Kieran Goodwin’s roots go back to the early days of both distressed debt investing and the credit default swap market, two classes of risk he has seen experience significant change over the last 25 years. Our conversation gets underway by exploring the notion of alpha decay in the distressed market, a diminishing opportunity set that has resulted from smarter capital entering the space, equipped with an understanding of the often complicated process around bankruptcy and reorganization. Kieran frames out the option characteristics of distressed investing in an interesting way, suggesting that the short or long profile of the exposure is about whether time is on your side or not while also arguing that it is arming yourself with a margin of safety in price that creates this runway, leaving the trade with more long vol attributes.
Distressed investing today, in Kieran’s view, is an adult swim only business, rife with creditor-on-creditor violence and requiring a large balance sheet to be in the room as indentures are changed or portions of a capital structure are being primed. We spend the remaining part of the discussion on the CLO business and the potential for a credit-widening cycle. Kieran describes the CLO machinery as a captive buyer base for loans that has served effectively as a quasi-index product that has facilitated market growth. While noting that the product has indeed been effective over the years, he points to concentration risk that can lead to a rapid rise in correlations and spreads. He also points to at least some early signs of an uptick in defaults.
Lastly, we touch on the electronification of credit trading and the factorization of credit exposure that technology has increasingly enabled. Involved as an investor in some of the initiatives to facilitate electronic trading, Kieran sees further growth here, accompanied by more continuous trading and price discovery.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Kieran Goodwin.
[00:00:00] Hello, this is Dean Curnutt and welcome to the Alpha Exchange where we explore topics
[00:00:07] in financial markets associated with managing risk, generating return, and the deployment
[00:00:12] of capital and the alternative investment industry.
[00:00:20] Here in Goodwin's roots go back to the early days of both the stress debt investing and
[00:00:24] the credit default swap market.
[00:00:25] New classes of risk he has seen experience significant change over the last 25 years.
[00:00:31] Our conversation gets underway by exploring the notion of Alpha Decay in the distressed
[00:00:35] market, a diminished opportunity set that has resulted from smarter capital entering
[00:00:40] the space equipped with an understanding of the often complicated process around bankruptcy
[00:00:46] and reorganization.
[00:00:47] Curen frames out the option characteristics of distressed investing in an interesting
[00:00:52] way, suggesting that the long or short profile of the exposure is about whether time is on
[00:00:57] your side or not while also arguing that it is arming yourself with a margin of safety
[00:01:02] and price that creates this runway leaving the trade with more long vol attributes.
[00:01:09] Distressed investing today in Curen's view is an adult swim only business, rife with
[00:01:13] creditor on creditor violence and requiring a large balance sheet to be in the room as
[00:01:18] indentures are changed or portions of a capital structure are being primed.
[00:01:23] We spend the remaining part of the discussion on the CLO business and the potential for a
[00:01:27] credit widening cycle.
[00:01:29] Curen describes the CLO machinery as a captive buyer base for loans that has served as a
[00:01:34] quasi index product that has facilitated market growth.
[00:01:38] While noting that the product has indeed been effective over the years, he points
[00:01:42] to concentration risk that can lead to a rapid rise in correlations and spreads.
[00:01:47] He also points to at least some early signs of an uptick in defaults.
[00:01:51] Lastly we touch on the electronefication of credit trading and the factorization of credit
[00:01:55] exposure that technology has increasingly enabled.
[00:01:59] Involved as an investor in some of the initiatives to facilitate electronic trading,
[00:02:04] Curen sees further growth here accompanied by more continuous trading and price discovery.
[00:02:09] I hope you enjoy this episode of the Alpha Exchange, my conversation with Curen Goodman.
[00:02:15] My guest today on the Alpha Exchange is Curen Goodwin.
[00:02:19] He is a hedge fund founder, video game creator, advisor to several funds and a thinker on all
[00:02:27] matters of risk here.
[00:02:29] And it's great to reconnect and thanks for being a guest on the podcast.
[00:02:32] Happy to be here, Dean.
[00:02:34] Always enjoy conversing with you about all the arcane matters of the market.
[00:02:40] Yeah, we've connected over the years on vol and optionality.
[00:02:43] That'll be some portion of our conversation.
[00:02:45] I was just looking back through old emails and you'd reached out to me.
[00:02:49] Gosh, I think it's 2018 around a podcast I did with Chris Cole.
[00:02:54] So it was one of the first ones and I'm 150 odd episodes in and running strong based
[00:02:59] on the likes of being able to engage with guests like you.
[00:03:02] So thank you.
[00:03:03] You've had a long career in markets.
[00:03:06] You've done a lot.
[00:03:07] You started on the sell side.
[00:03:08] You were one of the earlier participants in the credit derivatives markets.
[00:03:12] You spent a lot of time at King Street running trading founded panning for a number of years
[00:03:18] and now you're kind of looking around and evaluating things.
[00:03:21] So we'll have a lot to talk about.
[00:03:23] Why don't we just go back a little bit and talk about some of your early days in
[00:03:27] the distressed industry, that asset class, the credit derivatives asset class.
[00:03:32] I'm always interested in speaking to folks like you who've been at this a long
[00:03:37] time and evaluating change.
[00:03:39] And so maybe take us back to some of the early days in distressed.
[00:03:44] One of the things I picked up on in another podcast you did was this sort of idea
[00:03:49] of alpha decay in distress that a secret doesn't stay a secret when there's
[00:03:53] profits to be had.
[00:03:55] I'd love for you to run through that with respect to the distressed industry
[00:03:59] and how maybe it's expertise or technology have effectively arped away
[00:04:05] some of the alpha that you saw in your early days.
[00:04:08] So I mean, I went to the buy side 2002 and I was like a prop trader after being
[00:04:13] one of the first market makers in credit derivatives.
[00:04:16] And I think one of my insights about credit derivatives and application
[00:04:21] was the fact that you could be short via owning CDS and you had a known
[00:04:28] downside to premium and your upside is if the company actually defaulted
[00:04:33] when the distress would be kind of par minus the recovery.
[00:04:37] So pitching that trade to many much smarter credit investors, I was more
[00:04:42] of came from the derivative side.
[00:04:44] I started understanding their mindset and the stress like Fran Biondi,
[00:04:48] King Street as far as a distressed investor was an early adopter of credit
[00:04:53] risk is King Street always thought about the short side.
[00:04:56] They were kind of a short long credit fund where sometimes they would
[00:05:00] short the credits that they thought would eventually be distressed
[00:05:03] and then go along them.
[00:05:04] And then trading prop on myself went through the defaults of WorldCom
[00:05:10] and Adulthea in the kind of TMT blow up of 2002 and then had a chance
[00:05:16] to join King Street in 2004 after having known Fran and Brian from
[00:05:21] 1999 really because I wanted to learn more about distressed
[00:05:25] really where was the offer created and getting there they had had on
[00:05:30] the Enron trade on that was a big position for them at the time from
[00:05:34] 2001, even 2004 and 2005.
[00:05:37] They were still reaping the fruit of that trade and yeah, the
[00:05:41] process of distressed wasn't really widely known.
[00:05:46] I mean you had a handful of participants that mostly kind of
[00:05:50] came out of the late 80s early 90s cycle that then spun off into
[00:05:56] hedge funds that really understood Chapter 11 and the reorganization
[00:06:02] of such.
[00:06:03] And there was alpha just in getting court documents before the
[00:06:07] next fund.
[00:06:09] So this informational edge that 15 to 25 distressed investors had
[00:06:16] over the rest of the market was real.
[00:06:19] There was more of a silo with respect of the credit market
[00:06:23] participants, meaning like insurance company they were forced to sell
[00:06:27] it when a credit came distressed or got to rated triple C because
[00:06:32] they didn't necessarily have their own reorganization unit internally.
