Michael Leffell – Opening Doors to Niche Private Opportunities at 10 East (EP.373)

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2:31Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators .com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

3:11Clients of capital allocators or podcast guests may maintain positions and securities discussed on this podcast. My guest on today's show is Michael LaFell, the managing member of Portage Partners, chairman of Canoe Intelligence, and founder and chairman of 10 East, an investment platform for sophisticated investors to access private markets by co -investing alongside Michael and his team. Michael was former deputy executive managing member of Davidson Kempner, where he spent 21 years before retiring in 2010. He formed a family office shortly thereafter and developed Portage, Canoe, and 10 East out of his investing activities.

3:53Our conversation covers Michael's professional investment career, personal investing following his retirement, and businesses created from those activities. And a little disclaimer's in order. I've known Michael for about a decade, and after becoming impressed by the quality of tennis offerings, its research process, and high -quality investment team, I became an advisor to the organization and an investor in multiple offerings. Before we get going, I doubt you remember the 1996 movie starring John Travolta called Michael. His character is an archangel sent to Earth to mend wounded hearts. I don't remember much about the movie, nor should you, as I don't think it was all that great.

4:35But I do remember one line when Travolta's questioned about his angelic status while smoking a cigarette. He replies, I'm not that kind of angel. Now, we've had a particularly good run of guests on the show of late, and you might have noticed an unusual trend. Three of the last four Monday guests are all named Michael, and all four subjects are Michael's. First, Mobison, then two on Milken, and now LaFell. All three legends in the business, all three with incredible experience and wisdom to share, and all three with a first name in common. We all recognize there's a diversity issue in the industry, and usually that refers to a lack of women.

5:15And we also think about ethnic and racial diversity. But this might be the first time we've suffered a lack of cognitive diversity across similar -minded parents when it came time to signing their children's birth certificates. In other words, it's not that kind of diversity issue. We typically release our shows in the order we record, so this scheduling falls completely on me. Thanks so much for spreading the word about the abundance of Michaels on capital allocators. And by the way, so as not to gloss over the real issues of diversity, we featured women on 72 of the 477 release shows on our platform, or 15 % of the total.

5:56It's not a high number, but my hunch is it's in line or above the industry representation. And with that, please enjoy my conversation with Michael LaFell. Michael, thanks so much for joining me. That's a great pleasure. Thank you for having me. Why don't you take me all the way back to your upbringing? That's going back quite a ways. I grew up in Montreal. My father was a congregational rabbi. Growing up in Quebec in the 60s and 70s was interesting, highlighted particularly by what's going on today, since there was pretty significant anti -Semitism from the Roman Catholic Church at the time. That wasn't a driving factor for us.

6:37In the late 60s and early 70s, the Separatist Party began to emerge in Quebec, which wanted to separate Quebec from the rest of Canada. That one time, that resulted in some terrorist kidnappings and the imposition by Prime Minister Pierre Trudeau of the martial law in Montreal and Quebec. So at a time, there were tanks and soldiers stationed all over Montreal. In any event, it became obvious, certainly by 1976 and 77, that if French was not your native language, your career opportunities in Quebec would be limited. So my brothers all went to university in the United States, as did I. And the transition going to the States from Canada was not that difficult.

7:23And quite frankly, coming from a day school, I was a little surprised at the light course load I had at university. It seemed easy at the time. Any conversations that we had at the table, aside from the Montreal Canadiens or Montreal Expos focused on ideas. There was not much discussion about gossip or people. It was idea drought. What type of ideas? A lot of politics, literature, history, things we were studying in school. I wouldn't say necessarily heavy, but topics of interest, and we'd have a constant stream of guests coming through the house who were guest lecturers. So there'd be people coming to discuss recent archaeological digs in Jerusalem.

8:05This would be late 60s and early 70s when Israel was still pretty young. And it was a different situation in society than it has become. We'd have chancellors of universities come and tell us what was going on in their schools. So it was a pretty dynamic environment. And as the youngest of four, I tended to listen more than speak. Of all those ideas that are around you, Do you remember any of them really capturing you back then? Not really, quite frankly. Although something must have triggered an interest in history for me, because as soon as I was ready to go off to college, it's the only thing I had interest in studying.

