Characteristics of Great Investors

it's a great pleasure to welcome Tom Barrett to Stanford as our keynote speaker for the 2008 principle investing conference Tom don't move it move it they're like to move but what we're seeing the only thing that I can say I'm George's introduction is clear I can't keep a job first of all I I can't tell you what a thrill it is for me to be introduced by George because we we've shared two boards for a decade and I've learned so much from you as has the management on the the companies whose boards we we serve George has this way of allowing all the titans of industry who are ego battling around the table you've all seen this this amazing psychic phenomena that takes place normal people walk into a boardroom and turn into maniacs and George sits quietly listening to the presentation and there's always a CFO and a CEO who have in the back of their mind this one question they pray nobody ever asks and when George drops those glasses and starts with the words could you explain they all dive under the table for cover he has a amazing ability to do that when I was asked to to be here today I was I was thrilled of course because it's a privilege to speak at schools that had returned my admissions application unopened many years ago so I'm really honored but I was I was I was trying to think of what would be interesting and what could I contribute to an otherwise unbelievably formidable group of panelists and speakers who are following and I decided the best thing I could do is to find something that I may know a little bit more than they know and I was unable to think of anything except maybe surfing and and I want to get I want to give you just the the framework of what I'm going to talk to you about is really not the stuff it's it's the tools that you need to be able to work and implement this stuff which as years have gone on when we look at what are what are the what are the real differences between alpha and beta what are the real attributes of what all of you who are in school today are going to need in the work force and what all of you who are in the work force need is a competitive tool it ends up being that you've got to have the clubs in your bag right you you you need to find a discipline and then you need to start working on the tools and the golf course will change the sand traps will change the fairways will change but but the tools that you develop over time will be what you which are able to utilize so in thinking of a theme I have I have three sons all of whom surf so for me to spend father-son bonding time with them it's a mile out at sea and terrifying circumstances and this last Christmas one of my son's is a professional surfer and we were out in Hawaii surfing and he and his in his professional pals were telling all the amateurs who had been surfing in five six seven foot waves that there was a swell coming up and they should go in at this particular spot that we were surfing of course as is the case nobody ever listens and the swells start building and all this and I'm looking I'm looking how to see I'm paddling out and I see the sky just go dark and this rogue set starts rolling in there's a whole series of 3040 people caught in this impact zone and three or four people paddling up behind it needless to say what happens is that this rogue wave hits shatters the boards and the leashes those boards and leashes go flying and everybody in the aftermath is diving for cover and for five minutes you didn't know if anybody survived I mean literally you didn't know if anybody survived and what came to mind at that moment after I found my son washed up on somebody else at surf board and everything had calmed down was that this is where we are this is the moment that we're in today this is what opportunity fund investing is like so what I'm going to talk to you about is just some characteristics of great investors many of whom you're going to hear today and then I'm going to give you tidbits of of of what our view is what our point of view is where we are in the world that'll be like an anchovy on a Caesar salad you know that the rest of the speakers in the panelists this afternoon will be the lettuce and they can look at us as the anchovy some of you may like it and leave it on and some of you may toss it away but first of all opportunity fund investor you the limited partners who are here will tell you that they make their money and asset allocation that the decision of where the money goes is the most important decision they make so whether whether you allocate to equities whether you allocate to fix income or the allocate to alternative investment that that major decision is where you really make your money and then within that within that tiny tier everybody has an expertise ours happens to be produce extraordinary return and people would like to tell you that you can produce extraordinary return without extraordinary risk that's a fallacy it's impossible all returns regress to the mean professor Parker taught you that in finance 101 it doesn't work that way you have to find extraordinary risk but you have to practice extraordinary risk and that's the key so in our business the ingredients to produce extraordinary returns is be prepared and master how to take and find extraordinary risk and that's that's really what we've done and it's exactly analogous to to surfing I'm going to show you it isn't like just a clip it's not a game this isn't a joke it's not like just something that you just go out and do it this is something that's it's serious this is life-threatening every second and and I think personally it's incredible to see the lack of appreciation for the power of this wave there's a lot of jockeying going on I can see everybody's just looking towards the rides you know they can't even see that the left didn't exist at pe'ahi so the sets come around I looked there and I go ahead just set me up with the left I don't care about the right so I take off on this left and all Center