transcript: peter troob – monkey business in high yield ... · funds, high-yield debt, mezzanine...

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Transcript: Peter Troob – Monkey Business in High Yield (EP.59) Published Date: July 2, 2018 Length: 52 min Web page: capitalallocatorspodcast.com/troob/ Peter Troob is the co-Founder and CIO of Troob Capital Management, an opportunistic investor and family office with particular expertise in distressed situations. Prior to starting TCM in 2002, Peter spent six years focusing on distressed debt investing at Contrarian Capital and Everest Capital. He started his career as an investment banker, and after his tenure in self-proclaimed purgatory, he co-authored the entertaining book Monkey Business: Swinging Through the Wall Street Jungle. Our conversation begins with life as an investment banking analyst, and turns to competing with large distressed funds, the frothy high yield market, trickery in the CDS market, high yield ETFs, idiosyncratic opportunities, diversifying family assets, managing teams, and learning from the dinner table. Topics: Control stakes, credit derivatives, distressed investing, family offices, hedge

funds, high-yield debt, mezzanine financing, private equity, venture capital. Edited by: Ilir Shkurti, CFA

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Capital Allocators Podcast EP.59: Peter Troob

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Show Notes

2:09 – Start of his career 3:02 – Peter's book Monkey Business 3:47 – The life of an investment banker 4:22 – Decision to leave the bank 4:50 – His experience at a hedge fund 5:27 – Some of his early mistakes 6:15 – The dynamics of distressed debt investing 8:05 – The approriate size for a distressed fund 11:28 – What should your expectations be if you invest in a large fund 13:12 – Short credit thesis 18:00 – Impact of private equity owned companies on defaults 19:49 – Shenanigans are we seeing in the CDS market 24:36 – Concerns about high yield ETFs 26:42 – Investing family capital 29:16 – Sourcing idiosyncratic deals 32:49 – What Peter has learned about managing a team 35:43 – Hiring millennials 36:22 – Lessons from investing mistakes 43:05 – What is it like working with family 45:58 – Closing questions 49:56 - Thinking in Bets: Making Smarter Decisions When You Don't Have All the Facts

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Ted Seides: 0:05 Hello, 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 keep up to date by visiting www.capitalallocatorspodcast.com.

My guest on today's show is Peter Troob, the co-founder and chief investment officer of Troob Capital Management, an opportunistic investor and family office with particular expertise in distressed situations. Prior to starting TCM in 2002, Peter spent six years focusing on distressed debt investing at Contrarian Capital and Everest Capital. He started his career as an investment banker, and after his tenure in self-proclaimed purgatory, he coauthored the entertaining book ‘Monkey Business: Swinging through the Wall Street Jungle”. Our conversation begins with life as an investment banking analyst, and turns to competing with large distressed funds, the frothy high yield market, trickery in the CDS market, high yield ETFs, idiosyncratic opportunities, diversifying family assets, managing teams, and learning from the dinner table.

Before we get going, I'd like to invite you to join the Capital Allocators Think Tank, a premium content subscription service where you can discuss each episode with me and the guests, alongside allocators are sizable pools of capital. You'll also gain access to the library of transcripts of past episodes. Visit capitalallocatorspodcast.com, and click the premium content button to sign up for either a corporate or individual membership.

Thanks for your support. Please enjoy my enlivening conversation with Peter Troop.

Ted Seides: 02:04 Peter, thanks for joining me. Thank you.

Peter Troob: 02:06 Thank you! Nice to see you again.

Ted: 02:08 Nice to see you. Well. You started your career as an investment banker.

Peter: 02:12 Yes, I did.

Ted: 02:14 And you did something through that process that not many people have done. Why don't you take me through the story?

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Peter: 02:22 I actually graduated Duke in 1991, and I didn't know what I wanted to do. My father was on Wall Street and so it was my brother, so I worked at Kidder Peabody. Doesn't exist anymore, but it was fun. I was lucky enough to go back to Harvard Business School, and on the way out, because I did still didn't know what I wanted to do, I went back into banking at DLJ. And after a very short time there I realized I was doing the same thing that I was doing back at Kidder except I was older, and more tired. And after leaving I decided to write a book, with a friend of mine, about that time. It’s called Monkey Business: Swinging through the Wall Street Jungle.

Ted: 03:03 I remember reading that book and not having been a banker, and always being curious what that experience [was] about. Why don't you talk some about what's in the book, because it's probably eye-opening for those who haven't had the experience.

Peter: 03:16 Right. For a young investment banker, which I was at the time, it's really just about a coming of age, of realizing that the emperor has no clothes. Realizing that you're toiling in obscurity probably for less than $15 an hour, even though you thought you were going to be master of the universe. Some people can continue on that path and they become successful bankers. Other people, such as myself, didn't have the patience or the time to wait for that, and decided that time was more important to me than money, and I wanted to move on to.

Ted: 03:49 How did you actually spend your time as a banker?

Peter: 03:50 Well, at that time—again, this is pre internet days—at the end of that book, we were doing everything from constantly putting stuff through the copy machines… We had to basically deal with rewrites constantly, and a lot of just waiting. You know, waiting for the phone calls from the senior bankers to continue to tell us how we have to re-change something. So we would sit around from about 8 PM till 2-3 AM being a master word processor out of a business school. So we did.

Ted: 04:24 And so what was the impetus for you leaving the bank?

Peter: 04:27 Well, I think it tires you, it drains you. And it was a great experience to do it, but it wasn't a career path I wanted to choose. And at that time it was 1996, the hedge fund business


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was really just getting going in earnest. I was lucky enough to find a headhunter who put me in touch with a hedge fund. I didn't even know what a hedge fund was and off I went into the world of hedge fund land.

