Alan Waxman - Private Credit and the Modern Financial System - [Invest Like the Best, EP.466]

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To learn more, visit psum.vc. This is a unique conversation. It's my second with Alan Waxman, the founder and leader of SixTree, one of the largest private capital investment firms in the world. Him and I have been going back and forth about the history of financial guidelines and incentives and how those systems through time shape the system that we live in today and shape outcomes in the financial markets. We thought it would be a neat opportunity to walk through in great detail what he calls System 1, 2, and 3, going all the way back to 1933 and the initial regulation Glass-Steagall, which kicked off System 1. We then go through System 2 from 2000 to 2008 and the global financial crisis and then go into great detail for the system that we're living in today. The reason all this history is interesting to me is that ultimately it's about the incentives and the ways that investors and investing firms make money. We have this great conversation about what Alan calls the factory model of investing, defined by the industrialization of both raising money and deploying money, sort of the opposite of the old school artisanal investment model that's entirely focused on earning outstanding investment returns. His historical perspective and lens on what's driving outcomes I think is useful information and history for all of us as we try to navigate one of the most dynamic periods of creative destruction in capital markets history. Please enjoy my second conversation with Alan Waxman. We're facing one of the most interesting capital market setups of all time alongside one of the most interesting just world environments, geopolitics, technology, and you and I have talked a lot about the shaping forces that will determine how things play out from here. One of those things that I want to start with, we'll talk about AI, we'll talk about geopolitics, some other big things that might be shaping the world, but there's one that is probably under discussed that you are in a very unique position to teach us about, which is what you call the guardrails and the incentives of the financial system itself. The reason we're doing this today is so much discussion of private credit, direct lending, things happening in private markets that's getting a lot of attention in the news. You can see it in stock prices of certain companies. I think the whole world is grappling with this, trying to figure out what the hell is going on and what to expect. You are a deep historian of this topic. I thought it would be a really cool opportunity just to have you teach us all about this important factor in what's going to happen in the future. What is your general frame for the financial system and how it impacts the world? There's a lot going on in the news. What I'd say is what you're reading in the news today are the symptoms, but not really the root cause. As an investor, when we try to figure out what's happening in a current moment, which is we're definitely in a moment right now, we do two things. First of all, we think about it from the standpoint of, how did this get here? What's the history of it? How do we get here to really figure out the current moment and also determine where we're going? I think we'll talk a little bit about the history of how we got here. The second thing, and you hit this, is looking at everything through systems. We think about systems, we think about the incentive system, guardrails, and market structure. First of all, I'm not an economic historian. What I'm going to do is tell the story of history as it relates to the current moment. I think you've got to go back to pre-1929 crash. When you think about the American financial system, it's basically like the wild wild west. It was pretty unregulated. There were many causes of the 1929 crash. There was poor monetary policy, agricultural recession, margin lending, but one of the main parts that caused it is you had this idea of commercial banks. Think about commercial banks. Individuals go put their money into a bank as deposits. Commercial banks basically were in the same house as principal risk-taking activities, so the investment banks. These were all part of the same thing. As you can imagine, when that happens, there's a massive conflict of interest. Really, the story starts for the current moment, starts in 1933. This is after the 1929 crash. This is after 9,000 banks failed. Think about that. 9,000 banks failed. 1933, Glass-Steagall, probably one of the most important regulations that took place, and also the establishment of the FDIC, which ensured deposits for individuals at banks up to a certain limit. Glass-Steagall basically said these commercial banks, which was deposit-taking institutions from individuals, just got really burned in the 1929 crash, basically become separated from the investment banks. At the time, think about principal risk-taking. Think about in today's parlance, private capital investment banks, those got separated. That's the first system. When I think about the first system that explains where we got to the current moment, let's just call it system one. It's from 1933 to 1999. When you look at post-war war II with the separation of commercial banks and investment banks, you basically have, after post-war war II, 50 years, a pretty stable system other than the SNL crisis in the 1980s, which was a big event. It was a pretty good system, but the system wasn't optimized for economic growth because you only had a pretty conservative with a lot of guardrails, commercial bank providing finance across. Yeah, it's just low-risk appetite. Yeah. So it's a low-risk appetite. And again, because one, the fixed income market hadn't developed, which is part of the story here, but also because investment banks, they were more in the moving business than the storage business. They were pricing securities to basically sell to other people. They weren't pricing it to hold for their own balance sheet. Now, that changes as we get into the 80s, but again, broadly speaking, for this first system from 1933 to 1999, it was working. It just wasn't optimized. The lesson from this is with really good guardrails, you can get long stability. You can get long stability, but again, you also have to think about job creation and economic growth. And I think if there's one criticism of the system, which is why the Glass-Steagall Act got repealed in 1999, I could talk about why it got repealed. What led to the steps leading up to that is that it wasn't optimized. And as you go to a more globalized world and you're competing with, say, European banks, you become less and less competitive. So in a non-globalized world, it was probably okay. But as we got to a more globalized world, it wasn't really optimized to maximize economic growth for the country. Okay, so we get to the mid-late 90s. What happens in addition to new competitive pressures? Walk us through the transition into what becomes system too. So at the time, again, we've got separation of investment banks and commercial banks. All of a sudden, European banks who weren't part of the same Glass-Steagall regulation, they started to unite with each other. So commercial banks and investment banks in Europe started to come together, which started to put the American commercial banks at a big disadvantage. And not only were they coming together, but they were also taking on more leverage than what was allowed with the guardrails of American commercial banks. So as a result of that, as you can imagine, all those commercial banks and many market participants are saying, hey, we can't really compete against some of these European guys in 1998. Deutsche Bank bought