E432: $24 Billion Investor on Private Credit, the Psychology of Winning & Fear of Failure

0:00Monroe Capital has grown to$24 billion firm, deploying$10 billion a year. But when you started in 2001, it was a completely different market. What made you want to enter private credit? Excellent question. So my background is accounting and finance and law. I practiced law for about 14 years. I did M &A and bank financing law, mostly for private equity transactions. And what I noticed is that throughout my career, we worked with banks on transactions. Banks were relatively inflexible in terms of their financing because they had regulations and they had certain ways they had to do deals. The only two non-banks that existed at that time were GE Capital and Heller Financial.

0:44And they weren't regulated, so they could structure deals in all kinds of more creative ways and customize transactions for companies. but they were doing larger deals. There was nobody really doing lower middle market or smaller deals in a non-bank format. So I thought that as opposed to working 24-7 and building hours as a lawyer, that I could take what I learned as a lawyer, take what I learned representing PE funds and banks, and apply that to transactional finance and do it the way GE, Capital, and Heller Financial were doing it in a way that was more user-friendly for smaller companies, more Main Street America.

1:27And I started Monroe in 2001 and I managed to recruit three guys that were excellent bankers. One was a credit guy, one was an origination person, one was an underwriter that joined me in this new venture. They were each making$100 ,000 a year and they had families and they were a little reticent to do it, but I convinced them that we were going to be successful and this was going to be the new form of finance as the future unfolded. I'm so curious because not that much innovation is done in the financial markets. What made you so confident that you were on the cusp of a new asset class? I didn't.

2:10I just was tired and burnt out being a lawyer and I wanted to build something. I'm an entrepreneur at heart, and I'm a business builder. And I thought that if I could get a clean shot at building a banking product, a finance product, the good news is banking's been around forever. Transaction finance was being done by banks. And I was confident that if I could come in and do the same type of financing, but with less rules and providing more creativity that we could build a business. Now, at the end of the day, I didn't know how big of a business we could build. I thought we could build a business.

2:48We could put a couple hundred million dollars, three, four hundred million dollars to work, and it would be a success. So what happened is that I got into it and I realized that there was a much bigger market here than I had anticipated and that I had to realign my thinking into how to build a business as opposed to just do deals. And your original goal was three, 400 million today. As I mentioned, you have 24 billion deployed. What gets you up every day to keep on building the business bigger and bigger? Another good question. I think part of that is being an entrepreneur and part of that is being afraid to fail.

3:31Every day I get up and I think about how we can grow the business, what we can do, what new areas we can get into. I was always a competitive ball player. I was a basketball guy. If I didn't do this, my first goal was to be a professional basketball player. That didn't quite work out the way I wanted. So I had to default into my next goal, which was accounting and finance. So it's the competitive spirit. It's about winning. It's not about dollars. It's not about numbers. I keep telling people that the way to be successful in whatever career that you want to pursue is not by being satisfied. It's always by moving the goalposts out.

4:14Once you have an achievement, don't rest on your achievement. Don't rest on your laurels. Don't read the newspaper clippings. One of my favorite analogies is I'm a sports guy. I'm a big basketball guy. Michael Jordan was a Chicago guy. He played basketball in Chicago, probably the greatest athlete, the greatest basketball player ever. He never read the newspapers. Every week, every day, people would write all these great superlatives about him. They said he was the greatest. He did this, he did that. And he just went out every game and won. And he went out and he worked hard and he practiced hard and he performed.

4:51And that's what I tell my people that's what I tell mentors my mentees when I speak to a lot of trade organizations I say don't focus on your accomplishments focus on the work that you've done the effort you put in to get there and then to keep moving your goals because if you keep moving your goals you'll continue to strive and achieve if you don't do that you're never going to get to the next layer you're never going to get to the next level of achievement many of your peers many of which I've gotten to know as well, these business builders and finance, many of them are billionaires. They all say the same thing, which is, I love the competitiveness.