8:45So once you did that at school, how did you set out on what would become your professional career? After college, I went to law school. I got a job at a law firm. most interesting because I had interned for a smallish firm after my second year. I continued to work there during my third year. And toward the end of that year, probably in late April, the firm announced that they were bringing in a lateral litigator to run the litigation department. By that time, I had accepted an offer from them to return after graduation as a litigator. I went and introduced myself to this gentleman and he said, well, show me a resume and I'll see if we have room for you.

9:25So here I am about to graduate from law school, studying for finals, I had to worry about the bar exam, and I quickly decided I had to go find a job as well. So I had a plateful that month and I ended up finding a job with a firm called K. Scholar, where I practiced litigation for four years. What was your path from practicing litigation to investing? The first step was not enjoying being a litigator. I found it not very rewarding and the hours were brutal. By matter of serendipity, I was introduced to Marvin Davidson, who was running M .H. Davidson and Company at the time. I was told it was a hedge fund.

10:05I had no idea what a hedge fund was. I met Marvin and spent 45 minutes talking to him on the parlor level of a brownstone on East 63rd Street. He said they were interested in hiring somebody to invest in the financial instruments of distressed and troubled companies. I said, okay, that sounds interesting. And as I was leaving, he said, make sure to introduce yourself to Tommy, Tom Kempler, and don't let the grass grow under your feet. I met Tommy. We spoke. They guaranteed me the same salary I'd have made as a lawyer. We shook hands and that was it. What was the hedge fund back then? We had $20 million under management.

10:47I think I was the fifth professional and it was Tommy, Marvin, Steve, Scott, and then myself. They were doing merger arbitrage and Tommy was going to start doing some credit stuff, investing in distressed and bankrupt companies. I started there and I was given a telephone and a Quotron machine, not even a computer. The first assignment that Tommy asked me to do was to model out the five -year financials for the public service Company in New Hampshire, which was then in bankruptcy because of the Seabrook nuclear reactor. And I modeled it out with a Hewlett -Packard 19B2 and an accounting ledger.

11:27And the amazing lesson from that is when I look at a spreadsheet today, I actually understand what each cell means. And from that first project, what was the first big set of opportunities that you saw? So that would have been 1988 that I went there. And shortly thereafter, Drexel started to go bankrupt. And then we had the savings and loan crisis. So that created a bunch of unforced sellers of bank debt and bonds. So the first big opportunity we really transacted in that was new was buying bank debt. And bank debt did not historically trade. So these were one -off transactions. It was pretty much a small group of banks and funds that were doing it.

12:16I think Goldman Sachs, Oppenheimer & Company, Lehman Brothers, Bear Stearns, we were there. Randy Smith was there. Maybe Chuck Davidson was playing around at Steinhardt Partners a little bit. So we started buying bank debt. And then the real entertainment came and we had the opportunity to buy an unfunded revolver. Marvin had this thing. He would call you up to his office several times for the proponent of an investment to explain it. And you'd go over it and over it and over it. And he'd pick up any difference in the presentation and question you about it. So to try to explain to somebody that you were buying an unfunded revolver at 50 cents on the dollar and the seller is going to give you 50 cents.

12:59So forever unfunded, you just pocketed 50 cents was pretty entertaining. And we ended up doing it. But the lesson there was we were completely focused on what we were doing. We were buying senior and secure debt in bankrupt and troubled companies. The bankruptcy laws at the time entitled us to collect interest, either current or to accrue it. And if our analysis was correct, there was relatively modest risk of losing capital. The point there was to take those fundamental skills and gradually extend them into other areas. We weren't going off on adventures. We weren't going off in tangents. We were taking baby steps one at a time to extend what we did into newer areas.

13:41What was the competitive landscape like in the early years? I think back then there's probably more opportunities in capital chasing it. It was a club of people. There were people you'd want to invest alongside and there were people you would avoid. So there were some investors that I would never want to go into a transaction with. There were some types of companies or industries I'd never want to go into a transaction with. I was never really fond of gambling businesses because of issues about the licenses. We were very fond of utilities because they would always be needed. What are some of the key things you learned from Marvin?

14:20The first thing is always look for an advantage. edge. What kind of edge can you get in something? So in the early years, we would have someone stationed at the SEC. And when a company we were following filed something, this person or company would take it and fax it back to us. And we had those rolls of fax paper that if you didn't read it quickly enough, the print would disappear. So you can't get that edge anymore. Information is too quick and too free flowing, but that was a lawful edge we could get. So that's number one. The second thing was to always react to dynamics. When something changes, whether it is the legal background, the business itself, the personnel involved or delays, something is going on.

