“I was being pushed for education, education, education. My dad also really planted a seed in my head that I had to have my own business… it was just terrific guidance for me and my personality.”
Joshua S. Friedman is Co-Founder, Co-Chairman and Co-Chief Executive Officer of Canyon Partners, LLC, a leading global alternative asset management firm. He received Institutional Investor’s “Lifetime Achievement” Award.
Growing up in a working-class household with parents who emphasized education and entrepreneurialism set Friedman on a path of academic achievement and professional success. Friedman takes us through his experience starting his own company and why he prefers the term “alternative-credit” firm to hedge fund in describing his company’s outside-of-box investing approach. “We like things where there's a lot of change and with change there's a lot of complexity, and with complexity there's an opportunity to create a dollar for fifty cents…”
Scaramucci and Friedman discuss solution-based strategies in times of distressed investment cycles, especially now as we see the financial effects of the pandemic.
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SPEAKER
Joshua Friedman
Co-Founder & Co-Chairman
Canyon Partners
MODERATOR
Anthony Scaramucci
Founder & Managing Partner
SkyBridge
EPISODE TRANSCRIPT
John Darsie: (00:07)
Hello everyone. Welcome back to SALT Talks. My name is John Darsie. I'm the managing director of SALT, which is a global thought leadership forum at the intersection of finance, technology, and public policy. We've been doing these SALT Talks, which are a series of digital interviews, with leading investors, creators, and thinkers during the work from home period to replicate the experience that we bring at our global SALT Conferences, which of course are on hiatus during the pandemic. What we really try to do at these conferences is provide a platform for big, important ideas that we think are changing the world and also provide our audience a window into the minds of subject matter experts, which is what we have today.
John Darsie: (00:46)
We're very excited to welcome Josh Friedman to SALT Talks. Josh is the co-founder, co-chairman, and co-CEO of Canyon Partners, which is a leading global alternative asset management firm specializing in value-oriented investments for endowments, foundations, pensions, sovereign wealth funds and other institutional investors. Josh sort of has the cream of the crop in terms of his educational background. He graduated from Harvard College. He got his bachelor's degree summa cum laude, Phi Beta Kappa in physics from Harvard College. He graduated with a master's degree from Oxford University with honors in politics and economics where he was a Marshall Scholar. He also graduated from Harvard Law School, magna cum laude, and Harvard Business School, where he was a Baker Scholar.
John Darsie: (01:32)
Prior to Canyon, Josh was a director of capital markets at Drexel Burnham, and prior to Drexel, he worked in mergers and acquisitions at Goldman Sachs. He serves on several boards, including the board of directors of Harvard Management Company. He's also a member of Harvard’s Committee on University Resources, the Harvard Business School Board of Dean's Advisors, and the Harvard University Task Force on Science and Engineering. Josh is a trustee for the Andrew W. Mellen Foundation, CalTech, the Los Angeles Philharmonic, and the Los Angeles County Museum of Art. He serves on the investment committees for the Broad Foundation and the J. Paul Getty Trust and chairs the Caltech and LACMA Investment Committees. Josh also serves on the board of the UCLA Hospital Department of Neurosurgery and the UCLA Anderson School of Management.
John Darsie: (02:24)
So we're extremely excited to welcome Josh to SALT Talks today. Reminder, if you have any questions for Josh during the course of today's talk, you can enter them in the Q&A box at the bottom of your video screen. Conducting today's interview, as we've done with most of these SALT Talks, is Anthony Scaramucci, the founder and managing partner of Skybridge Capital, which is a global alternative investment firm. I'm going to turn it over to Anthony to begin the interview.
Anthony Scaramucci: (02:48)
John, thanks very much, and I'm happy that you're not wearing your star spangled suit for this SALT conference that you were wearing on the Fourth of July because Josh Friedman and I, we don't dress like that, okay? It's just not in our DNA as Jews and Italians to dress like that, but that's a separate topic.
Anthony Scaramucci: (03:05)
Josh, welcome to the program. I think I want to state this. We made an investment in your fund April 1. Congratulations on your performance since April 1. Obviously Skybridge and its investors are super happy about that. John went over your background, but I want you to take us back a little bit to where you grew up, what your parents were like, and why you decided to go in this direction career-wise and then obviously we can talk a little bit about the portfolio and what you're doing now.
Josh Friedman: (03:37)
Sure. Thank you, Anthony. Thanks very much. I should just mention that if that list of extracurricular activities looked a little long, it was because I've actually rotated off a couple of those positions and I apologize for not updating that for this discussion.