bankers trust, and that was definitely a moment. Citibank announced that it was merging with Travelers, which at the time when they announced the merger, it actually wasn't allowed under Glass-Steagall, under the current regulation. So that's what sort of led up to it. So I think it's a couple things, globalization. Now all of a sudden, you're competing against Europeans who have, think about they can provide services and balance sheet and capital. You're at a pretty big disadvantage. So the system one started to get less competitive as we moved into a globalized world. And that led to 1999 when Glass-Steagall was repealed. So what comes in its place? It's basically just deregulation. It's deregulation. And literally after that, you saw a wave of mergers of combining commercial banks and investment banks. So you saw JP Morgan Chase. There's many others, but with everything, there's not gone effect. So that came together, created these powerhouses that could compete with what was going on in Europe. But now you had all these investment banks that weren't commercial banks. So think about my old firm Goldman Sachs and many others. Now they had to start competing. They didn't have access to cheap capital because they weren't a commercial bank. They had to compete with combined investment banks and commercial banks because a lot of the commercial banks, both in Europe and the US, they started to use their balance sheet to get investment banking business. So what did all the investment banks do? They started to leverage up. And that's one of the other stories is leading into the system is the development of the fixed income markets. So think about corporate bonds, mortgage backed securities, asset backed securities, sovereign debt. That went literally from the 80s to the 90s, went from $7 trillion to $14 trillion. These are all financing mechanisms that could finance the investment banks to basically allow them to leverage up. And that's what started to happen. So literally from the time of Glass-Steagall being repealed, you had commercial banks uniting with investment banks, both in US and Europe. You had leverage going up. Leverage went up for commercial banks. In some cases, 20, 30 times leveraged. And all the investment banks were operating with leverage because they had to take on leverage to be able to compete with the combined commercial banks and investment banks. And then nine years later, what happened? You had the GFC. Now, just to be clear, there's a lot as a polarizing debate of how much attribution, the repeal of Glass-Steagall, had on the GFC. What do you think? Well, I think like everything, it's nuanced. There was definitely some attribution to it. I think that was clearly not the only reason. My view, it's some combination, but ultimately it had to do with the system and the set of incentives. In that case, after putting all this together, a lack of guardrails that existed in the first system we spoke about. And in system two is the lesson that it's the combination of liquidity or asset liability mismatches and leverage that basically is the cocktail for every historical financial crisis. One of those two are both are involved. Leverage always plays a role, and they're all connected, but just the mismatching of assets and liabilities. You could be the best investor in the world making the best illiquid investments. But if someone comes and asks for your money in a quarter, when you haven't had time to actually have that investment play out the way that you underwrote it to do, you're going to be about investing, you're going to call it out of your option, and you might have to sell it at a deep discount. So there's a few things. I think it's one, anytime you bring retail or individuals to think about people depositing into a bank next to principal risk taking activity, I think that's one thing. The second thing is just anytime you mismatch assets and liabilities. And then the third thing, again, going back to what we talked about earlier is what are the incentives, what are the guardrails, and what's the market structure? Okay, so then what happens? So obviously we know about global financial crisis is terrifying and the reaction is many things, but what is installed post-GFC that sets the seeds for, I guess, what we'll call the current system, system three. So in 2010, two things happened. First is Basel III was passed by G20 nations. I'll explain what that is. And the second thing is Dodd-Frank. When you think about Basel III, so this applies across all commercial banks, and by the way, a number of investment banks that were not commercial banks were forced to become commercial banks as a result of this, those commercial banks, and this is really a Basel III thing, had restrictions on capital, which for your audience, think about that as leverage, so the amount that they could be levered up so they didn't get levered up 30 to one or 40 to one like they did pre-GFC. And the second thing is restrictions on liquidity. And liquidity is basically through a bunch of shocks and areas, a bunch of things going wrong, do you have enough liquidity to meet all your obligations? That was a key part of it. Dodd-Frank was more aimed at in the Volcker rule that that didn't really last long, was really aimed at the principal investing activity. I would say it's more for the commercial banks. It was more Basel III, but Dodd-Frank played a big role, certainly in the short term. How would you explain just system three and its guardrails and incentives to people out there? System three, in my opinion, it took like 125 years to get here. It has the potential to be the best system American finance has ever had. Because when you think about commercial banks or deposit taking institutions, by the way, that are basically backstopped by the government, insured by the government through the FDIC. So think about GFC, there was a bailout, the taxpayer bailout, that's not good for society. That's not good for the middle class. That was not a good outcome for America. For those institutions having restrictions on capital or leverage and liquidity, where they're doing lower risk taking activity to finance a system, that's a good pillar of any financial system. Converse on the other side, and this is where the current movement starts to come in, is now you've got private capital and commitments. When you think about private capital, think about pension funds, sovereign wealth funds, endowments, insurance company, providing capital in the beginning of this period, so-called system three, post-bassel three, post-GFC, that's what resulted in the growth of the private capital industry. Because it was filling in the gaps. So think about principal risk taking activities, private capital was filling in the gap. And with the exception of hedge funds and really REITs, those were matched assets and liabilities. So you think about private equity, private real estate, private infrastructure, private credit, they never had someone that could literally ask for their money back or they didn't have deposits saying they need to get their money back. They can't get it back because of the liquid assets. So that just to put it in context, private capital from pre-GFC to post-GFC is about two trillion. Pre-GFC, it's grown to around 14, 15 trillion. Private credit, which is in the news today, grew from 500 billion to about two trillion, what is today. So massive growth. And this filled the gap for that principal risk taking capital, provide risk capital to all parts of the American economy, which is a good thing. And I would say up until 2018, the system was working great. You had commercial banks, deposit taking institution, effectively backed up by the government, doing safer things. And then you had matched assets and liabilities where an investor, a set of assets, couldn't get caught out of their option, providing the risk capital. That's a pretty good system. Until we started to see behavioral changes in 2018. As your business scales up, everything gets more complex, especially your compliance and security needs. 