Ladies and gentlemen, welcome to the Business Brew.
I am your host, Bill Brewster. Thank you, as always for giving
me your time. This episode features Blake
Haxton of Brandywine Global Asset Management.
Brandywine Global is a Franklin Templeton company.
This particular conversation focuses mostly on high yield.
Blake is an analyst that works with friend of the show John
Mcclane and friend in real life. John and I do some man Hangouts
and catch up on the phone. So holler at me John, if you
want to. Anyway, I digress.
I quite enjoy talking to Blake. Blake covers a bunch of, I would
say cyclical and basic materials industries.
I think it's a perspective that is good to hear and one of the
questions that I've been asking myself is spreads are
compressed. The front end of the curve is
quite a bit higher than the back end.
Why take duration? Why take risk at a time when
spreads appear compressed? Why high yield as opposed to
private credit? Why equity when private credit
is sort of promising or I shouldn't say promising.
But if you read KKRS report, the forward projected returns are
quite nice. And talking to the guys at
Brandywine help me contextualize the entire, at least in my mind,
where the risks are and what may be safer and where the risks
are. So anyway, I like these guys a
lot. I hope that this conversation
adds something to your life as well.
And as always, none of this is investment advice.
All of this is for entertainment purposes only.
Consult a financial advisor before making investment
decisions. Consider your own unique
circumstances and do your own due diligence.
All right, on to the episode. All right, So ladies and
gentlemen, Blake Haxton from the Brandywine Global Headquarters.
Blake, how you doing today? I'm.
Doing pretty well, Bill. Thanks for having me.
Yeah, you're welcome, man. Nice to chat with you the other
week and shout out to my man John McLean for making this
happen. So thanks again for dropping by.
Do you want to? I don't know if people remember
the John McLean episode, but why don't you give a little bit of a
background on what you do? This or so, I'm a credit
research analyst here at Brandywine Global and
specifically I sit on the high yield team and work for John
McLean and Bill's Ox Jack Parker.
And we manage about 5 billion across from different
strategies, all high yield credit and they trade the
portfolio and manage the portfolio and I get to just sit
and do research all day. So just support them across the
structure. And it's just been, it's great
team, great place to be. That you were recently featured
in Barron's. That's got to be kind of cool.
Yeah, that was the 1st. That was pretty neat.
I didn't see that one coming. That was a lot of fun.
I mean, I'm sure like I saw, I've been subscribed to the The
Journal of Barron's for, you know, years and years and then
you could see yourself being that's for fun.
Yeah, that would be you Send your mom a copy.
Oh yeah. Yeah, there you go.
That's that's necessary. And what exactly do you cover
for those that don't know what Brandywine does and and what you
do within it? Yeah, absolutely.
So I cover energy transports, some basic industries to home
building, aggregates, things like that.
And then I do some metals and mining as well.
We're a small team, so we kind of cover the waterfront between
all of us. My background actually started
out at a prior firm, same team but different firm as mostly an
equity analysts covering the same spaces.
And then a couple years ago came over here at Brandywine with
John, Bill and Jack to do a full time, but picked up a little bit
more coverage. And that's really, those are
really my areas of focus though. I would think that those
businesses on average are better to lend to than to own the
equity side of, but there there are always exceptions to the
rule. There are, there are by and
large I would agree with you. There are certainly more
opportunities we think put, put capital to work.
There are only in the equity side you can pretty quickly
choose your favorite handful maybe.
And for the most part, I mean they're all cyclical businesses,
they're all commodity type businesses for the most part.
So very few by and businesses in those spaces, if you get a hold
of a few, they can work out really well.
But to your point, generally being as capital intensive as
they are and as difficult as they are, high yields a little
bit better of a place to be an analyst because they're just
more to do. I guess when we talked you had
mentioned that, that you thought that like the general theme and
some of your coverage is, is sort of supply discipline and
and tightness. I don't mean to be putting words
in your mouth, but is that an accurate representation of what
you said or did I make that up? No, I think that's a pretty good
summary. I mean, whenever I say that, and
to your point, I think I said that regarding housing or home
building, I should say in particular energy, certainly
mining to a certain extent, transports to a much lesser
extent. We're probably going through a
little bit of an overbuilding in some of those industries.
But no, I think you're right. We like to say, you know,
strongly held opinions revised weekly around here because as
soon as you get comfortable with management discipline and CapEx
discipline, somebody's always the first guy to to eat the
cookie, right? I don't know if you've heard
that at the Build Psychology experiment.
I'll give you one cookie now, but if you wait half an hour,
I'll give you 2. And the kids that wait the half
an hour always seem to do supposedly get better outcomes
in life. So somebody always goes after
it. So at the moment, looks like
things are holding in there pretty well, which of course
allows me to hold pricing. And in these industries, you
really make your money on price, you don't make it on volume.
So you want to be involved when you're on a big price upswing
and supply is constrained because that's when you know
from a valuation perspective your revenue and your margin
generally go the same way. They're generally pretty
correlated. And if those if your revenue and
your margin go the same way at the same time, you usually get
evaluation re rating in both directions.
So if you can participate on the way up, I mean you've got
multiples on your return and then of course you'll get you
know multiples on the way down. So very much we want to be
paying. Attention to it.
But we're cautiously constructive on some of these
industries where as long as we can see that that discipline is
holding, we're happy to be involved and we like some of the
opportunities we've got. Certainly it's not like it was
in 2020 where we had, but we felt like we had opportunities
all over the place. A lot of those have gone away.
But to that extent, we still feel like we're able to put
money to work for the attractive incremental returns.
You mentioned that industrials are sort of like not as tight.
What would what would you say just broadly, what are you
covering in industrials? Sure.
So we've covered rails trucking and this is more transports,
it's a start. But rails, trucking, airlines
and then capital goods is a little bit more.
I would want to be a little more specific there because aerospace
manufacturing or aggregates or even even long life producer
goods are all going to be their own sort of have their own
flavor to them. I and again, I think we could be
specific Rails for example, they're consolidated down.
Do I think the cats out of the bag?
Those are pretty good businesses at this point, at least class
ones. Valuations I think would hint at
that. We would agree gross margins are
incredibly strong. Have them for a while.
So you really the debate there is sort of, you know, do you
want to own it at 17 times or 25 times and which one's worth it?
And it's credit to the management teams.
A lot of the capital allocation has been pretty strong.
Obviously Berkshire owns one of the question ones.
So that helps where any contrast that with maybe I might say the
airlines where we obviously COVID just saying it was a
demand corrections and understanding.
But then they came back and they think, you know, the securities
all did well on this revenge travel reopening trade, which
was true to some extent, was probably never as true as the
market thought there for a while.
And then now I think the industry, not only has it grown
at the same time they've gotten cost pressure on the labour and
and fuel side, but now they're having to figure out that
airline ticket pricing get a little bit of my head of head of
myself. But ticket pricing is really
driven by patterns in seasonality and being able to
see, you know, down to the day and the hour.
What is this? What's the demand pattern going
to be? And after COVID, those patterns
clearly changed. I'm sure everyone listening,
both of us have probably, you know, work.
Our travel for work or in pleasure is not the same,
doesn't have the same cadence to it as it did before COVID.
Whether it's not work called work, work remotely, you just
figured out that that last trip you have to take to see that
client can be done on Zoom. Whatever the case may be, our
patterns have changed, our habits have changed.
So I think airlines are working through that and there's more
than enough capacity out there right now to do that in terms of
seating capacity and what those are just not good things for the
airlines, a famously capital destructive industry.
And at the moment returns are for the legacies for the the big
carriers. Big three are OK, they're not
great, but they're OK. And for the low cost carriers
they're pretty poor. So they are, we probably seen
not as much discipline on the capital side in spite of Airbus
and Boeing's best efforts to keep planes out of the market,
which yeah, has been pretty, pretty remarkable.
Yeah, the the low cost carriers, what they got hit more from the
cost increases on the labor side, right?
Yeah. I think, I think the answer
there is they've always had a lower ability or the, I think
consensus has been they have a less ability to pass through
price to their consumers, which we would agree with.
That's certainly true. So on a percentage basis, yeah,
they're not going to be able to take pricing the way that the
legacies can if if prices rise. And we're seeing that.
Obviously, we've also gone through some labor shortages
where if you look at the last few races that pilots have
gotten, they're really pretty substantial.
I mean, that's yeah, I remember growing up being a pilot,
especially after 911 was kind of a tough career to be in because
my mileage, mileage loan was down, overall compensation was
down, and now it's gotten tight again.
So pilots are going to get spot again the the absolute
elasticity on some of those tickets, it is pretty.
Low. So really the low cost carriers
and this is call it the allegiance, the spirits to some
extent SW, although they're sort of in between their ability
really depends on how you can get the price low enough to
cause someone to take a trip they may not otherwise have in
the budget. And so they and that's just a
different buying decision. Then, you know, you or I have a
meeting and New York next week, and we got to be there no matter
what. So it's just that that demand
profile has changed. And I think, excuse me, that
demand profile has remained the same, but the cost structure has
changed. So they're in a bit of a tough
spot right now. Federal government, the policy
being what it is, JetBlue tries to buy Spirit, that gets
blocked. I think that leaves a real
question mark for the future of that business model, but we'll
see. Yeah.
It seems to me that like they could do a deal with Alaska and
then Spirit could do a deal with Frontier, but I don't.
But maybe that's wrong. You know, it's an interesting
question. I think it's a hotly debated
one. I mean with Alaska barring
Hawaiian that that one may well go through.
Meanwhile, I was in tough, tough spot financially, although so
was spirit. So it didn't, you know,
apparently that didn't control in that case.
I think to your point, Frontier and Spirit make a lot of sense.
But to the extent that you still end up with one fewer low cost
carrier, which seems to be what the judge focused on, then you
might still be in trouble. I think the industry that writ
large says you find the same aircraft type.
They're both, they're both Airbus airlines.
There's a lot of synergy there that would make a lot of sense.
You sort of end up with a counterbalance to Southwest,
basically an Airbus version of the Southwest just to the
market. Market can probably handle that
and everybody's got enough returns to go around, but we'll
see. I mean, at this point, you know,
why buy a carrier that's threatening bankruptcy?
It's things have gotten so tough that we're not asking those
questions. So we'll see.
Really what we're going to have to see is it is either a
dramatic increase in demand, which if you go back pre COVID
demand was pretty steady, sort of up and to the right.