[00:06:37] So going through the process and trying to find good assets,
[00:06:43] good companies with bad balance sheets there was a lot to choose
[00:06:46] from, especially after the tech bubble.
[00:06:49] And as you're describing, like I just believe when you have
[00:06:54] knowledge in a particular institution, eventually there's going
[00:06:59] to be an osmosis of that knowledge as people leave that
[00:07:02] institution or create their own fund or go back to the sell
[00:07:05] side or what have you and you need to find new alpha and
[00:07:09] taking 2010 to 2012 off after I left King Street and you know
[00:07:14] clearly there's sometimes when there's just a flood of defaults
[00:07:17] like in 2008 where if you have capital, you're going to be able
[00:07:21] to find opportunity.
[00:07:23] But one of the big differences in those two years was the
[00:07:27] emergence of reorg research, which is a third party provider
[00:07:32] of research for distressed and stressed situations.
[00:07:37] So now the whole process was pretty much anyone you signed up
[00:07:41] to get top quality research and you had to find a different
[00:07:46] angle to attack, which was beginning of credit on credit
[00:07:51] or violence, which is taking on new forms every day right now.
[00:07:55] So that's a little bit of my perspective on a change.
[00:08:00] So when we think about credit investing, providing capital
[00:08:03] and then taking some default risk in pursuit of some
[00:08:08] return above the risk free rate, you're typically framed as
[00:08:11] being short volatility right?
[00:08:13] That's what the Merton model would tell us about the spread
[00:08:17] premium as being some variation of the black shoals option
[00:08:21] premium.
[00:08:22] When you think about distressed, can you definitively say that
[00:08:26] your long or shortfall is a very situation specific?
[00:08:30] Are there situations in which a distressed investor finds him
[00:08:34] or herself long vol versus shortfall?
[00:08:36] Tell us a little bit more about distressed investing from an
[00:08:39] optionality standpoint.
[00:08:41] Yeah, it's a great question.
[00:08:42] You want a margin of safety because the process not only is
[00:08:48] it talking about a reorganization process, not only many
[00:08:51] times uncertain on which class in the capital structure,
[00:08:56] how is this distribution of assets going to occur?
[00:09:00] But also it's very costly.
[00:09:02] You have the advisors, the financial advisors, you have
[00:09:06] legal, you have auditors and the bills that you rack up.
[00:09:09] The entities you rack up, these state racks up are massive.
[00:09:12] So the debt holders at that point ultimately they're paying
[00:09:18] for it.
[00:09:19] So when I think about long and short volatility with
[00:09:22] distress, like one word that pops to mind is obsolescent
[00:09:25] risk.
[00:09:26] Mostly a company files that goes into chapter 11, then it
[00:09:30] goes into chapter 7.
[00:09:32] I guess every once in a while you have the chapter 7
[00:09:34] right to liquidation.
[00:09:36] But does this company need to exist?
[00:09:38] And will the burden of a reorganization be too much to
[00:09:42] bear such that like its competitors can take customers
[00:09:46] or its assets depreciate too quickly, its employees leave?
[00:09:51] I mean you have a ton of risk.
[00:09:52] So I do think that many times like your shortfall in that
[00:09:56] situation when a smaller company goes into reorganization
[00:10:01] or in a more competitive field where capital expenditures
[00:10:05] are required constantly.
[00:10:07] And then conversely, if you have hard assets and it's a
[00:10:11] bigger real estate, I mean if you think about the
[00:10:13] Lehman as a good example in 2008, the operations pretty
[00:10:18] much stopped of the broker dealer and you were left
[00:10:22] with these assets, many of which were hard assets
[00:10:25] and obviously you had much more liabilities.
[00:10:28] But you didn't have to worry about as much as the erosion
[00:10:31] of the assets from an operational perspective.
[00:10:35] So then if you were like, hey I have some margin of
[00:10:37] safety here and we are in a depressed environment with
[00:10:41] respect to financial assets, real estate assets.
[00:10:45] Then I would say you were long volatility.
[00:10:47] Some of the first, the low print on Lehman was
[00:10:50] eight cents on the dollar.
[00:10:52] And I think unsecured is recovered around 40 or so.
[00:10:56] And again, they had the benefit of all the QE and rates
[00:11:00] got cut and real estate got back bit up.
[00:11:03] So there are a lot of positives but there was
[00:11:05] definitely enough margin of safety that it was a
[00:11:07] cheap way to be long post the financial crisis.
[00:11:11] It's a great way to frame the question which is
[00:11:14] around how much cushion you have.
[00:11:17] There's that old saying there's no bad security
[00:11:19] and there's only bad prices.
[00:11:21] And the scariest security becomes investable at the
[00:11:25] right price.
[00:11:27] I do think time is the key there.
[00:11:28] Theta is the key, right?
[00:11:30] Like when time is on your side in a Lehman then
[00:11:33] you're long vol.
[00:11:35] When time is against you, I think you're short vol.
[00:11:38] That's just one generic way of saying it.
[00:11:40] Yeah no that's well framed.
[00:11:42] I wanted to get your take on the early days at
[00:11:45] King Street so as you said you're coming off a
[00:11:48] little bit of a risk.
[00:11:50] So I think that's one of the things that's really
[00:11:52] important to note about the telco distress cycle.
[00:11:55] Of course there's a lot of fraud, counting fraud with
[00:11:58] WorldCom and Tyco and Adelphia mixed in there.
[00:12:01] But these assets are investable just by way of
[00:12:04] this margin of safety.
[00:12:06] And then we go through this four or five year
[00:12:09] period, the housing bubble and all the
[00:12:12] securitization that's built around the bubble is
[00:12:15] that we've got this giant complex of financial
[00:12:17] assets built really with very little margin of
[00:12:20] safety you'll know better than I do.
[00:12:22] But I think the five year IG went to 20 odd
[00:12:25] basis points.
[00:12:26] Morgan Stanley traded at 20 basis points on a
[00:12:29] five year CDS.
[00:12:30] King Street did really well in managing
[00:12:33] through that when a lot of other firms just
[00:12:36] really blew up.
[00:12:38] What was that like just in terms of playing
[00:12:41] defense and what was the right mix of defensive
[00:12:44] positions that helped you manage through that
[00:12:46] incredibly volatile period from call it
[00:12:48] mid-07 to mid-09?
[00:12:50] Frank and Ryan when they started the firm,
[00:12:53] they quickly thought about the short side.
[00:12:56] I'm not saying right away but they were curing
[00:12:59] us to start doing credit derivative trades in
[00:13:02] 99 then I joined in 04 and in my experience
[00:13:05] and knowledge in the space it was definitely
[00:13:08] synergistic to their acumen as credit
[00:13:12] investors in their perspective is thinking about
[00:13:15] the downside, thinking about the short side.
[00:13:17] So I think it was very much the culture of the
[00:13:20] firm which helped and we were constantly
[00:13:23] worried about what was the downside and then
[00:13:26] seeing as you say everything being priced
[00:13:29] for perfection and then having some pretty
[00:13:32] alarming conversations with the sell side
[00:13:35] with respect to subprime and all the
[00:13:38] other things that were going on.
[00:13:40] So I think that was the first thing that
[00:13:42] happened was that we had a lot of
[00:13:44] security issues and we had to go right.
[00:13:46] One of the conversations we had where it's like
[00:13:49] if home price appreciation was flat for two
[00:13:52] years then subprime
[00:13:54] security issues kind of blow up because they
[00:13:57] only had a two year teaser rate and they
[00:13:59] needed home price appreciation.
