Jon Gray in Conversation with Professor Brian Lancaster | Columbia Business School

I wanted to be a professional athlete, like all little boys, I guess. In the seventies in Chicago, I played sports. That's what mattered to me. Basketball, baseball, football. I would say school was not a primary focus. I got to that probably a little later than most people, certainly people high achieving people like the folks in this room. The most frustrating thing was I grew late, so my high school athletic career was not what I would've hoped it would be. But it was interesting you mentioned Blackstone, which is a funny story. My grandfather had a manufacturing company that did automotive parts called Blackstone Manufacturing Corporation. Unfortunately it got into financial trouble late seventies, early eighties. But I was very proud of the fact that when I got the job at Blackstone straight out of college, just before my grandfather passed, I told him I'm going to work at Blackstone, so he was very happy about that. But I would say I was focused on making friends, sports, athletics, and the good thing was I did good enough in school that I was able to get to the East Coast and get to Penn. That's really where everything changed for me.

I would say luck has been a core competency for me for a long time. What happened? First of all, I'd never been to the East Coast. Connecting the dots from Chicago to Blackstone, I got to Penn. I remember I came to New York and it was at Columbia. I had a friend who'd gone to Columbia in fall break of my freshman year. In 1988, I came to New York and I was like, wow, this is amazing. But I made a really good decision at Penn, which was to get a dual degree. I was an English major and I was in Wharton and Finance, and that turned out great in terms of all sorts of life skills. But most importantly in my senior year, I met a young woman in romantic poetry class. She's blushing. Yeah. And I got a job at this very small investment advisory firm Blackstone. If you said why did I go to Blackstone? I think part of it was I was a bit of a political junkie. Pete Peterson, one of the co-founders with Steve, had been a former Secretary of Commerce. At the time, Roger Altman, who'd been in the Treasury Department, David Stockman, who'd been the head of OMB. People were talking about this new LBO business. It wasn't even called private equity. It seemed sort of exciting to go to a smaller place. I was very fortunate to get that opportunity. You're right, I joined a tiny little firm with 75 people and $750 million. No, I had no idea that 33 years later we'd have a trillion two and this global thing. It was just, it seemed like a really interesting place to go. There were very compelling people running the firm, and this LBO business seemed particularly interesting.

I would say a couple things. First off, I think big firms can still be great places because big places can train you, which is super valuable to get basic skills. I also think you can work in a small group at a big place, and that can feel very entrepreneurial. But if you said what was in the water, I would say there was this incredible drive, and it really starts with Steve Schwarzman, this sort of will to win that we've gotta keep going, innovating. You wanna be at a place where there's this passionate drive to be successful and to be excellent at what you do. You see that with entertainers or athletes or people who really succeed. They have this passion, and that was there. I think there was also a sense that we should hire really great people. So if you go to work at a place where there are amazingly talented human beings who are, of course, again, very driven, good things can happen. The great thing about finance is you're making it up as you go along. What the rules were 10 years ago or 20 years ago, you can change the rules. You can invest in a new asset class, you can come up with a new structure. So if you have a firm that has very driven people who are also very talented, that is a great combination. Then look, the decision by the founders to not just be another M&A boutique advisory firm, but to go into this private equity business was very smart because the business was just starting. It was back in a world where there were only a handful of firms doing private equity, raising capital from institutions to buy businesses. Then quickly thereafter, which is where my story picks up, they had the idea, and Steve really pushed this, which is, if we can do private equity, well, why can't we do real estate private equity, and then why can't we invest in hedge funds and why can't we invest in credit? Oftentimes it's the same customers, and you're getting more and more intellectual capital from this. For me and my story, a year into doing M&A and private equity work, I was offered the opportunity to go to a fledgling real estate business that was just starting. They had hired one guy out of Chicago named John Schreiber. They had really no one there. They said, hey, do you wanna help with this? I talked to my consigliere and my parents, and it was like, okay, why not? So I do think being at a place where there is this real drive, this will to win, to me that's the thing you wanna be around. If you overlay that with some real entrepreneurial spirit, special things can happen. By the way, you still make plenty of mistakes along the way, but there's this sort of relentless drive to win.

