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Before we transition to the episode, I want to highlight the Founders Podcast, which is part of our Colossus Network. David Senra, who hosts Founders, has devoted his life to learning from history's greatest entrepreneurs and every week he distills the lessons of a different founder. If you want an entry point, I highly recommend starting with episode 136 on Estee Lauder or episode 288 on Ralph Lauren. I hosted David on Invest Like the Best last summer, and it's hard not to walk away insanely energized after listening to any episode with him. You can find a link to founders and those episodes in the show notes of this conversation.

You can also search all past transcripts on our website, joincolossus.com. Hello and welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best.

This show

is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at joincolossus.com.

Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of positive some or O'Shaughnessy asset management.

This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of positive some or O'Shaughnessy asset management may maintain positions in

the securities discussed in this podcast.

My guest this week is Scott Goodwin. Scott is the co-founder and managing partner of Diameter Capital Partners, which he started as a credit hedge fund in 2017 and has expanded into a $13 billion investment firm that covers all credit markets. Scott spent the first 8 years of his career at Citi, where he rose to head of high yield trading before moving to Anchorage Capital in 2010, where he led the global trading desk. Scott is 1 of my favorite examples of the joke I used to make about this show when I said it should be called, this is who you're up against. He's 1 of the sharpest investors I know, and I'm sure you'll see why.

Please enjoy my great discussion with Scott Goodwin. All right, Scott, maybe an appropriate place to start would be to compare what you think of as the theme of the 2010s with what you think the theme will be of the 2020s across investing writ large.

If I look at the 2010s, it's all about private equity, shareholders, return of capital, dividends, 0 rates. Now you're in an environment driven by inflation, higher rates, likely return of that capital to lenders, pensioners, savers, creditors who are robbed of it in the 10s. You have this transition back that takes a long time. That's the theme that I like investing behind for the 2020s, which is exciting from a credit perspective because we're yield investors and credit investors. We haven't had that opportunity really since

2008. You said it takes a long time. Give some tangible examples, little anecdotes or something of how this might start to play out. If you're sitting there as a pension and you have a 7% bogey or 8% bogey and your equities are at all time highs, and now you feel like, now I'm funded, I'm going

to start to rotate into investment grade corporate debt. You can buy 30-year investment grade corporate debt now yielding 5 and a half to 7%, depending on the credit quality. And that starts to be a meaningful defeasement of your liability relative to equities that might have more convexity, but you don't need that convexity anymore because you can defuse your liability. Those decisions take time to get made. You also have the other side of it, which is a company just has too much debt, has been zombified by COVID.

Maybe there's too much debt on the capital structure, but because rates were so low during COVID, the coupons are low. They've got maturities in 27, 28, 29. The bonds are trading at 60 cents on the dollar, 70 cents on the dollar. They're not defaulting tomorrow, but the creditors are essentially the equity. And eventually there's gonna be that transfer of value back to the creditors.

So those are 2 kind of barbell examples of how I think it will happen.

I think there's different personality types that thrive in equity versus credit. I know early on in your career, you figured out that equities weren't for you. Maybe describe in your mind the prototypical skill set differences between those 2 types and who would thrive the most?

Well, Morgan Stanley didn't want me back after my junior year summer. So equities weren't going to be for me because they didn't offer me a job. I think for me, I'm naturally skeptical. And in credit, you're always thinking about how much can I lose? Am I going to get my principal back?

Am I going to get my interest payments? Or is the thing about the smart equity investors I know, who have the last 10 years made a lot more money than I have because they've been thinking about the upside. How can earnings or revenue for this business double, triple, quadruple? So that difference of thinking about downside versus thinking about upside is very fundamental. And then when you think about credit investing, you have the asset side of the balance sheet, which the equity guys are focused on.

So how many widgets does this company make? How many PCs does this company make? But then there's the liability side of the balance sheet that the equity universe, frankly, misses a lot. I think they're learning about it again now a little bit. Thinking about what Carvana or companies like that have gone through.

You're seeing the liability side start to matter more, but what's the debt structure? What are the maturities? What are the covenants? What assets can the company sell? What can they not sell?

Can they move assets around? So that liability structure and sort of the unholy acts that can be done by creditors or to creditors is something that we like to meld into our process from a credit perspective.

You've raised Carvana, such an interesting example, just because people listening can probably visualize the stock chart. And you see a stock chart like that, and the obvious question is like, how could this happen? The amount of destruction of value for the equity over, let's say 18 months or something like that, just seems at odds with what we think about how markets function almost. How could it be that it was valued at this and now it's valued at this?

That example is a finance company that was doing really well when rates were 0 and people believed in a huge TAM. Now people realize that rates are not going to be 0 forever. So their finance business, effectively subprime finance business, isn't earning as much as it was. The TAM isn't what it was. And they're just not that good at selling used cars.

But I think you go into bubbles and the Fed inflates and deflates them. And the 1 we're on the precipice of deflating right now or in the process of beginning to deflate, driven by tech, healthcare venture, private equity and 0 rates and private credit. It's all 0 rates. Where can I put my money where there's convexity? When there's no yield, people hunt for other ways to get convexity or optionality.

Can you talk about the concept of a credit cycle, which listeners will be roughly familiar with, but I think drives a lot of where the opportunity is. And I want to talk about in the credit cycles that you've seen and or studied, but really seen and participated in, how they felt different, maybe going back to like, say, 2000, so that we can talk about this 1 specifically and how it's different. But first, what is a credit cycle from your perspective?

So when we think about credit cycles, we think of booms and busts in business, booms and busts in the economy associated with companies that are either cyclical, that have a problem due to an economic change. So in COVID, that meant rental car companies and cruises and airlines that literally couldn't perform their business. Their balance sheets were fine 1 day and not fine the next day. And then you have another type of credit cycle, which is more driven by secular change. So Amazon killing all the retailers over the past 10 years.

So for us, credit cycles aren't just

02, 07, 08,

and COVID. There are series of micro cycles going on all the time in different sectors. Maybe the energy thing in 2016 is the best example of that. If I unpack that and go back, I started at Salomon City in 2002 working for Jim Zelter and what kind of the learnings were from him early on, it was there are a lot of companies that need money right now for project finance in telecom and power. That's what's been built up.

And there was a series of asbestos bankruptcies as well. That was a bubble built up largely in the high yield market, tradable bonds, investment grade market, power, telecom and fraud were the main parts of that credit cycle. There was a huge amount of money to be made in distressed because you had mutual funds that would bond default or they get downgraded and they sell them to the stress guys. And there wasn't as much competition for those people in distress. And the liability side of the balance sheet we talked about, those people had real edge, go to the courthouse.

They would have lawyers, they would know exactly what was going on. That liability side edge, because of the advent of real research and everybody having a doc person on staff has largely been competed away within the credit universe. That's the first cycle I was a part of. Then we get to the LBO boom and bust. So if you think about LBOs and probably 40% of high yield issuance was driven for LBOs in 2007.

I don't think we've seen that number since then. And there was a ton of leverage built up in the system very quickly, chasing a private equity boom. You had a housing bus that took the economy down, that took those deals down as well. So those companies weren't actually the problem. It was the housing bus that took the economy down, that caused them to have a problem.

That was another very fast V for a lot of those companies. I was at Citi and then left in 2010 to go to Anchorage. But I'm at Citi, my mentors, Jim, John Eckerson, Ronnie Mateo had all left. They're gone. I'm kind of there by myself with a few people who are left, moving the deck chairs around, watching the stock be at a dollar, and frankly, learning from my clients.

