lot more practical. Where there are loads that seem to have risks being elevated, how do we crack open the debt documents? Is the security structure as robust as we thought? What's the social issues around this dynamic? Are we in a club or a syndicate? Will we have to deal with others or are we bilateral? How are the management team going to respond? Are they appropriately incentivized? Is there some regulatory overlay to this that we need to be thinking about? Those non-financial or quantitative things that we've embedded in the process that have made it better.

• 40:02Speaker 02

  If you turn from thinking about risks to the opportunity set, how do you look at the opportunity set in Australia, in the rest of Asia and the rest of the world?

• 40:11Speaker 00

  I'll start with Australia versus the rest of Asia. The opportunity we like exists because there are these areas where it's more sensible for banks to not do things directly or to partner up. We love that model where we can be arbitraging these things where banks used to do them, but it's not efficient and we can be a solution provider in that area where we can capture some premium. In other parts of Asia, that dynamic doesn't exist. We're often looking, the ambit of what banks can do in that market is wide. And whenever you're trying to compete with someone with such a low cost of capital, you have to step up the risk curve. It's not that it's bad loans, but it's just not our business. We're not in that opportunistic credit business.

• 40:55Speaker 00

  We're seeing globally that those same thematics around banks changing the way that they approach real world lending, not just sponsor finance, is gaining pace. We were fortunate when we were expanding our US presence. That happened to coincide with the time when there was the regional banking crisis. My CEO, Chris, we were on a plane over to the US, literally that weekend of Silicon Valley Bank. That has also shifted the dynamic where you're seeing this whole tale of regional banks here in the US looking for different ways to approach the markets as they deal with managing the rest of their balance sheets and the regulatory impost that's coming. You're seeing the overlay of the Basel III, IV regimes coming through in all parts of the world.

• 41:40Speaker 00

  This opportunity around providing real world finance is where we see the most opportunity. And we see it because of the arbitrage that we believe exists for structural reasons.

• 41:51Speaker 02

  How do you think about your right to win the right loans in the US, a much more competitive market relative to your positioning compared to Australia, where you're clearly one of the big players in the market?

• 42:04Speaker 00

  In this area of asset-based finance, we can do that. We're not trying to do direct sponsor-backed lending here in the US. What we've done is to apply an asset-based finance way of thinking to get some exposure to that sector. We've publicly announced some strategic partnerships in that space that enable us to do that. So we can be applying an asset-based finance facility to get diversified exposure into the sector in a private way, but where we still get to curate what's actually in the book. That works well for us. The rest of the asset-based finance market, we see as an emerging space and we think there's just going to be tens of trillions of dollars of capital that move into that area. We're investing early and we're bringing this way of thinking to the market, hopefully

• 42:47Speaker 00

  leveraging some IP, structuring technology that is a little bit different to what's here in this market.

• 42:54Speaker 02

  What are the strengths and weaknesses of having an advisory business alongside an asset manager?

• 43:00Speaker 00

  That phenomenon for us operates in Australia. You have to be careful around conflict when you have a diversified business. So of course you have to think about that lens. There's a huge amount of advantage in having an advisory business. One, it gives you a very interesting set of IP, access to the market, creates a degree of halo. At the right level, there's the ability to have the right feedback loops around what does and doesn't make sense. The fact that we have a diversified group also means we're in lots of lines of business. And that means that we can be sensible about leaning in when it makes sense and pulling back when it doesn't.

• 43:40Speaker 02

  What's it like being a public company in Australia?

• 43:44Speaker 00

  It's good to be a public company and it's hard to be a public company at the same time. The advantage is you have currency, capital. Being a public company gives you a degree of accountability to the public market, to a range of investors that are not just you as an individual or a series of partners. And that is a good thing. The hard thing about being a public company is sometimes that accountability can be too short-term focused versus long-term focused. And so you're always having balance. What I've liked about MA and the ethos that the founders embedded within the business was this idea that they wanted people to be owners too, owners of a business, not just renters. When we were a private company, that was allowing people to participate in owning the business.

• 44:29Speaker 00

  That's continued as an ethos as a public company. While we're listed, we're still a third owned by staff. That idea of alignment runs deep for us. You've got to balance the two.

• 44:39Speaker 02

  How's the Moles relationship evolved from the early days to building the asset manager to now also participating in the US?

• 44:47Speaker 00

  Moles is invested in MA, the company. That relationship is very strong on the advisory side of the business where I used to be. Now that I'm in the investment business on the asset management side, it's different. We operate separately and I think about them as cousins in the market, but in the asset management side, it's separate.

• 45:07Speaker 02

  As you start to build your presence here and elsewhere in the world, what are you hoping to achieve at MA over the next bunch of years?

• 45:15Speaker 00

  We want to be one of the preeminent managers, particularly in this fixed income alternative, private debt. We want to contribute to the redefinition of what it means to be in private credit. And that's a lofty ambition, but it's one that we're really committed to.

• 45:32Speaker 02

  I'd love to get your perspective on the noise that you see around private credit happening, particularly in the US and some of the structures in place.