[00:14:01] That just struck us as like, well I've
[00:14:04] had a house, I'm sitting in my apartment
[00:14:06] and as you talk about securitization like I
[00:14:08] think the early 2000s when rates got cut
[00:14:11] and the combination of derivatives and
[00:14:14] securitization kind of came together from
[00:14:16] the early 90s then you had synthetic
[00:14:19] CDOs in every asset class
[00:14:22] and it was just like the science experiment
[00:14:24] obviously gone wrong.
[00:14:26] So the price perfection
[00:14:28] and we just believed in contagion.
[00:14:30] I still believe in contagion and I think
[00:14:32] most of the people that were in King
[00:14:34] Street at the time we thought that was a
[00:14:36] real risk. Also during
[00:14:38] the time in the credit market we
[00:14:40] went through massive LBOs going on
[00:14:42] which were going to require
[00:14:44] which today doesn't seem like a lot
[00:14:46] but five, ten billion dollars
[00:14:48] of syndicated bank loans
[00:14:50] and like how is this going to get done
[00:14:52] and it was all just piling up
[00:14:54] and we were just like alright how
[00:14:56] can we protect ourselves and we knew a
[00:14:58] lot about credit derivatives in the short
[00:15:00] side and as you say spreads are really
[00:15:02] important.
[00:15:04] So you didn't have to be a hero.
[00:15:06] You could buy CDS
[00:15:08] on investment grade names
[00:15:10] below 50 basis points and some of them
[00:15:12] turned out to be 100 to 1 payouts.
[00:15:14] Amazing.
[00:15:16] You referenced this concept of contagion
[00:15:18] which was a lot of things obviously it
[00:15:20] invokes thoughts around systemic risk
[00:15:22] and counterparty risk in the financial system
[00:15:24] but it's also about
[00:15:26] hidden correlations and just trying to
[00:15:28] press ourselves to just think
[00:15:30] about what the linkages are
[00:15:32] that may not be in plain sight.
[00:15:34] I wanted to just go back to
[00:15:36] call it 0607
[00:15:38] giddy period of
[00:15:40] 10 VIX and these ultra low
[00:15:42] credit spreads with just a lot of leverage
[00:15:44] in the investment banks 30
[00:15:46] to 35X. I mean it was
[00:15:48] reasonably in plain sight
[00:15:50] and I was at
[00:15:52] Bank of America, I was on a
[00:15:54] management committee that interacted with a lot of the other
[00:15:56] asset classes so I was
[00:15:58] an equity derivatives guy
[00:16:00] and Brian Higgins brother Patrick
[00:16:02] was a mortgage sales person running a desk
[00:16:04] at B of A at the time and he used to always talk
[00:16:06] about the magnetar trade, the magnetar trade
[00:16:08] and just got me so interested
[00:16:10] in trying to understand what was happening
[00:16:12] in this
[00:16:14] sister asset class and what I
[00:16:16] noticed herein was
[00:16:18] good for my desk, our trades
[00:16:20] just got bigger and bigger
[00:16:22] and then I realized after interacting
[00:16:24] with some folks on the CDS side that those
[00:16:26] trades were just enormous. Orders
[00:16:28] of magnitudes bigger than
[00:16:30] the prints that we were putting up
[00:16:32] on the equity derivatives side.
[00:16:34] It's just a fascinating thing to sort of
[00:16:36] think back on and the why
[00:16:38] and how we got to that
[00:16:40] very exposed
[00:16:42] state you said around
[00:16:44] taking down the loans for
[00:16:46] the buyouts just
[00:16:48] incredibly exposed to something going wrong.
[00:16:50] The problem was
[00:16:52] I remember being on the sell side
[00:16:54] and gosh we're so old, we're talking
[00:16:56] a long time ago.
[00:16:58] But when we were first signing up accounts
[00:17:00] 25 years ago
[00:17:02] to do CDS, you want
[00:17:04] to have an is there agreement with them
[00:17:06] and part of the is there agreement
[00:17:08] is the upfront
[00:17:10] margin that they're going to post
[00:17:12] if they are selling CDS
[00:17:14] and then the variable margin as the position
[00:17:16] if it moves against
[00:17:18] them the counterparty has to post additional margin
[00:17:20] and this idea of margin
[00:17:22] in derivatives if you think about any
[00:17:24] the CBOA
[00:17:26] or any kind of exchange
[00:17:28] that trades options
[00:17:30] or futures initial margin
[00:17:32] and variable margin that's posted all the time.
[00:17:34] So in CDS though
[00:17:36] there was somewhat of a race to the bottom
[00:17:38] if a counterparty that was rated
[00:17:40] double A or triple A
[00:17:42] was selling CDS
[00:17:44] on a credit risk that was deemed
[00:17:46] to be triple A
[00:17:48] and they were collecting
[00:17:50] 15, 20 basis points
[00:17:52] and
[00:17:54] the salesperson or whoever wanted to get
[00:17:56] the trade done would be like well they don't want
[00:17:58] to post any margin because
[00:18:00] they're triple A and this risk is
[00:18:02] triple A and
[00:18:04] what's the chances of
[00:18:06] both this
[00:18:08] risk blowing up and then blowing up
[00:18:10] and like we talk about correlations
[00:18:12] actually
[00:18:14] chances were a lot higher than we thought.
[00:18:16] So there were many
[00:18:18] entities
[00:18:20] that were able to not
[00:18:22] post margin and basically sell options
[00:18:24] and that started
[00:18:26] with Berkshire Hathaway
[00:18:28] and they did it in every product
[00:18:30] they did it in out of the money options in S&P
[00:18:32] they were just like we're at Berkshire we're not going to post margin
[00:18:34] because
[00:18:36] the downside of posting margin is that you don't have
[00:18:38] use of that capital.