Josh Friedman: (03:52)
By way of background, I grew up outside of Boston. My dad was not college educated but managed and grew up in a very poor household. My mother was a school teacher. My dad ended up being a non-college graduate engineer, basically, because he was a smart guy. He really had dreams of me being an entrepreneur and I was pushed educationally, which is pretty typical for that era, particularly in our type of household. I was pushed from the time I was a little kid to go to Harvard and Harvard Business School and Harvard Law School. Then I was told you have to have your own business, don't work for other people because that's the formula for success and for job satisfaction.
Anthony Scaramucci: (04:33)
What town in Boston are you from, Josh? I didn't realize you were from-
Josh Friedman: (04:37)
I was born in Natick and then we moved to Wayland. It was where you moved if you were Jewish-
Anthony Scaramucci: (04:42)
So you're the secondmost famous person from Natick, right? We know Doug Flutie's from Natick, right? You remember Doug?
Josh Friedman: (04:48)
There you go. Absolutely. There's a bunch of actually money managers from that area. Steve Pagliuca's from Framingham, which is the next town over. Jim Pryor's from Weston, which is the fancy town next to Wayland. It was your basic Boston suburb.
Josh Friedman: (05:04)
But from the time I was a kid, my dad ... I was being pushed for education, education, education. My dad also really planted a seed in my head that I had to have my own business. I think that was ... I pretty much did everything my dad said even though he didn't know the name of a single Wall Street firm and even though he didn't really have the background to give that guidance it was just terrific guidance for me and my personality.
Josh Friedman: (05:28)
I somehow thought I'd be a tech entrepreneur out on Route 128 where there are all these startups. I was a physics, electronics, gadget guy and then I somehow got lured into Wall Street at Goldman Sachs. The entrepreneurial bug gave me, I think, the confidence to leave Goldman after a couple of years and join Drexel, which was doing the most entrepreneurial things on Wall Street. Every client was someone who didn't really have the money but wanted to dream big and make the company better and create value and that's what we were doing, is facilitating those deals.
Josh Friedman: (06:00)
Then when the opportunity arose, I started Canyon. I didn't want to have a conventional job after Drexel vanished because I figured this was my chance. I partnered with my old law school and business school roommate who was also at Drexel, Mitch Julis. Mitch was a bankruptcy lawyer. We liked investing really complex, value oriented situations. That's what we were involved with at Drexel and so that's what we did. We didn't know what we were doing initially when we started the business. We had a choice, would you do a private equity fund, could you do mutual fund, or could you do hedge fund? We didn't really know anything about raising or how to do it, so we rounded up some money from friends and family and we started with about $17 million in the hedge fund format, because the mutual fund format was too liquid in terms of the liabilities for us to manage the types of strategies we wanted to do, and we really didn't know how to raise private equity money anyway, although some of those types of products came later in our career.
Josh Friedman: (07:03)
That was how-
Anthony Scaramucci: (07:04)
I've heard you say that you're an alternative credit investor, you're not really a hedge fund manager, so describe that to our viewers and listeners. What do you mean by that?
Josh Friedman: (07:13)
Well, it's a good question. I don't love the term hedge fund because it really refers to a fee structure more than it refers to a strategy and there are as many different types of hedge funds from global macro to equity long short to everything in between, to quantitative, et cetera. So I just think of what we do with the assets and the format happens to be one that's consistent in terms of liquidity profile and fee structure where I think we can justify our existence quite well to investors and also have less of a liquidity mismatch.
Josh Friedman: (07:43)
So you have to really look at what is that we do, what is alternative credit? What it means is that we really try to focus on things that are a little out of the box, that are unusual situations. Generally speaking, things that are less easily accessed by conventional investors who are, say, mutual fund or ETFs or other more siloed type of investors. So we like things where there's a lot of change and with change there's a lot of complexity, and with complexity there's an opportunity to create a dollar for fifty cents or forty cents or sixty cents or eighty cents but hopefully less than a dollar.
Josh Friedman: (08:19)
So we like bankruptcies where there's a complicated process of fixing the balance sheet. Sometimes there's litigation and there's challenging of rights and priorities within a capital structure, so we like bankruptcy. We like distressed. We like when things don't fit conventional buyers. For example, mutual funds might be only allowed to buy things that are in the high yield index. They might be an active manager, they might try to change the weightings, but when something falls out of the index because it's upgraded or something enters the index because it's downgraded from IG, all of a sudden there's a lot of buying and selling and that buying and selling doesn't necessarily have to do with deep analysis of the securities. It has to do with the mandate of the purchaser.