was much calmer and there was a bit of just quietness it was like now we were able to separate herself because for a while like the last couple years is with all these people coming and now on touching point where it's so chaotic such a circus that we could detach ourselves from it in a way you know is funny I felt more safe with all the sharks over on the left side than with all the people over on the right side that's summarize that's into my presentation right it says everything when you're in the middle of the crowds the tailwind has been right on our fanny so for the last 10 years all of us have been brilliant why because the momentum has just been carrying us upward only and the packs and the amateurs join in that phenomenon and to separate yourself from that pack to get to get out of the way is the key and I think the last comment was was really brilliant that he felt more comfortable with the sharks on the left than he did in the notion of the harness security on the right because we all love to invest in packs especially those of us were reporting to limited limited partners these limited partners have to rely on consultants consultants have to rely on information information is a commodity right I mean we like to say that there's information arbitrage there is no information arbitrage you go to the most prestigious school in the world Stanford you have a question that you want answered without analytical ability just facts you push Google and the kuda graduated from Culver High has the same information that has taken you eight years to get so if you think information is going to be the edge I have bad news for you it isn't going to work you look at once you've graduated two big waves it's like once you've graduated out of Business School you've got to assume everybody's great everybody is great and I have bad news for you when you graduate from Business School it starts all over again that heap just keeps waving the cream goes to the top now you have a new Kadri of people they're all good they're all talented and that competitive set starts all over again so in order to distinguish yourself you have a number of things that you need to do harder work more preparation more risk quicker risk analysis take the left instead of the right a combination of all of those things but you have to distinguish yourself with something and terror along the way is a good thing it's a healthy thing to be complacent to have hubris is is is essential that as you're looking at an investment as we look at investments or as we look at our great peers most of people who you're going to talk to this afternoon what they know is where the exit is before the entrance what they develop over time is an instinct about it not so much the informational analytical ability of where it is we're going to talk a little later about themes about developing themes and what happens mostly is great investors who develop the theme after the instinct they don't create the theme and go out in the world and try and find the theme and we're going to we're going to talk about that in depth but it's about taking risk not avoiding risk especially an opportunity fund investing it's it's the key anticipation is everything it's it's those years of knowledge and wisdom of wandering through those jungles to find elephants and tigers and giraffes that perhaps you weren't looking for that all go to this Kadri of experiential stuff that when you go to draw on is there and and being quick on that trigger and being able to adapt instantly to change your point of view which is why when I say it's it's the tools in your gut and your golf bag it's not so much the golf course it's the key because it goes from a sand trap to a green and an instant and if you're invested in just hitting out of sand traps and there's not a sand trap there you're in big trouble avoiding crowded takeoffs humility all those things we've talked about before it's it's really the key and adaptability and cultural $0.06 I think one of the most essential ingredients for any great private equity investor is that is their ability to be able to sense the culture we talk about globalization the globalization is interpreted by little tiny nodes of localization so understanding the fabric of what they're in of what they're doing where they're going is the key you know a lot of this is obvious but showing respect to those around you and then demanding respect is a very delicate balance because humility unless unless you are the number one smartest person in the field that you're in you can be unfriendly you can be not nice you can be arrogant and you'll probably succeed if you're the number two or three then you better learn those other attributes these people have to like you you have to figure out how to express your talent and ability how to be able to use it so getting getting into this place where you're extending your own comfort zone if you extend it too little you can't compete if you extend it too much you're dead so harnessing this this adaptability this risk tolerance is one of the toughest things opportunistic versus strategic you know this is a moment and you're going to be talking about it all day where no matter what anybody tells you nobody has any idea what's happening every hour is a different situation and the truth is it doesn't matter what's happening what matters is that you have a focus and a point of view as to how to handle the volatility but most investors go out and create a theme so they get a Kadri of brilliant business school and law school grads put them in a room say come up with where you think the world is going they spend hours and days and weeks creating a theme then they take that theme they march out in the world and try and get the world to align with their theme and once you get invested in that theme you're not paying attention so much to the other things that are happening around you because you're trying to confirm the theme that you spent so much time and so much effort and