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Robert Brunswick:
Hello, my name is Robert Brunswick and I’m Chairman of Buchanan Street Partners, a real estate investment management firm. And I’d like to welcome you to Counting Capital, our podcast that we’ve created for our clients, our registered investment advisors, families, and just lifelong learners. And today, we’re going to talk to someone who’s in the investment space, Ray Kennedy with Hotchkis & Wiley. Ray, welcome. Great to have you on the program.
Ray Kennedy:
Thanks for inviting me.
Robert Brunswick:
So Ray, I thought we’d start off with a little bit of an overview on your career, how you got into the asset management and fixed income investing space, and what truly really attracted you to this business. So maybe, I understand you didn’t get into Cal, so you had to go to Stanford. Is that how it all started?
Ray Kennedy:
Oh, there. Let’s not go down that path. I came into it in an indirect route. I was a Stanford engineer, was working for Arthur Anderson and was consulting in London for the London Stock Exchange doing the famous Big Bang project. So, it was my first introduction to the financial markets I enjoyed it. I was actually working with traders on the floor. I designed the trading system that actually took stock trading off the floor and onto computers in London. So I said, “I want to go and do this.” I didn’t have any education, so I went to UCLA, got my finance degree. And this was during the era of Milken, Drexel, big LBOs. This is late 1980s.
Robert Brunswick:
Late. Okay, ’80s.
Ray Kennedy:
So if you think about that period, that was just total what are characterized as just a wide open field in finance, especially in high yield finance. Loved it. Was doing LBO stuff. During my summer intern and I decided I was going to work-
Robert Brunswick:
LBO, leveraged buyouts.
Ray Kennedy:
That’s correct.
Robert Brunswick:
Okay.
Ray Kennedy:
And I had the opportunity to work for Prudential, which was the largest investor in leveraged buyouts at that time. So, I did that for about eight years, basically doing what I characterize as high risk investing in companies, often taking warrants or equity, but most of the time we were taking debt. And during this period, PIMCO came on the radar because they were looking for money. So, I was involved in a very complex financing for PIMCO while they were doing a merger, and they asked me to join and come on what we call the public side. So, I’m actively trading bonds at this point. Why am I in this field? I love to learn. That’s the sole reason. Everything I do is I’m constantly learning a new business, new management team, new industry of some sort. I’ve been underground in mines for two or three days. I’ve been on oil rigs, I’ve been on drill ships, I’ve been in Upper Canada looking at oriented strand board plants. I’ve been in Korea touring the largest auto manufacturing.
Robert Brunswick:
Okay, so let me stop you for a second.
Ray Kennedy:
So, it’s all about learning.
Robert Brunswick:
I’m loving this. As we talk about learning and a passion you clearly have. And what you just educated me on, you’re not just reading paper, you’re touching collateral.
Ray Kennedy:
Correct.
Robert Brunswick:
You are? Okay.
Ray Kennedy:
I’m touching companies, I’m touching management teams. And my first introduction to this business, I didn’t even have a chance to look at reds. I basically had to look at financial statements. So two things really stand out. One, I’m passionate about learning about companies, but I’m also really good at analyzing financial statements. And you either kind of have that knack or you don’t. I can look at a cashflow statement and tell you in two minutes whether this company’s going to make it or not. And so the combination of the two really fit my skillset for investing in this space and it’s a very specialized space. I know we’re going to talk about that a little bit more.
Robert Brunswick:
Sure. A great frame for everybody to understand your background, your passions and your acumen. So thank you on that. I want to now turn a little bit to, if you can stay broad for a minute, help our audience understand the fixed income space broadly, because you participate in one segment of fixed income, I would describe it as. How would you just lay out for us fixed income broadly?
Ray Kennedy:
Sure. When companies are built, they basically will use equity, but they also use debt. Debt is often used to acquire companies, to build plants, sometimes to buy stock. So you have two parts of what we call the capital structure, debt and equity. We’re the fixed income or debt part of that. That’s the space I play in. Within that, there’s obviously different variations of risk. I specialize in the area of corporate debt. But for example, states issue debt, US government issues debt, obviously then you have companies who issue debt. And so what is that? What does that mean? When Tesla comes to the market, they first issued equity but then they borrowed money to build their plants. So, my job is to basically look for opportunities in that debt space, the fixed income space. For investors, that means you’re getting a coupon, you’re getting principle back, and generally you want a portfolio of these. Most investors generally will run something like a 60/40 portfolio, maybe 60% equity, 40% debt. As you get older, you may see the inverse, have more 60% fixed income, 40%-
Robert Brunswick:
So, let me slow you down because I want to make sure we’re all following you. So when you say 60% equity, 40% debt, the debt is really what I’m going to characterize as the fixed income side of an investor’s portfolio?
