Masterclass

CEO of Norges Bank Nicolai Tangen, interviews Marc Rowan, CEO of Apollo 

The origins of podcasts can be traced back to the 1980s, but the term podcast itself was coined in 2004 by a Guardian journalist, Ben Hammersley, who concatenated the words “iPod” and “broadcast”. It has come a long way since, and has decidedly shifted public discourse away from the “legacy media”. Indeed, legacy media is undergoing an identity crisis and the premonition of its demise is illustrated by the fact that the term has become parenthesized. Case in point is President-Elect Donald Trump. Trump participated in nearly two dozen podcast episodes and livestreams in the lead-up to the election, and his most notable stop was The Joe Rogan Experience, where he joined Rogan for a three-hour meandering discussion at the podcaster’s Austin-based studio. That episode alone had racked up over 50 million views on YouTube; it is argued that this contributed to his electoral victory. Having established the significance of podcasts, I encourage you to listen to In Good Company with Nicolai Tangen, CEO of the world’s largest single investor, Norges Bank Investment Management, in which he interviews Marc Rowan, CEO of Apollo Global Management. It was nothing short of a masterclass by Rowan, and one that we will transcribe almost verbatim (albeit slightly edited).

First, the origin story. Founded by Leon Black, former head of M&A at the now-defunct Drexel Burnham Lambert, Apollo Global Management was established in 1990 following Drexel’s collapse. Black partnered with several former Drexel executives to create the new venture, raising $400 million in seed capital for its first investment fund. Apollo thrived during the downturn of the junk bond market, acquiring distressed securities and taking substantial stakes in companies undergoing bankruptcy restructuring. In March 2011, Apollo went public. The public offering positioned Apollo among a select group of publicly traded buyout firms on the New York Stock Exchange, joining industry giants such as Blackstone Group, Kohlberg Kravis Roberts, and Fortress Investment Group. Apollo’s real estate investments are managed through several entities, including its publicly traded real estate investment trust, Apollo Commercial Real Estate Finance, which went public in September 2009. Notably, this was prior to its parent company going public. The firm’s evolution has been underpinned by its acquisition of Athene Holding, a retirement services provider, which Rowan credits with “turbocharging” Apollo’s expansion into credit.

The decision to merge with Athene was initially met with scepticism from Apollo’s competitors, who believed that taking on the heavily regulated, capital-intensive balance sheet of a life insurance company would hinder Apollo’s capital-light, high-margin asset management business. But Rowan and his team saw this as an opportunity. By leveraging Athene’s access to low-cost capital, Apollo has expanded its credit reach and, as Rowan noted, positioned itself at the “investment grade end of the marketplace,” enabling it to fund large-scale, long-term projects like infrastructure and renewable energy. This commitment to long-term growth and careful risk management has won over investors.

Rowan:

If you look at the best way to describe what we do is to think about how we employ people. So if you look at the asset management business, we are 3,000 people in asset management. Then you look at the retirement services business, where 1,500 people in retirement services. And then there are 4,000 other people at Apollo who do not carry an Apollo business card, but instead originate credit. 

What we needed to be successful in that business was investment grade fixed income. But with a spread, and we start with a baseline view that public markets, particularly public fixed income markets, offer no alpha. So if your entire business model is dependent on fixed income alpha, and there is none, what do you do?

Well, you build the origination capability to service initially yourself, and that's what got us into credit origination. And then you realize that you want to be diversified. You don't want 100 % of any risk. You want 25% of everything and 100% of nothing. So we built a client business side by side.

Tangen:

There's been a lot of focus on how you are replacing banks through direct deals with companies. What business are you taking away from them or doing instead of them? 

Rowan:

Well, I think it's actually a bit of a misnomer. The press likes to report on this notion of banks and investors fighting over private credit.

But I think we have to start with a definition. What is private credit? Well, for most people, it means levered lending or direct lending, which is a below investment grade activity. And yes, it is true that the vast majority of levered loans used to be originated in the banking system, and now they are split between being originated in the banking system and being originated in the investment marketplace.

And yes, we are engaged in that business, but it is a very small part of our business. Generally, financial pundits and other market participants are missing the bigger trend… The vast majority of private credit is investment grade. So we look and now say, are we replacing the banks? Generally not.

Tangen:

Well, you're also working with the banks, right? You just did a big deal with Citibank. 

Rowan:

A bank is actually really, really good at doing some things. A bank is funded short, and lends long. A bank is not a great source of really long term capital. And think about what we're borrowing money for today. We're borrowing money for infrastructure, for energy transition, for next generation data and power, all really long term assets.

These are not the ideal assets for a bank balance sheet. Typically, they would go to the investment grade bond market, but they happen not to be great assets for the investment grade bond market either, because they are generally complex projects or structured in some way. What we are doing is we are matching really long term insurance liabilities with really long term investment grade counterparties in credit and becoming a provider of capital.

Because in almost every financial system, there are only two sources of credit. It comes from the banking system or from the investment marketplace. There's no third choice. Around the world, for whatever reason, regulators have decided that banks should do less, and investors should do more. And of that piece that investors do more, the investment grade piece, particularly the piece that is not well suited to the IG public market, is what we have really come to do very, very well.

