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

My guest today is Kieran Goodwin. Kieran spent over two decades at the frontier of credit investing. During the global financial crisis, he was a Partner and Head of Trading at King Street Capital, which grew from $4 billion to $20 billion while he was there. He then left to start his own credit hedge fund, Panning Capital Management. In our discussion, we cover the state of private credit today, which forms of alpha he’s most skeptical of, and the blend of EQ and IQ necessary for success and investing. Please enjoy my conversation with Kieran Goodwin. Founders Podcast Founders Episode 136 - Estee Lauder Founders Episode 288 - Ralph Lauren For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Tegus, the modern research platform for leading investors. Tired of running your own expert calls to get up to speed on a company? Tegus lets you ramp faster and find answers to critical questions more efficiently than any alternative method. The gold standard for research, the Tegus platform delivers unmatched access to timely, qualitative insights through the largest and most differentiated expert call transcript database. With over 55,000 transcripts spanning 22,000 public and private companies, investors can accelerate their fundamental research process by discovering highly-differentiated and reliable insights that can’t be found anywhere else in the market. As a listener, drive your next investment thesis forward with Tegus for free at tegus.co/patrick. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes. Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes (00:03:00) - (First question) - His view of the state of private credit in capital markets (00:06:56) - The notion of ball washing and why it’s important to understand (00:09:04) - What the worst-case domino effects of ball washing could be (00:12:21) - Arriving at a place where JP Morgan could borrow so much at the fund level (00:14:20) - Lessons learned from the worst trade he made (00:16:53) - What could happen in the world of private credit in the next few years and how the bigger players tend to benefit (00:19:29) - Thoughts on the world of venture capital right now (00:21:13) - The time he was at the peak of his power as an investor (00:24:03) - From being new at something to incredibly successful seemingly overnight (00:26:42) - What kinds of alpha he believes exists and which ones he’s skeptical about (00:29:30) - Thoughts on income share agreements (00:31:24) - Why there aren’t more initiatives for new talent to trade their student loans for future earnings (00:33:13) - The power of EQ over IQ and why it’s important for investor success (00:35:49) - Whether or not now is a good time to get into the field of capital markets (00:37:54) - Key tenants to know when learning credit investing specifically (00:40:09) - Things people misunderstand about the power of volatility (00:42:39) - Ways he managed to stretch his own imagination effectively (00:48:06) - The natural inclination to be short volatility (00:49:24) - Incorporating long volatility into his portfolio and life (00:52:20) - Thoughts on synergy in relationships (00:55:48) - Other interesting lessons learned from sports (00:57:50) - The roles of the multiple coaches that sit in for an NBA team (00:59:42) - The kindest thing anyone has ever done for him

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:35Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts and you can access all our podcasts, including edited transcripts, show notes and other resources to keep learning at joincolossus.com.

• 1:00Speaker 01

  Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum or O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum or O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

• 1:32Patrick O'Shaughnessy?

  My guest today is Kieran Goodwin. Kieran spent over two decades at the frontier of credit investing. During the global financial crisis, he was a partner and head of trading at King Street Capital, which grew from $4 billion to $20 billion while he was there. He then left to start his own credit hedge fund, Panning Capital Management. In our discussion, we cover the state of private credit today, which forms of alpha he's most skeptical of, and the blend of EQ and IQ necessary for success in investing. Please enjoy my conversation with Kieran Goodwin.

• 2:03Patrick O'Shaughnessy?

  So maybe a fun place to begin is with the world of private credit. We talked a lot about it already today at lunch, but I think your take on it is especially interesting. Can you just give what you view as the state of the union of private credit today in capital markets and why you find it interesting as just a category to consider?

• 2:22Speaker 02

  The growth of private credit, you kind of have to start the conversation there. I mean, you had this asset class that was somewhat of a cottage industry around the time of the great financial crisis and confluence events happened. Probably the most important is that rates went to zero. So there was a search for yield that benefited spread product wherever. But then also you had the Fed OCC rules where banks could not lend to companies greater than six times EBITDA. So with private equity looking for debt to finance capital structures, private credit was a solution in a sense.

• 3:05Speaker 02

  And then as private credit equity had more and more dry powder, the results were doing well, there was more demand for private credit. So you just had an explosion of growth and this contraption setup of more private equity, more private credit, but still with 0% as so for LIBOR, LIBOR at the time now so for, and spreads being 550 to 600, you're getting 6%. The funds needed to lever themselves to get to 8, 9%. If you're an alternative asset manager and you're coming to an LP and saying, I can give you 5, 6%, no one cares. It's got to be like at least high single digits. And what the allocators loved was there's no volatility. Jason Zweig at Wall Street Journal wrote a great article talking about how Cliffwater,

• 3:50Speaker 02

  who's not only consultant, but also in private credit, put out on a fund, a 10-sharp ratio. He interviewed Professor Sharp, I can't remember his first name, and Professor Sharp was like, that's ridiculous. Obviously, and they pulled it from it. But that's the world we're living in where like there's this ultimate sharp ratios and everyone's like, there's no vol and like, of course, there's vol, there's vol to anything. Your car leaves the lot and it's down 30%. There's volatility, it's just you're not marketing to market. So the difference between volatility of what an asset's worth and actually marking it is different. So you've had this explosion and now we have rates much higher. So you have these loans that are five to seven year loans, loans made in 2019, 2021. The companies thought they were going to pay five and a half, 6% interest on.