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Ridge line is revolutionizing investment management, helping ambitious firms scale faster, operate smarter and stay ahead of the curve. See what Ridge line can unlock for your firm. Schedule a demo at ridge line.ai. Just to put a pin on an elegant well designed system of guardrails and incentives. The commercial model where it's lower risk and protected or backstopped and higher risk seeking capital where the assets and liabilities are matched is a good system. It's a good system. Yeah. All crisis is generally are caused from not credit issues or others. They might start in other issues, but it's mismatched assets and liabilities. So you mentioned this year, 2018 is being a pivotal point. I want to explain that transition, but it feels important. You and I have talked about this notion of years of the factory model before. We're going to go into that in more detail, but just to plant the seed in people's mind, define the factory model just briefly. And then I want to talk about what happened to get us transitioned and the incentives towards that model. So the way that we define the factory model in our industry is there's two parts to it and then there's an output. First part is the industrialization of the fundraising process, say liability gathering, literally raising as much capital as you possibly can as fast as you can. So that's the industrialization of the liability side of the fundraising side. That comes first. And then what comes second is then as a result of that, the industrialization of the asset side. So think about investing. So if you're on an investment team and all of a sudden your firm has a lot of money to invest and it's just sitting there and maybe there's a time stamp on it, all of a sudden your behavior has to start to change because you have to deploy that money much quicker. And what's the best way to raise a lot of capital quickly? Make it very simple. Make it very narrow because if it's wide, that's too hard to explain. So you want to make it as narrow as possible. And you're also willing to take, let's say, make concessions on the type of capital you raise. So meaning maybe it's got a term where they can ask for your money back. So instead of perfectly mass assets liabilities, maybe you're willing to start to not have perfectly matched assets liabilities because you want to raise it as fast as possible. And again, when people hear this, they're going to think I'm only talking about the bigger firms in our industry, but it filtered down to mid-sized firms, smaller firms for a whole bunch of reasons. But this whole factory model behavior started to reveal itself in 2018. The visual that's coming to mind on the asset side, and again, we'll come back to both these ideas in more detail, but I think of an artisan making a horse saddle or something by hand, and then I get an order for 100,000 horse saddles. I can't make it by hand. I got to make a fact. That is the exact way to think about because it's a different model when you're building that horse saddle versus you get a massive order. But one point's important is that it starts always on the liability side, and then it goes to the asset side, and then you get the current moment that we're in that I know we're going to talk about. It starts on the liability side because why? Because if you just all of a sudden go to that example, it's a really good example of the horse saddle, all of a sudden, if you don't have a factory that can produce 100,000 on the artisanal side, you're not ever having to think about it. You could have an industrialization of the asset side, but if your liability constrained, you're not going to change behavior because you don't have the capital to go do that. You'll run out of money in five days. So it's got to start on the liability side where you raise all the money, then you have it, then the behavioral change starts. These two things, it's first liability side, it starts the industrialization, and as a result of that, it goes to the asset side. Which is interesting because if you add up every conversation I've ever had with an investor, 98% of the time spent is on the asset side. What do you invest again and why? Exactly. By the way, that's okay if you have perfectly as match assets and liabilities, it's okay, but let's imagine a world where every investor you spoke about had a term in their agreement after three years, the investor had the option to call their money back. That would probably be something you want to be talking about a lot. And by the way, prior to 2018, going back to the financial system, the private capital probably was pretty perfectly massaged assets and liabilities. It would seem if everything was frictionless and I was a GP, I would of course have matched liabilities. If I could just snap as much capital as I wanted into existence, yeah, of course, I want to have no problems. So what's the series of events starting in 2018? What were the first examples of this and then how has it evolved? The first signal is underwriting because investing or lending, you can invest as much money as you want, you can lend as much money. That's not the skill. The skill is investing. It's that artisanal behavior. Everyone talks about private credit, but we started to see it in every asset class. We started to see it in real estate. We started to see it in infrastructure. We started to see it in private credit. It wasn't actually bad, but we started to see behaviors like terms that you would never do because obviously when you lower your underwriting standards, guess what happens? Your deployment pace can go up. You have an origination engine. You're sourcing all these deals and let's say you're an artisanal, you might have a hit rate of half a percent you look at. If you lower your underwriting standards, your hit rate on deals that you might do might go to 2% or 3%. It's literally all in your control. So I think we started to see it, but it was just like something we started to notice changes behavior, but it wasn't full-fledged factory model industrialization. COVID happened and then post COVID, it was game-along for the factory model, both on the liability raising side and also on the asset side. Literally that behavior started to accelerate in incredible ways right after COVID. The capital, the liability has come from lots of different pockets, but my mind goes to the wealth channel that everyone's talking about now, institutional channel as well. Maybe put a little more color on where it actually came from, where it's coming from. What started to change in 2018 is there are these things called SMAs, so separately managed accounts. Prior to 2018, for the most part, the private capital ecosystem was basically funneled through funds. So think about commingled funds, lots of investors come into one fund to pursue a certain strategy. And all of a sudden, there started to be every conversation with every LP was basically, we want an SMA. We want one fund to one just to do XYZ for us. You go to an LP, you basically say, hey, we're going to raise $500 million or $100 million, and we're going to do direct winning, or we're going to do private equity, or we're going to do real estate. And all of a sudden, there started to be a proliferation where literally three years prior, it was not in any conversation, every conversation was SMAs. And what it is, it was just the industry starting to raise capital from the institutional channels, so not wealth, the