Ray Kennedy:
That’s correct.
Robert Brunswick:
That provides the predictability of return. And when you say coupon, it’s really in essence a current return?
Ray Kennedy:
That’s correct.
Robert Brunswick:
Okay.
Ray Kennedy:
Yeah, in our terminology, we are looking at what is the interest rate that you’re going to get off that, and then obviously, that tends to be the income stream that maybe people use for living. If you’re a pension plan, you tend to have a big chunk of your portfolio in fixed income because you use that maybe to pay the pensioners and then to grow the pension plan, you’ll use the equity part of the portfolio,
Robert Brunswick:
Which is a higher yield, but also less predictability to it. Higher yield potential I should say.
Ray Kennedy:
Potentially.
Robert Brunswick:
So just before we dive into your specialty within fixed income, let’s be clear, there’s many different types of risk returns within fixed income. There’s more conservative yield in fixed income, annuity bond for example, versus what you do is high yield. So just make sure we understand the range of fixed income kind of products.
Ray Kennedy:
Good question. So, there’s a rating scale-
Robert Brunswick:
There you go.
Ray Kennedy:
… that people use go. It ranges from A to basically, D. If you’re a triple A, which is considered the gold standard, you would be the equivalent of the US government. If you’re a lower quality like a triple C, you’re a company that’s probably on the verge of bankruptcy. So, most states are either triple Bs or single A type risk. Low risk, probability of getting your money back is very high, but you get obviously low coupon or low interest rate. Then you come to the world of corporate debt and that’s where things will get more complicated. You may have a company like JP Morgan, a rated very low interest rate debt, but then you may have a higher risk bank, as we’ve all learned in the most recent market, where their debt could be trading at 10%, where they have an interest rate of almost 10%. So, my space tends to be in this lower quality area where there’s a higher risk of default, but you also get a higher yield.
Robert Brunswick:
So, I broadly describe you as a hunter. You hunt for investments where you think there is a mismatch to the risk return, meaning the return’s more interesting than maybe the risk might speak to in terms of the pricing. So, I think specifically, you invest in undervalued debt securities of companies creating what I would call high yield bonds. You’ve created approximately a $2 billion portfolio on behalf of what high net worths and institutions. Tell me a little bit about your clients.
Ray Kennedy:
Sure. Our mix of business is largely a combination of mutual funds. So, we have a large mutual fund that’s sold off Fidelity, Charles Schwab, TD Ameritrade, or you could buy directly through our own platform. And then the other side of it are basically pension funds, San Diego County employees, New Jersey, State of Texas funds. That’s the type of thing that we would be involved. So it’s a combination. You always like to do that. So, in terms of the risk profile, again, it’s going to be lower quality, we’re looking at companies that are undervalued, but here’s a nuance about our market that that’s interesting. We’re at the nexus of capitalism. So what does that mean? So for example, if a company’s being created, a wireless company or a auto company like Tesla, they tend to come to our market and they use that as their growth. So those are the growing opportunities that you see. And so we’re trying to invest in them.
Quite often they are asset rich, they don’t have much cashflow. It requires an extensive amount of analysis, and our job is to determine whether or not that’s going to be a good idea or is it going to go bankrupt? Most of the time they’ll do well. The satellite business came from this, the cable industry came from this, the wireless industry came from this. We were investing in cable 30 years ago when people didn’t even know about it. Well, obviously cable today is everything you see. On the other side of it is we have companies that are having secular changes in the other direction. For example, coal companies. Coal companies at one point represented almost 10% of our market. There’s hardly any coal companies left today.
So, the Yellow Pages. Most people forgot that there used to be something called a book that had all of the data about companies that you could possibly do business with. That was actually in the high yield market before it went bankrupt. So we’re at this crossroad of capitalism, whereas companies are emerging and companies are declining. And our job is to try to find the value in that. Some will say it’s a minefield, we just say it’s an opportunity set. We’re looking for companies that can survive. They’re shrinking, like the steel companies in the US, and at the same time we’re trying to find the next set of cable companies that are going to evolve.
Robert Brunswick:
So beautifully said. I like the way you package that. You’re a portfolio manager. So with my $100 that I’m going to give you, how many positions will I have within my investment, different types of companies, and I assume virtually all of them are non-investment grade, so I’m going to assume they’re single B. Is that fair to say? Or share with me a little bit about the collateral that I’m going to get in my $100 portfolio with you.