Ted: 04:51 And what was that experience like?

Peter: 04:53 You know, that experience was excellent. I mean, again, I liked the idea of learning and trying to figure stuff out. And what I found was these guys worked smart and not. It wasn't like didn't work hard. You worked hard all the time, but you didn't have to do it by sitting at an office all night and they made decisions that had impact on their returns.

And it was a great experience. I mean, it still is. I'm still managing hedge funds. But I worked at a hedge fund in Connecticut and I learned a ton about risk, reward mistakes, good investments, and how sometimes luck plays a big part of it.

Ted: 05:27 So what were some of your earliest mistakes that you remember?

Peter: 05:30 The earliest mistakes I remember… I remember believing that when Home Depot and Lowe’s were getting bigger and bigger, that a little place called Hechinger would live. And I believed that there was something in there that they could still be a third player in a big market, and the answer was that was not right.

Also, we got involved in early on—when you're dealing with large companies… this one happened to be Harris jazz down in New Orleans—sometimes the guy with more money can wait you out. So you learn that. I feel, when you get involved in investments what you really want to understand is you want to either have control, or you have to know that you were just a rider on the investment and hope that the decision makers are like-minded with you.

Ted: 06:16 And so you started… the hedge fund was a credit fund. Is that right?

Peter: 06:22 The hedge fund I started in was a credit fund, correct. Bank and bonds.

Ted: 06:24 So to be clear, someone waiting you out. It was that a particular negotiated situation?


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Peter: 06:29 Yeah, it's. You're going through a bankruptcy. You're trying to figure out where you fit in the process, and in the meantime there's money that needs to be spent. There is a waiting period, and your money, your investors’ money has to be patient waiting with you. And if there is another party that has longer term locked up money and can wait you out, you will eventually lose.

Ted: 06:53 And is that true across distressed…? So if you think about that as an investment area, there are big players. There are players with much longer duration capital than others. Do they consistently have a competitive advantage because of that?

Peter: 07:06 You know, they didn't at one point, but now they've gotten so large I think the answer is absolutely yes. The very large players, I mean the ones with north at ten, twenty billion, even bigger than that, they just have longer term assets. They can make structurally interesting decisions, and they can both wait you out and buy you out in, like, rights offerings where you can't keep up with them. And so being the smaller guy allows you to be a little more nimble definitely. But in the long run, they also get first look, they get last look at investments, and are bright. So that combination, and you add that with money, it's formidable. I mean the distressed world has become institutionalized. It is not a free for all, which is, you know, everyone's sharing information anymore. It is fiefdoms that are being controlled by the larger players, and it's good for them. But for smaller players you get sort of ground up I think.

Ted: 08:05 So if you're an allocator looking at that space, there's always talk. There’s the big guys, there's talk about middle market distressed, lower middle market distressed. Somewhere in there is this tradeoff between sizes too big limiting the opportunity set, but then as you say, there are huge structural advantages in negotiating whatever it is in distressed. How do you think about where that inflection point hits?

Peter: 08:29 This might be unfortunate for some of the listeners to listen to and as much as I am a middle market distressed guy, the large guys have a big advantage right now. They really get the look at a better deals and they get to structure them themselves. You have to go pretty far down the curve, maybe sub-twenty, sub-fifteen million dollar kind of investments where they don't care anymore. And where they don't care, the buyer who can get into these smaller deals can structure the deal.

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Remember what a big guy does well is he looks at a need and he structures around it. He doesn't look at a deal. He looks at a need. And what a small guy does is the same. The problem was everywhere in between, you’re just a rider on the other person's structure, where you will never know it as well as they do ever. You might think you do, but you don't. So you can play middle market, but really you're on a raft in their stream. You are not the guy who creates the stream.

So I look at the big guys, they're institutionalized and a very bright. As a large money allocator, I go there. Or, I go way downstream to guys who make their little, little, little, little rivers and downstream, meaning GUYS doing under-twenty million dollar need investments.

Ted: 09:50 So if we just do the numbers, $20 million times twenty or thirty positions, you're talking about a couple hundred million dollar fund.

Peter: 09:58 That’s right... that’s it. I would not… if I'm talking to a couple hundred million dollar fund and they tell you a bunch of names that sound just like the big guys names, that's nice, but you're just riding on the other guy.

Ted: 10:08 Is the liquidity meaningfully different in that?

Peter: 10:13 You know if you're a $20 million a pop and times ten or twenty or thirty names, your liquidity is going to be better than if some guy owns $400 million of something. But not enormously better. What you really want is to go even further down and want your average project size to be between two and six or seven million. I know it's…

Ted: 10:33 In a bigger structure?

Peter: 10:34 Only if you can. If there's enough investments in a bigger structure, just… If there's thirty investments in a seven-million average name, then that's a $210 million dollars. That's fine. But liquidity is not great when you are looking to sell 10 million of a high yield issue or an esoteric issue. You'll push that thing around. If a guy's to sell 50 or 60, they'll totally annihilate it. But I think the large players…. there is no liquidity, but I don't think they're telling people there is liquidity.





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I mean, maybe they are and if you believe there's liquidity in the large players, you're misunderstanding what they do. They structure deals. They own companies, they're not there to sell them, and if they do, there's no buyer. Because they are the bottom on the distress cycle, so they have to make something better and then jettison it as it gets better. It gets worse, they're just going to keep putting money into try to fix it.

Ted: 11:29 So if you invest in one of these large funds, should your expectation be that the vast majority of the investments are these types of primary structure and control situations?

