Kieran Goodwin - Imagination, Volatility, and the Pursuit of Alpha - [Invest Like the Best, EP.331]

Transcript from https://podmenti.com/t/eca738fe9ba19cc7

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Hello and welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best.
This show is an open ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money.
Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at joincolossis.com
Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO of O'Shaughnessy Asset Management.
All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum or O'Shaughnessy Asset Management.
This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.
Clients of Positive Sum or O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.
My guest today is Kieran Goodwin.
Kieran spent over two decades at the frontier of credit investing. During the global financial crisis, he was a partner and head of trading at King Street Capital, which grew from 4 billion to 20 billion while he was there.
He then left to start his own credit hedge fund panning capital management.
In our discussion, we cover the state of private credit today, which forms of alpha he's most skeptical of, and the blend of EQ and IQ necessary for success in investing.
Please enjoy my conversation with Kieran Goodwin.
So maybe a fun place to begin is with the world of private credit. We talked a lot about it already today at lunch, but
I think your take on it is especially interesting. Can you just give what you view as the state of the union of private credit today in capital markets and why you find it interesting as just a category to consider?
the growth of private credit
You kinda have to start the conversation there.
I mean you had
This asset class
That was somewhat of a cottage industry.
around the time of the great financial crisis.
And
Confluence events happened.
probably the most important is that rates went to zero. So there was a search for yield that benefited
Spread product wherever.
But then also you had
the Fed OCC rules
Where
Banks could not lend to companies greater than six times EBA.
So
With
Private equity.
Looking for
Debt to finance.
capital structures
Private credit was a solution, in a sense.
And then as private credit equity had more and more dry powder, the results were doing well.
There was more demand for private credit.
So you just had an explosion of growth.
And this
contraption set up.
Of
More private equity, more private credit.
But
still with zero percent as
So for a libre, a library time now so for
And spreads being five fifty to six hundred.
You're getting six percent.
the funds needed to lever themselves to get to eight nine percent.
If you're an alternative asset manager and you're coming to
an L P and saying I can give you five, six percent, no one cares. It's gotta be like at least high single digits.
And what the allocators loved
was there's no volatility.
Jason Zweig at Wall Street Journal wrote a great article.
Talking about our Cliff Water who's
not only consultant, but also in private credit, put out on a fund a 10 sharp ratio. He interviewed
Professor Sharp. I can't remember his first name.
And Professor Sharp was like
That's ridiculous. Obviously and they pulled it from it.
But that's the world we're living in where like there's this ultimate sharp ratios and everyone's like there's no vol and like
Of course there's Vaughl.
There's volatile anything. Your car leaves the lot and it's down thirty percent. There's volatility. It's just you're not marking it to market. So the difference between
volatility of what an asset's worth and actually marking it.
Is different. So you've had this explosion.
And now we have rates much higher. So you have these loans that are five to seven year loans.
Loans made in two thousand nineteen twelve, twenty twenty one.
The companies thought they were gonna pay five and a half, six percent interest on.
And now those are eleven percent interest loans. And
If you think about the typical private equity middle market company
They were bought at twelve times.
Hibra
They put seven turns of leverage on it.
In seven turns of leverage.
Only allows
you use all your EBIT you can pay fourteen points two eight or so whatever percent
Interest.
So now you're paying eleven where you were paying six.
There's a lot less room for error right now.
And we haven't seen that interest really flow through'cause like
These rates happen so fast and furious that even Q one of last year, like rates were really, really low. So
I think going forward you seeing a lot more stress on these companies.
You're gonna have more defaults. Like defaults are picking up.
Some bad trades were done.
Private equity
As an asset class been around for forty odd years.
And sometimes excess gets in the system. We saw it with the massive LEOs before the great financial crisis.
I would say
There's probably more excess in private equity in the middle market space than anywhere else.
And it's direct lenders. So when we say private credit, I'm really speaking about direct lending.
particularly to middle market private.
Equity sponsored companies.
I don't think it's unnatural to think that
You're gonna have more defaults.
And
The sub one hundred million dollar IBA
Space.
Then you are
in necessarily S P
Companies.
You've dealt with a lot of GPs, LPs, you've been both talk about this notion of volwashing, the
concept itself and why it's an important thing to think about and understand from the allocators perspective, from the GP's perspective, from the end customer, the asset owners perspective. Just think it's like a neat, interesting concept.
You think about
Institutional allocation to alternative asset management. We'll start with someone like David Swenson.
Who was the godfather?
in a sense of thinking about
that alternative assets should be in any big
institutional portfolio given that you have
A longer time horizon.
Well, you have competition.
When David Spencer first started
He was probably the chief bottle washer and was looking, you know, meeting private equity guys, meeting hedge fund.
real asset managers.
And now within a place like Yale or any other place they have teams.
They have the private credit team, private equity team, hedge fund team.
Infrastructure.
And all of those individuals
are competing.
To get
more assets in the portfolio. Cause that's how they ascend and maybe become the CIO.
So
When you have your monthly meeting or quarterly meeting and you're looking at returns
And you're the
long short equity hedge fund
Allocator.
And you've got volatility everywhere.
versus you're the private credit allocator and you're like, Yeah, we're doing our ten percent annual I was
Every month it's eighty, ninety basis points.
Checks in the mail.
That's like a pretty powerful position in the last few years.
So
Yeah, I've done five hundred meetings as a GP.
And there are few allocators
that really embrace volatility.
They would rather have
Let's call it an orb strategy.
That's
Fifteen percent. Which I mean, so would I. Think about it. If you can make fifteen percent
Forever with no volatility. Like
Sounds pretty good. Yeah, who wouldn't sign up for that?
But the reality is
That
When you're in a business cycle and
The faults are picking up.
You would think and we've seen in the high yield markets, we see in the levered loan markets, prices are going down.
We're not seeing in the private credit markets'cause there's no observable
Secondary trading of loans.
Talk about like what you think could be the domino or domino effects here because
The whole idea behind bowl washing is a lot of this stuff happens very slowly.
Unlike something like Silicon Valley Bank or something that publicly traded equity marks all over the place, you know what's going on.
seems fine until it's not, and then it can go poof really quickly. What is like the worst case scenario you could envision for how
what I'll call like bad private credit.
Loans.
go wrong and get worked out in the market.
