Bloomberg Wealth: Josh Friedman

If you take a step back the private markets in general have exploded at the expense of the public markets. I think people overreacted to the Fed raising short term rates and just anticipated a much worse outcome than what we've actually seen. You've got to think independently. You've got to be a contrarian and you can't be motivated by fear of missing out or by envy. Canyon Partners co-founder and co-CEO Josh Friedman always knew he would run his own business one day. From the time I was very young my dad would say to me you have to go to Harvard and when you're done you have to have your own business. He just never thought that business would be an investment firm. What I really wanted to do was I wanted to run a tech company. I got a little bit waylaid in that in that trajectory because Goldman Sachs was particularly good at recruiting top students at law school and business school. And he never left finance. Friedman started Canyon in 1990 with his best friend and roommate from Harvard Law School. The firm focuses largely on private credit investing a market that has soared in popularity in recent years and could reach two point eight trillion dollars by 2028. According to Morgan Stanley estimates I think people figured out quite correctly that there was an opportunity to move quicker and more with more alacrity to help finance private equity firms that were growing quickly move quicker and more efficiently than commercial banks. Today Canyon manages more than twenty six billion dollars with 200 employees across seven global offices. Not bad for a kid whose first degree was a bachelor's in physics. So for those who aren't investment aficionados what does Canyon Partners do. What kind of firm is it. Canyon is basically a credit firm. We focus on things that are intellectually challenging and complex as opposed to middle of the plate types of things. So we started our careers as Canyon focusing on distressed debt. We've widened that that viewpoint quite quite a bit to encompass structured credit real estate credit things that are transitioning from complex to simple arbitrage things of that sort. Things with is a very high payoff to doing thorough and complex research. So credit is very popular these days. Private credit has been seen as one of the great growth areas in the investment world. Why is it that private credit is so popular these days as opposed to 10 years ago or 20 years ago. I think if you take a step back the private markets in general have exploded at the expense of the public markets. Part of that's regulatory. Part of that's just structural in the market. I think private credit particularly exploded when the banks took a step back. I think people figured out quite correctly that there was an opportunity to move quicker and more with more alacrity to help finance private equity firms that were growing quickly move quicker and more efficiently than commercial banks. Well the banks would say well the private credit firms that are now dominating this business large private equity firms firms like yours they are not regulated. So the banks when they lend money they're lending money typically off their balance sheet or money from the FDIC guaranteed and therefore they have some constraints and what they can do and they're often regulated by the Federal Reserve. The private equity firms that have private credit businesses or private credit firms that just do private credit or credit kind of investments they are not regulated. So therefore the argument that the banks make is that maybe these firms are not going to be really doing good deals and ultimately there'll be a problem when when the economy slows down. How do you respond to that. I think it certainly could be correct. I think private credit has a lot of different forms and and and varieties that straight down the middle of the plate unit tranche lending which is basically first lean plus second lean combined into one that layer of the capital structure has gotten to be very crowded with the explosion of private credit firms who have grown based on that product. And at this point you could argue there's probably too much credit availability chasing too few deals. So there's probably a half a trillion sitting on the sidelines. And as a result spreads have come down. Rates have come down. The depth of lending has gone up and the covenants have weakened. Generally speaking the private credit world is operating with with sophisticated investors who take a certain amount of risk and with much much less leverage applied to those loans. The leverage in commercial banks is generally much higher than the leverage you see in private credit. So the problems while they might arise here and there are much less likely to be systematic or existential for the financial system in the way that we saw in 2008 when banks were way over leveraged with a lot of not very good credit products mostly in that case real estate based. Somebody gives you money to invest in private credit. One of your private credit funds. What kind of rate of return should they reasonably expect. I think it depends on what what they're doing what those what those entities are on things like distressed. I think we expect that to be mid teens to 20 percent on things like CLOs. Average returns have been north of 15 and and less than 20. They've been in that range very consistently for many many years. Let's talk about real estate for a moment. It is generally the view that large cities like Los Angeles San Francisco New York Chicago have office buildings that are not being occupied that much because people work in home. And also the rents have come down a bit because they can't fill these empty spaces there. And because interest rates are so high the overall cap value of our capitalization rate for these buildings is lower than it used to be. So there is a view that the banks have on their balance sheets senior debt and mezzanine debt that is not worth 100 cents on the dollar maybe not even worth 50 cents on the dollar. But they're not selling it in the in the enormous amounts that people would have