Private Credit: Extensive discussion of rapid growth, asset-liability mismatches, leverage, and liquidity risks creating potential dislocations.
Non-traded BDCs: Detailed focus on dividend cuts, redemption queues, mark dispersion, and the importance of transparency and risk management in navigating outflows.
Interval Funds: Examination of structural 5% quarterly liquidity, gating limits, and the need for larger liquidity sleeves and careful handling of unfunded commitments.
SaaS Defaults: Bearish view on software/SaaS credit driven by overcapitalization, ARR lending, rising volatility, and expected wave of impairments and defaults.
AI Disruption: AI increases dispersion and volatility, widening credit spreads and raising default risks while creating equity winners and losers.
Secondary Opportunities: Saba expects growing secondary trading in private credit and is exploring tender offers to provide liquidity at discounts to NAV.
Marks and Leverage: Concerns about inconsistent marks across managers and reliance on fund-level leverage to meet return targets, amplifying downside in stress.
Key Players: References to Blackstone, Apollo, Oaktree, Blue Owl, and banks highlight differing approaches to communication, liquidity management, and portfolio transparency.
Transcript
I've looked throughout my career for asset liability mismatches and I truly believe that asset liability mismatches cause liquidity crunches and liquidity crunches can cause credit crunches. Credit is correlated when it gets stressed. the bare case which I'm not saying it's going to happen but what happens is you get redemptions you get some real defaults you get for selling of private credit and in the interval funds you just run out of what's liquid and the bar to gate is really high that goes on a feedback loop of where's the actual bid for private credit it's hard to Today, [music] I'm Ted Sides and this is Capital Allocators. [music] My guest on today's show is Kieran Goodwin, partner at Saba Capital, a $6 billion hedge fund manager that seeks to identify dislocations in credit and equity markets to generate convex returns in volatile times. Kieran has been one of the top credit traders on the street for the last three decades across roles in investment banks in the9s and early 2000s, King Street, [music] his own hedge fund, Panning Capital, and most recently Saba that he joined in 2024. Our [music] conversation covers a tour of Kieran's background, including early experience with credit derivatives, growth at King Street, lifespan of panning, downtime between stints, [music] and re-engagement with Boaz Weinstein at Saba. We then turn to risks in the private credit market, including its rapid growth, asset liability mismatches, pricing marks, leverage, liquidity, [music] default risk, and the potential for reflexive problems. Kieran shares how managers should navigate the environment and how he's positioning Saba to benefit. [music] Before we get going, after a long winter, we're starting to see green shoots in the changing of the season. [music] Spring training for baseball, March Madness for basketball, and the sunshine double in tennis all remind us that hope springs eternal. But these days, it's harder to be optimistic about another list of challenges. Private market liquidity, peace around the world, and keeping up with my son Eric in creating witty spread the [music] word clips. Now, I can't figure out what will happen in private credit, how the private equity bottleneck will ease, what benchmark should replace the S&P 500, or why so many people have reached out commenting on Eric's lack of interest in the show. But I do know that the answers await from our incredible guests, and you should encourage all your colleagues to listen in and find out that truth. Thanks so much [music] for spreading the word. Please enjoy my conversation with Kieran Goodwin. Kieran, thanks for doing this. Happy to be here, Ted. Great to see you. Why don't you take me back to what led you into finance in the first place? I was a computer science major at Duke. My junior year, a good friend of mine gave me a book. He said, "I think you'll like this." And it was Lars Poker. I read it in one night. Literally, it was a party that night. I stayed in my room, read the book in one sitting. I know Michael Lewis thought it was a way to dissuade people, but I took it the other way. I liked math. I liked puzzles. I liked risk in a sense. Learned how to play poker with my grandparents when I was young. I hadn't really been much exposed to the markets, but after reading that book, I was like, "This is something that fits me." >> And what was your experience like on the street? >> Another buddy from Duke's dad was looking for an analyst at Smith Barney. My friend recommended me. I had had a job in consulting at Anderson Consulting which became Accenture like a computer science programming job. Interviewed there which was fortunate. Did that for a year as an analyst then became a sales trader at Smith Barney with my math background. Tried to get into equity derivatives. There was no seats. I got into interest rate derivatives at Smith Barney which great first four years. then left there in 1995 to go with a senior trader who was an interest rate derivative trader to City Bank to become a credit derivative trader which I actually didn't even know what that meant but I trusted the guy and left with him. >> What did you see in the differences across banks in your time on the street? >> When you're talking 25 years ago culturally the places were much different. Smith Barney for example was Italian and Irish Catholic. Morgan Stanley was more waspy. Then I moved to City Bank which were strong derivatives really international mix which was unique at the time. Then I went to Merrill which was like Mother Merrill. Many people got jobs on the street because they had a relative that was doing it or they grew up in the tri-state area or had some connection. It was much different than now. >> What led you to go from that initial step from one bank to another bank during your time there? I got enamored with this idea of derivatives and options and swaps. Thinking about edge in the form of knowing the bond math better in a sense starting interest rate derivatives seemed like a green field and I was pretty young at the time. City Bank, they had a strong derivative culture but really weren't talking to investors. So I figured out I needed to make a move if I was doing credit derivatives to a place that actually traded credit. I went to Solomon Brothers which was a great experience. That was the beginning of real cred with the Asian contasia of 97. Then I had an opportunity to join Merryill which I interviewed prior. Had a bunch of friends there that I wanted to work with that I thought were talented people. Moved there in '98. Trying to optimize maximize my quest to make credit derivatives a real thing. When you first moved to the buy side, what did you think you knew that you didn't going from prop to a hedge fund? >> It's funny. I remember there was this client at Citadel, Dave Sniderman, who's now the head of Magnetar. He gave me some insight. He's like, when you're on the sell side, you buy in the bid and sell on the offer. That's what you're trying to do. And then when you go to the buy side and you initiate a trade, you're automatically down because you're paying bid offer. And especially in credit derivatives, corporate bonds at the time, the bid offers were real. I was like, "Wow, you have to be much more intentional. You have to come into the day with a plan." I feel like I had a plan on the sell side, but I was also reacting to flow and reacting to clients. The strategy of thinking about how you want to create a portfolio, trading positions, also exit strategy, all of that hits you in the face when you go to the buy side. What was your time at King Street like? >> It was awesome. It was a blur in a sense. I met a friend Beyond and Brian Higgins in the late 90s when I was at Merrill. A friend of mine who was a salesperson knew them and we pitched them the idea of credit derivatives as a way to go short because they had been short in high yield bonds. This was a more efficient way to go short non-reourse in a sense. We had a great relationship there. I talked to them when I was going to the buy side. They weren't ready. I went traded prop for a couple of years. Then I was getting recruited as Fran for a reference. He's like, "Why don't you come here?" At the time I understood the credit markets. I understood derivatives and how credit derivatives fit in and relationship between bonds and credit the basis. I wanted to go deeper into distress investing. Thinking about value, it was magical in the sense Fran was this amazing distress investor, great analyst. I had this other skill set which not a lot of buy sides had. So the combination was so much synergy coupled with amazing amount of volatility in the markets starting in ' 05 with some mini default cycle then LBOs's and then subprime and into GFC. >> What did you learn about navigating all those choppy times? >> Learning options. I remember when I became an interest rate trader I got the John Hull book about option theory and went through it and it's probably some of the deepest studying I ever did. I was always more comfortable being long options than short options. The goal was how do you find the cheapest options with the lowest amount of theta in the markets. Meeting someone like Fran who intuitively understood options from a distressed investor standpoint that was eye opening. We were always long options in the sense that we were buying either distressed debt or we were shorting credit. We embrace the volatility and probably did our best during times of volatility and when markets are calm, I'm not that good. [laughter and gasps] But you started early on in credit derivatives bringing that over to the buy side as a short mechanism distressed when it was still a cottage industry. How did you think about navigating the changes in the credit markets over the years of your career? I was learning from the ground up coming over there and there was still remnants of Enron's which was a great case study to understand how you have this going through chapter 11 which for Enron was pretty much a liquidation credit at the same time was developing complexity as far as all the tranches of indices that were trading and synthetic CDOS and correlation trading that was all happening I looked at what Fran and Brian were comfortable as investors how does that translate into what I For instance, in late ' 05, we had this many default cycle in auto parts and airlines, there were all these correlation trades that blew up such that when you were trunching portfolio credit synthetically via CDS, the equity tunch got really cheap. It reminds me today where you just had one or two sectors having a lot of stress like we have today and the SAS with respect to levered loans and we're seeing it in CLO equity has way underperformed the relative loan market because all of the damage has been in one sector is the first loss the equity piece you're getting the brunt of that. What did you see differently as a trader working with fundamental investors? >> When I was a sellside or trading prop for a couple years, my time frame was a few months, maybe 6 months. When you're doing value investing, whether it's distressed or stressed layman position for instance, many of these distressed firms had for 10 years. It's a book which the chapters you don't know what's going to happen and pivot. You have basic ideas of where you think value is, but that can change. And trying to always be curious on a situation for years at a time. That takes a level of concentration that me as a trader didn't come naturally to >> over your time at King Street. How did you think about your own career when you went to leave? >> I left in early 10, 2007, 