I'm just pointing out
A possibility.
What could happen is
Given that
Yeah.
Eight, nine, ten, eleven percent net.
to investors.
If you were involved
As a GP if you're in a direct lending market.
You were making loans that
So for plus six hundred.
You had to have leverage at the font level. So you went
Two
A Goldman Sachs, City, GP, all the big banks.
I'm gonna lever this fund.
one to one. So if I have a billion dollar fund, I'm
gonna make two billion alone. I'm gonna borrow a billion
And they would give you a line of financing.
And that line has covenants.
And
The mark to market.
of the loans you're required to go to a third party valuation
provider that gives you a mark.
Most of those marks are gonna be par.
All the time.
That's part of the volwashing in a sense.
There's arguments to be made for or against that.
We don't necessarily have to go there.
But
Defaults are real.
That's the the nature of credit.
When principle comes due.
You pay me your don't.
And
Yeah, we can do amendments, what have you, but
End of the day, it's not performing.
As defaults pick up, which we've seen in Q one.
And again, I think it's gonna be in the lower end of the market, is gonna have a bigger percentage defaults than the higher end of the market.
If that trend does continue.
You're gonna see some of the worst.
Performing portfolios of all of private credit.
Their lines are gonna get cut.
And the
Leverage providers, the banks, the sell side.
is going to say you need to start paying us down this line.
And if they don't have loans coming due to pay off
They're gonna have to sell loans in the secondary market.
Many of these direct lending
loans are bilateral in nature, meaning it's just the lender
And the borrower.
So th there's no
public information.
So just the process of selling a loan
As the GP
You're gonna have to tell your borough, like listen
I'm gonna take this private information.
give it to a third party to evaluate the loan to see if I can sell it.
That's gonna be cumbersome.
As we see
When
Wall Street is financing positions, whether it's
Listed equities.
Or
Hedge fund stakes.
Whatever it is, warehousing lines.
They're pretty good about getting paid back.
I mean outside of the credit swiss situation
Wall Street uh the lenders have very good track record.
If one of these or two of these situations happen
All the other banks will know.
This is happening and they're gonna start
Okay.
Who are worst performers? Which ones are we worried about? Let's have conversations.
The correlation of
Hey.
This is not an issue.
And they're gonna be able to pay us back.
That goes from like nobody has a problem to like there's a lot of problems really quickly.
The billion dollars in your example that's
debt capital from JP Morgan or something to the fund.
Talk a bit about like the origin of that piece. Why is JP Morgan in that business?
What got us to there where that amount of
borrowing was possible at the fund level, assuming that like if something like this were to happen, new lending will probably dry up too.
I've heard anecdotally that's much harder to get today than just because of rising rates.
I just feel like maybe the system is getting a sense that up against a natural limit. Right, right. We wanted to do X billion of that and we've kinda hit our w limit.
As we've seen, private credit is keeps growing and
More funds are out every day trying to raise more money, there's a natural limit of that. Which I think is the Fed report, I think was about a couple hundred billion dollars.
of Dre clones.
Of lending by banks to funds.
So how did we get here?
The fun would just say like hey listen.
I'm gonna raise a billion.
I'm only gonna lever it one time. So you have fifty percent cushion on these loans.
Which are all first lien loans.
That
would have again fifty percent cushion.
So let's just do diversity of the loan pool and
What would have to happen?
And so if they're earning Libra plus
Five fifty, six hundred.
Then
the bank who's gonna lend the fund money
It's saying
Well
If I lend it live, it's two fifty, three hundred.
That's a pretty good deal for me because I'm top of the stack.
of a first lean position anyway with diversity.
And I think this GP
knows how to make good loans. I have a relationship, what have you.
If you think about where we were with zero percent rates
And deposits.
A place like JP Morgan, Bank of America.
Goldman Sachs.
They were taking in money at zero.
And now they're lending it out.
Lia plus two fifty, three hundred, and even liar was one percent, two percent.
But now
their deposit base is probably getting a little more competitive as well. So it's like is this loan
that they're making as good a business in a sense.
There's a related lesson here from I think you call it the worst trade you've made. Can you tell that story and then we'll talk about the lesson?
Yeah.
Thanks for bringing that up. Yeah, so back in the summer of
Two thousand and two.
I was trading prop.
at UBS.
And I had
a position in WorldCom. I own bonds that matured in early two thousand three, and they were trading eighty cents on the dollar.
And
the other debt of worldcom was trading decently lower the further maturities.
And one of the reasons that
I bought this
bond was because they had a revolver.
That was
Let's say June of O three.
So they had an undrawn revolver which they could have
Drew from the bank.
uh five hundred million dollars and easily paid off this maturity.
So the only way
That you could get crushed on this position, and I was short.
A bunch of other this is my long, this is gonna pay for my short. I was actually overall bearish at the time.
This was the smart long to have.
The only way you could get crushed was fraud.
I was like, what are they doing here?
And
What happened? Fraud. Fraud happened so I got crushed. It's good to know.
What's gonna kill you and it kills you, it still hurts.
Even if you gotta understand that. What was the fraud of WorldCom? Really, at the end of the day, Bernie Evers went to jail.
The fraud was
WorldCom.
was capitalizing operating expenses.
We had this
early two thousands fiber
Everything's getting put in the ground, massive growth still, even though
There was a consolidation, like the level threes and the global crossings went down, WorldCom and ATT were still
Growing
And ATTs
Even on margins or
Thirty percent.
twenty eight percent and worldcoms were like forty two percent.
And A T like guys were getting fired because
They couldn't keep up with WorldCom. Well WorldCom was just taking regular expenses that were operating expenses.
They were putting them below the line as capital expenses, so their operating margins looked a lot better.
So
The point I was making, like that was twenty one years ago.
When you're thinking about the explosion.
of middle market private equity.
I mean absolute explosion in the last fifteen years.
There's gotta be some of that.
I play golf a little bit.
Someone's like, What'd you shoot? Like a ninety? I shot a ninety.
Was it a hard ninety or a soft ninety?
Like something it's a big difference. Oh just give me a triple there kind of thing.
Hard numbers and soft numbers are much different.
And I feel like in the world of EBITDA
There is this notion
Of hard and soft.
And in a good market.
Soft is okay.
But in a tougher market
Everyone wants hard number.