1 of the reasons I went to Anchorage was I had a lot of the same shorts as the Anchorage guys in 08, and we worked to turn them into longs in 09. A lot of my career has been about finding shorts, then getting long the other side and following these credits through the cycle. And I liked how Kevin and Tony and the Anchorage team did that. So they asked me to join in 2010, and I joined them coming out of the GFC cycle. But then soon after that, we had a cycle in Europe.

I got there, I think, in May of 2010, and all of a sudden, Greece was exploding. Frankly, the learnings from the European sovereign cycle were very relevant to what happened during COVID, because it was the first time in my career that you'd seen real intervention by sovereign corporate debt markets buying a lot of debt and supporting the market. So you had in 20, in DRAHI, whatever it takes, they're going to buy Italian bonds, buy Spanish bonds. Eventually, they ran out of those bonds to buy. They bought corporate bonds with the CSPP program and then distorted the corporate bond market in Europe for a long time, which allowed REITs to issue at 1%.

That's going to now create a good distressed opportunity. But what we saw then was whatever it takes intervention works in investment grade and corporate bonds.

2015, 16, 17

is the energy and commodity bust. That's a real credit cycle sector driven like I was talking about. So there's a ton of new issuance in energy. The shale boom is being built up over many years. I remember meeting with Aubrey McClendon from Chesapeake in 2003 or 2004 at Citi in a roadshow.

And he showed us a chart. I think they issued the Chesapeake nines that year, the nines of like 08 or

09.

And he showed us a chart of where natural gas was gonna go. And I don't think it saw that target for a long time. But that was the beginnings of it, like in the early 2000s. At Anchorage in 2010, 11, and 12, we were financing companies in the Bakken, the Marcellus, the Mississippi Lime, the Permian. We knew all these bases.

So when energy started to trade poorly in the middle of 2014 and start to trade down a lot, and you start to have these high correlation sell-offs, that's 1 characteristic of credit cycles is, whether it's a sector-based cycle or it's a macro cycle, the beginning sell-off in credit is 0 dispersion, high correlation. People are selling what they can sell. That creates tremendous opportunities because in that first wave, things will go down that probably shouldn't have gone down at all. And you can buy those and short the bad stuff. So we looked at that first sell-off in 2014 and you had the Permian credits, many of which have now been rolled up, the Parsley's, the Crown Rocks, the Diamondbacks had gone from par to 70 cents on the dollar.

The Mississippi line, which is a worse basin, the Sand Ridges and the offshore credits had gone from say par to 50. The distressed funds are all looking at the stuff at

50.

They're heuristically saying, I have to buy the lowest dollar price. That's what I've been trained to do. And they're generalists generally. They don't have sector specialists, although that's changing because of some of the mistakes made in the teens. But they're drawn to that low dollar price.

We're sitting there saying, wow, this stuff in the Permian is covered at par, even if oil is at 30 or

40

bucks. Whereas the Mississippi Lime stuff, we didn't like anyways. Let's buy the Permian stuff at 70 and short this at 50. And that trade ended up making maybe 30 points on the long and 50 on the short. I wish we'd held it that whole time.

In extremis, that's what it would have made. But you had multiple bites at the apple and fits and starts in that credit cycle. And you usually do. Rarely do you go like COVID from A to Z in 1 month. Credit cycles are, and the 1 we're about to talk about, the post-COVID cycle that we're about to enter now is, it's a slow moving cycle.

Much more like the 02, 03, 04, 05, what I went through at the beginning of my career, which was a buildup of excess in certain sectors driven by some economic shifts and changes in the interest rate environment that led to a cycle. The things in 2011 and 12, systemic, GFC, systemic. Energy, not systemic, but commodity price. If you have a bond that's at par, that works at $70 oil, and all of a sudden oil's at 20, it doesn't work. It's not that the bond's worth 50, it might be worth 0.

Now, what happened in the energy thing was you had all these bonds that went to trading at 0 to 20 cents on the dollar. But some of them had a couple of years of cash around and could fund their interest payments. He said, well, I can buy for 5 to 10 cents. But I think about the best trades I saw in 08 and 09, it was people coming in and buying the LBO and secured debt. I was at the broker dealer at Citi because there was a lot of option value at those spots.

Now we're sitting here at Anchorage and we've got, wow, there's some really interesting opportunities. These bonds are at 5, 10, 15 cents. So we try to figure out which one's had enough runway and it's same thing happened again in COVID. And you ended up buying what were IOs that recovered par, because oil didn't stay at 20 or 30 bucks forever. It went back up eventually because supply and demand balances.

And I think in commodities, you had the same thing in Freeport and some of the copper companies as well. When you have a commodity, a first quartile or second quartile commodity company that trades down a lot in credit, it's a really unique opportunity because the commodities have such a high volatility factor associated with them. If they have enough runway that they can last

12

to 24 months, you're supposed to take a shot on that debt.

And is the opportunity a function of knowing the names incredibly well? Seems like a theme across the stories in your career is you get, you said, multiple bites of the apple. If you know a name well enough, you end up dealing with the same company, the same credits like over and over and over again. And so speed and familiarity become key components of the opportunity to do well in these displacements. Is that roughly right?

Yeah. You'll hear if you walk around the floor of diameter and we've got, I think, almost in the low sixties of people now going to 70 pretty soon, you'll hear know the names echoing through the walls and the halls. It literally means know the names. We're not kidding because credit is an asset class that is naturally very different than equities. It's a carry-based asset class, you get your coupon.

Equity investors are looking for total return. We're approaching credit not from a get my coupon mentality. We're approaching it from a total return mentality. And if you want to approach an asset class that is carry based from a total return mentality, that means you have to see where the ball is going. Most credit investors are rules-based.

They have to buy this duration of bond or this rating of bond or this sector of bond. Most have daily liabilities. Most of the credit money is in structures away from private credit in mutual funds or ETFs, not most, but a decent amount of the credit money is in those structures that have to say 30 or 40% of the high yield market, less the IG market, but have to leave, can leave at any day. And loans, same thing, 30 to 40%. CLO is the rest of the low market.

If you can leave any day and you have an underlying market that has discontinuous equities over the counter market, you better be ready to make decisions quickly.

What's quickly?

Seconds, minutes. And I think that's something that my partner, Jonathan, and I really put together when we were building Diameter was, we want to develop a process, and we had built this at Anchorage, but we wanted to put it almost on steroids of how can we be a provider to liquidity into inflection points in markets, credits, and sectors? Because the banks aren't sitting there providing liquidity anymore. They're intermediating in the middle. When there's a big seller or something, when there's an inflection point in a credit, a downgrade, an upgrade, an M&A event, a bankruptcy, any sort of event that causes a lot of trading, we don't want to be just starting our research then.

And if you're just a distressed person that's reactionarily looking at what's in distress, you're going to be starting then. But if you're looking at the market every day, you're doing new issue, you're shorting, You have a CLO business that looks at new issue and knows all the loans. You're forced to think proactive and thematically. So we want our analysts, our telecom analysts, is focused on level 3 right now in the distress space to also be thinking about whatever's happening with AT&T and Verizon and T-Mobile that might impact the distressed telecom names. It's that full cycle investing within a sector being very sector specialized on the research side and then product specialized on the trading side that I think allows you to make fast decisions because if you're not product specialized in trading and you're a tourist to say investment grade, or you're a tourist to high yield, or you're a tourist to distress, you're not necessarily gonna get the call from the bank when there's that opportunity.