[00:18:40] So then other triple A's
[00:18:42] which weren't as good
[00:18:44] as Berkshire so I don't necessarily blame
[00:18:46] Berkshire for doing
[00:18:48] what they did
[00:18:50] because you could argue that he is the best
[00:18:52] but he was triple A
[00:18:54] or Berkshire was triple A
[00:18:56] Warren Buffett being Berkshire somewhat
[00:18:58] but sure, AIG was triple A as well
[00:19:00] and AIG was obviously
[00:19:02] as we saw
[00:19:04] for short as far as financial
[00:19:06] acumen of Berkshire Hathaway
[00:19:08] but they were
[00:19:10] able to not have to post margin
[00:19:12] so
[00:19:14] if you're not posting margin
[00:19:16] and you can sell protection
[00:19:18] the return on capital
[00:19:20] is infant
[00:19:22] and when people
[00:19:24] think that they're in a free money trade
[00:19:28] they tend to do as much as they can
[00:19:30] so
[00:19:32] I mean that was why the trades got to be so big
[00:19:34] because no one was posting margin
[00:19:36] and then the variable margin
[00:19:38] it was based on
[00:19:40] downgrades
[00:19:42] and then obviously
[00:19:44] when AIG got downgraded
[00:19:46] and the triple A risk
[00:19:48] and subprime that they sold or even in corporates
[00:19:50] was billions of dollars
[00:19:52] they didn't have the money
[00:19:54] so the correlation
[00:19:56] was one
[00:19:58] if AIG was forced to post margin
[00:20:00] from the get go
[00:20:02] the subprime blow up
[00:20:04] I mean it would have been big on balance sheet
[00:20:06] but not nearly as big as it was
[00:20:08] because there wouldn't have been as big of off balance sheet situation
[00:20:10] I think it's a great point
[00:20:12] so much of the outcomes
[00:20:14] of positioning
[00:20:16] are a function of the rules of the road
[00:20:18] and with AIG
[00:20:20] I think it's a really underappreciated acceleration
[00:20:22] in the financial crisis
[00:20:24] and of course AIG went down
[00:20:26] effectively the same week as Lehman
[00:20:28] but it was really that downgrade
[00:20:30] from triple A to something different
[00:20:32] that forced them to start posting
[00:20:34] and there's a great book on it
[00:20:36] it's called fatal risk
[00:20:38] in my opinion around the financial crisis
[00:20:40] it specifically deals with AIGFP
[00:20:42] and they talk a lot
[00:20:44] about the history of the financial products unit
[00:20:46] which actually had a great
[00:20:48] reputation for risk management
[00:20:50] and they just lost their way
[00:20:52] Joe Cassano got bigger and bigger
[00:20:54] and you were a hero
[00:20:56] as you said it's an infinite return
[00:20:58] where you don't have to post
[00:21:00] and when there are no defaults
[00:21:02] that margin of safety or lack of it
[00:21:04] just doesn't matter
[00:21:06] when they did have to post
[00:21:08] as you call it quote, variation margin
[00:21:10] the back office basically
[00:21:12] had to get out a dictionary
[00:21:14] and look up what the word meant
[00:21:16] they didn't even understand the concept
[00:21:18] it's pretty fascinating
[00:21:20] so I think one of the themes
[00:21:22] is this idea of liquidity
[00:21:24] that just sort of comes and goes
[00:21:26] much more quickly than folks
[00:21:28] appreciate
[00:21:30] I've heard you talk about gating
[00:21:32] not just in hedge funds
[00:21:34] I thought we might just have you
[00:21:36] talk a little bit about the UK pension
[00:21:38] short lived
[00:21:40] but pretty intense debacle
[00:21:42] and I want to say it's September or October of 2022
[00:21:44] basically
[00:21:46] a systemic risk event
[00:21:48] anytime you have to get your central bank involved
[00:21:50] it's a pretty big deal
[00:21:52] and so you have this
[00:21:54] goal of hedging
[00:21:56] and you blow up on hedging because of market to market risk
[00:21:58] what does that tell you
[00:22:00] about how quickly we can jump
[00:22:02] from something that's liquid to illiquid
[00:22:04] the best hedge is
[00:22:06] like not having to hedge
[00:22:08] like the business is hedged
[00:22:10] I mean anytime you have
[00:22:12] multiple legs
[00:22:14] when you're running an asset liability
[00:22:16] structure
[00:22:18] it just gets harder and harder
[00:22:20] and also it's just like
[00:22:22] whether it's the UK
[00:22:24] pensions or insurance
[00:22:26] and also Silicon Valley Bank
[00:22:28] and just B of A
[00:22:30] it's just these unintended consequences
[00:22:32] right like I mean
[00:22:34] it gets back to volatility
[00:22:36] volatility
[00:22:38] is never good for leverage
[00:22:40] if you're unlevered and you're long equity
[00:22:42] volatility is good for you
[00:22:44] assuming you have a portfolio of equity
[00:22:46] because like you're going to have some wins
[00:22:48] you're going to have some losses but your losses are
[00:22:50] capped to what you invested
[00:22:52] and your wins are potentially unlimited
[00:22:54] but when you get leverage
[00:22:56] when you have liabilities in general
[00:22:58] we talk about
[00:23:00] you said before credit your short vol
[00:23:02] but I just think anytime you're levered
[00:23:04] so if you're funding
[00:23:06] long assets with liabilities
[00:23:08] you're short vol
[00:23:10] because we even saw
[00:23:12] in Silicon Valley Bank
[00:23:14] this idea that
[00:23:16] deposits
[00:23:18] you could have argued that that was a great
[00:23:20] source of funding during the financial crisis
[00:23:22] as opposed to repo
[00:23:24] but now and maybe because
[00:23:26] social media or just the actual
[00:23:28] education
[00:23:30] or just the depositors
[00:23:32] or basically depositors
[00:23:34] were highly correlated group
[00:23:36] short term deposits are short vol
[00:23:38] so
[00:23:40] I think it comes back to like anytime you have
[00:23:42] a system
[00:23:44] that's levered
[00:23:46] if you have massive change
[00:23:48] and volatility is just kind of measuring change
[00:23:50] whether it's
[00:23:52] equity price change or interest rate
[00:23:54] that you just had
[00:23:56] last year or credit spread change
[00:23:58] there's going to be unintended consequences
[00:24:00] not every
[00:24:02] financial entity is going to be able to
[00:24:04] get through that change
[00:24:06] without some holes in the balance sheet
[00:24:08] when it comes to risk premiums
[00:24:10] it seems that we should be
[00:24:12] weary when the marginal price
[00:24:14] setter is an especially
[00:24:16] market sensitive
[00:24:18] investor I go back to LTCM
[00:24:20] from my vantage point I was at
[00:24:22] one of the others in 1998
[00:24:24] doing a lot of long dated equity vol
[00:24:26] they were a big seller of vega very different
[00:24:28] than the zero DTE
[00:24:30] gamma intensive craze
[00:24:32] of today but obviously
[00:24:34] very mark to market sensitive
[00:24:36] and so you get something where
[00:24:38] the stuff can move pretty quickly
[00:24:40] and they were among the few investors
[00:24:42] doing it but they were so large
[00:24:44] that they became
[00:24:46] especially vulnerable when things started to move against them
[00:24:48] I would love for you to talk
[00:24:50] about crowding you mentioned
[00:24:52] that in the
[00:24:54] old days the early days of distress there were
[00:24:56] 15 to 20
[00:24:58] entities that were big big players in the market
[00:25:00] I'd love to understand how
[00:25:02] that's changed over the years
[00:25:04] but also just from an investor
[00:25:06] standpoint I always want to know who's
[00:25:08] alongside me and
[00:25:10] whether they
[00:25:12] potentially become vulnerable and
[00:25:14] that vulnerability creates
[00:25:16] headaches for me I know a lot of the
[00:25:18] best situations have
[00:25:20] predator clubs and so forth
[00:25:22] talk to us about
[00:25:24] crowding from your standpoint and how you
[00:25:26] evaluate and kind of avoid that risk
[00:25:28] as far as the stress is concerned
[00:25:30] I still think it's
[00:25:32] a pretty small club
[00:25:34] I actually think entrance into the club
[00:25:36] or what you need to be
[00:25:38] successful is
[00:25:40] different I think
[00:25:42] 20 years ago you could be
[00:25:44] more passive and again just
[00:25:46] understand the process and following