Josh Friedman: (09:06)
So we like when there's that kind of complexity, when things fall out of indices, when things get put in indices. We're looking for catalysts and we're looking for an alignment of incentives. We often work directly with sponsors to structure very complicated solutions to problems that they face that the general capital markets don't allow them to solve. We're operating in this world of what I would call complex credit and across a variety of asset classes from structured assets such as CLO tranches or RMBS or CMBS or other kind of ABS to more conventional, high yield to bank loans, to unfunded revolvers to all sorts of different types of securities.
Josh Friedman: (09:48)
Does that make us a hedge fund? Well, in format, we're a hedge fund, but I don't think of us as a traditional hedge fund. By the way, we do hedge also. We have significant short positions from time to time in different indices or in individual securities. I'm not ever really sure what the name hedge fund means so I'd rather call us an alternative credit firm or a value firm.
Anthony Scaramucci: (10:09)
No, it makes sense. Josh, you made a recent investment. You sent me a press release. I think it's a great example of what you do and it fits our space because at Skybridge our fund, we have a nice sized position in your fund but we also own a lot of structured credit, you made an investment in a mortgage servicing company recently and I was wondering if you could tell us a little bit about that, opportunistically, how you feel about structured credit and mortgages and why you made that investment.
Josh Friedman: (10:39)
We've always had a lot of deep expertise in that ABS area. We've invested double digit million in the infrastructure of the firm to service that area. It was a very opportunistic and great area when RMBS blew up in the middle part of the last decade, and particularly around ... actually around 2012 when Maiden Lane came along and the government was selling its securities and there was peak value. Also before that, we started our investing in that area really in 2007.
Josh Friedman: (11:12)
What we did recently is a good example. We had a changing capital market. We had COVID drive a hole in the markets, a liquidity hole as well as a value hole, and there were many, many players out there and I know we've talked about a number of them both with you and with some of the senior members of your team, where investors in their search for yield in an environment of shrinking yield have leveraged up mortgage securities and asset-backed securities and mortgage servicing rights and servicer advances and both agency and non-agency mortgage, but with big leverage and a lot of time it was a mismatch. So the mismatch meant that in order to produce a yield, they had used low cost repo financing from commercial banks, which can be pulled at any moment, to purchase securities that weren't all that liquid.
Josh Friedman: (12:01)
So when the value started to diminish, a lot of the repo lenders pulled their lines and we saw this in different types of entities and we looked at ... post-pandemic, there was just the initial crash of the wave where we saw a number of these opportunities. Some were just real estate loans that were leveraged up 80%. Some were combinations of mortgage servicing rights, et cetera, like the one that we discussed. We like that because the complexity means we have less competition. The challenge for that sponsor in that situation was how do I stop the banks from forcing me to sell my portfolio down at really bad prices at the worst possible time?
Josh Friedman: (12:39)
So that sponsor did some of that, and it cost them. Then the concept was if we can put in a senior secured loan that picks up the residual value in every one of those lines, maybe we can get the banks to stand still, they can term out that repo lending. Now all of a sudden the selling stops and there's so much more optionality on the equity, this is a public equity, that it's going to become a self-fulfilling, almost like a flywheel. You stop the selling, you can then originate new loans in a market where prices are cheaper and there can be big positive apprection to the value of the equity and that's more cushion under our loan.
Anthony Scaramucci: (13:17)
I mean, there's basically an inflection point here, right, because the cascade of selling ... people like you and I are opportunistic. We see that as an opportunity to buy as opposed to an opportunity to panic out of the position. So you made a very nice size investment there and you have optionality into the equity as well as you're getting coupon. Is that fair to say?
Josh Friedman: (13:38)
Yeah, there are two ways to play these, as you rightly point out. One way is you just buy the things people are selling. We did some of that, too, in our funds although it was hard because it was quick and there wasn't as much liquidity as we liked to buy big pieces. The other way to invest is take a structure that is suffering from this and stabilize it. So we made a stabilizing loan. It was in the low teens at a little discount to par, senior secured, and we also got an awful lot of warrants struck on the common stock. Half of them were struck at the money at that time, and because we knew that once this deal was announced the market would say, "Ah, their balance sheet is now stable, they don't have to sell anything and in fact they have the firepower to buy things," that would sort of cause the stock to move up and we'd get to participate in those warrants in addition to getting to participate by having a very good debt security. So it's exactly what you said. We wanted to have the upside that our debt was creating and did sort of a creative custom solution.
Josh Friedman: (14:40)
The other point that's really important on this one, Anthony, that I would mention is that I think the nature of distressed investing this entire cycle will be a little bit different from what in the prior cycle. In prior cycles, there were ... well, other than the fact that in the last decade most of the distressed were kind of bad companies with bad balance sheets, but we can come to that later. I think a lot of the distressed investing, traditionally, was you buy debt. If it goes down, you buy more, you buy more, you buy more. You then face off and have a fight with the sponsor and it's sort of like a loan to own, we're going to have a big battle with whoever the old control player was because we own the debt, they own the equity and we're going to try to win and control the company.