How do you think
this plays out. Like if you had to handicap it.
What do you think happens in the world of private credit in the next three years or something like that?
Well I mean
Let's just say
In the law of large numbers, the amount of growth that we've had in the asset class has been astounding.
It's gone from
Two hundred and fifty billion dollars in two thousand ten to one point four trillion.
If I take a step back.
I think the asset cash will keep growing.
If I have to handicap it, I think there's gonna be a consolidation.
And it's gonna be a shakeout.
And probably the bigger players benefit from that shakeout.
Like we've seen in every other
Alternative asset.
Class in a sense.
Describe what you mean there.
in terms of the the cycle that happens there where the bigger players ultimately benefit.
Well
If you have thousands of managers Oh, which there are two thousand or something. Yeah, yeah. Thousands of managers, I just don't think the talent is evenly distributed and there's gonna be
I'm not saying who it is, but like it's gonna be
Some funds that just go away.
Just like we'll see in venture, just like we'll see in middle market private equity.
But that process of them getting
Blown out.
Might
caused a hiccup for a bit.
In the market in general.
Institution allocators are like, Wait.
I'm not always gonna get nine percent back. I could get
Seventy cents on the dollar back.
It's not gonna be zeros like you could in venture. You you could literally give your money and get back nothing in a venture fund.
But it's gonna be super disappointing.
Potentially super disappointing.
On the margin.
Which I think will
Pause.
And then the bigger firms
that have more resources
And
probably deeper relationships.
are gonna see like this cleanup trade.
Is a pretty fat pitch.
And we should lean in.
When the market really needs capital.
Which
I'm not one to think about
You always see your like these funding cliffs, like oh, so much commercial real estate, all this is due, and like
I've heard this always how y'all in market next year there's so much to do, like
There's always a lot of maturities due.
If you get a market where
All of a sudden there's a pause a bit. There's a decent amount of dry powder in private credit as well.
Pricing can't really change that much.
It sulfers at five percent.
And leverage is probably down from
Normal.
middle market company would be twelve times
E but uh
They're lending at seven, maybe they're lending five and a half turns now.
But it's still so for plus six percent. Again, there's limits on how much interest you can't pay fifteen percent. It just doesn't work for
almost any company. If you can pay fifteen percent.
You don't need debt.
In a sense, you're a good enough business that you should just raise equity.
What do you think of the world of venture right now? I know you've thought about it a little bit and met some people that do that style of investing and understand the setup. What do you think of that space?
I mean I again like much like
Private credit.
It was a cottage. I mean there were some big players
A sixteen Z and Sequoia and bunch of others have massive
Established players, but
There were a lot of small firms in venture
at the time of the financial crisis that had a a ton of growth. And then there's been
So many
Two people starting a firm with fifty hundred million dollars. There's just hundreds and hundreds of those kind of firms.
I'd say the barrier to entry
As far as alternative asset.
Managers the lowest has been adventure.
You just don't need
the SEC registration and prime brokerage and the bank relationships and it's much easier to set up
Two people, you and I, let's do a fun. We raise thirteen million dollars.
Really hard to do in private equity.
No one cares in private credit.
Hedge funds.
The fixed costs. You used to be able to do it. Now you can't really do it.
So
I think the smaller managers
Are gonna get blown up.
And
You're gonna have a shakeout.
We hear about all the time.
with respect to institutional allocators.
They have a denominator effect.
They've put out
More money in drawdown vehicles, whether it's private equity, private credit, real estate, or venture.
They were getting capital back to them so quickly on wins.
They're like, All right, let's make a bigger allocation and now they're capitals not only do they put out more than they
Think

But it's getting drawn quicker.
And now there's gonna be a pullback like wait.
Let's look at how we didn't venture.
And actually
Most of our money was made with
one out of our fifteen managers.
I think there's gonna be a natural consolidation.
If you think back across your entire investing career,
Can you paint the picture of the time that you felt you were at the peak of your powers?
Yes.
Yeah, clearly.
I had a massive advantage.
Which right time, right place, you catch the right wave. I'm a big believer that
It's more important to be on the right wave.
Then necessarily
Be the best surfer.
The wave is more important.
And
I started in credit derivatives in nineteen ninety five.
Almost by default.
I was trading in straight options and move firms.
We have a C for you, it's credit derivatives.
So that means for the first three years, I just talked to myself. I mean, I had credit derivative trader on my car, business card, no one knew what it was.
No one will give me the time of day.
It was good to think about the markets and
optionality and credit markets and how this product would potentially fit in and the use case for it.
So then the market picked up.
As soon as the Asian crisis happened and then long term capital and Russia and
And then you had
Y two K and the tech meltdown and
Obviously nine eleven, Enron, WorldCom. So like from ninety seven to oh two
Supervol time.
really high volatility in the equity markets, but also in the credit markets. Really, really high volatility.
Which is one of the reasons like convert hedge funds did so well. They had
Amazingly high equity volatility that they were hedging against and then the credit spreads were wide.
They had like kind of the best of both worlds.
So then I trade pop for a couple of years.
When I was trading pro
'Cause I'd started in the credit derivative market, like I almost knew every trade that was happening.
I kinda knew
Why every trade was happening.
Starting in a market and seeing it grow up.
Getting a sense of like
Knowing what every market move, every price that
happen.
You get like a sense of calm almost.
Nothing surprising.
And understanding the origin
So
Going into
Two thousand
Eight.
It was way worse than I ever thought it was gonna be.
I felt
that I was as good as I could be at that time.
We had a great team.
And
Yeah, I was a king shoe at the time and Fran Beyondi.
Who taught me a ton about
Distress investing, credit investing.
We had like
Two circles
I had this kind of derivative optionality.
New product background. He had
Deep value.
The intersection when those two circles kinda intersected.
That sliver we felt like we had a big advantage that we were seeing
the markets from two different angles.
that most people weren't.
That's the period.
That oh six, oh seven period.
When
The world of subprime was blowing up.
And commercial real estate was blowing up.
And all these LBOs were like
How are you gonna fund these LBOs? And we were really, really sure that they were gonna get hung
And that there was gonna be contagion.
We were super confident.
On our view.
Can you explain the psychology of
being very successful in the hedge fund.
career or profession.
What it's like to go from
learning something, being new at something to
making a ton of money.
in a fairly like virtual job.