I've talked to folks in the industry that they say the rule
of thumb is GDP plus one or two percent, so call it 3 or 4% a
year. And in any given market, you
grow, you'll grow 3 or 4% a year.
And if you keep ticket prices flat, it's about what you'll do.
And that's, that's not heroic demand growth, but it's not bad
either. And as long as that's
consistent, then I think it's probably enough to go around.
But you know, we've got to get back to some sort of equilibrium
here where you can justify your cost capital on an increasingly
expensive aircraft. So we'll see, again, cautiously
constructive on that, but we'll see a little less discipline.
Contrast that with, let's say, energy, where there's been a ton
of capital flight out of the industry, either because we've
had three downturns in the last 10 years and everyone's been
burned so badly that they just don't want to go there anymore,
or because ESG considerations have just taken oil and gas off
the table entirely. Then it, you know, it's very
hard to win these businesses in that sense, and there's not as
many dollars to me around. So nice place to be.
Like we say, I mean the last few years, we got a big year in 2022
on oil prices, great for energy, bad for airlines, bad for oil
consumers. But it ended up plugging some
holes in a few of the balance sheets that were leftover that
still had some question marks. So that industry has been a
fantastic place to put capital to work since COVID.
So we want to be choosy and that's sort of how we like to
think about it is on a capital returns basis, where is the Cap
X going and price for the good of the service tends to
oscillate opposite the capital expenditure.
And we want to be on the right side of that.
Usually you have to be a little bit of a contrarian.
If we can be the high yield space does offer you those
opportunities. We like to be in the new issue
market if if businesses are are raising capital refinancing.
But we're also thrilled to be in the secondary market.
A lot of our really good opportunities that come in the
secondary market where we haven't been involved until
something goes wrong and then we can swoop in and scoop up some
bonds for a pretty significant discount.
And we want to be small enough that we can participate in small
issues that get forgotten about. So we don't, we don't see a lot
of those right now. Of course, I'm sure all your
listeners will know spreads are tight relative to where they
have been. Total returns are still pretty
good because the, you know, Fed treasuries are still offering
some actual yield for the first time.
In in many years. So that the high yield index is
somewhere around 8% yield, the worst you're all in right now.
Just it's probably not a bad return.
But again, some of that because a lot of these credits have the
really lousy credits have migrated into the private space
and some of the larger high yield credits have been
upgraded. So overall our space is probably
a little higher quality than it's been for several years and
and that probably explains to some extent some of that that
spread tightening. I didn't realize that the high
yield index was the total return projection was eight that that
seems pretty solid. Yeah.
I mean it's, it's not. I mean it.
What's the duration on that? I want to say about three 3 1/2.
OK. I know most of the credits are
in that three to 4-5 year range right now.
I mean it's an inherently short duration asset class because of
course businesses just generally don't want to learn for that
long to below investment grade businesses.
We like being in the front end with the shape of the curve
being what it is. We're very content to sit in 1-2
and three-year credits where businesses we understand.
And to your point, when you're all in yields at 8 and OK, so
let's just let's say that, you know, you're, you're all in
yield for it being higher up capital structures, you know,
7-8, nine in a lot of these credit cases, if you look at the
shape of the curve right now, you're sort of getting paid to
be in the front end on yields. And our space is inherently
short duration asset class for the most part to begin with.
And if you look at like a yield the worst on let's say the
benchmark and high yield, it's right around 8 at the moment.
Well, you're the earnings yield on the S&P is around 4.
Now granted, again, I was in equity and less than it's a
begin with. I guess those are not apples to
apples and funny people can illicit why that is.
But it's a decent place to start.
And a 4% earnings yield on on equities compared with somewhere
around 8 on high yield, I think you'll feel pretty decent about.
I think the counter argument for that is a spreads are not wide
and a lot of allocators like to see spreads blow out before they
put capital to work. And by spread blowout we were at
around 3:50 right now that might be 5 or 600 is where you is
where a capital allocator sometimes want to say hey, I
want to shift into the asset class, but again that.
Then to your point, you got to tell me what goes on with rates.
Well, that's exactly right. Where do you think that front
end ends up and where do you think that spreads can be?
We're still able to find a lot of credits that are played
trading below par, which is somewhere that we like.
This gives us a little bit of an extra margin safety against our
against our lending, which is a nice place to be of course.
And like you say, you got to take the rates view out beyond
that. So from our perspective, we
don't, we don't think we have to bet the farm on rates really one
way or the other get a pretty decent all in return.
From here. And really as we say we're rates
will impact us for sure, but we're more of a credit strategy,
the name of the game process, get paid back well into
businesses that return to capital.
And if we do that well and consistently over time, we think
we're going to be able to deliver a nice return.
There are some things in high yield that we have going for us.
Anyway, I would say we as a. As an asset class.
It's hard. With you that's really not
terribly efficient even to this point.
I want and I want to say it's something in the ballpark of 75%
of actually managed high yield strategies beat the benchmark.
Oh, interesting. Yeah, which I'm sure a lot of
you listeners can come. Is it as an equity guy at some
point in life that's got to be shocking where active
management's a dirty word. But the fact of the matter is,
as I say, not that efficient. It's not very liquid.
And there's this, there's this odd function of some of these
indexes where you know, if you're a market weighted index
in equities, especially recently, you've ended up just
owning more and more of the best businesses.
Whereas in high yield, if, if you are again you're sort of
market weighted in terms of how much debt you have outstanding,
there's a chance you might end up owning more and more of the
worst businesses of the most lever companies.
And if you can avoid a few of those, you end up really looking
a lot different from the benchmark just by virtue of the
fact that of how the the. Constituents.
Yeah, the. Benchmarks constructed.
Yeah, exactly. So active share usually ends up
being pretty high across the board because, you know, for
that exact reason. And then we've also been
fortunate enough to find some very small issues.
And then by small, I mean three $400 million based value bonds
that we're big enough to take a pretty substantial chunk of, but
we're not so big they can't won't have an impact on the
portfolio returns. And that's right beside who want
to be. We will, we will not grow to the
sky here. We want to make sure that we're
managing assets first and foremost for clients and for
ourselves. We don't have a lot of running
money in these strategies. So we want the numbers to be
good and we want to be able to take advantage of those
opportunities and we still able to find those even in these
tight tighter. Spread environments.
So we like being, we like being in that space.
I remember when I talked to John and since then it seems to me
that at least the pitch in high yield is that there is the
opportunity to invest in companies like Post, maybe like
Charter where you have these companies that maybe like
shorted debt at the right time, but are actually pretty solid
companies. So they, they might screen over
levered, but there's a few different, you know, levers that
they can pull. Now, I, I would assume that
mining and and oil is not exactly the same thing, but I'm
curious what your views are on the quality of the of the
underlying high yield market as opposed to maybe the connotation
that high yield might bring. Yeah, sure.
That's a great question. And to answer your question, I
do think that for anyone that's been been a capital allocator
choosing between asset classes and between security types for a
while now, I do think high yield per Southeast has gotten a
little bit better. One of the big functions of that
is really since the GFC, we've seen private credit come on and
become go from maybe not a niche asset class, but to be a huge
player in the market and that's had a few impacts.
One is that a lot of the probably harder credits to lend
to really we've seen going to that space and there are a lot
of reasons for that. But with the growth of private
credit, a lot of the sketchier over lever, you know, more
difficult situations have actually ended up out of the
public markets. So we just don't see them
anymore. And I think that's probably been
the, if I put my finger on it, that'd be the biggest driver.
And I say that with some hesitation only because granted,
they're they're now in private credit and you don't always have
the information to make those claims.
It's been pointed out recently that the faults have not exactly
ripped and they're not, you know, if you just went by the
default numbers, things aren't so bad.
Things look OK. That's probably about right.
But on the other hand, you know, in a lot of private credit
scenarios, you don't really ever have to default depending on who
the sponsor is or who the lender is.
You can renegotiate, you can amend it stand.
You can amend and pretend as, as, as may be the case.
So the capital structures themselves and the way they are
constituted from from capital markets have changed a little
bit. So yeah, we do think that the
underlying quality, a lot of these businesses in high yield
space per SE for public bonds has probably migrated up and
improved. And we're able to lend to
businesses that are, you know, like you said, maybe not maybe
these maybe aren't great companies, but they're really
pretty solid and they're companies where you've got real
asset values behind them as you say, you got assets in the
ground that. Are.
Are so essential in the industries they serve.
I. Give you an example, and this is
an area I'm more familiar with, but sort of parallels your the
media examples in the cable providers a little bit is an
area where we historically didn't make as many loans was in
the midstream space oil and gas pipelines.
And reason for that was we could get better risk returns.
The risk return offers, I should say, in the oil fields of the
gas fields they were attached to.
Basically you had these pipelines that were serving
these these oil fields. And if you looked at the yield
and the leverage and pipeline, it wasn't quite as attractive
from the return perspective as the actual oil producer they
were attached to. And we thought, well, if the oil
producer goes poorly, then owning a bridge to nowhere
doesn't really do any good. And for a while pipelines
reviewed as oh, this is a fiction shovels way to play oil
and gas, we didn't think they weren't necessarily priced that
way. So we for the most part just
went went to the actual producer.
That has sort of shifted recently where we've seen so
much consolidation on the production side that pipelines
now although they look a little bit more levered and certainly
the balance sheets are more lever to just measure let's say
EV to EBITDA to keep it simple. There are several terms more
leverage, but they've also got fixed contracts with the
producers and the producers are healthy enough that we're not
terribly concerned they're going to meet those commitments.
So, yeah, right. So to your point, so you were.
Initially a little bit worried about what counterparty risk or
something like that, like if they don't deliver then who you
going to collect? From.
Exactly. And, and for us it was more of
a, it was a little bit of a counterparty risk question.
It was also just the outright return question because for a
long time, you know, in a zero interest rate environment, you
know, some of these pipelines, you know, the MLPS famously you
could offer a, you could offer a mid single to high single digit
type return. Then that was a very popular
investment for a long time. And, and which is
understandable, I'm not saying it's wrong, but it also created
conditions where it was just a little too tight, where we could
get low teens in the oil producer and we had a view on
that producer and that price. So our relative basis, we
thought they were a little bit, a little bit too expensive for
us. And again, now let's say the
producers have done so well that those returns have come back and
we've seen that dynamic shift a little bit.
And if you look. Under the hood, we still think
those are pretty high quality businesses.
We always would have said they were decent businesses but for
the returns. That are which ones?