Peter: 10:39 You know, I think you'll get a better outcome. I don't know what they're telling people, but I want them to control their outcomes. If they control them and they're wrong, they can own up to it, but if they control them and they’re right, they've done it for the right fundamental work. If they're just getting in and out as they… thinking they’re traders, but they've got five, six billion dollars, then they're more or less… now they're morphing into what I would call macro fund. Then you may as well look at the macro guys, because if you want to be liquid and big, it seems like the macro world is the only place you really can do it. I don't think you can do it in the distressed world.

Ted: 12:16 Yeah. And how different do the returns look from the leader in the control situations and someone who collects a portfolio where they're partnering up with them.

Peter: 12:24 I think any one year can come out differently, but I think over time you're going to get high single, low double digit returns out of the control leader and you're going to get 500 basis points worse out of the other guys. Over time, because you get caught… they'll get caught as a small guy not getting all the information, not knowing what the real decisions are and you might be riding a nice wave and then suddenly someone pokes a huge hole in your raft and you're like, you're out of control.

That happens, continuously. If you watch funds, including funds that I've managed, you can't... It happens. You can't know everything, and you certainly can't know the same thing that the large guy knows about how he structured the deal, what his intention is, his conversations with the company, his knowledge of the way they want to turn the business. It goes on and on and that way.




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Ted: 13:13 So if we take that concept and layer it over in the current market environment, you have done a bunch of work suggesting that we might be near the end of a cycle.

Peter: 13:23 Correct.

Ted: 13:24 So take me through the thesis and then what you're doing about it.

Peter: 13:30 Correct. I mean, I got… now I might look back and say lucky, fortunate enough to put this same trade on in 2006 and be very successful and be short, high yield bonds. Now either I got very right or I'm looking at a false premise to do it again. It's an interesting dynamic because, of course, I thought it was right. In 2014 I saw the same thing, so that's a while ago now.

Ted: 13:57 What was that thing?

Peter: 13:58 The thing was that bonds and bank debt were tight. Bonds were trading well above a hundred. You're effectively buying a put option because you know that the upside on the bond is capped due to call ability on the bond. And of course over those years from 14, 15, 16, 17, what's happened is refinancings have pushed out maturities and durations, and this word called convexity should be in people's heads more because now, a high yield bond has extreme convexity where it never did before. Effectively, every time rates move up, bonds will go down because you have longer durations.

So what I see is companies that did not deliver, they levered up because they were able to borrow cheaper. That's fine. They pushed out their maturities… very smart. They lowered their coupons because the market wanted yield and was for it. And what you have is a massive market about $1.1, $1.2 trillion of bonds in the high yield market, half of which are BB and half of which are below BB... That is weak. It's five times levered and you have a market that's very vulnerable.

Now some people say there are no defaults. Some people will say that these companies are doing okay, they can pay their interest… And all of that may be true, but right now topline growth isn't there and these companies are struggling. At one point that'll come to a head and so now you have a huge amount of CLO issuance, and now bank loans are up to almost 1 trillion.





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So you have… you're also a top heavy capital structure. When you mush together top heavy capital structures on top of unsecured levered bonds with no covenants, you're going to finally have a problem. So the question is picking up three, four, five, six percent in high yield from today forward, it's like picking up pennies in front of a steam roller. Is it worth it? That's the question and my answer to that is no. You can get yield in other ways… REITs, and some bonds, and some other… and even treasuries these days. And you can short vulnerable, high yield bonds and, I think, do pretty well.

Ted: 16:08 Let's bring Chuck Prince into the conversation because the economy's doing well.

Peter: 16:10 Yep.

Ted: 16:10 You said there's no covenants, which makes it hard to trip.

Peter: 16:12 Correct.

Ted: 16:12 So it's really a question of can you pay. Credit markets are really robust, so it hasn't been hard for companies to extend their maturities. How do you think about timing?

Peter: 16:26 Timing is the key. You really can't think about timing. If that's the key, if you have to get it right, then you can't do it. You have to say this is part of your portfolio. You have to say “Yes, while the music's playing, you got to keep dancing.” And you should with 95 percent of your portfolio. But how do you live without a hedge? How do you live with...? You don't think your house is going to burn down, but you buy insurance. If your house is on fire, you can't buy it. The idea that you are going to miss out on a little bit to buy that insurance and that you can't afford to do that is a greed, I think, that could be a mistake for a lot of investors. And this idea that you invest in non-liquid structured product bonds and say, “But look at those! They never go down”. They don't go down because they never get marked. It's not that they don't go down because they don't go down. That's a fool's game that will get exposed at the right time, where investors are saying, “Well that's safe”. It's not safe. It's just not marked as that. A big difference.

Ted: 17:29 How much of the universe of issuance is sitting in the hands of private equity-owned companies.





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Peter: 16:26 I have to check that. I mean, I don't have an answer. It's at least half. Private equity is huge. Private equity uses the high yield bond market, so if you're invested in private equity, you're invested in the high yield bond market. Don't think that you don't have exposure. And they should borrow as much as they can for the IRR is of their equity. It makes total sense for them. And so, the high yield bond market is just something that's been used ever since Milken created it in the late eighties for the LBO firms, so a lot

Ted: 18:00 So if you look at it through a cycle with the lens of... sort of what happened in ’08 and ‘09 when private equity… They now have huge war chest of cash in a lot of situations, it was in their vested interest to keep that option value of the equity going so they have money they could put in, they could refinance the bonds. Do you think differently about those types of bonds because of that extra private layer of capital?

