John Phelan is a co-founder and Managing Partner of MSD Capital, L.P., a private investment firm that manages the capital of Michael S. Dell and his family. Mr. Phelan co-founded the firm in 1998 and has overseen its growth from $400 million in assets under management to more than $10 billion today. Mr. Phelan currently serves on the North American Advisory Board for the LSE and sponsors scholarships for General Course, Masters and Ph.D. students studying at the LSE. He earned a General Course degree with an emphasis in Economics and International Relations from the LSE.
How did you end up at the LSE?
I was an undergraduate at Southern Methodist University in Dallas, Texas majoring in Economics and Political Science and decided that I wanted to study abroad. I thought the LSE had one of the best Economics and Political Science programmes and a very strong global reputation. From a political standpoint I also thought there were a lot of fascinating things going on in Europe at the time. So, studying in London where I could be close to the dynamic changes happening on the continent, while also experiencing the English educational system, really appealed to me.
What was LSE like when you arrived? What was the atmosphere of the school and the student body like?
It still had a reputation of being a left-wing, radical school, but there was in fact a larger conservative element than I would have guessed. The debates in the Students’ Union were quite vitriolic at times with Labour sitting on the left, the Tories on the right and the Independents in the centre. These debates often became quite heated, but were always great exchanges of ideas.
The refreshing thing for me about the LSE was that professors always welcomed balanced views. In the US there is sometimes a suspicion of professors leading students one way or the other; that was not the case at the LSE. The other aspect that surprised me was the amount of anti-Americanism in London at that time. That was during the Reagan era when the US had just deployed cruise missiles in Germany, which led many pundits to believe that the US was trying to make Europe the nuclear target for Russia. With all of these geopolitical tensions, especially in Europe, it was a very interesting time to be at the LSE.
Were there a lot of Americans at the LSE when you were there? Did it live up to the acronym Let’s See Europe?
I was a General Course student and was at the LSE for an entire year; however, some of the GC students were only there for a semester. I would say, generally speaking, that the GC students who were at LSE for the entire year took it fairly seriously. There was certainly an element of “Let’s See Europe” in that we travelled around Europe during breaks, but for the most part I would say that those of us who were at the LSE for the whole year were quite diligent.
Was there a particular professor or class that you especially enjoyed at the LSE?
Jeffrey Stern taught a class on US and Soviet relations that I found very interesting. I thought it was a great class and he was a very compelling professor. On the economics side I had Michael Pyne for a class on the History of Economic Thought, a class which has been incredibly useful to me over the years. The arguments have not really changed that much and it is really interesting to have looked at them from a historical context and see many of the same arguments being made today. History does repeat itself!
Could you give current students at the LSE a brief synopsis of your career: how you found your way after the LSE and ultimately how you came to be the co-head of MSD Capital?
When I graduated from Harvard Business School in 1990 it was a very tough period and jobs were scarce. I ended up working for Sam Zell, a noteworthy real estate investor, and we started looking at some corporate opportunities, including Executive Life, which was a very large bankrupt life insurer that had a significant portfolio of high-yield – or what they called back then – “junk” bonds. Working on that deal and analyzing a significant number of troubled companies with outstanding junk bonds made me realize how much I liked investing in the public markets. We ended up not winning that deal, but afterwards I went in to Mr. Zell and suggested that we open an operation to invest in publicly traded junk bonds. I thought there was a huge opportunity and we had already done a lot of the work. Mr. Zell wanted to own companies rather than pieces of companies so I ended up joining Eddie Lampert and ESL Partners where I applied much of that thinking in the context of distressed investing and merger arbitrage.
After seven great years, I left Eddie and ESL to take some time off and had decided to start my own firm. I spent an enormous amount of time thinking about what type of investment firm I wanted to run and writing up a business plan. During this process I had lunch with Michael Dell. He asked me what I was planning to do and I gave him this business plan. He said, “Why don’t you do this for me?” I ended up partnering with Glenn Fuhrman and we have been running MSD together for the last 11 years. We now have a team of more than 80 employees in our offices in New York, London and Santa Monica.
Would you describe a little bit of the investment approach of MSD and where it sits relative to hedge funds or private equity funds?
MSD Capital has a flexible/opportunistic investment approach. We invest in multiple asset classes across the capital structure. We have eight separate investment strategies, including publicly-traded securities, traditional private equity activities, and real estate and special opportunities.
We view ourselves as an investment firm that has a long–term fundamental value approach. We do not behave like traditional investment firms. We try to be contrarians, which is much tougher than you think and we firmly believe in taking concentrated approach to help us avoid what I call “diworsification”. The thing we focus on the most is expected value analysis and risk-adjusted returns. I think there are quite a few hedge funds in the US and Europe that have exceptional records, but they have done so by taking on a fair degree of leverage. If, like them, you are going to run a 3, 5 or 10:1 levered firm, you better deliver 25-plus per cent annualised rates of return – because you’re taking that risk. We evaluate our performance differently. We rarely use leverage and we look for investments that will yield an appropriate spread over the risk-free rate (I say that hesitantly, given what is going on today) or government debt.
The great thing about our approach is that companies often seek us out as a partner because they know we will be a good long-term shareholder. We tell people who want to sell their companies: “Your business is a painting and you get to hang it in our museum.” What I mean by that is we are there to take care of their business, to be a steward of it and to help them build long-term value.
By contrast, a lot of investors pursue similar strategies and are constantly trading or buying and selling companies. They have very little incentive to make the intelligent-but-with-some-reasonable-probability-of-looking-like-an-idiot decision. We try to do the opposite of what everyone else is doing. Two of my favorite mantras are, “Invert everything,” and “It is a thin line that separates courage from stupidity.” People tend to forget two important things: one, high price means high risk, low price means lower risk; and two, the more capital that goes into a specificspace, the lower the returns will be.
In 1937 the market dropped very rapidly – almost 50 per cent – and Keynes, who was on the King’s College endowment committee, began to get letters saying, “Don’t you think you should reduce your exposure, the market is falling.” Keynes, finally exasperated, wrote a memo back, “I wouldn’t consider it improper to own a few shares at the bottom of the market. Your apparent approach is that I should be liquidating as the market gets more attractive and that I should be buying as it goes up.” He then went on to say one of my favourite lines, “I consider it the duty of every serious investor to suffer grievous losses with great equanimity.” So we try to be opportunistic and we take a very long-term, value-oriented, research-intensive approach to investing.
As a member of the North American Advisory Board of LSE, what do you see on the horizon for the School? Are there any specific challenges or opportunities that you see facing the School?
I think Howard Davies has done a fantastic job and has a real vision for how to run the School. The enormous diversity of students who go through the LSE is one of the School’s great assets and a real advantage. I also think the new Management programme is a very interesting idea and the School has an ability to add value to both students and employers with the addition of that program.
The main challenge facing the LSE is to update its ageing infrastructure. It’s especially difficult in London, where space is at a premium, but I think the New Academic Building is a great step in the right direction. Another issue facing the LSE will likely be government budget cuts that take money away from higher education institutions. The LSE has a dedicated alumni base, but I think we can engage them a bit more to give back to the school.
When I reflect back on my time at the LSE, I know it was a life-changing experience and I feel as though I owe a lot to the School. I’m sure almost everyone who goes through the LSE feels the same way, so the alumni can be instrumental in ensuring that LSE is able to update its campus and classrooms and remain an elite university.
I think the School is very well positioned to meet the challenges that lie ahead and that it will continue to attract world-class professors and students. I’m very excited about the LSE’s future.