Podcast Transcript: Daniel Zwirn on Finding Value in the Biggest Bubble in History

This is an edited transcript of our podcast episode with Daniel Zwirn, published 14 April 2022. Dan Zwirn is the Co-Founder, CEO, and CIO of Arena Investors LP. Arena is a $3.4 billion global investment firm focusing on special situations asset and credit investments in corporates, real estate, structured finance, and corporate securities.  Before founding Arena in 2015, between 2009 and 2015, Dan founded and/or led several specialty finance enterprises including Applied Data Finance (a consumer finance company), North Mill Capital (an asset-based lender), and Lantern Endowment Partners (an investment fund). In the podcast, we discuss the problem with niche investors, the inflation problem, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

Introduction

Bilal Hafeez (00:00): 

Welcome to Macro Hive Conversations with Bilal Hafeez. Macro Hive helps educate investors and provide investment insights for all markets from crypto to equities, to bonds. For our latest views, visit macrohive.com. We recently conducted a survey of Macro Hive members, and the feedback was very positive. What stood out for me though, was the educational role Macro Hive is increasingly playing for our members. In this context, members love our new explainers, where we give overviews on topics like fertiliser prices, the EU taxonomy on green energy and the blockchain. 

Members also learn a lot from our deep dives where we summarise the latest academic papers on markets and the economy. Then there’s a member Slack room where people can help each other understand different niches of markets or the economy. Macro Hive is there for an excellent educational resource for investing in markets and understanding the global economy. You can get access to all of these resources as well as our timely market updates and investment views as a member of Macro Hive. 

Normally, membership costs the same as a few weekly cappuccinos, but as it’s Easter, which is a great time to start a fresh and make new habits, we have a very special offer where you can pay just $1 for two months membership. Now there’s no excuse not to become a Macro Hive member. Just go to macrohive.com/easter to get that special offer.  

And if you’re a professional or institutional investor, we have a more high-octane product that features all of my and the Macro Hive researchers’ teams views, our model portfolio, trade ideas and machine learning models, and much more. Hit me up on Bloomberg or email me at bilal@macrohive.com to find out more.  

Now, onto this episode’s guest, Daniel Zwirn. Dan co-founded Arena Investors in 2015. Arena is a $3.4 billion global investment firm focusing on special situations, assets, and credit investments in corporates, real estate, structured finance and corporate securities. Before founding Arena between 2009 and 2015, Dan founded and led several specialty finance enterprises, including Applied Data Finance, North Mill Capital, and Lantin Endowment Partners. In 2001, while the managing direct and founder of the Special Opportunities Group at Highbridge Capital Management, Dan, along with Highbridge co-founded D.B. Zwirn & Co, a global special situation firm, which grew into a $6 billion enterprise. He previously founded the Special Opportunities Group of MSD Capital, the private investment firm of Michael Dell. Now, onto our conversation.  

So, greetings Dan, it’s great to have you on the podcast show. I’ve been looking forward to our conversation for a while now, and I’d like to kick off with learning a bit about your background. I always like to ask my guests their origin story, where do you go to university? What did you study? Was it inevitable you would end up in finance and then something about your journey till now? 

Daniel Zwirn (02:52): 

Sure. Well, so I grew up in Pittsburgh, Pennsylvania in the 1970s, which at that time was one of the kind of big corporate headquarters in the US and had no idea whatsoever about finance and ended up going to the university of Pennsylvania in a programme called the management and technology programme where I did both an undergraduate degree from the Wharton School of Business, as well as a computer science degree from the, at the time, the Moore School of Electrical Engineering. 

And while I was there, I started to meet people who were familiar with the kind of whole world of Wall Street. And it struck me that there was a possibility to kind of move along quite a bit faster with a lot more efficiency in the world of finance than perhaps in the world of kind of joining a conglomerate and moving all over the world every 18 months, such that, like I saw in Pittsburgh, you could end up 40 years later, at the top of one of these large industrial enterprises. 