Ray Kennedy:
So, we’re typically going to have between 150 to 200 names. That gives you enough diversification so that if one of the companies doesn’t perform, the other ones will support you. In general, in high yield, about 75% of your return will come from your coupon, your interest rate that’s paid out. The typical portfolio will be split between double B, single Bs and even some triple Cs.
Robert Brunswick:
Okay.
Ray Kennedy:
We’ll actually own some high risk ideas. Typically, we’d run a broad diversity of industries, again, to avoid any individual industry risk. For example, you would never want all your portfolio in a coal industry, because we could all see that going down, for example. And the typical name you’d see would be for example, public hospital companies, community health. You basically have tenant health, you have obviously HCA. HCA is high quality, community is low quality. So that would be a mix. Those are great assets because they’re difficult to replicate. In many instances we’re buying first lien positions in those. We own companies like a roofing manufacturer. Most of the roofs in the US are asphalt based. The biggest roofing manufacturer is called GAF. That’s one of my core positions in the portfolio because good weather, bad weather, people always have to replace roofs.
Robert Brunswick:
So, Ray, talk to me about the term of the individual bond that you’re buying from these companies. First of all, how many of these companies of these 100 would I know their name?
Ray Kennedy:
Probably at best 20%.
Robert Brunswick:
Okay, so 20% is a household name of sorts?
Ray Kennedy:
Correct.
Robert Brunswick:
And then what is the position or the tenure of your debt if you will, the term?
Ray Kennedy:
Most of the bonds are what we call generic structure. They’re eight years maturity, but they’re callable after four years. And that’s important. So, for example, if you have a bond that… Let’s use an example bond. Okay, so a good example of a bond is Hanes brand.
Robert Brunswick:
Sure.
Ray Kennedy:
Hanes brand’s, the underwear manufacturer. It’s always fun to talk about. They have an eight-year bond that basically is callable after four years, and has about a 7% coupon, it trades at 90 cents in the dollar. If I buy that bond, my expectation is it will probably be called four or five years out. Most bonds don’t mature in high yield, they get called early or they go bankrupt. And so part of our job is to try to cost, so predict when we think it will be called, why it might be called, et cetera. And so that’s a typical type of bond that we would put in the portfolio.
Robert Brunswick:
And are you buying these bonds daily, selling bonds daily, or imagine that it’s a little bit longer holds for most of this stuff?
Ray Kennedy:
We have two classifications we characterize. We have what we call our core portfolio, which these are the names that literally will never change in the portfolio unless they get called in and may replace them with another bond. That would be the roofing company I was talking about. I’ve owned that bond for almost 30 years. Some variation of the bond as they’re constantly refinancing. The other bonds may be shorter term investment horizons. In that instance we may own them for weeks, months, maybe a year or two. So, it’s all about what the risk reward is and whether we think we should continue to hold it. We are doing this every hour with our portfolio. We constantly have cash that has to be reinvested and we’re constantly selling ideas that we think have either matured or going the wrong direction.
Robert Brunswick:
Ray, I want to move a little bit to your career, and I think of entrepreneurship and the path of someone in your line of work. He worked for one of the most prestigious companies in the space, PIMCO. I think about some of the icons, the pioneers of the investment space coming out of PIMCO. So, how long were you at PIMCO?
Ray Kennedy:
A little over 12 years.
Robert Brunswick:
12 years. So, can you share with us a little bit about some takeaways of what you learned under the PIMCO culture, working with some of those icons, and then maybe why you would leave at that, what I would call maybe earlier in your career, at maybe the pinnacle of your career?
Ray Kennedy:
Right.
Robert Brunswick:
Share with us.
Ray Kennedy:
So lay the groundwork. When I joined or got involved with them, they had about 40 billion in assets. When I left, they were approaching a trillion. So, imagine a growth company like that. It was a phenomenal experience. I loved every minute of it. It was like drinking out of a fire hose every day. We had constant growth of new ideas. If you found a new product, the idea was you ran with it. It was basically a complete open field for ideas. And so the closed fund business was largely my growth area. At one point we generated one fund that was 4 billion in size.
When I joined, we didn’t even have a credit team. And so one part of my job there was actually start the credit team and get that going. I sat on the investment committee when it was first formed. So, I was sitting there with Bill, Mohamed, Paul. Another person named Chris Allen is a person behind the scenes who’s very involved. And so from a standpoint of excitement, learning, growth, the ability to do what you wanted to do, as long as it was a productive growth part of the business, you got to do it.