expected. Why is all this bank debt for real estate not on the market and being sold by the banks now. Well some of it is. And what what happens in in real estate with banks is typically the problems don't happen until maturity happens or you need a refinancing and it's not available or rents turnover and or tenants turnover. And now you have vacancies. Some of these buildings are literally obsolete. David I mean there are there are buildings that were built in 1960 on Third Avenue here in New York that have been recapped so many times with money coming out and more and more debt and with population migrating to different areas with brand new buildings that look completely different from older buildings that might have lower ceilings and not the right kind of infrastructure. Some buildings are just completely obsolete. And there's a lot of that. I've heard estimates as much as 20 percent of the office building stock in the United States. So it takes a while before those problems hit. And sometimes they're not really fixable through the capital structure. Sometimes those properties are actually worth whatever the dirt is minus the cost of carting away the structure. Opportunities in real estate tend to start at the top of the capitalization and they work their way down. So the first opportunities are good properties that just weren't anticipating 6 percent interest rates. They were anticipating 3 percent interest rates. And when debt becomes due they have to figure out a solution to that problem. Eventually you work your way down to the problems of buildings that have substantially large vacancy rates and and are almost not re tenant double because they're so obsolete. And we'll see those. And we have seen some of those already. But they tend to be when there's a moment of default or crisis. Now with interest rates as high as they have been for the last two years or so the general view was for a while that we're going to have a so-called hard landing which is a euphemism for a recession. We haven't really had that. How did we avoid a recession given how high interest rates were. You know I've been a little bit of a contrarian in in the last couple of years. And I think now I'm probably a little more consensus driven in the sense that I I kind of agree with the concept that rates are not likely to come down until after the after the election and that that the economy is starting to see a little more signs of shakiness with consumers and where they're spending their money and so forth. But I think if you go back the economy is strong. And I think people were so concerned about higher rates. And yet there were some there was so much fiscal stimulus built up in the economy. Unemployment was extremely low. Consumer balance sheets were extremely strong. Bank balance sheets weren't particularly leveraged. I think people overreacted to the Fed raising short term rates and just anticipated a much worse outcome than what we've actually seen. I really wanted to do something on my own. I wanted to have a shot at having my own business. Let's talk about your background. So where were you born. So I grew up outside of Boston in a suburb. Now you got into Harvard. So you must have done reasonably well in high school. Were you like first in your class or something like that. I was. I had the benefit of parents who thought that education was the path to having the kinds of alternatives and flexibility in what you did in your life. And so that was a major focus of my parents. So when I became a good student they were constantly leaning on me to be a better student. So you went to Harvard and you graduated summa cum laude. I did. Now summa is the highest you can get. But you also won a Marshall scholarship. Marshall scholarships are given by the British government to the best academic students in U.S. colleges as I understand it. So you must have been one of the top two or three people at Harvard academically to get a Marshall scholarship. Is that right. I was ranked in the very top of my class. I was a physics major. I think there are plenty of people in my class at Harvard who are an order of magnitude more naturally blessed than I was with. Why don't you want to be a physics major. That's not the easiest major. Well it is and it isn't. If you're really good at math and science it's a lot more predictable than trying to rely on someone to grade your essay in history. And I loved math. I love science and I thought I was really good at it. And then I got to Harvard and I encountered people who just didn't study and just knew everything. And they were brilliant. So you became a Marshall scholar and you studied at Oxford. Yes. And did you get a degree there. I did. I got a degree in politics and economics. So I wanted to do something that was completely different. Something was unlikely to be exposed to in the future in my at least in my education. Now a number of times when people go to Oxford as a Rhodes scholar or Marshall scholar they come back and they get a degree back in the United States that might help their career like a law degree or a medical degree or business degree. But you've got a law and a business degree. Did your parents say you know enough studying already. Get your career going. It was almost the opposite. My my dad didn't know a lot about career paths per se. But from the time I was very young my dad would say to me you have to go to Harvard. That's because he was from Boston and that was the school he knew that was the best school for someone brought up in his in his neighborhood and in Roxbury back then. And he said you have to go to law school and you have to go to business school at Harvard. And when you're done you have to have your own business. Don't work for people and don't be a lawyer or at least don't do it for long. Right. So you graduate and you get all these degrees. What do you want to do with that. Well what I did was different from what I wanted to do. What I really wanted to do was I wanted to run a tech company and tech back then meant electronics and signal processing. It meant all those companies that were located outside of