Marty Fridson, Chief Investment Officer at Lehmann Livian Fridson, has been recognized as a key figure in the evolution of high-yield bonds. His contributions are highlighted in The Making of Modern Corporate Finance, a new book by Donald H. Chew, Jr., where he is featured alongside esteemed financial thinkers like Nobel laureate Merton Miller. Chapter 10 explores Marty’s role in transforming high-yield debt from a niche market into a major institutional asset class, reinforcing his reputation as a leader in corporate finance.
This post is a reflection on his work in the high-yield revolution, from providing objective research that shaped investor confidence to challenging prevailing narratives about speculative-grade issuers. We also examine the broader impact of open debate in financial markets, a principle that has guided his career. As Don Chew’s book illustrates, the rise of high-yield bonds was more than a financial innovation—it reshaped corporate finance, risk assessment, and capital markets.
Up until the late 1970s, explains Chew, the editor of the Journal of Applied Corporate Finance since its inception, the opportunity to raise capital in the public bond market was essentially unavailable to companies with noninvestment grade credit ratings. Up until that time, almost all issues with BB or lower ratings were “fallen angels,” rated BBB or higher when they came to market but later downgraded by Moody’s and Standard & Poor’s. Opening the new-issue market to so-called junk issuers provided attractive financing to emerging telecommunications, cable television, casino, and independent oil exploration & production companies. Along the way, high-yield bonds evolved from a financial backwater to a staple of institutional portfolios.
Marty’s role in that evolution began as major life insurance companies expressed interest in investing in high-yield debt, but were apprehensive about a market overwhelmingly dominated by a single underwriter, Drexel Burnham Lambert. They encouraged entry into the business by leading investment banks such as Morgan Stanley, which hired Marty to head its Corporate Bond Research Department.
Mainstream institutional investors considered it imperative to receive bona fide, objective analysis of the emerging asset class, not just promotion in the guise of research. Marty’s boss, Fixed Income Research Department head Robert Platt, recognized that need and counseled him to be an analyst, not an advocate. Marty took that sound advice to heart, objectively reporting whatever results his analysis produced, regardless of whether the findings were “good for business.” For example, he contested the high yield advocates’ narrative that original-issue high-yield companies were overwhelmingly “rising stars” of American industry, while their investment grade counterparts were “dinosaurs” inexorably doomed to suffer financial decline. In reality, Marty’s research found, defaults by the supposed up-and-coming high-yield issuers outnumbered upgrades to BBB or above.
Also on the subject of defaults, Marty brought attention to the work of the actuary and academician Irwin Vanderhoof. At the time—the mid-1980s—high-yield advocates were making their case partly on the basis of the fairly low, 2% or so, default losses experienced in the preceding decades. Vanderhoof predicted higher default rates going forward. Previously, he pointed out, the high-yield universe had consisted primarily of fallen angels, which were concentrated in the least risky speculative-grade rating category, BB. In contrast, the new issues that proliferated in the 1980s contained a large component of companies with B ratings, a class that historically experienced a substantially higher default rate. Now, the high-yield universe was much more heavily weighted with those riskier bonds than in the past.
Looking at the situation through an actuarial lens, Vanderhoof predicted that whenever the next recession arrived, the default rate would climb to a higher cyclical peak than in the 1980 and 1982 recessions. His prediction proved accurate, as the default rate soared to double digits in 1990. Drexel, whose business was overwhelmingly concentrated in high yield rather than diversified over a wide variety of financial businesses as at other investment banks, went bankrupt.
Marty’s commitment to going wherever the evidence led established the credibility of his research effort at Morgan Stanley and later at Merrill Lynch. Consequently, market participants took him seriously when he sought to disprove the media-promoted notion that high-yield bond investments were primarily to blame for the tidal wave of savings and loan failures that crested in 1990. Had he not laid the groundwork with analysis that forthrightly addressed the risks as well as the rewards of high-yield investing, his assessment of the S&L crisis likely would have been dismissed as an attempt to downplay the hazards of a renegade asset class.
Don Chew concludes his chapter with a discussion of Marty’s dissatisfaction with Drexel’s unwillingness to respond to a 1990 Wall Street Journal op-ed by economist Herbert Stein. Stein disputed the claim that high-yield financing raised the overall level of U.S. Gross National Product. In his view, the supply of investment capital at a given time is fixed, so that which went to Drexel-financed enterprises merely reduced the amount available for other productive uses within the economy. Chew argues, in contrast, that it matters a great deal how productively capital is being employed. He contends that entrepreneurs who raised capital in the high yield market got more bang for the buck than other users.
Marty does not disagree. His point is just that if the former head of the president’s Council of Economic Advisers writes an op-ed in the nation’s largest-circulation daily newspaper that challenges a key point of your sales pitch, it does not constitute a valid response to ignore it, while continuing to tell investors that they have a moral duty to bolster the U.S. economy by buying Drexel-underwritten high-yield bonds. Marty believes that open and honest debate is essential to making financial markets work optimally, both for investors and for the businesses on which people depend for life’s necessities. Don Chew’s excellent new book, by way of Columbia Business School Publishing, contributes substantively and eloquently to that debate.
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