[00:25:48] the court proceedings
[00:25:50] and how different creditors would get
[00:25:52] treated and you would definitely
[00:25:54] assert your rights but it was more
[00:25:56] just like doing your homework and reading
[00:25:58] documents and understanding
[00:26:00] subsidiaries and the guarantees
[00:26:02] they had just the flow of funds
[00:26:04] in the waterfall where now
[00:26:06] if you want to be successful
[00:26:08] the stress investor you have to
[00:26:10] be super active
[00:26:12] and you pretty much
[00:26:14] need a pretty big balance sheet behind you
[00:26:16] because
[00:26:18] you're having situations where
[00:26:20] creditors are clubbing up
[00:26:22] and changing
[00:26:24] indentures with votes
[00:26:26] and are able to
[00:26:28] put a class
[00:26:30] if you even thought of first lane
[00:26:32] they're going to prime you with
[00:26:34] a new loan because they can
[00:26:36] so if you're not
[00:26:38] in the room and to get in
[00:26:40] the room you've got to be bright
[00:26:42] and you know what you're doing and have good ideas
[00:26:44] but you also have to have pretty big checkbook
[00:26:46] you're out of the room
[00:26:48] and being out of the room right now
[00:26:50] is scary it's pretty binary
[00:26:52] situation many of these
[00:26:54] good
[00:26:56] distress players are also kind of
[00:26:58] involved in the CLO market
[00:27:00] so that might be a separate business
[00:27:02] but it might be a source
[00:27:04] of where they're getting the heads up
[00:27:06] that a capital structure
[00:27:08] is teetering so they can
[00:27:10] really go to the company
[00:27:12] and propose some kind
[00:27:14] of restructuring and out of court restructuring
[00:27:16] they're not good for you
[00:27:18] if you're not in the room
[00:27:20] so
[00:27:22] I think that's a little different from the whole idea
[00:27:24] of crowding it's like almost the reverse
[00:27:26] of crowding like you want to be with the crowd
[00:27:28] you want to be on the inside
[00:27:30] but yeah like markets in general
[00:27:32] I think it goes to indexing
[00:27:34] right like where are the flows
[00:27:36] coming from and credit markets
[00:27:38] are the ones that I guess I'm closest to
[00:27:40] even though I'm not
[00:27:42] like necessarily active day to day
[00:27:44] and whether it's investment
[00:27:46] grade or kind of par high yields
[00:27:48] or the CLO market
[00:27:50] everyone's pretty much an index fund
[00:27:52] if you're running a CLO
[00:27:54] there's some exceptions let's say
[00:27:56] the top 20%
[00:27:58] of CLO managers are actually
[00:28:00] trying to
[00:28:02] be different and being thoughtful about
[00:28:04] outperforming
[00:28:06] but it's been a pretty good business
[00:28:08] in CLO since
[00:28:10] 2010 just to
[00:28:12] mimic the index in the sense of
[00:28:14] hey if I'm
[00:28:16] okay, if I'm average
[00:28:18] and I can gather funds
[00:28:20] and keep issuing more CLOs
[00:28:22] and getting more AUM
[00:28:24] the margins of the business for the GP
[00:28:26] get better with size
[00:28:28] there's some fixed costs and people
[00:28:30] and then as I grow
[00:28:32] it gets to be a better and better business
[00:28:34] again I think is the same
[00:28:36] in
[00:28:38] investment grade and high yield long only
[00:28:40] management like size matters
[00:28:42] so instead of trying
[00:28:44] to be an outperformer
[00:28:46] probably one of the best credit investors
[00:28:48] as far as a long only
[00:28:50] was Dan Fuss
[00:28:52] and he was always looking to outperform
[00:28:54] and be a contrarian
[00:28:56] and he was at Loomis sales for
[00:28:58] a long, long time
[00:29:00] and I think his son still does it
[00:29:02] his fund was a great fund
[00:29:04] but it didn't grow nearly
[00:29:06] as much as Vanguard
[00:29:08] or PIMCO or BlackRock
[00:29:10] because they were like hey if I can lower
[00:29:12] costs and just kind of
[00:29:14] be the index that's a much better
[00:29:16] strategy so
[00:29:18] that transformation
[00:29:20] of the credit markets in the last 15 years
[00:29:22] that's basically like all the flows
[00:29:24] are binary like if money's coming
[00:29:26] into the market and IG and high
[00:29:28] yields spreads are going tighter
[00:29:30] and if money's coming out spreads are going
[00:29:32] wider we had some volatility
[00:29:34] obviously in 22
[00:29:36] and then from the end of 22
[00:29:38] to now I mean
[00:29:40] high yield has been
[00:29:42] a very good place to be and that's
[00:29:44] super highly correlated with funds
[00:29:46] that have been coming into high yield
[00:29:48] you know mutual funds and ETFs
[00:29:50] which is pretty similar to the equity markets
[00:29:52] the strategy of
[00:29:54] being bigger and lowering
[00:29:56] expenses from an asset management
[00:29:58] strategy has been
[00:30:00] much more lucrative than
[00:30:02] trying to outperform the market
[00:30:04] which is hard I'm not saying that's easy
[00:30:06] but it seems like less people are trying
[00:30:08] I want to get a little
[00:30:10] into the weeds on some of your thinking
[00:30:12] on the current state of credit markets
[00:30:14] and maybe specifically
[00:30:16] the CLO business you've taken to
[00:30:18] Twitter and you really been
[00:30:20] posting some very thoughtful stuff and one of
[00:30:22] them was on CLOs that you did
[00:30:24] last year and I think there was
[00:30:26] some contemplation there
[00:30:28] of a credit cycle this idea that
[00:30:30] we've had a seismic
[00:30:32] shift in rates from 0
[00:30:34] to 5 I hadn't seen that
[00:30:36] in a long long time and there's
[00:30:38] likely to be implications
[00:30:40] I guess we haven't really seen them
[00:30:42] just yet but when I think
[00:30:44] about credit cycles and I just
[00:30:46] loved for you to weigh in on this
[00:30:48] you had of course the financial
[00:30:50] crisis I mean that's a
[00:30:52] giant episode of contagion
[00:30:54] everything gets just shaken
[00:30:56] the financial system gets vastly weakened
[00:30:58] so spreads are just
[00:31:00] wider for a long time
[00:31:02] we talked about the telco bust
[00:31:04] and let's call it 2002
[00:31:06] maybe there's a mini
[00:31:08] cycle it's energy centric
[00:31:10] in 2015
[00:31:12] and 16 but
[00:31:14] where is the concept of a
[00:31:16] sustained and significant
[00:31:18] widening of credit
[00:31:20] spreads is that a thing of the past
[00:31:22] how do you look at the
[00:31:24] concept of a credit cycle these days
[00:31:26] it's a great question as someone
[00:31:28] that
[00:31:30] has done well
[00:31:32] in some credit cycles in the past
[00:31:34] when spreads widened and the falls picked up
[00:31:36] I'm definitely biased
[00:31:38] I'm not going to deny it
[00:31:40] that maybe
[00:31:42] too much of a concern with that said like
[00:31:44] if you look at my personal portfolio
[00:31:46] I'm pretty long I have one short position
[00:31:48] that's a few percent
[00:31:50] so I have probably more cash
[00:31:52] than a normal person
[00:31:54] as far as percentage wise
[00:31:56] more cash but not crazy amount of cash
[00:31:58] listen I like the
[00:32:00] vol I like chaos
[00:32:02] so there's a I just
[00:32:04] enjoy change I guess
[00:32:06] and that's maybe callous like I don't want
[00:32:08] companies to default
[00:32:10] and go into business I do want capitalism
[00:32:12] to get rid of excesses
[00:32:14] but yeah it's a great question
[00:32:16] and do you think with the rising rates
[00:32:18] it is surprising
[00:32:20] I mean defaults are picking up
[00:32:22] they're definitely picking up
[00:32:24] but you had I guess November of
[00:32:26] 22 chat GBT came out
[00:32:28] and I feel like that's
[00:32:30] just been a crazy
[00:32:32] bullish
[00:32:34] factor I mean there's just been so much
[00:32:36] capital
[00:32:38] put into
[00:32:40] AI whether it's obviously
[00:32:42] buying chips but data centers
[00:32:44] and
[00:32:46] that factor alone
[00:32:48] has kind of pushed off
[00:32:50] the credit cycle but
[00:32:52] with that said of all the private
[00:32:54] credit I can't remember who's index this is
[00:32:56] but it's like somebody like Lincoln
[00:32:58] or Cliffwater like someone