Josh Friedman: (15:24)
I think there are going to be many, many more situations because the sponsors have so much capital themselves where the opportunity is to go in, to price a solution in partnership with the sponsor to fix the balance sheet and if they want to play along in that security once we've negotiated and priced it, that's perfect for them, because they have that capital, but they can't simply do it themselves.
Anthony Scaramucci: (15:49)
And there are [crosstalk 00:15:49], but let me ask you a followup on that, though. These companies, many of them were performing very well in the 3.5% unemployment environment and U.S. economy growing at 2.4%, and so there wasn't necessarily a bad business, they just got stopped by the COVID-19 crisis. Are these companies getting enough help from the government? So it's an interesting distress cycle in the sense that even some of these companies that you're willing to work with, they could be getting some capital help from the government, too, so doesn't that provide a rocket boost in some ways?
Josh Friedman: (16:23)
It does, and there's a difference. Maybe if I could take one step back and maybe just talk about the environment going into COVID and then it'll make sense, because I think the government can't possibly solve some of the balance sheet problems. The government can solve liquidity problems in the market. That's what the Fed essentially does. They're buying securities, they're giving the market confidence, they're encouraging people to essentially front run them by getting in front of the wave of purchases of the Fed by purchasing new securities whether in the primary market or the secondary market. That's a useful function. The Fed can't fundamentally fix a balance sheet that's too leveraged.
Josh Friedman: (17:04)
Going into COVID, and this is what I want taking a step backwards, the pre-COVID environment was a really stretched environment for credit. We had had ten years of increasing employment, decreasing unemployment, ten years of economic expansion, ten years of declining interest rates. So there was this global hunt for yield and the U.S. was sort of the best market for that because yields were negative in other countries. So what happened as a result because of all the pensions and endowments and foundations and retirees and others who want yield and don't necessarily have a mission or mandate to be in the equity markets, the debt markets were getting really heated up and corporate debt as a percentage of GDP was at an all-time peak going into the pandemic. We had the highest debt to EBITDA ratios we hade ever seen, period. We had the highest percentage of deals that were using adjusted EBITDA. So we were getting prospectuses to look at that didn't even really have EBITDA, they had all sorts of adjustments to make EBITDA look higher than it actually was.
Josh Friedman: (18:13)
We had an explosion of triple-B debt within the investment grade universe. So the lowest grade of investment grade became the largest part of that universe. We also had a complete abandonment of covenants, both in bonds and in bank debt. 85% of bank debt, roughly, was covenant-light which really meant no covenants. So the market was ripe for an adjustment in the debt markets because people were ... if you're a passive fund and you get an inflow and you're trying to mimic the high yield index, you have to buy something. So it's not a question of you carefully assessing every credit. You have to look like the index and then you can figure out maybe I'll overweight this and underweight that.
Josh Friedman: (18:58)
So this drive of capital was kind of driving prices up, driving yields down, driving covenants down, and in parallel, the private equity universe was exploding. So the private equity issuers were taking advantage of this and leveraging up everything. So it was kind of poised for an adjustment.
Josh Friedman: (19:17)
When the pandemic hit, you immediately had revenues go to zero in so many businesses, and I just don't believe that the private equity partner who was doing a deal a year prior to the pandemic or two years prior was telling the associate, "Please run the pro forma with zero revenue for three months followed by an environment with double digit unemployment and a slow recovery." I think that there are a lot of balance sheets today that are really stressed and right now they're trying to get from here to there, get to the end of this pandemic, get to a point where they have better visibility and then try to revive themselves.
Josh Friedman: (19:58)
That sort of gets to your question, has the government fixed that? Well, there's a difference between fiscal policy and monetary policy. Yeah, the special loans that become forgiven and things of that sort are helpful, but really the Fed's activity, and most of the government's activity generally, was immediate, it was massive, it was significant, but it was all designed to restore liquidity in the capital markets to help those big employers, the ones who are [inaudible 00:20:32] in terms of investment grade or who are in businesses like the airline business or the cruise business or whatever but employ a lot of people. Let the capital markets heal by telling everybody, "Yeah, we're going to be in there buying." And they did that. But what they don't do is fix a balance sheet that is fundamentally overly levered in a world that's fundamentally a slower world.
Anthony Scaramucci: (20:56)
So therefore, there are tremendous opportunities in what you're doing. Some of that dislocation you're fund experienced, but then you are adept in being very opportunistic and running towards some of the fires that were going on in the markets, which is why you've had such great performance since April.