Peter: 18:27 The answer is yes, but you're making the assumption—which is wrong, which I think a lot of people do—that that capital held in the private equity sponsors will come in as equity. Why? They're very smart. If you've looked lately, or not lately, it's amazing how they will come in. They will see an unsecured bond and say, “I'll lend it at second lien position, a one and a half times losing position”, whatever that is. Or one and three quarters leading position. They can slice that paper thin. They get between the wall and the wallpaper and they know how to do it.

So they will be economic animals. They will look for the best return for the reward of what the risk they're taking and there is no reason why they come in and just subordinate themselves to bonds and save the bond market. Why? They know the covenants that they've cut in these bonds better than the bond holders do, and they know exactly what… I mean. You can see it in what they did with J-Crew, where they can.. and now I think they might be doing it in PetSmart as well, where they're able to have a restricted payment baskets, move parts of companies out, and the bond guys get held sitting there holding less assets in a worse company. And by the way, it's better off for the private equity guys. The private equity guys are in control of the future with their war chests, not the high yield guys.



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Ted: 19:52 The other dynamic we've seen of late is shenanigans in the CDS market. What are you seeing with these companies and what's happening and how do you think that plays out?

Peter: 20:00 Yeah, I mean, well, first CDS, as I think you know, it's on many less companies now because it's a derivative game. And, you can play games in that derivative world to make it so that the company really didn't default, or it doesn't go by the letter of the default. Remember, these aren't securities. These are all derivatives. Many times derivatives of derivatives of securities.

I think it's a great tool for the banks to make money because they trade them, and I think a lot of very smart people are using them as they are designed, meaning they're not using them as they're designed, they're using them by what the design says. If the design says you're allowed to do it one way, then just because it's unfair, that's now… What’s unfair? If a guy wanted to take a half-court shot every single time and make it, it's not like, “Well, you're not allowed to shoot from behind half court.” Go ahead, until they decide to change the rule. So, I know they're going through the machinations of changing that rule because large smart players have learned how, some people would say, to manipulate it. I would say I don't think it is manipulation. They're playing by the rule of the letter of the way it's written. Hey, you know, “That's too bad.”

Ted: 21:11 Have you been in any situations where you were in a company, either owning the bonds, shorting the bonds, owning CDS, selling CDS, and one of these things, like a Hovnanian or one of these things played out, and what… What do you do when you're in the game?

Peter: 21:25 I'm a little easier on this one. I've smelled it in a couple of things I've been in. I get out of the gate, I will get run over. I can't play that game. I’m not nearly big enough to deal with it, and so what I do is I just allow the big guys to beat each other up. Which they're doing, sometimes in the darks, in sometimes in the paper.

Ted: 21:11 How do you think that distressed world, whether it’s hedge fund, private equity, hybrid, plays out over time?

Peter: 21:53 Well, first of all, that world is falling on top of each other. Is Apollo and KKR and oak tree…? What's the difference? And the answer is there's not a lot of difference. They're all very bright. They all


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are very good at what they do and they will get into situations where they're at odds or they're working together.

So what do I really think? It's an institutional market. It is actually. It's become a normal market. The problem is if everybody has money and they're looking for distressed in that part of the market, it'll never show up. Because when the, when something goes to a 11, 12, 15 percent yield, if that becomes the thing that everyone buys, then it'll never get there. So you either have to have a monster shock to the system, which I'm not sure anyone foresees, or you're going to find that distressed returns are muted because of the amount of money until money starts coming out.

Again, I think where the money will be made as if you got to go downstream to smaller deals. These big firms, they'll say they'll do a smaller deal, but they'll only do it on an add-on to a larger deal. It's not worth their while, not because they don't want to deal with a deal that's 8 million, 14 million. It just doesn't move their needle when they're 15 billion. So they do, on average, my guess is they've got to put anywhere from a hundred to five hundred million to work on every investment they're working on. The idea they put fifty is a placeholder to the decision if they're going to grow. Because remember, they may be working with leverage, so a twenty billion dollar fund, it might have purchasing power of forty billion, and just because you have 30 or 40 billion invested, you're not going to invest in hundreds and hundreds of things. You’re still going to have a core investment, maybe 80 names, so you can just do the division.

Ted: 23:40 So do all these firms then ultimately have similar looking portfolios?

Peter: 23:44 Well, they certainly have a portion that are going to be similar because there's only so many large companies that they can put the money to work, feel like they have some sense of liquidity. And then, of course, there are only so many companies that fall at any one time and so they all race in to work on them, which is actually what they're paid to do. The answer is they're going to be similar.

And the question is—and I know I don't have the facts on this—but I know like Goldman and other guys are trying to figure out how to create EFTs that sort of match those. I wonder, you know,


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I don't have an answer... I wonder if they're going to be pretty good alternatives.

Ted: 24:20 Yeah, I mean just that end up being the ultimate free rider.

Peter: 24:22 Well, yes. For a guy who's going to invest, just making up a number, one to five million into one of these funds, if you can do it through a nice EFT that's liquid, it may just be the better alternative.

Ted: 24:37 So the flip side of that is you hear a lot that high yield ETFs in particular have this massive liquidity mismatch, the underlying assets from the daily… intraday liquidity. Do you get concerned of what could happen to the market in a sell off because of those vehicles?

Peter: 24:56 Oh yeah. I mean they are the proverbial tail that wags the dog. They are the marginal price setter every day, every quarter, every month. You see it. Flows are in, flows are out. They don't think they just do. They want to stay in balance. If there is a liquidity push-out—out of the marketplace… you will see those, in my view, maybe not gap down because, re member, they could just sell it to another buyer—it's when people need to sell. There aren't buyers, so then conversions occur, you know, redemptions of the units. When you start having that problem, you'll just see gapping.