• 4:36Speaker 02

  And now those are 11% interest loans. And if you think about the typical private equity middle market company, they were bought at 12 times EBITDA. They put seven turns of leverage on it and seven turns of leverage only allows. If you use all your EBITDA, you can pay 14.28 or so whatever percent interest. So now you're paying 11 where you were paying six. There's a lot less room for error right now. And we haven't seen that interest really flow through because like these rates haven't so fast and furious that even Q1 of last year, like rates were really, really low. So I think going forward, you're seeing a lot more stress on these companies. You're going to have more defaults, like defaults are picking up.

• 5:20Speaker 02

  Some bad trades were done. Private equity as an asset class has been around for 40 odd years. And sometimes excess gets in the system. We saw it with the massive LBOs before the great financial crisis. I would say there's probably more excess in private equity in the middle market space than anywhere else. And it's direct lenders. So when we say private credit, I'm really speaking about direct lending, particularly to middle market, private equity sponsored companies. I don't think it's unnatural to think that you're going to have more defaults in the sub $100 million EBITDA space than you are in necessarily S and P companies.

• 5:59Patrick O'Shaughnessy?

  You've dealt with a lot of GPs, LPs, you've been both. Talk about this notion of vol washing, the concept itself and why it's an important thing to think about and understand from the allocator's perspective, from the GP's perspective, from the end customer, the asset owner's perspective. Just think it's like a neat, interesting concept.

• 6:15Speaker 02

  You think about institutional allocation to alternative asset management. We'll start with someone like David Swensen, who was the godfather in a sense of thinking about that alternative assets should be in any big institutional portfolio, given that you have a longer time horizon. Well, you have competition. When David Swensen first started, he was probably the chief bottle washer and was looking, you know, meeting private equity guys, meeting hedge fund, real asset managers. And now, within a place like Yale or any other place, they have teams. They have the private credit team, private equity team, hedge fund team, infrastructure. And all of those individuals are competing to get more assets in the portfolio because

• 6:58Speaker 02

  that's how they ascend and maybe become the CIO. So when you have your monthly meeting or quarterly meeting and you're looking at returns and you're the long-short equity hedge fund allocator and you've got volatility everywhere versus you're the private credit allocator and you're like, yeah, we're doing our 10% annualized, every month it's 80, 90 basis points, checks in the mail. That's like a pretty powerful position in the last few years. So, yeah, I've done 500 meetings as a GP and there are few allocators that really embrace volatility. They would rather have, let's call it an ARB strategy, that's 15%, which, I mean, so

• 7:43Speaker 02

  would I. Think about it, if you can make 15% forever with no volatility, like-

• 7:48Patrick O'Shaughnessy?

  Sounds pretty good.

• 7:48Speaker 02

  Yeah, who wouldn't sign up for that? But the reality is that when you're in a business cycle and the faults are picking up, you would think, and we've seen in the high-yield markets, we've seen in the levered loan markets, prices are going down. We're not seeing in the private credit markets because there's no observable secondary trading of loans.

• 8:07Patrick O'Shaughnessy?

  Talk about like what you think could be the domino or domino effects here because the whole idea behind bottle washing is a lot of this stuff happens very slowly. Unlike something like Silicon Valley Bank or something that publicly traded equity, marks all over the place, you know what's going on, seems fine until it's not, and then it can go poof really quickly. What is like the worst-case scenario you could envision for how what I'll call like bad private credit loans go wrong and get worked out in the market?

• 8:34Speaker 02

  I'm just pointing out a possibility. What could happen is, given that to achieve 8, 9, 10, 11% net to investors-

• 8:45Speaker 02

  If you were involved as a GP, if you're in a direct lending market, you were making loans at SOFR plus 600, you had to have leverage at the fund level. So you went to Goldman Sachs, Citi, JP, all the big banks. I'm going to lever this fund one to one. So if I have a billion dollar fund, I'm going to make 2 billion in loans. I'm going to borrow a billion. And they would give you a line of financing. And that line has covenants. And the mark to market of the loans, you're required to go to a third-party valuation provider that gives you a mark. Most of those marks are going to be par all the time. That's part of the vol washing, in a sense.