Josh Friedman: (21:13)
I think it's important to ... I think we probably got caught more off guard than we should have, in the first quarter particularly, because of the type of disruption that occurred and we had more, maybe, COVID-central business that were particularly hurt by that.
Anthony Scaramucci: (21:30)
Yeah, ourselves too.
Josh Friedman: (21:32)
But if you have the right kind of capital and the right kind of investors and you have a contrarian mindset, it lets you feel comfortable running toward the fire, if you will. There was really a series of fires as opposed to a single fire, and we talked about the first one was, "Okay, the Fed's coming to the rescue. Let's run in front of the Fed before they do their buying," and what did the Fed do? They stabilized the money market funds. They then came in with the second day market purchase programs and those programs were designed, really, to address the IG market and the recently downgraded IG companies. That allowed people like Boeing and Ford and so many other issuers to come to market because investors said, "Ah, even if the Fed hasn't really started buying yet, they're going to be there. They're telling you they're going to be there." The Fed wanted it that way because they prefer the secondary market do the work for them anyway.
Josh Friedman: (22:32)
So that worked in a really powerful and important way. The secondary market corporate credit facilities hit high yield indices, too, and ETFs. I think the Fed maybe the second largest holder of the Fidelity ETF now. They've become big purchasers. Today they had an announcement that if the market continues to be this robust, maybe they'll back off a little. So we'll see. But if it doesn't, they'll be right back there.
Josh Friedman: (22:57)
So the first wave was kind of front run the Fed, buy high yield, buy IG. That's more of a trade than investment, not really necessarily what we do a lot of. The second phase was absolutely in these balance sheets that were in trouble that were kind of pushed over the edge by COVID. There were two types. One was the ABS type things that had repo financing, because the banks all of a sudden pulled their horns in and again this was a small part of this year's cycle. It was a huge part of the cycle in 2008. The banks were much more leveraged, they pulled a lot in '08, in the global financial crisis. This time they weren't. They had better balance sheets, but they definitely got conservative on their repo financing and so we saw, and we still see, mortgage loans that are subject to leverage. We saw a lot of ABS. We saw some of these companies that focused on this structured credit but with a lot of leverage.
Josh Friedman: (23:53)
The other part of that phase were that, where I say companies were kind of the edge getting pushed over, were the companies that were already in trouble. The Neiman Marcus, J Crew, J C Penney, et cetera, Brooks Brothers, where there are DIP loan opportunities, et cetera. Not really necessarily the best opportunities, in my view. Those were more taking advantage of people who had already been hurt by being in those credits, so they were already in the credit and they say, "Ah, we'll do the DIP loan," and they're trying to take advantage of the fact that some of their partners in the old debt are not allowed to put up the DIP loans so if they make it really juicy, they can get a bigger percentage of it. A little bit of that going on.
Josh Friedman: (24:36)
The next thing, and the more interesting thing, is the credits that just traded badly or the ones that are now starting to show weakness because the environment still is quite weak. We've got double digit unemployment. The balance sheet doesn't have staying power. This requires more patience. So there was sort of a quick reflex, get right in there, and react to those first ones and now we're in a cycle that I think will take a material amount of time to play out because a lot of the sponsors, a lot of the PE firms are saying, "Let me just get through the summer and then I've got to figure out how I'm going to fix this."
Anthony Scaramucci: (25:14)
It makes great sense, Josh. You left out structured credit, so I'm just curious of what your opinion is there. Obviously the Fed bought triple-A tranches and new issues and things like that, but that seems to have lagged the other credits that you're mentioning. Do you have an opinion there?
Josh Friedman: (25:31)
Well, I think the structured credit was great at the very beginning, like instantly you saw tranches of aircraft securitizations and real estate securitizations and servicing rights and all those securitizations. They tend to be smaller tranches, less liquid, less of it actually traded. If you could fix the overall balance sheet, you stopped the selling, like in the case of the deal we did. They were initially selling way down. As soon as they stabilized the balance sheet termed out the repo, that was the end of that. We're still seeing leverage real estate loans in higher supply than we've ever seen, so that's good.
Josh Friedman: (26:07)
I think that cycle will continue, I absolutely expect. It's a large market, a lot of the tranches that trade, traded small size. It requires a lot of discipline and patience, but if you're willing to pick up pieces here and pieces there and you have the analytics to be able to quickly process a lot of names, I think it's still a very good market. I like that market a lot. It's not as cheap as it was before all the Fed activity, but that's true of all the markets right now.