Like you're not.
Making a widget.
You're sort of like a symbol manipulator.
And then all of a sudden you have a lot of money.
What is that?
Experience like.
I'm gonna use probably a terrible word'cause my vocabulary isn't as good as yours.
It's surreal.
It's out of body in a sense.
Overnight successes are ten years in the making.
Rarely do you have someone that just
Steps in on
Day one.
Most of the time
I would say
Whether it's
private equity or
hedge fund.
During your twenties.
You're kind of learning a craft.
And then
If you're lucky
You get some insights.
that maybe are unique.
There's an a
assume narrative out there.
that you're like, I don't believe in this. Now everyone's believing this. I I don't think this is true.
And the payout if I'm right.
Betting against that.
is massive.
And then if you're really lucky
You get in a seat.
Where
You have real leverage.

And then you need it to happen.
So there's like a confluence of events. So
There's definitely some luck involved in that. When it all does happen.
It can happen really quickly.
And then it's like what now?
How do I follow it up? Yeah, what's my next album? Right. You think about like bands.
And this is not a unique thought, but like
I remember in college
I'm old.
Blues travelers came to Duke.
bunch and
They released their album and it was like awesome. And then they released their second album was awesome. They've been working on those songs for like
Seven or eight years.
And then they released their third album and it kinda sucks because like
They only had like eight months.
This is all I got, right? It's like the first book for an author, same phenomenon. Yeah, this that phenomenon, it's like all right, what's the follow up? So
In any kind of investing, like I'm always amazed.
In awe of
The investors
That can change stripes.
And
Be fluid over
decades of just figuring out how to make money.
It's kind of
Sobering.
When someone like Stan Drackmore
I listen at the Sown Conference.
And he's always like, Listen, you know, it's harder now because every time
We were getting into a recession. I knew the Fed was gonna have to cut rates and I would just buy the two year note.
I can't do that this time. This time is different.
And someone like him who's
And on anyone's all time great list, when he says it like
There's no magic formula.
It's a puzzle that
Every day you have to
to go home a little defeated.
with the benefit of a lot of perspective and you and I have always talked about lots of different kinds of investing.
What kind of alpha?
Do you believe exists or can exist?
And what kinds of alpha are you skeptical of?
Well, the skeptical is easier.
I just think information, right? That was massive alpha.
over time.
So
If you think about distressed.
There was a real alpha in knowing, understanding
The process, the bankruptcy. Chapter Eleven.
The court proceedings.
Filings that had to be made.
Reading those filings.
And then
There's an osmosis that happens where
There's some firms that are really good at it.
Some people leave those firms, start their own firms. So
understanding the process, that alpha gets dissipated.
But then like reorg research comes out, which
That just completely flattened the playing field. So the process of bankruptcy.
I mean, yes, there's twists on it and turns on it.
And you think about the same thing with long short equity.
I don't
really understand
How going quarter to quarter
Is there any alpha anymore? I think there was alpha at some point.
I think that informational edge
in any market over time.
Where is their alpha? I do believe there's alpha in time.
And I believe there's alpha
in the permanence of your capital.
Going back to Buffett.
His big advantage is
But he had time and permanence of capital.
I definitely think there's alpha there.
I think there's alpha
In understanding
new technology.
Whether it's biotech or
AI or blockchain.
But then you always have to find a new new thing.
Doesn't persist.
But being on the edge, there's definitely alpha.
If you're advising then
I don't even know who to put in the hypothetical here. A a student, someone that's interested in investing, a pension manager, like whoever.
A lot of people invest.
Is the right average advice just put it in a vanguard fund?
Do you think or should anyone and if so who
Endeavor to do more than that.
I don't believe in passive income.
I do think there's alpha, like you wanna be a hustler, like
And you wanna
own real estate and
Beyond your man, and you can do it on the side, or you have a buddy
That you trust.
that you can empower
I think there's a decent amount of alpha in
small medium businesses and
Being more efficient.
I'm a big fan of Blackstone.
I think
Many of the massive
Alternative asset managers have a tremendous amount of talent at them.
I just happen to know a bunch of people at Blackstone better.
And
For their real estate funds.
Regardless of what we think about real estate, like
we were talking about before, like I think they have the best network. They source
Better than anyone else.
They understand
All aspects of the market.
They're seeing it on the private equity side. What
real estate trends are there's synergies there.
If you had an allocation
To Blackstone in real estate.
That's a pretty good place to be.
Speaking of Alpha, what do you think of income share agreements?
I'm a big fan of income sharing agreements.
I do think that
We hear every day.
a problem with our economy is that we're over levered.
Whether it's the public, private.
the Western society and the whole world is over levered.
I mean you think about the Bitcoin maximumist.
So much leverage. She out.
It really comes back to the fact that there's
Debt.
If we had zero percent debt to GDP
the Bitcoin maximalist wouldn't really have a great argument.
If all the dollars were backed by gold.
What would their argument be?
So it comes to debt. So
How do you finance a venture, a person
An entity
Without debt, well equity.
That's the other side of it.
So
That's the way I view income sharing agreements.
Is
That if you were
A person
has some talent or ambition
Or idea.
And you're willing to give up
Some percentage of your upside. It shouldn't be too much.
It shouldn't

probably ten or fifteen percent.
So it's not like you're like I I can't believe I'm working for somebody else.
Then
I think equity financing is a great way.
To capitalize a talented person.
And what does the equity finance get them?
Well get some resources now.
That
would enable them
to
best use their talents.
And get
Training.
Someone like an athlete, you get training, you get better nutrition, you get better sleep.
If it's a YouTube personality, you get better microphones.
You get better people working with you.
If it's a DJ
You get a marketing firm.
Whatever it is.
Could be an engineer coming out of MIT.
I just don't want any student loans. I don't want to think about that.
I want a place to live. I want a
Help my parents out.
I just want a peace of mind.
that I can perform better.
Why do you think there aren't more of these?
All that makes sense to me.
And I think a lot of people
Obviously like the more
capital there was here, the more efficiently priced stuff would get.
the M I T C S grad or something would probably have a pretty nice
Not that they could sell ten percent of their or whatever it is.
So why isn't there more of this?
It's an idea that's been bantied about quite a bit for five, six years now, but doesn't seem like there's any critical mass.