[00:33:00] that follows the credit cycles
[00:33:02] 17% of
[00:33:04] private credit
[00:33:06] companies that have
[00:33:08] interest coverage ratios on one or less
[00:33:10] and of those
[00:33:12] 70% of the 17%
[00:33:14] are $100 million and less even
[00:33:16] companies so
[00:33:18] I do think that the stress is happening
[00:33:20] at the middle market lower the middle market
[00:33:22] level and I do think
[00:33:24] it's hard to see that stress
[00:33:26] with respect to prices
[00:33:28] because we don't know
[00:33:30] the prices of private credit
[00:33:32] I mean we did have a big default
[00:33:34] in private credit Thrasio
[00:33:36] which was Amazon
[00:33:38] reseller roll up and it was
[00:33:40] raised a decent amount of capital
[00:33:42] from both on the equity and the debt side
[00:33:44] from pretty
[00:33:46] well regarded investors
[00:33:48] so
[00:33:50] there's some stuff coming but like
[00:33:52] yeah I mean
[00:33:54] is productivity going to be
[00:33:56] amazingly increased because of AI
[00:33:58] I think one day
[00:34:00] I mean AI though right now I was talking
[00:34:02] to a friend of mine the other day about this
[00:34:04] it reminds me a little bit
[00:34:06] of fiber and
[00:34:08] I don't want to talk about 25 years ago again
[00:34:10] but like when global crossing level 3
[00:34:12] which both restructured
[00:34:14] I mean global crossing
[00:34:16] that just liquidated level 3
[00:34:18] still around I can't remember
[00:34:20] it got bought by somebody
[00:34:22] frontier I think anyway
[00:34:24] that was just a misalocation capital
[00:34:26] all the fibers used today were thankful
[00:34:28] that all that fiber was laid
[00:34:30] 25 years ago and
[00:34:32] I don't know maybe AI's eyes like that I mean
[00:34:34] the data centers
[00:34:36] is it too much of a boom now
[00:34:38] I mean the difference being that the chips
[00:34:40] are depreciate right
[00:34:42] the actual fiber lasts for a long time
[00:34:44] the chips depreciate but the data centers
[00:34:46] near good power sources
[00:34:48] they don't necessarily depreciate so
[00:34:50] in my life like the only
[00:34:52] use case currently
[00:34:54] today for AI
[00:34:56] is for
[00:34:58] high school and college kids
[00:35:00] to write papers but
[00:35:02] I mean that could change pretty
[00:35:04] violently pretty quickly
[00:35:06] but yeah I do think we have a tail to cities
[00:35:08] right now I do think that there's some super
[00:35:10] interesting things going on
[00:35:12] with respect to AI
[00:35:14] and just wow we might be in this
[00:35:16] new age but then
[00:35:18] you've got some old school businesses
[00:35:20] that got levered up
[00:35:22] bought by private equity
[00:35:24] levered up by private credit
[00:35:26] that might not be able to sustain
[00:35:28] 10 plus percent interest
[00:35:30] payments for that long
[00:35:32] so
[00:35:34] totally keep your eye off the ball
[00:35:36] so some of what you were talking about earlier
[00:35:38] there was not a cliff as this
[00:35:40] and Val Laundering big
[00:35:42] box issue for him and I think for you as well
[00:35:44] and the question is
[00:35:46] and this is just around that series of tweets
[00:35:48] that you had sent last year
[00:35:50] around the C.L.O. business I found it extremely
[00:35:52] interesting you know you're talking about
[00:35:54] this corporate financing
[00:35:56] vehicle the loan the leverage loan
[00:35:58] and this industry
[00:36:00] this product the C.L.O. product that's built
[00:36:02] around it and is really
[00:36:04] a captive buyer of this
[00:36:06] product and I think what
[00:36:08] some of what you're pointing to and I'd love for you to just
[00:36:10] expand on it is just some of the
[00:36:12] risks that we should at least pay
[00:36:14] attention to or at least imagine
[00:36:16] could be activated as a result
[00:36:18] of having such a captive
[00:36:20] audience of buyers
[00:36:22] maybe just walk through that
[00:36:24] a little bit yeah I mean
[00:36:26] the C.L.O. product
[00:36:28] has been a good product
[00:36:30] so far it started around
[00:36:32] 2000 or so CBOs
[00:36:34] were bad just the high yield bonds
[00:36:36] and then
[00:36:38] C.L.O.s were better because they
[00:36:40] were first lean loans recoveries were
[00:36:42] higher they held up in 08
[00:36:44] in the sense that
[00:36:46] yeah equity lost and some of
[00:36:48] the subordinated but like triple
[00:36:50] A's double A's they never got that
[00:36:52] part of the capital structure with losses
[00:36:54] so roughly they're 10 times levered
[00:36:56] so
[00:36:58] they buy 100 dollars of loans and they have
[00:37:00] 10 dollars of equity and the rest
[00:37:02] of the cap structure is funded
[00:37:04] by the debt pieces starting at double
[00:37:06] B all the way up to triple A's
[00:37:08] so I think they represent
[00:37:10] around 70% of the new issue
[00:37:12] market that keeps going higher and higher
[00:37:14] so just like equity indexing
[00:37:16] it's like if you have
[00:37:18] one type of buyer
[00:37:20] that's motivated one type of way
[00:37:22] when they're not buying
[00:37:24] the market shuts down so
[00:37:26] C.L.O. managers
[00:37:28] they'll issue a new deal
[00:37:30] when the arbitrage
[00:37:32] makes sense and one
[00:37:34] of the biggest driver on the arbitrage
[00:37:36] is the biggest driver
[00:37:38] is where they can place the debt
[00:37:40] what spreads can they place the triple
[00:37:42] A's which is the biggest part so that
[00:37:44] really important then double A's single
[00:37:46] A's triple B's double B's so
[00:37:48] where they can place the debt so
[00:37:50] if the secondary
[00:37:52] tranches
[00:37:54] triple A double A all the way down
[00:37:56] are trading poorly
[00:37:58] then there's spreads
[00:38:00] widen out and
[00:38:02] you can't do a new deal
[00:38:04] and like what causes the secondary tranches
[00:38:06] to trade poorly
[00:38:08] well that would be an increase
[00:38:10] in defaults
[00:38:12] and or which is probably together
[00:38:14] a drop in loan prices where
[00:38:16] there's more perceived risk of the equity
[00:38:18] returns and then double B returns and what have
[00:38:20] you spreads widen out so
[00:38:22] I guess my point is it's like
[00:38:24] you've got this market
[00:38:26] that's disintermediated
[00:38:28] real credit decisions
[00:38:30] in the sense that like if you're a C.L.O.
[00:38:32] manager and you buy
[00:38:34] you have a 1 or 2% position in all these different
[00:38:36] loans you're doing credit work
[00:38:38] on the loans I'm not saying you're not
[00:38:40] but you're not going as deep
[00:38:42] because one
[00:38:44] you have a ton of competition with
[00:38:46] a bunch of other C.L.O. managers that are kind of doing
[00:38:48] the exact same thing so
[00:38:50] if you don't take a loan that's trading a little
[00:38:52] wider then some other manager
[00:38:54] might take it and they might be
[00:38:56] able to offer a little bit of deal
[00:38:58] to their equity and they might be a little more
[00:39:00] competitive and box you out
[00:39:02] so there's some pressure that you're competing
[00:39:04] and then
[00:39:06] you're like worst case like it's only a 1
[00:39:08] or 2% position I'm diversified
[00:39:10] when you talk about diversification
[00:39:12] you have to talk about correlation
[00:39:14] so
[00:39:16] in 2008 we saw
[00:39:18] that first-ling loan prices were
[00:39:20] super correlated because we had a bunch
[00:39:22] of hedge funds that were levered long
[00:39:24] on total return swaps
[00:39:26] and they got tapped out the C.L.O.
[00:39:28] product is better in the sense it's term
[00:39:30] leverage so you can't get
[00:39:32] tapped out but
[00:39:34] now that it dominates
[00:39:36] the market from primary market buying
[00:39:38] 70 75%
[00:39:40] of the new issue loans
[00:39:42] if it gets shut down for extended period
[00:39:44] of time that means companies
[00:39:46] can't refinance
[00:39:48] and the lack of
[00:39:50] not refinance can cause a default on its
[00:39:52] own so I do think
[00:39:54] just the
[00:39:56] concentration risk to the C.L.O. market
[00:39:58] I mean it's real
[00:40:00] there isn't going to be a C.L.O.