institutional channels, so pension funds, sovereign wealth funds, to some extent endowments, raise as much capital as possible in the simplest form. Start on the institutional side with SMAs, but the growth in institutional SMAs started to really taper off. The next place where the industry started to go was the wealth space. And the wealth space in general, just from a historical perspective, it is typically the easiest to raise, the simplest to raise. It's typically the cheapest. That doesn't mean that they're not smart, just the cheapest. But the other characterization of the wealth space is that it's always easiest to raise in the pro cyclical environments when things are going really well. But when things start to not go well, the wealth space or retail or individuals want their money back quickly. I just want a level set on that's an important concept, and that's where it started to go. And that got us to one of the symptoms that are here today. But the one thing I want to point out, and we'll talk about the current moment, is that the SMA was a symptom. What's going on in the wealth system? The wealth system is a symptom. When you think about some of the stuff you see in stuck private assets, where there's so many assets around the world in private real estate, private infrastructure, private equity that literally were companies or assets that were bought and really post COVID, sort of 2021, early 2022, paid way too much. They're stuck assets. All that stuff is symptoms. The root cause of this is the change of behavior patterns of the factory model. That's the root cause. And again, one of the things that's not frustrating, but unfortunate is that everything that is covered in the media is just talking about the symptoms and not actually getting to the root cause. And again, when you think about history, people talk about the symptoms, but when you start to diagnose what happened and how we got there, it had to do with the root cause. And I think that's something that hopefully this conversation provides some greater clarity on. So if I think about this model, and we've talked about, maybe you can mention the multiples that markets had been putting on asset management companies that we can look at public markets and see everything transparently, how much markets were willing to pay for the equity in multiple basis, what the multiple is of that drives the incentive to raise money. The story of the factory model starts to correspond with FRE multiples. What is FRE? FRE stands for fee-related earnings. Fee-related earnings is basically your management fee profit. So you raise a fund, it's got a management fee on it, you got a set of expenses, and what's left over, that is your fee-related earnings. These things for our industry started traded between, let's say early 2010s, call it 10 to 15 times FRE. In 2018, when all this started, it stepped up to call it 15 to 20 times. Obviously, depends on the comp set. Before this current moment, we're at 25 to 30 times plus. That's where it is. And by the way, if you go back to the early passing of Basel 3 and Dodd-Frank, there was a massive secular opportunity to fill the gap that was left from commercial banks being constrained. And then the system found its sort of state-state place, but in order to keep growing, and again, it's the whole industry, what do they do? Many participants adopted the factory model. And is maybe the crass way to say this, in the factory model, the GP, the founder of the firm, stands to make a lot more money from the equity of their GP than from the carry they would earn through investing or something like this? What I'd say is that, look, to be a CEO of one of these larger, it's hard. You have a lot of different constituents. It's really hard. As an investor firm, sometimes it's good to grow and sometimes it's not good to grow. It depends on what's the investment environment, what's the quality of your liability structure, what's the flexibility of your investment model to sort of migrate to where the best opportunities are. It just depends, but I think it boils down to what's your clarity of purpose. There are a number of people that are public that I would say have not adopted a factory model. There are a number of people that are not public that have adopted a factory model, maybe because they want to get bought by one of the larger guys, or maybe if you're a midsize firm and you want to be one of them. The issue is just because you're large and just because you're public, it doesn't mean that you've adopted the factory model. It's like, what is your clarity of purpose? Now, if your clarity of purpose is to be an investment bank, then maybe that is what you want to be, a factory model. But if you're going to do it, you better have a really good risk management. And that's why, if you look at commercial banks, Jamie Dimon is probably one of the best risk managers of all time. What he can do from a risk management perspective, and you saw in GFC and you've seen it other times in his career, he's a better risk manager, but the rest of the industry that follows suit because they want to be Jamie Dimon, they might not be as good a risk manager as him. And it's the same thing over here. So it's not just the larger guys, because remember, the industry always follows the larger guys, but it's not certain that just because you're public, just because you're large, that you've actually adopted the factory model. What are the most common in your mind telltale signs of a firm that's in this model? What is a firm that's adopted the factory model look like that's distinct from an investment model based firm? First of all, you know, when you see it, you can see it in the underwriting, we're in a bunch of different asset classes, you can see it, particularly like if you're a fixed income investor, a credit investor, because you have capped upside, there's terms you just don't give. A lot of those terms have been given to facilitate deployment. You should not do those terms because it's all good when you're in a post-synchral environment, but if you have capped upside and you're earning a 10% return and all the collateral that your 10% is based on can literally be taken out of your collateral package overnight, or for that 10% return, you can be levered up because let's say there's an AI disruption in some software company, it's reposition their business and they can basically lever you up, so you go from 50% loan to value to 120% loan to value, those are just things that you shouldn't do for a 10% return. The first time we did this, we talked a lot about return per unit of risk. It basically sounds like the thing happening in the factory model is that that has fallen out of whack. The objective function becomes more deployment of capital because that ties to size of my business, multiple in the business, how much money I'm making as a shareholder or whatever, and it's fundamentally divorced from the investing equation, which is return units per unit of risk or something like that. So map this onto the news cycle today. What is happening? Where are their asset liability mismatches? What are the nature of them? What's the implications? Again, go back post-COVID, that's when the wealth space took off. So the democratization of alternatives or private capital, which just to be clear, not against that. Some of the factory models that are out there have raised capital from the wealth channel in irresponsible ways. So first of all, in general, you're taking an illiquid asset and you're giving investors an ability to get their money back quarterly. They say semi-liquid, there's no semi-liquid. Okay, there's no such thing as semi-liquid. Anyone that's an investor that's been through a bunch of cycles, there's liquid and then there's illiquid because