Why not?
I think some of the areas it was first tried were the coding schools.
And I don't think that was the right Lambda, et cetera. Yeah, I don't think that was the right cohort.
of individuals.
I think it's best
first tried on like
Whatever the field is
The top one percent talent.
Where you have the chance to have an outlier that really outperforms.
So
It could be
computer science majors at MIT.
And
It could be
minor league baseball players. Or it could be
U to personalities that have hit certain metrics.
are already and like are they gonna be the next Mr Beast?
I think investors need to see
A chance
For
The hundred X.
on some portion of the portfolio.
And it's a capital market. It's a new market.
So
There's a demand for capital.
From the individuals.
And the providers of capital.
They haven't gotten return.
I think all the deals that have been done have been
Not that great.
And then there's also an education side to it.
Whereas if I know Purdue University had
Mitch Daniels was a big proponent of it. Maybe like the eighteen, nineteen, twenty year olds didn't really understand what they were signing up for.
Not that they understand what they're signing up for when they're taking student loans.
So I do think there's an education side of it.
But
Starting with the outperformers.
The real chance for
The right tail risk.
Is critical.
If you think about right tail risk in investing organizations and you were
Backing.
Let's say you're investing money in a GP.
And you got to like build the CIO like you would build like a Madden character or something.
And you get a hundred EQ points and a hundred IQ points.
Just generically, how would you allocate those
If you're trying to achieve most investment firm success.
I'm assuming the IQ is like at certain level. Like if I give him a hundred EQ points, he's not gonna be a zero IQ. Yeah, let's say we start at the average, right? At a hundred and ten or whatever.
I think it's more EQ than IQ.
But I think the EQ
There has to be like a humble
aspect of the EQ, which I think is a part of EQ is like
Knowing when to be humble.
Being comfortable
With
hiring
People that
maybe much smarter than you.
But you feel like you can still add.
To their experience.
You can still help them, you can still help them achieve
their maximum potential.
As investors.
I think that's a big part of EQ.
That coaching
managing aspect of
A group of individuals which yeah, most of
Whether it's a hedge fund or
There's more IQ probably than EQ.
Yeah. If you think about your reference class, like
you happen to know a lot of the very successful
leading investors of the generation or whatever.
Do you think that that's true that those people on average have very high EQs?
There's definitely exceptions.
Some of the investors
That I've met
That don't necessarily have
High
EQs with respect to relating to others.
They have a sense of calm.
Where they're very
capable of not being influenced by others.
Which
might not be like great for a team.
They might not give you great feedback.
Whether Soros said like his back hurt and he was just so like
They're not afraid to like come in and sell everything or say no.
If they don't have
a really good EQ, they've got like a strong sense of
Their independents.
Which
It's hard not to get influenced.
Because
Yeah, you're at an organization and like even though it's like professional, it's don't take it personally, it's business.
Everyone takes everything a little personally.
If you're a PM and you have
Someone that
You work with
has done really good work and come up with great ideas and
I think that idea's stupid.
It's hard to tell them all the time that.
You can either be really, really gifted
as g giving messages, which is high EQ.
Or you could like I don't really care and like that's just the way I am.
What do you think of with the current
Set up.
the world of investing or capital markets careers.
as something that really talented people should go and do.
Do you think that right now is a good time?
If you're a smart soon to be Duke grad or MIT grad or whatever it is.
to go into the field of capital markets or do you think that that talent
should go into biotech or you know, somewhere else.
It's easy for me to say like oh you shouldn't go in, you should try to make the world a better place.
Somewhat self serving.
I think there's a tremendous amount of change. I think
You have to have go in wide open and be like, Where's the change gonna take place in the capital markets?
I'm a big
proponent of the blockchain. I have no prediction on the price of
Bitcoin or Ethereum or any other
But I do think the blockchain
Will help
solve some problems we have.
it's hard to move money around the world. So global payment system.
is built on forty, fifty year old rails.
And settlement risk and
Counterparty risk is
Real in every
Kind of whether it's a
listed market or over the counter market.
Where the blockchain can solve that problem as well. I'm not saying it's happening tomorrow. So
I think
If you're going into the capital markets, like how do you solve problems, the blockchain can help.
What's AI gonna do? Well, it's gonna do a lot. So if you
or thinking about how does AI change capital markets, how does it change investing, how does it change
How capital gets allocated.
What did debt structures look like?
Does AI help on credit?
Credit's hard.
At some level credit
Is all about belief.
Do I believe I'm gonna give you yeah.
I'm gonna pay Do you believe
that I'll pay you back.
There's ability to pay and willingness to pay.
And we saw that
During the subprime debacle.
Is
that if a creditor was like, you have the money and the debtor was like, Well, I don't need to pay you because I'm not getting kicked out of the house.
The willingness to pay went way down.
Even that with
Institutions.
If you're a bad actor
in the capital markets it's harder to borrow money the next time.
The company's
Or entities that pay back and are fair.
They're more credit worthy.
I guess it goes a little beyond numbers in a sense.
If you were teaching like a college course or maybe a graduate level course on credit investing specifically,
What would be like the most major sections that you think would be teachable?
And important to learn.
for someone that wanted to do that style of investing.
The best credit
analysts that I've seen.
really understand cash flow and can
Raise a flag like
Wait, this doesn't make sense. Why doesn't Even I and cash flow
Tie out.
Why is this explanation taking seventeen different
footnotes to follow and why do I have to
go around in a maze to see where the numbers are.
I mean, I think accounting and is really, really important.
Then I think it's about
Optionality.
Which I think I'm very good at.
is understanding optionality.
In the sense that asset values change.
Over time.
You have a capital structure today.
You have a company
That has a hundred million dollars of EBITDA.
And the market says it's worth
Ten times.
And that's a billion dollar company.
And
Some
private credit firm will when you
five times. They'll lend you fifty percent loan to value.
So you have five hundred million in debt.
Five hundred million of equity.
on a billion dollar company.
Well, we all know like asset values change over time.
What is causing
Those assets
To go up or down?
Your customers, the margins.
Supply chain
cost of labor, there's all these different factors.
And the great credit worthy companies or entities like the US government, what have you
They have a lower volatility.
And like understanding
Business
And why do you have an eighty percent gross margin?
And is that sustainable?