And so, Wall Street attracted me very quickly and I started reading everything I could and talking to everyone I could and ended up in mergers at Lazard Freres, where I worked in media and communications. My first transaction was the acquisition of Paramount by Viacom. And there learned that was kind of a kind of pre-millennial experience, that was great domain learning as well as how to be a professional and how to deal with quite varied personalities. 

But got very quick exposure to very senior folks who had very high standards for what they wanted to see and how they wanted to see it, and also learned about the media business. And from there, I went to private equity in communications as well at a firm called Madison Dearborn Partners in Chicago, which is a great place where I learned a lot and then went to Harvard Business School. 

And while I was at Madison Dearborn, I started to think about the notion of what would make an investment business a good business, and kind of wrote out a plan for the business we have today here at Arena in 1995, that basically was based on the notion that looking historically, there was an opportunity to really look at the degree to which firms like MDP at the time and more so at the time Blackstone or Hicks, Muse or Carlisle were viewed as stewards of capital. 

And could you use that relationship with investors to really diversify yourself away from simply larger scale PE and really be a gateway to the alternative’s universe for those folks. And if you could do that, could you then look at how to access capital more efficiently, which the hedge fund world gave you. And could you look at husbanding scarce resources or cash or assets and effectively become what we refer to as a global chaser of illiquidity. And could you then optimise your infrastructure to kind of leverage that flexible mandate of the hedge fund world to kind of create advantage and on and on and on. 

Bilal Hafeez (05:55): 

And that idea came very early to you in the mid-1990s? 

Daniel Zwirn (05:59): 

Yes. Look, I’m a geek a little bit about the kind of financial history and there is no nothing new under the sun. And if you look at the European merchant houses of the 1800s, or you look at the global green traders, or you look at the most successful Asian Hongs, what was unique in all of those instances was that they weren’t better pickers of situations, they weren’t the smartest investor who could pick the right stock. They husbanded scarce resources, frequently cash, but sometimes other things. 

And they demanded a premium for effectively the dealing with some sort of process issue versus requiring themselves to be smarter than the other guy. They had a true edge and they systematically created more and more of it. And that notion of, as I said, being a global chaser of illiquidity seemed to never stop working. And so the question was, how do you create that in the modern era? And that’s what led me to the business we have today. 

The problem with niche investors 

Bilal Hafeez (07:02): 

That’s great. And why do you think there aren’t that many firms doing what you’re doing or structured in this way, where you’ve combined the ability to raise capital in a way that allows you to deploy it with certain opportunities, the hedge fund structure of one level, the illiquidity investments on the other level, and not just being a pure play private PE firm? I mean, why aren’t there more of such firms? 

Daniel Zwirn (07:26): 

Well, I think arguably it creates some dissonance on the part of investors, right? So, in the time since the GFC, the vast majority of the explosion in alternative assets has come from the world of what I would call generally draw down investors, right? That kind of came from among others, the pension world, where there was this notion of top down allocation, right? 

I want to go to a department store full of investment options. And I want to pick my best European real estate mezzanine firm and my best Japanese private equity firm and so on and so forth. And I derive value, I create value for my key stakeholders, investment committee, or otherwise, by being able to have a top down view and pick from these little products off the shelf. And as opposed to pre GFC hedge fund world, which over time became very comfortable with, let’s just put the ball in the hands of the right person and give them the ability, not only to do whatever makes sense, but more importantly, not do what doesn’t make sense. 

And let’s rely on alignment of interest to kind of drive forward opportunities and allow us to avoid moral hazard. And so, as the alternative space kind of has grown in and around the draw down world, there has been a systematic under appreciation for the risks associated with moral hazard. And so if I have the quote unquote, best European real estate mezzanine debt investor, that investor will tend to be a hammer that only sees nails, right? And kind of leaps over the cliff and take my money with him. 