The producers or the? I'm sorry the pipe, I'm sorry
the pipelines. Yeah, yeah, that.
What you might call infrastructure producers, and I
have AI, have an. Aversion typically take or pay
right and you've got some fixed price or some escalators
adjusted for inflation. That that's exactly right.
Least among the larger ones. That's it.
And especially in this environment you really are the
low cost provider of your service.
If you want to transport liquids, then.
Having a pipeline. In the ground is going to be the
best way to do it. You know, you're competing with
truck and Navy rail at this point and you're going to win on
a on a unit basis, you're going to win every time.
One way you then you had to watch out for was how much
development CapEx you're going to put in the ground.
How many more pipes did you have to put in to sustain your
production and meet your commitments With the investment
case in the US being what it is, The system is so built out at
this point that I don't want to say everyone's in cash flow
harvest mode, but it's sort of shifted that way from hey, let's
explore and put new, new lines in to hey, let's sit tight and
be conservative and just try and manage what we've gotten around.
That's the situation. Warm up more comfortable with.
Of course we don't think there's a as much risk you get out over
your skis doing a lot and a lot of these fields from especially
in the basins we probably all heard of the Permian, the
Bakken, the Eagle fur Yeah, they're not growing the way they
used to, but they're going to be around for a long time.
And like you say, our low duration asset class, we're
making 3-4 or five year loans. We don't have a problem with
these fields declining a lot faster than that to to actually
make a commitment. So yeah, pretty, pretty
attractive space to be in, all things considered, right now.
Yeah, Yeah. So when you have a three-year
duration, I mean, your primary source of repayment is, is refi,
right, Typically, and I mean, I guess it's cash flow from
operations, but you're for all intents.
And purposes you're. Getting refined out.
Yeah, that. That that's the case we're
seeing, we are seeing some, some indications that you know, hey,
we're going to get you'll get taken out out of cash flow.
A number of Enps we've went to are below one turn.
So your debt profile your is is below next 12 months EBITDA and
there's still a high yield business.
So which is which is pretty shocking when you really think
about it or I should say net debt.
I mean a lot of these companies have a lot of cash in the
balance sheet and they're generating cash from OPS.
Maybe they'll roll it, maybe they won't.
A lot of that at this point has to do with the duration of the
asset itself. So when we talk about duration
of credit, obviously that has to do with the time the cash flows
on the on the loans, but with oil and gas particularly has to
do with the payback period in the fuel itself.
Like give you 2 extreme examples to maybe frame this up.
When you frack an oil well, the rate which oil comes back out of
the well will decline in some cases as much as 50% from year
one to year two. And then it it trails off.
Is there, it's a diminishing return where the that rate of
deceleration slows down over time and then after 2025, thirty
years, there's no more oil coming out and you plug the well
and that's it. But if you look at the math
roughly and again it depends on the field, that depends on the
exact technique used, but you might get half of all the oil
you ever get out of that well in the first 12 months after you
frack. So timing is incredibly
important. Whereas let's say we go up to
Canada, which is also a place we haven't been terribly active
historically, but it put a lot more money to work recently
where you have like an oil sands type field where no kidding,
they have 100 years worth of inventory.
They could produce oil at the rate they're producing it right
now for a century and nothing will change.
And. You know what I missed about
that? I, I asked a buddy who was in
the Permian and I asked him, I was like, what, what's the deal
with the Canadian assets? And he, he was like, they suck.
And I, I didn't ask him the right follow up, but I think
that the reason that he said that they're not very good
assets is if you look at like the returns on capital, they're
not great, but a lot of capitals already sunk.
And, and maybe I'm wrong, right? But like, I asked somebody about
CNQI was like, can you explain to me why so many people love
CNQ and they don't, you know, treat it like they do
Occidental? Because when I look at the
returns on assets on this business, they're like, not
particularly they don't, they don't pop off the page.
And he's like, you're not, you're not thinking about the
incrementals, the capitals already sunk and the reserves
are super long. And it's just not going to take
a whole lot of incremental capital to get the cash out of
the, you know, to get cash flow out of your reserves.
Well, that's right. And there's a lot.
So there's a lot that goes into that right now in terms of that
debate. So a couple things real quick
about Canada 1. Historically and even in recent
history, the differential has been a killer.
The referential just being the price you get from making it in
Canada and you got to deliver it to the market.
Yeah, because you can't ship it right?
Exactly. It's been very hard to get it
out of the middle of the country.
A lot of this is in Alberta, a lot of it's very far north
consultant Calgary. But you got to get it to the
Hoover or you got to get it into the US down to Oklahoma, which
is where the Wti's price or really the Gulf Coast, which is
where we actually look. So that differential has been
anywhere between 10 up to 25 bucks when it gets really ugly.
So you can imagine, I mean you know, if oil is 70, which today
it's around 80, but I mean over the last few.
Years in Canada, you got to be at 45.
Exactly. So if you, if you're standing at
the wellhead, so to speak, and you asked how much money you can
get oil out of ground for, it's a really low number, but then
you've got all these costs on top.
That's been a problem historically.
They just opened a new pipeline into Vancouver more or less that
helps alleviate some of that. It does two things.
One, it opens up 600,000 barrels a day at export capacity.
So that makes a big difference. It's called the Trans Mountain
expansion. The other thing it does is it
just makes production more predictable in the sense that
now you've got producers that aren't going to be hoping this
pipeline opens in time and maybe risking a glut in the middle of
country. And so we think that probably
tamps down some of the volatility of those
differentials as well. So that's, that's one step in
the right direction. 2 is that I think this, and this gets to a
much larger debate, is how long is the world going to need oil
for? And once your thought says, as
you, as I'm sure you've seen, there are some major forecasting
bodies that say, well, we're at peak oil right now.
They all have yet to be right, but that's what they said.
My view and we chatted about this last week, if you look at
the energy use and you can define that as calories, you can
define it as joules, you can find it as barrels of oil use in
the developed Western world versus everywhere else in the
world. I mean, the energy distribution
is so uneven, it's unbelievable. And what what's going to have to
happen is you're going to need an energy source that
essentially helps close that gap between the developing markets
in the developed world or the developed world has to tell the
developing world. To that.
I might want to say off top of my head, you know, there's what,
7 billion people on Earth and 6 billion of them use less energy
on a daily basis than your average refrigerator.
You know, I mean, good luck telling someone they can't have
air conditioning in a car and A and a scooter and a
refrigerator. To some extent, that's what this
is going to come down to. So, and this is a big, I realize
this is a huge, huge subject to get into and there are a lot of
different ways to. I think it's kind of interesting
that at the same time we'd have to tell them not to have a
refrigerator. We don't mind just plowing money
into AI, which apparently I I mean I'm going to mess up the
stat, but like one GPU uses I I somebody else look it up, but
it's like many houses worth of energy in a year is what APO you
uses or whatever. Oh yeah, I mean we.
I think it's it's crazy the the juxtaposition of we are on the
edge of a climate crisis that must be stopped, but also we
need to go after AI full, full blast is like something that
makes my head spin a little. It it, it does.
And I think if you look historically, we never really
transition off of energy. We just add new sources of
energy as a species. Yeah.
You know, like we never really got away from coal, so to speak.
We did in certain local markets that the US uses less coal
because we found shale gas and it's a lot cheaper.
Makes a lot of sense, but the world still burns a lot of coal.
We just keep using more and more energy from different sources
unless and until something dramatically changes.
I I think that's probably a decent bet.
And to give you an idea, I mean, some of these businesses trade
at in the single digit multiples anyway of earnings.
And this is real earnings now. This isn't the, you know,
adjusted, you know, EBITDA when you're trying to, you know,
cheat. I mean, this is, this is actual
cash flow. So you flip that upside down and
say, OK, I've got in less than 10 years, I'm getting all my
money back at these prices. And you know, do you think we're
going to need oil in 10 years? I mean, I think, I think the
answer is yes, we'll be paying attention to that, but I think
the answer is yes. And we not to say that other
sources won't grow as well. We think there's a place for
renewables. We think there's a place for
really every kind of energy we can create.
There's going to be a place for, we'll find a way to use it.
That's one thing humans are very, very good at.
But Needless to say, we don't think that the duration of these
assets is matching up with the duration that some investors are
taking on them. And we think that provides a bit
of an opportunity. I mean the the easy answer is
ESG, but I'm conflicted as to whether or not I think that's
the actual answer. I mean, part, part of me thinks
that there's so much money flowing to chasing assets that
are going a lot higher in price consistently.
That why mess around with sort of these, these cheaper assets
that, you know, historically somebody ends up cheating in the
market and gets all messed up. And maybe maybe you think your
PE is 15, but your actual duration or seven, but your
actual duration is closer to 15 or something.
I, I, I think, I think that's probably close to reality.
I don't know. You know, somebody that spends
most of his time in, you know, energy or energy intensive
investments. There are plenty of people that
want to use ESG to explain the underperformance at different
times. I think that is too simple to
your .11. Simple fact is this industry has
been a terrible place to put money to work until very
recently. And yeah, you know, yeah, we had
a, it was the place to be in some respects from, you know, O
5 to O eight. People made a lot of money.
Obviously, the fracking revolution totally changed the
dynamic of the market. We've had several downturns,
both supply and demand driven in the last 10 years.
COVID sort of put a floor in which -40 is a heck of a floor.
And and then yeah. Sure, the return since then had
been really, really good off an incredibly low base.
But it's also hard for me to look around and say, hey, you
know, how many times have you bitten before you shot?
And there are plenty of portfolio managers that would
tell you, OK, after the third downturn in five years, you
know, we we'd had enough. And yeah, and that's, and that,
that explains a lot. I mean, I, I think I want to say
in 2020 oil or these numbers won't be exactly right, but oil
made-up a tremendous portion of our energy writ large.
Was it something like 20 or 30% of the S&P in 2008?
And I want to say in 20/20 it was 2.
It got down to 2% at the low. I mean, it just didn't play the
same role in the economy, at least on pricing basis.
So part of it was you didn't have to have an opinion on
energy. Then it used to be absolutely
crucial that, you know, every fund and every allocator had to
have an opinion on what was going to happen to oil prices.
And then that went away for a while.
That may be coming back. I think the Russia, Ukraine war
has brought a lot more of that back into focus when people
started to ask, OK, one question we need to ask is what's the
break even price that clears the market?
And that's one level of analysis.
That's a hard question to answer, but that's one question.