so much money investing in we're really what happens at a time like this is you need to be themelis you need to react to all those little test tubes that are floating by you without a point of view just looking for that experiential arbitrage there's a great book by the way for any you haven't read it Nicholas tail that also happens to be Lebanese which who I'm a little prejudiced so you know loyalty to ideas is is a very difficult thing and we all talked about thinking outside the box I don't think thinking outside the box does a thing you have to live outside the box you have to have a set of experiences that have nothing to do with your primary business purpose it's why for those of you who are motivated by money if you go and talk to 300 of the wealthiest people in the world I guarantee you 299 of them will tell you they were never concerned with money money isn't what drove them their money isn't what got them their money wasn't their motivation it was a passion for something else money happened to be the other result of what it was and so this Renaissance ability if you look at every great investor in private equity they're all Renaissance men or women they all have some unique factors some very interesting categories they're all involved in bizarre things because all of those other life experiences bring a point of view that's much more flexible than being an alpha manager to public equities and I'm not down grading that at all the fact that public managers haven't beat the S&P index for any 10-year period since the beginning of time has nothing to do with it which is true by the way some common-sense things you know especially when you're in school long line relationships when you're building relationships because you need them they hardly ever work because the world is too transparent so when you're out concentrating on a networking on cultivating on building relationships it's oh it's always very difficult but if you make that a life practice over time that karma bank builds builds up and the great investors especially in the private equity world have spent decades building and collecting those relationships and they draw on them over a period of time the the accessibility of you to them or of them to transactions is also an unbelievable factor is the most powerful people I've found over time are the easiest to get to its inversely proportionate to what you would think it's absolutely true you want to call Warren Buffett this afternoon and tell him what a wonderful magnanimous thing it was that he did to bid on the municipal bond portfolio the bond insurers and to leave them with the CDOs and the CD X's you'll get him on the phone within 2 or 3 hours you want to get the vice president of AIG it'll take you four days just the way that it works you know after a great education one piece of advice is what happens is like racehorses you train thoroughbreds on a track with other thoroughbreds so you're very careful that they don't get kicked you want to put them in separate paddocks you want to make sure that they're brushed and polished two times a day you feed them separately and then you take them to a track it's like ultimate fighting right you bring a and a prize boxer who's only been with boxers and you put him in a ring with a jujitsu Brazilian maniac and the rules change so this prize boxer doesn't know what just happened to him he's on he's on his back he's on the ground and somebody's using another set of rules well after a great education this is what happens when you go out into the world so you have to without losing your ethics get to that edge again you have to retrain yourself to risk you have to train retrain yourself to the street a bit and take all those great tools and use them in a more adaptable form this I think summarizes the use of information this is what we find in our organization which is the information you have is not the information you want the information you want is not the information you need the information you need is not the information you can get and the information you get everyone has so we sit there after months and months of analysis and due diligence and this is where we always end up everybody has the same information so you know you go to auctions this is this is this is what I love i you know Wall Street is so amazing because we all resisted going to auctions so now we have art you know our teams will walk in bidding on on companies against Morgan Stanley Goldman Sachs TPG Blackstone Carlyle KKR the toughest smartest investors in the world and come out high five and this was awesome we want we just paid the highest price over the smartest investors in the world what could be smart about this right it just it's counter to it doesn't make any sense all the training that I've done with Laird and Derek and Brett and the strap crew and the windsurfing and everything I've done to this point has helped prepare me for a bad situation and to enjoy what I am being given the rides the waves you know it's not just a matter of surviving but it's a matter of writing and and performing a lot of these people have skipped a lot of steps because they want to go out and ride this wave and I can understand why it's a it's to draw it's exciting it's a sense of accomplishments all these things but I think that might be taking some some unnecessary risks you can't cheat that many steps and think that you're you're going to be able to pull it off for that long and I think that's the bottom line message is you can't cheat the process it's it's time in the saddle when it when a when is it your back momentum looks everything it makes everything look great the wind is now on our head it's a different time and those who took the shortcuts made it look simple will have a difficult time what I thought I do now is is take ten minutes and just give you our view of the world I think we circulated at Chairman's corner that gave you a more in-depth view of the useless information that we can provide on where