• 9:28Speaker 02

  There's arguments to be made for or against that. We don't necessarily have to go there. But defaults are real. That's the nature of credit. When principal comes due, you pay me or you don't. And yeah, we can do amendments, what have you. But end of the day, it's nonperforming. As defaults pick up, which we've seen in Q1, and again, I think it's going to be in the lower end of the market, is going to have a bigger percentage of defaults than the higher end of the market. If that trend does continue, you're going to see some of the worst performing portfolios of all of private credit, their lines are going to get cut. And the leverage providers, the banks, the sell-side, is going to say, you need to start paying us down this line.

• 10:11Speaker 02

  And if they don't have loans coming due to pay off, they're going to have to sell loans in the secondary market. Many of these direct lending loans are bilateral in nature, meaning it's just the lender and the borrower. So there's no public information. So just the process of selling a loan, as the GP, you're going to have to tell your borrower, like, listen, I'm going to take this private information, give it to a third-party to evaluate the loan, see if I can sell it. That's going to be cumbersome. As we see when Wall Street is financing positions, whether it's listed equities or hedge fund stakes, whatever it is, warehousing lines, they're pretty good about getting paid back.

• 10:55Speaker 02

  I mean, outside of the Credit Suisse situation, Wall Street, the lenders have a very good track record. If one of the years or two of these situations happen, all the other banks will know this is happening and they're going to start, okay, who are our worst performers? Which ones are we worried about? Let's have conversations. The correlation of, hey, this is not an issue and they're going to be able to pay us back. That goes from like, nobody has a problem to like, there's a lot of problems really quickly.

• 11:23Patrick O'Shaughnessy?

  The billion dollars in your example, that's debt capital from JP Morgan or something to the fund. Talk a bit about like, the origin of that piece. Why is JP Morgan in that business? What got us to there where that amount of borrowing was possible at the fund level? Assuming that like, if something like this were to happen, new lending will probably dry up too.

• 11:45Speaker 02

  I've heard anecdotally, that's much harder to get today.

• 11:48Patrick O'Shaughnessy?

  It is, just because of rising rates.

• 11:50Speaker 02

  I just feel like maybe the system is getting a sense that-

• 11:54Patrick O'Shaughnessy?

  Up against the natural limit.

• 11:55Speaker 02

  Right, right. We wanted to do X billion of that and we've kind of hit our limit. As we've seen, private credit is, keeps growing and more funds are out every day trying to raise more monies. There's a natural limit of that, which I think is, the Fed report, I think it was about a couple hundred billion dollars.

• 12:10Patrick O'Shaughnessy?

  Of direct loans.

• 12:11Speaker 02

  Of lending by banks to funds. So, how did we get here? The fund would just say like, hey, listen, I'm going to raise a billion. I'm only going to lever it one time, so you have 50% cushion on these loans, which are all first lien loans that would have, again, 50% cushion. So let's just do diversity of the loan pool and what would have to happen. And so if they're earning LIBOR plus 550, 600, then the bank who's going to lend the fund money is saying, well, if I lend it LIBOR's 250, 300, that's a pretty good deal for me because I'm top of the stack of a first lien position anyway with diversity. And I think this GP knows how to make good loans.

• 12:56Speaker 02

  I have a relationship, what have you. If you think about where we were with 0% rates and deposits, a place like JP Morgan, Bank of America, Goldman Sachs, they were taking in money at zero. And now they're lending it out, LIBOR plus 250, 300, and even LIBOR was 1%, 2%. But now their deposit base is probably getting a little more competitive as well. So it's like, is this loan that they're making as good a business, in a sense?

• 13:22Patrick O'Shaughnessy?

  There's a related lesson here from, I think you call it the worst trade you've made. Can you tell that story and then we'll talk about the lesson?

• 13:29Speaker 02

  Yeah, thanks for bringing that up. Yeah, so back in the summer of 2002, I was trading prop at UBS and I had a position in WorldCom. I owned bonds that matured in early 2003 and they were trading 80 cents on the dollar. And the other debt of WorldCom was trading decently lower, the further maturities. And one of the reasons that I bought this bond was because they had a revolver that was, let's say, June of '03. So they had an undrawn revolver, which they could have drew from the bank, $500 million, and easily paid off this maturity. So the only way that you could get crushed on this position, and I was short a bunch

• 14:13Speaker 02

  of other, this is my long, this is going to pay for my short. I was actually overall bearish at the time. This was the smart long to have. The only way you could get crushed was fraud. I was like, what are they doing here? And what happened? Fraud. Fraud happened, so I got crushed. It's good to know what's going to kill you, and it kills you, it still hurts, even if you've got to understand that. What was the fraud of WorldCom? Really, at the end of the day, Bernie Evers went to jail. The fraud was, WorldCom was capitalizing operating expenses. We had this early 2000s, fiber, everything's getting put in the ground, massive growth still, even though there was a consolidation, like the Level 3s and the Global Crossing went down, WorldCom and AT&T were still growing.