Boston on Route 128. Eventually I wanted to own one of those companies and run it and so forth. I got a little bit waylaid in that in that trajectory because Goldman Sachs was particularly good at recruiting top students at law school and business school. So I thought well I'll go to Goldman Sachs for a few years. All right. So you're at Goldman for a few years and presumably pretty smart guy. You'll rise up. Why did you decide to leave Goldman. And why did you decide to go where you went. My roommate from law school and business school Mitch Julis who became my partner at Canyon when we started the firm in 1990. Mitch was a bankruptcy lawyer who decided he didn't want to be a lawyer. He was writing articles on investing in the 1983 recession. And one of the investment strategies he was writing about was buying junk bonds. And he came out to L.A. to interview Drexel and Mike Milken. And he ended up joining as a bankruptcy analyst. He overheard Mike saying he really needed someone to call on private equity firms and try to get them to use high yield bonds as a financing tool. And he said hey you should call my friend Josh. And so I I got a call from Mike and three weeks later I I left. So you have these degrees from Harvard degrees from Oxford top of your class practically everywhere you go. Goldman is the pinnacle of the investment banking world. Drexel while Mike is brilliant was not considered in the league of Goldman in terms of prestige. Did your parents tell you you know you're going from the top to a place that's kind of a new boy on the block. I knew exactly what he was doing. One of my friends at Goldman and I had a little file box of all these entrepreneurs doing transformative things in the capital markets. People who were doing bootstrap transactions which is what they called leveraged buyouts back then. There were maybe two handfuls three handfuls of leveraged buyout firms at all. And Drexel's mission was to try to do what Mike's mission at least for me was to try to get these these private equity firms not to deal with equitable and prudential and CNA and Northwest Mutual to try to finance their deals but rather to use high yield bonds because we can be quicker more efficient and and really facilitate a much higher velocity of transactions and much more certainty. So you get the Drexel. What year was that. That was 1984. All right. So Drexel is doing really very well. But eventually Mike gets into trouble legally and eventually go Drexel goes bankrupt. So were you at Drexel when it went bankrupt. Yes I was. What was that like the day it filed for bankruptcy. Were you shocked. No I wasn't shocked. I think you could see the cracks in the foundation as much as two years before. So I was already planning an exit whether or not Drexel vanished. So Drexel files for bankruptcy. You're employed there. Do your parents call you and say hey your firm just filed for bankruptcy. What are you going to do. I don't remember David. I think I I do know that I didn't want to take a job. Once Drexel was gone many of my colleagues went to other firms and started high yield groups that became huge profit engines for all of those firms on the street. Every one of those firms. I really wanted to do something on my own. I wanted to have a shot at having my own business. So I don't think I ever would have left if things continued on the trajectory that they were on and things were great. It was it was so much fun and so innovative and so exciting. But here was an opportunity that landed in my lap to do something on my own. So you started Canyon Partners in what year. Nineteen ninety with my partner Mitch and a few other. So what's the likelihood of starting your business with your roommate from from school. That rarely happens right. It does. It was a great opportunity. I think we we both wanted to take a shot. We have different strengths and weaknesses. We thought we could do something. We really didn't have a very well thought out or intelligent. How did you Well initially we each put in some of our own money and we had a couple of other partners did the same thing that at least let us hire some people and get started. We were doing advisory work initially because that could put bread on the table every day just through advisory fees that you receive every every month. And we had some very high profile significant restructuring advisory work. We didn't really want to do that. We wanted to be investors. So we talked a few institutions into giving us some managed accounts and we started investing as well. So today the business has taken off. How large is Canyon Partners now in terms of assets under management. We're about twenty six billion dollars. Twenty six billion. And how many employees do you have. About two hundred and thirty five. And you are still running it with your partner. Yes. And you think I might you might step back from some point because I've been running for a while. You're just going to keep running it for a dozen years or so. Well we did just sign on for another five years. Says as you know we took on an outside investor for the first time in our history which really helped capitalize the firm that outside investor you took on as a large Japanese insurance company. Yes the largest insurance company in Japan. And what do they do for you. We want to create a firm that has permanence and has stability. Bringing in an outside investor helped do that because first of all it capitalized the balance sheet with hundreds of millions of dollars of capital that doesn't go in our pockets but goes on our balance sheet so that we can face the world in a more in a more forward leaning way as opposed to a more defensive way where it gets decapitalized every year. Now as we mentioned earlier you were born in Massachusetts. You're educated there largely though sometime in England. You've lived largely in New York and Los Angeles. And now you've moved your headquarters to Dallas and you're living in Dallas. So I Dallas a wonderful city. I saw a TV show called Dallas. But is that what attracted you to Dallas or why are you in Dallas. Dallas is a great place to do