2008, 2009. We were in the thick of it. It was exhilarating and satisfying. Worked with amazing people, but it was draining. I had young kids at the time. We had done as a firm way better than I thought. We started when I got there at 4 billion. We're up to 22 billion for the six years I was there. The S&P was flat and we were up over 100%. And then personally, I did a lot better. I needed a reset. I wasn't thinking about what was next as much as I just know that right now I need to pause. So what'd you do >> for two years? I failed to reinvent myself many times. I went to work for Mayor Bloomberg as an unpaid consultant. I think I lasted three months. Then I went back to school to get a masters in education that lasted 4 months. The pace of play was way too slow. I bought a farm upstate. I worked with a farmer on some green houses. Nothing took. Then a great friend of mine, Frank Edmmonds, who was at King Street, was leaving King Street. I was like, "What are you going to do?" And he's like, "I'm hoping to start a hedge fund." I'm like, "Oh, that's interesting." With whom? And he was like, "My goal was to convince you." That was the perfect partner for me. Frank was lead analyst, head of research at King Street, trained a bunch of analysts. We were complimentary in the sense that he was more calm and collected than I was. and Southern Gentleman. I like, well, if I'm ever going to have a chance to start a hedge fund, this would be an ideal partner on so many levels. >> Take me through that journey. >> Frank ended up staying at King Street for another year. I started panning on my own. It was fun in the sense that the day I left King Street, there were five different LPs that reached out to me. Most called me. It seems foreign now. No one calls each other. At first, we're like, "Thank you for your efforts. You really helped King Street do well for us as an LP, which was gratifying. If you ever want to start something, we'd love to talk to you. I dismissed it, but remembered who those people were. I think four of them invested on day one out of 10 investors, which is great. You have that confidence is amazing. Even with that, you do 100 meetings, you get 10 investors. It's hard. Starting a hedge fund is difficult. Anyone who does it successfully, I always have a hat tip to because you're out on your own and it's easy for people to say no. >> How big was panning out of the box for the first couple months? >> We launched with 600 million and we did really well and one of the mistakes I made was we took in money too quickly. So we grew pretty fast. Had 2.5 billion within 18 months or so. >> What happened over the couple years you were running it? >> We ran it for six years. I personally made a lot of mistakes in running panning. One was not necessarily understanding that we were in this low volume regime and it wasn't really going to change. Getting the macro right sometimes even as a fundamental investor is crucial. That was a painful lesson to learn. But we started off so hot in 2013 we're up 20% net that it's also like oh wow this is easy. That's the worst thing you can think about as an investor. I think every day you have to assume you start with a zero next to your name. You're probably going to have some hurdle adversity to overcome. 2014 we're doing well. It got tougher. We were up one for that year. 15 was a really hard year. We were down five, then up five or six and 16. I just got tired of it to be honest. I had too mature of a team. I was better as a manager training younger people. That was my experience at King Street. I learned that in real time. Had a talented team, but it didn't fit the way that I operated the best. >> What were some of the other mistakes you made? >> Every manager at some level gets away from what they're good at. Sometimes that makes you uncomfortable and gives you bad risk positions. So, you stretch on what your comfort level was. For instance, I was in the Fanny Freddy preferred early. A good salesperson called me. He's like, "This is cheap option. This guy had a great nose." I was like, "Oh, that is that does make a ton of sense." So, we bought them at three and they were 13. I remember thinking, "Wow, now this becomes a legal bet." The delta went from a five or 10 delta to 40 delta. That's not my strong suit. Even if it's not mission drift, you just have to get out of trades. There were a bunch of trades that we went into. They were in my wheelhouse and then they did well and they got out of my wheelhouse and some of them were really bad reversals. >> So, you got a step away the second time probably knowing that the slow pace wasn't going to work for you. How did you spend those next couple years? >> I left in 18 then my kids were older. It was great to be with them. they were in high school or coming to high school and were super busy interacting with them and helping them navigate their days and assisting them. That was super rewarding. Going to see their event, helping them with homework, thinking about their college journey. I was definitely busy with that. I remember getting the advice when I left King Street. You should meet with as many people as you can. I was like, no, I want to try to help New York City. I want to try to be a teacher. This time I was more open. I would literally meet with anybody for coffee that was interesting. During that time I met you for the first time. I was more open-minded about it, more relaxed about it. With maturity, you get some wisdom. >> How do you think at that time about what you wanted to do next? >> I was resigned to the fact that I probably wasn't going to be an investor again. I didn't think there would be a third act. It was somewhat by chance. I failed again trying to reinvent myself, but they were more fun failures. I took a standup comedy class and performed. When you do these classes, they intermix real comedians because otherwise it could suck for the audience. See a bunch of people that weren't really good through my kid school. I became friendly with Jim Gaffigan. So I technically open for Jim Gaffin. I went on right after or else I would have pursued that. CO was literally the next day and I lost momentum. I created a game on an app that was a fun project. So I was not trying to necessarily save the world but just pursue things that were fun for me. Then Boaz, who I've known since the late 90s, he reached out to me in 21. He was like, "Oh, I'm putting up a board for a proxy fight on a closed end fund that owns levered loans. Would you want to do it?" I'm like, "Sure." I know a lot about levered loans. I've got time. I did that. A couple years later, I was still on the board. He was like, "Hey, can you come in? I'm thinking about making a bid for Sculptor. They have a credit business that's long fundamental credit, and you know more about that than I do. Would you help me?" And I'm like, "Sure, I'll help you." We went through that process. I'd never been in a hostile takeover situation. The bidding group was super interesting people that he's friends with. That took six months and we didn't win. But that got me. Maybe there is an itch to scratch. I honestly before that hadn't thought about what could I do. We lost around Thanksgiving. After the holiday season, I went into Boaz in early 24. Hey, listen. That was cool. He's like, "Not for me." Because I spent a lot of legal money, [laughter] but we made a lot of money for the shareholders of Oxif or Sculptor. I was like, I have a couple ideas. Hire me as a consultant and I'll run these down and if nothing comes of it, then we'll part ways. I was like, I want a wisdom role and I had these ideas. I didn't necessarily want to trade anything per se. So, that's how I got to Sabo. >> What did you put your hooks into when you got there? >> I had two ideas. One was the corporate bond market investment grade high yield had gotten more electronically traded over time. I'd first thought about it in 2015 and 16 when market access was getting some real traction like oh could we build a business where we could be a local in a sense of responding to market access. I met with a quant who had built something put that in the back of my mind. 2020 I believe that same guy Alex Reichman was starting a business and I was an angel investor and put a bunch of people together. It was called Tradewell just got bought by Seapport. So think about electronic trading my thought process was there was enough white space that an actual buyside fund could come in with a systematic approach to corporate bonds. Electronic trading allows you to do that. I was able to recruit two young guys from Jane Street to join Saba to set up a new fund manager called Saba LT. LT stands for low touch. These two guys, Rob and David, joined in May. They built out a team. They started coding right away. We turned the ALGO on to trade internal Saba money in March. Learned some stuff. Went back to the drawing board. Turned it on again in June in earnest. Took outside capital in November of 24. I got a team of 13. I say I had the idea for the movie. I was the producer. I pitched it to Boaz. He green lit it. He was the studio head. Rob and David are the star writers, directors, and they have their team. I helped them with strategy, helped them hire, helped them with raising money with LPs, relationships with the sell side and de facto credit strategist for them right now. I'm going to move out of that role at some point. But that's really interesting. Secondly, I was like, something's going to happen in private credit. I have no idea. I wrote a tweet in 23 before joining Saba that I thought there were some asset liability mismatches. That got a lot of traction. I was like, nothing against private credit, but it's grown so fast. There's going to be some hiccup along the way, and I feel like Saba will have an opportunity to get along. In my spare time, I was reading about public BDC's, meeting with sellside analysts, learning as much as I could about all the different non-traded BDC's, public interval funds, and the like. >> Take me through the path of private credit, from financial crisis, replacing banks to where we are today. from the financial crisis. The idea was banks aren't necessarily the best vehicle to make loans because they have deposit flight risk. Also, you had the six time lever rule. I forget the name of the rule. The guideline banks, we don't really want you lending to six time levered companies. Some companies that are six times levered like a software company could be a good credit risk. Private credit been around. It's not like Gallob started Aries and even Silverpoint. There are a lot of people doing private credit. But this idea of okay, let's do an institutional style draw down fund. The duration of that fund matches the assets and we take away this asset liability mismatch. Everyone talks about direct lending. There's all kinds of private credit, but let's just talk about direct lending for now. That made total sense. But then you had this idea of we still can make more loans, but we're tapping out a demand here a bit. maybe we do a non-traded BDC, which was now up to 2018. That's where I was like, well, this is the original asset liability mismatch that you tried to cure by doing a draw down fund because you might have all the investors looking for the exit. Even though it's definitely 100% on page one of any perspectus or there's a gate, you're going to get 5% liquidity. It grew really fast. 0 to350 billion dollars in non-traded BDC's from 2018 to now. That's unprecedented. As you look at the rest of the interval fund structure and the growth of the wealth channel into this space, what are some of the strengths and weaknesses in the various differences between the original draw down structures mentioned the non-traded BDC's now the interal funds? >> The draw down fund has got the best asset liability mismatch. I'm invested in a bunch of different kinds of draw down