5:31I love to compete. Do you think when they say that they mean that they like to self-actualize or do they like to beat others? Where's that competitiveness really coming from? I think it's more self-actualization. It's not so much beating others. You know, the real people that I look at that have been successful and that are role models, what I've tried to do is I've tried to lead from an organizational standpoint and drive change and drive efficiency. And what happens is that when you focus on others and compete, you want to beat somebody. You want to do something better than somebody else. And that's not a great motivation to build businesses.

6:19What I'm focused on and what I've always been focused on is I want to lead. I want others to compete with me. I want to create space and I want to build Monroe and let others compete with me. Let them try to figure out what we're doing. Let them figure out how to chase us. It's much more effective from an organizational standpoint if you instill that kind of mindset in your company and force people to drive and be as successful as they can within an organizational setting and then let others compete with you and don't focus on what other people are doing. We've never done that. This episode is presented by Juniper Square, the operations partner for private markets.

7:04there's this meme in the market about different sources of fuel when it comes to motivation have your sources of fuels changed or evolved over your career or have it always been about self actualization from the very beginning it's something within me i mean this is something that's innate i think in people some people have that desire to um to get up and go and attack and work and win. I think that's a special talent and a special gene because some days you don't want to do that. Sometimes life throws you curveballs. Sometimes you get stuck. And what I try to tell people is that every day is a different day.

7:49Get up, go at it. Whatever happened yesterday is yesterday. Don't read the news. Get out and look at the future and plot your course. and a lot of the entrepreneurs that you've had on your podcasts and that I've been lucky enough to interact with, they share that vision. It's not so much focus on failure. Everyone is afraid to fail, but in spite of that, they're willing to accept failure to get on to the next level, and I think you have to have that mindset as an entrepreneur and as a business leader that it's okay to fail. Failure doesn't determine who you are. What determines who you are is not getting up and trying again.

8:32You might be surprised by my reference, but I had Jake Paul probably a few hundred episodes ago, and I pressed him on this issue. We got to spend an entire day with him. He's just so driven. And I just was so curious about why he's now driven. Now he's starting a gaming company, a consumer packaging company. And he said he just loves playing games and winning games. And he thinks business is one of the most fun and most challenging games to play. Everybody's got their own motivation. I'm an entrepreneur. I want to win. I'm a competitor. I've been a competitor since I was four years old. I competed in soccer.

9:12I competed in basketball. I competed in baseball. I competed in football. and there's nothing like a team sport, but everybody has some inner drive that makes them different. You know, for me, you know, I can tell you that my father was a Holocaust survivor and he lost his two sisters. He lost his mother. He lost his father. He was alone at 13 years old in Poland and he was in four different concentration camps and he was liberated out of Dachau by the Allied army. And there were a thousand permutations of why he should not have lived. He's managed to survive in the most difficult circumstances anybody could ever imagine.

9:56And he made his way to Israel. He fought in the independence war in Israel. After the independence war of Israel, he came to the U.S. as a new minted immigrant. They sent him to Korea. And that's how he got a citizenship by fighting in Korea. So he came back to the U.S. and he had been through the first 24 years of his life, one of the worst possible experiences. I was the first one to go to college in my family. So I felt internally that I was driven to do something. I was driven to do something that he couldn't do, that nobody in my family could ever do or achieve before. So I had a fire burning.

10:36I didn't know this always at the time. I just competed as a kid like any other kid on the ball fields. But I had this fire that was burning inside of me that other people didn't have. And I wanted to drive a legacy for my father because he could never do what I was able to do. So I was carrying around this baggage for a long time until I finally kind of understood myself better as I got older, that I was different, that I had this drive that other people didn't have. And I think a lot of it was because of my background. And everybody's got something in their background that drives them in some way, shape, or form.

11:18And I think that the best business people can channel that drive and use that drive in a good way. Lots of people use adverse experiences in a bad way. And it debilitates people or it freezes people. I'm the opposite. I look at an adverse experience and I take that in and I use that. And I tell people this when I speak to a lot of the younger people that we work with that take whatever you can and turn that into fuel to make you do what you don't think you can do. And certainly in my case, I think that was part of it. It's so fascinating. I'm also the son of immigrants. My parents came here when I was four years old before I could really remember.