If you're in the market every day, they're gonna call you, and our process for our hedge fund and our drawdown fund doesn't have an investment committee. John and I make all the decisions. We work together on them and his background is much more research restructuring legal minus trading risk portfolio management. That comes together when we both love something, we can make fast decisions at those inflection points, but it's because we vetted and we have a list of names with each analyst that we've already vetted with them and then we update on each quarter.

Could you give a story, hypothetical or real, that helps us understand, like 1 of these decision moments where it is seconds or minutes that you're making, I'll call a substantial decision, whether that's with dollars or percent of the portfolio or however you want to interpret it. I just want to get in the room a bit on why this all comes together as an advantage for you and your investors.

Sure. Sure. I'll give you an example from COVID. That's maybe the most interesting example. The levered loan market is a market that is very opaque.

70%

of the market is private issuers, which means there's no public stock you can file. You have to go on the interlink site to get the financials. And levered loans don't settle like stocks or bonds. It's mind boggling, but levered loan settlement process could take anywhere from a week to months. Hopefully someday blockchain will fix that, but it hasn't yet.

So we're sitting there in the second week of March, and we share with the banks the names we're focused on. So I'm sharing with the banks each morning, here are the names we're focused on. So they know if they get a seller of anything on that list, they should call me. We want to be transparent and open with them. Again, we're trying to make them smarter.

We're housing that risk, they're looking to move it.

Are you emailing them, calling them?

I'm sending them an IB and then I'm also talking to them. For each bank, sort of nuance the list a little bit, as are the traders on our team. And the head of loan trading at B of A calls me. He says, hey, it's 7am. I've got a mutual fund that's got a billion dollar outflow in loans.

They're calling us because we have the fastest settlement process for loans. Okay. They own these names on your list. Can you buy 500 million by 8am because they want to make some progress? I call John.

We're like, let's not buy cyclical stuff. We don't know what's going to happen here. We're starting to buy a little bit of IG, because we think the government's going to start buying IG, but this is junk-rated loans. And we had had our analysts in software learn all the software loans in 2019, because we said, well, if there's a recession and there's a cyclical environment, the whole loan market's going to trade down, because that's where a lot of the excesses are building up, but software will be the most defensive place, the stickier. So we bid that firm for 500 million of loans, of which 350 was software loans.

Let's say the average price on them the prior day was in the high 80s. We bid around 80, so down say 10% or 8 points, and they sold it to us. And I think there are probably 2 firms in the world that could have responded to that call within 15 minutes. And we responded, I think, within 5. But they called us because A, we had shared the list with them.

And B, they knew we had a track record of providing liquidity into these dislocations and responding fast. So that speed of capital in that situation provided a lot of alpha. 2 of the loans were Sprint, which was getting bought by T-Mobile, and Infor-Lawson, which was getting bought by the Koch family. So they were getting bought by investment grade companies. We were buying them in the lower mid 80s.

Sprint was a little higher, but that opportunity I think exemplifies being ready, learning the names proactively, not necessarily because there's an investment to do today, but because you know when there's an inflection point, there's certain kind of things you want to buy. And that does create some level of busy work, but it's all about process and being prepared so that you can make fast decisions.

Can you talk about how you think of the evolution of where alpha comes from in credit over maybe just across your whole career. You said your liquidity provision there, which to me is a really important thing to think about and talk about as a source of alpha. But what have been the sources of alpha across your career and what are still here, What are gone?

Early on, it was the liability side of the stress market. And that was the firms that were early in that, that were excellent 20, 25 years ago, that were early and in there, and they knew the docs and other people didn't. That was a real source of alpha. I think that alpha in terms of just understanding the docs better than other people or having the information is gone. If you fast forward to the GFC, I think a lot of the alpha there was liability structure.

Who could hold the trade? We were at Citi, we sold most of our levered loan book to a bunch of private equity guys and gave them back leverage. They had to re-up that leverage, but they were able to hold that trade from those loans going from 80 to 40 to par. And if I look at funds that were successful during that time period, it was those that could hold the trade or had liquid enough investments that they could change their mind. When we think about liquidity and investing, we're not just focused on what is the best risk adjusted return.

We're also for our hedge fund or dislocation fund thinking about what is the best liquidity adjusted return. Because most of the time, you're not getting paid enough to go into illiquids if you have capital that's supposed to be doing liquid things. And a way to know was a lot about holding the trade. Because if you were levered, Selwood was 1 of our biggest counter parties. 2007, the market goes down for like 3 days.

And they were, I mean, these numbers are pretty incredible, but they were something like 90 to 1 levered on levered loans on LCDS, which is a product that doesn't exist anymore. As a secured unsecured basis trade, They were gone in 3 days, basically. And that was a real lesson for me about gross and leverage and watching how quickly that unwound. And at Citi, watching some of the mistakes that were made. There were real lessons to be learned in my career of, frankly, watching other people make mistakes and learning from them versus having to make them myself.

But that source of alpha of liability structure is still around in credit today. I think it's much more appropriately distributed. Now you have private credit funds have funding that matches the not only LP capital, but the leverage matches the duration of the assets. There are a lot of the CLO equity, which is a more volatile product from a market to market perspective, great product through a number of cycles, but maybe not for somebody who has quarterly liquidity. That now sits in different hands, more insurance, more pension, more long-term liability type of money.

There's still a lot of money in daily liquidity, ETF, mutual fund. That creates a lot of the intraday and intermonth volatility in credit because the underlying assets don't necessarily match the daily liability structure. I would say speed is something that when credit markets were much more liquid and the banks were taking a lot of risk, when I was on the sell side, call it 2002 to

2010,

and maybe a little bit after that, 11, 12, 13. There was more liquidity in the market, the banks are committing a lot of capital. Speed wasn't as relevant because the bank traders were always the fastest. They were seeing everything going on. They knew what everyone was doing.

As they became less focused on risk and knowing the names, frankly, and more focused on just moving widgets around from 1 account to another. The combination of understanding the underlying credits and being fast, because I think a lot of people understand the credits, most of them are slow and reactionary. Having a process that allows for speed of decision-making is alpha. There's no doubt about it. The example I gave you about the levered loan things is an extreme 1 in COVID, but happens every day.

Is another way of saying that liquidity provision?

Yes. If you look at the strategies that the pods will employ or other funds have employed in the past, it's not liquidity provision to every name. Providing liquidity as a mean reversion strategy, which some people have employed, eventually you're going to blow up because you're going to provide liquidity to something that doesn't mean revert. If you do it with a real knowledge of the underlying credits, you're going to make mistakes, but you're doing it with a better margin of safety. So yes, it's liquidity provision, but it's also doing it with speed.

It's different for us to be able to make that decision in 10 or 15 minutes because we've already done the work. Whereas if they had called 1 of our peers at that point in time, they get the junior trader who might talk to the senior trader, might talk to the junior analyst, talk to the senior analyst, talk to the PM. And then when the PM's back on Thursday for investment committee, 4 days later, they'll talk about it. But they've missed it. There's so much drawdown capital out there that people are having to adapt their models to be a little more nimble.

I mean, it's why we'll have an investment committee process for our private credit business. We have 1 for our CLO business that are a little bit slower moving, they're more primary base. But the hedge fund, the drawdown fund that John and I run every day, that have to be focused on secondary markets as a lot of the opportunity, that speed of decision making is a real part of the alpha.