Yeah, risky deal. Well, look, I think the hardest thing about investing is things don't go up in a straight line. There are cycles and things that happen. Look at what happened here on April 2nd. The world can change quickly. There can be natural disasters. You can have a management team that does something unethical. You can have a great investing segment. US housing went up in value from basically 1944 till 2008, 2007, uninterrupted. Everyone thought that would be the case, and things can change. So what begins to happen to you is you work at an investment firm and things go wrong. You begin to develop some muscle memory about this. You quickly try to identify is what happened cyclical in nature? There's been a recession, a slowdown, but the long term demand for this product or service will continue to grow. Or is it secular? Is it the taxi cab medallion, which because Uber shows up, demand plummets relative to historic levels? You also begin to realize when you experience these things that your best investment opportunities tend to come along at the moments of greatest dislocation. When things feel great, 2000, 2007, 2021, no one's worried. The prices are really high, and you're actually taking on the greatest amount of risk. Yet when things reset, and it's the financial crisis, stocks are down 50%, real estate's down massively, everyone can only think about what further can go wrong, when actually at that point you should be thinking about what could go right. For me, the thing that was the hardest was we bought Hilton Hotels in 2007, in one of the worst time investments in world history. We committed in the summer, shortly after Blackstone as a firm went public. We closed in the fall. We bought it for $26 billion, and we borrowed $20 billion, which is not something at this age I would do anymore, but we did back then. Within 18 months, cash flow to the business was down 40%. You were reading in the paper all the time how this business was gonna go bankrupt. I was lucky to be the architect of this transaction. To make it doubly worse, we had put it was the biggest investment ever in our real estate business and our private equity business. So we'd put a lot of chips in on this, so it didn't feel great. At one point in the spring of '09, we also had a lawsuit, both a civil and then a potential criminal lawsuit about taking information from a competitor. Nothing ever came to that. I remember talking to the CEO, Chris Nassetta, who's a great guy and a friend, and still runs Hilton. I said to Chris, the good news is we were on the cover of the Journal for this potential scandal. We'd written the investment down by 75%. I said, Chris, the good news is it cannot possibly get any worse than this. Ultimately in that case, we put $800 million into the company to help deleverage it, get the debt extended. The business kept growing outside the US. Ultimately, the hotel business was cyclical and recovered. It grew a bunch. We took it public, we broke it into three companies. Ultimately, we made $14 plus billion dollars in the most successful private equity or real estate private equity deal of all time. So to your question, Brian, yes, I think you need a certain level of equanimity, but you also need to recognize sometimes you've just made a bad call. You've fundamentally overpaid for something. You got caught up in the hype, like in the .com era, something, and you have to try to recognize the difference. But I think as an investor, you've gotta hang in there. Months like this last month can be scary, and people's immediate reaction is just sell everything. But you gotta hang in there. I'm sure we'll talk about the current environment, but I think having a little bit of a longer term approach, and we have this as a firm, I think it's so important if you're gonna go into the investment business.

So let's go back to the Hilton story for a sec. After the Hilton experience as an investor, you look back and say, gosh, I paid a huge price for a business. I bought it at the absolute worst time, and yet I ultimately had this amazing outcome. By the way, if we had just held onto our Hilton stock, it would've gone up another 3, 4, 5 times because it's just such a good underlying business. What I came to believe was that too often we're looking at our 50 page model and the footnote on a certain thing, and we're forgetting what really matters is that first paragraph. What's the neighborhood you're investing in? Is there a long-term tailwind that makes this a compelling opportunity? It's always possible to buy a business in a good neighborhood. You could overpay or you could buy a bad business in a good neighborhood, but if you tend to fish in a better pond, your chance of success goes up. So I'll talk about data centers, which I think are actually in a very good pond. It's much harder to buy old media businesses or landline phone companies or department stores. Why do I think data centers are in a good neighborhood? We have a simple view that our lives are moving online. Obviously we're gonna shop more online, we're going to be in social media, we're gonna share all this information. But the biggest change is really coming from AI in particular, which is gonna revolutionize everything we do. There are 8 billion people, and there are gonna be billions of virtual bots helping us do a million things. It's gonna change how you act with companies, everything you do, how you get information. Every time you do a query or every time you put a photo into ChatGPT and ask for something back, that requires data. Ultimately, when we have a lot of robots doing a lot of different things, that's gonna require data, and the physical manifestation of the data and the compute power is the data center. So that would argue that there's gonna be a lot of need for data centers, which today are obviously filled with a lot of GPUs. By the way, adjacent to that, there's gonna be enormous demand for power. So boring things like utilities become much more interesting. Electrical equipment providers, utility services. There's just gonna be huge need for electricity and power, well above what we've experienced, which has basically been flat power usage for 25 years. It's starting to grow four plus percent a year. The question on the data centers is, there was a lot of need for railroads after the Civil War, but we built too many of them. You could go through a lot of examples of great and important things where everybody got over enthused. The thing I like about the data centers is you don't build a $2 billion data center speculatively. These are not condos in Miami or Dubai. These are things that require, they're very specialized and they cost a lot of money. That is a limiting factor. The second limiting factor is the power. Normally you would think if you had big companies, the big hyperscalers out there, Microsoft, Google, Amazon, Facebook, you would think all the leverage would necessarily fall to them and drive the economics down. Obviously as major tenants, they do have that. But because the power is hard to come by, if you can have a site that's entitled, you can have a reasonable negotiation about the economics. So if you engage in this business and you're not doing speculative behavior and you're signing long-term leases that are 15 to 20 years with the biggest companies in the world, that seems like a reasonable thing. Now, is it possible that big companies went out there and started pre-leasing a little too much space, need to pause? Are there concerns generally about capital availability and return on capital from AI? Could that make people pause? Sure. But do I think the direction of travel will be the need for more and more data centers? I absolutely do. Therefore, if we own the biggest data center company in the US and we own the biggest data center company in Asia, and we have the biggest powered land bank in Europe, I think that's a good place to be.