The other question is, OK, given some geopolitical event, how
high could it go? And if we don't have a position
in some of those securities, at least from a, for lack of a
better word, insurance perspective, how do we need to
allocate to make sure we're not on the outside looking at?
I think 2022 is a prime example of that.
This is the conversation that I've I've had with myself a
little bit and it's two years late and my man Jake would have,
you know, probably tell me a year and a half ago.
That I should have. Well, he did tell me multiple
times and I didn't listen, but yeah, that's I I know that we're
sort of like past the this is the 70s redux narrative, but
what if we're not like I I don't, I don't know that I want
to like have an all on bet that that we're not past the 70s or,
or even if we're not past the 70s, if eighty really is the new
60, you know, some of these things are going to work pretty
nicely and I don't know what the rest of the.
World will look like. Well, well, that's you're right.
That is the debate that is the question or is to repeat myself,
I would say cautiously constructive.
Part of that constructive is when we look at who we think the
swing producers are and let's just broadly define that as
American shale, CE, OS and OPEC energy secretaries.
Those are the decision makers that really control the market
at this point and let's try and ignore what they say and just
watch what they do. Within recent history, we've
seen oil go back down to the low 70s, sixties neighborhood and by
and large those two groups. Both.
Pulled back and we saw that happen, right.
So all rig counts come down. We've seen consolidation, we've
seen capital not flow back into the industry and we've seen OPEC
ministers. And this is this has been
expounded on any number of podcasts.
So I, I won't get into it, but it looks like they want oil
somewhere in the 80s or 90s in order to be able to clear their
budgets to make their commit. Saudi famously is now investing
a lot in Vision 20-30, Russia's fighting war.
So there's good reason to think that they want to put a floor
under crisis, whether or not they have the wherewithal and.
The ability to do that is a different differently, different
hotly debated question. But Henning said that we get a
huge portion of the cost curve that seems pretty sensitive to
that $6070 a barrel range. So, OK, we can underwrite a lot
of these businesses that are in the market today at that price.
And I'm not thinking we're not going to be the kind of returns
that were available in 2020. But these are still.
Pretty competitive investments. So to your point on, OK, do I
want to go all in on this? My words, not yours, I'm
stealing them from some commentators, but in sort of a
new super cycle, thesis and energy, you want to go all in on
that? Or do you want to say, no, this
time's different, We're all done using oil.
I mean, I think the answer is certainly somewhere in the
middle. But having said that, you can
take some of that risk. You can take risk in a pretty
cost efficient way right now would be the way I would say it.
And if we're sitting here in five or ten years and either of
those things come to fruition, I don't think you're going to
regret having put some capital to work there.
Whether or not we do see a tremendous rip in prices or we
just see things sort of Peter out and basically everybody
earns their cost capital over a long term, which is what, you
know, what sex work would say will happen.
You'll earn a decent return either way and you will have
taken some serious risk off the table.
We're all consumers of energy in any number of ways, so I do like
having some of my own exposure in that just because it provides
the hedge to my own lifestyle. I told my parents the same
thing. It's just seems like pretty good
advice to stick to. So at this point where
valuations are, it's not a real stretch to try and get some of
that exposure. You don't have to have a strong
opinion, that's what I'm trying to say.
There are a lot of ways this can work out where you still earn a
pretty decent return and you've protected yourself from a real
tail risk in that. Yeah.
I guess, you know circling back to the to earlier in the
conversation you had said like the equity yield is call it 4%
and high yield total return expectations around eight.
I think what's interesting is like there's this issue, right
where some of the some of the more quality names in equities I
think are I understand why like when I, when I hear 30 PEI think
of like a longer duration asset, right?
Like I don't think of it as, and maybe maybe that's wrong to
think that way, but I think of it as like long duration.
And I guess that I the people that are paying that are
comfortable with the growth that's on the come.
But should somebody decide that that is actually probably not
worth taking that much duration, you really need to, you're going
to need to live through a lot of growth and that growth has to
happen. Whereas maybe the upside is not
there, right? Like maybe 8% is not sufficient.
But and, and I guess on the 8th, if you're only taking three
years, you have more in reinvestment risk.
But it just something seems wacky to me right now about the
way that things are, are priced. And I guess I would have always
said that I don't understand how certain things are, are priced
right now and, and I probably never will.
And that's probably why I should outsource some decisions to the
market. But it's just something
something's odd about the difference in in a way that
certain things are, are trading. I mean, even private credit,
like I, I think that that that's where the junk of yesteryear
used to live. I think everyone can agree that
sort of like the junkier, more levered credits, but, and it's
incestuous and I've, I've got, I've got plenty of issues with
it, but like what I can't get over is if you don't like
private credit, how do you like private equity?
Because like to me that like private equity is like way
riskier than private credit. And at least at least in the
private credit landscape, you hope it multiples get cut by 30%
or so. There's still some asset value
there for you where where the equity you really only have one
way out. Well.
Unless I don't see the ball clearly, which is possible.
No, I mean, I this is easy to say.
I've always been in the public market.
So again, easy for a guy that's, you know, to to beat up somebody
else's book, right? Yeah.
I mean, to your point, I think listening to some of the people
that seem to know what they're doing there and even seeing the
deals that come our way in the public markets and how they how
they are valued relatively. And I hate to say this, but it
does seem like there really is a economy of scale isn't quite the
right description maybe, But you really want to pick your manager
very, very carefully, right? Yeah.
The private managers that do a great job are going to do a
great job. They get access to the right
deals. They've got enough powder to
make the make the transaction happen.
They can be creative on the balance sheet, which is
something that I'm loathe to say.
But the fact of the matter is they can.
They've understood that after all the regulation that came in
a lot of this debt that used to be on bank balance sheets.
And it's, you know, I will say this, but it's probably better
off being in the private markets than being on bank balance
sheets for reasons of liquidity, because speed of transaction,
because of who can underwrite the risk, reason, clarity, all
those things. They really probably are better
off being in the private space in general.
But you know, if you don't have a manager that knows what
they're doing, to your point, maybe that downsides a lot lower
than investors think it to be. I've heard a number of private
equity or private equity and private debt managers recently
in the media say things like, well, we're getting superior
yields for less risk. I mean, I'm not looking at their
that's. That's a beautiful thing.
Could you imagine? I've never.
Seen it in finance, right? And I'm a die in the wool value
investor. And I do believe that
opportunity and risk are not always opposites.
But I think that to the extent it's true, it probably won't be
true for very long. And when it ceases to be true,
it will probably see suddenly and painfully.
And I. Like how you.
Said that. Thank you.
That's our maybe that's our sales picture why you ought to
be in public bond so to speak. But we do.
One of the reasons that we we do like the public bond space is
there's there is a lot of disclosure and it's a well under
well trafficked asset class at this point.
It's a couple generations older than some of the private credit
vintages in that way. So we think there's some, you
know, there's a lot of history here to lean on, which is nice.
Maybe a false sense of security, but it's a sense of security
nonetheless. And like, like you say, you
know, superior returns for less risk.
It's just the type of thing that's true until it isn't.
And man, when it isn't, it shows up all of a sudden.
So yeah, I think we share your, we share your concerns.
I'm not going to sit over here and say that the whole asset
class is a waste of time. I don't think that's true at
all. I think they're going to be some
managers that put up some. Extra terms?
Yeah, I don't, I don't even think that either.
I I guess I guess what I really scratched my head at is how
equities are trading. However, every single bull
market climbs a wall of worry and naysayers, so my having this
feeling probably means the bull has a lot further to run.
As well said, I'm sure you've seen the same thing.
If you look at the distribution of returns and inequities so
far, even this year, it's like you owned some of the AI
oriented names or you haven't done terribly well.
And maybe that's right, maybe it isn't.
But by the same token, and here I am talking about a 4% earnings
yield in the S&P. If you go down the capital
structure a little bit and say, let's say, let's look at some
mid caps, let's look at some small caps, let's go Russell to
value those valuations seem a lot more reasonable to me.
Part of the reason I say that it's those are those type of
businesses are usually the ones you see that issue high yield
debt, right? They're they're nobody's
favorite. They're capital intensive,
they're cyclical, but they're usually around been around for a
long time. They provide a good or a service
that's essential to the economy, right, air travel, energy, so on
and so forth. So we multiple on those
companies. Those look a lot more reasonable
to me. Those are in some cases high
singles, low teens type multiples much closer to
historic norms. And the debate there is all
right. Well, if you're heading into a
recession, these are not typically companies you want to
own. Most people will tell you that
are we or aren't we is really the battleground there.
But the multiples seem to suggest that it's battleground
and the multiples about where it should be given that we don't
have agreement on where the next cycle is going to start or where
it's going to go. And of course your opinion on
rates is going to influence what you think that right multiple is
going to be over a long period of time.
So that's another layer to it. But regardless, in some
industries, like I say, I think that that the capital allocation
has gotten a lot better and you can actually put capital to work
given you've got a long time horizon.
I mean, in the short run, I've never been terribly good at the
short run. So it's easier to just say, I
don't want to play that game. But we think in the short run,
again, like it, it could go any direction.
Long run, we think there's some pretty reasonable opportunities
out there. So, and then we're seeing that
we're seeing in my high yield space even, you know, sometimes
we see things go wrong a little bit before the equity markets.
Do. You know, I, I think the market
to your point is climbing a wall of worry almost in spite of
itself. I mean, I've been reading
reports about housing inventory is going up and new home sales
are declining and now there's a lot of home sales going on sold.
But what they don't, which is, which is true, but what they
don't tell you is that inventories and and depend.
Low yeah, is growing off of like the lowest base.
Yeah, exactly. They're not back to 2019 levels.
Yeah, that's crazy, right we've. Seen, we've seen rates go up,
you know several 100 basis points and mortgages go up
several 100 basis points and yet we really haven't normalized
yet. It doesn't look like it to me in
terms of those inventory numbers.
The extent we have, it's not extreme so and nonetheless
housing prices have yet to correct massively.
So. OK, maybe you know, it's there's
a lot to be said for this. The crash is coming and I know
that gets clicks, but we haven't quite seen it yet.
And I always take a lot of comfort in how worried the
market seems to be, right? I mean, greedy, one of those are
fearful, Fearful one of those are greedy.