Why do you think it is that so many of the big like institutional pools of capital, maybe it's literally just a 0 interest rate thing, have relatively fewer credit managers? When on a risk adjusted basis, like especially given what you're describing, it seems like you could probably hang with anybody if you adjust for risk and liquidity. The average school endowment investment team or something like this, like they'll have tons of venture, they'll have tons

of- We have very few school endowments too.

Yeah, So why is that?

I think part of it is that that particular group of people was very focused the past 10 or 15 years on equities and venture and private equity, and that's worked for them. Returns have been great. And now maybe they're pivoting a little bit. We've seen a lot more interest from that group. If you think about the credit fund performance from say 2013 to

2018,

and maybe getting into 2019, pretty terrible, right? The distressed funds are doing coal and newspapers and shipping and bad energy bonds. The returns are terrible. I wouldn't have wanted to be in that space either. And some funds are getting too big, which really dilutes the alpha.

If trading and speed create alpha, then size is almost naturally at some scale a detractor. So I think it's part of that where the returns were bad. There was no concept of a cost for getting a liquid. There was no stopouts. Every time there was a sell-off, the Fed would step in.

Now you have an hour where the Fed's a headwind and there's a cost now for being a liquid. You can't get your money out of that venture fund, even maybe down 20% from your mark, or that private equity fund down 20% from your mark, or that 21 vintage private credit fund down

10%.

You can't get out and go buy investment grade at

7%

or high yield at 9 or some specific opportunities. I think that's part of it. What did

it feel like to be inside of a place that was getting arguably too big in terms of AUM to be able to enjoy those alpha opportunities? I know 1 of the things at Diameter where the fund is closed, that you're very wary of being the right size and not being too big. And I think that's a result of having been too big at a prior stop. So what did that feel like as it happened to you as a trader?

So I was running the whole performing risk and then my partner, John, ran research. So sitting there trying to trade, especially the shorts, what was probably the biggest short book in single name credit globally. It went from being like, okay, we're betting on earnings announcements, we're betting on downgrades and upgrades, very specific things to our short book is private equity style. It's becoming an index proxy with sector overlays. Because we're too big to change our mind if we're wrong.

That 300 million position was liquid and tradable in 2012. Now it should be 50 or 60. So those changes were, frankly, much more apparent after the fact to me than at the time. But there's a real trade-off between management fees and returns. And I think part of the reason that LPs pushed back on some of the credit hedge funds and the performance in the teens was that they chose management fees and growth of AUM over returns.

And we've tried in the hedge fund to be scaling it in a way that focuses on returns, not management fees. We'd return capital at the end of 2021. I think we'll probably return capital again at some time in the future, because we want to size it to maximum returns and the scalability issues are around capital markets and shorting. So we think about the scalability of those 2 areas. If we hadn't opened Europe, the London office last year, we would have had to shrink it from where it is now, but that's allowed, the Europe has created a lot more capacity.

1 of the things I find most interesting about you and Diameter is, from what I can tell from the outside looking in, the firm really is as much an expression of you and John as people into the firm culture and DNA, as you could imagine, if you really think about investing careers that are worthwhile in the end, meaning like they produced alpha, they did a good job, they did well for their LPs at scale, you kind of see that theme over and over again, where it's like, Buffett would be the canonical example, of course, just incredible alignment between the personality of the investors, the founders and the firm. And for that reason, because most people listening are investors or a lot of them anyway, that might have ambitions to start their own firm. I want to tell your personal story from like childhood just because it's kind of remarkable how Cleanly aligned it is and maybe you could start with Bill James like even go back that far

My dad worked at JPMorgan for 30 years. I was born in Paris moved to the States when I was 4, grew up in New York suburbs, lucky enough that my dad was in finance. That gave me a head start. There's no doubt about that. I'm a sports fanatic.

Don Mattingly was my hero growing up. My dad and I went to Rangers games, would go to Keene's Chop house. We were there at the 94.

I was there.

94 Stanley Cup. Amazing Matto Matto Matto being the devils and then Messier with the guarantee and winning the game like these are my formative moments. And I was on the Royals and T-Ball. So even though I was a Madden fan, I said to my dad, you know, we need to go to the Royals Yankees game. And it turned out that the year we went to this game, Bo Jackson was on the Royals and Deion Sanders on the Yankees.

And this is like 1 of the great Yankees games. You'll remember this game. Bo's up first 3 times up, home run, home run, home run. And this is in the Bo knows era. Dion comes up.

I think it's probably the fifth or sixth inning. Hits a sinking liner at Bo who's playing center field. Bo dives and separates his shoulder. Dion inside the park home run. Bo's injured, has to walk off the field to the crowd chanting, you know, Bo no shit.

I was just a sports nut and I got into baseball. I was cruising around reading the sporting news or 1 of the baseball weekly, these things I would get every week. And I see that there's something called Bill James fantasy baseball. You're an early baseball guy. Bill James was kind of the original statistician sabermetrics guy.

And he had created a business with a company called Stats Incorporated, the data source for all the sports leagues. And I'm at the time, I think 8 or 9 years old. So I sign up for Bill Janes Fantasy Baseball. I have to put in a bunch of spreadsheets on who I wanna draft at the beginning of the year. They run a snake draft, which means the first pick in 1 round, the last pick in the next round.

And I get put in a league randomly with 15 other people from around the country. Just so happens 4 of those guys were in Boston, worked at Standish, worked at the same firm. I win the first couple of years I'm in this league.

At 8 year old.

8, 09:10, right around there. So I beat these guys and they invite me up to Boston. I would talk to them after school before sports practice about trades once every couple of weeks. So they think I'm in college or something. They invite me up to Boston and say, come up, go to Yankees, Red Sox.

You should see Fenway. You're a huge Yankees fan. You know, Mattingly sucks. I said, OK, but can I bring my dad? They said, why?

Well, I'm now I'm 10 or 11, 12 at the time. So I bring my dad up there and I think 1 of my brothers came with us, too. And we go to Fenway with these guys. We go to 1 of their houses in Newton for a barbecue, go to Fenway, super nice guys. And they're saying to my dad, your kid's researching these players.

He's killing us. We're supposed to be the investing guys. He really needs to be getting into investing. I talk to my dad on the train home And he says, well, I ride the train with people who are in the investing side of finance. You want to talk to them, they can teach you about it.

So lucky enough, I'm living in this town and my dad's riding the train every day with Tony James who ends up running Blackstone later. John McFarland at the time was at Solomon, but ends up being the CEO of Tudor, Richard Shilton, upcoming equity long short guy at the time, and Mike Clark, who was running Convertible Bonds at CS. So the 4 of them really combined to help me think through as a young teenager, how I would get interested in that business. I opened a need trade account and I would look in the journal and make horrible stock picks and then Compaq was the first stock I bought because I had a Compaq computer. Hopefully my process has evolved since then a little bit, but that evolved to working on the floor of the stock exchange as a runner.

I would take the train in

15

for a guy named Donato Cotone, who was what's called a $2 broker. And $2 brokers are basically overflow shares for Seahaster Goldman or some big bank. Their floor brokers couldn't take all their flow, they would give it to a $2 broker. And this guy was a legend of the floor. So working for him, getting his lunch from Il Molino every day, taking the train in from Connecticut and then following that into, and really John McFarland deserves a lot of credit for this, but him helping me follow that passion into college, mentoring me a lot, working with him, and then learning from Paul at Tudor 1 summer, got me very excited about markets, investing.