Well, I like Nadeem's analogy. Nadeem, by the way, was a Columbia undergrad. Yes, told us that. But if you really think about what is investing at its core, it's really pattern recognition. You're trying to take a bunch of dots, connect them, and see a pattern before other people. In liquid markets, you're trying to identify that a day, a week, a month. In private markets, you might be thinking years in advance. So that's what you're trying to get at. If we are the largest investor in private markets in the world, and we control 250 companies and 13,000 pieces of real estate and all this infrastructure, shouldn't we be able to identify things and use AI to do it, but also human beings to see patterns, to get signals from what we're seeing in our portfolio? Clearly on inflation when it was going up, we saw it faster. We've certainly been seeing inflation coming down more. There's been all sorts of talk about sticky inflation, and yet we would say we've continued to see shelter costs migrate down. The labor market has been softening. Now we're gonna see a surge from goods inflation, obviously given the tariffs. But that data is very helpful. You can see things from ports, businesses, airports, huge distribution companies. You get all these insights in terms of financial firms, what's happening in the world. If you can begin to see patterns, it could be real time things that make you nervous about inflation, so you're gonna try to lock in your debt or buy a bunch of long-term hedges. Or it could be longer term patterns like, hey, I'm seeing all this buying in e-commerce, which is showing up in our logistics business. Well, why don't we buy more warehouses, not just in the US but globally? Why don't we try to migrate more of our retail businesses to be direct to consumer? It's funny, I just at four o'clock had my operating committee, all the people running the different businesses, and we were going around the table talking about what are we seeing real time? What are we seeing in data? What are we seeing anecdotally? You're trying to take that insight both informally, formally with dashboards, and use that to be better investors. If you see one of these really powerful patterns, if you see a neighborhood, you talked about India, and you see what's happening there, rising middle class, a government that's pro-growth, a place where the physical infrastructure, the legal infrastructure, the capital market infrastructure's improving, hey, let's go all in. In an ideal world, you do it in private equity and real estate if it makes sense, in infrastructure, credit, in a whole range of your activities. To me, we're looking both for real-time data to make short-term decisions, should we sell a stock or issue some debt, but also these longer term secular trends that we're trying to capture, and we're trying to use the Blackstone data machine to capture it. I would say it's still a work in progress. I wouldn't give us an A plus, but I think we've come a long way.

Well, I would say this. We don't forecast the GDP because there's a lot of technical stuff based on pre-buying in anticipation of the tariffs, which pulled GDP down. I would just say, if you start on the first quarter, growth across our companies was pretty good. We said publicly on earnings a week and a half ago that revenue in our private equity companies was up 6%. Credit default in our non-investment grade 2000 borrowers was 50 basis points, very low. We actually saw very healthy leasing in our very large logistics business as well. So we saw broad based health. Obviously the announcements on April 2nd have caused things to shift. Interestingly, much of the economy continues to sort of move along because so much of the economy is tied to employment, and employment remains pretty strong. If I was looking for weakness in the economy, it would be rising unemployment claims. The data, there's not a ton of hard data showing the slowdown. Where are you seeing it? Look, companies who are in the direct path of travel, if you're a manufacturer, you are a retailer and your input costs, you're now scrambling and there's a real impact. They're beginning to look at capital expenditures, employment. That's where you're seeing companies real time try to figure out what they can do, can they source from other places and so forth. We've obviously seen a slowdown in the capital markets because IPOs and M&A activity generally require a certain level of confidence, sort of tariff firma, and people get cautious given what's happened. So that slows down. Decision making generally at businesses, if you were thinking of signing that big lease or opening that new factory, when there's this level of uncertainty, people pull back a bit. Now, where does it go? I think the tariff diplomacy, much of it gets resolved relatively quickly. I don't know what that means, next few months, whatever, because the administration has said publicly they wanna try to get these things resolved. So I think we'll see a series of deals announced and people will begin to see a path. I think where it's trickier is with China, who is our largest trading partner, I guess, outside of Canada and Mexico. But because there's a whole range of issues, that's probably more complicated and takes longer. I think some of the extreme uncertainty starts to go away here a little bit. The thing if you wanna feel a little better is when you think about past crises. If you think about the global financial crisis, we had trillions of dollars of excess debt in our financial system, in our housing system. That took a long time to work through. If you think about COVID, we were all home in our PJs, that shut down large portions of the economy. We own theme parks and so forth, they weren't very busy there for a few months. This was policy induced. So if the policies change, you can see things, or if there are negotiations, you can see outcomes that reduce the uncertainty and volatility. I do think it is going to cause clearly some level of slowing here, but to me it's really about the duration this goes on. If you have high uncertainty for a very longer period of time, that becomes more challenging. If that uncertainty, some of it starts to get resolved and people start to see a path, that'll give market participants more confidence. I go back to what we're talking about as investors. All this stuff is obviously very important for the here and now, but just spend a few days in Northern California and hear about how they're moving to change the world and what's coming. I think that story longer term is much more important.