funds and they're ugly. You get capital calls, you get distributions, you're getting a lot of K1s. I'm in a good fund started in 2012. Still have a 10% position in it. They last a long time. They don't necessarily meet the demands of retail from that standpoint. Then you have the non-traded BDC which I do think that there is a potential for a non-traded BDC to work with the right private wealth client. The marketing happened pretty fast and furious and there might be a mismatch of the right client to the product. The level of sophistication of the private wealth channel is varied. I don't know if it's like we're going to videotape you saying that you understand about gates. I don't know if that's the right thing or not. It's probably not. And interval funds honestly didn't know what an interval fund was until recently. It's a concept that's somewhat strange in the sense that it's less levered. So that makes sense. Then how do you meet that demand? The bar you can't really gate. You have to give the 5%. The 5% or so liquidity every quarter. That's a great feature that has to be cash. As long as you have assets that you can turn to cash or you have lines at the heart of any of these non-traded BDCs or interval funds, what's the risk management? How thoughtful was the risk management? Is this contemplated for assets going down? How long can you sustain outflows for? I started a hedge fund. You launch, you take in money, you're like, "This is great." King Street was a wild ride. We were growing assets all the time. It's hard to think about the downside. What happens if we suck for a while? Then what? No one really wants to talk about that. >> What would proper risk management look like in one of these products? >> Good risk management would be a bigger liquidity sleeve. So maybe more levered loan PSLs trying to minimize unfunded commitments would be good. Unfunded commitments, whether it's a delay draw term loan or a revolver, no one wants those. there's economic cost of doing business. That's why credit derivatives was started. Banks didn't want those on. Let's hedge them out. You're not getting paid as much. You have the same credit risk. That would be one. Then being transparent on what is in the portfolio. Apollo came out. We're going to mark every month. That's a good move. But having marks that are as accurate as possible. It's hard sometimes. I'm not saying that there isn't going to be variance amongst marks, especially on private credit. But really being good about marks, whoever explains their portfolio the best, does that mean one pagers which you get in an institutional fund or does that mean a teachin? That's where I'd like to see it to go. Even though you're like, well, how is that risk management? The better that you inform your investors about your process and the investments that are in the vehicle, whatever the vehicle is, the more comfortable they get, the less they're going to rush to the door. >> I'd love to walk through a couple of the issues that commonly come up. You mentioned two of them, leverage and marks, but when I start with the marks in the private credit world. When you look at loans underneath one of these portfolios, where do you have concerns that the marks may not be accurate? There's some obvious ones where you see, let's just say, public BDC's that own the same club deal, the same loan, one BDC versus another, or two or three versus a fourth BDC. there's a massive variance in a second lean especially where you're like wait the first lean we know is stressed a bit so maybe it's worth 90 or 85 not that it's impaired but we'll throw it out a bad sector it's a stressed SAS loan and it has a second lean the second lean's got to be below 85 then you have one where a bunch of guys are marking at 60 and then there's a fourth one marking 85 come on you can do better than that yeah maybe if you marked at 70 so there's some wild varants, easy ones. >> When you look at the volume of those situations where it's easy that there's a wild discrepancy, how does that roll up into whether that's a systemic problem in the space? >> If you rated the big non-traded or public BDC managers on a scale of 1 to 10, 10's the best marker and one's the worst marker, what's the nav difference? If the guy that's rated 10, he's at the top of the heap. His nav is probably the most accurate snapshot for this. Obviously, there's delay here as well because they marked by quarter, which is Apollo trying to do. What is the guy that's rated one? What's the difference in NAV? Four, 5%, maybe six. It compounds a bit. Then you have micro situations where loans are getting marked from 100 to zero in one quarter. Everyone goes to the worst because credit is about believing. You have to believe. Creree is credit means to believe. And when you lose belief, it happens really quickly. Trust is the biggest thing. Recently, there have been this wave of redemption requests above that 5% threshold in the non-traded BDC's and interval funds. And that question of belief comes into play of what happens the next quarter. How do you think about the difference between the reflexivity that comes from the investors redeeming and the underlying fundamentals of the loans in these portfolios? >> How does a normal person think about the fundamentals or some crazy bear like me? [laughter] I've looked throughout my career for asset liability mismatches and I truly believe that asset liability mismatches cause liquidity crunches and liquidity crunches can cause credit crunches. Credit is correlated when it gets stressed. I have a good pulse on retail mindset in that this is an income product. That's why the private wealth channel cares about it. It's not like this is Apple stock. 10 years ago, private wealth loved MLPS. That was the income product. Then we had the energy crunch and mini default cycle in 2015 16. Retail doesn't really care about MLPS. They will find their income product Azure. There's a sense of almost tide with retail. They like the product. The tide's in. They don't like it. The tide's coming out. If you think about how this redemption cycle started in Q4, we had Blackstone BCR, Gallibs, the non-traded BDC, and Oak Tree's non-traded BDC. They all had to cut the dividend 10%. It made total sense. So far was down 175 basis points. New issue spreads were in. We had 300 basis points less than realistic gross yield of BDC's from 2022 23 till now. You got to cut the divs. redemptions went from 2.1% of the top six to 4.3%. There are financial adviserss, wealth managers, whatever, RAS, they have a simple rule of thumb. You cut my dividend, I'm out. That's what works for me. I don't care if it's a blue chip stock. You think about GE, that was a big blue chip. Cut the divid, I'm out. I just have a 30-year history. That's how I go. Understanding that mindset is important in understanding reflexivity. They don't need this product. In order for managers to keep the stem the wave, they have to prove to the private wealth channel that first of all everything's marked here correctly and here's what we're investing in. Here's why we think we deserve your money. That has to be a really open conversation. The factors on who comes out of this wave the best. Underwriting is number one. Do you have a good loan book? Is your loan book better than the market? Do you have alpha? Number two, risk management. Have you given yourself enough room to navigate? Can you sell a position? Do you have unfunded commitments that are going to trip you up a bit? Do you have enough of a liquidity sleeve? All those moves. The third factor of how transparent how you communicate and how you instill trust with your investors is going to be a big one. The scenario described in Q4, rates come down, cut the dividends, very rational, the yields are going less unflating rate notes. The other side of the underwriting is the default cycle. And it's very different. Private credit, one lender, one company, they can defer, pretend, extend, whatever it is. How do you think about how to measure successful underwriting? As you're looking at the different managers that are offering these loans, >> you have to go line by line and look at where they have problem loans, how many of their loans are either marked below 80 or you think should be marked below 80. Hindsight's 2020. SAS was the darling of private assets, whether it's private equity or private credit or even venture. SAS was the darling of alts. If you're like, "Hey, I'm all in on technology. That's my thing." And there are some funds non-traded or public BDC's. If you want that, this is what I'm giving you. That's what you signed up for. And we're in this period of how much is AI going to disrupt. If you think about economics, 80% gross margins. They're not going to last forever. Someone's going to try to figure out how to attack them. This whole it's like switching costs. Clearly technology switching customers. People are thinking about that problem. But I would say portfolio construction. If you're not saying you're all soft, I'm doing a technology fund, but I'm 50% software. Do all your investors realize that? Is that something that you have communicated to everyone? That's where you get the disconnect. We're going to have a wave of defaults in the software space. I don't think that's crazy to think about because we've had so much capital go into the space that from a venture or private equity standpoint, hey, listen, the upsides are so amazing that we can take some losers. We can still do well. Venture will tell you three out of 10 is good for them and they can take a bunch of zeros. Private equity doesn't like zeros, but they can take down 20% or some ties. When you're talking about credit, you take any zeros, it's tough or serious impairments. >> If you look at signpost of the default cycle, you had defaults, you have some cash pay that moves to pick. How do you tease out where we are today? >> I think about credit cycles from the standpoint of misallocation of capital. In the early 2000s, you had a massive rush of capital into telekcom tech space. that capital whether it's global crossing or level three laying fiber cable I'm glad they did it but they did it a little too quick with the bad capital structure so misallocation capital isn't necessarily bad but in this SAS space it seems inevitable credit cycles are good for capitalistic economy we haven't had one in a long time so some of it's do you really think we're never going to have one I push back everyone's like oh we're fine the productivity that AI hopefully transmits into the economy There's going to be winners and losers. If you're long credit, you're short volatility. You want things to chug along because you don't have upside. Yeah, growth is okay, but you more want stability. When you introduce something like AI, the paradigm has shifted. You're going to have winners and losers. That shifting increases volatility. Higher volatility means more likely good and bad outcomes. And credit, it means spread should go wider. There should be some more defaults. A lot of the past cycles were funded by a significant amount of leverage. What are you seeing in the underlying fundamentals of the businesses as it flows through to what you're concerned about in the structures of some of these credit vehicles and leverage? The alt space is always trying to be creative and look for opportunities as to where to deploy capital. This idea of ARR loans, no one would have done that. you would have gotten laughed at a bit that you're lending to a company that has negative IBIDA and you're not getting any warrants. That was venture lending. You're doing venture lending without warrants. But SAS had been a great model for a long time, but we're in a progrowth space. It's pro- cyclical. I don't think AR loans, they're good riskreward. They work for a long time. Maybe some people did well with them. There's some investors that are great timers