I'm not saying now it's by no mean now it's the time to be
greedy. I don't think that's our view,
but at the end of the day of what we said to begin with on
the credit side, you do have to understand the business and you
got to know the name and you got to understand how management
thinks and you want to understand the cash flows on a
three statement basis. And that sounds oversimplified,
but it's important. And and especially in fixed
income, it's very easy to focus on the big levers and forget
that you're lending to individual companies that
actually have to go out and operate in the economy.
And I think when we look at the portfolio on that basis, we feel
a lot more comfortable making decisions and assessing risk.
Then to your point, all these very important high level
questions that are worth discussing, but we're trying to
put together a portfolio to earn a return.
We all have to go home at night, be accountable to our families
on what we put them in. Then then I think our view
shifts and we think the the risk reward is still they're pretty
attractive on an all in basis. Well, I don't know what else you
do. It's not like you're not going
to get out of the market. That makes no sense.
I guess it, it seems to me that the pitch on, on private and not
to go back to private credit, but I think the pitch on private
credit is if, if they can deliver, you know, 11:50 or
whatever percent, why would you own equity?
And I almost wonder if it's not the same similar pitch as it
pertains to debt generally. I mean if you if you really I
guess on an after tax basis eight turns.
Into what, five and a? Half or six or so, but still
that's that's not like a terrible return historically as
long as you can reinvest at that.
Well, well, that's, I mean you hit the nail on the head and
yeah, it certainly a lot of this been fixed income world's
contingent on your own tax implications because you
obviously want to try and avoid the the income hit for a lot of
people. But I see exactly the same way.
I mean if you can get, I mean some of these, these target IR
Rs are 12 to 15% through the cycle.
And I mean, if you can get 12 to 15% in a debt instrument, then
you don't really need to owe much else.
I mean, that's yeah. I mean, that's going to meet
just about everyone else's investing goals.
And if it doesn't, then your goals are probably not
realistic, which to your point, makes me suspicious that those
numbers are not right over a full cycle, you know, throughout
the duration of an investment lifetime.
Like say, I mean to the extent it's right, it won't be right
for long. So yeah.
Maybe you can participate early and get a big rip.
You have to hear the, to hear the private equity allocators
tell it, they think the market can continue to grow.
And it's got a lot of green pastures still.
Hey, Nate, Maybe, yeah. I I hope it's true.
If it's true, we're all going to be in great shape.
Oh, right. Right.
I mean, if it's truly a better way to, if it helps the capital
markets function and delivers great returns to people that
understand and can underwrite the risk, I mean, that's, and
that's all any of us are really trying to do, right?
And hey, at the end of the day, it might also take some
volatility out of the banking system and financial system writ
large by marrying the risk to people that are, you know,
understand it and can allocate accordingly.
That's that's, that's also that's AI think one of the
arguments that's been made for the last, call it 15 years is
that that's it's a better way for capital to flow through the
system. And I think there's a lot to
that argument. So.
Like I say, I'm not rooting against anybody, but when you
see some of those returns be that good for that long, you
know, that makes me worry a little bit.
Yeah, Wait, let's get back to housing real quick because I
don't know that we closed that loop.
So, so I mean, like, what's your version of reality when it comes
to where we are from a housing perspective?
Because there's, there's, I mean, all you know, it's, it's
been interesting these past couple months, a lot of these
stocks have rolled over. And I think the debate is our
margins going to collapse and how sustainable is the current
building pace and are we going to have to slow down?
And I'm kind of curious to hear you riff.
On it, yeah, sure. And that's a great place to
start. I think some of the some of the
equities have rolled over. We've seen in Florida, to me
stands out where the builder surveys, builders are saying
that there's some weakness in the market and they're starting
to get a little concerned, which makes sense given how strong the
market's been since 2020 down there.
Yeah, man, they, they built so much.
They just built a ton and I know now they're fighting with, you
know, I'm sitting here in Columbus, OH, So very, very
different view of the world locally.
Obviously insurance down there, insurance cost has spiked.
So that's creating another. Yeah.
And OK, great. Now we've got higher mortgage,
mortgages that are starting to work their way through the
system and we've got higher insurance rates, excuse me.
So the carrying cost of a home in some of these markets is
going up and that's somebody to pay attention to.
That being said. I think it's something like 40%
of homes or single family homes don't have a mortgage.
Today. Really.
It's a very high number. And.
Wow, that is high. And when you think about it, I
mean, I think there are several reasons for that.
One is you've had baby boomers and really up to Gen.
X have lived through the greatest wealth period of wealth
creation in the history of the world.
And it's been broad based in the US and home prices have gone up
basically 3X since 1990, give or take.
So that's a pretty great way to get out from under a 30 year
mortgage. And yeah, you know, I think a
lot of people are now having this conversation with their
parents or grandparents even saying, hey, I appreciate you
want to downsize, but you don't have any debt on this house.
What do you, what are you doing that for?
And I think a lot of people are retiring in place.
A lot of people are like where they're at.
And that's a factor, I think. And the I'm now I'm talking
about, of course, what's going to be strong in the housing
market. I think an under discussed issue
at the moment is we're starting to see what will be the greatest
transfer of wealth between generations in history, right
from retirees into, you know, my generation and and, and I Gen.
or whatever we're calling what's coming next.
And a lot of that is coming in the way of down payments on
houses. And you asked, you know, and I'm
skeptical that the numbers on this are really, really clear,
but there's a lot of help on first time for first time
homeowners from older generations.
That's another way in which you're keeping debt at a
manageable level. So all that rolls up to and
then, I'm sorry, the last piece I would say is we've still had a
lot of immigration in the United States over the last 30 years.
So you have more people and more wealth to go around.
And the housing stock does not look like it's kept up.
Obviously that that number really hasn't kept up since O
eight O 9. It's the, it's recent history
there where numbers haven't gone through the system.
And now that we're seeing some really, some really strong
demand, especially for new homes, I want to say the average
home in the United States and I'm I might get this little
wrong. It's it's around 30 or 40 years.
I want to say it's almost 40 years that's.
What I thought it. Was and how the stock is, is
aging and demand for new homes is should be pretty strong.
We now have a generation. My, you know, my generation.
I'm sitting here 33 years old. I mean, you know, I graduated
high school in 2009 and nobody wanted to go into the trades.
I mean, all the trades were out of work.
You just couldn't get, you couldn't get employment there.
And so you have generation like I say that their labor market,
there's this pocket in labor market where it was very hard to
get still work. And now obviously the demand for
that's been very strong. I think it's gratifying now to
see young kids considering maybe that instead of college or
higher education where maybe that bill's not exactly worth
it. But that's a whole different
discussion. Anyway, there you go.
There's your supply constraint. So looking at it from the
builder's perspective, it's a volatile time, but I think it
shakes out where builders can still earn a pretty nice return
on their assets. And accounting for home building
inventory because of the way you have to account for land and
work in progress inventory is a little weird.
But if you look at balance sheets for home builders,
they're really, they're really pretty strong, even the ones
that have debt on and back to industries that have learned
their lesson. I mean, home building, I think
is right near the front of the pack in terms of what were what
were management teams doing that blew up in O eight O 9.
And this is the classic, you know, Charlie Munger, just tell
me where I die so I don't ever grow them again.
You know, you get management teams that say we are not going
to own, we're not going to we're not going to take a lot of debt,
buy a bunch of land where we're not actively building homes for
sale because that's how you blow up.
Yep, famously NVR is a home builder that you know that stock
chart is, is incredible. If you want to look at over the
last 30 years, they had a model where they optioned all their
land and could let those options expire.
Yeah, higher upfront costs, sure, but they could let the
options expire in a downturn and didn't get stuck with a lot of
expensive inventory on the balance sheet.
And we've seen a number of home builders copy that style in, in
one way or another. Maybe they each have a little
bit of a different flavor to it, but that's become much more
common. And so to the extent we are in a
slow down which certainly going from 22 to 23 when rates really
climbed, we saw. Home sales decelerate and home
buildings decelerate to the extent that continues.
The businesses themselves still seem reasonably priced and
probably are in a reasonable return over a long period of
time. We've participated in a number
of homeowners credits over the last year that have been nice
returners for us. These are home builders that do
not want to get over leveraged. Every conversation is I would
say a fearful conversation. Back to our discussion earlier,
all the questions from investors are how manageable is your
leverage? What's your cash flow like?
What's your interest coverage like?
I mean, that's a question that a lot of teams haven't had to ask
for a while for a while. I mean, OK, what in a zero
interest rate environment, you know, the discussion was, hey,
net debt to EBITDA, what's your, what's your coverage?
Can we get paid back on the face value, not on a cash flow basis?
Can we cover the interest going out the door because you had,
you know, mid to low single digit interest rates.
Well, to be part of private credit now you've got companies
printing low teens interest rates and that kind of coverage
is now a much more active discussion.
But as relates to home building, be remiss not to say you know,
the old cliche about location, location, location.
That's certainly the case. You know, the markets that have
done well, the Midwest, I'm sitting here in Ohio, we've
grown nicely. Not gangbusters necessarily, but
there's been demand to soak up the supply.
And if anything, I'd say demands out, you know, outpace supply a
little bit. Certain markets where people
still want to be. I mean, it's easier, as much as
the Buckeye and me would love to just take a swing at, you know,
California in the PAC 10 people still, when you poll young
people and they say if money was no object, where would you want
to live? People still say Southern
California and New York. And I don't think that's going
to change in a tremendous way. We've seen some shifts here for
across living and other things, but at the end of the day the
ability to put new inventory in those markets is still going to
be a pretty good investment. It's that you can make it
happen. So all of that is to say, I know
I've I've given you the just rampant both sided in here.
But yeah, we're looking at gross margins for home builders in the
mid to high teens and return on assets in the teens for
relatively low inventory and very manageable leverage from
our perspective. And these are equities that
trade high, single, low, double digit type multiples, OK.
And I like, like I say, you tend to make more money in these
industries on price than you do on volume.
So I like to see where are some uncontrollable supply
constraints, and I mean uncontrollable from the
perspective of management. And if you don't have enough
labor and you don't have enough supply chain to get out from
under the demand, then I like that because you're not as prone
to bad actors, you know, coming in and oversupplying the market.
Yeah, they almost can't. Right.
Oh, that's, that's exactly right.
I mean, you talk to home builders for as an example, this
is another where where another one where having some scale
really doesn't make a difference.
If you ask home builders, hey, how many homes do you want to
build in the market? And they'll say, well, you know,
I mean as many as we can sell, but we want to make sure we
build just enough to keep our trades employed because the
tradesman will say, well, hey, as long as you can keep me
employed and get me to work, then I'm not going to look
elsewhere. That's exactly right.