And if you look historically at the last several hundred years, and certainly the modern capital market starting in the 1600s in Amsterdam and forward, but many examples before that, moral hazard is what destroys financial enterprise over and over and over again. The feeling that if I don’t do X, I won’t make my daily bread, so I’m going to do it and I’m going to make excuses for it, no matter how unappealing it is until finally there’s a collapse that destroys people in our business, whether that’s in this era, funds or banks or insurance companies, or many other forms of financial entities have died by that very same sword over and over and over again. And so we try to avoid it. And we have investors who buy into that notion and understand that with flexibility comes risk reduction, not risk increase. 

Bilal Hafeez (10:11): 

And if you are to take the approach you take, how do you maintain some levels of expertise in all of these different asset classes? The pension fund wants to invest in European mezzanine or Japanese private equity, it may well be the case that, that might be the opportunity right now. And how do you have that expertise then? 

Daniel Zwirn (10:31): 

That speaks to the question of how do I get the domain expertise milk without buying the cow. And so we delineate between those who work with our firm and those with whom we partner or joint venture in various ways around the world. And our investment teams have a unique domain capability that is monetisable throughout a cycle because it’s wide enough to do so, whether that’s north American corporate, north American real estate, structured finance, global capital markets, European illiquids, there’s enough meat on that bone throughout a cycle to allow for the avoidance of moral hazard. 

That said, within all of those areas, there are kind of what I would call sub sectors or so up areas where there’s some particular unique sourcing, analytical or servicing capability that we’d love to access that is able to be understood very thoroughly by our teams, but where the opportunity is kind of episodically of interest. 

And so the question is, can we access those things on a variable cost efficient basis in a hyper aligned manner, right? Meaning, our partners are always writing cheques that are very meaningful to them, such that while we make the decisions for our investments jointly or rather the investments that we have jointly, we make the decisions solely, the ability to have a partner on their side that is there for them when there’s something that makes sense is very valuable. 

And the very fact that they are writing cheques themselves frequently means that we are collectively on the right side of the moral hazard trade, right, where they’re actually highly disincentivized to just want to be a hammer that sees nails because they have their commercial life on the line. And so this complimentary group of investment units that we have mixed with these joint ventures that give us this access means that we get all the domain expertise that comes with people who know a very particular thing and have done it for 30 years, but without being on the wrong side of the moral hazard question, putting into business people who have to put money out in order to kind of do well and cover their overhead and pay their employees, that is the key. 

And so that combination is vital and you couldn’t make that work unless you had the flexibility of mandate that we do such that we can be there for them when it makes sense. It wouldn’t work if you go well, I know you have that great opportunity, but oh, by the way, by our statute or our rules, we can’t do X, even though it’s commercially totally the right thing to do, right, then it wouldn’t work. And so it all comes together, right? The combination of the flexibility of mandate, the proprietary and hyper aligned sourcing infrastructure, and then all the kind of pipes and mechanics to make it all run, have to all be there in place for it to work in the way that it does. And we’ve been able to assemble that and explain that to investors and have them buy into that combination of capabilities that gives us a sustainable edge. 

Understanding attachment points and understanding risk 

Bilal Hafeez (13:48): 

It sounds really quite comprehensive. And so, I mean, how do you go about finding investments then? I mean, do you have a top down approach where you first look at the business cycle and then start to drill down by product and by region, can you talk a bit more about the actual process itself? 

Daniel Zwirn (14:04): 

Sure. Well, it’s actually very much a bottom up process and it’s based on the logic that the more permutations of industry product and geography we’re looking at, the more we’ll see the dispersion on a risk reward basis among all of those potential investment opportunities. And so the more you see, the more orthogonality there is, i.e., the lack of correlation amongst the things that you’re looking at, the more obvious the difference is between that which is really compelling and that which is highly uncompelling. 

And so that really kind of starts with mowing through huge numbers of opportunities and by virtue of having 100 people at our firm plus another several hundred within our various joint ventures all around the world, we’re looking at 10 to 15000 things in order to find 70 or 80 or 100 that makes sense. 