things are because of course we don't know any better than anybody else and then we'll have time for questions and answers but you know the long and the short of it is that markets are very predictable is all accesses regress to the mean but before they regress to the mean they revert to the other excess and that pendulum swings back and forth and we're in the middle of a pendulum swing and nobody's quite sure where it's going and the pendulum swing started as an excess driven by accounting as it's always driven and the analogies between 1990 which was a time before most of you were born and at that time by the way I had blonde hair and blue eyes I was devastating it was it was amazing before we got into this silly business and and and now and the similarities are very are very close in that what would drove the demise of the Savings and Loan industry in 1990 was a regulatory realignment of the industry it took an industry that was was a boring mortgage origination business and turned it into a hot financial business driven by capital regulatory requirements and accounting and that's virtually what's happened now with securitization and derivatives is banks who have already a very low capital regulatory requirements so for every dollar of capital you can borrow against it ten dollars in the box and $90 out of the box when you get that off-balance sheet with a derivative you increase that leverage a hundred times so as all good businessmen do using the tools they have in the in accounting instruments that they've got in an upward only market they started creating more and more products and they started to find more and more animals that wanted to eat the product and they created products to meet that animal and and ratings a triple-a rating only provides a capital arbitrage because if you're an insurance company or a foreign bank and you buy a triple-a rated piece of paper you have no capital charge on that investment where if I buy a whole loan instead of that securitized piece of paper I have a capital charge or three or four dollars against that dollar of capital so what happened was nothing wrong just the financial industry doing what it does best which is carving and creating these products moving a lot of balance sheet so they had more capital feeding the animal with the animal wanted to eat in an upward wind only environment you know that's what happens but the difference between 1990 and now is it was very simple when you hit a crisis which you always find and the crisis was you had a borrower you knew who the borrow was you had a lender you knew the lender was you had a piece of collateral you knew where it was and you had a series of resolutions you could foreclose on it you could have a discounted payoff you could restructure the loan now all of you are in the wrong school if you wanted to figure out how to solve derivatives you need to be in the nuclear physics department I don't know if any of you have ever read I'm sure some of you have an actual description of some of the sophisticated CDOs and ciello structures you need Inspector Clouseau to try and figure out what's going on and as a special servicer responsible to then now remember none of this we haven't gotten to default we're not talking about defaults we're talking about fair value accounting does anybody here an accountant does anybody here understand for value accounting nobody does now the smartest students and alumni in the world I'm telling you no one understands for value accounting including the accounts and that's why what you're going to see with the banks is this continual meltdown because there's no possible way of marking the market long term liabilities and assets in the manner in which we're doing so on top of that you have this bond insurer meltdown the bond insure meltdown everybody's looking to well look what having to magic today look what's happening to am back look what's happened to FDIC no problem you can have all the bond insurers go broke and at the holding company the bond insurers it's not such a big problem there's only one problem is underneath that you have 189 billion of guaranteed debt that's held in other banks so when societe Generale's debt I mean is this was one of the greatest thing I love America you watch CNBC after this kid by the way you want to hire this kid anybody who could figure out how to do seven point nine billion right I mean this would this was a feat this is this wasn't some small little task and all the commentators come out and say this is the greatest thing that ever happening on amis healthy because they didn't lose the money in derivatives they lost it on fraud it's unbelievable so the real problem Societe Generale is am back and FDIC have seventy six billion of rated society's general debt against forty billion of capital so downgrade just puts them gone they're just gone it's just history so and we could talk on about you know we talked about Warren Buffett's offer on I'm buying the municipal portfolio it's a smart business move for him it makes no sense for those companies so you have this banking problem which is write down but that's not really the problem of what's happened the problems what happens what do they do for revenues so you're taking write downs they're trying to look in their rearview mirror and say okay we've got all these problems we need to fix the problems in the meantime there's no IPO business there's no M&A business there's no mortgage business you'll see some of the big investment banks get out of the securitization business altogether and you could see this being the beginning of the end of triple-a rated securities and we can talk about that more later what is the purpose of a triple-a rating from groups who have proved themselves to be totally unreliable totally unreliable in every instance and the market will react to this over time the coupling and decoupling and you're going to have a globalization panel with people who are much smarter than I our point of view is absolutely