Arena’s Dan Zwirn sees tough times ahead and that’s just fine

The market response to the 7.7% October rise in consumer prices from the year before, down from 8.2% in September and lower than economists’ average estimate, suggested a more optimistic mindset among investors. The S&P 500 that day surged 5.5% to 3,956.37, its strongest one-day gain in more than two years, while the Nasdaq Composite jumped 7.4% to 11,114.15. The Dow Jones Industrial Average advanced 3.7% to 33,715.37.

That leaves Mr. Zwirn in familiar territory, at the pessimistic end of the market sentiment spectrum.

Mr. Zwirn, who founded Arena in 2015, has been warning for years that overly aggressive monetary and fiscal policy was creating a financial house of cards. This year’s ugly turn for markets — with spiking inflation igniting an aggressive rate hiking cycle by central banks — hasn’t forced the firm to review its business strategy, he said.

Instead, “the environment has come into line with my thinking,” Mr. Zwirn said.

That hardly makes him a Nostradamus, Mr. Zwirn said. The arithmetic of how markets work simply made it inevitable that the “completely unnecessary quantitative easing started in 2012” and put into overdrive in 2020, combined with “grossly irresponsible fiscal policy,” would result in escalating inflation, he said.

On that score, he contends, markets would have desperately liked to see a Republican sweep in the U.S. midterm elections on Nov. 8, as gridlock — with Republicans in charge of Congress and Democrat Joe Biden’s term as president extending through January 2025 — would limit the potential for further “grotesquely profligate spending.” As of Nov. 11, a number of races remain too close to call but Republicans look set to at least regain control of the House of Representatives.

More broadly, investors on the lookout for market-friendly policy pivots anytime soon are likely to be disappointed, he said.

If some market players still hold out hope that “once risk-free gets to 4.5%, inflation will come back down … that’s totally not going to happen,” Mr. Zwirn said. “It doesn’t take into account the fact that quantitative easing basically gives you another … 300 to 500 basis points of risk free that needs to get worked out,” he said.

The punchline? “I think there’s a lot of downs relative to the upside from here.”

If the market outlook is grim, however, the prospects for Arena’s private credit lending business is anything but.

Arena has eight business units – North American corporate; real estate; structured finance; global capital markets; European illiquid; Asia-Pacific illiquid; natural resources; and secondaries and liquidity solutions — and in each “there are exceptional things that we’re pursuing” now, Mr. Zwirn said.

From a credit perspective, trillions of dollars went into growth-oriented enterprises that systematically sacrificed profitability to boost revenues in pursuit of escalating valuations. That left those companies in a box when that growth didn’t show up, he said.

Now, with the collapse in those capitalizations, a capital provider such as Arena can be “a beneficiary of (those enterprises’) desperation not to price their equity,” coming in way senior, super low loan-to-value, with considerable potential to extract high yields, Mr. Zwirn said.

The opportunities Arena is finding now for all eight business units, ranging from “kind of tactical, to already happening, and then on the way,” have become far more numerous over the past year, he said.

In many cases, it’s an “enterprise, or an asset, or an area or a team we’ve been following for years and we’ve both been saying, hey, love you but nothing to do. And then it’s like, they call us or we call them and we gotta run, right? Here it is, we gotta get out there,” he said.

On the tactical side, an example of the opportunities thrown up this year as equities quickly fell into bear market territory has been convertible bonds.

When the “convert market kind of exploded” early this year as the shares of major issuers such as tech companies led the way down, “institutional owners of the converts sold but meme owners of the stock didn’t react nearly as dramatically,” creating free upside for investors who bought the convertible bonds as well as puts on the underlying stock, Mr. Zwirn said. “We did a bunch of that,” he said.

The biggest opportunities coming down the pike for Arena will be found in the leveraged finance space, as the market’s new math puts a stop to financial buyers paying 13 times for an eight times business, Mr. Zwirn said. Similar opportunities will present themselves in mortgages and asset-backed securities, he said.

The entire game of “I over-lend … at too high a multiple, to finance a private equity buyer’s too high a multiple acquisition is now over because it was completely dependent on accessing financing that itself was dependent on issuing collateralized loan obligations, which were themselves dependent on the ready availability of AAAs and people willing to buy other people’s CLO equity at incredibly tight expected returns,” he said.

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