again, going back to the history of the wealth channel or individuals or retail, the one thing we know it's very post-COVID. We're in a pro-cycle environment. It's easy to raise money and when you're not and when there's problems or dislocation like there is today, they want their money back. So you basically had mismatching of illiquid assets and liabilities. So that's one part of it. The second thing is that they would raise these very narrow. What I mean by narrow is it's just direct lending. So it's not like you can invest in direct lending and real estate and infrastructure and asset-based finance. No, no, it's just very narrow, just direct lending or just asset-based finance or just this straight. That's a narrow strategy. And maybe that's okay if you raise the right amount of capital, but if you raise an unlimited amount of capital where your investing is dictated, not on good investments in the market, but basically dictated by how much money you can raise. There's never a governor on how much money to raise. And the thing about these wealth vehicles, when they raise it, they have to invest it right away. We call it inflow investing. They have to invest it wide away. So they raise as much money as they can. And if they don't invest it right away, it dilutes the return of that vehicle. To ground this in actual reality as much as possible. We've talked about all these guardrails, all these incentives, the three problems, all this stuff where the system structure begins to determine fate. What is fate? What is actually happening today? What's happening today is there are these vehicles called perpetual private BDCs. These have been raised in the wealth channel. So individuals, wealthy, massive one, they've been raised. And again, in some cases, not all cases, in very narrow strategies, so just direct lending or just private equity. And really the catalyst was software in AI. And also some of the market volatility, but started to question the quality of their portfolio. Or it could have just been market volatility because of what's going on outside of this, where people want their money back. There's a limit on how much money people can ask for. And basically a lot of in the perpetual private BDC space, the amount of money people have asked for has exceeded what is the 5% limit. And that's creating all the noise that you're reading about. What's the range of so what's here? I can imagine once a what is like, tough shit, you can't have your money back, and the world keeps spinning. Another is something dangerous and scary and systemic because past financial crises have tended to be downstream of some domino, you know, like private BDCs or whatever it is. Each time it's different. What do you think the range of implications of all this is? I don't think this is a systemic issue yet for two reasons. One, we're only five years into this. So it's early. And the second thing, at least for now, there's a pretty strong economic backdrop. There's definitely risk to it. So I don't think this is systemic. It could turn out that way, but that's actually not what I think is going to happen. I do think there needs to be a major recalibration of behaviors in the way that people approach this well channel, because if you go back to what we talked about earlier, anytime society or finance system puts wealth or retail individuals next to principal risk taping, if you look throughout history, that's where problems start to happen. Most of it's been with commercial banks because that's been the primary pillar of the finance system. But now with this new pillar and private capital, it's starting to touch risk capital and it's starting to become more asset liability mismatched. But when you look at the quantum of the problem, as at least as specifically relates to this, it's pretty small in the green scheme of things. So what's going on is in private markets in the wealth channel, very small allocations to private investments historically, 1%, 2%. And that channel is smart. They see that value creation and returns are happening without them in private markets. They want access to it. Seems fair. That 2% is expected to go wherever, 10% plus percent in the decade to come. So I guess the question is, how can we do it responsibly? If you are going to raise a narrow strategy just directly or just privately, you need to govern the amount of inflows that come in. So sometimes you just say, no, maybe you have a waiting list. But again, because flows come in in pro cyclical times, if you only have a $100 million vehicle, maybe it's always a good time to invest. But if you have a much larger view, it just gets really hard because maybe it's a good time to invest. Maybe it's not. And that's why I think where this will go responsibly, I think you're going to have to have very wide apertures because ultimately in every ecosystem, whether it's direct lending or private equity or real estate or infrastructure, they go through supply demand dynamics. Sometimes there's supply of capital is really high and demand is low. That's probably not a good time to invest. And sometimes demand of capital is really high and supply of capital is really low. Again, not certainly, but probably a pretty good time to invest. And it oscillates within each ecosystem all the time. So I just think you want a wide aperture. But if you're going to do that, you can't just all of a sudden show up, which is probably what's going to happen after this week. Everyone's going to show up and say, oh, I'm a multi-strategy private capital fund. I'm going to do whatever. Well, yeah, you got to be able to do it. But you also got to have the capabilities to be able to do that. And there's a number of people that do, but you can't just all of a sudden do it. It's like a style of investing. And I think those are the key attributes that will make up responsible investing. But I think the biggest thing is just being very upfront. When you want your money back, you have to assume it's a 2008 crisis, 1929. And if you're comfortable keeping it invested, then you're probably suitable investor. You said before that maybe system three could be like the Goldilocks scenario. I was always interested in around financial crises, moral hazard as a topic, and the socialization or spreading of this risk that one person takes to make more money and they'll be bailed out or something like this. It seems like this mismatch, this asset liability mismatch, is something that in the current system, maybe it's cyclical and it waxes and wanes, but selfish people are going to take advantage of the ability to raise more money forever unless the responsibility is mandated or regulated or more clearly laid out. You think we have some evolution still to do to create the Goldilocks scenario? I think that's what really needs to be thought about. I think that's going to happen as part of this recalibration process, but that is a much better outcome. There can be good legislation, but there's a risk that it's not the right guardrail and it's not good for competitiveness and it creates like the next crisis. The best answer is a market mechanism like you have within institutional investors where if you do irresponsible things or you're not a good investor, if you change your business model, they're going to punish you by not giving you money for your next fund. If I turn all of this into ideas or guidelines for people running investment firms or who want to launch an investment firm or something, what are the right principles to take away? Obviously, one is keep your liabilities and your assets well matched. That's a major one that anyone can do and maybe you have to work a little harder to raise money, but you'll be thankful for it. A second is maintain an underwriting standard that's extraordinary