everything is coupled there's no such thing as decoupling so when you increase the consumers ability to buy in America the flip and I were talking about it before you might as well just write the Chinese to check don't give the American consumer the cheque just send it to China because that's where it's going to end up so the reliance of everybody on everybody and in this soup is there to stay the all of the governmental intervention it's the same thing that it was in the 90s it only postpones the inevitable the inability for the American government just to let the market take care of this flush at all let the foreclosures go to foreclosures let the bankruptcies go to bankruptcies and the market will mark itself to market in an instant you know project lifeline allowing all of these foreclosures 30 more days and poor Hank Paulson is one of the most brilliant guys in the world he couldn't even read his script you know he was so disgusted with himself as he's reading there's this new brilliant Bush proposal it's unbelievable the Fed intervention the fiscal package it's all just postponing the inevitable and in fact you see it in the market because all of these things are supposed to instill confidence and what happens is mortgage rates go up Hillary Clinton comes and says well great we'll just put a moratorium on interest rates for four years it'll be great nobody'll have a mortgage on the house in the world right you'll just destroy the mortgage market in its entirety so it's it's a tough time sovereign funds I mean with what's happened is if you look at Citigroup for instance internal cost of capital about two percent they need a capital in an afternoon they go to to foreign fund investors they get the money at nine to eleven percent without the sovereign fund of course Americans are yelling oh my god we're being taken over by the Arabs but let's pay them another trillion dollars a year in windfall petrol dollars for the oil that we have you know where you all should be we all should be in Dubai right now with Stanford University of Dubai how many how many of you bender Dubai is it the most amazing phenomenon you've ever seen in your life it's incredible it'll probably be a disastrous ugly ending but at the moment all of the money in the world is going there Abu Dhabi is the richest per capita country in the world and no matter what we do we're sending our dollars there and trying to recycle them here so who owns all the debt of America we have 13 trillion in debt the Arabs the Chinese and the Japanese and we're worried about intervention of them taking a total position in one of our banks we're not worried about them owning the nine trillion of debt or the five trillion of the stock market and mortgage market that we have today it's in Congress we want them to open their markets to us and we want to close our markets to them the bottom line I think our take through this is it's not a liquidity confidence crisis its countenance a confidence crisis and this distribution channel of how financial product gets disseminated in the regulatory environment which is hold is is really really in trouble so you know what are the best places to invest it our view is the greatest long investment is America if you look at the dollar against every other currency it's cheap it's going to stay cheap there's no other solution the dollar has to remain getting pounded what happens when that happens is inflation and inflation will rage as it always rages so if you look at all these ingredients of an emerging market the u.s. is probably the best emerging market if you look at all of the emerging markets that people have talked about before and you're going to have a lot presented to you this afternoon about China and India China and India obviously for growth or place that you need to be it's hard to find Westerners that have actually exited those markets with money those are two very sophisticated places with very sophisticated and investors that don't really need capital the difference between the two is in India you have an average tenure of a real estate development company of two years but every graduate speaks English so every graduate from India gets on an airplane with a package of a Township that they want to promote to some US entity in China you have hardly anybody that speaks English and you have development companies that have been there for 25 years so nobody gets on an airplane coming here with a package to present to a u.s. investor either way none of the US investors in in massive terms have done very well in those markets the markets that are starting to explode are the Middle Eastern Russia very difficult to penetrate takes a long a long time to build those relationships and it's a little bit counterintuitive but I think you're going to be short Japan China Korea long the US Middle East and Russia will continue to be dominant places amazed the amazing thing in the middle of all this is the general economy is actually quite good a lot of you probably saw the retail numbers that came out of the fourth fourth quarter retail numbers are great Walmart Home Depot or up it's incongruity of what's going on so I think the bottom line is nobody has any idea what's really happening and the good news for investors which I think you're going to hear through throughout the day is America's resilient the investors who are going to speak to you today are amongst the smartest in the best that have the mobility to move through these volatile markets and as long as there's volatility there's tremendous opportunity to be had we've kind of talked about all this in the parade's of horrible which you're going to you're going to hear during the day the trickle-down effect the reason I think this is so much deeper I was listening to a lot of the commentary this morning they're saying it's over the shorts are off everything is fine go out and spend again I was looking for Jim Herbert first republic' to get another jumbo loan on a new house I think it's all