And so those things just naturally bubble up. In some ways, it’s a little bit like even as Jim Rogers has said in one of his books, he doesn’t feel like he invests, he feels like he just waits until there’s money sitting in the corner that he can just walk over and kind of brush into his pocket. If it’s not that obvious, we don’t want to kind of be near it. And so that funnelling, or what we call the Darwinian funnel whereby we’re kind of force ranking on a risk adjusted basis among a very great number of opportunities that differ in significant ways amongst one another is how we find the kind of the cream skim flow, so to speak that allows us to deliver the edge that we do. 

Bilal Hafeez (15:40): 

And how quantitative is the approach? I mean, you mentioned sort of 10 to 15000 opportunities. I mean, presumably there’s some quantitative process as well, to be able to have such a wide reach. 

Daniel Zwirn (15:51): 

I would say we would apply what we refer to as attachment points to everything that we do, right? So whether it’s a company or a piece of property or a structured finance asset, or a tradable security, we look at each opportunity as a vertical stacked set of risks, where at the top you have by definition, the least risk and at the bottom, you have the most risk. And at the top you have the least susceptibility to either idiosyncratic or macro risks, at the bottom you have the greatest level of exposure to those risks. 

And furthermore, we overlay beyond on that, that relative amount of risk, the duration that we’re involved, right? So the longer I’m involved in a given investment, the more chance I have to be exposed to a risk, again, either idiosyncratic or macro. So the question is among all those different things, where is the greatest amount of return relative to the most senior part of the stack of risk for the shortest period of time, right? And so if you look at everything through that lens and kind of optimise for that ratio of return per unit of risk as measured by attachment point, hyphen duration, right, you find yourself in some pretty good stuff. 

Examples of high-return/low-risk investments 

Bilal Hafeez (17:17): 

Understood. No, that makes sense. Do you have a few opportunities that you can talk about and then we can kind of see how the process works in practise? 

Daniel Zwirn (17:27): 

Sure. So as a simple example, we have been buying non performing loans in the New York tri-state area with a partner at par, from banks. So why is that interesting? Well, they’re non-performing, so they’re not paying interest for some reason, but they’re the most senior obligation in the capital structure. They’re secured with liens on very understandable property. They have average loan to values of call it 65%, but the borrower is not paying. 

And maybe it’s because cashflow has been momentarily reduced for whatever reason, or they otherwise are not in the mood. And by virtue of that, they’re what’s called a criticised asset. So the bank has to put up more capital against it. And so it’s actually that much less profitable for them to wear that asset on their balance sheet, because they can’t leverage it. And as a result of it being non-performing, instead of the borrower being charged three or 4%, it’s typically subject to statutory default interest in New York state of kind of in excess of 20%. 

And so that’s accruing along the way. And so if the bank sells a loan at par, it’s happy. It gets the capital back. You can put it into a new loan where it has to put up much less capital than a criticised asset. So it’s an accretive thing for the bank. It gets rid of someone who’s probably been a pain in their butt for some reason or other and is not paying, but they give away all the 20 plus percent accrued that they likely haven’t been accruing on their books, even though it’s accruing to the borrower and they’ve kind of cleaned out a problem. 

And so we buy that at par, even though the unpaid balance is significantly above that. And we might say to the borrower, because mind you, we’re still at 65% loan to value or 70, please go ahead and refinance us, including our accrued 20 plus percent rate, so our unpaid balance, which would be a profitable exercise or we’ll do a new loan or we’ll extend this loan out for another six or 12 months. But instead of 4%, we’ll charge in the mid teens, which is kind of your new risk zip code now because borrower, you haven’t been paying, even though the loan is certainly worth par because there’s significant value subordinate to the loan. 

Or there’s door number three, which is we’ll foreclose and take the asset and monetise it because we know it’s significantly worth more than par and we’ll make even more. And so, as you can see at exercise while there’s some kind of bumps to that process, to that situation, it’s immensely difficult to see how you lose money and whether it’s door number one, door number two, or door number three, we’re going to make a pretty good amount of money for simply taking an asset through a process one way or another. 