I went to Duke knowing that I wanted to do investing and trading. There was no doubt in my mind. Duke was a great thing to go through and an amazing experience, but I wasn't exploring what I wanted to do after that. That was kind of my story.

It sounds like unheard of right now that you would have a 14-year-old or something doing some of the stuff that you got to do. What did those 4 guys that your dad was riding the train with? Literally, what did they tell you or teach you during that period of time that stoked your interest? It just seems to me that in this business, apprenticeship is so important, mentorship is so important if you're lucky to get those kinds of people early in your career.

I mean, they all taught different things, but I would say from certain people, it was about learning from your mistakes and integrity. From others, it was about trading and pain trades. Some of them were more on the banking side. It was really just getting exposure to these people every few months and picking their brains. Now, John McFarland, who I probably kept in touch with the best of that group is on our board now.

Has really been a leading mentor for us in Diameter in terms of building the culture, the compensation structure, the alignment structure of the place. Worked at Salomon and helped save Salomon with Buffett and then went to be CEO of Tudor and is just an incredible human being.

If you think about the things that you've gotten right and wrong building diameter, and I know there was a period of time before you started the firm, when you were on like a listening tour, I guess I would call it, you were sitting out, you couldn't be running money, and so you were learning and asking questions. What did those people tell you in that period about, setting aside investing now for a second, about running a great investment firm? Like in things that you listened to and maybe a paid off or diamond. Sure.

So number 1 was alignment on your team. You want to create a culture of alignment where people are rooting for the person next to them to succeed. And that may sound funny.

Or obvious.

Yeah, or obvious. But when you have a culture where the compensation is a zero-sum game and people feel like they're fighting for that pie, you're not necessarily rooting for the person next to you to succeed. That was number 1 for us. Everyone on the team have points that's at a senior level so that even if I'm not having a good day or a good year, if I can help my neighbor who's got the most interesting sector succeed because of my network, or I've seen something in a doc that can help them or something before, that was critical. Some of the other great advice we got was around liability structure.

Like I mentioned to you, I think it's alpha, which was focused on aligning it to sort of the least common denominator of your portfolio. And the case of our hedge fund, that was going to be whatever we're doing in distressed. And if we wanted to have a third to half of the hedge fund in distress at different points in time. I think it got close to half during COVID or just after COVID. You need to have a liability structure in terms of investor level gates that allow you to manage through that if people want to get out.

I think another thing that was really important for us was raise enough money so you don't have to be fundraising once you start investing. And that was a really, really important point for us because we want to raise enough money to be relevant to the banks. We like to give the banks our research and trade with them a lot, but if we can only do 1 or 2000000 or something, we're not that relevant to them. To the liquidity provision point you made earlier, if I can't speak for a 25 or $50 million block that someone has to sell, I can't be that call. So we had to raise a billion dollars.

And then in terms of managing the relationship between me and John, we had come from a place with 2 PMs. And when we were doing a lot of the early meetings, all the LPs were like, oh, I hate the co-PM thing. It was like when in the LP training course, you get told no co-PMs, that sucks, That's terrible. And that's fine if one's the telecom analyst and one's the financials analyst. There may not be a lot of synergies, but John's background is research, restructuring, legal.

He went to Yale Law School. He worked at the Chicago Court of Appeals under Richard Posner. He's investment banking background. Mine is, I don't have any modeling investment banking trading. I went straight on the trading desk.

It is trading, risk, portfolio management. So melding that together, that research and trading for us really worked. But in terms of managing the relationship, we have 1 person who has given us amazing advice early on was Isaac Kaur, suggested we work with a coach that he had worked with. And so we've met with her every week since we started, before we started. She's helped manage our relationship, manage the team, and now she works full time for us as our chief people officer.

So having some of those things, those fail safes, where other people had made mistakes or we had seen mistakes made at our prior firms in our lives, we tried to build for them early on so we wouldn't make those same mistakes. But we did make some mistakes in hiring, actually. And it wasn't that we hired bad people. It was we hired people who didn't fit our model. Because we were testing for depth.

When you're hiring analysts, and you're not investing at that time, we had a model portfolio. And like everybody's model portfolio, it was killing it. There's never been a mock portfolio that's done that. I can guarantee you that. No training costs.

We were testing for depth. We would give these guys case after case, how deep can you go? How well do you know this? And we ended up with some people that fit our model really well, which was depth and breadth. We want you to be able to go really deep, but be really wide, know your whole sector.

Some people on the team were just more like the depth guy or the depth girl. And what we realized after 6 months was that didn't work for us. I think we had 5 or 6 analysts in the beginning and we needed people that could really cover a wide swath. But when something special came up, they could go deep. And when you're hiring for a startup with an indeterminate amount of capital, you're not necessarily getting the rocks.

We couldn't hire people who worked for us before. We had non-competes. I mean, you're not necessarily getting the rockstar analyst to walk out the door of his fund. So it was people who either were really good, but for some reason or another, were willing to take a shot on us or had something else in their career that was going on. And some of them wanted to put the furniture in 1 day, talk to an LP the next day, and then work on a credit for 6 months.

And we found that they didn't like a lot of process, a few of them. We need process. We want to, and we built this at Anchorage, we want process around the research so that the sectors are covered, the topical things that we know there's a new issue coming or there's an event that might happen in that name so that we're ready. It's all about being ready. And that wasn't for everyone.

So we worked with our coach and other members of the team to figure out how are we gonna change our process so that we can hire people who can do this depth and breadth. So we changed the cases. Went from like 1 or 2 deep cases to 3 different cases. 1 to test depth, 1 to test networking, and 1 to test speed.

What do you mean by networking?

So the depth case is bring us something, anything you know, that you know the best. Don't do any new work. You can just bring it to us. We'll go through it. The networking case is we're going to give you something you don't know.

You can talk to anybody you want. You've got a week. How well can you figure this thing out? It's not in a sector, you know, probably. So how well can you figure it?

How well can you not only do your deep work, but talk to the network to figure out the narrative. And then speed is just, we give you something, you have a short amount of time, that's obvious. Because I think that those are, especially in credit where there are restructuring advisors and there are capital markets bankers, there's all these different people around the nexus of credit. Having a strong network is critical. It's critical to understanding the narrative of a situation.

We talked earlier about equity versus credit and the idea of imagination is really important in equity investing, like imagining what the TAM might be, what might become, what a team could accomplish. What role, if any, does imagination play in credit investing?

A lot on the structuring side. So if you think about what's happening right now with a lot of the companies that are in need of money in both, let's call it generally the private credit and levered loan space where the bubbles have been built up, they are moving assets away from creditors to raise capital And they're doing it in very clever ways. 1 has just done it by creating a double dip, which is essentially an extra claim through an inner company without actually moving any assets. There's a lot of imagination and structure around that. And then I think about when you're in a distress situation, when we're sitting there looking at Hertz in the middle of 2020, and we're saying, well, what's this business going to be?

You have to think about the narrative of a company as it goes through the process. In equities, you have 1 stock. In credit, in the case of Hertz, let's say you have the common equity, then you had the senior unsecured debt, then you had the second lien debt, the first lien debt, and you had the ABS on the cars. So, you have all these layers you can invest in the capital structure. And you have to think about, Hertz is doing no business right now, but I'm looking at the data from China and China is reopening already in May, June of

2020.