or however you want to define it. Any other major advice that you give to people running investment firms or just principles you have for building Sixth Street that flow from all this history and thinking? First, what's your clarity of purpose? What's your day one clarity of purpose? Is that say, consistent over time? Is your clarity of purpose to raise a bunch of liabilities or is it to drive good returns for investors? Maybe it's both. Maybe you can do that. Maybe some firms can do that, but what is your clarity of purpose? This is something we talk a lot about at Sixth Street is that if you look at all the great companies that have been around for a long time, they got one thing right is they never forgot what their purpose was, which is to serve their customers. It's enticing to raise a bunch of money. It's enticing once you raise it to a best lot of money. That doesn't mean that you have to do it. Sixth Street, we're multi-strategy, private capital firm. We do a bunch of things. One of the things we do is direct lending. We have one of the best track records. We've been here longer than in direct lending. I started the direct lending business in 2001 when there was only two of us. We've watched this and we could have gone to the wealth channel and raised all the same vehicles because of our track record. We have how many dollars of perpetual private BDCs we have? Exactly zero. It's not that we couldn't have. We just didn't think it was the right thing and we didn't think it was consistent with our clarity of purpose. That's why we didn't do it. It's easy to get FOMO. I just think you just got to block out that noise. It always comes back to first principles of clarity of purpose, what are your values? If you say consistent with that, judging by the best companies that have been around for a long time, that's your pathway to building a great company that's going to be here for a long time, not short-termism. Again, back to the news cycle. There's this thing of firms that manage lots of private credit strategies, SMA exposure, et cetera. Some of their stock prices are really hurting. We've talked about all the reasons, ad nauseam for the mismatch, et cetera. What do you think happens in private credit land? I think in hope that this is going to be a recalibration. People are going to re-adopt a more prudent underwriting. I think people in the industry will change behaviors. By the way, in some cases, the market will change their behaviors because you may not be able to raise more capital. The market mechanism, I think, will work. This is a hopeful, I think it'll stabilize. Hopefully, the best thing about the current moment is that this happened not in a deeper session. It happened when the economy was pretty relatively helpful. There's definitely risk out there to be worried about, but this would be much different. If you think about redemptions on a lot of these wealth vehicles, if it were a distressed environment, the redemptions would be 2, 3x what they are. To me, this is a gift to the industry to recalibrate. There's a lot of smart people in our industry, a lot of great investors. I think the industry will recalibrate. Then, if you think stepping back for the American financial system, commercial banks, you could have a really powerful system supporting economic growth with commercial banks providing one pillar, safer, good guardrails, and private capital providing the risk capital. That's a pretty good system. I think if we get that right, it's really going to set up America to be really optimized economic growth. That's what I'm hopeful about. Your finance team isn't losing money on big mistakes. It's leaking through a thousand tiny decisions nobody's watching. Ramp puts guardrails on spending before it happens. Real-time limits, automatic rules, zero firefighting. Try it at ramp.com. As your business grows, Vanta scales with you, automating compliance and giving you a single source of truth for security and risk. Learn more at Vanta.com. Every investment firm is unique and generic AI doesn't understand your process. Rogo does. It's an AI platform built specifically for Wall Street connected to your data, understanding your process, and producing real outputs. Check them out at rogo.ai. The best AI and software companies from open AI to cursor to perplexity use WorkOS to become enterprise ready overnight, not in months. Visit workos.com to skip the unglamorous infrastructure work and focus on your product. Ridgeline is redefining asset management technology as a true partner, not just a software vendor. They've helped firms 5x in scale, enabling faster growth, smarter operations, and a competitive edge. Visit ridgelineapps.com to see what they can unlock for your firm. You alluded to AI and software being one of the early dominoes that got this whole discussion rolling and people's redemptions and reactions and things. It seems like if you think about creative destruction as a force driving the U.S. experiment since its inception, talk about facing a tiger. We are facing a hardcore period of creative destruction. How do you think about that? Given the open wide mandate of 6th Street, your ability to go put your capital and your customers' capital in so many different places, just talk to you like the opportunity set today. Of course, I want to hear what you think about AI and software. I can't help myself. This just feels like such a time to be alive, but also opportunity and danger. There's lots of opportunity on me. I live on the LLMs. I play with them. Actually, my wife makes fun of me because I'm constantly playing with my friend Claude or my friend Chat Jim and I. I'm not your friend, Rock. I actually play with them all because I like to ask them the same question to see how they answer it differently and just try to get a feel for it. But big believer on the productivity opportunity, there's a lot of good with it, but there's definitely risk on the transition. You mentioned software. That was one of the catalysts that got us into the current moment, but everyone's so focused on software. I think having lived in Silicon Valley, I know you spend a lot of time there. This is not just software. This is every industry because once one company in any industry figures out how to actually use it as a tool and really figures out how to use your agentic capabilities and drive higher margins, if you're one of the companies that's a slow adopter and you're not active, you're going to have some of the same problems that people perceive the overall software industry to have today. It's not just software. It's across everything. But look, one of the best things about the American project is crave destruction because it allows for prudent allocation of capital to the right places that are going to drive the right outcomes. If you think about the unfolding set of opportunities that it creates, one of the categories that you and I always talk about that I'm so interested in is one's own development. And the highly adaptable people seem like they're going to be set up for lots of success in this environment. How do you think about your team? And I know you have a team that's a very long tenure that tends to be at 6th Street for a career. How do you think about their development and new things that you can do as the leader to make sure that they are all dynamic as things change really fast? I know you're playing with the LLMs all the time, but this is an important part of your job, your team. How are you thinking about it? When we hire someone, we're looking for a lot of things. But two of the things that we're looking for, are they an open architecture person? Can they play tennis, what we call playing tennis, bounce different ideas even when you disagree with someone? And the second thing is, are