Robert Brunswick:
Sure.
Ray Kennedy:
And the only reason I stopped was I just got tired. At some point you realize you start making personal sacrifices, and I realized I’d been doing this for a long time. I had done well financially and I realized I had the opportunity to do two things. One is give back to my community a bit. And I actually did a little bit of teaching at the high school level. The second thing I did was get involved in the local foundation. So, the high school foundation, people will tell you that I was involved in the rebuilding of the infrastructure around there. So I did that as an opportunity to be re-engaged with my family. And I really enjoyed both periods. I would not have given up the PIMCO experience, nor would I give up the time that I got to spend with my family and get re-engaged. I took the choice of going from being the very well known in the space to taking a smaller position.
Robert Brunswick:
A regular guy.
Ray Kennedy:
And I’m okay with that.
Robert Brunswick:
Yeah. But then all of a sudden, you got back into the business world. So what happened with Hotchkis, and what tempted you to get back? Because it sounds like you had set this up perfectly for yourself.
Ray Kennedy:
Absolutely. I actually did not think I’d get back in the business. And then the great financial crisis occurred, the height of the market went down to almost 65 cents.
Robert Brunswick:
So, this is 2009?
Ray Kennedy:
2008, 2009.
Robert Brunswick:
Okay.
Ray Kennedy:
The CEO of Hotchkis is my freshman roommate from college, and he asked me to start this business. They were trying to restart their overall business. They’re a value equity firm. They were struggling during that period and they were looking for a growth area. So I said, “That’s fine, I’ll start this high yield business over here.” So, I was involved in the initial funding of it. I actually paid for all the expenses for our loans the first year.
And with the idea that I could do… I wanted a few things. One is I wanted to get back to my roots of what I’d call credit investing, which is looking at small companies, versus at the end of PIMCO we had a saying which is all of us love to invest, but the business of investing gets old. And I was at the end doing the business of investing and less investing. You have clients, I would spend two weeks a year in Japan. I would have to go to Finland twice, including January, because we have a big client base there. Reviews, 40 different reviews at the end of the year. It wore on you after a while.
Robert Brunswick:
So, in my business we refer to it as working in the business versus on the business. And I’m sensing in this next chapter for you, you almost had the chance to work on the business and be a bit of an entrepreneur-
Ray Kennedy:
Exactly.
Robert Brunswick:
… in helping build it. And that was exciting for you.
Ray Kennedy:
And we used the research platform at Hotchkis and their phenomenal analysts. We use the distribution platform. So it was turnkey for us to set this up. I brought a few colleagues over from PIMCO and we were able to build a real business.
Robert Brunswick:
So, Ray, you’re clearly a professional investor and you’ve done quite well and there’s a lot of people that entrust you with their investments. How do you invest personally? And as I say that, I imagine you eat your own cooking. So it’s important to your investors to know that you’re meaningfully invested side by side with them. So, share a little bit about your own personal investment philosophy.
Ray Kennedy:
So, I do have a large chunk of my assets directly in my fund. That’s the easiest way to do it. And unfortunately it’s not necessarily the most tax efficient. So I do also balance that out with the approach of using outside managers, including Buchanan Street. And so the idea being that I basically have a diversified portfolio. So, I have obviously a chunk in equities. In our business it’s challenging to directly invest in equities because of the SEC regulations. So, I tend to use an outside manager and let them do it. And then we just have a discussion a few times a year. And that’s the same of individual bonds. There’s a very elaborate process to do something that could potentially be in conflict with your clients. But I very strongly believe in supporting your own asset class. And it’s helped, I think, quite a bit in raising assets for our own business.
Robert Brunswick:
So, as an investment manager, and I think about ourself, and you look at real risk return and reconciling risk to the return in the public markets. I’m curious if you think, forgetting maybe the particulars of today’s market, more broadly, I’d like to talk, do you regularly see missed priced risk? I assume you do and that’s why you make the investment as you see it. But I’m curious how good is the market publicly at reconciling risk and providing the right return?
Ray Kennedy:
That’s a very difficult question to answer. You have to decide whether you believe Mr. Market is right or that Mr. Market is inefficient. And the answer is both are correct. If I see a bond that’s trading down, nine times out of 10, someone probably has information. They have some insight that I’ve missed. So, then at that point you have to use your judgment about whether or not you’ve seen this pattern before and the opportunity will recover. So, is that a mispricing? Is that undervalued? Is the market getting it wrong? The market may not be getting it wrong at that point in time. What they’re missing is the upside.