Anthony Scaramucci: (26:40)
Yeah, well, I mean some of that's true, but CRTs and some of the other stuff, basically the plain vanilla, mortgage backed securities are still lagging because of the threat of mortgage delinquencies. I think that's where the meteor strike was. People said, "Oh my God, we're going into our homes. We're going to have 25% unemployment and 25% mortgage delinquencies," and so what you described about repo lines being pulled happened to the mortgage rates, happened to some of our friends in the industry that went down 40% to 70% during the crisis.
Josh Friedman: (27:15)
Yeah, the leverage ... the guys who had leverage on those securities-
Anthony Scaramucci: (27:18)
Yeah, I know. Exactly.
Josh Friedman: (27:19)
... got destroyed. I think, also, to some extent while there's a lot of paper floating out there, some of it still being offered at prices that are too high because they don't have quite the urgency that they had before. The other thing, and some of it's low quality, and I also think that there's a certain amount of uncertainty in real estate valuation generally, where it's, at least from our point of view, a little bit unknowable. Mutli family is one thing, particularly in places where it's supply constrained. Commercial, do we really know what residential ... sorry, what office demand is going to be forward when everybody's working from home and there's the whole of you need more space per employee, but you need less space.
Anthony Scaramucci: (28:10)
We agree. I mean, those trends that accelerated, that's one of the reasons why we sold out of some of our community banking exposure that was tied to commercial office buildings and retail strip centers, but I think we're very constructive and very positive on the tranches of mortgages in white collar communities, affluent communities, where they're the primary home of the resident and those residents, frankly, are able to work remotely and keep their job. So that's where we see still a tremendous opportunity.
Anthony Scaramucci: (28:39)
I want to switch gears before I bring John into the equation and get some questions from the audience. You've seen a lot of different scenarios in your career on Wall Street, three decade plus career on Wall Street, ups and downs, '87 crash, the David Askin crisis of '94, the long term capital management crisis of '98, obviously a global financial crisis. How is this different, the COVID-19 crisis of 2020? How does it compare and how do you think it ends?
Josh Friedman: (29:12)
First of all, I think every crisis has certain things in common. We always think it's different, we always think it feels like the end of the world, and it always comes back and it always comes back strong. This one's compounded by political uncertainty, by social uncertainty. There are a lot of unique characteristics to this particular crisis and it hits hard and it hits deep and it's taken out of business a lot of small Main Street businesses, but people want to come back. I like to think of myself as an optimist generally, but part of our job as credit investors is to be a cynic also. So we're kind of in between.
Josh Friedman: (30:01)
Look, the COVID crisis will pass somehow. It'll either pass because there's excellent treatment, there's essentially ... it passes through the community and enough people have immunity that it doesn't spread and becomes a more permanent fixture but at a lower level like the flu, or because we've come up with a good vaccine. All these might take longer and there might be ups and downs in between, but if you see beyond that, it will pass. I don't think we really know the affect of staggering amount of fiscal and monetary policy that has just been undertaken, and I think we should be a little bit humble in our confidence about what it means when you have the Fed be this active and the Treasury be this active. Stan Druckenmiller had some interesting comments on those issues, as have others.
Josh Friedman: (30:55)
At the end of the day, the catalyst for this particular disruption will pass, but we still had certain things going on before that. We had over exuberance in the debt markets. We had private equity become the asset class of choice and therefore leverage applied across the universe. We had an enormous amount of capital raised by private equity firms for other activity like rescue financings and so forth, yet when you talk to private equity firm number one, the last person he wants to talk to about doing a rescue financing is private equity firm number two, which is good for us because we're sort of a neutral party in that equation. We're not threatening him, we're not in their competitive business. We're more of a partner.
Josh Friedman: (31:41)
So I think that what will happen is eventually we'll see the COVID part go away. We'll be left with a huge headache in the economy because we have a lot of unemployment. It will take some time to get the animal spirits back. As you know, markets are psychological animals and when people put their hands in their pockets and don't make capital expenditures and there's uncertainty, it has a self-reinforcing way-
Anthony Scaramucci: (32:05)
Question. It cycles, the panic cycles. People are ... you know, Josh. Lee Cooperman was my old boss and you've met Lee many times, obviously, and we've had dinner together at the SALT Conference. One of his best lines that I often repeat, "Everybody is a long term investor until they have short term losses and then they strike a match to their hair and they run around in a circle." So I applaud you for being a contrarian and having the wisdom to see through the current cycle to the other side.
Anthony Scaramucci: (32:35)
I'm going to turn it over to John Darsie, who's not wearing his star spangled sports jacket. I mean, you would never wear ... Friedman, you would never be caught dead in the jacket that Darsie was wearing on the Fourth of July, but let's leave it at that and John, what are the questions from the outside?
