Marathon Asset Management

What I Give Thanks To As Thanksgiving approaches, I find myself filled with gratitude. I'm thankful for the privilege of working alongside such talented and driven professionals, the opportunity to lead an incredible firm, and for living in a country that offers boundless opportunities for success. I'm especially grateful to this great nation for providing the chance for me and its citizens to thrive. As we take time to gather with family and enjoy the harvest at our dining room table, I must also reflect on this period of transition of leadership for our great nation, while I am also compelled to share with you my concern regarding our nation’s predicament. My concerns: -The staggering level of government debt in the U.S. now exceeds $36T (v. GDP of $28T). -UST debt outstanding is $28T (excluding what is held by Federal Reserve and Non-Marketable Federal Debt which combined is $36T). -The massive maturity wall comprised of short-term UST & T-bills must be rolled over; I hope the Bond Vigilantes stay at bay. -The Red bar below illustrates the $12.5T of debt that has less than a 2-year maturity. -The Treasury Department has played a dangerous game of confidence, issuing too much short-term debt vs. long term debt. -Huge mistake to not lock-in low rates when rates were low. If millions of homeowners could do it, why didn’t the Treasury? -45% of UST debt outstanding is a huge % to have in short-term debt that matures in < 2 years. -The U.S. government deficit is running ~6.5%, including state and municipal deficits the total federal-state-municipal deficit is 8.2%. -Issuing long duration debt would likely result in a steeper curve/higher mortgage rates with greater UST funding costs. -Deficits and debt issuance by Treasury is sucking significant capital from the private sectors in the U.S. as well as Europe and EM countries alike. Let’s hope that responsible government can cut our federal deficit to 3% as yesterday’s headlines suggest. Putting this long-term worry aside, I can think of no better place to invest in a sector where supply is significantly less, where asset selection is critical and where the opportunity to capture alpha is substantial: -Public Credit market can earn 7% or +250bps vs. UST -Private Credit Funds that earn 12% or +750bps vs. UST I wish everyone a Happy Thanksgiving, health, happiness, and prosperity!

A Man with 3 Missions Scott Bessent will be Treasury Secretary; he will focus on 3 key goals: 3% growth, 3% budget deficit-to-GDP and producing 3 million barrels of additional oil. 1. 3% GDP is achievable if pro-growth policies unleash animal spirits. Lower taxes, less regulation is essential to the plan. Equities markets believe this, small stocks are cheering for this. The bond market is a little leerier. I believe 2% is the long-term growth rate for the U.S. economy, but with the right policies, 3% is entirely possible. 2. Budget deficits of 3% in year 1 is highly improbable since the deficit is running at >6%. By year 4, it’s entirely possible to get to a 3% deficit if GDP growth accelerates and DOGE gets its job done. The real power of DOGE will be to not only cut pork but cut down the heavy hand of government regulation that stymies growth (i.e., barrier for start-up, construction, supply chains, technology, energy, banking, and pharma). There is absolutely no reason we can not get our deficit back down to 3%. 3. To increase the U.S. oil production by 3 million barrels per day would require expanding federal land for oil and gas leasing beyond its current scope. This would bring significant revenues for the U.S. (both leases and taxes). Drill-baby-Drill would also put pressure on oil prices. Under this scenario, I believe oil would fall from $70 to $40 per barrel with this extra supply hitting the market. Consumers would benefit, but producers would feel the brunt. Oil services would thrive with increased production. The U.S. is already the largest producer in the world generating ~13 million barrels per day, followed by OPEC & the Emerging Market Producers (see chart below). There will be a lot of news about tariffs in the coming days, and the headlines will be a starting point from which to negotiate. So, it’s best not to focus on the headlines, but rather the back-of-the-house negotiations that will take place with an added focus to close the borders, stop the traffic of illegal drugs entering the U.S. and apply trade reciprocity - forcing other countries pay the same tariffs they charge the U.S. Having said this, for companies that are importing goods from China, there will be a greater cost to bear. Elasticity will dictate whether prices can be passed along to consumers, but in many cases, it will be a hit to the U.S. company that pays the import tax (this is how tariffs are applied - at port of entry). Credit investors, Equity & Private Equity investors should be on notice as Q1 guidance is just around the corner. Select companies will feel margin pressure if their manufacturing or supply chain is China based. Notice given. Recently, I had the distinct pleasure to have dinner with Scott Bessent, a brilliant man with impressive credentials and command of economic policy, international law, trade, and monetary policy. Scott is a man on a mission.