So OK, what does that look like? Well, in a given city, maybe
that looks like two or three communities at an absorption
rate of a couple houses a month. How many houses that are that
community get sold every month or every year?
Well, great, at that pace, the market can probably absorb it.
We can keep our trades employed. And.
You know how much of a problem some of the really small
builders that want to do a house or two at a time and they might
have their favorite electrician, plumber, you know, you name it,
come in well, the earth's back of the line.
So yeah, to your point, there's there's a for the time being at
least there seems to be a a meaningful but not deadly supply
constraint that is keeping the market from going gangbusters.
And so long is there. And that will just like anything
else that will mean revert over time that'll work its way
through the system. But for the time being it seems
like it's it's sort of a sticky issue.
And. As long as that's true, we think
that, you know, capital is going to be able to earn a nice
return. So yeah, now there's a there's
also discussion there about what are these kind of interesting
around, You know, how much does home price and building costs
impact the inflation discussion, which then impacts your rate
discussion, which impacts your mortgage discussion.
And now you've got the same issue on both sides of the
housing debate. That's clear as mud right now
because because anybody looking at building supply, we were
chatting the other weekend, lumber prices have come come
back down tremendously from the squeeze we saw in 2020.
But at these prices, you know, mills aren't making a lot of
money. So we would think that price
probably reverts a little bit. All right, Well, how sticky is
that? To me it looks like there will
be some some cost push through out into the future.
I mean, hopefully they can bring some efficiencies out of it.
I know people, depending on who you talk to, we'll say we
basically built a house the way we did 30 years ago, some of the
materials a little more advanced, a little more energy
efficient, just that or the other.
But until we see a big breakthrough there, then those
numbers probably don't change very much.
So anyways, trying to put a point on it, it's an incredibly
dynamic situation from both the supply and the demand side
nationally. I think you can get a much
better feel in certain local markets and when it comes to the
home builders that are big enough to have public securities
out there, either debt or equity, then seems like you're
paying a fair price for the landscape that you're
approaching right now. So again, probably a decent
place to have some capital to put to work.
Yeah. Then maybe this is an impossible
question to answer without actual specific examples, but
how do you think about going down on the credit quality to
get a little bit more yield? All else equal?
Would you be more biased on a little less yield for a little
higher credit quality? Or this is an impossible
question to frame the way I'm? Asked No, no, it's it's a very
important. Question.
I mean, look. I'll just let me tell you my
bias and like you said, we got, you know, I'm going to say this.
I'm just, I can just feel John Mcclane and Bill's ox cringe.
As I said this, I there's nothing more attractive to me
has died. The wool value guy did a nice
high coupon and a really high yield.
And I'm thinking, hey, I'm going to earn teens and get paid back.
This is going to be great. You know, I think when we get
investments like that, you know, we all start fantasizing in our
head, OK, how many of how many of these do I need for?
I don't even need to, you know, I have to replace my income.
Yeah, I'm a sucker for that. I've learned my lesson.
I've gotten my hand caught in the procedure a couple times.
And that is just a painful lesson that you don't want to
learn twice a couple. I think the lesson there is
really and in high yield, I think this is even more true in
high yield than it is in equities, to be honest with you.
Because equities there's so there can be so much emotion in
it that sometimes you get an equity price that in my opinion,
doesn't have the information quality that you think it does.
Maybe the market's short term, maybe there's something
technically going on, who knows. My view is that doesn't happen
as much in high yield credit. If something is priced wide to a
similar bond and you look at comparables and something's
weird, chances are very, very good there's a reason for it.
So here's a great, I can give you an example.
A lot of our Canadian credits for oil and gas we priced there
was a credit and I I don't want to get into specifics, but there
was a company we went to last fall that printed a 12% coupon
and came to market for the first time.
And at the time you know interest rate per the yields
were really high singles for for energy with but your antenna
goes up like OK, this is several 100 basis points more yield than
than is being offered in the market for similar sized
businesses. Like.
My gut reaction is to say we're going to pass because that's
what it takes to get this deal done.
There's probably a good reason. Yeah, why exactly?
We want to be able to know exactly why that's happening.
And in that case, back to our earlier discussion, there were
several things we could look at that we felt like we had a good
handle on why the market was looking at it the way it was and
why that was incorrect. And so to try and answer your
question on do you want a little higher quality, a little less
yield, a little less yield, a little more quality, The short
answer is that's portfolio management question that really
has to come out with you as you construct the overall portfolio
and is above my pay grade. So how to answer like that?
Having said that, to the extent you find something that has more
yield for a lower credit quality, it's very, very
important to have a much sharper view of why you are divergent
from the market. And to the extent you can do
that, we're thrilled. I mean, as an analyst, that's
my, I mean that's my Super Bowl. Can I find a credit that is, can
we find a mispriced credit that performs the way we want it to
and and is really added to the overall portfolio in a
meaningful way? That's what we're looking for
every day. I wouldn't put a percentage on
it in terms of opportunities. We look at and pass on the vast
majority of things that have these really high yields we're
going to pass on because they're, they're, you know,
they're cheap for a reason, right?
So I would say that the very inversely with our confidence,
you know, give you an example on the other side, 2 fallen angels
that have since been upgraded, oxygen, petroleum and Ford
Motor. Well, you know, I've covered
those businesses for a while. Not a lot of secrets.
Yeah, we can debate the quality of the overall oil market or the
overall automobile market in the US Hey, fine.
But at the end of the day, he's really understood credits and we
know why they're doing what they're doing.
We don't need to go hunt for specifics around the deal.
Those again really since been. Upgraded to very.
Low IG, but been upgraded. OK, that's fine.
Those are well understood. Those are very liquid, no big
deal. The other thing I would say on
this point is it's not just the yield we want to pay attention
to or the coupon, it's the liquidity.
And this is something that I've had to come a long way on on
learning because, you know, these guys grew up in the credit
markets and the teams grew up in the credit markets and I grew up
in the equity markets. And you know, and equities, even
small cap equities, you're used to being pretty liquid if you're
a long term holder, just being able to get a position unless
you're in a really massive fund is generally not that hard.
And certainly if you're an individual investor, it's almost
never a consideration, right? Higher credit just does not work
that way. And this ties back in how we
were saying it's a less efficient asset class.
There are issues, you know, 200, three, $100 million face value
that might trade a couple times a week if you're lucky.
And the spread on the bid ask for it might be whole percentage
points. You know, I mean, on stocks are
used to the spread being a couple pennies maybe, right?
And understanding where those credits are priced and being
able to be in the seat and see, OK, you know, these bid and ask
prices are skewed from where they can be.
I mean, you can essentially demand a liquidity bringing from
the market on both the bid and the ask side if you know what
you're looking at. And so that's so every credit we
get involved in that's a piece of the discussion is how much of
this do we want, how liquid will it be?
Can we take advantage of the liquidity dynamics in the market
Because if we can't, there's going to be a return premium we
can get somewhere else. And I'm trying to answer the
question you originally. Asked which was.
You know, higher credit, lower yield or lower quality, higher
yield, excuse me, something that's important to understand.
Is. The way the ETFs and the way
passive has impacted this market, forgive me for jumping
around, but it speaks exactly to this liquidity issue because in
the equity market, passive has famously taken over.
It's very hard to beat the passive benchmark.
And there's a very good passive benchmark when you go out and
get, you know, the S&P 500 ETF and and that's great.
You're paying a couple basis points if that.
I think a couple of them are at 0 now, right?
To say make revenue either way. What happens in a high yield
space? Is the high yield.
ETS people want to use them tactically to get exposure to
the asset crash as a whole, which is really a spread and
rate bet and there's something to be said for that.
But practically what happens is that a whole lot of capital
moves into one of those ETS. The ETF has to go out and buy a
little bit of every issue in the market that's in that benchmark,
or at least it tries to. Well, if you get down the.
The face value. Structure and down the market
value structure into the really small bonds that are really
illiquid. That is AI mean I won't say if
they price agnostic bitter, but it's it's close If they price
insensitive bitter on that particular credit that maybe
they just want to put money to work and you can go ZAP the
premium because they want to get involved.
And then it works the same way on the sell.
They pull much money out all of a sudden you have a buyer that's
not or a seller that's not really selling based on price,
which is a great place to be on the other side of the
transaction. So those are all factors we
want. To keep in mind as.
We look at this, I mean, first and foremost, we're always going
to be business analysts and we're always going to look at it
from the bottom up and can we get paid back?
I mean that's the that's the most important thing.
But there are these secondary considerations in our market
where we want to be aware of how those things work because that
that is going to impact our total return in the way we put
the portfolio together. So I know I've really bounced
around. On you here but.
No, that makes sense. Your questions, I mean, I was, I
was. Trying to ask you a question
that. Would have you talk.
Like this. So I'm glad that you're talking
like this. It's a great question.
It's a very perceptive question because.
Even though we've all been doing this for, you know, our teams
work together for before I was almost 10 years exactly, just
about 10 years, we've known each other, work together in all
kinds of different capacities. This exact discussion is still
the one we have sitting around the office and we all sit
within, you know, we're all in the office every day and we sit
within hours reach of each other.
And when the credit comes up, we're going to take all of these
boxes because any one of these could just subtly shift the
dynamic of what's going on. And that's why this this job is
kind of fun. It's kind of fun.
It's a lot fun. And it's also where you feel
like you can really add a lot of value as an active manager by
having an opinion and understanding how to interact
with the market as opposed to, hey, I've got this view of oil
prices and I've got this view of gas and I've got, you know,
here's what I think home builders are going to do.
Those are fun puzzles to try and solve.
But then when it comes to the tactics of how do you express
that opinion? I mean, that is also a very
important part of how you put the strategy together.
So it's a very technical asset class.
In that. Sense and it's very important to
put all those facets together or else you might be leaving some
real money on the table. And these returns like I say
these these, these can be several 100 basis points at a
time. So this is meaningful, you know,
this is meaningful return prospects that we just want to
make sure we have an eye on and have a view on.
So I think you can also tell in this discussion in the beginning
when I said, hey, I'm a research analyst.
I don't trade the portfolio when I don't, I don't manage
portfolio as PM and I love my role because I.