In the U. S., bank lending is down to less than 30% of the overall market. In Europe, it's still 65%. In Europe, they are squeezing the banks harder than in the U. S., Basel III endgame, and so on. But at the same time, they have not liberalized on the investor side. It does not surprise me that Europe suffers from a capital deficit.

The U. S. is by far, the luckiest place in the world from a capital markets point of view. 50% of the world's capital is raised here and the diversity of sources. So again, think about an investor. Every dollar that moves out of the banking system increases the resiliency of the system and reduces the leverage.

A bank is levered 12 to 14 times, an investor is generally not levered at all. There is a reduction in leverage and diversity. A bank borrows short and lends long. Investors generally borrow long and lend long. There is no maturity transformation. There is no guarantee from Treasury. There is no deposit.

But the thing that always gets regulators, what percentage of a bank's balance sheet in the US, and Europe for that matter, is investment grade? 60%. Plus or minus. For us, our balance sheet, better than 90% investment grade. 

We're in the alpha generation business. Now we are only in the public markets, right? It's not in our mandate to be in the private market. What are we losing out on? You're losing out on 80% of the investable market [80% of companies over $100 million in revenue are private]. 

Think about people who are supposed to be able to outperform the index. Active managers. How have active managers done? Well, basically 90 plus percent of the time for the past 20 years, they have failed to beat the index. Did they get stupider? No. The structure of our market has changed. It doesn't mean bad.

It just means indexed and correlated. And so an investor, particularly an international investor who wants to express an opinion in the U. S., no longer comes in and buys a basket of securities. They buy the index. 

Tangen:

Now, you're also in the private equity industry?

Rowan:

I have forecast and I've said publicly, I think returns in traditional private markets on existing vintages of funds done over the past decade will be low. Why? People invested generally in the midst of the U. S. printing a trillion dollars following the financial crisis and then following COVID and you had interest rates near zero.

And I think we're going to have a bit of a shakeout in our industry. People who are giving you, in my term, private markets beta, I think are going to be smaller going forward, they will be less successful and people who really stuck to what they do well, giving you private markets alpha, I think, will continue to be very, very successful.

… my forecast for the industry is that you will end up with the large and the small. I think the middle is going to be a very, very tough place to be for a variety of reasons. 

But I also think we're going to have increased demand for private assets. I think that demand is going to come from family offices. It's coming from individuals. And it may in fact come from retirement systems. 

All of a sudden you have another source of demand: you have individuals who have almost no exposure to private assets, who are roughly the same size of institutions, who I believe will also participate in that marketplace. You then have retirement systems and retirement plans looking to provide retirement income who already have been big buyers of private assets, primarily fixed income assets, who are expanding what they do as the population ages.

And finally, I think you have public markets and private markets convergence. It's happening first in the debt market, but I think it will eventually happen to some extent in the equity market. So institutions who historically have limited their participation in private assets to their alternatives bucket, that was done out of a mistaken belief that private was risky and public was safe.

Tangen:

So is there such a thing as an Apollo investment philosophy? 

Rowan:

There is. It's that purchase price matters. We are great at finding value. Sometimes that value comes from trading hard work for purchase price, as in our private equity portfolio and asset management. But if you translate it over to fixed income. It's finding excess return per unit of risk. 

What do we offer people? What do we offer a client? We offer them judgment.

There's no secret sauce. There's no, you know, algorithm in the back room. It's judgment. How do you get judgment? I think you get it over a long period of time seeing what we do and don't do in a variety of challenging and not so challenging circumstances. 

What's been interesting about this is this industry started with private equity. Private equity is a very expensive cost of capital. Think of it as a 20% plus rate of return that is required. How many companies in the world with leverage are appropriate for that high cost of capital?

The answer is a few. Over time, what we've done is we've taken our skill set, our ability to originate, our ability to analyze, our ability to source, our ability to discern, and we've extended it from investment grade to levered equity. We've actually lowered our cost of capital substantially over time.

If you look at the average investment Apollo makes today, it probably has a 6 or 7% cost of capital. 

No, spreads are tight. In a world with geopolitical risk, where valuations are high and spreads are tight, why would I want to take lots of risk today? There'll be a time to take risk. After financial markets correct. At some point, they always do. That'll be a time when we want to take risk. But if you're looking for the Apollo DNA and Apollo philosophy, excess return per unit of risk.

Tangen:

So, this is a time where you're holding back a bit? 

Rowan:

We're definitely holding back in adjusting how we invest. Right now, we want return. So, if I give you the credit market return, reaching down the capital structure and taking more subordinated risk feels like a bad, bad idea today. 

Investors would be wise to examine Rowan’s “judgement” which he has cultivated over many decades in high finance, that: valuations are still too high, the amount of private capital is going to increase from non-institutional sources, larger firms are going to dominate and it is going to get tougher still to generate alpha. In fact, Tangen began the podcast by saying NBIM “are the lucky owner of just under 2% of Apollo”. This is a prime example of the growing chasm between private markets and public market players. It is Rowan’s firm that is increasingly the goliath, not Tangen’s.