garbage I think when when the March results are in when this quarter is in it's going to be a disaster and that trickle-down effect when you start really getting to defaults you haven't gotten to default you know you're going to hear you've got some of the of the best LBL and private equity investors here this afternoon there's challenges you can't pay a 20% premium to a company that was it as historic high put five times leverage on it have the market then evaporate 30% of your market cap value and say everything's great it's not going to be great cielos ceos CMBS RMBS all challenged as that moves through the system there's going to be huge problems sometimes when the water is too turbulent you have to concentrate on something easily and this is it so I think my last minister do and then we'll have some questions is you know every every morning a lion wakes up in the jungle and knows that it has one thing to do it's got to run faster than the slowest gazelle and every gazelle wakes up it knows one thing that to survive it has to run faster than the fastest lion so whether you're a lion or a gazelle you better get up and start running that's the bottom line Thanks we've got about 15 minutes or so for questions yes sir say that or you know or you simply deal with it the the the question is that yeah I've said going to auction you you feel foolish and since auctions have been the vehicle of choice for Wall Street in the last decade what's the solution if auctions don't work than what is the solution and I think the answer is in an upward market auctions work because what happens is everything you would have bought in the last ten years and I think all of us all around these panels today have to be honest with each other is no one knows were they brilliant or were they lucky and the truth is it doesn't matter right if you're an investor I mean we're stewards of limited partners money so as long as we're producing results whether we were lucky or whether we were smart is irrelevant so in that node going to auction when you have all of this ability when you have these teams that can actually create value so you have a financial engineering package you have an acquisition package you can compensate management differently you can increase Eva da you you have an exit and in the exit in most many of these instances for the last few years have been dividend recaps refinancing recaps right so it's been it's it's we we've all lived off credit it's just been a credit arbitrage is that debt has been cheaper than equity the stock market's been idiotic right when you think about it it makes no sense you go out and have a multiple on a company of equity investors with the equity and you can replace that equity with debt 600 basis points cheaper so I mean this was the arbitrage so it did make sense because as long as that debt was available then the parade of returns could continue now we have a different situation so even though it felt awkward at the time it was absolutely the smart thing to do because every CEO of a company would never think of auctioning and it's of course why are the CEOs auctioning their companies because these guys are sitting here having gone to great business schools like this managing thousands and thousands of employees and they're watching these private equity guys driving Ferraris going to their homes on the beach and their options are going down the tubes because the public equity market wasn't giving them value as CEOs for what they're doing so everybody said well let's jump ship we want to be on the private equity side so the private equity guys say great we're going to make you even richer than you are here's compensation package here's what you're going to do here's what the piece of promote in the market did what it did so I think that's now changed private equity will react very quickly there'll be a new gig on the street less leveraged a different set of tools just like they switch to two pipes in two hold positions there'll be a new set of financial criteria and they'll take all the great tools they have of knowing how to manage knowing how to buy knowing how to be really more servicing to their investor base than the public equity can only when you look at public equities we said well the reason that you you pay this liquidity premium because you get transparency you get a professional management team you get liquidity we've proved in the last ten years none of those things are true there's hardly an accounting firm left alive right we thought accounting was the method of responsibility and transparency what we found is a five year period every accounting firm went bust they went bust because of lawsuits you're going to see the same thing happen to Investment Banking all these people who bought derivatives I guarantee you that the little sheiks sitting in Abu Dhabi who is buying 750 billion of these derivatives and never read the book you get a blue book Morgan Stanley Goldman Sachs Citibank and they create a secondary market they think they're buying a security now when all of this slows down and all of a sudden these lawyers sit down and say you know we just lost a trillion dollars I guarantee you the lawsuits that are behind this are going to make what happen in the RTC look like nothing so the wave on the wave on the wave is complicated auctions will always be there but private equity figure out something else now because without debt it's got to be a different gig yes sir yeah the question is I had mentioned the Dubai will probably and badly and what's the rationale for that number one I'm a big supporter of Dubai but just to give you a little bit of a background you have seven arab emirates that were were a consolidation of seven tribes that were put together by the british because you have 300,000 Emiratis 300,000 citizens who are the richest citizens in the world now as a result of the british having discovered oil in abu dhabi which is a separate fiefdom so the only the only one of the seven arab