John Darsie: (32:52)
The first question, Josh, is about how long is this particular market going to stay around where it's such a rich environment for the type of distressed credit investing that you do, and what are the different phases of that opportunity set?
Josh Friedman: (33:06)
Well, I think ... I went through this a little bit. There was the initial front run the Fed, buy high yield, buy IG, just buy anything. That's over. That's happened. Spreads are still, by the way, quite a bit wider than they were at the beginning, but maybe appropriately so. I think that, and the other phases, the ABS phase, the private equity deals that we realize suddenly don't work, I think that this last phase, this sort of good company/bad balance sheet phase ... now remember, pre-COVID most of the distress was energy, metals and mining, shipping, and of course retail and maybe tech companies from the old tech world that didn't transition to the Cloud. So they were basically companies that had fundamental problems with the value of their business and their competitive position.
Josh Friedman: (33:59)
Post-COVID, because of all the private equity activity and all the re-leveraging, there are now a lot more companies that have balance sheets that aren't appropriate to even a slightly slower economic environment. Remember, we hit 3.5% unemployment going into this, and now we've got double digit unemployment, and I think that takes a while to work through. I think it'll take three, four, five years and I think we'll see, in terms of the opportunity set, it won't be that super rich, every fish that goes by you looks like a good one to catch. It's going to be okay, here's a good company with a bad balance sheet that was interrupted by this. Here's another one, here's another one, here's another one. You're starting to see companies of that ilk, from Acorn to Travelport to Legato to others that have very good businesses, potentially. Not potentially. They have very good businesses, but COVID created a situation where the balance sheet didn't work. I think you'll see a lot more of those but they will show up a little slower, they'll show up intermittently, but there'll be some large and very good companies that just don't have the staying power.
Josh Friedman: (35:09)
So the phases, some of the phases were really quick as we described. The trading ones, some of those ABS structures, the repo driven things, some of the initial companies that were on the edge that just got pushed over, but now we're in the more "patience will be rewarded" market, and I think it'll go for a while. I also think you're in a market where a lot of capital's been gathered and that's in a way not a bad thing because it means that a lot of the PE firms that have gathered that capital will be looking for partners to help price a solution to their deal where they can co-invest in it. They can't price a solution to their own deal. They're conflicted.
John Darsie: (35:51)
So if you look at the March drawdown that took place in some of these structured credit markets and markets that are now in distress, what do you think the time frame is for recovering some of those technical losses that took place because of tightened repo requirements and things of that nature?
Josh Friedman: (36:06)
Most of those are ... well, a lot of those particular ones have recovered a lot already. Some of them will not recover because they were forced by the nature of their balance to sell at the bottom. That's the worst ones. A lot of those repo driven structures are really not in a good position to recover value because they had to shrink the balance sheet so significantly just to get the stability, and now with the Fed's supercharging of the markets, there's maybe less opportunity for them to grow back to where they were. They don't want to necessarily have the same tenuous balance sheet, but the big spread, additional originations they could do would be harder when the Fed has driven spreads so low. I think a lot of that is this year's business. A lot of it's happened already.
John Darsie: (36:52)
So Canyon is a global firm. As you look at the opportunity set, are you focused mainly in the United States, or what do you view the opportunity set and the risks, frankly, of places like China, Asia, and other emerging and then developed markets in Europe?
Josh Friedman: (37:09)
Sure. We do have an office in Hong Kong. We have an office in London and in Tokyo. When you're a credit investor, the most important thing that you need is rule of law so you have a predictability in the restructuring process. In China, you have two issues. One is history has not been your friend in terms of being a creditor, and that's true by the way in most non-U.S. jurisdictions except for maybe western Europe. However, there was a lot of progress and a lot of desire to create normalized capital markets, but now you've also got that being interrupted a bit with politics.
Josh Friedman: (37:48)
So I would say we are likely to feel like at our size, which is large but not overwhelming if you want to think of our firm that way, we have the scale to be sophisticated and participate in these complex and good sized, critical mass, stable types of vehicles and companies, but I don't think we're so large that we feel like, "Oh my God, we have to be everywhere." So I would expect that the non-U.S. activity would be a pretty small percentage of what we do going forward because there's more than enough here, and I think the U.S. probably was hit a little bit harder with COVID in some respects. There were two hits. One is COVID itself and two is the political response to COVID, and between the two of them, it's been very costly to a lot of businesses. So I think that presents a lot of opportunities here.