15:10So be sensitive to that and try to figure out what. Don't just pass it off and go on to the next investment opportunity. The third thing would be always commit things to writing. That was one of the early disciplines we took on because having something in writing creates accountability. There's no he said, she said. The analyst has committed something. You know what was said and when it was said. And if it proves out correct, great. If it proves out wrong, there's a lesson to be learned. And the final thing I think is to always take advantage of uncorrelated opportunities. So when you had the savings and loan crisis, banks became forced sellers of debt for regulatory reasons.

15:51They often didn't care what the price was. They had to get it off their books. We were the beneficiaries of that. We saw a similar situation recently when Silicon Valley Bank and Signature Bank went bust and the FDIC took over their books. The FDIC was selling it. They were giving it away at very, very advantageous prices. What was MH Davidson became Davidson Kempner and has been one of the longest standing funds through a few iterations of succession. And I'd love to hear what you saw in the dynamics of the organization that allowed it to continue to succeed as long as it has. DK just celebrated its 40th year.

16:34I think the key element there is hiring the right people, coaching them in the right way. There's a way of thinking about things. There's a way of being disciplined in what you do, being focused in what you do, being honest, transparent, logical. It's bad news first. Don't try to hide it. It's always going to come out. Accept it. Accepting responsibility for your actions and moving forward. There was not much second guessing when something went wrong. It's what lesson can I learn from this? There's always tomorrow. What were some of the ways you saw effective coaching of people on the team? I think just having to go up and explain an investment idea repeatedly is a way of coaching.

17:16It's not overt coaching, but it's a way of coaching. Tell me what you think. Tell me why you think it, why we should do it, how much capital we should commit. Then do it again. over time, you get to really know whether you have a good idea or not. The other big coaching thing here is never rush. When somebody is rushing you to make a decision, back then it was enough to say, I'm not doing it. And to this day, I won't do it. If somebody's rushing me that you have to act now on a new idea, say, what was tomorrow? Forget about it. I'm not that interested. There's millions of investment ideas out there.

17:52A little bit of a juxtaposition of two things you said. One is this idea of looking for the next opportunity. And then the other, sticking to what you know, how did you decide over the years what were appropriate things to move into that you hadn't been doing and which ones you wanted to avoid? The key element is something I said earlier, which is can we extend our core skill set into something different. So I think having been a credit guy for many years, more recently we decided to do some venture. That was not a natural extension of the skill sets. We had to think carefully about how we're going to do that.

18:29But to go from understanding balance sheets and credit to trying to identify direct investment opportunities, it's a similar skill that you're using. So DK is now on what its third generation of leadership. So after you had brought in and trained your people, how did you keep them around for so long? So I think the original structure at Davidson was created by Marvin and Tommy, and it was basically an old Wall Street partnership structure. In that respect, every partner in the firm did well if the firm did well and did poorly if the firm did poorly. And the hope there was that if merger arbitrage was having a gangbang year, then the guys in distress where I was would not glom onto capital for mediocre ideas.

19:21We would prefer to let the arbitrage guys make a killing because we would do well financially from that. So partners were incented for the firm to do well. And at the associate level, there was generally some sort of broad band of profits that would be used to compensate the associates. Associates who were outstanding would get paid more. Associates who were less outstanding would get paid less. And associates who were even less outstanding would get paid materially less. To my knowledge, the structure has changed a little bit over time as there are now managing directors and other interim levels between associate and partner.

20:06And I think that there are some other incentives that are put in in terms of profit sharing and co -investment for the other levels. But at the end of the day, the focus was always to have all of the investment professionals be incented for the firm as a whole to do well. You decided to retire some time ago. What was the thought process that went into that? Well, there were two things. I guess first is a year or two before I retired, a very good friend of mine was taking the train from Westchester County to New York, to the city. He got to Grand Central Terminal, felt pain in his left chest, got back on the train, went back to White Plains and was rushed to the hospital with a heart attack.

20:48And that just reinforced for me that life changes on a dime. And what is the good of having a fair measure of success and not having the time to really enjoy it and use it when things can just turn on you right away. So that was part of it. Another part of it was I wanted to have more control over my time. There were other things I was interested in doing. And if you're in a partnership, I believe you have to be 100 % in or not there. And if you're not 100 % in, you're not doing your partners a favor and you're not doing yourself a favor. So I discussed with my partners, they had asked me to stay on for a year beyond my original target to make for an orderly transition.