emirates that really has spendable capital from natural resources is abu dhabi not dubai so dubai in order to find its own place brilliantly and shrewdly decided that it would become the commercial capital of the Middle East Lebanon was war-torn Cyprus was inefficient the bureaucracies existed everywhere else so they went to Singapore and they basically hired the Singaporean government and said we want to create a new country so in 10 years you have best of class of everything the best Airport the best hotels the best golf course is the best tennis courts the best technology centres the best everything but the underpinning of all that has not been windfall Petro dollars the underpinning of that has been the sale of residential commercial property so if you're an Iranian sitting across the Straits of Hormuz all of you probably remember your geography Abu Dhabi sits on a point three miles across from that point in the Straits of Hormuz is Iran so we have Iranian sitting there saying you know on a bad weekend if Israel launches a nuclear missile we're going to have a really tough time swimming across this three miles to get to Abu Dhabi so Dubai said great what we're going to do is for everybody who buys a million dollar condo we're going to give you residents so now you have 300,000 Emiratis and Emirates and you have six and a half million six and a half million people employees residents part-time residents not occupying all those units so when you look at the natural element of Dubai it's unbelievably successful the people are unbelievably smart the product is fantastic but the excesses of this speculative thrust will probably have a consequence at some point so when I say a great disaster I'm a believer the Dubai is there for the long term and Abu Dhabi of Dubai gets in trouble even though it's been building on a leveraged basis Abu Dhabi you know with one day's pumping can bail out Dubai from all of its vagaries so I think the Middle East is here to stay as well as long as you're burning motor fuel no matter what we say about alternative energy it's not really going to make a difference China in one day burns all the oil that you can save through every kind of ethanol or alternative energy manufacturing process that you want in your automobiles so when you look on a global basis it's going to take 30 years to fix that problem so I meant an awful couple when I say it's it's an excess it's there's so much building there's there's more cranes in goodbye in China today then everywhere else in the world times - it's it's amazing do you also see it as an opportunity for colony or it does it not produce the returns that you required great great question on infrastructure with the municipal bond dilemma that infrastructure is going to be a new project finance opening is that an opportunity for colony and the answer is is yes but it's it's like pulling into a gas station and needing a different octane fuel private equity and opportunity funds have been geared to 20% plus returns and the world is corrected itself so when a deal walks into our office in Singapore it doesn't know what it is it doesn't know is it an opportunity fund deals and infrastructure deals at a value-added deal is it LBO do it just knows it's a deal and we've all bifurcated ourselves into these little Chinese menu alternative asset groups but but what's happened is is the big guys are all going to multi-platform so if you look at Carlyle TPG Blackstone they have a diversity of fund so their investors can invest in those funds with just a lower cost of capital but the deal sourcing pipeline which is the only place that you really differentiate yourself because they're all smart they're all brilliant they're all great at what they do it's how they source it so I think that that that there's a huge opportunity and infrastructure because what's going to happen is this arbitrage of having a bond insurer which gave it to ratings I mean remember it was already triple-a rated so now you had a bond insurer which was just allowed that capital regulatory piece of buyers out in the marketplace will be gone and the Triple A status itself is threatened so project finance for all those municipalities as they're searching is going to be is going to be a big arena and will participate will just participate with a different kind of fuel it'll be a separate definable fund but I think what you're going to see is infrastructure funds will be the flavor of this year it'll be a great place to invest yes sir in the thought process that you went through to sort of process what was happening what would look what was the evolution of your forming the understanding that the evolution of our thought process was it started with a sneak preview at the at the credit market we had never seen the banks starting to act the way but this is before subprime because subprime is a misnomer subprime was just the peek under the covers of this redistribution of credit that had gone on and I think most of us had realized that the frenzy of lenders the risk that lenders were taking as they moved up that loan to value or as they moved up the multiple of ebody stream was becoming insane and the reason was becoming insane is they weren't keeping on their balance sheet so as originate and syndicate the banking business had changed it was no longer matched assets liabilities it was create sibs and all of these Kaspar financing vehicles where they could create unbelievable exponential profits without ever hitting their capital Tier one tier two requirements so I think the first place that we all started to feel it was the bank started to back up on the commitments on our corporate deals which they hadn't done I mean for the last decade they had always held our feet to the fire as to these commitments and and none of us had ever had any need to hold them to the fire Inlet what happened as they started coming back you've all heard covenant light well we used to borrow money 10 years ago you used to borrow money and you had