So, that’s basically, our job all day long is trying to figure out these situations and trying to realize that this is a batting average. I’m never going to be 100%, but if I get 90% of my ideas right, I probably will outperform. And that’s the goal here at the end of the day. And we always debate whether the market’s right or whether we’re right. And I do believe the market sees something and they’re pricing it correctly for that point in time. The question is the opportunity going forward.
Robert Brunswick:
Brilliant. I’m going to take you back to the start of our talk today. You said what you’re most passionate about is you’re a lifelong learner, you like uncovering and learning new things. Is that the favorite aspect of your job today?
Ray Kennedy:
Yes it is. Absolutely.
Robert Brunswick:
Are you still learning?
Ray Kennedy:
About once a week, I’ll run across a situation and I’ll walk away going, “I didn’t even know that existed. I didn’t even know that business was created.” For example, I was introduced to the concept of firms that basically do nothing but buy lawsuits and then they just build a portfolio of lawsuits, and then some work, some don’t. And based upon that, they can generate return for their investors. Obviously they’re ex lawyers in many instances, or lawyers from major law firms, and they’re buying these claims.
Robert Brunswick:
So, these are contingent winnings that they participate in?
Ray Kennedy:
Exactly. They’ll get 30, 40% if that works out. New business model. Never introduced to something like that.
Robert Brunswick:
Yeah, it’s funny you say that. I’m often amazed at just all the businesses there are out there and the different ways to make money.
Ray Kennedy:
Exactly.
Robert Brunswick:
And as you look at alternative investing, you see more and more of those kind of business options that you can consider. So, as we bring this to a close today, I’d like you to particularly talk to the younger generation, if you will. And what advice might you give them as they think about starting their careers, and from what you’ve learned, if you were to start again today knowing what you know, what words of advice might you provide?
Ray Kennedy:
Yeah, that’s a loaded question there. First of all, I have to give a plug for bonds because in the turmoil over the last couple of months, my son finally said to me, “Why aren’t I invested in bonds?” And I said, “Well, do you want to learn about them?” And one of the things I do realize is that the youth out there don’t understand bonds. And I even saw an article the other day about people are brushing off their books going, “What is a bond? How does it work?” My son, who’s an app developer, has said, “You really need to sit down and to help our generation understand bonds.” I’ve thought about that. That’s a really interesting idea because maybe we should do an app or something like that.
So I would tell, first of all, that generation, there’s an asset class out there besides equity. Everyone wants to buy Google, Starbucks, and all that stuff, that’s fun. Buying a bond, at times, can see boring. But as my son is discovering, it’s a very valuable part of the portfolio. He’s very happy he has bonds right now. Advice to young investors, the buy side tends to get overlooked and you tend to-
Robert Brunswick:
So can you be a little clearer?
Ray Kennedy:
I’m sorry.
Robert Brunswick:
Good. Thank you.
Ray Kennedy:
So, youth, when they get into our business, they tend to go to what we call The Street, that’s Wall Street. And you think what they do is, their job is acquisitions of companies, they help companies issue debt, and they can be analysts in doing that. They can trade debt and it’s sexy. That’s fun. They like it. They like the adrenaline that comes along with that. Typically, what happens is they reach a point where they realize that this is tiring. I want to get something a little bit more interesting and long term. And that tends to be our side because we’re investors. We’re buying what the street is selling, so to speak. That’s why we call that the sell side and we call us the buy side. And I would tell investors that for me, the lesson I took away, which was I was never trained in the financial space.
I was an engineer and I just put myself in positions that were uncomfortable at times and was able to develop a knowledge of finance. I discovered I’m pretty good at reading financial statements. And as a result I set myself up to have the opportunity to join PIMCO. I’m the classic case of where preparation meets luck creates opportunity. So I guess, my advice is learn everything you can, do as much as you can, don’t just get slotted into one area. I think the great thing about our business is we have constant job openings. We have constant opportunities. There’s always a new product out there that’s being created. And so everyone should try as much as they can to learn because you never know when that opportunity is going to come around like mine did for PIMCO.
Robert Brunswick:
Great takeaways. This has been wonderful. I think about preparation equals luck, nexus of capitalism. We’ve definitely had some good learning today. I hope you’ve all enjoyed it and I’ll look forward to seeing you again in our next episode. Thank you very much.