It will eventually happen, it'll work itself through. The ETF will then get smarter and better the next time around. But you'll have to live through that and it's not going to be fun if you're an owner of that thinking that it's a bond portfolio and you see it down 11 percent in three weeks and you're like, “I didn't think that could happen” and that might be three years’ worth of income to you by the way, income that you pay tax on and you lose just real money in principal.

I'm more worried about things like the bank loan indexes. They are revamping… the fastest bank loan you could sell under LSDA docs is seven days. So why can I buy and sell that stuff in seven seconds? Now if that starts to get shaky, high yield is all of the bonds below bank debt, so then you would think everyone will run and start selling that to. The combination could get sort of ugly. When? I don't know, but it'll happen and then everyone will


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look back and go, “Oh, we should have had stop gaps.” And they'll come up with new solutions.

Ted: 26.43 So if we take a step away from that somewhat sober market environment, why don't you go through how you think about investing capital and for your family and client?

Peter: 26:57 Right. I mean, what we've been fortunate enough to have a family office for about 10 years and what we always found, again is what I had mentioned before, is if we could buy from sellers in need, they're small enough where it's to non-brokered market under $15 million and under $10,000,000 need. They have a problem somewhere else. They sell something good to fund something that they have the issue with or they have a problem somewhere and they want to get rid of that itself. They have family offices that have investor turnover, CIO turnover. Now they want to jettison a lot of the things that they were once invested in.

We've been fortunate enough to get to know a lot of our clients and we've said if you have a need, we can fill that need. Small companies they get involved in that need money. They might need a receivable financing. They might need… They might need to borrow money. They might need a convertible bond, they might need equity. What we found is, as long as we're structuring it and we're coming up with the solution, we can help control our outcome. It's the best you can do. I'm still going to make mistakes, but we get good returns because we feel confident in going in.

Once you get into a brokered situation, it's not that it's bad, but if you don't get the last look, effectively in my world, I think you get no look. It's like the Ricky Bobby quote, right? If you're not first, you’re last, right? And the problem is there's a high probability you're not the guy getting the last look. Because there is only one guy who gets it and it's usually a bigger guy.

Ted: 28.24 And so what's the variety of types of needs that you've been able to fill?

Peter: 28:31 Right. We filled everything from receivable finance, meaning a company, you know, just needs money for the receivables that take too long for them to collect, but they need the money to


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build new inventory, let's say for another order. So they're willing to give you…

Ted: 28:45 And that's direct source of the company?

Peter: 28:48 That's direct source to the company. Companies almost always need some sort of what people call bridging. It’s bridge finance, but I really can think about what it means. It's a bridge to something else they're trying to do and in the meantime they're short a little bit of money.

Then there's always mez loans. Again, not dissimilar, that is almost a bridge between they have some money on both ends, equity and maybe bank, but they don't have enough to do the whole project or whatever they're doing, so they need another little piece in between. So they come at higher rates.

Ted: 29:15 How are you finding this?

Peter: 29:17 Well, a combination of things. I mean, we've been out there in the marketplace for a decade looking, and so we have… we call on our investor base and we always ask them. We are constantly out there, and when people are giving us money for our hedge funds, we ask them do they have anything that they'd like to get rid of? Whether they'd like us to take a look at, to have us take a look and help them with a solution. That is a continuous process with accounts, with lawyers, with administrators. And over time, you get a nice flow of investment

Ted: 29:50 And how do you figure out when you're filtering through what comes in, which are coming to you from some type of… call it distress seller?

Peter: 29:59 I think what you have to do, it's a simple issue, which I think everybody knows. It's the power of no. You have to be able to say, if someone's trying to hustle you, then you just say, “I don't have time for that. No.” Or if it's, “Send me your best term sheet.” I don't need to send you a term sheet so you can shop it. You have to very quickly understand if there's a need, if there's a timeframe on it and how you can help. If you're just looking to rip them off, that's not good either because your relationship sours and even if you give them money, you're at odds, you want to work with them, you want them to be successful. You just have to have them, up front, understand, “Hey, you don't have assets. I don't lend to no-assets. You have revenue, so I'll lend to you,


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but I want a piece of your revenue.” Merchant Cash Advance as an example. “We want to get a piece of your revenue monthly and I want it first.” And they might say “That's too expensive for me,” and I say “That's fine.” Then find someone else and that's the best way to find these. But when you come and make a decision to do something, you got to do it. You can't just be a “lookie-loo” and just look and look and then not do anything. You have got to get in there and be honest that you will put that money to work, and they have to feel that and then you have to know they're going to do the deal with you. Once we smell we’re being shopped were out.

Ted: 31:15 So with your family capital, let's just talk about that piece. How do you think about diversification?

Peter: 31:20 I want probably 30 percent liquidity, because I always believed there is something around the corner. And I want to be the guy who buys and doesn't have to sell, because I could get myself into the same problem as anyone else. And I know this is not the greatest thing to say, but being in the hedge fund business for all these years, it's interesting how few hedge funds I give money to, and it's not because I don't want to, it's that the market's gotten more efficient. There's a lot of other ways to invest to make money without having to give your money to someone else and… I'm not begrudging anyone to buy Apple or Google or Facebook. I find that not valuable for the fees.

Then there are valuable things, things that I say “I can't do that.” I'm invested in a firm, for instance, a guy who buys secondary interest of venture capital companies, like a treasurer wants to get rid of some of his shares. I can't do that, so I invest in them and they do a great job in that niche.

I let you know, I'm invested in a real estate guy who has mez loans into very specific types of real estate. I can't find that as much as I'd like and by the way I do find it and then I call them in and hey, they helped me. So I think if you have to, you shouldn't invest in things that you can't do, and you have to be careful on how much liquidity you take, because you'll have a problem that's unforeseen to you too. So everyone has that problem.