[00:40:02] manager that like hey even though
[00:40:04] the equity is 0%
[00:40:06] return I'm going to do a deal
[00:40:08] just because these companies need to
[00:40:10] refi it's not going to work like
[00:40:12] that it has to make sense
[00:40:14] and then you can say well the companies can issue
[00:40:16] wider levels
[00:40:18] but then at some level
[00:40:20] it's just like well does that even make
[00:40:22] sense for the company can they afford that interest
[00:40:24] so I just think this
[00:40:26] concentration
[00:40:28] leads to correlation
[00:40:30] if that makes sense
[00:40:32] well one company I'll put that in quotes
[00:40:34] that as
[00:40:36] free constant refinancing needs is the one
[00:40:38] that we live in the country
[00:40:40] U.S.
[00:40:42] what do you think about the U.S.
[00:40:44] debt issue there's
[00:40:46] a certain cohort
[00:40:48] out there saying look
[00:40:50] the alarmists have been complaining about this
[00:40:52] for a long time
[00:40:54] and we're a giant economy
[00:40:56] with great
[00:40:58] from a tax standpoint
[00:41:00] what's your thought on U.S.
[00:41:02] debt and then I've seen
[00:41:04] you talk a little bit about
[00:41:06] the blockchain and Bitcoin
[00:41:08] perhaps linked to concerns
[00:41:10] around U.S. debt
[00:41:12] I guess like
[00:41:14] I'm a closet Austrian
[00:41:16] I thought modern monetary theory was pretty dumb
[00:41:18] I'm glad that's like not necessarily
[00:41:20] as talked about
[00:41:22] it's still taking a victory lap
[00:41:24] somehow I'm not sure why but
[00:41:26] yeah so
[00:41:28] I think they can kick the can
[00:41:30] for a while
[00:41:32] and I could even argue
[00:41:34] looking back at
[00:41:36] 2008 the idea of
[00:41:38] a U.S.
[00:41:40] which at the time I thought
[00:41:42] certainly wrong on
[00:41:44] I can even argue that was a good idea
[00:41:46] but
[00:41:48] I just don't think it can go forever
[00:41:50] you get to the point
[00:41:52] it's the gradually then suddenly
[00:41:54] moment we live in New York City
[00:41:56] and
[00:41:58] I love New York I don't think I'd make
[00:42:00] a lifestyle choice for taxes
[00:42:02] I paid a lot of New York City taxes
[00:42:04] but like at some point
[00:42:06] you're gonna force me out
[00:42:08] I mean I'm not saying today but like
[00:42:10] they're like oh just raise more taxes
[00:42:12] like okay well how does that work
[00:42:14] does it 75%
[00:42:16] do people stop working
[00:42:18] there's clearly not enough revenue
[00:42:20] to service the debt
[00:42:22] at its current rate
[00:42:24] I don't see the end game if you just keep
[00:42:26] projecting it out like what is the solution
[00:42:28] to the deficits we're running
[00:42:30] maybe it's productivity
[00:42:32] but
[00:42:34] it's a ton of productivity
[00:42:36] so I don't worry
[00:42:38] that tomorrow the U.S. dollar is gonna default
[00:42:40] I definitely keep an eye on
[00:42:42] Bitcoin
[00:42:44] as somewhat of a barometer to it
[00:42:46] but like it's not necessarily perfectly correlated
[00:42:48] but I do see like
[00:42:50] the use case for
[00:42:52] other countries that aren't
[00:42:54] the reserve currency
[00:42:56] there's definitely a decent amount of wealth
[00:42:58] going into Bitcoin as a way
[00:43:00] to be a store value
[00:43:02] so I mean to me like Bitcoin is the only
[00:43:04] cryptocurrency
[00:43:06] that has a use case so far
[00:43:08] but yeah the deficit problem
[00:43:10] is tough and I do think
[00:43:12] that like
[00:43:14] while we might not
[00:43:16] be affected by it our kids and
[00:43:18] hopefully grandkids
[00:43:20] if we have grandkids like they're gonna be affected
[00:43:22] by it like I just don't see the end game
[00:43:24] no one's been able to explain
[00:43:26] or I mean if there is an explanation
[00:43:28] I haven't read it yet on how this ends
[00:43:30] but I'm not sure if it's going to work out
[00:43:32] well.
[00:43:34] Yeah sadly it's not part of the political
[00:43:36] conversation it's not exactly a
[00:43:38] vote winner these days
[00:43:40] the notion of dealt tightening
[00:43:42] Cliff has this a little bit kind of a godfather
[00:43:44] of factor
[00:43:46] investing value in momentum
[00:43:48] and I wanted to get some of your thoughts on
[00:43:50] just fixed income
[00:43:52] and credit market electronification
[00:43:54] there's some advancements
[00:43:56] towards factorization
[00:43:58] like quality and value
[00:44:00] from a credit standpoint to put
[00:44:02] portfolios together what do you see
[00:44:04] there and where do you see that going
[00:44:06] 2015-16
[00:44:08] I kind of had to change it hard
[00:44:10] I was like oh there's 40,000 bond
[00:44:12] QCIP so like doesn't make sense
[00:44:14] like it does in the equity market
[00:44:16] where all the equity is fungible
[00:44:18] and you have one issue with 150 different
[00:44:20] but then I remember like
[00:44:22] reading about autonomous driving and all that
[00:44:24] and I was like well if we can drive our cars
[00:44:26] honestly we can definitely trade bonds
[00:44:28] we just need more
[00:44:30] computational power
[00:44:32] and I started thinking about electronic markets
[00:44:34] and obviously market access
[00:44:36] and trade web
[00:44:38] started getting more market share
[00:44:40] stocks were going up
[00:44:42] yeah so and then
[00:44:44] 2020 I led a seed round
[00:44:46] for a company called Tradewell
[00:44:48] they've created an execution algo
[00:44:50] before the core bond market
[00:44:52] to interface with the exchanges
[00:44:54] because I was thinking about the problem
[00:44:56] and it's like it doesn't make any sense
[00:44:58] for voice trading
[00:45:00] electronic is definitely the way to go
[00:45:02] the market keeps growing
[00:45:04] the biggest mutual funds
[00:45:06] are some of the most sophisticated
[00:45:08] in trying to lower cost
[00:45:10] they really embrace the electronic
[00:45:12] case of the core bond market so all their rebalances
[00:45:14] are done automated
[00:45:16] and they have their own algo
[00:45:18] so there there you've got
[00:45:20] the big dealers
[00:45:22] or in San Diego actually Jean Street
[00:45:24] jumped in a few years back
[00:45:26] they're doming that flow
[00:45:28] you still have 90%
[00:45:30] or more of the core bond
[00:45:32] participants that are doing
[00:45:34] very few trades because they have to do the
[00:45:36] manually which is kind of silly
[00:45:38] they're not automated so
[00:45:40] the time it takes but we're seeing
[00:45:42] ticket sizes go down just like equities
[00:45:44] 25 years ago
[00:45:46] I started equities
[00:45:48] in the early 90s and the block
[00:45:50] trading desk was like the center
[00:45:52] and big blocks of stock would trade
[00:45:54] and now really to blocks
[00:45:56] trade it's everything's electronic
[00:45:58] trading becomes less
[00:46:00] digital of big blocks
[00:46:02] and more analog of where it's constant
[00:46:04] flow of smaller pieces
[00:46:06] and we're seeing that in the credit markets
[00:46:08] and I think
[00:46:10] in the IG market we're about 40%
[00:46:12] of average jelly volume which is
[00:46:14] I think last month was like 40 billion
[00:46:16] so 16 billion is getting done
[00:46:18] in electronic form markets
[00:46:20] and in high yield I think
[00:46:22] it's about 30%