When Pondering Spreads, Focus on Absolute Returns IG and High Yield spreads are trading at their tightest levels in 20 years. The trader is hesitant to invest when spreads are tight. The investor, however, recognizes that the absolute yield is at its average return over the past 2 decades. As I discussed in my post last week, I expect spreads to be locked in at tight levels in 2025 as earnings, GDP, and credit worthiness remain robust. Despite the Fed lowering rates, longer-term rates remaining “higher for longer” allowing investors to earn a relatively attractive current yield. US IG, High Yield and BSL outperformed their counterparts in Europe in 2024, and I expect a repeat in 2025, as does UBS as shown in the bar chart below. If HY and BSL can earn 7%+ in 2025 as UBS and I expect, that is pretty good given how tight spreads are. Remember that spreads are tight for a reason - credit conditions are improving. I believe default rates will decline dramatically in the coming year, but with over 2,000 credits in the US alone, credit selection is critical for performance. Special Note 1: While credit markets have a green light, the most important caveat today is to avoid companies that rely on Chinese imports for manufacturing/supply chain - increased tariffs are coming by Q2 ’25, and companies who primarily source from China, will begin to feel it, in certain cases this impact could be equal to a company’s entire operating margin. Special Note 2: We should recognize that UST risk represents a tail risk, with massive issuance on its way, a condition which adds duration risk and will most steepen the yield curve - I plan to elaborate on this in the coming days. Short duration structured credit remains highly attractive, it offers greater than +100bp pick-up relative to corporate credit with favorable tailwinds with room for spreads to tighten further. Marathon Asset Management has identified terrific value in RMBS, ABS and CLOs, with the greatest alpha extracted in the CMBS market given the huge divergence in credit scores throughout the CMBS complex. I am bullish CMBS as I turned bullish on CRE over the summer, however, not all boats will get the lift since many are too damaged. This is precisely when a great credit manager can earn its stripes. Of course, for those that can invest in Private Credit, there is a huge value proposition to gain with +300bps of excess return relative to public markets, but sourcing and investment judgement is everything. Too much money has been raised and many are too slow to deploy. For those with robust sourcing channels, it’s the best value proposition in my belief.

High Conviction: Stay short Washington D.C. Office market. The true vacancy rate may approach 30% v. current vacancy rate of 17%. CoStar’s recent forecast that D. C. vacancy will rise to 21%— low balls what’s really going on. According to this special report (below), federal agencies are shockingly only utilizing 12% of its office space; with record federal employment, it appears most federal workers work from home. This means one thing, office rents will fall since vacancies are rising. Now add the DOGE-factor and your model might suggest that vacancies will soar to ~30%. The truth according to this article below shares this stark reality. With government job cuts likely coming, and select agencies to be relocated to other regions of the country, the feds may push more property onto the market. D.C. may give San Fran a run for its money as the worst office market. While I believe the CRE asset class has set a bottom, every sector has a unique dynamic and the picture is not reassuring for the D.C. area office sub-market. Vornado Realty Trust and SL Green Realty Corp. on the other hand looks solid, as NYC class A office is back! Stay strong Washington D.C., I always root for you, and it remains the one of most beautiful, if not the most beautiful centrally planned cities in the world.

Marathon Asset Management & Webster Bank are pleased to announce the acquisition financing of Sunbelt Modular Inc. “Marathon's powerful partnership with Webster Bank offers reliable, tailored, and creative financing solutions to middle market companies and private equity sponsors,” said Bruce Richards, Marathon’s CEO and Chairman. “Marathon’s leadership and expertise across our Private Credit programs – Direct Lending, Capital Solutions, and Asset-Based Lending – coupled with Webster Bank’s exceptional middle market sponsor lending program and broader commercial banking services, offers a highly differentiated suite of capabilities.” Marathon and Webster Bank - A Powerful Private Credit Partnership!