And why do you have a forty five percent EBITDA margin? And is that sustainable? Why is the fifteen percent EBITDA margin
Actually really sustainable where there is a real moat there.
Those questions and understanding volatility around
The numbers.
It's not static, it's always moving.
And debt is forever.
So everyone
looks at like oh they're credit where they they borrowed money, they're rated
We know the rating agencies are behind.
If you're waiting for A to tell you
that it's a less credit obviously in private credit there's no ratings whatsoever.
So you just always have to be paranoid as a credit investor.
What can change.
What can put me
Where
I don't have that cushion where I'm actually now quitting.
What about something similar similar question around volatility specifically, given that's something obviously you've spent a crazy amount of time thinking about and working within
What do people
underestimate about the power of volatility or not understand well enough about the power of volatility.
in capital markets.
The lack of imagination.
I mean I read a quote one time
Hundreds of years ago.
to polymaster talking.
And they're like, Oh, he can't be a mathematician because he doesn't have the imagination.
Which is kinda like oh but like if you think about math
Really, like when you think about like
And I'm not a mathematician, like
How did they come up with it? How did they think of that? Who thought of zero, right? Like that is crazy imagination.
to think about the concept, negative numbers, what have you.
That we take for granted.
And that's what I think about volatility is like imagination.
I'm not saying anyone predicted the pandemic.
But like how quickly things can go upside down.
Honestly, I'm not in the markets every day.
I'm not using it as an excuse, but like
Silicon Valley Bank.
It's kind of insane.
They're a public company.
that is issuing
Quarterly earnings reports.
And the market saw the hole in the balance sheet. It was reported.
And no one was like, wait, why do you own fifty billion dollars of tenure notes?
Why do you have unhedged interest rate risk of that size? Like why don't you own
Three year
corporate bonds or like
Short dated CLO Triple A tranches.
No one questioned
And it didn't happen overnight. This happened like they were buying. They didn't even have like a risk officer for like a year or something. I never thought that a financial institution would blow up because of interest rate risk. That's such a basic risk.
It's like you can do interest rate risk.
Literally like with a pen and paper.
Patrick, how many ten years do you have?
I've got fifty billion.
You don't have that much equity, Patrick, like you're like negative equity because of these
Yeah, it's fine. You know, like like it just seems absurd.
That that happened.
And it's like somewhat lack of imagination.
And not to be a doomsday or'cause really good things happen.
I'm always in awe of
Great growth investors.
That have the imagination
Not that, you know, I was believing that we're gonna have
Tesla full automation of taxis and everything like that. But like SpaceX is pretty amazing. Like if you think about like if you said
to me ten years ago, yeah, there's this guy
He's working on this thing, electric cars, you're like, ah, electric cars, that makes sense. And then he's gonna do this other like space company and
That's gonna be bigger.
What are you talking about?
So I do think
having imagination in investing.
is key.
That's how you really understand volatility.
Is there anything you ever did to stretch your own imagination effectively?
What I tried to do
Is the narrative is becoming more powerful.
You've tapped into that just in all your podcasts.
But there's assumed narratives that are out.
Everywhere.
I think as a sidewalk
Probably we're getting better at really
Exploring narratives and be like, Is this really what
We want a society.
But in the financial landscape
There's so many assumed narratives.
So I do think like exploring
What does everyone believe
And
Why?
Is that true? Like it's a little Byron Katie that we were talking about before. It's like
Trying to understand
What is the nature of a triple A rating?
What does that really mean?
It's never gonna default. Well, could this possibly ever default?
Yeah, yeah, it could. And has Triple A's defaulted?
Actually, yeah, they have defaulted.
Mutual funds. I never knew that a mutual fund could gate.
two thousand eight hedge fund gated.
Tons of hedge funds put gates up.
Wow, that's kinda scary as an L P like.
They can just put your gate up.
Funds are putting gates up now, there's some funds.
I never thought about mutual funds putting gates up.
But now it's like
Not consumes me, but like
This is gonna happen again.
I mean, I thought during the pandemic
You had no trading in corporate bonds happening, spreads widening every day.
The search for yield.
Some of the big
Vanguard, Pimco, and I'm not picking on them. Like they became proxy like money market funds.
You were getting zero in a money market fund.
as a retiree. You're like, I need some income. So you buy
An investment grade fund or crossover fund.
And that was effectively your money market fund.
But there was no trading.
You think about a money market fund
Mike Green talks about this binary of like index funds. When they get money, they buy. When they get redemptions, they sell. Like it's zero one.
You get a bunch of redemptions and you can't sell any bonds because the market isn't open.
What do you do as a mutual fund? You put a gate out.
I don't think that
Most investors realize
most mutual fund investors realize they're subject to a gate.
It's an open ended fun.
They think that they have
One or two day liquidity.
And if they put their notice in, they'll get their money back.
Yeah, it's interesting to go down the line and try to think of the beliefs
that are most deeply entrenched or held and consider the opposite of those things.
This seems like a really worthwhile exercise for literally everyone in any kind of asset class.
Even if your money's in the bank.
Everyone just went through this. Wait a minute. How many people actually understood the FDIC insurance? I don't want to be like, oh, I mean two hundred fifty thousand dollars is a lot of money. So it's like most people, it's like not an issue, whatever.
You've these young founders
Oh my gosh, I just raised
ten million dollars for my series A and like I'm
Top of the world.
And I put it in the bank because I'm like twenty four years old and like I don't I don't want to like I want it in a safe bank. Everyone's telling me like this is a great bank, put it in that bank, Silicon Valley Bank. And you're like, wait, I have to deal with the fact that I'm a creditor to this bank. I mean it didn't happen, but like that's crazy.
There's just so many assumptions.
But yeah, there's narratives that everyone believes.
I think thinking about
Just their narratives. And sometimes it's who's a good investor, who's a bad investor, then what's a good investment, what's a bad investment. But then there's the structural.
Lastly, I mean I do think
The Silicon Valley Bank gets back to this, but there's always asset liability mismatches. Say a bit more about that, just like the nature of that concept.
Well, the road to hell is paved with positive carry.
So if you
Invest long and borrow short.
usually there's positive carrier. Like right now in the treasury curve it's inverted, but
Most
Yield curves.
Or
Possibly slow.
I mean you think about all the blow ups over time.