And so that’s a pretty asymmetric return per unit of risk, right? And particularly because it’s all set up to be effectuated within a year. So, I’m taking very little value risk because there’s 30, 35% subordinate value to us, junior to us, taking very little duration risk. In fact, I control the duration, right, but I’m getting paid somewhere between the teens and 20 plus percent to just kind of walk this asset through its natural resolution one way or another. 

Bilal Hafeez (21:10): 

I mean, that’s very clear and I wonder, I mean, how much competition is there to acquire those assets then? I mean, the way you describe it sounds really compelling. 

Daniel Zwirn (21:19): 

Well, not everybody wants to go through that sturm and drang with a counterparty, not everyone wants to buy those assets, who are capable of doing that process in bits of eights and tens and twelves and $15 million pops, right? A lot of folks like to put tonnes of money at it in one shot, right? And you have to go find it. You have to be knocking on the door of in this case, commercial bank workout officers, staying in touch saying, hey, I’m here if you need me for a period of time and we have partners who make it their business to know those people. 

And so putting all those pieces together to be there when that opportunity arises is the challenge. By being there at the right time with the right kind of money with the right appetite and the right capabilities when the opportunity arises, you’ve kind of won before you started. And the question is, how do you set yourself up as an organisation such that you keep seeing things just like that over and over and over again. And that’s what we spend our time thinking about. 

Why we are in the largest asset bubble ever 

Bilal Hafeez (22:20): 

And so you see so many of these types of deals and if we step back, there’s a lot of talk right now about us being in a bubble, in markets there’s been too much leverage, central bank’s been printing money. And so what were your thoughts on that? Because you probably see it at a much more granular level than many other people do. 

Daniel Zwirn (22:39): 

Yeah, well, I think we are possibly the largest asset bubble that there’s ever been. We have had really profligate and inappropriate monetary policy in the US and elsewhere in developed markets since the early 20 teens, right? There was some justification for those methods in the wake of the crisis in helping effectively jumpstart the world’s major developed economies through effectively borrowing from the future to kind of bring markets back to where they needed to be. 

But there was no excuse for doing that once we were out of that and yet it continued. And through a combination of quantitative easing and artificially suppressed rates, basically risk was systematically mispriced. And when you systematically misprice risk and you set up a dynamic whereby the markets are trained to expect that if there’s an issue, the Fed will come to their rescue, the obvious thing happens, which is that people take way more risk than they should because they don’t think there’s any reason not to. 

And so what Japan showed us is that, that can work for a while. You can just create a couple decades of bad risk pricing and a bit of a malaise, but you can potentially avoid a material panic. What has changed in the last 12 to 18 months is that we’ve combined that really inappropriate monetary policy with grossly profligate fiscal policy. And so you can’t just start spending way more than you have while people have been trained to take on tonnes and tonnes of risk, because what ultimately then happens is inflation. And inflation comes in forms, right in terms of consumer prices, as well as asset inflation, which effectively represents the de-basing of the value of a given currency, right? 

So, the purchasing power of the US dollar or the Euro or the Yen has been materially diminished. And what happens is then, and it’s never not happened is that inflation begets more inflation until something arises to stop it. And either that will be appropriate monetary policy, which the Fed has thus far not seen fit to implement because it’s obviously politically difficult and people will be angry at them, et cetera, et cetera. It’s not good for maintaining one’s job security in those seats or a material panic will result. 

And that is how it has always been, that arithmetic is unavoidable. Either we will preemptively attempt to bring this under control or the market will do it for, and that’s how it’s always been and that’s how it always will be. And so we’ll continue to see this inflation and it’s exactly at the wrong time, given the kind of bowling up of the market that we’ve seen through, as people call it, the everything bubble since the early 20 teens. So it’s a very treacherous time. 