and they know it's bad riskreward, but they can ride a wave really well. But I do think we're going to have less ARR loans if we do get this software shakeout. >> As these redemptions start to come in, if you were a GP of one of these funds and the redemption amount exceeded that 5% threshold, what do you think the best way to handle that situation is? Are you thinking about it for the maximizing the fees of this fund or are you thinking about it in scope of a bigger picture with BCR? Blackstone pretty much is the only alt manager that has gone through something. They have the experience of B rate and they cleared that queue a short amount of time, sold assets, got some strategic investors to come in. They did a great job in clearing that queue and now is not surprisingly when BCRED had 7.9% redemptions. They thought about it. Listen, we're going to do everything we can to get everyone their money back. For Blackstone that has 1.3 trillion and has deep ties in the private wealth channel, that was probably the best move. If you say on the other side of the equation, you're an interval fund and you're a manager and this is all you have this one fund, maybe that's not the right move. Maybe you're supposed to only do the minimum you can. At the same time, if you're only doing the minimum, you do have to think what happens for two or three more quarters. Are there riskmanagement decisions I can make today that might be a little painful and maybe I have to shrink my balance sheet to get through this and grow. You have to at least consider the scenario where your AUM is shrinking and during that period you have to do the best you can and instilling trust and confidence in your investors to get through the tough times. So you circle back as the second thing that intrigued you when you were talking to Boaz about joining Saba. This something could happen big in this private credit space. How are you now thinking opportunistically about investing as some of these things are happening? It's been widely reported we are tendering for one of the blue owl funds their blue owl obdc2 which we're going to see if there is any demand for liquidity at a discount to NAV. It's new territory, so we'll see. We don't know if there's going to be demand or not. We think there is potentially demand. The space is $350 billion of assets plus another 100 billion of interval funds. So 450 billion plus some non-traded REITs. Big big space. It's a small percent of investors that do get gated or looking for liquidity. It could be a decent opportunity to make an investment. If anyone else wants to top our bid, they can. It's not like we have anything proprietary in that regard. If we do become a shareholder, we want to be constructive. We hope for transparency, not only for us, but for all shareholders in every fund. That's the best way to get through this time. Through this stress, we're going to see secondary trading of private credit. How stressed that is is TBD. It's starting to pick up a little more now. Obviously, it makes sense. Some of the best club deals that are the best credits are trading at par right now. If you want to buy any private credit loan at par, I'm sure you could get filled pretty quickly. We're thinking about that as well as potential opportunity set. >> What does it take in terms of research and flow from your team to be prepared to jump on a something that could be very opportunistic? We're going through the filings line by line and trying to map out the capital structure as best we can to understand all the leverage in a particular. Not every BDC is the same. There are some that are more levered, less levered, and then there's some that have CLLO positions and unfunded commitments. So, you have to stress understanding the capital structure is important. You can do your best on trying to figure out what the right price of the credit is, but most of the BDC's are pretty diversified. You're thinking about one mark or two marks is not going to necessarily change the economics, but then also not taking at face value what the industry concentration are. Literally putting in every loan into claude or chatbt to figure out what do they think it is. There has been some mislabeling of concentrations. If you put on your self-p profofessed bear hat and paint a picture for how this goes from uncertain today to something that's a lot worse. What do you see happening from here to there? This is where I get all the hate in Twitter. Now you're stoking the fires. the bare case which I'm not saying it's going to happen but what happens is you get redemptions you get some real defaults you get for selling of private credit and in the interval funds you just run out of what's liquid and the bar to gate is really high you literally need an SEC exemption and that's not because prices are low you have to show the SEC I don't have any liquidity that goes on a feedback loop of where's the actual bid for private credit. It's hard to say. A good bid would be in the low 90s for good stuff because the absolute yields aren't that amazing. S plus 500 loan is 8% or 9%. It's got a five duration. So you're bidding 90, you're getting 11%. One of the issues with private credit is all the returns are predicated at leverage at the fund level. You need fund level leverage to get anyone excited about it. If anyone came out with a unlevered BDC, it would be a yawn, especially after fees. JP Morgan marked down some software loans as far as their bank lender. That's the other issue is that going back before, are we worried about the top 10 managers or are we worried about the bottom cortile? When the rates were zero, you had some institutions that raised funds that probably weren't the most experienced or skilled investors. If their portfolios start getting seven or eight percent defaults, but some of the underperformers have 15 or 20 percent defaults in their portfolio, maybe heavy in a bad sector or so, banks are going to start cutting lines or not renewing lines and there's an asset liability mismatch on the lines. Then the banks are going to pull back a bit and gets a little harder for everybody. That's where you get the feedback loop on prices going down which causes more redemption, less interest. Where's the clearing level from an unlevered level? Where do the distress funds really come in? And it's probably decently low. You don't want to test that bid. Lastly, the worst worst case scenario, which is far far away, would be that there is lack of confidence in some of the annuity providers that have loaded up mostly on tripleB rated private credit or better. But is there a potential where their annuitants start surrendering policies? That's the ugly ugly. I don't know what the probability is. It's not a high probability, but that's where it gets bad. When you move down in the capital stack, eventually that has to hit private equity with a lot of these direct loans being sponsor back deals. Yes, if you get a big default cycle, S&P is down, MSEI is down. So, private equity has to be down, but there's going to be more variance amongst private equity, then credit is more correlated. You're going to have tougher times because you have the fund level leverage and you might have to make a sale that you don't want to make and the upside isn't as much. Whereas if you're private equity and you have a portfolio company that incorporates AI, well, that could be a good one. Overall, the beta private equity, if you look at just from the industry, the beta, yeah, it'll be a loser as well. This idea of asymmetry, the upside in equity versus downside in credit, I think that starts coming through. And then from the secondary standpoint, could you see some good opportunities in private equity secondaries? Yes. Could you see in private credit secondaries? Depends on the vintage. The problem I have with private credit secondaries is how old are the loans? Because the loans in typical 7 years, but you hope to be refied in three or four years. Once it gets past four years, there's probably a reason for it. I'm not saying that there isn't optimistic marketing and private equity, but you could have a company that's been in the portfolio for seven years and actually did take an upturn. there's less likely in private credit that that's happening. There's definitely a problem in private equity if you get a default cycle. >> What do you think most investors in this space misunderstand the most? >> Liquidity. I understand private markets and I have investments in funds. There's some advantage as being an LP and not being tempted to trade. I don't need that temptation. And that's okay if you're a GP of a private fund and you don't need liquidity. You're like, "These are my bets. I made these investments." But when you need liquidity or you get liquidity taken from you, that's where traders come in. There are firms that have more of a trading talent on the private credit side and there's some that don't. That's going to be the differentiator when it goes away. truly whether it's during the GFC or the early 2000s around world com all that stuff it's always shocking even if you're David ter who probably has traded those markets as well as anyone on the credit side I'm sure there were d like oh my gosh I can't believe I hit that bid and it's down 20 points everybody has a plan until you get punched in the face like Mike Tyson that's liquidity >> what gets you excited each day when you're coming into the office now >> I still like the puzzle I don't want to wake up to Bloomberg and think about a position level, but the puzzle of the market, what's going to happen and how our problem is going to get solved is still super interesting. >> All right, Karen, I want to make sure I get a chance to ask you a couple fun closing questions before we go. Before we get to the closing questions, I want to tell you about one of our strategic investments. We've made a few and each are working on a product or service we think will be valuable to our community. One is Thema. For all the private equity managers out there, FEMA uses AI to help map the landscape and source private businesses. It's incredible what a well-designed AI tool can do to accelerate the discovery of businesses in private markets. There's a link in the show notes so you can learn more. And here are those closing questions. What's your favorite hobby or activity outside of work and family? >> Playing basketball. I am old and I don't know how much longer I can play, but I love the game. I play at least once a week. I try to do everything I can to keep that going for as long as possible. >> Which two people have had the biggest impact on your professional life? >> Two coaches, my junior high JV basketball coach and my high school coach, Tony Casamasa and Reggie Weiss. So many life lessons about how to be a good teammate. It's all about the team. It's your job to provide value to the team. Effort, diving for loose balls, body language, defense wins championships, which is probably the best advice with respect to investing. Protect your downside. >> All right, Karen, last one. What life lesson have you learned that you wish you knew a lot earlier in life? >> Never lose your cool. Never yell or break a phone. When I started in trading floors in the 90s, they were pretty rough and tumble, and you always had to worry about getting picked off. I probably got upset more than the average person. I always apologize, but there's really no reason to. >> Look, Kieran, thanks so much for sharing your insights on what's going on and look forward to seeing what happens. >> Thank you so much, Ted. It was super fun to do this with you. >> Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators.com where you can [music] access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time. [music] >> All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is forformational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.