21:34And it went very smoothly, I'm happy to say. And it gave me the opportunity to spend more time with my children, to really delve into some reading that I had not focused on for years and to develop my philanthropy in a more meaningful way. The biggest concern I had when I decided to step back was intellectual engagement. At a firm like Davidson, I don't know how many people we had there at the time, probably 100 or so. And each one of them was incredibly smart and talented. They kept each other and be on my toes. And I knew that if I stepped back, I'd have to replicate that somehow because I didn't want to go and play golf six days a week.

22:18Once you stepped away and you'd had some success, you now have your own balance sheet. How did you think about investing your capital on your own? I began to look at ways to broaden my own portfolio. And I began to think about where could I find inefficiencies? Where would there be room to create an edge? And by I mean a serious edge. And that arena was obviously in the private markets. In those markets, we see mispricing and information asymmetry. Now, of course, you have to be on the right side of that. And that's something we spend a lot of time trying to assure we are. To create a vehicle for finding those investment opportunities, I started what originated as my family office.

23:07It was called Portage Partners. The original idea was to create a nimble vehicle that could compound my personal capital through cycles. I want it to be diversified. I want it to be flexible. So when we look at the private markets, some of the large investors are geared to certain strategies that incentivize them to write huge tickets, irrespective of the market environment. In a way, that's indiscriminate capital deployment, which is really a big no -no in investing. It's something to avoid. Over time, we had some other investors come into the fold, and they were pretty shrewd guys who liked our model, who had all made money on their own in the markets.

23:54Each of these individuals added significant value to us, and we call them partners. Today, we have a thesis -driven focus on capacity -constrained niche exposures across all sorts of private markets. We opportunistically invest across all sectors, vehicles, but it is usually under a particular theme that unifies the investment. Some of these themes we have focused on in the past, for example, would be cybersecurity, onshoring of production and manufacturing, logistics, and multifamily real estate. Every time we extend our tentacles into something new, we do it very gradually. We take baby steps to make sure we understand the area and gradually get more aggressive.

24:44The fundamental strategy is to bring institutional quality diligence to mid -market opportunities where we believe we can generate outsized returns. Over the last 12 years, I guess that has proved to be the case. What are your favorite types of investments? Someone who's an uneconomic seller and something that interests me. So when banks are selling because the regulators tell them they have to get stuff off their balance sheets, that's heaven. But they have to sell, so they're going to take a price. And I really like that kind of opportunity. Whether it's banks or fund selling, we're going to see opportunities where venture capital and private equity funds are winding down.

25:28They're at their 10 -year limit. Maybe they can get another year. They're going to have to sell things. So hopefully we can be in a position to take advantage of that. How do you conduct diligence when you're on your own? The diligence comes in several very interesting aspects. First, you must diligence the sponsor who's bringing the idea to you. You want to do background checks on them, validate their honesty, their integrity, their transparency. You want to get a sense of whether they are good investors, what's the quality of their diligence. and to do this, the team meets with a sponsor several times and before we actually make an investment, I have a face -to -face meeting with them.

26:15Then we would also diligence the specifics of the idea, the thesis of the idea. Is it something that makes sense to us? Is it in a geographic area that we understand? So if somebody brings us an opportunity in Spain, I'm less likely to jump on it than if somebody brings us an opportunity to redevelop garden apartments in South Carolina. It all drives down to who's bringing the idea and what's the nature of the thesis behind it. If we can get comfortable with those two things, then I will often do a test transaction with the sponsor to validate how they work and how we work with them. Is their reporting good?

26:57Are they responsive to our questions, do they talk to us? You would be surprised at the number of sponsors who, once they get your money as an investor, don't really want to pick up the phone. And we would be remiss to put our investors and our partners in a situation where a sponsor doesn't want to speak with us. Once the investment is made, there's ongoing work in monitoring it that requires quarterly calls or biannual calls with the sponsor, following up on the performance. Does the performance that's being reported track with the performance that they had underwritten? If not, why not? If so, why is it doing as well or better than expected?

27:41If there's a problem, how are they working on it? How are they working it out? It's mostly when there's a problem that we get really involved and start pushing the sponsor to force a resolution. How do potential investments fall off your radar in the process? There's about five or six things that are really important to understand whether something's a no go. First off, if we're looking at a sponsor and there's two partners and they've never worked together before, that's something I'm always apprehensive about. I think that one of them will not be there in six months, and I don't want that institutional risk.