A lot of hedge fund blow ups, long term capital, whatever, they're levered thirty to one. Like how come they blow up?'Cause
Their leverage is overnight leverage and they have longer dated assets. The assets get marked down.
And their margin gets pulled and they have to sell everything. That's happen time and again. Yeah, M F Global, it happened.
I mean, that's what happened in Silicon Valley Bank. They had tenure notes that got marked down.
And their liabilities to deposits were overnight deposits, they all left and they went out of business.
private credit funds.
My point with the private credit funds, there is an asset liability mismatch.
A lot of these funds have leverage.
The leverage is to some big banks are sophisticated. And I'm not saying that there hasn't been any diligence done. There's been diligence done.
But
They have went
money, their assets are long dated loans.
And
They do not match
the financing lines that they have with the banks.
So if those lines
have to be paid back.
They're gonna be forced
to sell assets to pay those back.
And that's where the that's a liability mismatch comes in.
I mean a mutual fund has an asset liability mismatch.
They're giving out one day liquidity.
And they might
have assets that might take more than one day to sell.
That's a mismatch.
I guess in this case the positive carry thing.
It's just always gonna be that way because the natural slope of the curve is what it is. That's probably gonna always last. So you just wanna be mindful of Yes, you wanna be mind you wanna break down like how was an investor
You're getting back to your alpha. Like where is the alpha coming from?
And is it a time alpha?
Is it an informational edge?
Is it illiquidity? I mean there is can get alpha in liquid illiquidity.
But if the alpha's coming from an asset liability mismatch
They can work for a long time. Long, long time.
I'm not saying they're all terrible.
Depends how much leverage.
If private credit, if defaults don't come in
Let's just say f T one was an outlier and
We don't hit a recession and defaults drop off.
then maybe the private credit funds will never have to deal with it.
Do you think it's fair to say that
most people and the natural inclination is to be short volatility.
Oh yeah.
I mean short volatility is positive carry.
Honestly.
When you say
Someone wins the lottery.
Even though a lot of people that win lottery end up
Spending all the money.
If you've been a financial advisor
One of your clients came in and said
I just want a billion, you'd be like
Well you should take
X percentage of it and put it in T bills.
You have Carrie.
T bills are ninety days, whatever, but like a little bit short volatility that the federal government's gonna keep rolling its dead.
Anytime you're lending money.
Your short vault.
I mean it comes back to the nature of
If I'm lending money.
As a private credit fund, as a bank.
As an individual.
I just don't want the assets.
to go down.
Oh.
That entity.
So I want everything to stay where it is.
If I'm lending money and I have fifty percent loan to value, I have a fifty percent equity cushion.
It can go down a little bit and I'm fine.
But I don't want volatility. I don't really care if it goes up.
That's the thing, you know, asset volatility, it can go up all of a sudden
A billion dollar company's worth two billion and you've only lent five hundred million. Oh, that's great.
As a lender
If you had to choose would you want volatility or no volatility, not knowing which kind of volatility you're gonna get, upside or downside.
You're like, I want no volatility.
I don't
get benefit of the upside.
How do you think about incorporating long ball
In your portfolio or in your life. You said earlier the key to vol is imagination.
so many of the amazing things in life happen
outside maybe the bounds of what we would expect or think are possible.
So how do you think about incorporating the concept of more long
Volatility exposure.
Just in general, both financially and otherwise.
I worked with an option trader is that and this was like talking about
Listed options.
He's like you should never sell an option.
That was
less than ten basis points.
He was just like that's
Two out of the money, you don't want to be short that option. But if you reverse that.
And you're like
Is there possible to buy a thousand of one options? Thousand one payout?
Five thousand, ten thousand?
Yeah, I mean in our lifetime
I haven't hit on any personally. I don't know if you have.
I've seen a ton.
That have happened.
Whatever you think about Bitcoin.
It was public for many years where you could be up ten thousand times your money.
And a bunch of other crypto.
I think that's one of the reasons that Tesla
has such a fandom.
Is that there are so many people probably more than any other stock.
where people have made fifty hundred times their money.
Elon can do no wrong.
So thinking about
How is the market pricing?
The probability
And I think once you get beyond that.
Hundred and one, two hundred and one.
Realm.
It becomes really inefficient.
The pricing of the options are inefficient. In your favor to be long ball. You should definitely not be short, though.
It's silly.
To be short, those
If you can find them, and I'm not saying you should just go out and try to buy five thousand one options, but more saying it's mispriced. I'm just saying like yeah, as you get to the bounds of listed options, I see more and more mispricings.
as opposed to like at the money options.
So that just tells me that like
It's really, really hard.
The log normal curve doesn't work.
Yeah, option pricing
Thinking about movements.
Make sense.
When the outlier happens, the ten standard deviation move, the fifteen that we're never supposed to see, and we see them all the time.
Then it's interesting to think about
Is there
a pond that might have a bunch of those options in it.
Stop me if I'm stretching here, but do you think this same concept applies outside of finance and markets?
Yeah.
Well think about like just
Finding
a spouse or partner.
There's so many people that you could be compatible with.
And
You find someone
They're a great person, a lot of alignment.
But there just isn't
that one spark where you're like, you know what?
This is a great partner to
This person checks so many boxes, but like there's not that one spark.
But then you find that person that checks all the boxes.
And has that like one spark?
You see people
That find those people
And you're like, wow, I didn't know that was possible.
the right combinations of people in organizations.
I'm a huge believer in synergy.
When it comes to relationships.
And
That's optionality.
To me, in a sense.
Explain that.
A little bit more the idea of synergy and relationships. What exactly you mean by that?
Well
Can I use a basketball?
Course, let's do it.
Familiar ground for both of us. Yes.
I'm big Dude Coops fan and
I think J J Raddock
He's controversial, whatever. I understand why people don't like J Podcaster. Yeah, he's a great podcaster.
He's really insightful. He's a bright guy.
And he made a point about the Celtics team
He's like yeah.
Jalen Brown and
Tatum, Jason Tatum, who's a Duke Guy and I'm a fan of

too much of the same player.
So they aren't synergistic in a sense.
You can't get mismatches.
You do a pick and roll with those two.
Doesn't matter.
Whereas if you do a pick and roll with
Jamil M Murray and the Joker.