• 14:55Speaker 02

  And AT&T's EBITDA margins were 30%, 28%, and WorldCom's were like 42%. And AT&T, like, guys were getting fired because they couldn't keep up with WorldCom. WorldCom was just taking regular expenses that were operating expenses, they were putting them below the line as capital expenses, so their operating margins looked a lot better. So, the point I was making, like, that was 21 years ago, when you're thinking about the explosion of middle-market private equity, I mean, absolute explosion in the last 15 years, there's got to be some of that. I play golf a little bit. Someone's like, what'd you shoot? Like, a 90? I shot a 90. Was it a hard 90 or a soft 90? Like, it's a big difference.

• 15:39Speaker 02

  "Oh, just give me a triple there," kind of thing. Hard numbers and soft numbers are much different. And I feel like in the world of EBITDA, there is this notion of hard and soft. And in a good market... Soft is okay, but in a tougher market, everyone wants hard numbers.

• 15:55Patrick O'Shaughnessy?

  How do you think this plays out? Like if you had to handicap it, what do you think happens in the world of private credit in the next three years or something like that?

• 16:04Speaker 02

  Well, I mean, let's just say in the law of large numbers, the amount of growth that we've had in the asset class has been astounding. It's gone from $250 billion in 2010 to 1.4 trillion. If I take a step back, I think the asset class will keep growing. If I have to handicap it, I think there's going to be a consolidation and it's going to be a shakeout. And probably the bigger players benefit from that shakeout, like we've seen in every other alternative asset class, in a sense.

• 16:34Patrick O'Shaughnessy?

  Describe what you mean there in terms of the cycle that happens there where the bigger players ultimately benefit?

• 16:40Speaker 02

  Well, if you have thousands of managers.

• 16:42Patrick O'Shaughnessy?

  Of which there are 2,000 or something.

• 16:44Speaker 02

  Yeah, yeah, thousand managers. I just don't think the talent is evenly distributed. And there's going to be, I'm not saying who it is, but like, it's going to be some funds that just go away, just like we'll see in venture, just like we'll see in middle market private equity. But that process of them getting blown out might cause a hiccup for a bit in the market in general. Institution allocators are like, wait, I'm not always going to get 9% back. I could get 70 cents on the dollar back. It's not going to be zeros like you could in venture. You could literally give your money and get back nothing in a venture fund. But it's going to be super disappointing, potentially super disappointing

• 17:23Speaker 02

  on the margin, which I think will pause. And then the bigger firms that have more resources and probably deeper relationships are going to see like this cleanup trade is a pretty fat pitch and we should lean in when the market really needs capital, which I'm not one to think about. You always hear like these funding cliffs, like, oh, so much commercial real estate, all this is due. And like, I've heard this always, how you'll in market next year, there's so much due. Like, there's always a lot of maturities due. If you get a market where all of a sudden there's a pause a bit, there's a decent amount of dry powder in private. private credit as well. Pricing can't really change that much.

• 18:04Speaker 02

  It's so far as at 5% and leverage is probably down from normal middle market company would be 12 times EBITDA. They're lending at seven, maybe they're lending five and a half turns now, but it's still so far plus 6%. Again, there's limits on how much interest you can't pay 15%. It just doesn't work for almost any company. If you can pay 15%, you don't need debt. In a sense, you're a good enough business that you should just raise equity.

• 18:31Patrick O'Shaughnessy?

  What do you think of the world of venture right now? I know you thought about it a little bit and met some people that do that style of investing and understand the setup. What do you think of that space?

• 18:40Speaker 02

  I mean, again, like much like private credit, it was a cottage. I mean, there were some big players, A16Z and Sequoia and a bunch of others, massive established players. But there are a lot of small firms in venture at the time of the financial crisis that had a ton of growth. And then there's been so many two people starting a firm with 50, 100 million dollars. There's just hundreds and hundreds of those kind of firms. I'd say the barrier to entry as far as alternative asset managers, the lowest has been adventure. You just don't need the SEC registration and prime brokerage and the bank relationships. And it's much easier to set up two people, you and I, let's do a fund. We raised 13 million dollars, really hard to do in private equity.

• 19:25Speaker 02

  No one cares in private credit, hedge funds, the fixed costs. You used to be able to do it, now you can't really do it. So I think the smaller managers are going to get blown up and you're going to have a shakeout. We hear about all the time with respect to institutional allocators, they have a denominator effect. They've put out more money in drawdown vehicles, whether it's private equity, private credit, real estate or venture. They were getting capital back to them so quickly on wins. They're like, all right, let's make a bigger allocation. And now their capitals, not only do they put out more than they think they're going to have, but it's getting drawn quicker. And now there's going to be a pullback like, wait, let's look at how we did in venture.

• 20:07Speaker 02

  And actually, most of our money was made with one out of our 15 managers. I think there's going to be a natural consolidation.

• 20:15Patrick O'Shaughnessy?