a whole series of thresholds which you had to maintain within the operating companies non-financial defaults so if something was going wrong in the company the bank had recourse to you for either more collateral for asset sales for something as the competition went on in the industry they went to covenant light which all of the negotiators the users of the product said we're not going to give you those covenants lend us the money and we'll pay you back the money that's that's what you're going to get and the banks in the frenzy and the easy distribution of that product all over the world did that so I think that the first indication was we saw the bank's backing up and then as she started to look through the system the confusing thing was the economy was pretty good everybody's business I think what everybody will tell you today is all the private equity guys are going to say their businesses are fine you don't see it in the business usually you see it in the business you see it in the financial structure the capital structures are strained and it's not even on the default structures with the defaults are all as a result of these downgrades it's not as a result outside of the residential mortgage cycle which always happens right I mean the difference in the residential mortgage which which we weren't panicked about we knew foreclosures were up and home builders are always a sucker punch and I'm not offending any home builders but if you look at what you're buying it's it's it's the worst manufacturing business in the world they operated five or six percent margins right you've got to go long on real estate out ten years to have inventory takes you seven years to get entitlements you can't build houses manufactured in advance because you get stuck with inventory and you're in the cyclic 11:00 flow of the mortgage markets so I don't think too many people paid attention to what was going on in the residential market but no one had any idea of the far-reaching implications including the banks by the way the banks did nothing wrong I mean there's no culpability here they were manufacturing product that was being digested by a world who had become drunk on credit it's it's it's it's what all of us attend America was the epicentre of credit consumption and now what we're doing is we're trying to retrain ourselves we're all in rehab right I mean I think everybody here everybody who's on these panels will tell you we're all in credit rehab and it's a difficult thing to digest because you have you have to teach this pony a new trick so the analytical process I think is just have some volatility quite honestly we were related because it had been a long time that dealing with amateurs and amateurs taking undue risk we're producing higher returns and when you're being judged in the same category it's very frustrating so having a correction is a healthy thing is a good thing and it produces another whole set of opportunities which if you can adapt and you're not trapped by the prison that you built in the past can be phenomenal but I think it's still unfolding anybody who tells you that they know what's going on it's an accurate I mean this is going to be very volatile 2008 very volt yes sir Middle Eastern money we talked about how there is massive investment on stock market but we are may be uncomfortable with investment coming into the banks over the long term do you expect there to be a backlash against foreign investment in the US equity market parted from the Middle East or do you expect it to be the inverse that will be more open to that unfortunately I think the reality is there will be a backlash which is the wrong answer right I mean which what you love is through this experience to create a new bridge of tolerance of this natural distrust between the East and the West in that bridge of Tolerance would be built on on the backs of commercialism where you don't have any of these political or religious points of view but the distrust on both sides is is is startlingly eminent because the Middle East there I mean as all of you know there is no such thing as the Middle East you you have 50 countries with a hundred languages and and 300 religions and they hardly agree on anything they don't agree on borders they don't agree on religion they don't agree on language they don't agree on anything and they all have different points of view and they all love America they all love America and they all love Americans at the moment many of them are little confused about America's political policy to them they didn't go looking for Citibank they didn't go looking for UBS they didn't go looking for any of these institutions they came to them and they responded with no governance no board seats no tools which we've all in the private equity said are you guys crazy we'll invest with you but it's too soon it's a falling knife don't invest at this point wait another ten minutes we'll invest with you and we'll bring with you the tools so they've invested make it in these entities alongside of Management right and why did management go to them instead of us because management wanted to keep their job right it's that it's that simple so my hope is that through this there'll be another huge bridge of Tolerance because the the Middle East for the next ten years we better get used to it and we better learn how to deal with them and it's the epicenter of the world for the financially for for money and financial matters it's on its third generation they're getting good they're smart they're mostly Western educated I think most of them are well-meaning they can be great partners but America will always miss play its hand especially in the midst of of terrorism and all the difficult things we're dealing with Thanks [Applause]

Channel: Stanford Graduate School of Business

Views: 45,741

Rating: 4.78157 out of 5

Keywords: real estate, principal investment, private equity, investment

Id: YnqoA-vAbRs

Length: 52min 47sec (3167 seconds)

Published: Wed Aug 05 2009