Now you've got two mismatches. Chaos, yeah. Yeah, it's total chaos. So it's like
If you and I have the same talents.
And we get along and we're compatible.
I don't know if we have synergy though.
Do I make you better or do you make me better?
That's I mean I guess.
The synergistic effect.
having the right combo.
You can't
have all leaders and you can't have all
Introverts. I mean it's gotta be some mixture.
Yeah, I love that idea. Think of the Joker in Jamal Murray as the paradigm you want to go after for sure.
Say a bit about
goal orientation as a
concept in
Investing.
Where I think in investing it's
Especially in liquid securities or something.
where there's less salesmanship, you can just press buttons to buy and sell.
We think of this as like incredibly like intellectual pursuit.
You're just reading and studying and thinking all day.
at least as I saw is less about goals. It's less about like an operating business where you're setting up things you want to accomplish and then knocking them down.
What role do you think goals play, if any, in a successful
investing career or process.
I was more of the mindset
It was like
More the infinite game.
Graham Duncan.
Like to talk about
That was my mindset.
Unsolvable puzzle that
you toiled out every day and you made some headwinds and
If you kept your process right.
And you're disciplined.
you were gonna get some nuggets that were fulfilling and
There would be some alpha there. Like you were kinda mining for alpha.
In a sense.
It's hard.
To set goals.
with respect to like every day I wanna get this much alpha or what have you.
Yeah, it's like fits and starts and you're on the right path. But there is a process of understanding when to cut bait and
This isn't a good idea, this isn't a good position.
And let's press here.
So I do feel like it's more the infinite game.
I do feel like
I would say
Some of the hedge fund investing is a little different.
Then
the other alternative asset classes.
Where it is more how much can we manage and how
Big can we make this.
And that may work.
Again, going back to the Blackstone.
And they're
A real estate business.
I feel like they've shot the moon.
Using game of hearts
analogy. Like I feel like they do
They have all the cards, they see everything, their flow's better than everyone else's and
And like they've got a good sense. Scale is okay. It's okay. Scale's good. Yeah, scale's good.
But when it comes to private credit, I don't know if that's right.
I think you might be reaching
a bit and justify lending
at top of cycles to
Again, companies that
don't have the hardest numbers and
Why are you making this loan? Well, because we need to raise the money to be the number one player or
We want these
GPs to come to us first.
That's where I think
Goals.
Can get in the way of it.
Have you learned any other interesting lessons from
I guess sports is where my mind goes. Basketball even more specifically.
About
Teamwork or performance.
From
having spent so much time watching and studying
Sports.
With respect to sports, I think the fact that the competition
Is always so fierce.
I mean if you think about let's just go it doesn't matter. I mean NBA or NFL.
The staffing.
How come the staffs keep
getting bigger and bigger.
You watch a
NBA game, there's like fifteen guys that are coaches now.
I think in nineteen seventy nine the NBA went to like three coaches or something.
And the NFL is the same.
Literally'cause it's the game within the game.
There is just the little nuance of where do you get the advantage?
I mean, remembering Bill Belichick
wanted a left footed punter.
Because the ball spun the opposite way.
And
It's a
Kind of an experiment.
Where like everyone is playing by the same rules, same cap.
Same schedules.
How do you get an advantage?
That's where
I do feel like the best
As far as investor management.
Those firms never
took for granted their lead.
And if you see in sports
Why were the Pittsburgh Steelers a dominant franchise? Well, they were the first ones to really scout
historically black colleges. They they crushed it there.
Billy Bean, obviously everyone knows, but like there's always
some alpha that they're mining, it feels like.
To get
To uh
better result and what should be like a fifty everyone should be five hundred.
In a sense.
So I do think yeah, in investment management like
The firms that have always
push the limits of like what makes sense and let's experiment.
I mean, I think Jeff Bezos was thinking about
His analogy
I'm saying
Hey, you can wait for a fat pitch, but the difference between business is that
In baseball you can always hit a grand slam.
Here you can hit a ten thousand run home run, right? Which is like imagination and volatility.
Yeah.
It's incredible to think about.
I actually don't know the answer to this question. I saw I noticed this the other night at the Warriors game.
It literally is like fifteen guys with the same like gear on or whatever.
It makes the seating all weird because the players end up sitting like further down.
And it's all this block of coaches. What are those guys doing?
They all have a shooting coach. Now there's like
A big man shooting coach and
The three pointer guy and like there's multiple shooting coaches.
trainers that are just biomechanics making sure everyone's loose.
I mean they all have
The equivalent of offensive and defensive coordinators
Plus the game management coach that just
Hey, timeouts, fouls.
How many fouls we can give.
Again then it position coaches
Yeah, there's just so many.
At the margin, if you think about it.
The warriors, I don't know, it's worth six billion dollars.
NBA teams are up ten X in the last
Ten, fifteen years.
At the margin, like should you be paying a guy three hundred grand?
As an extra coach? Yeah, like why not? Yeah, yeah.
Yeah, it's an amazing thing to watch and consider. I I love the idea of like the game within the game and I think it's a really clean to investing.
You dig in on some of these
Amazing investors.
And the degree to which they'll go.
To learn more, understand better. I mean, Ken Griffin that place is unbelievable. If you dig in there, like you kind of can't believe what you find. He takes nothing for granted.
He'd made no assumption.
If you said it to anyone at Goldman Sachs,
There's gonna be a hedge fund.
that is gonna start a securities business.
And dominate
Equity trading
And equity options.
And make seven billion dollars in a year doing it.
And it's gonna be private. They'll be like, What are you talking about? That's like so silly.
And he did it.
Imagination is the key recurring. I've only met him once and
His imagination
was definitely striking.
And rarely
does like the first thing you notice about someone about like their imagination.
Well, I think it's a great place to wind down the conversation. The notion of
Thinking about imagination in everything, mispriced options everywhere is just a powerful, wonderful thing.
Because of what could be possible. I ask everyone that I interview the same traditional closing question. What's the kindest thing that anyone's ever done for you?
I mean it's kinda cliche.
It's my parents.
I went to a college and they were like middle class and
Economics never came up. They're like
Do whatever you have to do.
They did that with my brother and sister.
And
They just always had belief.
In us?
That unconditional.
Support is
The kindest thing.
Wonderful. Kieran and I always so enjoy our conversations. Thanks for your time.
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