  If you think back across your entire investing career, can you paint the picture of the time that you felt you were at the peak of your powers?

• 20:23Speaker 02

  Yes, yeah, clearly. I had a massive advantage, which right time, right place, you catch the right wave. I'm a big believer that it's more important to be on the right wave than necessarily be the best surfer. The wave is more important. And I started in credit derivatives in 1995, almost by default. I was trading interest rate options and move firms. We have a seat for you. It's credit derivatives. So that means for the first three years, I just talked to myself. I mean, I had credit derivative trader on my card, business card. No one knew what it was. No one gave me the time of day. It was good to think about the markets and optionality and credit markets and how this product would potentially fit in, the use case for it. So then the market picked up as soon as the

• 21:08Speaker 02

  Asian crisis happened, and then long-term capital and Russia, and then you had Y2K and the tech meltdown, and obviously 9/11, Enron, WorldCom. So like, from 97 to 02, super volatile time. Really high volatility in the equity markets, but also in the credit markets. Really, really high volatility, which is one of the reasons like convert hedge funds did so well. They had amazingly high equity volatility that they were hedging against, and then the credit spreads were wide. They had like kind of the best of both worlds. So then I traded prop for a couple of years. When I was trading prop, because I'd started in the credit derivative market, like, I almost knew every trade that was happening. I kind of knew why every trade was happening. Starting in a market and seeing

• 21:50Speaker 02

  it grow up, getting a sense of like, knowing what every market move, every price that happened, you get like a sense of calm, almost. Nothing's surprising. And understanding the origin. So going into 2008, it was way worse than I ever thought it was going to be. I felt that I was as good as I could be at that time. We had a great team, and Yeah, I was at King's Street at the time and Fran Biondi, who taught me a ton about distressed investing, credit investing. We had like two circles. I had this kind of derivative optionality, new product background. He had deep value.

• 22:32Speaker 02

  The intersection, when those two circles kind of intersected, that sliver, we felt like we had a big advantage, that we were seeing the markets from two different angles that most people weren't. That's the period, that 06, 07 period, when the world of subprime was blowing up and commercial real estate was blowing up. And all these LBOs were like, how are you going to fund these LBOs? And we were really, really sure that they were going to get hung and that there was going to be contagion. We were super confident on our view.

• 23:06Patrick O'Shaughnessy?

  Can you explain the psychology of being very successful in the hedge fund career or profession? What it's like to go from learning something, being new at something, to making a ton of money in a fairly like virtual job? Like you're not making a widget. You're sort of like a symbol manipulator. And then all of a sudden, you have a lot of money. What is that experience like?

• 23:31Speaker 02

  I'm going to use probably a terrible word because my vocabulary isn't as good as yours. It's surreal. It's out of body in a sense. Overnight successes are 10 years in the making. Rarely do you have someone that just steps in on day one. Most of the time, I would say, whether it's private equity or hedge fund, during your twenties, you're kind of learning a craft. And then if you're lucky, you get some insights that maybe are unique. There's an assumed narrative out there that you're like, I don't believe in this. Everyone's believing this. Like, I don't think this is true. And the payout, if I'm right, betting against that is massive. And then if you're really lucky, you get in a seat where you have real leverage

• 24:16Speaker 02

  to be in a situation. And then you need it to happen. So there's like a confluence event. So there's definitely some luck involved in that. When it all does happen, It can happen really quickly and then it's like, what now?

• 24:30Patrick O'Shaughnessy?

  How do I follow it up?

• 24:31Speaker 02

  Yeah, what's my next album? Right? You think about like bands and this is not a unique thought, but like I remember in college, I'm old, Blues Travelers came to Duke, a bunch, and they released their album and it was like awesome. And then they released their second album. It was awesome. They'd been working on those songs for like seven or eight years. And then they released their third album.

• 24:52Patrick O'Shaughnessy?

  Sucked.

• 24:53Speaker 02

  It kind of sucks because like they only had like eight months. This is all I got, right?

• 24:58Patrick O'Shaughnessy?

  It's like the first book for an author, same phenomenon.

• 25:00Speaker 02

  Yeah, that phenomenon. It's like, all right, what's the follow up? So in any kind of investing, like I'm always amazed in awe of the investors that can change stripes and be fluid over decades of just figuring out how to make money. It's kind of sobering when someone like Stan Druckenmuller, I'd listen to this own conference and he's always like, listen, you know, it's harder now because every time we were getting into a recession, I knew the Fed was going to have to cut rates and I would just buy the two-year note. I can't do that this time. This time is different. And someone like him, who's on anyone's all-time great list, when he says it, like, there's no magic formula. It's a puzzle that every day you have to go home a little defeated.

• 25:45Patrick O'Shaughnessy?

  With the benefit of a lot of perspective, and you and I have always talked about lots of different kinds of investing, what kind of alpha do you believe exists or can exist? And what kinds of alpha are you skeptical of?