Kieran Goodwin – Private Credit Concerns (EP.494)
Summary
Transcript
I've looked throughout my career for asset liability mismatches and I truly believe that asset liability mismatches cause liquidity crunches and liquidity crunches can cause credit crunches. Credit is correlated when it gets stressed. the bare case which I'm not saying it's going to happen but what happens is you get redemptions you get some real defaults you get for selling of private credit and in the interval funds you just run out of what's liquid and the bar to gate is really high that goes on a feedback loop of where's the actual bid for private credit it's hard to Today, [music] I'm Ted Sides and this is Capital Allocators. [music] My guest on today's show is Kieran Goodwin, partner at Saba Capital, a $6 billion hedge fund manager that seeks to identify dislocations in credit and equity markets to generate convex returns in volatile times. Kieran has been one of the top credit traders on the street for the last three decades across roles in investment banks in the9s and early 2000s, King Street, [music] his own hedge fund, Panning Capital, and most recently Saba that he joined in 2024. Our [music] conversation covers a tour of Kieran's background, including early experience with credit derivatives, growth at King Street, lifespan of panning, downtime between stints, [music] and re-engagement with Boaz Weinstein at Saba. We then turn to risks in the private credit market, including its rapid growth, asset liability mismatches, pricing marks, leverage, liquidity, [music] default risk, and the potential for reflexive problems. Kieran shares how managers should navigate the environment and how he's positioning Saba to benefit. [music] Before we get going, after a long winter, we're starting to see green shoots in the changing of the season. [music] Spring training for baseball, March Madness for basketball, and the sunshine double in tennis all remind us that hope springs eternal. But these days, it's harder to be optimistic about another list of challenges. Private market liquidity, peace around the world, and keeping up with my son Eric in creating witty spread the [music] word clips. Now, I can't figure out what will happen in private credit, how the private equity bottleneck will ease, what benchmark should replace the S&P 500, or why so many people have reached out commenting on Eric's lack of interest in the show. But I do know that the answers await from our incredible guests, and you should encourage all your colleagues to listen in and find out that truth. Thanks so much [music] for spreading the word. Please enjoy my conversation with Kieran Goodwin. Kieran, thanks for doing this. Happy to be here, Ted. Great to see you. Why don't you take me back to what led you into finance in the first place? I was a computer science major at Duke. My junior year, a good friend of mine gave me a book. He said, "I think you'll like this." And it was Lars Poker. I read it in one night. Literally, it was a party that night. I stayed in my room, read the book in one sitting. I know Michael Lewis thought it was a way to dissuade people, but I took it the other way. I liked math. I liked puzzles. I liked risk in a sense. Learned how to play poker with my grandparents when I was young. I hadn't really been much exposed to the markets, but after reading that book, I was like, "This is something that fits me." >> And what was your experience like on the street? >> Another buddy from Duke's dad was looking for an analyst at Smith Barney. My friend recommended me. I had had a job in consulting at Anderson Consulting which became Accenture like a computer science programming job. Interviewed there which was fortunate. Did that for a year as an analyst then became a sales trader at Smith Barney with my math background. Tried to get into equity derivatives. There was no seats. I got into interest rate derivatives at Smith Barney which great first four years. then left there in 1995 to go with a senior trader who was an interest rate derivative trader to City Bank to become a credit derivative trader which I actually didn't even know what that meant but I trusted the guy and left with him. >> What did you see in the differences across banks in your time on the street? >> When you're talking 25 years ago culturally the places were much different. Smith Barney for example was Italian and Irish Catholic. Morgan Stanley was more waspy. Then I moved to City Bank which were strong derivatives really international mix which was unique at the time. Then I went to Merrill which was like Mother Merrill. Many people got jobs on the street because they had a relative that was doing it or they grew up in the tri-state area or had some connection. It was much different than now. >> What led you to go from that initial step from one bank to another bank during your time there? I got enamored with this idea of derivatives and options and swaps. Thinking about edge in the form of knowing the bond math better in a sense starting interest rate derivatives seemed like a green field and I was pretty young at the time. City Bank, they had a strong derivative culture but really weren't talking to investors. So I figured out I needed to make a move if I was doing credit derivatives to a place that actually traded credit. I went to Solomon Brothers which was a great experience. That was the beginning of real cred with the Asian contasia of 97. Then I had an opportunity to join Merryill which I interviewed prior. Had a bunch of friends there that I wanted to work with that I thought were talented people. Moved there in '98. Trying to optimize maximize my quest to make credit derivatives a real thing. When you first moved to the buy side, what did you think you knew that you didn't going from prop to a hedge fund? >> It's funny. I remember there was this client at Citadel, Dave Sniderman, who's now the head of Magnetar. He gave me some insight. He's like, when you're on the sell side, you buy in the bid and sell on the offer. That's what you're trying to do. And then when you go to the buy side and you initiate a trade, you're automatically down because you're paying bid offer. And especially in credit derivatives, corporate bonds at the time, the bid offers were real. I was like, "Wow, you have to be much more intentional. You have to come into the day with a plan." I feel like I had a plan on the sell side, but I was also reacting to flow and reacting to clients. The strategy of thinking about how you want to create a portfolio, trading positions, also exit strategy, all of that hits you in the face when you go to the buy side. What was your time at King Street like? >> It was awesome. It was a blur in a sense. I met a friend Beyond and Brian Higgins in the late 90s when I was at Merrill. A friend of mine who was a salesperson knew them and we pitched them the idea of credit derivatives as a way to go short because they had been short in high yield bonds. This was a more efficient way to go short non-reourse in a sense. We had a great relationship there. I talked to them when I was going to the buy side. They weren't ready. I went traded prop for a couple of years. Then I was getting recruited as Fran for a reference. He's like, "Why don't you come here?" At the time I understood the credit markets. I understood derivatives and how credit derivatives fit in and relationship between bonds and credit the basis. I wanted to go deeper into distress investing. Thinking about value, it was magical in the sense Fran was this amazing distress investor, great analyst. I had this other skill set which not a lot of buy sides had. So the combination was so much synergy coupled with amazing amount of volatility in the markets starting in ' 05 with some mini default cycle then LBOs's and then subprime and into GFC. >> What did you learn about navigating all those choppy times? >> Learning options. I remember when I became an interest rate trader I got the John Hull book about option theory and went through it and it's probably some of the deepest studying I ever did. I was always more comfortable being long options than short options. The goal was how do you find the cheapest options with the lowest amount of theta in the markets. Meeting someone like Fran who intuitively understood options from a distressed investor standpoint that was eye opening. We were always long options in the sense that we were buying either distressed debt or we were shorting credit. We embrace the volatility and probably did our best during times of volatility and when markets are calm, I'm not that good. [laughter and gasps] But you started early on in credit derivatives bringing that over to the buy side as a short mechanism distressed when it was still a cottage industry. How did you think about navigating the changes in the credit markets over the years of your career? I was learning from the ground up coming over there and there was still remnants of Enron's which was a great case study to understand how you have this going through chapter 11 which for Enron was pretty much a liquidation credit at the same time was developing complexity as far as all the tranches of indices that were trading and synthetic CDOS and correlation trading that was all happening I looked at what Fran and Brian were comfortable as investors how does that translate into what I For instance, in late ' 05, we had this many default cycle in auto parts and airlines, there were all these correlation trades that blew up such that when you were trunching portfolio credit synthetically via CDS, the equity tunch got really cheap. It reminds me today where you just had one or two sectors having a lot of stress like we have today and the SAS with respect to levered loans and we're seeing it in CLO equity has way underperformed the relative loan market because all of the damage has been in one sector is the first loss the equity piece you're getting the brunt of that. What did you see differently as a trader working with fundamental investors? >> When I was a sellside or trading prop for a couple years, my time frame was a few months, maybe 6 months. When you're doing value investing, whether it's distressed or stressed layman position for instance, many of these distressed firms had for 10 years. It's a book which the chapters you don't know what's going to happen and pivot. You have basic ideas of where you think value is, but that can change. And trying to always be curious on a situation for years at a time. That takes a level of concentration that me as a trader didn't come naturally to >> over your time at King Street. How did you think about your own career when you went to leave? >> I left in early 10, 2007, 2008, 2009. We were in the thick of it. It was exhilarating and satisfying. Worked with amazing people, but it was draining. I had young kids at the time. We had done as a firm way better than I thought. We started when I got there at 4 billion. We're up to 22 billion for the six years I was there. The S&P was flat and we were up over 100%. And then personally, I did a lot better. I needed a reset. I wasn't thinking about what was next as much as I just know that right now I need to pause. So what'd you do >> for two years? I failed to reinvent myself many times. I went to work for Mayor Bloomberg as an unpaid consultant. I think I lasted three months. Then I went back to school to get a masters in education that lasted 4 months. The pace of play was way too slow. I bought a farm upstate. I worked with a farmer on some green houses. Nothing took. Then a great friend of mine, Frank Edmmonds, who was