So I probably make less. I keep a healthy amount of in treasuries instead of cash, but I'll spend six, nine months a year treasuries to try to just keep myself liquid.


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Ted: 32:50 What have you learned over the years about managing a team?

Peter: 32:53 Well, I was just talking to someone else about this. First of all, and I know it sounds a little bit weird, everyone has greatness in them. Like, everyone. I really do. I believe that you just have to tap into it and find it. And they have to find it. People actually are… they work hard. I mean, I've had a team together for 16 years, most of us together for the whole time. And people are honest. People are hardworking. I know it's my business and I love it the most, but for guys who don't own the business, they love it a lot. And you have to…. I know, again, there's a little bit Zen…. You have to engender love, not fear. Fear will cause people to leave. We had like… for instance, in my organization, we have no lock-ups. I pay people at the end of the year, the doors unlocked, they can go whenever they want. And they've all stayed. Because when you get handcuffed, all you want to do is break out of the handcuffs.

So I think you also have to deal with people's personalities. And the hardest part, what I've always found, is taking that incremental person, that one person can change your investment group’s cocktail that tastes like shit, you know? So you've got to be very careful bringing them in. People feel threatened. There's an issue. There's, I mean, it goes on and on.

So I have not built a huge organization, probably because of that. I watched my father who had 200 people and it was… there was a lot of personal problems. We have 12. It's been very calm and nice and I've… I like the way they interact with each other.

Ted: 34:24 How do you make investment decisions with the tape?

Peter: 34:27 You know, you've got to give everybody. You've got to empower everyone. You have to allow people to believe in it, want to invest in it, prove it to everybody else. And you have to allow, including of… inclusive of myself, people to say, “I don't think you're right”, and have to listen. You can't cram everything down people's throats. I think a lot of people in hedge funds and in funds in general, there are two decision makers and everyone else tries to please them. That might work, because those two people may make all the right decisions. So it doesn't seem to say that doesn't work, but you have to empower people to say to the boss, “I don't agree with you and these are the reasons.” And you know what? It can be the most junior person who says that… Reverting


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all the way back to investment banking, that's why I didn't like it. I felt like I knew stuff and maybe I was wrong, but you know...

It had to do with a deal actually in retail. My parents are in retail and I knew it very well and I wanted to explain that, and they didn't want to hear from me because I was young. Big mistake because in that one I knew. Sometimes you think you know when you don't, but sometimes you do know and everyone should listen. So if I'm in a negotiation internally about an investment and the junior guy goes, “I've done more of the work. I've spent the time. I think you're wrong,” I have to say I better look into it again. Not, “No, you're not. You're wrong because you're young and it's a bad idea. “

Ted: 35:43 Have you heard any millennials?

Peter: 35:45 Yes. I have hired millennials and to be totally honest, I've hired three. And the only thing that made a big problem I have is you got to get off that phone. I mean, when I see... I know it's a way to communicate and I know I'm old school, but you can't sit in an office, yapping back and forth with your friends all day long. The problem is if you don't concentrate, you break your concentration every five minutes, it doesn't work. That one kills me.

But on the other side, it's unfair to say millennials, you know, some of them don't want to work. That's not true. They worked very hard. I think they see the world differently and I liked the way they see it and you know, I'll keep hiring them.

Ted: 36:23 So let's go back to some investment lessons and mistakes we started with one of your first ones. What have you learned over the years from making mistakes?

Peter: 36:33 I think my biggest mistake that I made in my own firm—the other mistakes I made actually earlier in my career—Is you have to align your interests with whoever you're investing with early, and you have to think about exits when you enter. Buying is fun and easy. Exiting is hard, and so if you don't align your interests, then at least… you don't have a roadmap.

Ted: 36:57 How did that play out?


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Peter: 36:58 Well, you know, as my dad would say, you know, if you don't know where you're going, any path will get you there. Right? So you got to know where you're going.

I was invested in a deal and again—this one did not work out—I invested in a deal where I was the third largest holder and we came to another deal with a company and this. This was a deteriorating business that we needed to jettison into another company that would run it off for cash flow. And when we finally got to the table, and we had done all the work, and we got the deal sold, one of the other big guys got greedy and said we could sell it for more. Now, I could only kick. I could scream, I could push, I could do whatever, but I couldn't do it. So we didn't sell. The company deteriorated, the buyer went away. Another buyer never emerged. It turned into a total disaster. I have to blame myself because I knew I was the third biggest going in. I think you have to make in your head to decision. You're either going to go in and ride the coattails of the decision makers… Absolutely fine, which is what you do when you buy any stock, do you think about it.

Or you should have control. You should have an ability to control… that can be control to owning something that has a five year life, so you know the contract gives you control or control where you own a majority of the business. But non-controlling… being third in an investment is like coming forth in the Olympics. It just feels like crap, you know, and you waste a lot of time. You spend a lot of time getting there and, you know, you lose.

Ted: 38:27 So in a typical portfolio, I would imagine there's a mix of control situations and non-control situations, in the sense that the control situations take a lot of time. Everyone is a little bit capacity-constrained. After you learn that, did you start spending your time differently on the non-control situations?

Peter: 38:48 Yes. I spend my time doing much more work getting in, and then I spent much more time monitoring the controller. Because that's who made the decision. It's not anyone else. Everyone else can talk and yap all they want. The controller controls. So get to know them.