• 25:57Speaker 02

  Well, the skeptical is easier. I just think information, right? That was massive alpha over time. So if you think about distressed, there was real alpha in knowing, understanding the process, the bankruptcy, chapter 11, the court proceedings, filings that had to be made, reading those filings. And then there's an osmosis that happens where there's some firms that are really good at it. Some people leave those firms, start their own firms. So understanding the process, that alpha gets dissipated. But then like reorg research comes out, which that just completely flattened the playing field. So the process of bankruptcy, I mean, yes, there's twists on it and turns on it. And you think about the same thing with long short equity. I don't really understand.

• 26:42Speaker 02

  How going quarter to quarter, is there any alpha anymore? I think there was alpha at some point. I think that informational edge in any market over time. Where is there alpha? I do believe there's alpha in time and I believe there's alpha in the permanence of your capital. Going back to Buffett, his big advantage is he had time and permanence of capital. I definitely think there's alpha there. I think there's alpha in understanding new technology, whether it's biotech or AI or blockchain. But then you always have to find a new, new thing. Doesn't persist. But being on the edge, there's definitely alpha.

• 27:20Patrick O'Shaughnessy?

  If you're advising, then I don't even know who to put in a hypothetical here. A student, someone that's interested in investing, a pension manager, like whoever, a lot of people invest. Is the right average advice, just put it in a Vanguard fund, do you think? Or should anyone, and if so, who endeavor to do more than that?

• 27:39Speaker 02

  I don't believe in passive income. I do think there's alpha, like you want to be a hustler, like, and you want to own real estate and be entrepreneur. And you can do it on the side or you have a buddy that you trust, that you can empower. I think there's a decent amount of alpha in small, medium businesses and being more efficient. I'm a big fan of Blackstone. I think many of the massive alternative asset managers have a tremendous amount of talent at them. I just happen to know a bunch of people at Blackstone better. And for their real estate funds, regardless of what we think about real estate, like we were talking about before, like I think they have the best network. They source better than anyone else. They understand all aspects of the market.

• 28:23Speaker 02

  They're seeing it on the private equity side, what real estate trends are, there's synergies there. If you had an allocation to Blackstone in real estate, that's a pretty good place to be.

• 28:33Patrick O'Shaughnessy?

  Speaking of alpha, what do you think of income share agreements?

• 28:36Speaker 02

  I'm a big fan of income sharing agreements. I do think that we hear every day, a problem with our economy is that we're over levered. Whether it's the public, private, the Western society, the whole world is over levered. I mean, you think about the Bitcoin maximalist, so much leverage, fiat. It really comes back to the fact that there is debt. If we had 0% debt to GDP. The Bitcoin maximalist wouldn't really have a great argument. If all the dollars were backed by gold, what would their argument be? So it comes to debt. So how do you finance a venture, a person, an entity without debt? Well, equity, that's the other side of it.

• 29:18Speaker 02

  So that's the way I view income sharing agreements is that if you're a person, has some talent or ambition or idea and you're willing to give up some percentage of your upside, it shouldn't be too much. It shouldn't be more than probably 10 or 15%. So it's not like you're like, I can't believe I'm working for somebody else. Then I think equity financing is a great way to capitalize a talented person. And what does the equity finance get them? Well, it gets them resources now that would enable them to best use their talents and get training, someone like an athlete, you get training, you get better nutrition,

• 30:02Speaker 02

  you get better sleep. If it's a YouTube personality, you get better microphones, you get better people working with you. If it's a DJ, you get a marketing firm, whatever it is, could be an engineer coming out of MIT. I just don't want any student loans. I don't want to think about that. I want a place to live. I want to help my parents out. I just want a peace of mind that I can perform better.

• 30:26Patrick O'Shaughnessy?

  Why do you think there aren't more of these? All that makes sense to me. And I think a lot of people, obviously, like the more capital there was here, the more efficiently priced stuff would get. The MIT CS grad or something would probably have a pretty nice nut that they could sell 10% of their.

• 30:42Speaker 02

  For 10 years, 20 years.

• 30:44Patrick O'Shaughnessy?

  So why isn't there more of this? It's an idea that's been bandied about quite a bit for five, six years now, but it doesn't seem like there's any critical mass. Why not?

• 30:53Speaker 02

  I think some of the areas it was first tried were the coding schools. And I don't think that was the right.

• 30:59Patrick O'Shaughnessy?

  Lambda, et cetera.

• 31:00Speaker 02

  Yeah, I don't think that was the right cohort of individuals. I think it's best first tried on like whatever the field is, the top 1% talent. Where you have the chance to have an outlier that really outperforms. So it could be computer science majors at MIT. And it could be minor league baseball players. Or it could be YouTube personalities that have hit certain metrics are already. And like, are they going to be the next Mr. Beast? I think investors need to see a chance for the 100X on some portion of the portfolio. And it's a capital market. It's a new market. So there's a demand for capital from the individuals.