they a learner? Surprisingly, we track all the AI usage on the LLM models. Our usage across our entire firm is off the charts. One, because of the types of people we hire, but I just think in general, in stepping away from 6th Street, is that if you're not adaptive in this environment and you're not a learner, you're literally committed to learning every day and improving yourself every day, you have the risk of getting lost in what's happening and about to happen in a more accentuated way. I have an off the wall one for you. It's been deeply impactful on me. Can you explain this paper one sheet system for how you get everything done and track what you do? I actually did a presentation to our entire firm on personal organization systems because I think as an investor, as a business person, the scariest thing you have is time. And one of the most important skill sets is your dynamic prioritization of that time on the highest impact things. So we always talk about return on time. And what my personal organization system does, I call it the brain, is I literally try to get the way my brain is structured on one sheet of paper. So all my important priorities, people, businesses, investment themes, I mean, it changes over time based on what's needed for me because my job changes every year because I have to evolve. I try to get my brain on paper and it allows me to dynamically prioritize where the highest return on my time is. That's number one. And the second thing it allows me to do is I capture so that I never have loose ends. I try to always follow up on everything, be proactive about things. I just think proactive is a key thing. It's very clear what my top five strategic priorities, all the tactical stuff, and I'm constantly looking at it, updating it. I do it all by hand because for me, I have to actually put pen on paper. Once my sheet fills up of all my tactical stuff, the small stuff I have to do, I start a new sheet, and then I write literally all it takes me like an hour. I generally do it on a Sunday. And there's never a time I actually go through that process on a Sunday where I don't connect two or three dots or think of a new idea. That's my left brain. And that's why on the second sheet, which I can't remember if I should, Yeah, we did the right brain, right? And then on my right brain sheet, which is the second page, which is all my creative ideas, themes, business building ideas, people, better leadership, just whatever comes to mind, thinking about the current moment, I literally start thinking about why are we here? How do we get here? That's kind of how I started to really dive into history. And I just write stuff down and I track it. And I've done that for 25 years. So I have all my right brain thoughts over 25 years. And what happens is I'll go back and I'll look at them every year at the end of the year, I go back and read all my right brain thoughts. And sometimes there are ideas that I had from 10 years ago, from 15 years ago, that surfaced today and become relevant today. So I try to get my left brain on the first page, my right brain, the second, and then I try to get them working together. And again, it just helps me see things I want is just a clear thinking on so I can try to see the world not only for what it looks like today, what it's been, but also where it might go and how can six trees be part of that? One of the things that stuck out to me seeing the actual sheet, I'm thinking about the left brain sheet where there's different boxes. I'm curious what the different boxes are. And one of the things that I found very powerful was that one of the segments is a list of people to call. It was a crazy list. It was like a shitload of people and then like tons of strikeouts. And when you run out of space, you then copy it to another page, but you also copy over all the stuff that is lower turnover, I guess I would call it. And that act is like a big part of just embedding it in your brain. The process of that. So looking at it as part of it, but the best ideas come out of actually the process when I'm writing it all down. Physically writing. So what are the other segments of that first page? There's a list of people to call. There's like five or six boxes. I can't remember what they are. What are those boxes? I think I told this last time we have everyone affirmed our personal business plan. My personal business plan at the end of the year I've done for 25, 30 years. It takes me three weeks to do my personal business plan. And that's why I said the last time we spent all this time evaluating companies. Do they have a business plan or not? And then most people do you have a business plan for yourself? They don't have one. That's why we make everyone in our firm do personal business plans. But from that personal business plan I do at the end of the year, I get a lot of clarity just from reading, going back to stuff I wrote. What are my top five priorities of how I can drive the most impact to our firm, our investors? What are the absolute complete clarity on what those five things are? And I have a box for each of those five things. So that's five boxes on each of those things. Then I have high priorities because again those have different cadence to them. Everything has a different cadence which is why I think you have to see everything together. The boxes on the page change every year. Just like our themes every year change. Everything has to change every year because it goes back to adapting because the world's always changing so quickly. If you're not adapting yourself then you're going to get lost in this world. So I'll have my five strategic priorities of my time. I'll have people I really want to focus on this could be internal, external. I also have on there my health because despite drinking this I think about it because I actually think I have to be healthy to be able to do my job. What would be an example of something that gets written down in health? I've got on there Vitamin D. I'm very focused on Vitamin D. I've got my left hip. I had an old soccer injury so I'm focused on left hip mobility. But it's something you just see every day. I see it every day. Yeah, everything. Like there's different things. It's also the personal side so I keep balanced. It is an intention system but it's also a return on time system and an ability to dynamically prioritize. He talked to younger people who are just coming up through the business even some older people still don't have to prioritize their time. It's really hard to do because literally you could spend all your time on one thing. So how to manage the time and just being able to see that in your brain or in the matrix that's kind of I think about it. Another thing that the last time we talked really stuck in my head was I just turned 40 and we were talking about the opportunity you have from age 40 to 50 which got me wondering about 20 to 30 and 30 to 40. If you think back on the major eras of building and managing a life's work in a career tied to specific ages, what have you learned? 20 to 30 for me was education, learning just as much as I could, asking as many dumb questions as possible. 23 you think you know stuff but if you haven't been through cycles or made a lot of mistakes and seen other people make mistakes and see people make good decisions and good long-term decisions and short-term decisions, you don't really know anything from your 20 to 30. 