And it seems like nobody's taking the public transportation. Well, what does that mean? They're going to drive. Well, there are no cars are being produced. What does that mean then?

They're going to buy used cars. Okay, why do Hertz go bankrupt? Well, A, no one's traveling, but B, most of the Hertz debt is just a margin loan on the ABS and the used car securitizations. So used car prices crash. If used car prices are going to go up a lot, that's going to benefit Hertz.

So we were an investor in the first lean. And we're sitting here looking at this and we bought the first lien at like 75 or 80 cents. We ended up being us and Apollo were the 2 largest investors in the first lien. If this is what's happening in China and that happens in the US, used car prices are going to skyrocket. And maybe the narrative is going to change in this bankruptcy that the first lien isn't the fulcrum or the controller of the equity through the bankruptcy.

It can be the junior debt, which is trading at 15 cents. So we bought the junior debt on that option. You have this convex option that used car prices are going to skyrocket. That's a simplistic example, but thinking about how companies evolve through a bankruptcy process and through their life cycle, and how the capital structure interacts with changes in the macro and changes in the micro is a lot of how you have to think creatively about credit. It's less about, there's this huge TAM and delivery, How can I address it?

What we're trying to solve for is knowing names and then touching them at different points in their life cycles, be it long, short, different parts of the capital structure that we think management and the micro and macro economy are going to favor or disfavor.

I have more questions about effective building of the firm, respecting this partnership model that you guys have, the CoPM thing, and then also the investment team and how it's evolved. I think you and I maybe have talked about a series of breakfasts that you've had with your partner for like a long, long time, that's just like a fun excuse to talk about the partnership. But maybe talk about those breakfasts every week for however long you've been doing it, like the value of them and just what you've learned about an actual partnership in investing where it's often 1 person that's leading the investment firm.

Yeah. So I don't think Diameter works without both of us. And I don't think I'm successful without John, probably the other way around to the degree we are in terms of investing. It's a very symbiotic relationship. We thought about doing a fund as early as 2012 together.

We met in 2010. We became very close friends. We realized we had really synergistic skill sets similar to Kevin and Tony above us. They were a great example of putting research and trading together and how synergistic that can be. And John at the end of 2012 was ready to do it.

I wasn't. He left to go to Centerbridge to learn the liability side of investing. Anchorage is much more focused on the asset side. How many widgets can you make? Centerbridge is what on all the acts can I do in the docks?

He went to learn that. I stayed at Anchorage, learn more from Kevin and Tony, But John and he left, I would say, not on amazing terms. If you left Anchorage, you were dead. So he leaves and he still wanted to talk credits because he went to a place that wasn't sector based. It was more generalist.

He's always calling back trying to get the credits. We wouldn't call as John. So I went to Duke, huge ACC basketball fan. He's Jewish, also a basketball fan. And Tamir Goodman was the Jewish Jordan, like faces in the crowd in the late 90s.

So he would call back as Tamir Goodman. Nobody knew the joke except for me and John. They're like, who is this Tamir guy calling? So we would talk credits as Tamir on the desk. And then every Sunday we would meet at Bubby's in Tribeca for breakfast with our kids.

His son and my son are the same age. We'd take them and we typically would have someone, Jason Brow from Goldman who lived near there would join and he would pay and listen. So we would talk credits then. And that really evolved once we thought, okay, we're going to start this business, to every Sunday morning meeting together, going through the portfolio. I mean, whether it's on Zoom or in person, we've missed 2 in 6 years since we started.

So, From 7 to 9 a.m. Every Sunday, we're sitting there going through the book, the hedge fund and the drawdown fund portfolios. And my week is spent more trading, talking to the banks about capital markets, talking to the analysts about the credits that we're involved in that week, going through the new issue calendar. John's has spent thinking thematically with the research team about what's going to happen in the future, going through their models, talking to restructuring advisors. So it gives us both a chance to step back for 36 hours from the market and then sit down fresh every Sunday morning and go through the book.

And that's been a really helpful exercise to make sure that we're on the same page risk-wise. We've built it with our coach at the beginning, Tracy, to be a process that we really can't ever avoid. Even if one's traveling somewhere on the other side of the world, we find a time to do it. And I think it's allowed a consistency of portfolio management and consistency of message from us to our team in terms of risk, what kind of risk we want in the book, where we want the team focused. We take notes on it that the whole team can see.

So, they can all see that's what they're going to be working on this week, or that's what Scott and John were talking about, and they can push back. The part of the process we have is then on Sundays at 4.30, everyone on the research team sends us what they're going to focus on that week and what their long-term focus is. And then Monday morning, we sit down with the whole team, either in person or on Zoom, and we go through all those workflows. Everyone on the whole team knows what each other is working on. If you covered something 5 years ago and you don't cover it anymore, you can still have input to what this person's working on.

We want that transparency. If you have the alignment where everybody has carry, you're gonna have people that wanna contribute to other people's work. And that's been really, really helpful for us, I think.

What has Tracy done for you guys and then for the business and the way the team like gels together over time?

Tracy Fenton, recommended to us by Isaac. I think with me and John, we both struggle with different things at different times. Her background is in a maximum security prison in Canada. So she's got an interesting background.

Say the least. Yeah.

And we met her, she was working with hedge funds and the corporate team of 1 beauty company actually. And she's first started working with me and John and really helping us with management skills, managing stress of starting a new business, managing different personality types. Which of us would be better fit to manage different people on the team, helping us calibrate that? As we've grown, she's gotten more involved with the whole team, not just us. And she was consulting initially once a week with me and John.

Now that became over a couple of years meeting with the team once a quarter. As of Jan 1 this year, being full-time on the team. And what is she doing? She's process, hiring, culture, helping the stuff that we can't deal with minute to minute. From a team perspective, this person, they're stressed because they have a sick family member, how can we help them?

John and I might be missing some element of that, how we could help them. So she's making sure that we're helping them in an appropriate fashion. Her EQ is much higher than mine. I'm calibrating up or down how I'm interacting with people based on what she thinks we should be doing.

What kinds of questions does she ask you specifically, or I guess you and John, that you think are most insightful or effective?

It's a lot about human interaction and what the downside would be if you did something differently. Making you retrospectively think about something you said or did, and if you did it differently, what would have changed? And trying to teach me at least, less John, more me, helping me figure out better ways to manage, my intensity's great for the market, but managing that, interacting with people, So that's for me. For John, it's different stuff. It's really tailored to each person.

I think that's what makes her so good.

As you look at the landscape of investing firms kind of writ large, what do you think most will or needs to change over the next decade?

We talked about the shift from equity to yield. I do think that liability structures have tricked people into believing that being illiquid was better than being liquid necessarily. So the vol washing Kieran talked about with you a couple of weeks ago needs to be exposed. And the asset classes that have vol washed to have either sharps that are artificial or low dispersion within an asset class, that will be exposed from an asset management perspective. And then fees can be calibrated not based off what the product is, but based on how good the manager is.

Because right now, if you talk about private credit, which is a business we're about to get into, you spent a lot of time with Kieran, you've had almost no vol in the returns, no dispersion. And the biggest winners have been the guys who had the most second lien or the most equity co-invest, who used the most leverage. Those are probably going to be the biggest losers the next few years. And the de novo private credit opportunity right now is pretty incredible. You're talking about first lien debt, 50% loan to value,

11%, 12%.