• 31:44Speaker 02

  And the providers of capital, they haven't gotten return. I think all the deals that have been done have been not that great. And then there's also an education side to it. Whereas if I know Purdue University had Mitch Daniels was a big proponent of it. Maybe like the 18, 19, 20 year olds didn't really understand what they were signing up for. Not that they understand what they're signing up for when they're taking student loans. So I do think there's an education side of it. But starting with the outperformers, the real chance for the right tail risk is critical.

• 32:16Patrick O'Shaughnessy?

  If you think about right tail risk in investing organizations and you were backing, let's say you're investing money in a GP. And you got to like build the CIO like you would build like a Madden character or something. And you get 100 EQ points and 100 IQ points. Just generically, how would you allocate those? If you were trying to achieve most investment firm success?

• 32:39Speaker 02

  I'm assuming the IQ is like at certain level. Like if I give him 100 EQ points, he's not going to be a zero IQ.

• 32:45Patrick O'Shaughnessy?

  Yeah, let's say we start at the average, right? At 110 or whatever.

• 32:48Speaker 02

  I think it's more EQ than IQ. But I think the EQ, there has to be like a humble aspect of the EQ, which I think is a part of EQ is like knowing when to be humble. Being comfortable with hiring.

• 33:03Speaker 02

  People that may be much smarter than you, but you feel like you can still add to their experience. You can still help them. You can still help them achieve their maximal potential as investors. I think that's a big part of EQ, that coaching, managing aspects of a group of individuals, which, yeah, most of, whether it's a hedge fund or there's more IQ probably than EQ.

• 33:29Patrick O'Shaughnessy?

  Yeah. If you think about your reference class, like you happen to know a lot of the very successful, leading investors of the generation or whatever. Do you think that that's true? That those people on average have very high EQs?

• 33:42Speaker 02

  There's definitely exceptions. Some of the investors that I've met that don't necessarily have high EQs with respect to relating to others, they have a sense of calm where they're very capable of not being influenced by others, which might not be like great for a team. They might not give you great feedback, whether Soros said like his back hurt and he was to sell, like they're not afraid to like come in and sell everything or say no. If they don't have a really good EQ, they've got like a strong sense of their independence, which it's hard not to get influenced because, yeah, you're at an organization

• 34:25Speaker 02

  and like, even though it's like professional, don't take it personally, it's business. Everyone takes everything a little personally. If you're a PM and you have someone that you work with has done really good work and come with great ideas and I think that idea is stupid. It's hard to tell them all the time that you can either be really, really gifted as giving messages, which is high EQ, or you're like, I don't really care. And like, that's just the way I am.

• 34:52Patrick O'Shaughnessy?

  What do you think of with the current setup, the world of investing or capital markets careers?

• 34:59Patrick O'Shaughnessy?

  As something that really talented people should go and do. Do you think that right now is a good time? If you're a smart soon to be Duke grad or MIT grad or whatever it is to go into the field of capital markets? Or do you think that that talent should go into biotech or you know, somewhere else?

• 35:14Speaker 02

  It's easy for me to say like, oh, you shouldn't go in. You should try to make the world a better place. Somewhat self-serving. I think there's a tremendous amount of change. I think you have to go in wide open and be like, where's the change going to take place in the capital markets? I'm a big proponent of the blockchain. I have no prediction on the price of Bitcoin or Ethereum or any other. But I do think the blockchain will help solve some problems we have. It's hard to move money around the world. So global payment system is built on 40, 50 year old rails. And settlement risk and counterparty risk is real in every kind of, whether it's a listed market or over the counter market, where the blockchain can solve that problem as well. I'm not saying it's happening tomorrow.

• 35:56Speaker 02

  So I think if you're going into the capital markets, like how do you solve problems? The blockchain can help. What's AI going to do? Well, it's going to do a lot. So if you are thinking about how does AI change capital markets? How does it change investing? How's it change how capital gets allocated? What do debt structures look like? Does AI help on credit? Credit's hard. At some level, credit is all about belief. Do I believe I'm going to give you, I'm going to pay? Do you believe that I'll pay you back? There's ability to pay and willingness to pay. And we saw that during the subprime debacle is that if a creditor was like, you have the money. And the debtor was like, well, I don't need to pay you because I'm not getting kicked out of the house. The willingness to pay went way down.

• 36:41Speaker 02

  Even that with institutions, if you're a bad actor in the capital markets, it's harder to borrow money the next time. The companies or entities that pay back and are fair, they're more credit worthy. I guess it goes a little beyond numbers in a sense.

• 36:56Patrick O'Shaughnessy?

  If you were teaching like a college course or maybe a graduate level course on credit investing specifically, what would be like the most major sections that you think would be teachable and important to learn for someone that wanted to do that style of investing?