12:05They came here with$600. My mom worked two minimum wage jobs. I did feel this burden of executing and being excellent from the very beginning because of my parents' sacrifice. But it is interesting, the same people in the same situation can, their interpretation, I know it sounds trite, but how you interpret something. In many ways, me and my sister kind of interpreted the situation very differently. I interpreted it as a mandate, and I interpreted it as why I would be successful, and that this was this competitive advantage that I would have going forward versus my sister kind of took a different perspective to it.

12:43it's real. I've got two brothers and a sister as well, and we're all different. My brothers think I'm crazy for the level of effort, the work I do. We've got today offices in Seoul and Abu Dhabi and Sydney and London and Paris. I spend a week or so a year in each one of those offices. I spend a fair amount of time with our larger clients throughout the world, and they think I'm absolutely crazy for doing what I do. Different people, I guess it's just a different way to motivate and DNA. And I think what I tell people is use that however it is to motivate yourself to be better. Speaking of motivation, competitive advantage.

13:25When I look at the private credit market today, there's thousands of firms. I think when you started, there was a small handful, but today there's thousands of them. How does Monroe Capital differentiate itself in this market? That's another good question. There's 550 private credit firms today. Of that 550, 40 % have been around less than 10 years. Four of the 550 have been around for more than 20 years, which is a fascinating statistic. which means of the 550, less than 15 were around before the great financial crisis. So it's a relatively young industry. It's been the fastest growing asset class among private assets.

14:11It's a$2 trillion market today. It'll be a$5 trillion market in five years. everybody has gotten into it. Every big Wall Street asset manager, when I was going through my early days in my career, KKR, Carlisle, Apollo, Aries, those were private equity funds. Today, those businesses are two-thirds private credit. And it just shows from a market standpoint, the sheer amount of volume of credit in the marketplace. When I started my business, over 20 years ago, 24 years ago, 90 % of the financing for transactions for LBOs, for buyouts was done in the banking system. 10 % was done outside the banking system.

15:00To give you some perspective, David, today, 90 % of the financing for transactions and buyouts are done outside the banking system through private credit managers. 10 % are within the banking system, the regulated banking system. And the reason for that is the GFC. During the financial crisis, banks failed. They didn't fail because they had bad loans. They didn't fail because they had bad assets. Yeah, there was a subprime contagion. That was an issue. But that didn't tank banks. Tanked banks was liquidity challenges. And the liquidity challenges were that, at the time, banks were underwriting credit.

15:44So in other words, Apollo or Aries or Carlyle or KKR would go to the banks, they would do an acquisition, the banks would give them a commitment for$6 billion,$7 billion,$8 billion to finance a transaction. The banks never intended to hold that commitment. They intended to distribute it. So they were at origination and distribution. It was a fee income business at that time before the financial crisis. And what happened was it always worked. There was always pension funds, insurance companies, sovereign wealth funds, investors to buy that credit because it was paying higher than market rates. What happened during the financial crisis is all of a sudden the music stopped and it stopped within a 30-day period in late 2007.

16:30When that music stopped, these banks had tremendous amounts of commitments out to private equity funds that they couldn't fund because nobody was buying. And when nobody bought those, the government had to step in. And we created this thing called TARP at the time. And that provided liquidity to the banks. Government provided liquidity. The taxpayers provided liquidity under TARP. And that TARP money went to the banks so the banks could digest their commitments. Otherwise, banks would fail. I mean, we had a number of banks fail at the time. Wachovia Bank failed. Citibank failed. Wells Fargo almost failed.

17:10So the government came in and they protected the banks by giving them all this TARP money so that from a liquidity standpoint, they would survive. So what happened? The Fed, Congress, and everybody else that was a regulatory body said, we're never going to allow this to happen again. We're never going to allow taxpayers to have to bail out banks because of LBOs and all these private equity firms that were committing big dollars. So they passed a bunch of legislation and regulations that said, banks can't do this. We don't want banks to be in this business. We're going to put very high capital requirements on banks to do leverage buyout loans.