Let’s assume corporate/individual tax rates will be lowered, but it’s my opinion that the President-elect will not rush tax cuts into his first-year agenda since the current 2017 tax code does not expire until year-end 2025. Since the President-elect has this extra year to address tax cuts, he will likely focus on his more pressing policy agenda items that are also a priority which he will want to get done in the first year, knowing they have a 2-year window before mid-term elections with plenty of time to return to taxes. Timing wise, I expect these agenda items to be addressed in Year 1: 1) Tariff negotiations out of the shoot to be led by the masterful and brilliant Howard W. Lutnick (first volley is 60% tariffs for China & 10-20% for ROW) 2) Regulatory relief to ‘unburden what has been burdened’ (Banks, M&A, Energy, etc) 3) Immigration/Border enforcement 4) DOGE led by the greatest technologist and operator of my lifetime 5) Roll-back of select IRA provisions i.e. tax credits granted to green initiatives that have thus far resulted in ~$1T revenue loss for IRS as these companies took the tax credits and sell them to companies that buy the credits and reduce their taxes (i.e. tech companies and money-center banks are largest buyers of tax credits). As for tariffs, I don’t believe the pundits, thus far tariffs have added little to core inflation rate - exporters will eat their tariff to keep the business; +currency devalues v. US$ for export nations to remain competitive (same tariff result 8 years ago during the first administration). Who will be the next head of Treasury Department? Your guess is as good as mine, but Treasury Secretary Rowan has a nice sound to it. While Marc is an outsider to the DC establishment, I believe most of us in the investment world know he would do an amazing job. It’s an important role that critical for the economy. Policies impact markets, how pro-growth will policies be, will business confidence take a step-function higher, what baskets are the winners/losers? Just some of the questions to ask. For instance, what’s in your M&A basket (companies most likely to be acquired) vs. your loser basket (clean energy, hospitals, vaccine pharma-focused).

Thinking Out of the Box: Let me start with my conclusion and then explain my logic. Given the recent increase in funded status for Public Pension plans, it is my humble opinion that public plans are over-allocated to public/private equity. The average pension plan has ~60% exposure to public/private equities. Public plans actuarial return requirement has fallen to ~6%, the rate required to fulfill their pension distributions, while yields have risen and private credit has become a more optimal solution. Let’s unpack/debate 3 key points: 1. If a pension plan has a 6% return requirement and Private Credit can deliver 11-12% consistently year-after-year, then why not flip the script, and have 50% in Private Credit, and 10% multi-asset public credit to meet liquidity requirements - not 60% allocation to equities. Private Credit has evolved, it’s a defined asset class (prior to 2010 it was not). Muscle memory dictates that equities is the way to tilt for success. 2. Shockingly, the S&P 500 has compounded only +5% IRR per annum since January 1, 2000, a much lower than most think since it has generated a 20%+ IRR in 2023/24. There has been only 2 other times in past 100 years when equities had back-to-back 20%+ annual returns. As we close in on the first 1/4 of this century, equities have delivered a mere 5% annually. Traditional PE (top-quartile) has done well, while growth/venture have under-performed PE, except for the top 10% of this cohort. While I remain constructive for equities, one can argue that equities are rich—see chart below, while the bigger point is that fixed income is a better match v. fixed liabilities. 3. Insurance companies are highly regulated by the NAIC/state commissioner who require insurers to invest in fixed income to match asset vs. liabilities. In recent years, insurance companies have begun to invest more heavily in private credit given the meaningful yield pick-up vs. public fixed income. Led by the brilliant minds at Athene, other insurers have adopted this model of leaning into private credit. Insurance companies can allocate ~15% to private credit, only limited by the capital requirement imposed by regulators. Pension plans do not have this constraint and have significantly greater flexibility. In contrast, insurance companies also have liabilities to fulfill, yet they have just ~5% equity market exposure (percent of assets held by general account). Given the volatility of equities vs. the higher-for-longer return profile for private credit, capital allocators may want to consider these 3 key points (above). Public pension funds have an amazing model, staffed by brilliant CIOs with their strong investment staff(s). Partnering with their consulting firms, plan sponsors have a chance to flip this model, increasing the allocation to private credit that may be a better match vs. their liabilities. Is it time to rebalance?