at King Street, was leaving King Street. I was like, "What are you going to do?" And he's like, "I'm hoping to start a hedge fund." I'm like, "Oh, that's interesting." With whom? And he was like, "My goal was to convince you." That was the perfect partner for me. Frank was lead analyst, head of research at King Street, trained a bunch of analysts. We were complimentary in the sense that he was more calm and collected than I was. and Southern Gentleman. I like, well, if I'm ever going to have a chance to start a hedge fund, this would be an ideal partner on so many levels. >> Take me through that journey. >> Frank ended up staying at King Street for another year. I started panning on my own. It was fun in the sense that the day I left King Street, there were five different LPs that reached out to me. Most called me. It seems foreign now. No one calls each other. At first, we're like, "Thank you for your efforts. You really helped King Street do well for us as an LP, which was gratifying. If you ever want to start something, we'd love to talk to you. I dismissed it, but remembered who those people were. I think four of them invested on day one out of 10 investors, which is great. You have that confidence is amazing. Even with that, you do 100 meetings, you get 10 investors. It's hard. Starting a hedge fund is difficult. Anyone who does it successfully, I always have a hat tip to because you're out on your own and it's easy for people to say no. >> How big was panning out of the box for the first couple months? >> We launched with 600 million and we did really well and one of the mistakes I made was we took in money too quickly. So we grew pretty fast. Had 2.5 billion within 18 months or so. >> What happened over the couple years you were running it? >> We ran it for six years. I personally made a lot of mistakes in running panning. One was not necessarily understanding that we were in this low volume regime and it wasn't really going to change. Getting the macro right sometimes even as a fundamental investor is crucial. That was a painful lesson to learn. But we started off so hot in 2013 we're up 20% net that it's also like oh wow this is easy. That's the worst thing you can think about as an investor. I think every day you have to assume you start with a zero next to your name. You're probably going to have some hurdle adversity to overcome. 2014 we're doing well. It got tougher. We were up one for that year. 15 was a really hard year. We were down five, then up five or six and 16. I just got tired of it to be honest. I had too mature of a team. I was better as a manager training younger people. That was my experience at King Street. I learned that in real time. Had a talented team, but it didn't fit the way that I operated the best. >> What were some of the other mistakes you made? >> Every manager at some level gets away from what they're good at. Sometimes that makes you uncomfortable and gives you bad risk positions. So, you stretch on what your comfort level was. For instance, I was in the Fanny Freddy preferred early. A good salesperson called me. He's like, "This is cheap option. This guy had a great nose." I was like, "Oh, that is that does make a ton of sense." So, we bought them at three and they were 13. I remember thinking, "Wow, now this becomes a legal bet." The delta went from a five or 10 delta to 40 delta. That's not my strong suit. Even if it's not mission drift, you just have to get out of trades. There were a bunch of trades that we went into. They were in my wheelhouse and then they did well and they got out of my wheelhouse and some of them were really bad reversals. >> So, you got a step away the second time probably knowing that the slow pace wasn't going to work for you. How did you spend those next couple years? >> I left in 18 then my kids were older. It was great to be with them. they were in high school or coming to high school and were super busy interacting with them and helping them navigate their days and assisting them. That was super rewarding. Going to see their event, helping them with homework, thinking about their college journey. I was definitely busy with that. I remember getting the advice when I left King Street. You should meet with as many people as you can. I was like, no, I want to try to help New York City. I want to try to be a teacher. This time I was more open. I would literally meet with anybody for coffee that was interesting. During that time I met you for the first time. I was more open-minded about it, more relaxed about it. With maturity, you get some wisdom. >> How do you think at that time about what you wanted to do next? >> I was resigned to the fact that I probably wasn't going to be an investor again. I didn't think there would be a third act. It was somewhat by chance. I failed again trying to reinvent myself, but they were more fun failures. I took a standup comedy class and performed. When you do these classes, they intermix real comedians because otherwise it could suck for the audience. See a bunch of people that weren't really good through my kid school. I became friendly with Jim Gaffigan. So I technically open for Jim Gaffin. I went on right after or else I would have pursued that. CO was literally the next day and I lost momentum. I created a game on an app that was a fun project. So I was not trying to necessarily save the world but just pursue things that were fun for me. Then Boaz, who I've known since the late 90s, he reached out to me in 21. He was like, "Oh, I'm putting up a board for a proxy fight on a closed end fund that owns levered loans. Would you want to do it?" I'm like, "Sure." I know a lot about levered loans. I've got time. I did that. A couple years later, I was still on the board. He was like, "Hey, can you come in? I'm thinking about making a bid for Sculptor. They have a credit business that's long fundamental credit, and you know more about that than I do. Would you help me?" And I'm like, "Sure, I'll help you." We went through that process. I'd never been in a hostile takeover situation. The bidding group was super interesting people that he's friends with. That took six months and we didn't win. But that got me. Maybe there is an itch to scratch. I honestly before that hadn't thought about what could I do. We lost around Thanksgiving. After the holiday season, I went into Boaz in early 24. Hey, listen. That was cool. He's like, "Not for me." Because I spent a lot of legal money, [laughter] but we made a lot of money for the shareholders of Oxif or Sculptor. I was like, I have a couple ideas. Hire me as a consultant and I'll run these down and if nothing comes of it, then we'll part ways. I was like, I want a wisdom role and I had these ideas. I didn't necessarily want to trade anything per se. So, that's how I got to Sabo. >> What did you put your hooks into when you got there? >> I had two ideas. One was the corporate bond market investment grade high yield had gotten more electronically traded over time. I'd first thought about it in 2015 and 16 when market access was getting some real traction like oh could we build a business where we could be a local in a sense of responding to market access. I met with a quant who had built something put that in the back of my mind. 2020 I believe that same guy Alex Reichman was starting a business and I was an angel investor and put a bunch of people together. It was called Tradewell just got bought by Seapport. So think about electronic trading my thought process was there was enough white space that an actual buyside fund could come in with a systematic approach to corporate bonds. Electronic trading allows you to do that. I was able to recruit two young guys from Jane Street to join Saba to set up a new fund manager called Saba LT. LT stands for low touch. These two guys, Rob and David, joined in May. They built out a team. They started coding right away. We turned the ALGO on to trade internal Saba money in March. Learned some stuff. Went back to the drawing board. Turned it on again in June in earnest. Took outside capital in November of 24. I got a team of 13. I say I had the idea for the movie. I was the producer. I pitched it to Boaz. He green lit it. He was the studio head. Rob and David are the star writers, directors, and they have their team. I helped them with strategy, helped them hire, helped them with raising money with LPs, relationships with the sell side and de facto credit strategist for them right now. I'm going to move out of that role at some point. But that's really interesting. Secondly, I was like, something's going to happen in private credit. I have no idea. I wrote a tweet in 23 before joining Saba that I thought there were some asset liability mismatches. That got a lot of traction. I was like, nothing against private credit, but it's grown so fast. There's going to be some hiccup along the way, and I feel like Saba will have an opportunity to get along. In my spare time, I was reading about public BDC's, meeting with sellside analysts, learning as much as I could about all the different non-traded BDC's, public interval funds, and the like. >> Take me through the path of private credit, from financial crisis, replacing banks to where we are today. from the financial crisis. The idea was banks aren't necessarily the best vehicle to make loans because they have deposit flight risk. Also, you had the six time lever rule. I forget the name of the rule. The guideline banks, we don't really want you lending to six time levered companies. Some companies that are six times levered like a software company could be a good credit risk. Private credit been around. It's not like Gallob started Aries and even Silverpoint. There are a lot of people doing private credit. But this idea of okay, let's do an institutional style draw down fund. The duration of that fund matches the assets and we take away this asset liability mismatch. Everyone talks about direct lending. There's all kinds of private credit, but let's just talk about direct lending for now. That made total sense. But then you had this idea of we still can make more loans, but we're tapping out a demand here a bit. maybe we do a non-traded BDC, which was now up to 2018. That's where I was like, well, this is the original asset liability mismatch that you tried to cure by doing a draw down fund because you might have all the investors looking for the exit. Even though it's definitely 100% on page one of any perspectus or there's a gate, you're going to get 5% liquidity. It grew really fast. 0 to350 billion dollars in non-traded BDC's from 2018 to now. That's unprecedented. As you look at the rest of the interval fund structure and the growth of the wealth channel into this space, what are some of the strengths and weaknesses in the various differences between the original draw down structures mentioned the non-traded BDC's now the interal funds? >> The draw down fund has got the best asset liability mismatch. I'm invested in a bunch of different kinds of draw down funds and they're ugly. You get capital calls, you get distributions, you're getting a lot of K1s. I'm in a good fund started in 2012. Still have a 10% position in it. They last a long time. They don't necessarily meet the demands of retail from that standpoint. Then you have the non-traded BDC which I do think that there is a potential for a non-traded BDC to work with the right private wealth client. The marketing happened pretty fast and furious and there might be a mismatch of the right client to the product. The level of sophistication of the private wealth channel is varied. I don't know if it's