The structure we're going to use to raise the capital around it that Apollo seeding will have a higher return based on the seed economics. But I think that there was a lot of poor lending done and mistakes made in that market over the past few years that need to be shaken out. But that's not true just for private credit. It's true for venture. It's true for private equity.

It's true for a lot of other areas. It's just going to take time.

There's a great investor, I won't name him just in case, here in Greenwich that told me this philosophy of how to decide where to go next with the firm. And you just talked about getting into the private credit business. And there's all these considerations, like you don't wanna cannibalize or dilute other strategies, all sorts of considerations. How do you think about your philosophy here? Like how do you decide what might be an attractive place to take the business versus just like, we can raise money there, so we should do it.

Yeah. So number 1 is don't cannibalize. I think that's the main thing we start with when we think about doing something that we're not already doing. And the napkin we had when we were planning it out at Bubbies was hedge fund, drawdown fund, CDOs and CLOs. That was the business plan.

We had that business plan 6 or 7 years ago before we started. And we've done those methodically, US and Europe. Where the private credit thing comes in is, does it cannibalize? No, we're not doing direct lending out of our hedge fund or our drawdown fund necessarily, and we shouldn't be. Is it synergistic to our existing platform?

Yes, we'll grow our relationships with sponsors and we'll learn more names and we'll know the sectors better, we'll know the management teams better. So that helps us investing across the platform. Is it an offensive or defensive move? I think in the case of private credit, it's both for us. Offensive in that, yeah, we can learn more names, we can broaden our funnel from an industry perspective.

So knowing those management teams is going to help us with the hedge fund, the drawdown fund and the CLO business and having a tight relationship with the sponsors. But defensive in that the banks have been a huge partner for us and now they're being disintermediated in the capital market space. So some of the flow we used to get from them, we're now seeing from private equity sponsor XYZ and that sponsor saying to us, well, you're only showing me a public solution. I want to see a private solution too. I respect you a lot, but I need to see both.

And defensive in that respect. We think we can build a really interesting private credit business that focuses on senior secured lending. A lot of the larger guys have gone really up market and chased the bigger deals. There's a big middle market opportunity. And I think that also you're gonna, as Kieran was talking about with you, you're going to have a vintage issue with private credit where if you've got a legacy book with a lot of distractions, maybe your eye's not going to be as on the ball on the DeNovo opportunity, which is actually super interesting.

The very first time that you and I had breakfast, You said something that stuck in my mind, which was about how you interacted with your team. And you said you call balls and strikes, like very clearly. We talked a lot about transparency and like feedback loops and stuff. Is there anything else? I'm curious to hear more about that, but also anything like that, that you think is really important about how your team works and learns together that you would advise others consider when building their investment teams?

Well, not everything fits for everybody. Calling balls and stripes doesn't fit for everybody. It's not how we run all the business, But for the hedge fund, the drawdown fund, that's how we run it. I have an anxiety about missing things. We miss a big short, we miss a big long, more of the shorts.

There's less people competing for that alpha, so it's easier to get if you can get it right. I have that anxiety and I've always been much more motivated by failure than rewarded by success. And that's something that that transparency and calling balls and strikes comes from. I don't think that that's for every platform or every investor. Certainly doesn't fit every person on our team.

So we calibrate it up and down depending on who they are a bit. But 1 thing it does do is it makes you be intellectually honest. And 1 thing we realized was that when we were getting out of things, I think if I would say our greatest differentiator from a portfolio management perspective is we sell things before they go down, that were long. When we make a mistake, we get out fast. And that is loss avoidance and not falling in love with positions is critical.

We did that a number of times on stuff that was in the 90s or par and had it go to 10, 20 cents on the dollar. We missed the short. Analyst, great call for getting out, but we should have been short. So we had to change the process because the analyst isn't necessarily going to go from, oh my God, I love this to maybe he's changing the seat or he or she is changing his thesis a little bit. And I'm saying, sell, sell, sell, just saying we should be short.

So we have product specific trading and sector specific research. So we said to the traders, it's your job when we're punching out of something that's a par thing that we loved, not because the relative value has changed or because it's hit our price target or because the macro has changed, but because the thesis on this specific name has changed, you've got to say, we should be thinking about shorting it. And they've done a good job of pushing that up now. And we've had a few winners because we changed that, put that break point in such that forced a conversation. I like to create elements of process that force conversations on credits.

Why do you think it is that you're motivated more by the loss of wins or whatever? Is that just a hard wiring thing?

Motivated by failure. In my life, there have been disappointments. I was born with a great headstart on most people. But whether it's failing in baseball or getting dumped by a girl or not getting promoted when I thought I should at Citi or not being a partner at Anchorage, those failures have fueled me. Now that we've been, you know, knock on wood, somewhat successful, now there's a target on our back and people will take shots at us.

That's just more motivating. I don't think it's so much the loss avoidance as it is the anxiety of missing things. And that probably comes from my mom who had an anxiety about maybe missing social things. She would like miss a lunch, she'd be pissed.

Is that fuel in the form of wanting to prove someone else wrong or prove something to yourself?

It's just been there since I'm a kid. It's both prove them wrong more than anything else. And that's the competitive fire. But I have to harness it and channel it the right way because early in my career, I would alienate people because I would just be like a bull in a China shop, aggressive, aggressive, aggressive. Let's do this.

Let's do this. Let's do this. My EQ had to catch up with my trading ability. Hopefully over time, it's moved up a little bit towards it.

Where you are now, what kinds of things provide the most joy in the process for you? You're not failing, you're succeeding. Where does the joy most commonly come from for you?

So I would say when John and I, when the technical and the trading element, the risk element comes together with the research and we feel like we're ready for an event and then the event happens. It's amazing. We've had a couple over the past couple of weeks. So it's really fun having those moments because that's sort of like, it's all coming together and that's the process.

What have you learned about dealing with LPs? You and I were introduced by arguably 1 of the smartest guys in the world of investing, Kevin Kelly at Square Heritage many years ago. LPs are incredibly important to the business. I think having the right LPs can make a big difference. Early on, you said you debated between a seed and not taking a seed.

You didn't. I'm curious if you think that was the right decision. This doesn't get talked about enough behind great businesses often are, it's great structure to your point and great LPs. So what have you learned about that part of this whole story?

I credit Dan Stern for not taking the seat. He told us not to do it. He gave us great advice around liability structure and don't take a seat.

That's like something coming from the most famous seater probably ever.

Yeah. So, like he was done seating. So he, he felt like he'd give us honest advice on that 1. He gave us really good advice after we left Anchorage to not take a seed and to have the right liability structure to align with doing a lot of distressed because he didn't think we needed to take it.

Most famous seeder saying, don't take a seed. It's interesting. If you take

it, they're like golden handcuffs, right? You're married to that person forever. And it changes the economic structure as margins come down in this business, as margins have come down in asset management, the seed economics eat more of the economics and it makes it hard to be competitive at certain scales. So more because of that. I think from an LP perspective, we want as transparent as we are internally, we want to be that transparent externally with our partners.

So if you ask the people who invested in us day 1, if we followed what we said we were going to do, I think they would tell you it's pretty much what we said we were going to do. We're going to do a lot of capital markets, be active in long, short, do distress when it was interesting, not as an evergreen strategy, have a hedge fund, have drawdown fund, have CLOs and CDOs. Private credit's the 1 new thing, as I mentioned, but it's that transparency and also having relationships that are two-way. I didn't run the firm we worked at before. We would just go into the room.