Try. And present the business from
the bottom up and answer all the questions that, hey, we
discussed about this home builder, that home builder, this
oil producer in a way that it's easily digestible by these guys
that have to sit there and say, OK, when do we pull the trigger
to buy or sell? And I have to have all that in
mind. And then I have to interface
with the market and understand how this particular security is
created. You have to marry those views.
And every iteration, we think every forecast is just an
iteration about the future where you're trying to be a little
less wrong, right? I mean, no one's going to be
right. Specifically over time, as we've
iterated through that, I think we've got better at it.
And you do, right? I mean, after you've had a, you
know, a conversation about, you know, a company for the 10th
time, you sort of know how the other guy is is going to react,
which is great. It feels like a sport sometimes
where the team, you know, the hole is greater than some of the
parts because you can really work through things very
quickly. You know, we're going to have an
opinion on a credit pretty fast And and if we don't, we're
willing to say that, I mean, there are plenty of things we're
just going to put in a too hard bucket that, you know, don't.
I'm just going. To say, yeah, I'm, I'm.
Not really fit to have an opinion.
I don't care how good of a return prospect it looks like, I
will pass because that's not in our circle of competence.
There are also places where we can get up speed really quickly
and that's a lot of fun too. It's it's very additive
distraction. You feel like you can improve
over time. Yeah, yeah, I'd imagine.
I mean, everything is a get your money back issue, but I think
debt particularly is because you don't have the right side to
bail you out, right? There's no, there's never like
some huge winner in debt, right? You just get your money back and
move on. That's exactly right.
Well, it's like Howard Marks. You know, I think it's the I
would imagine the Marks memos is a gateway to a lot of young
people and and college and afterwards into credit and it's
a great place to start. But he calls the famous losers
game, right? It's a negative art.
You know, in credit it's about what you don't own and as long
as you don't own the things that default, you're going to put
together a pretty good track record.
I mean that is the game. You know, inequity to your .1
home run in the portfolio can cover all kinds of mistakes and
a lot of great track records of history have been made that way.
Credit is the exact opposite. You know, the best you can do
when you make the investment. Now I will say in the spirit of
being in covering all the all bases every once in a while and
especially in the high yield market, you will get a chance to
swing for a really nice return. 20/20 was that for us where we
were buying bonds at 30 or $0.40 in the dollar that ended up
earning, you know, high double digit.
Returns because they were just mispriced.
You have priced insensitive buyers, particularly in the high
yield market when things get ugly, holders can be very, if
they they don't, there are certain players even in high
yield that just don't want to hold bonds and things get
really, really ugly. And certainly March and April of
2020 was one of those times, and certainly in my industries.
Of airlines. Oil and gas, you name it.
Yeah, right. I mean, that was sort of
there's. Plenty was going wrong all.
At once, but there was a lot to do there and all of a sudden
you're look you go from seeing high single digit type yields
too 2030% type yields to maturity and say, OK, this is
the game has changed now we're not really in a pricing game,
we're in a survival game and how do we want to do that and we had
we had a view on some. Things we had a view on.
Some things ahead of time that allowed us to have an opinion
really quickly and that was really, really fun.
I am not a distressed analyst per.
Southeast. That's a very narrow skill set.
John started out in distressed and, and has done that and has a
lot of I understand how that system works.
I'm I am not the guy to ask there.
We also like to say, you know, distressed happens all at once
and then you go for long periods where there's not a lot to do
because the way cycles work. So do you want to is that is the
type of thing you want to do as a career or you can build a
strategy around? Yeah, it's tough.
It's tough. So that's probably a different.
Nice tool to have, but maybe not the strategy to run.
Exactly. Hey, it's great.
It's a nice to have. And there's nothing better than
owning quality when something you like falls out of bed and
then you can go straight into it.
I mean, that's sort of like the died in the world, Graham died
value investing where hey, I'm, I'm buying, maybe I'm not buying
dollars, but I'm buying, you know, 3/4 for a dime type thing.
I mean, that's, that's pretty fun.
So it's an element of it. It's an element of the high
yield market. It's less, it's probably going
to be less than it was going. It's probably going to be less
going forward than it has. Been in the past.
Back there just around private credit, a lot of those credits
are probably going to go through workouts and amendments and
capital infusions and it's subtly different way than they
have in the past. So I would anticipate that even
though definitely a believer that history doesn't.
Repeat, but rhymes. And default rates will
eventually rise, and we'll see trouble in the market.
Maybe that ends up working out a little differently going
forward. That might not manifest itself
in the public credit markets the way it has.
But nonetheless, we're always on.
We're always watchful for it. I mean, all of us have been
through situations where, you know, credits just get beaten
down and things go wrong and people get scared.
And you just know there's some panic selling and all of a
sudden you figure out how much. Conviction you have.
In that investment or not and and it's a painful.
Lesson to learn. But.
You know, once you learned a couple times, you hopefully get
a little quicker at making those decisions and understanding, you
know, when you want to put some capital to work when everyone
else is truly being fearful. Yeah.
How did you how? Did you work mean as an energy?
Covering energy? How did?
You work through COVID looking at I mean, you know, the the
picture changed so much from April to October.
I mean, how did you to the extent you can remember, oh, how
do you, how do you go through a time like?
That. And.
And get back to normal. Well, I can remember pretty
well. Oh, that was that.
Was that? Was really something else.
I'll try and. Tell you the story crime
logically, because in my nightmares, this is how it
works. That was.
Work I I should say real. This is obviously told from my
perspective, but at the time as an analyst and I don't think
they can hear me from where I'm sitting in the.
Office. So I'll, I'll go.
Ahead and say it, I mean, I, I really couldn't have been
working for better guys than the particularly the two guys I was
working for. Sukum Patel, who's who's not a
firm any longer. He he retired a few years ago.
I was really my mentor and first boss and energy and John
Mcclane, who is even though he's PM is that I as as an energy
analyst qua energy analyst, I put him up against anybody
working for those two guys in that environment was again,
about as lucky as you can be to see how to work through that.
So let's go back to January and February.
I remember being at a oil conference.
It was the last trip I took before COVID.
And I think for what whoever everyone that took one last trip
before COVID, you know where you were the last time you left your
house. I was in an oil and gas
conference. And this was right when Qasem
Soleimani had just been killed and there are Marines deploying
to Saudi Arabia to counteract Iran.
So we got a little bit of pop in the oil price and that was the
discussion point. Some of the headlines around
COVID and China had come out. But whatever were in this sort
of like the geopolitical risk premiums coming back in oil and
then COVID starts to come out. OK, this is a.
Problem. OK, we know this is a little
more widespread. What's going to happen?
I think it's probably been forgotten because of how how bad
COVID was for everyone, how traumatic that experience was.
Oil really fell off a Cliff for the first time when the OPEC
deal fell apart, which was a little bit before most people
went into lockdown. And I can tell you on that.
Saturday. When pictures.
Come out that the Russians and Saudis have walked out of the
OPEC room and they've knocked each other's flags over on the
desk and and the Saudis walked in and said we're going to
produce all out. I remember, you know six O clock
Sunday night I was in the office looking at where oil is going to
go because I'm like this is it this is going to be this is
going to be bad and it was I think we're off $20 that morning
I mean just a just an incredible move and that was appropriate.
I mean the market was getting. That right?
I think I was the first one in the office that morning out of
mostly just panic. And one of our old PMS, the old
old shopper was just a fantastic mentor and a guy that understood
energy very well. And they saw me come into the
kitchen and just laughed at me like, OK, welcome to the NFL,
kid. This is this is what this looks
like. And we huddle pretty quickly.
I mean, we put every security that we could trade up on the
wall and said, OK, here are coverage lists.
What do we want to do in this situation?
Now fortunately for us at the time, we had had a, I want to
say bearish. We had a really conservative
view of oil prices. We thought there was enough
production to go around early 2020, the discussion around
discipline in the US, it had started.
I mean there were plenty of management teams saying, hey, we
want to keep the capital out of the ground.
Shareholders were starting to be very impatient with management
about getting actual cash returns back, but it wasn't, I
mean it wasn't the money it is now.
And so we held some of the higher quality credits, much
more fractured industry, not nearly as consolidated as it is
today. I mean, it just in some ways it
looked totally different. So fortunately, we were sort of
on the sidelines from the really severe drawdowns of both the
debt and the equity side. So that from our perspective
things were ugly, but we were in a position to maneuver.
And first thing we did was say, OK, how do we feel about OPEC
and what they're going to do that's bad, but then how do we
feel about COVID? And so over the course of the
next two weeks, the discussion shifted from there's a price war
going on between Saudi and Russia to, OK, how bad is demand
really going to get? So we went from a supply
discussion to a demand discussion really quickly.
We were cautious there in the beginning about putting too much
money to work exactly for that reason.
We thought this, the supply shock was serious, but the
demand shock was even more serious.
I mean, you could watch the tanker tracker from Saudi to the
Gulf Coast of Texas and how much oil was going to be coming to
the United States. I mean, it was, it was that
obvious at that point in time. So we were a little bit patient.
And then of course, we hit April and May, oil goes negative and
it looks like now producers are capitulating.
OK, we're. Throwing in the towel, Lay down
the rates. We can't keep doing this.
OPEC understands. OK, this is the real.
Deal. There's we're.
Going to crash our budgets if we don't, oh, kind of cooperate and
get along here All right, there's the bid under oil
demand's still terrible and we don't have.
The vaccines yet? So you have to look out two or
three years to get back to a point that's tolerable.
And the strip, the future strip is still reading 30-40 dollars.
So these are not exciting times. But on the other hand, you've
got oil bonds that are trading 30 and 40 cents in the dollar.
And OK, we think we're getting paid for the price.
That's when we started to put a lot of capital to work and say,
OK, we think we understand these producers really well.
They're still small, they're out of the way.
If you're risk reverse at all, you don't want to be in these
credits. So that's when we started buying
up some of the small shale producers that we thought would
really be good tie up candidates, really good
consolidation candidates and the time and shale, you could really
just look at a map because the best, the best synergies in
shale really come from adjacency.
If your property is right next to the other one, you can drill
longer wells, you can get more out of your labor, you can get
more out of your infrastructure. I mean, it really was that
simple. Put the, put the puzzle pieces
together and, and take them all and go home.
And we probably had, I mean, I don't know, 10 or 15 names in
the portfolio would get taken out that way.
I mean, the consolidation wave came in and hit very strongly
and then in the back half of the year.