business. California is an amazing place. New York's an amazing place. They're both difficult places to do business for a variety of reasons. They're from a regulatory point of view from a cost of living standpoint. It's not so easy to hire people particularly middle and back office people where they're facing an enormous cost of living and an enormous tax rates and gas prices and everything else. So we thought we should offer an alternative. I think many firms in New York have been creating outposts or headquarters in in Florida. Dallas seemed like a great place to raise a family. There's there are great schools. There are a lot of places to live that are very close to the sort of uptown and downtown neighborhoods where most offices are located. So we thought it was time to offer an alternative. And we did that. Most of the big mistakes people make is because they see others doing it and they feel like oh my God how did I miss that. I'd better get into that. So is it a good time to invest today for the average investor who says well interest rates are pretty high. Inflation is still reasonably high. I should wait for a while or is it time to invest now. I think it depends on the area. I think for example distressed investing is very good right now. It doesn't have the same tone and flavor as prior distress cycles because in prior distress cycles there were a lot of bankruptcies and the economy was weak. What we have instead is a very strong economy and businesses that are doing quite well but simply have too much debt and they can't really refinance it. So there's a lot of balance sheet restructuring and there's a very very long list of situations like that. But they're they're not for the fainthearted because the behavior both by the borrowers and by the creditors vis a vis each other can be pretty rough. But I think that's that's an area of immediate opportunity. Real estate credit is an area of immediate opportunity because the banks have just been forced by both regulatory initiatives and by their own balance sheets to take a step back and an enormous step back. And a lot of the balance sheets there are unstable as well. So certain areas I think are extremely opportune and certain areas are more evergreen areas. I think that hedge funds try to be an evergreen strategy. And I think we're in a bit of a sweet spot now because credit is yielding so much versus where it was. So what is the best investment advice you've ever been given. Charlie Munger used to have a saying that things fall into three categories. Yes no and too complicated to figure out. We kind of ignore that a little bit because we we tend to gravitate toward complexity. But but I think there's a basic message in there that's a terrific one which is that you have to be patient and you have to be aggressive when the opportunities are are abundant. And you have to be quite disciplined at a time when they're not. And if you look at that period that we lived through where rates were ridiculously low it was easy to put money to work in things that were silly. In retrospect that was true in venture capital. It was true in equity markets. It was true in credit markets particularly. And I think having the kind of patience and discipline that that that that Charlie Munger Warren Buffett have had is is a great lesson for everyone in the investment world. What's the most common mistake that investors make in your view. I think that people are motivated. Another another lesson from the great Charlie Munger who if you have the benefit of living in Los Angeles for a while you know he you get the benefit of interacting with him periodically. Extraordinary person. He had a way of looking at both sides of the balance sheet and he really taught Warren Buffett I think to buy quality businesses as opposed to buying low quality businesses and being desperate to do it. When you look at what other people do they tend to be motivated by fear of missing out. As he used to say it's not greed it's envy that motivates people. And I think that most of the big mistakes people make is because they see others doing it and they feel like oh my God how did I miss that. I better get into that. I want to look like so and so who's doing a lot of growth equity and they transform their hedge fund into that. Or I have to be involved in this situation because everyone's doing it. You've got to think independently. You've got to be a contrarian and you can't be motivated by fear of missing out or by envy. It's a very very bad characteristic of human beings that makes them make bad investment decisions. So suppose somebody is watching this and they say I want to grow up to be Josh Friedman a very successful financial entrepreneur businessperson philanthropist. What is the best advice you can give to young people who might be interested in being like you. I think that people should. First of all they should make sure they get the most they can out of their education. That's a good thing. And I think it's important to do something that you love doing. You can't do something because it's financially rewarding and expected to be financially rewarding. That's just unlikely. That's not usually what happens. Usually the financial rewards come from you doing something that you like and that you're good at. And then you have a certain measure of luck because you happen to be in the right industry at the right time. I do think it's really important to pick good partners and good people to do business with. I was very very fortunate to have met Mitch back in law school and business school in our first year business school section and then to stay closely in touch and remain best friends for a long period of time and then start a business together. I do by far my best thinking when I'm talking to someone else. There are others. I'm not sure that's a model that I would necessarily encourage others to pursue. But at least for me the experience of being able to have somebody to interact with to disagree with someone who has a different viewpoint but enough of the same viewpoints has has been just a source of great rewards throughout my life.