like we're going to videotape you saying that you understand about gates. I don't know if that's the right thing or not. It's probably not. And interval funds honestly didn't know what an interval fund was until recently. It's a concept that's somewhat strange in the sense that it's less levered. So that makes sense. Then how do you meet that demand? The bar you can't really gate. You have to give the 5%. The 5% or so liquidity every quarter. That's a great feature that has to be cash. As long as you have assets that you can turn to cash or you have lines at the heart of any of these non-traded BDCs or interval funds, what's the risk management? How thoughtful was the risk management? Is this contemplated for assets going down? How long can you sustain outflows for? I started a hedge fund. You launch, you take in money, you're like, "This is great." King Street was a wild ride. We were growing assets all the time. It's hard to think about the downside. What happens if we suck for a while? Then what? No one really wants to talk about that. >> What would proper risk management look like in one of these products? >> Good risk management would be a bigger liquidity sleeve. So maybe more levered loan PSLs trying to minimize unfunded commitments would be good. Unfunded commitments, whether it's a delay draw term loan or a revolver, no one wants those. there's economic cost of doing business. That's why credit derivatives was started. Banks didn't want those on. Let's hedge them out. You're not getting paid as much. You have the same credit risk. That would be one. Then being transparent on what is in the portfolio. Apollo came out. We're going to mark every month. That's a good move. But having marks that are as accurate as possible. It's hard sometimes. I'm not saying that there isn't going to be variance amongst marks, especially on private credit. But really being good about marks, whoever explains their portfolio the best, does that mean one pagers which you get in an institutional fund or does that mean a teachin? That's where I'd like to see it to go. Even though you're like, well, how is that risk management? The better that you inform your investors about your process and the investments that are in the vehicle, whatever the vehicle is, the more comfortable they get, the less they're going to rush to the door. >> I'd love to walk through a couple of the issues that commonly come up. You mentioned two of them, leverage and marks, but when I start with the marks in the private credit world. When you look at loans underneath one of these portfolios, where do you have concerns that the marks may not be accurate? There's some obvious ones where you see, let's just say, public BDC's that own the same club deal, the same loan, one BDC versus another, or two or three versus a fourth BDC. there's a massive variance in a second lean especially where you're like wait the first lean we know is stressed a bit so maybe it's worth 90 or 85 not that it's impaired but we'll throw it out a bad sector it's a stressed SAS loan and it has a second lean the second lean's got to be below 85 then you have one where a bunch of guys are marking at 60 and then there's a fourth one marking 85 come on you can do better than that yeah maybe if you marked at 70 so there's some wild varants, easy ones. >> When you look at the volume of those situations where it's easy that there's a wild discrepancy, how does that roll up into whether that's a systemic problem in the space? >> If you rated the big non-traded or public BDC managers on a scale of 1 to 10, 10's the best marker and one's the worst marker, what's the nav difference? If the guy that's rated 10, he's at the top of the heap. His nav is probably the most accurate snapshot for this. Obviously, there's delay here as well because they marked by quarter, which is Apollo trying to do. What is the guy that's rated one? What's the difference in NAV? Four, 5%, maybe six. It compounds a bit. Then you have micro situations where loans are getting marked from 100 to zero in one quarter. Everyone goes to the worst because credit is about believing. You have to believe. Creree is credit means to believe. And when you lose belief, it happens really quickly. Trust is the biggest thing. Recently, there have been this wave of redemption requests above that 5% threshold in the non-traded BDC's and interval funds. And that question of belief comes into play of what happens the next quarter. How do you think about the difference between the reflexivity that comes from the investors redeeming and the underlying fundamentals of the loans in these portfolios? >> How does a normal person think about the fundamentals or some crazy bear like me? [laughter] I've looked throughout my career for asset liability mismatches and I truly believe that asset liability mismatches cause liquidity crunches and liquidity crunches can cause credit crunches. Credit is correlated when it gets stressed. I have a good pulse on retail mindset in that this is an income product. That's why the private wealth channel cares about it. It's not like this is Apple stock. 10 years ago, private wealth loved MLPS. That was the income product. Then we had the energy crunch and mini default cycle in 2015 16. Retail doesn't really care about MLPS. They will find their income product Azure. There's a sense of almost tide with retail. They like the product. The tide's in. They don't like it. The tide's coming out. If you think about how this redemption cycle started in Q4, we had Blackstone BCR, Gallibs, the non-traded BDC, and Oak Tree's non-traded BDC. They all had to cut the dividend 10%. It made total sense. So far was down 175 basis points. New issue spreads were in. We had 300 basis points less than realistic gross yield of BDC's from 2022 23 till now. You got to cut the divs. redemptions went from 2.1% of the top six to 4.3%. There are financial adviserss, wealth managers, whatever, RAS, they have a simple rule of thumb. You cut my dividend, I'm out. That's what works for me. I don't care if it's a blue chip stock. You think about GE, that was a big blue chip. Cut the divid, I'm out. I just have a 30-year history. That's how I go. Understanding that mindset is important in understanding reflexivity. They don't need this product. In order for managers to keep the stem the wave, they have to prove to the private wealth channel that first of all everything's marked here correctly and here's what we're investing in. Here's why we think we deserve your money. That has to be a really open conversation. The factors on who comes out of this wave the best. Underwriting is number one. Do you have a good loan book? Is your loan book better than the market? Do you have alpha? Number two, risk management. Have you given yourself enough room to navigate? Can you sell a position? Do you have unfunded commitments that are going to trip you up a bit? Do you have enough of a liquidity sleeve? All those moves. The third factor of how transparent how you communicate and how you instill trust with your investors is going to be a big one. The scenario described in Q4, rates come down, cut the dividends, very rational, the yields are going less unflating rate notes. The other side of the underwriting is the default cycle. And it's very different. Private credit, one lender, one company, they can defer, pretend, extend, whatever it is. How do you think about how to measure successful underwriting? As you're looking at the different managers that are offering these loans, >> you have to go line by line and look at where they have problem loans, how many of their loans are either marked below 80 or you think should be marked below 80. Hindsight's 2020. SAS was the darling of private assets, whether it's private equity or private credit or even venture. SAS was the darling of alts. If you're like, "Hey, I'm all in on technology. That's my thing." And there are some funds non-traded or public BDC's. If you want that, this is what I'm giving you. That's what you signed up for. And we're in this period of how much is AI going to disrupt. If you think about economics, 80% gross margins. They're not going to last forever. Someone's going to try to figure out how to attack them. This whole it's like switching costs. Clearly technology switching customers. People are thinking about that problem. But I would say portfolio construction. If you're not saying you're all soft, I'm doing a technology fund, but I'm 50% software. Do all your investors realize that? Is that something that you have communicated to everyone? That's where you get the disconnect. We're going to have a wave of defaults in the software space. I don't think that's crazy to think about because we've had so much capital go into the space that from a venture or private equity standpoint, hey, listen, the upsides are so amazing that we can take some losers. We can still do well. Venture will tell you three out of 10 is good for them and they can take a bunch of zeros. Private equity doesn't like zeros, but they can take down 20% or some ties. When you're talking about credit, you take any zeros, it's tough or serious impairments. >> If you look at signpost of the default cycle, you had defaults, you have some cash pay that moves to pick. How do you tease out where we are today? >> I think about credit cycles from the standpoint of misallocation of capital. In the early 2000s, you had a massive rush of capital into telekcom tech space. that capital whether it's global crossing or level three laying fiber cable I'm glad they did it but they did it a little too quick with the bad capital structure so misallocation capital isn't necessarily bad but in this SAS space it seems inevitable credit cycles are good for capitalistic economy we haven't had one in a long time so some of it's do you really think we're never going to have one I push back everyone's like oh we're fine the productivity that AI hopefully transmits into the economy There's going to be winners and losers. If you're long credit, you're short volatility. You want things to chug along because you don't have upside. Yeah, growth is okay, but you more want stability. When you introduce something like AI, the paradigm has shifted. You're going to have winners and losers. That shifting increases volatility. Higher volatility means more likely good and bad outcomes. And credit, it means spread should go wider. There should be some more defaults. A lot of the past cycles were funded by a significant amount of leverage. What are you seeing in the underlying fundamentals of the businesses as it flows through to what you're concerned about in the structures of some of these credit vehicles and leverage? The alt space is always trying to be creative and look for opportunities as to where to deploy capital. This idea of ARR loans, no one would have done that. you would have gotten laughed at a bit that you're lending to a company that has negative IBIDA and you're not getting any warrants. That was venture lending. You're doing venture lending without warrants. But SAS had been a great model for a long time, but we're in a progrowth space. It's pro- cyclical. I don't think AR loans, they're good riskreward. They work for a long time. Maybe some people did well with them. There's some investors that are great timers and they know it's bad riskreward, but they can ride a wave really well. But I do think we're going to have less ARR loans if we do get this software shakeout. >> As these redemptions start to come in, if you were a GP of one of these funds and the redemption amount exceeded that 5% threshold, what do you