And not that in no way do I want to take credit for calling the
vaccines would work. I, I would hope they would
didn't really have a strong view, but then the vaccines came
in and of course that really kicked off what ended up being a
tremendous rally in everything energy because you know, now
that you've got production down and the price rally kicked off,
it just ran for the next couple of years.
And I'll make this is a bit of a technical point, but I think one
thing that's important to understand about that particular
rally and the oil industry as it stands now back to the client
rates. Shale is a large shale wells or
a specifically US shale wells, which is between the United
States and Canada. That's really we're really the
shale producers in the world. They declined at such a rate
that the market clearing price between supply and demand,
probably the reaction function to that so to speak is probably
much faster than it has been historically.
So if you look at a conventional oil well like you know they
drill offshore, they drill the least, the oil declines at mid
to high single digits every year.
You get that much less oil out of the well year over year.
Back to the point around shale, shale is more like 30 or 40%.
So when you stop drilling in shale.
People talk about the shale treadmill.
Where these producers just have to keep drilling wells, keep
their production up. If you stop drilling in shale,
supply drops much faster than it has historically.
So part of what happened in 2020 was you had shale contributing a
much larger portion of overall global supply, so it could react
a lot faster and supply could correct much quicker than the
industry was maybe used to in past downturns.
And that's one of the reasons that was such a short.
Downturn in that sense. We had nine months of prices
being in the basement, and then starting that fall, they start
to creep back up. A lot of that had to do with how
reactive the shale producers could be.
That's still to some extent forms our view now.
All right. In a real price shock
environment, how quickly can the March market reach equilibrium?
There's a natural shock absorber in the speed of the capital
expenditure and the speed of the drilling where we don't have to
worry about plugging wells or abandoning wells.
You're just turning them off. Naturally, the decline rate is
going to bring it back into into equilibrium.
Oh, because every. Every.
Year you're losing. So much.
Production so. That's a little.
Bit what's behind? Ark and we were.
Relying on that a little. Bit going down market and we
think since it's probably been true so anyway yes great
learning experience really glad we could express some opinions
there very exciting returns I mean I don't think I say this
and then I'll be. Proven wrong tomorrow.
But I would be surprised if in my career, opportunities like
that show up again, barring a true geopolitical event.
Just based on supply and demand, I mean.
Those are, you know, if we got a once.
Every hundred year pandemic then that's probably about what
you'll see on the demand side would be my guess.
But but you know, you got to dust off.
The Gram. And dot, at that point, because
now you're now you're really doing Mr. Market is are we a
voting machine or are we a weighing machine?
And and yeah, you know, do you run outside with if it's?
You know it's raining. Gold do you run outside with a
bucket That's that's kind of the question you have to answer
there so yes, I I know that's a very long way of answering your
question. How do you feel about Nah, I
like it well, in 2020, but you know well we all got the got the
stars from it and I think it's it definitely helped us as a
team. I think understand and see how
people react and what kind of questions you want to answer and
yeah, how much trust each other and, you know, can you rely on
people to make make. Decisions.
How do you? Behave when things really,
really get ugly. Yeah.
So that was I won't say. When it hits the that's it, I.
Wouldn't want to I'm. Not going to sit here.
And say, oh, that was a blast, I'd like to do it again.
I wouldn't, right. But I was still fairly early and
I started my first year as Nailis was 2016.
So this is, you know, four years in and you still a little bit
used. To it I've been doing energy
for. Two years at that.
Point and I do, and I still feel this.
Up until that point, I had a deep, deep sense of insecurity
about just not knowing what I'm doing.
Which was right? I'm convinced I was right about
that. I didn't know what I was doing
and afterwards me doesn't mean I I still have that sense of
paranoia. Probably just my personality but
I'll never be comfortable doing it.
But I, I have a distinct mental shift before and after of
saying, OK, well, at least you can't tell me that I I haven't
been through a cycle before. Yeah, that's right.
Yeah, I've been through. One of the one of the craziest
cycles. Yeah, right.
A once in 100 years. I haven't seen as much as most
people, but I haven't. You know I'm not.
You know, I wasn't born yesterday either.
Yeah, no doubt. Is there anything that?
That like is really interesting out there that's caught your
eye. Are things pretty calm on the
horizon? I would characterize things as
pretty. Calm on the.
Horizon, I mean, to answer your question, it's been a while
since there's anything where I was, I would like banging the
table and say, hey, we got to look at this.
This is a really good opportunity.
Things look fairly efficiently priced to me at this point.
Yeah, if, if that cuts rates, then that'll be a tailwind to
every fixed income instrument and that'll help.
But, you know, we'll see how. Much does the front end.
Impact. That like I had told you, I was
having a conversation with somebody and their theory was
that the front end is where all the issuance is.
So that's what's actually priced and the back end is not doesn't
have as much price discovery in it right now.
And I don't know if that's crazy talk or if that's reality.
I mean that's, that's a really good question.
I. I don't deal at all.
In the long end, really so. I wouldn't want to give you an
opinion on whether the price discovery there is good or not.
I feel like I understand where the debate is, but I don't have
a particularly strong view other than all the worries we all have
as American citizens of OK, well, if if inflation doesn't
come down and they don't, then they can't lower rates or won't
lower rates on the back of it, then what happens to the federal
budget? Maybe that's a question I think
we're all afraid of. But you know, at the front, it's
really a question on the front end, particularly in high yield
because to your point, a lot of these credits will be refinanced
or paid off in cash and when you go to refinance.
Very few of these. Credits ever go?
Current they usually want to refinance more than a year in
advance so they're and that could be as much as a year or
two. If you have let's say you have
two two bonds outstanding, you get a three-year A2 year bond
and a three-year bond maybe call them both at the same time.
Granted, a lot of these bonds do have call protection, so you
kind of know you call yield the worst or yield the outcome when
is the earliest this bond can get rewired or taken away from
you. So there's a little bit of a
buffer there where it's not like, you know, we're not
exactly running the tomorrow's interest rate or fed funds in
into the yield. Having said that, the loans have
gone from being priced in Libor to sulfur and that's that's a
front end rate. So I would taking too long to
answer your question of it's meaningful.
I mean, it can have it can have a really big impact and it does
it does directly flow into how we price all these instruments.
Now it has a fairly uniform flow.
So from our perspective, it's, it's a little easier to say,
well, given where rates are, where should these other credits
be relative? That's one question.
And that doesn't even move at the front end.
But by the time by the time you're, you have a very short
duration credit the you know the whether or not it's right a lot
of. The risk has been taken.
At less and less risk has been baked into that, so the spread
tends to be a little. Narrower.
In there that mitigates it a little bit.
You don't have to worry. About, you know, quite the same
distribution of outcomes. So things do do tighten up a
little bit and that that that spread.
I'll move it, but like you say, it'll move the whole market.
I mean, no question about it. Does it's it is very meaningful.
Yeah, I know mortgages and things like like long duration
instruments being priced off of, you know, long duration
government securities is is obviously a well trodden an
understood. Relationship.
But even at even at the front end, it it impacts us too to be
part of our valuation. I mean, I know that's, that's a
debate, right. If you got an earnings yield of
4% on the S&P and Treasuries are paying 4%, you know the.
Nice thing is the S and. P can grow the earnings right
where the. Treasuries can, but well, it's
exactly right that that's the other point.
There, it's not. Apples and oranges, that is,
repeated the boy, oh boy, doesn't seem like a time that
there's the rain falling. From the sky, but then it but
who knows? I don't know, it'll probably do.
What it's done? Historically in perpetuity and
with bumps and and, you know, peaks and valleys.
Yeah, right. I would say impersonally.
My view is has been and maybe this is this is naive.
I actually, I told this at a meeting and we were talking to
some some clients in Paris actually a couple months ago and
I was giving them this whole spiel and I said, and they asked
a very similar question. I said, look, at the end of the
day, you know, putting capital work in the American capital
markets has been the right thing to do at almost any point in
time in the last 100 years if you had a long enough time
horizon. And yeah, you know, I because of
that, I'm still, you know, if you get I'm always an optimist
given enough time and yeah, and the.
Guy looked at me and laughed. And said, yeah, that's because
you're an. American, you know, it was
coming coming from a French and he he wasn't, he wasn't trying
to insolve it coming from a Frenchman.
It was it was pretty fun. I know because in a lot of
places, a lot of places. That just isn't true.
But in the US. Market it's been true and I
think it appears to be paranoid or pays to be.
Paranoid. I think it is worth worrying
about. I mean, I think part of our job
is to worry about whether that's not true going forward.
But be that as it may, I I think it probably will be.
So over the long run, we're still thrilled to be able to
invest into this market. And you know, it's like Buffett
says, being an American investor has been just the greatest
wealth creating tale and anybody could ask for.
And I don't think that's changed.
I know that's sort of the debate of the day, but I'm still
thrilled to get the opportunities we get.
Are they wildly obvious at the moment?
I would say probably not. Was there anything that I think
is a imminent national return? I don't know.
I haven't found anything that that I'm that excited about, but
I found I I feel as though I found plenty of things that if
you give me the chance to look out several.
Years I can. There be quite satisfactory and
that's my time horizon now. It's easy for a young guy to
say, you know, so I've got time on my.
Side. But Charlotte, you know, Monger
likes to say most of the money is made in the waiting and and
that probably is still going to be the case.
Well, if you're buying long duration.
Assets and you're thinking? Short, you got a mismatch.
If I've learned anything that's I've learned, that is well said.
Very well. Said yeah, no, the old cool man.
Well, listen, I appreciate you coming on.
The program and I I hope that you've enjoyed it and I I hope
that we stay in touch. I've enjoyed the pre work on
this. It will go likewise.
I thanks for letting me. Bounce around here and talk.
You know, it's funny. I get to talk to John, Bill and
Jack all the time, but it's it is really a you know, you said,
hey, don't you know these are obvious questions?
No, it's great. I hardly ever get to vocalize my
opinions to outside third party and it makes you you're talking
makes you think better. So yeah, I think that's right.
Writing to Absolutely. Absolutely.
So no. I appreciate you.
Taking the time and reaching out, it's been great getting to
getting to know you a little bit.
Obviously don't hesitate at any point going forward.
Love to do it again. Or even if you know some
security comes up and it's offline, you just want to ping
me about something I'm associated with.
Hey, let me don't. Don't be a stranger.
Be careful what you ask for on that.
There may be some inbounds. Hey, no, I'm I'm here for it.
I'm here for. It sounds good.
Hey, thanks, Bill. I appreciate it all.
Right, have a good one. Thank you.
You too.