Is there a doctor in the house? The last time that the Fed cut rates 75bps & UST rates rose 75bps was 1996. In modern day finance, this happened only once and the conditions today are strikingly similar to the late-1990s. The question is why this is occurring? Multiple choice (pick one): A. GDP growth forecast has strengthened B. Inflation expectations have risen well above the Fed’s stated 2% goal C. Federal Deficits of ~6% will require greater UST issuance, resulting in higher rates D. Interest rates rallied too far, and have now corrected towards fair value E. Realization that Fed will not cut rates as aggressively as market originally expected F. All the above I would love to hear your response to this question. I certainly have a strong view as to causation and its impending impact for markets, security/asset sector selection, relative value, and risk. Of special note, a big shout out to our federal government in managing our budget resulting in the U.S. national debt growing by $1 Trillion every 100 days. Yesterday, we surpassed $36T.

Further insight from my CNBC interview with Sara Eisen and Carl Quintanilla   We discussed Fed policy, outlook for rates, and unique dynamics that exist in the global credit markets. Here are 4 insights: 1. Banks dynamics have turned hugely positive: 1) NIM is soaring as front rates/bank funding costs decline relative to long end which will drive earnings, 2) less imposing federal regulations allow banks to reduce admin costs - hugely positive for large banks and regional banks alike. Jamie Dimon, the most outspoken on this issue says: “It’s been years of strangulation, there’s no question in my mind we have hurt ourselves with overregulation. We have five or six regulators, and they all want different things. We’re unable to do our job properly. It’s mind-numbing and very painful.”- Jamie Dimon. I worked for Jamie back in the day, and he has a tremendous track record, not only for how he navigated the 2008 financial crisis, but also for consistently delivering strong financial results, ability to manage risk, foster innovation, maintaining a forward-looking vision to advocate for responsible capitalism. 2. Tariffs are NOT as inflationary as most think. The impact on inflation with China tariffs 8 years ago were minimal and it will have marginal impact for US consumer this time around. The big beneficiary will be the U.S. who will bring back manufacturing to the U.S. create jobs with more reliable supply-chain. Vietnam, Cambodia, India, Mexico, Canada will also be beneficiaries. U.S. companies have had 8 years to move away from China and this trend will continue. I believe China will be forced to devalue its currency over time to remain competitive with exports and that the China manufacturers will also hold price to keep the business. 3. Long Ukraine, its sovereign debt (~$23B) trades ~15%+ yield. This opinion is based on my view that a deal will be worked out and reconstruction will begin. The Russia-Ukraine war has been devastating for both populations and their economy, alike. Russia GDP has fallen by 8%, Ukraine by 20% since the war began with casualties now exceeding 1 million men, combined. Both countries will come to the table, a deal will be worked out—that is my base case. The IMF, World Bank, EU, and U.S. will all provide aid for Ukraine and the Marathon Asset Management team is confident that investing in Ukraine's sovereign bonds not only supports humanitarian efforts but is also an attractive investment opportunity. 4. M&A activity adjusted for market cap is at its lowest level (2023, 2024) in 30 years - CEOs find it difficult to get regulatory approval. The next 4 years will see a boon to M&A as CEO confidence soars, for large and small businesses alike. This chart below shows 2016, but mark my words, when WSJ conduct its 2024 year-end survey, you will see the same inflection point as 8 years ago LBO activity will pick up considerably too. Investment Bankers rejoice!

Jonathon Siatkowski, Head of CLO Capital Markets, will take the stage at LSTA’s Tokyo Conference to discuss his insights on CLO investment strategies and their risk-return profiles. To learn more about attending, please visit: https://lnkd.in/dxQGPYSn If you will be in attendance, please reach out or say hello to Jonathan.