Look, I think the Fed has a difficult hand. Certainly they're gonna see a surge in goods inflation, which is a 20% weighting. So they'll get a surge in those numbers, just math, the 10% tariffs, the 145% tariffs, so that's there. But then they're gonna continue, I believe, to get good data as a result of shelter costs being lower, energy costs being down a bunch, the other components. I think they'll get favorable data. I think absent what had happened with tariffs, they would've had easy air cover to cut. I think now it makes it a harder call for them. But again, if they see what's happening as a one-time global, we're gonna have 10% tariffs with most people, maybe it's different with Canada and Mexico, China's gonna be at a higher level. This is a one-time thing, but all the other data points downward, then I think they'll have the opportunity and the air cover to cut. So I guess this delays things. I think they're also gonna be watching the labor market. So if the labor market hangs in there and there's still all this tariff uncertainty, then they'll be patient. But they have this dual mandate, which makes it really hard. They have to try to keep inflation under control, but they want to keep full employment. If they start to see unemployment going up, then I think they'll lean that way. If we stay fully employed, they'll probably take a little more time. But if you ask my gut, I think this is more of a one time shock. I'm not a buyer that inflation expectations are gonna drive people that often. This isn't the 1970s. We have very tight policy. CPI last month ex-shelter was one and a half percent, and short rates are four and a half. I think we have pretty tight policy. I think they have room to cut, but I fully understand why they're gonna wanna be patient.

Sure. So if you look at it just to frame the size of the business for us, credit is the largest business at Blackstone by AUM. If you look at our corporate and real estate credit, it's $465 billion. That has grown a ton over the last five years. The question would be, why is that the case? In almost everything you see in finance, in the asset management world, why do things grow? They grow because of performance. You asked what was in the water at Blackstone, we talked about the people and the culture, but clearly our product is about delivering great returns. That's our great tasting pizza. What's been happening is investors have been realizing that they can get higher returns with the same or lower levels of risk in private credit versus what they can get in liquid fixed income. The question is, why is that the case? Most of it is just because it's a direct to customer model. If you think about a loan originated by a financial institution and the origination and securitization and distribution costs, by the time that loan or bond gets to an investor, there have been a lot of economics that have come out of it. If on the other hand, you are an institutional investor, a university endowment or state pension fund, or an individual investor, and some of our non-traded BDC products, we're basically taking you and bringing you right up to the borrower and you're holding that loan and you're able to generate higher returns with the same or lower risk. It started in the non-investment grade world, basically lending to private equity firms when we bought companies. It has migrated now into investment grade credit. Particularly to your question, Brian, insurance companies. If you think about an insurance company, let's say it's a life and annuity company, it's got liabilities that might be five years, seven years on the annuity side, and then life policies that could be 30, 40 plus years. It is rational for them to trade away a little bit of liquidity, not for their whole portfolio, but for a portion of their portfolio that they would get owning bonds to do private credit. So we would go make a loan on their behalf to a data center company or an energy business or consumer finance, fund finance, a whole range, mostly of asset based finance. They can capture, let's call it 150 or 200 basis points higher than what they can if they bought a single A bond. Instead of getting 75 over, they're getting 225 over. In their business model, that's very powerful. It started with a handful of insurance companies doing it, and now it's becoming an increasingly competitive area where more and more are recognizing, a little bit like if you go back to the pension funds, 30 years ago they had all public equities and then this private equity thing started and it grew and grew and became a larger and larger piece of large pools of capital investing. If you looked at their fixed income portfolio, it's all been liquid. Now what you're watching is that same shift. That's why you see this business growing. If you ask me, are we near the beginning or the end, it feels much closer to the beginning because the penetration in large pools of capital is still very low. So I think it's gonna grow a lot, particularly on this investment grade side. What's interesting about it is it's super helpful as an evolution for our economy as we're re-industrializing, as we're building all these data centers, as we're building all this new power, we're gonna have a bunch of robotics and things. This type of private capital is very flexible to finance that. So I think it will get accelerated as that trend continues.