Josh Friedman: (38:46)
Europe actually has been ... western Europe and the U.K. in particular has been an area of a lot of activity for us in the stressed and distressed area recently. Our experience is that that's been more lumpy and it comes and goes.
Josh Friedman: (39:00)
What we won't do is access kind of smaller illiquid niches in the markets. A lot of people did leverage NPLs in Spain and Italy. I just think that you don't have to stretch for those kinds of things to earn a good yield in today's world.
John Darsie: (39:20)
The next question relates to sectors within the high yield market. Thematically as you look through high yield, are there certain sectors that you like that fit that good business/bad balance sheet due to the pandemic? Are there others that you view as bad business/bad balance sheet? Just go through within high yield what sectors you think are particularly attractive and which ones you're really steering clear of.
Josh Friedman: (39:44)
Retail, there's a lot of things going on. There are filings, and yes very lucky brands filed, but I don't think that's an area where we're likely to do a lot except occasionally at the very top of the capitalization, last in/first out type financing, but that'll be rare. It's just the reasons are so basic and fundamental in terms of the displacement of business we all know about. Energy is an area where I would say it's the one area, particularly ... well, there's upstream energy itself and there's more downstream, midstream energy services, et cetera. I think while we certainly made a good attempt to avoid oil price-driven securities or energy price-driven securities, even the services companies, drillers and others, they're almost all in restructuring today. I think that offers a lot of one-sided optionality at the prices they trade at because they trade for nothing. They trade for drill bits. It's a bad pun, but they sort of do. These are the best assets in the world and many of them are working, if you look at something like Transocean.
Josh Friedman: (40:56)
But, I'm just not sure that I would make a lot of new investments in that area today, just because I think it's very difficult to decouple it from commodity pricing. I think that the software area is a great area because there's lots of change, lots of transition, some companies growing, some not. The complexity and the technical knowledge required is a bit of an entry barrier against certain other players who participate in it, so we like that area a lot.
Josh Friedman: (41:30)
Travel and leisure is, I think, a really interesting area but one we have to be cautious because we don't know about the near terms effect of resurgence, et cetera, but it's an area we know well, and I think there may well be opportunities that are interesting there that are somewhat hedgeable as well. Then there are sort of the other broad categories which I think is just ... I think the stress levels will be spread across a variety of industries and I'd say on the other ones, we're pretty agnostic. We'll see what shows up.
John Darsie: (42:02)
All right. The last question, and it's a broad question, before I turn it back over to Anthony for a final word, is if you are a institutional investor or a family office or an RIA right now and you're looking out through the marketplace, obviously equities have largely rebounded from the March selloff, where do you see the best value in the marketplace today?
Josh Friedman: (42:23)
I think there's merit in going one step beyond. We do what we do so we can't opine on what others are doing, whether they're doing quant strategies or doing equity long short et cetera. There's no question the equity markets have rebounded very strongly, especially given the reality on the street, and a lot of that is driven by the Fed and in a zero interest environment where you can't just go and buy IG bonds and sleep at night and say, "Okay, I'm beating inflation," doesn't really work. You have to figure out something that's different, and I think ... our response to that is to look at these situations that are complex, they're in flux, and they don't fit into the general categories of broad high yield, broad investment grade, broad municipals, broad whatever, because I think those general categories are exactly what the Fed has driven the yield out of so there's not a lot of attractive risk/return in owning those types of index exposures and the equity markets have fully recovered, essentially.
Josh Friedman: (43:33)
So what do you do? So I think there are compromises where you don't give up all your liquidity, like being in a private equity type of structure where you're tied up for ten years, but you're in more intermediate liquidity structure where you can take advantage of the disruptions and disequilibrium, the bumps in the road and the shifts among asset classes and the downgrades and upgrades and things of that sort that provide you kind of debt-like surrogates for your money with, call it returns that have an expectation of being quite substantially higher than high yield, quite substantially higher than what is probably discounted in the IG high yield and even equity markets today.
Josh Friedman: (44:19)
So I think looking at alternatives today is a wise discipline.
John Darsie: (44:26)
Fantastic, Josh. Thanks so much for joining us today. I'm going to turn it back over to Anthony, if he has a final word.
Anthony Scaramucci: (44:31)
Well, Josh, I want to thank you for being with us, but more importantly thank you for being our partner. Skybridge and our funds are hugely excited to take this journey with you over the next several years and we're all off to a great start. So I want to thank you for joining a SALT Talk here. You've been to the SALT Conference before, you've been to our wine party in Davos. I hope we can get you back to one of our live events, Josh, and I hope those live events happen pretty soon. Thank you again.
Josh Friedman: (45:03)
I hope so, too, and thank you. Thank you very much, Anthony, and thank you, John.