Bilal Hafeez (25:46): 

And over the last few months, we have seen some corrections in markets, stocks have fallen somewhat, credit spreads have widened somewhat, we’ve seen a bit more volatility. Is that the beginning of the bubble being deflated? Does that bring valuation to more attractive levels or do you think this is just the beginning of something much bigger? 

Daniel Zwirn (26:07): 

The effect has been very all. And as you look across corporate credit, ABS, mortgages, all different forms of risk assets, the majority of the diminishing in value particularly on the fixed income side has really come from expectations on rates. And the reality is ultimately great moves in rates become great moves in credit, and we’re nowhere close to where we need to be on either of those two measures in order for there to be kind of good value generally in the markets. 

And there’s a whole lot of structural reasons why all effectively stemming from various forms of moral hazard, various forms of expecting something to save you that has allowed owners of those assets not to sell, to feel like there could be someone to help them avoid the inevitable losses that are coming. And so I think we’re only in the very beginnings of that. We’ve got a long way to go. 

Parallels to the 1970s (and 1960s) 

Bilal Hafeez (27:06): 

And many people make parallels in the 1970s. I mean, do you see parallels or do you think this is different or? 

Daniel Zwirn (27:13): 

Well, I think the 1970s started in the 1960s, right? And where you had in the US, a tremendous over commitment internationally and domestically with profligate fiscal policy and the resulting inflation was theoretically combated by wage price controls under Nixon, which of course didn’t work as top down government methods of that sort never worked and have never worked despite the fact that governments keep trying them. 

And that ultimately led you to inflation and to the mid 1970s. And at that point under Arthur Burns, then they started playing with the definition of inflation to try to pretend that it wasn’t happening, well, that doesn’t work either. And that’s why if we see our current government talking about things like the strategic oil reserve and how the meat packers are gouging and all of this nonsense that doesn’t speak to actually the underlying fundamental problems. 

And finally, you got to the stagflation of Carter, which was only ended by Volcker in the early ’80s. And so we’re certainly heading in that direction. Given the valorization of the monetary authority since then, it seems highly unrealistic to expect monetary authorities to kind of do the right thing. The level of blow back that a Paul Volcker would feel in today’s world would be such that it would be incredibly difficult to imagine someone coming in and doing that. And therefore, ultimately the correction will be left to the market and we will see continued, I believe continued diminishing of the value of the currency, i.e., inflation that will only be stopped with a panic. 

Bilal Hafeez (29:01): 

Quite sobering thoughts there. And so in this environment, are you biassed to hold, be a bit overweight cash? 

Daniel Zwirn (29:14): 

Well, cash is an ugly place to be, right? 

Bilal Hafeez (29:17): 

Yeah. With returns are so low and adjusted for inflation as well. 

Daniel Zwirn (29:21): 

Well, the government has demonstrated a commitment to destroy the value of fiat currency, right? And so that’s led to people running toward NFTs and forms of crypto and other kind of speculative non-income creating underlying assets in order to kind of find places to hide. What I think you do is you recognise, certainly we recognise that one saving grace is that the degree of bubbliness of investment opportunities is highly correlated with their available size. 

So going back to the example we just discussed, if that loan we bought was $150 million loan, instead of a $12 million loan, a lot more people would be there wanting to buy it and might in fact pay way more than par in order to get it. And so we focus on a greater number of smaller opportunities. It hadn’t been accorded the kind of benefit of the doubt given to larger scale risk assets. 

And so as an investment manager, when you go from being an investment business to a marketing business, and you are driven by deploying as much money as you can, as fast as you can to get to the next fundraise so that you can do it all over again, you’re not really geared to kind of stay where the opportunity is. You’re geared kind of sell more stuff. And as the alternative space gears itself more toward the kind of long only fidelity style marketing driven distribution oriented model, it leaves those types of opportunities that tend to flout the ability to scale open. And there’s a disproportionate return per unit of risk available, and we want to go after them. And that’s where we spend all of our time. 