• 45:41Speaker 00

  There's noise in the US and in other parts of the market, including Australia. What it all to me boils down to are these principles of disclosure, transparency and being clear, not just about what's in your portfolio, but it's also transparency around the risk-adjusted return of your book. Where are returns coming from? Are they coming from performance of loans as you thought per contract? Are they coming from high interest rates, lots of delinquency getting you to a net position? Is there leverage embedded in there? Is there structured complexity? What does it look like? What is the risk profile of the loans? Then there's this third layer of governance transparency. How you set up?

• 46:23Speaker 00

  How do you have the right checks and balances and controls that's necessary in credit? They're the sort of elements that are important. When they're understood, investors have confidence and they know what they're getting, whether that's the nature of the credit, the exposure to a particular type of sectors or something more balanced, or whether it's things that are in the news around, say liquidity and gaining. This is a long-term investment asset class. This is not liquid credit. The way people should be thinking about private credit is think about my portfolio. Let's use 60, 40. The part that's 60 is for growth. Then there's the part that's 40, the defensive, historically in bonds.

• 47:04Speaker 00

  How much of that 40 do I actually not need daily liquidity or very frequent liquidity? How much of it can I invest in a longer-term structure where I've got a contingent amount of liquidity? I can take some of my money, or sometimes all my money, out periodically, but I know I'm invested for the term of the underlying loans. For some people, that'll be 5%. For some people, that might be 20%. Whatever it is, it's about making sure that you understand that characteristic and that's the key thing going on. Take away all the noise. That's the fundamental challenge of the industry. It's what's under the hood? How do we enhance disclosure, transparency, communication of what we do in a way that people understand?

• 47:44Speaker 02

  All right, Frank, I want to make sure I get a chance to ask you a couple of closing questions. What was your first paid job and what did you learn from it?

• 47:51Speaker 00

  My first real paid job when I was in school was as a piano teacher. I worked with this guy in Australia, it was a place called Cole's Music House. And he had this interesting model where he'd teach people from kids to seniors based on pop songs, songs that were out there right now to make it fun. And he used intuitive methods. What I learned from it was the power of process, simply communicating complicated ideas. That's been helpful for me ultimately going into the world of finance because we love in this industry, jargon and complexity, but it's about bringing it back to first principles. And I learnt that on the job.

• 48:26Speaker 02

  Which two people have had the biggest impact on your professional life?

• 48:29Speaker 00

  In the restructuring business, there was someone retired and they wrote a book called Everything I Know in Life, I Learned From Doing a Restructuring. They sent it to a bunch of people. It's almost a bit of legend around the industry now. You can't buy this book on Amazon, but I've got a copy of it. It has basically 50 funny anecdotes. One of them, page 41, I notice, if you want to be a Jedi master, find your Yoda. It's all about the power of mentorship, people backing you, collaborating with you, bringing you through the ranks. I've had that from Chris Wyke, who's one of the co-founders of MA Financial Group. Today, our joint CEO. We've worked together since I was a baby banker. He's backed me and he's got behind me as we've wanted to do things like build a credit

• 49:12Speaker 00

  business from a small idea into something that's quite large and scalable. The other one for me has been my dad. My dad had all these great anecdotes and sayings when I was growing up. He'd say things to you that gave you these good life lessons. One of the best pieces of advice he ever gave me was you're only as good as your last game. I played a lot of sport growing up. Doesn't matter what you've done before. It's the next game is the one that matters. He used to use this anecdote of Australian rugby league player called Graham Langlands. Imagine it's a Derek Jeter or someone like that. This Graham Langlands back in 1975, he was in the grand final of his team. Incredible player, one of the greatest ever, what they call an immortal in that Australian sport.

• 49:56Speaker 00

  He showed up at this game, he was wearing white boots under a sponsorship deal with Adidas. This is the time when everyone wears colorful boots today, they were black boots only. And he had an absolute shocker. They got thrashed. His legacy was almost tarnished by this one thing where in that grand final, he was a show pony and it didn't work. You've got to bring that degree of focus to every day and to everything you do. You can't ride in the coattails of what's happened before. Those two people have been hugely influential in my professional career.

• 50:25Speaker 02

  What's your biggest investment pet peeve?

• 50:27Speaker 00

  My biggest investment pet peeve is when people focus only on the investments themselves. They forget that that's just one-third the job. Most of the alpha in the business of investing, I believe, comes from portfolio management and from risk management. These things are equal thirds. The real alpha is not coming from the investment side, it's coming from the portfolio management, the risk management.

• 50:52Speaker 02

  Frank, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

• 50:57Speaker 00

  It's easier to catch flies with honey rather than vinegar. If you come from a restructuring background, you're always thinking about leverage, pressure points, taking a hard line. It's this idea of balancing not just smarts and IQ, but with EQ, thinking about relationships, the things that incentivize people, what motivates people in a broader basis than discipline. It's been very influential for me. It's using more of the carrots rather than the sticks and knowing when to do that in the right circumstances. I wish I knew that earlier.

• 51:29Speaker 02

  Frank, thanks so much for sharing your story.

• 51:31Speaker 00

  Ted has been really fun. Thank you.

• 51:33Speaker 01

  Thanks for listening to this sponsored insight. Sponsored episodes are paid opportunities for another 12 to 18 managers a year to appear on the podcast. If you're interested in telling your story in front of the largest audience of investors in the industry, please email us at [email protected] to apply for one of the slots.

• 51:58Speaker 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.