[00:46:24] I don't know what the average jelly volume is there
[00:46:26] and that number
[00:46:28] three years ago was like
[00:46:30] 20 so it's doubled equities
[00:46:32] is like in the 80s I don't think we get there
[00:46:34] but I think we get to the 70s and IG
[00:46:36] and maybe the 60s in high yields
[00:46:38] I think we get smaller blocks I think we get more
[00:46:40] continuous pricing and when you
[00:46:42] have those factors
[00:46:44] I mean those qualities of a market
[00:46:46] then the factor investing
[00:46:48] becomes real like there's real signals
[00:46:50] so I think we're in the early days
[00:46:52] I think there's going to be more
[00:46:54] of quants coming into the space
[00:46:56] in a big way
[00:46:58] so yeah I'm very bullish
[00:47:00] on electronic markets
[00:47:02] grabbing more and more of the daily
[00:47:04] volume I'm very bullish
[00:47:06] on quants being able to have
[00:47:08] factor models and
[00:47:10] Stad Orb be effective
[00:47:12] in credit markets and
[00:47:14] you're going to have some volatility
[00:47:16] but I do think it's going to be
[00:47:18] a superior than the voice
[00:47:20] trading today as far as
[00:47:22] price discovery, liquidity
[00:47:24] that offer
[00:47:26] all the things that it brought to the
[00:47:28] equity markets I think it's
[00:47:30] going to happen and it is happening
[00:47:32] and the rate of change is picking up
[00:47:34] a bit. Yeah I mean one thing I would say
[00:47:36] about the US listed options market
[00:47:38] which I would say is just
[00:47:40] superior to all other markets is that
[00:47:42] price discovery on the screen
[00:47:44] ability to transact potentially
[00:47:46] in large size and just
[00:47:48] knowing what that bid offer looks like
[00:47:50] and the stack on both sides of it
[00:47:52] but as you say I mean 30 to 40%
[00:47:54] of the volume that's
[00:47:56] extremely impressive and I would say
[00:47:58] just following it from an outsider
[00:48:00] standpoint a huge
[00:48:02] amount of growth relative to
[00:48:04] a lot of the
[00:48:06] pessimism just given this idea
[00:48:08] that each one of these bonds is unique
[00:48:10] they have their own indentures there's so many issues
[00:48:12] boy that's pretty impressive
[00:48:14] 30 to 40% and so
[00:48:16] we innovate. Technology is a
[00:48:18] driving force for society, for markets
[00:48:20] I would love to close Karen
[00:48:22] just ask you to
[00:48:24] share some of your thoughts on
[00:48:26] financial innovation. We've talked a lot
[00:48:28] about optionality and
[00:48:30] I think we've sort of talked about being short options
[00:48:32] and the risk of asymmetry
[00:48:34] but finding things
[00:48:36] early can be a source
[00:48:38] of long optionality. You've talked
[00:48:40] about things like income sharing
[00:48:42] agreements which I think are pretty
[00:48:44] interesting a little controversial but I think
[00:48:46] pretty interesting. Are there other
[00:48:48] areas of
[00:48:50] financial innovation that you think are exciting
[00:48:52] and promising? What's on your mind
[00:48:54] there? Again as far as
[00:48:56] cryptocurrency I said
[00:48:58] Bitcoin is the only
[00:49:00] proven use case so far to
[00:49:02] me but the blockchain itself
[00:49:04] as a trustless
[00:49:06] ledger right you don't need the third party
[00:49:08] I think
[00:49:10] so much financial innovation is going to come out of it
[00:49:12] it's going to take
[00:49:14] time and there's going to be fits and starts
[00:49:16] but the fact that western union
[00:49:18] still exists charging
[00:49:20] not against western union they've been doing this forever
[00:49:22] and I'm sure they help people but
[00:49:24] they're still charging 7, 8, 9, 10%
[00:49:26] to move money from
[00:49:28] place to place and that seems silly
[00:49:30] and you talk about bid offer spreads
[00:49:32] and commission rates and everything
[00:49:34] but like the credit cards
[00:49:36] still charge
[00:49:38] 2, 3, 4% that seems
[00:49:40] silly like it seems like those
[00:49:42] rails need to be updated
[00:49:44] so payments and the movement of money
[00:49:46] to me with respect to blockchain
[00:49:48] just to give you an example I have a friend
[00:49:50] that
[00:49:52] lived in London
[00:49:54] US citizen lived in London for a long time
[00:49:56] so had citizenship in London and the UK as well
[00:49:58] and you know they had
[00:50:00] a pound account in Barclays
[00:50:02] JP Morgan the US dollar
[00:50:04] account and to move money
[00:50:06] still to this day
[00:50:08] between JP Morgan and Barclays
[00:50:10] you got to sell dollars
[00:50:12] 5 pounds and then wire it
[00:50:14] it's a multi-day it's 2, 3 days to do that
[00:50:16] and like the blockchains
[00:50:18] is definitely better than that
[00:50:20] so I just think there's
[00:50:22] whether it's
[00:50:24] credit decisions or securitization
[00:50:26] of the blockchain but just moving money
[00:50:28] and payments
[00:50:30] and then the tokenization
[00:50:32] why is there a counterparty risk
[00:50:34] going back to AIG
[00:50:36] the blockchain solves that
[00:50:38] it's not going to happen tomorrow
[00:50:40] but a counterparty risk can be
[00:50:42] much more efficient with the blockchain
[00:50:44] and I think when you take away frictions
[00:50:46] and you take away
[00:50:48] commissions and peg-bit offers
[00:50:50] and the VIGs you spur
[00:50:52] more growth
[00:50:54] the cost of capital
[00:50:56] by definition goes down
[00:50:58] and talking about income sharing
[00:51:00] I do think they are controversial
[00:51:02] but it comes back to this idea of cost of capital
[00:51:04] we want to make the capital markets
[00:51:06] the markets for capital
[00:51:08] as efficient as possible
[00:51:10] so that
[00:51:12] those needing capital have options
[00:51:14] and
[00:51:16] the price of capital is corresponding
[00:51:18] with the risk and the risk can be
[00:51:20] more transparent
[00:51:22] so the providers of capital can make decisions
[00:51:24] and the intermediaries
[00:51:26] I'm not saying intermediaries don't
[00:51:28] perform a duty but like
[00:51:30] how can we make that as efficient as possible
[00:51:32] so interesting
[00:51:34] I agree
[00:51:36] this has been a really interesting conversation
[00:51:38] I'm very happy we had a chance to reconnect
[00:51:40] and really appreciate the time to
[00:51:42] survey you on what's on your mind
[00:51:44] and learn a little bit more about
[00:51:46] your career history and present it
[00:51:48] to the listeners of the Alpha Exchange
[00:51:50] it's always a pleasure talking to you
[00:51:52] I appreciate you reaching out
[00:51:54] I hope you enjoy your podcast
[00:51:56] and wish you the best of luck
[00:51:58] and everything going forward
[00:52:00] I appreciate it, thank you
[00:52:02] you've been listening to the Alpha Exchange
[00:52:04] if you've enjoyed the show please do tell a friend
[00:52:06] and before we leave
[00:52:08] I wanted to invite you to drop us some feedback
[00:52:10] as we aim to utilize these conversations
[00:52:12] to contribute to the investment community's
[00:52:14] understanding of risk
[00:52:16] your input is valuable and provides direction
[00:52:18] on where we should focus
[00:52:20] please email us at feedback
[00:52:22] at alphatexchangepodcast.com
[00:52:24] thanks again and catch you next time