How pension funds can get better returns 

Bilal Hafeez (31:08): 

And when you look at the kind of end investor say, or say pension funds, they’ve been struggling to meet their liabilities or their future liabilities at the same time, they seem to fall for the marketing that you’ve mentioned, they kind of follow whatever the latest fad is. I mean, what would your advice be to pension funds around the world who it just looks like it’s going to be tough for them to deliver on their promises? 

Daniel Zwirn (31:35): 

Well, it isn’t easy. In fact, I was just asked this question by a very smart advisor to pension funds. And the answer was, I think there are places to hide here and there. One thesis that we’ve followed at an investment committee with which I’m involved is a focus on basically very experienced managers, even across different types of assets who are managing significantly smaller amounts than they otherwise are able to, because they, for instance, move from a giant firm to their own firm or whatever the reason might be, they’re putting up large amounts of their own dollars. And by virtue of going from the large place they were at to their own place, they go from being someone with 25 or 30 years of experience at an enormous gold star rated place to a quote unquote emerging manager. 

And so there’s an arbitrage opportunity available because a superstar person has not gotten its kind of badge of honour. And because it’s viewed as quote unquote first time fund, you get all that capability, basically managing a much smaller amount of assets that allows that manager to kind of access these kind of more differentiated opportunities and you get to make excess return. And there are dozens and dozens of those kinds of folks around the world who are very savvy and capable who are pursuing entrepreneurial opportunities or what have you, where you can create edge. 

I would also say that for large scale entities to really look through all of their investments using the filter of attachment points is helpful, right? So what we find with a lot of large scale allocators is there’s very little attention paid to where their asset exposure is in the stack of risk. So one example might be in commercial real estate where folks intuitively think of something like real estate as being stable and solid and wonderful, but don’t take into account that, that frequently means they’re on the bottom of a large stack of debt and subject to a very large amount of duration, which effectively puts them in a position of taking a very levered bet on credit spreads and risk free rate, right? 

And if you look through all of your investments with that lens of return per unit of attachment point slash duration risk, it certainly, it starts to paint a very different picture of a given allocator’s portfolio than he or she otherwise might understand it to be. And so there are ways to kind of dance among the raindrops. It’s certainly very difficult and a lot of the artificial and arbitrary indices and method that a number of these folks are tied to put them in a very difficult position where when they’re trying to avoid being effectively, a large scale price taker instead of a price maker. 

The big risks for the next 12 months 

Bilal Hafeez (34:34): 

And through our conversations, you’ve mentioned a number of different risks. I mean, for you, what are the biggest risks at the top of your mind for the next say, 12 months that make you worried or keep you up at night, so to speak? 

Daniel Zwirn (34:47): 

Well, they don’t materially worry us because we’re not exposed to them, but there are certainly left-tail risks that may precipitate the kind of sudden popping of the bubble. And those really are ultimately things that are not expected by the market. So you could see something like an invasion of Taiwan by China, as an example of being something that would be very surprising and much more impactful potentially than what we have with Russia and Ukraine. 

You could see a new version of COVID that is not nearly as easy to be, as ably to be extinguished as the current ones have been. You could see lots of different surprises. You could see a large scale financial enterprise subject to a massive fraud. And certainly over the last 14 years of everything going up, it is highly likely that many frauds have been covered up. And when in, as an example, in 2002 WorldCom kind of made itself apparent, it definitely scared the market very suddenly, and it caused large scale selling in a very furious way. So, there’s plenty of these kind of left tail idiosyncratic or macro risks out there that may arise. But there’s probably nothing more likely than just continued escalating inflation and as the excuses come and go, inevitably that tends to accelerate and that could be a very dangerous thing. 

Bilal Hafeez (36:24): 

Very sort of sobering there. Now we could continue talking about markets, but I did want to ask you a few personal questions, given your level of experience, one was what’s the best investment advice you’ve ever received? 