And again, this goes back to the discussion of the larger funds. It used to be in the old days, I could call the controllers, because we all were working together and no one could bump anyone else


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out. We weren't big in ‘96, ‘97, ‘98. Now they'll entertain me because they know me from the past as a person, but they'll need to speak to me or give me what they're thinking in their head. And so it makes it harder for a small investor to want to go talk to the large ones because they don't have time to talk to you. They get no value for it, so I don't understand why they would want to do it. And so it changes the dynamics of the game.

Ted 39:40 So of your peers who started in the business with you, depending on the degrees of success we're seeing, let's just call it a demographic shift. Hedge fund business is harder, sort of… It's probably in private equity and hedge funds, business is harder. People have made their money. What is it that's kept you going all the way through with the same energy you had fifteen years ago?

Peter: 40:03 Markets constantly change and there always are inefficient parts. Always. Not opaque. That doesn't mean opaque and not marked. I'm talking about inefficient when you can make money. And I like those. I like finding them. They're not easy to find. And a lot of big players have gone into a lot of a little veins and stop them all up, but there's still more. There are always more.

I mean I'll give you an example. Venture capital. Venture capital is interesting. Venture guys have lots of money and they put in Series A at two million, or friends and family at two million. You know, a Series A at five million valuation and another Series B at eleven, and then they still need more money but they're not growing. And what we're finding now out in the venture capital world is they will take a million dollars… let's call it two million. Two million dollars, and give you one and a half times your money, thee million back in two years, paying you monthly off of revenue stream. Now for me, that's almost a 30 percent IRR. It's a two to three over two years, and monthly. To them it's cheap financing because they look at it and say, “You're going to be basically come in at one and a half times your money.” That's nothing. If you bought the… If this company grows revenue, the next financing round will go from 11 million to 50. So they don't want to give away the equity. That is not being banked right now very well. Some guys are doing it here and there, but in general the venture capital guys would love my type of money for some of their companies, and I can get it off revenue, which is actually a real revenue stream and you can get a monthly. The payback


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is… could be within 12 months, and it's a nice return for everyone.

Ted 41:42 How do you discount the risk?

Peter: 41:44 Well, the risk on that… For instance this business, you just… the business has to fold tent so effectively if the company has money, and it continues to trying to get more revenue. There's a lot of times a “sustain” base, subscriber base. They have a base of revenue, so it's not as if you're lending them twenty… ten million dollars on a three million dollar revenue business. You might be lending them two million on a six million dollar revenue business, and you'll be getting a piece of their revenue for the next two years. So you have to make sure the business stays alive basically.

And then of course what I've found is, because of regulation and because of the way the regional banks and the community banks have to deal with regulation, there is a real void of… when companies entities need money again in the sub fifteen million dollar space and nobody really cares. A company needs four or five or six million dollars to grow. The bank isn't there to give it to them because they don't give real growth capital. They just want to have assets and very standard cash flow. Mez and those guys are all bigger. They'd rather do a bigger loan. Equity doesn't care. So there's a void, and that void is… you can make a lot of money in that void. You have to do it over and over and over. It's like a rinse and repeat, but you got to do it and you have to have the patience to work with all these small companies. But once you have a pattern, we've been very successful in doing it.

Ted 43:05 So you mentioned family office is also a family business. What's it been like working with your brother for a long time?

Peter: 43:12 It's great. And my brother and I started this business. We said this fifteen years ago to people. We say it today. If our relationship were to be soured, we close the business, the relationships more important. And there are times where it gets heated. We get angry. And then we got to remind each other that life is short and he's my brother. And it's nice to have a partner I know is not going to ever do anything to me that it's unethical. So that's good.

I only have one brother. I only have one sibling. You know, maybe it's because I came from a very family that didn't have a lot of tentacles, on my mother's side or my father's side. We both had


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no cousins, so we felt the sense of togetherness and we've kept it that way. And it's nice that our families are growing now. But a lot of people telling me they could never work with their brother. You know, they'd kill each other. We're very different as you know. We are very different people, but we work well together.

Ted 44:05 Were you guys surrounded by dinner table chat?

Peter: 44:08 Yeah. Well it was… It was… My mother owned the second biggest jewelry designer manufacturer next to Yurman. About 20 years ago she would sell it into Saks and Neiman's. So we watched her build a jewelry business. Actually, just for the record, she used to have a book business. It was called Dial-a-Book. It was the precursor to Amazon as she takes to reminding me

Ted 44:31 Dial-a-book on the phone?

Peter: 44:32 Before Internet. She was “Call up and get a book,” believe it or not. But we watched that business struggle and then she wanted inventory that meant some, till she went into the jewelry business. So we watched that.

Her father was an accountant, has own accounting firm to very wealthy people. So he always reminded us about, you watch it, you know, the whole three generations ruin the money, and how you set up the funds and the trust funds, and how you want to instill in your younger generation to do the work. Because a lot of times the first generation does it, the second grows it, and the third one just blows it. So we watched him, and he was an accountant to the Lehman’s and the Loeb’s and the Bronfman’s, and it was nice to see.

My father had a business as we discussed, selling small businesses. So he bought a company that sold small businesses. And nobody ever wanted it, because it was a pain to do. And when he was up to selling over a hundred small businesses a year, Citigroup bought his business.

And my other grandfather was a lawyer to musicians, and that it's just nice. They all had their own business and we ended up buying… He had, he couldn't get paid on some of his rights and he got paid in music. And one of the things that our family owns a very small part of, but it's very lucrative, is a little piece of Stand by Me”.


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And so I've learned that, you know, owning is hard. Being the boss and making decisions is hard, but I wouldn't have it any other way. I mean, I'd rather, you know, it's good.

Ted 45:55 So family businesses in the blood.

Peter: 45:57 Family business in the blood.