30 to 40 you're incredibly ambitious, you're still learning but you're trying to prove yourself. I started 6th Street with my partners when I was 33 or 34 so I didn't know what I didn't know. I mean I knew a lot but it's like you're going through that but you haven't made enough mistakes yet to like refine everything and you get to 40 or 50 and 40 or 50 it's like if you've spent time learning, again, continue to learn, you've made enough mistakes, you really know who you are at that point, know who you are as an investor and how you approach things, it's prime time. You get to 50 and then you're trying to really focus on being a mentor, developing the next generation and just trying to provide that voice in the room, not only in terms of investing but also leadership, management and really just trying to be a teacher to your team but also a warner because I still warn a lot from them but 40 to 50, that's go time. In go time, one of the questions that I've been asking everybody because I'm just selfishly curious about it at this age feels like the right time to ask is around the measurement of success. Kevin Kelly, one of the founders of Wired Magazine has this amazing idea which is like your success definition should be extremely bespoke to you. Traditional measures of success are traps, money, power, fame, etc. And I heard a founder recently say something like he measures success through the degree of radical self-respect. Success means complete self-respect and obviously that then means lots of other things but I'm so curious how if I'm going into prime time or something, I don't want to waste that. So the objective function of prime time needs to be success. That's good wisdom. Let's hit the mistake that people fall into is this whole idea of money, fame, fortune. Once you start to prioritize that, that's a cup that will never get filled. Keep trying to fill the cup and the cup keeps getting bigger and bigger. That cup never gets full. So I think that's one of the problems I think people make in our industry is that they think the cup, even people say oh it's easy for you to say where you are now. This is something my dad taught me when I was 10 years old. So this is not new. It was never the thing. For me it's like I just want to do great things, be excellent and do it with great people that share my values and do things the right way. That's on the business side and I want to do all that in a way and be excellent. Not competing against anyone else, competing against ourselves, but do show in a way where on the best dad, the best husband and it's getting one without the other. I just think you're going to be eight years old. You're looking at your mirror and what was the purpose of life. There's no purpose. The purpose of life for me and again it's certainly not about the cup. That's definitely never been it. It's about all those relationships you form and those experiences you go through with people. When you're 80, 85 years old you're looking back. Hopefully I'm healthy because I looked at my sheet a lot of times and it's those relationships and those experiences that I think drive to a fulfilled life and obviously it starts with your family but I have a lot of Hawaiian friends, your hui. The hui is the term for your group, your posi. Having those experiences of climbing up the mountain together and that's to me what it's all about. If you are around the right people, you have the clarity of purpose, you have the right values, you have the right culture and you're going up the mountain together, it's so fun. You never have to question first principles, how you're going to do business, trying to do the right way and it's what we call clean living. Again, doing that at the expense of not spending time with your family, I think that would be pretty unfulfilling to me. Last time I got to asking my traditional closing questions, I have to come up with a new one this time. One of my favorite things from our first discussion, when you sent us the visual which I love is the concept of facing the tiger. Maybe you can remind us what that means. I thought you were kidding in the conversation but like literally off the elevator is a giant tiger in your office which is so funny. I like the principle a lot but I'm also curious what it means to apply that principle for you and Sixth Street today in this fascinating dynamic environment. Face the Tiger, it's one of the core ethos of Sixth Street which is there's hard things in this world. We're going to make mistakes, we're going to have problems but when those problems happen instead of pointing fingers, we have just a saying from day one of our firm is that we look at the problems head on, we look at them together and we don't run from them, we run to them, we run right at them and that's what Face the Tiger is. For the environment we're in and this is what I told our entire firm is that we're in a world that the pace of change is rapidly accelerating and if you think the pace of change is accelerated now it's going to just continue and it continues accelerating which is why by the way from an investing standpoint going back to what we said earlier the idea that you're going to have a narrow investment strategy when the world is changing so much you're going to have oscillating supply-demand dynamics of good time, bad time, like it's just crazy to raise our too narrow strategy unless you put a governor on the mount of capital raises. But I think the biggest thing when you look at the human being is human beings in general don't change. There are small percentage that thrive in chaos and love it and step up like Michael Jordan, he love chaos, his heart rate's low and hit a game-winning shot but most human beings don't like change and as we start to go through this pace of change there's obviously a lot of anxiety, is AI, is it going to take my job, is it not? And our whole thing is you can sit there and be anxious about things or worry about things and be like hey this is what it is, the world's changing, we got to face the tiger, it's going to change whether we like it or not, it's going to happen. Yeah there's stuff from AI but what are you going to do about it? And that's what we say to people, it's like look we got to face the tiger and just remember you get one life, do you want to be average or do you want to be excellent and that's how we talk to our people. You keep talking about it enough and they get in the right headspace so when change happens or their disruption or something goes wrong they've got the tool that they can use, let's say face the tiger to be able to approach it and we try to just get that in our firm. I think I said this last time when problems happen we're like good let's go, game time, let's go and that's the way we've been since day one and I think to some extent the way we are as people. I wish I could do this with you every year, I hope we do. Thank you so much for your time. Thank you so much Patrick, appreciate it. Your finance team isn't losing money on big mistakes, it's leaking through a thousand tiny decisions nobody's watching. Ramp puts guardrails on spending before it happens, real-time limits, automatic rules, zero firefighting. Try it at ramp.com slash invest. As your business grows, Vanta scales with you, automating compliance and giving you a single source of truth for security and risk. Learn more at vanta.com slash invest. Ridgeline is redefining asset management technology as a true partner, not just a software vendor. They've helped firms 5x in scale, enabling faster growth, smarter operations and a competitive edge. Visit ridgelineapps.com to see what they can unlock through your firm. Every investment firm is unique and generic AI doesn't understand your process. Rogo does, it's an AI platform built specifically for Wall Street connected to your data, understanding your process and producing real outputs. Check them out at rogo.ai slash invest. The best AI and software companies from open AI to cursor to perplexity use WorkOS to become enterprise ready overnight, not in months. Visit workos.com to skip the unglamorous infrastructure work and focus on your product.