17:49We're going to put very low capital requirements to do accounts receivable financing, inventory, equipment, real estate financing, because those are good loans. We're going to put very high capital requirements, regulatory capital requirements on banks to do leverage buyouts, which are quote unquote bad loans. So what happened after the crisis? Exactly what the regulators thought would happen. All of that business went out of the banking system and it had to go somewhere. It went into the institutional market that was better able to digest that. And we needed asset managers to asset manage that because pension funds and insurance companies weren't set up to underwrite and to manage those loans.

18:31So asset managers got into the space. And slowly but surely from about 2010 to 2017, about five to seven years, we saw a tremendous influx of asset managers into private credit. And the big private equity firms said, look at all this capital flowing into the space. Let's get into the act as well. So we saw all the big asset managers get into it. And then private equity firms, we saw insurance companies, we saw worldwide asset management firms get into the space. And what's happened is that because more and more credit was being provided, the buyout business got bigger and bigger throughout the 2000 and from 2010 to 2020, we saw more and more credit available and it became the hottest and fastest growing private asset class.

19:27But it all came from the financial crisis where the regulators kind of changed the rules. I was there for seven years, six years before the financial crisis. So we had a little bit of an advantage. We had already built the business. We built our model. We knew what we wanted to do. We knew the market we wanted to play and I just stepped on the gas in 2010. And from 2010 to 2020, we grew our business at probably 25, 30 % a year, compounded. And there's no other industry or business that has done that. I laugh, I tell people, we're not a finance firm. We're a AI chip company. We're like NVIDIA. We've grown our business during that period of time.

20:10Now people laugh at me when I say that because the business has slowed a little bit, but it will continue to grow only because banks today are still burdened by a lot of the regulatory challenges from the financial crisis. You've said that there's only two ways to generate alpha in private credit. What are they? One is to make more money than the next guy. And the other way is to lose less money than the next guy. Private credit is a fixed income. Not making 2x, 3x, 5x your money. What we get paid to do is generate returns, safe, stable, consistent returns. Pension funds need that because every year pension funds have retirements.

20:53They have health and welfare benefits. They have member benefits. They need somewhere between 8 % to 9 % of their capital liquid, and it has to go out to members. Insurance companies write insurance policies on lives, probably average 40, 50 years. and they need to know that they have liquidity to pay out those insurance companies on an actuarial basis. Insurance companies need about 6 % a year to pay out. So if you look at that, insurance companies and pension funds, which make up the largest segment of the institutional investor segment throughout the world, they need a product and they need a product that provides consistent, stable returns, irrespective of inflation, deflation, recession, COVID, financial crisis, wars in the Middle East, wars in Europe, problems in Asia.

21:47And those institutional investors depend on those returns. The one place that there's been a consistent history of returns throughout all different economies, throughout all different interest rate environments, throughout all different pandemics has been private credit. And insurance companies and pension funds come to rely on that in making their own plans and in making their own allocations. So private credit has become an institutional staple for portfolios because of the return. So as that has continued to be dependent on, it's become a much more important asset class. and within the private credit universe, there's all kinds of private credit.

22:35There's upper market private credit. There's middle market private credit. There's lower middle market private credit. There's real estate private credit. There's venture debt private credit. There's specialty finance private credit. There's asset-backed finance private credit. And it's a very large universe. What we've tried to do at Monroe is find our space that we're really good at and build a moat around it. And we've focused on the lower middle market. We love the$35, $40 million EBITDA size companies and below. The reason why we love that is because Wall Street's not focused on it. Wall Street wants the bigger private credit.

23:13They want the larger companies, the upper middle market. The lower middle market is the largest segment of the U.S. population. 50 % of the workforce of the U.S. employment is in the lower middle market. It's Main Street America. There's 200 ,000 middle market companies in the U.S. It's a third of the GDP of the U.S. And we've focused on this market from the start. And what we've tried to do is build the biggest and best firm in that space. One thing I've learned from talking to hundreds of investors is that great investment firms aren't built on investment returns alone. The firms that endure are great at the things most people don't see.