think the best way to handle that situation is? Are you thinking about it for the maximizing the fees of this fund or are you thinking about it in scope of a bigger picture with BCR? Blackstone pretty much is the only alt manager that has gone through something. They have the experience of B rate and they cleared that queue a short amount of time, sold assets, got some strategic investors to come in. They did a great job in clearing that queue and now is not surprisingly when BCRED had 7.9% redemptions. They thought about it. Listen, we're going to do everything we can to get everyone their money back. For Blackstone that has 1.3 trillion and has deep ties in the private wealth channel, that was probably the best move. If you say on the other side of the equation, you're an interval fund and you're a manager and this is all you have this one fund, maybe that's not the right move. Maybe you're supposed to only do the minimum you can. At the same time, if you're only doing the minimum, you do have to think what happens for two or three more quarters. Are there riskmanagement decisions I can make today that might be a little painful and maybe I have to shrink my balance sheet to get through this and grow. You have to at least consider the scenario where your AUM is shrinking and during that period you have to do the best you can and instilling trust and confidence in your investors to get through the tough times. So you circle back as the second thing that intrigued you when you were talking to Boaz about joining Saba. This something could happen big in this private credit space. How are you now thinking opportunistically about investing as some of these things are happening? It's been widely reported we are tendering for one of the blue owl funds their blue owl obdc2 which we're going to see if there is any demand for liquidity at a discount to NAV. It's new territory, so we'll see. We don't know if there's going to be demand or not. We think there is potentially demand. The space is $350 billion of assets plus another 100 billion of interval funds. So 450 billion plus some non-traded REITs. Big big space. It's a small percent of investors that do get gated or looking for liquidity. It could be a decent opportunity to make an investment. If anyone else wants to top our bid, they can. It's not like we have anything proprietary in that regard. If we do become a shareholder, we want to be constructive. We hope for transparency, not only for us, but for all shareholders in every fund. That's the best way to get through this time. Through this stress, we're going to see secondary trading of private credit. How stressed that is is TBD. It's starting to pick up a little more now. Obviously, it makes sense. Some of the best club deals that are the best credits are trading at par right now. If you want to buy any private credit loan at par, I'm sure you could get filled pretty quickly. We're thinking about that as well as potential opportunity set. >> What does it take in terms of research and flow from your team to be prepared to jump on a something that could be very opportunistic? We're going through the filings line by line and trying to map out the capital structure as best we can to understand all the leverage in a particular. Not every BDC is the same. There are some that are more levered, less levered, and then there's some that have CLLO positions and unfunded commitments. So, you have to stress understanding the capital structure is important. You can do your best on trying to figure out what the right price of the credit is, but most of the BDC's are pretty diversified. You're thinking about one mark or two marks is not going to necessarily change the economics, but then also not taking at face value what the industry concentration are. Literally putting in every loan into claude or chatbt to figure out what do they think it is. There has been some mislabeling of concentrations. If you put on your self-p profofessed bear hat and paint a picture for how this goes from uncertain today to something that's a lot worse. What do you see happening from here to there? This is where I get all the hate in Twitter. Now you're stoking the fires. the bare case which I'm not saying it's going to happen but what happens is you get redemptions you get some real defaults you get for selling of private credit and in the interval funds you just run out of what's liquid and the bar to gate is really high you literally need an SEC exemption and that's not because prices are low you have to show the SEC I don't have any liquidity that goes on a feedback loop of where's the actual bid for private credit. It's hard to say. A good bid would be in the low 90s for good stuff because the absolute yields aren't that amazing. S plus 500 loan is 8% or 9%. It's got a five duration. So you're bidding 90, you're getting 11%. One of the issues with private credit is all the returns are predicated at leverage at the fund level. You need fund level leverage to get anyone excited about it. If anyone came out with a unlevered BDC, it would be a yawn, especially after fees. JP Morgan marked down some software loans as far as their bank lender. That's the other issue is that going back before, are we worried about the top 10 managers or are we worried about the bottom cortile? When the rates were zero, you had some institutions that raised funds that probably weren't the most experienced or skilled investors. If their portfolios start getting seven or eight percent defaults, but some of the underperformers have 15 or 20 percent defaults in their portfolio, maybe heavy in a bad sector or so, banks are going to start cutting lines or not renewing lines and there's an asset liability mismatch on the lines. Then the banks are going to pull back a bit and gets a little harder for everybody. That's where you get the feedback loop on prices going down which causes more redemption, less interest. Where's the clearing level from an unlevered level? Where do the distress funds really come in? And it's probably decently low. You don't want to test that bid. Lastly, the worst worst case scenario, which is far far away, would be that there is lack of confidence in some of the annuity providers that have loaded up mostly on tripleB rated private credit or better. But is there a potential where their annuitants start surrendering policies? That's the ugly ugly. I don't know what the probability is. It's not a high probability, but that's where it gets bad. When you move down in the capital stack, eventually that has to hit private equity with a lot of these direct loans being sponsor back deals. Yes, if you get a big default cycle, S&P is down, MSEI is down. So, private equity has to be down, but there's going to be more variance amongst private equity, then credit is more correlated. You're going to have tougher times because you have the fund level leverage and you might have to make a sale that you don't want to make and the upside isn't as much. Whereas if you're private equity and you have a portfolio company that incorporates AI, well, that could be a good one. Overall, the beta private equity, if you look at just from the industry, the beta, yeah, it'll be a loser as well. This idea of asymmetry, the upside in equity versus downside in credit, I think that starts coming through. And then from the secondary standpoint, could you see some good opportunities in private equity secondaries? Yes. Could you see in private credit secondaries? Depends on the vintage. The problem I have with private credit secondaries is how old are the loans? Because the loans in typical 7 years, but you hope to be refied in three or four years. Once it gets past four years, there's probably a reason for it. I'm not saying that there isn't optimistic marketing and private equity, but you could have a company that's been in the portfolio for seven years and actually did take an upturn. there's less likely in private credit that that's happening. There's definitely a problem in private equity if you get a default cycle. >> What do you think most investors in this space misunderstand the most? >> Liquidity. I understand private markets and I have investments in funds. There's some advantage as being an LP and not being tempted to trade. I don't need that temptation. And that's okay if you're a GP of a private fund and you don't need liquidity. You're like, "These are my bets. I made these investments." But when you need liquidity or you get liquidity taken from you, that's where traders come in. There are firms that have more of a trading talent on the private credit side and there's some that don't. That's going to be the differentiator when it goes away. truly whether it's during the GFC or the early 2000s around world com all that stuff it's always shocking even if you're David ter who probably has traded those markets as well as anyone on the credit side I'm sure there were d like oh my gosh I can't believe I hit that bid and it's down 20 points everybody has a plan until you get punched in the face like Mike Tyson that's liquidity >> what gets you excited each day when you're coming into the office now >> I still like the puzzle I don't want to wake up to Bloomberg and think about a position level, but the puzzle of the market, what's going to happen and how our problem is going to get solved is still super interesting. >> All right, Karen, I want to make sure I get a chance to ask you a couple fun closing questions before we go. Before we get to the closing questions, I want to tell you about one of our strategic investments. We've made a few and each are working on a product or service we think will be valuable to our community. One is Thema. For all the private equity managers out there, FEMA uses AI to help map the landscape and source private businesses. It's incredible what a well-designed AI tool can do to accelerate the discovery of businesses in private markets. There's a link in the show notes so you can learn more. And here are those closing questions. What's your favorite hobby or activity outside of work and family? >> Playing basketball. I am old and I don't know how much longer I can play, but I love the game. I play at least once a week. I try to do everything I can to keep that going for as long as possible. >> Which two people have had the biggest impact on your professional life? >> Two coaches, my junior high JV basketball coach and my high school coach, Tony Casamasa and Reggie Weiss. So many life lessons about how to be a good teammate. It's all about the team. It's your job to provide value to the team. Effort, diving for loose balls, body language, defense wins championships, which is probably the best advice with respect to investing. Protect your downside. >> All right, Karen, last one. What life lesson have you learned that you wish you knew a lot earlier in life? >> Never lose your cool. Never yell or break a phone. When I started in trading floors in the 90s, they were pretty rough and tumble, and you always had to worry about getting picked off. I probably got upset more than the average person. I always apologize, but there's really no reason to. >> Look, Kieran, thanks so much for sharing your insights on what's going on and look forward to seeing what happens. >> Thank you so much, Ted. It was super fun to do this with you. >> Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators.com where you can [music] access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time. [music] >> All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is forformational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.