Ted 46:00 All right, let's turn to some closing questions.

Peter: 46:01 Got It.

Ted 46:02 And what was your favorite sports moment?

Peter: 46:04 Oh God. I mean, one of them is sitting on my wall that I'm looking at. You know, Reggie Jackson hitting three home runs off of three different pitchers and I think it was the ‘77 World Series. And by the way, if people don't know this, it was his fourth home run in a row. He had hit one in the game the night before, but what they really don't know is, he hit it off of three different pitchers all on the first pitch. So he basically said, because you know, now everybody waits and sees the first pitch. He basically said, I think after the game... So when asked, you know, “You hit him off the first pitch,” he goes, “If you see a good pitch, you got to hit it.” So that was my favorite.

Ted 46:38 I love it. Yeah, I remember that quite well. What's your biggest investment pet peeve?

Peter: 46:43 I'm a fundamental guy, which puts me in an unfortunate minority at this stage in the investment cycle. I can't stand Adjusted EBITDA. It drives me out of my mind to try to… Look! I don't mind… some of it is real. You know, one-time costs are one-time costs. But recurring one-time costs are not one-time, and pro-forma for synergies and costs… with all the rules that are going around, how in the hell do they allow some of this Adjusted EBITDA to hit the pages of these documents that I look at… And it drives me nuts because it's so misleading and the bothers me. I wish they would at least put it somewhere deeper in the document where people had to actually want to see it, versus making it upfront as if it's real. It's not real. It's make believe, totally. And I think it falls a lot of investors. As I said in my book, if you want to read a prospectus properly, read it like a Chinese menu, read it from the back forward, or read like = the Bible, read it backwards.


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Ted 47:42 What's the most dangerous thing you've ever done?

Peter: 47:45 Well, when it matters, what type of danger…? I was saying, socially is probably going to Vegas alone, right? Professionally, it was starting my own business at 33—32 actually—and being very naïve. It was dangerous. As I look back, it was the greatest thing I ever did—the being that naïve.

And personally, I went with my family and we went whitewater rafting on inner tubes, you know, no big deal in Costa Rica. It was like, “What the hell am I doing?” Like I'm looking. I'm like, I'm worried about my son because I'm worried about myself. And then my wife and my daughter and I was like, “Nah, I'm not that big of an adventurist.”

Ted 48:25 When was the last time you were pleasantly surprised?

Peter: 48:27 If you saw me, I'm a, I'm a… my stature is about five eight. But I was a good basketball player. I like that. I was a long time ago. And I was a very good shooter. And my 16 year old son and I play horse and I do not lose to make him feel good. I beat him up pretty much every time. And the last time we played he beat me and beat me again, and he beat me again. And he was… he was making the shots when the pressure was on. I was pleasantly surprised that he had it in him to, you know, I now know he's better than I am. I wasn't mad. It made me pleasantly surprised.

Ted 48:59 What teaching from your parents has stayed with you?

Peter: 49:01 A couple things. I mean, my father, it was to take risks and realize that whenever you do, doors open. Even though you think it's a big risk, doors open, people help you. People are good. People don't want you to fail. I think people want you to succeed and I think they like to see you take risks so you don't… you're not afraid to fail. And you know, his other work ethic was basically work harder than anyone else. But my mother, it was about enthusiasm. Believing in yourself and your ideas. And what she would say—she's alive. So she still says it is—she says basically live in the present in the best way possible so that in the future you're not upset about your past. Basically that's… that was her big thing. Just you don't want to look back and be upset.

Ted 49:48 What information do you read that you get a lot out of that other people might not know about?


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Peter: 49:51 The thing that I've read, I just read it, actually, it was a book by Annie Duke called ‘Thinking in bets.” For me, it just struck a chord, happened to be a fun read. But the reality is—and it goes back to the short fund discussion we've had and about everything else I've done—you wonder if when you got it right, were you are right for the right reasons or are you going to do then get it right… get it wrong next time. Or when you got it wrong, it's okay because you were… you did it with the odds in your favor and if you had to do it again, you should do it again. And, it goes through all the machinations of how, sometimes your past experiences totally skew your future decisions incorrectly. You've got to take each decision and really play odds on each decision.

Ted: 50:33 All right, Pete, you're in your late nineties, you at Yankee Stadium, leaning back, watching the 20 consecutive world series champion Yankees win another game. Thinking back on your life, what life lesson have you learned that you wish you knew a lot earlier in your life?

Peter: 50:52 I mean, I think the biggest one—and again these things you learned from your parents as well—but this isn't a saying. I think actually I think maybe I made it up. It was in my book too, is: time is a nonrenewable commodity, so you can't waste it. That’s what drives me, by the way, nuts watching kids and stuff, just sometimes playing these video games all day. I mean, you don't want to waste the time. You want to enjoy your time, do it right.

I didn't think I wasted a lot of time, but of course I did too. I worried about things that I had no control over. You can't do that. I worried about… I love my children. I love that they work hard, but they're not who I want them to be. They are who they are.

I think you've got to accept people. You've got to accept life and you've got to take the time to enjoy it, literally all the time.

Ted: 51:40 Awesome. Pete, thanks so much.

Peter: 51:44 Thank you.

Ted Seides: 51:45 Hey, before you take off, I've started sending out a monthly email, the shares a small selection of what caught my eye over the month. I get a lot of emails like this and I'm sure you do too, so I'm only going to send no more than a handful of the very best things that caught my eye. If you'd like to receive that email, hop


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on my website at capitalallocatorspodcast.com and join the mailing list.

transcript: peter troob – monkey business in high yield ... · funds, high-yield debt, mezzanine...

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