23:54their operations, their relationship with LPs, and the quality of information they use to make decisions. And here's what AI has changed. Every firm now has access to the very same models, so the intelligence isn't the edge anymore. The edge is what you could feed it. A firm with its fund operations and data in one connected record can actually put AI to work. A firm running on disconnected systems simply can't. That's why thousands of GPs run their funds on Juniper Square. Juniper Square puts your fund operations, data and administration together in one connected record. That means less time managing disconnected systems and more time investing, working with LPs and building your firm.

24:33This episode is brought to you by Juniper Square, the operations partner for private market GPs. Learn more at junipersquare.com slash how I invest. That's junipersquare.com slash how I invest. The best conferences do two things well. The content challenges how you think, and the people in the seats are the ones whose opinions actually move markets. Alpha Summit is AlphaSense's annual user conference, and it's built around both. Join me at the Glass House in New York City, October 5th through 7th, for sessions going deep on where AI, data, and human expertise converge. The room will bring together over 1 ,000 institutional investors, corporate decision makers, and capital markets professionals from firms like Goldman Sachs, JP Morgan, and the top PE and hedge funds.

25:18If you listen to the show, you're already asking the right questions. Alpha Summit is where you go to stress test your thinking with the people working through the same problems at the highest level. Register at alphasummit.ai to secure your seat. And as a How to Invest listener, you will get 50 % off. Check the show notes for your exclusive discount code. I look forward to seeing you there. Call out the elephant in the room. A lot of people believe private credit is in a bubble and you referenced this earlier it's not as hot as it was a couple years ago in what ways is private credit in a bubble and in what ways is it not in a bubble the good news is when there's a lot of growth and there's some success you know the media picks it up you know the wall street journal financial times bloomberg do a lot of interviews I do a fair amount of TV and radio, and it's just gotten on everyone's attention.

26:14Institutional investors have always been in private credit, and they will always continue to be in private credit for the reasons that I said. The reason why there's been much more attention devoted to private credit is that the retail investors, the high net worth investors, have found private credit. about five years ago, for the same reasons the institutional investors have come to depend on private credit, high net worth individuals, doctors, dentists, lawyers, plumbers, electricians, people like you and I, put private credit in their portfolios today because they want a safe 10, 11 % return.

26:56When interest rates were zero five years ago, there was no better investment in the world than private credit. You went to buy a treasury, U.S. Treasury, it was paying 2%, 1.5%. You got to put your money in a bank account, you're getting 10 basis points. So what happened was, first it started with the retirees, people that were living on fixed income, older Americans and others. And then it went down into the 40s and 50 year olds. Today, private credit is in most people's portfolio for the same reason of institutional. So we saw the hottest area of growth over the last five years in private credit has not been from the institutional market.

27:38It's been from the high net worth retail market. We started a fund about six years ago for just high net worth people. And the reason why we did it is I was playing golf with a couple of money managers and they said, Ted, how do we get into your funds? You know, all the institutions are in Monroe, but how do we do it? And I said, well, we've got three or$4 million minimums and you put in for that and we can add you as an investor. They said, no, no, no, no. We've got investors that want to put$100 ,000 and we get 250 regular investors to be able to get a piece of this. So we came up with a 40-act vehicle that allowed for individual investors, changed our business.

28:17And we started that about six years ago. today that fund's got about$8 billion in that. 15 ,000 individual shareholders that average about $100 ,000 per investment. So if you think about that, that's massive. And just one small piece of the market. Look at a lot of the big money managers. I've got probably 15 people selling that product to RIA firms around the country. Apollo, Aries, they've got 300 people selling that product. So what's happened is there's been a tidal wave of money that's come into private credit from high net worth individual investors. And when that happens, I told the Financial Times a few weeks ago, high net worth individual investors are like fish.