This is what you should say. That was kind of the end of it. But now having a relationship, that's a two-way dialogue where we've sought out family offices in certain sectors. You mentioned 1 of them where we feel like we can help them manage their capital, their precious capital, and they can help us learn and be smarter on things. Because we are very well aware that there are certain sectors who are much smarter than we are.

So getting access to them or different pools of capital that have different mandates has been really special for us to learn about some of the philanthropic or other mandates. Frankly, burden is the wrong word, but striving for protecting their capital first and providing a good risk adjusted return when you meet the people and you spend a lot of time with them is something that I think we didn't really have the chance as minions at our prior firm to have those relationships. Now we have them. It's been 1 of the most rewarding parts of doing this.

You obviously know this business now from the inside out in every direction. If you're Kevin all of a sudden and you were allocating capital to other GPs. What things, attributes would be like non-negotiables for you now, understanding what it takes to build a successful investing business?

This advice was given to us. The thing I see cause the failure the most early on is You don't raise enough capital to prosecute your strategy and you spend more time fundraising than focusing on investing in the first few years. That's number 1, if you're funding a new business. Stay in your lane. If you've invested in someone to do credit and they're doing Chinese equities, you've probably invested in the wrong guy.

Is there a source of alpha adaptable based on changes in market conditions. Some strategies are trades. Distress is a trade. It's not an evergreen strategy. Whereas the consistent arb in credit because of liability structure and the backward looking nature of many of the investors is an evergreen strategy.

And you can prosecute it in different parts of the capital structure, investment grade, high yield, stress, distressed, structured credit all over the place. So that I think is maybe something that you're seeing now where maybe venture was really good trade and now people are stuck overweighted.

As we zoom now to the present day market, what else most has your attention? Like we haven't talked about AI at all, which I don't know how you think about it. I know you've had lots of conversations about it. So how do you attack new variables in the landscape like that 1 on a live active basis?

I mean, it's more relevant to the equity market than it is the credit market today because it's driving equity valuations at Nvidia and all these other stocks that have done really well the past few months. Credit A, there's not the convexity and B, the credit market's not made up of those kinds of businesses. They wouldn't need junk debt when their stocks are trading those kinds of valuations. What excites me about AI is it's a disruptor. And the question is, is it a disruptor that accelerates businesses and makes them better or is it a disruptor that kills them?

And I think it can be both. Maybe short-term, it's an accelerator for many from a cost perspective and from a process perspective. But when I look at some of the businesses that are in the investment grade world, let's say, or some of the lower touch and lower margin software businesses in the left-hand world, how AI can interact with them over the next 5 years, not over the next 1 year. It excites me because I think there are some businesses that longer term, the more low margin paper pushy businesses will have a really hard case for not being really disrupted and disintermediated. That gets us excited from an asymmetry perspective.

I can't even pretend to try to be expert in AI. I'm going to let the world teach me about it. But we can look at a credit in an industry that is a clear, obvious disruptor that trades at, say, a 50 spread or a 100 spread at par and say, well, that's an obvious short. And the market's not pricing the volatility options. Essentially the put, if you think about equity and credit, the credit puts usually much further out of the money.

But AI has the potential for some of these shorts to put the credit put as close to the money as the equity put if it's terminal for the business. That's exciting.

What else is going on in the world, if anything, that you think matters that change the dynamics of capital markets right now?

I mean, the banks. So, they're being disrupted from a capital perspective in terms of the private credit lenders, direct lenders. And we're seeing now that the regulators are more focused on them. Obviously, the yield curve doesn't help. We consider them great partners, but now they're needing to, through credit risk transfer transactions, do essentially derivative hedging trades to create more capital.

And I think whether it's Basel III or Basel IV, future regulatory things that are coming, that's only going to become more acute. And for us to be a counterparty on the other side of those credit risk transfer transactions, I don't want to get too in the weeds on them because they're complicated, is a great thing for us. The banks are transferring us very high quality risk. We're taking a junior slice alongside them and we're getting paid teens to 20% returns for what we think is a high quality portfolio of underlying assets. The regulation of banks and the opportunities it creates has been an ongoing opportunity

since 2008. For a long time, yeah. What feels to you like unfinished business for Diameter? Main fund's closed, you've done really well. It's a good story, great story.

What still feels like unfinished business to you?

The main fund is first, always. Like that's always unfinished business every day. I eat, sleep, and breathe what we're doing in the hedge fund, the drawdown fund every day. So that's first. In terms of the platform, Apollo bought a stake in the business last year to help us expand into Europe.

I think that European expansion has gone great. We've hired amazing people over there, but there's wood to chop in terms of getting that fully built out. And then private credit, which I think is, as I said, an offensive and defensive addition. We've hired very... We're not doing it with our existing team.

We've hired really strong people, really strong partners from existing firms to help us prosecute that, 3 partners who are starting over the next few months. And that is kind of it. We try to always have a 3 to 5 year plan. So we know where the business is going and that's 3 to 5 year plan. It's finding ways to get better at it every day.

We have to be a chameleon because the markets are always changing. If we sit back, then somebody else will beat us to the next trade. So we can't sit back. So we have to keep bringing in really strong people to our firm that can help us prosecute these strategies that are complimentary and accretive to what we're trying to do.

What's your reaction to everything going on in real estate? It seems like it's such a crazy market everywhere. Everywhere you look, there's just weird imbalances, there's weird stuff going on. There's the office thing. There's lots of weird residential stuff.

Does that affect how you view the world?

It's a huge future distressed opportunity. The shorting opportunity isn't as good because a lot of it's in unshortable securities. You see MBX we've had on for the past year and a half, that's been good, but a lot of the rebonds are down a lot already. So it's then what is the future long opportunity in public and private markets? And it's building a team of people who are focused on that sector in the US and Europe and building the network around prosecuting it.

But to me, as we talked about 02, 03, 04 being a longer cycle, this real estate cycle is going to be long and drawn out. I wouldn't be piling into it now. You can be patient and the office thing is hard because you don't really know long-term where occupancy is going. I like to say there's no bad bonds, just bad prices. There might-

There might be bad bonds.

There might be bad prices. There might be bad bonds in the real estate, in the office space.

I used to, a couple of years ago, joke that this show should instead be called, This is Who You're Up Against. I think this conversation has been 1 of my favorite examples of that concept, right? Like if you wanna get in this game, your level of interest back to your baseball days and intensity are the thing that form prices, that form capital markets and their dynamic nature. I just think it's so interesting to hear your John story. I think you know my traditional closing question for everybody.

What is the kindest thing that anyone's ever done for you?

I'll give you a personal 1 and a business 1. Personally, my wife, Kimberly, the most amazing person, partner I've ever met. She was a star athlete, played tennis at Boston College. Then it was a star at Vogue on the event side and publishing side. And she walked away from that job to help me build this business and build our family.

So that sacrifice she made as my partner is incredible and something like I wouldn't be able to do what I do without her every day, her support every day. And from a business side, Dan Allen and Tony Davis, who were 2 of the partners I worked for at Anchorage, supported us from day 1 when we wanted to build this business. And it wasn't necessarily in their best economic interest at the time. And that is something that we'll be forever grateful for. Selfless things, I think, and I think you mentioned my listening tour, like I try to do the same when people want to build businesses, we've tried to help them.

Yeah, pay it forward. Scott, it's been so much fun. Thanks for your time. Thank you. If you enjoyed this episode, check out join colossus.com.

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