Daniel Zwirn (36:38): 

Well, I think various forms of, as Buffet says, staying within your circle of competence. I think the biggest thing that we focus on in a general sense are distinguishing between those things that are under our control versus those things that aren’t. And when you see people invest in commodities or other kind of macro oriented areas, or non-asset producing assets like gold or crypto or things of that sort, you’re ultimately relying on what other people think. 

And we have no idea what other people think at any given time. And so we very much try to isolate what the place where we have edge, which is understanding kind of value today and it represented by a series of cash flow that will be created by a given thing that we’re looking at and where we sit in the stack of risk against that hard asset, whatever that might be. And so that’s seems kind of boring. It’s not as thrilling, doesn’t have the vol, you’re not going to make three times your money overnight. It’s a grinding thing. And as Buffet says, people are very unlikely to be happy with making money slowly, but that’s the only way lasting value is created in things that are within your circle of competence, where the items at issue are knowable. 

Bilal Hafeez (38:12): 

No, those are very wise words. And in many ways, the time we live in people don’t really have much patience. And so that really is an edge as well if you just have that willingness to grind out those returns. The other question I wanted to ask was, given you must be inundated with information and deals and so on, I mean, do you have a system of how you manage all of this and research as well, I guess? You must be exposed to so much. 

Daniel Zwirn (38:41): 

I am. Well, I think I would say, as we organise ourselves first off in so far as we focus on decisions and investments that are highly idiosyncratic, we attempt to systematise and make homogeneous everything else about our business. And so we are very much focused on our process and IT systems that allow us to mow through many of these different things that we look at. I’d say, number two is, and I learned from one of my early bosses, that a good view, which is you don’t understand anything you can’t write down clearly. And so everything that we do, we write down clearly and we go through it and we ask questions, we write those questions down and we answer those questions and we iterate and we iterate and we iterate in a very clear, crisp way. 

And so that works for me because I tend to like to read. I have a great capacity to read. I enjoy it very much. And so, we tend to have very set ways of writing things down, such that I can kind of get to the nub of what’s going on in a given investment pretty efficiently. And that has created a lot of great writers at our firm as a result, I think, who are able to communicate very clearly and effectively. And so working on that process by which those kind of raw ideas are processed into very clear crisp theses, focused on things that are knowable is kind of what we work on every day. 

Books that influenced Dan

Meditations (Aurelius) and Enchiridion (Epictetus). 

Bilal Hafeez (40:18): 

And you mentioned reading and I enjoy reading as well. So I always like to ask guests what books have influenced them. 

Daniel Zwirn (40:26): 

Well, it’s a pretty long list. I would say if I had to kind of pick one or two, I would say, I would note I’m pretty big of stoicism, which I think applies really well to investing among many other things. And so within that, I would give as examples, Marcus Aurelius Meditations or The Enchiridion of Epictetus, as good examples that I think can only make a would be investor more thoughtful and better at what he or she does, but also apply to many other things outside of investing. 

Bilal Hafeez (41:06): 

That’s great. That makes a lot of sense. And so finally, how can people learn more about yourself or your firm and your process? Where should they go to learn more? 

Daniel Zwirn (41:20): 

Well, we have a website www.arenaco.com and unlike a lot of firms in our business, we’re effectively a public company through our holding company partner West Aim, which is traded on the Toronto Stock Exchange under Bloomberg {WED:CN}. So there’s quite a bit of public information about us. 

Bilal Hafeez (41:43): 

Great. I’ll include all of that information on the show notes as well. So with that, thanks a lot. Dan, it was excellent speaking to you, and I learned a huge amount as well. 

Daniel Zwirn (41:52): 

You’re welcome. Nice to speak to you today. 

Bilal Hafeez (41:54): 

Thanks for listening to the episode. Please subscribe to the podcast show on Apple, Spotify or wherever you listen to podcasts. Leave a five-star rating, a nice comment, and let other people know about the show too. We’ll be super grateful. Finally, sign up to become a member of Macro Hive and macrohive.com. We’ll be back soon. So tune in then. 

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)