• 37:10Speaker 02

  The best credit analysts that I've seen really understand cash flow and can raise a flag like, wait, this doesn't make sense. Why doesn't EBITDA and cash flow tie out? Why is this explanation taking 17 different footnotes to follow? And why do I have to go around in a maze to see where the numbers are? I mean, I think accounting is really, really important. Then I think it's about optionality, which I think I'm very good at, is understanding optionality in the sense that asset values change over time. You have a capital structure today. You have a company that has $100 million of EBITDA and the market

• 37:49Speaker 02

  says it's worth 10x. And that's a billion dollar company. And some private credit firmals, they'll lend you five times. They'll lend you 50% loan to value. So you have 500 million of debt, 500 million of equity on a billion dollar company. Well, we all know like asset values change over time. What is causing those assets to go up or down? Your customers, the margins, the supply chain, cost of labor, there's all these different factors. And the great creditworthy companies or entities like the US government, what have you, they have a lower volatility. And like, understanding business and why do you have an 80% gross

• 38:30Speaker 02

  margin? And is that sustainable? And why do you have a 45% EBITDA margin? And is that sustainable? Why is the 15% EBITDA margin actually really sustainable? Well, there is a real moat there. Those questions and understanding volatility around the numbers, it's not static. It's always moving. And debt is forever. So everyone looks at like, oh, their credit where they borrowed money, they're rated. We know the rating agencies are behind. If you're waiting for a rating agency to tell you that it's a less credit, obviously in private credit, there's no ratings whatsoever. So you just always have to be paranoid as a credit investor. What can change? What can put me where I don't have that cushion where I'm actually now quitting?

• 39:11Patrick O'Shaughnessy?

  What about something similar, similar question around volatility specifically, given that's something, obviously, you've spent a crazy amount of time thinking about and working within. What do people underestimate about the power of volatility or not understand well enough about the power of volatility in capital markets?

• 39:27Speaker 02

  The lack of imagination. I mean, I read a quote one time hundreds of years ago, two polymaths were talking and they're like, oh, he can't be a mathematician because he doesn't have the imagination, which is kind of like, oh, but like, if you think about math, really, like, when you think about, like, and I'm not a mathematician, like, how did they come up with, how did they think of that? Who thought of zero, right? Like, that is crazy imagination to think about the concept, negative numbers, what have you, that we take for granted. And that's what I think about volatility is like imagination. I'm not saying anyone predicted the pandemic, but like, how quickly things can go upside down. Honestly, I'm not in the markets every day. I'm not using it as an excuse, but like,

• 40:08Speaker 02

  Silicon Valley Bank, it's kind of insane. They're a public company that is issuing quarterly earnings reports and the market saw the hole in the balance sheet. It was reported and no one was like, wait, why do you own $50 billion of 10-year notes? Why do you have unhedged interest rate risk of that size? Like, why don't you own three-year corporate bonds or like, short-dated CLO AAA tranches? No one questioned, and it didn't happen overnight. This happened, like, they were buying-

• 40:38Patrick O'Shaughnessy?

  Yeah, they didn't even have like a risk officer for like a year or something.

• 40:41Speaker 02

  I never thought, again, a financial institution would blow up because of interest rate risk. It's such a basic risk. It's like, you can do interest rate risk literally like with a pen and paper. Patrick, how many 10-years you have? I've got 50 billion. You don't have that much equity, Patrick. Like, you're like, negative equity because of these, yeah, it's fine. You know, like, it just seems absurd that that happened. And it's like, somewhat lack of imagination. And not to be a doomsayer, because really good things happen. I'm always in awe of great growth investors that have the imagination. Not that, you know, I was believing that we're going to have Tesla, full automation of taxis and everything like that, but like, SpaceX is pretty amazing. Like, if you think about like- If you said to me 10 years ago, yeah, there's this guy.

• 41:25Speaker 02

  He's working on this thing, electric cars. You're like, oh, electric cars. That makes sense. And then he's going to do this other like space company and that's going to be bigger. What are you talking about? So I do think having imagination in investing is key. That's how you really understand volatility.

• 41:42Patrick O'Shaughnessy?

  Is there anything you ever did to stretch your own imagination effectively?

• 41:47Speaker 02

  What I tried to do is the narrative is becoming more powerful. You've tapped into that just in all your podcasts, but there's assumed narratives that are out everywhere. I think as a society, probably we're getting better at really exploring narratives and be like, is this really what we want as a society? But in the financial landscape, there's so many assumed narratives. So I do think like exploring, what does everyone believe? And why is that true? Like it's a little Byron Katie that we were talking about before. It's like trying to understand what is the nature of a triple A rating? What does that really mean? It's never going to default or could this possibly ever default? Yeah, yeah, it could. And has triple A's defaulted? Actually, yeah, they have defaulted.

• 42:32Speaker 02

  Mutual funds, I never knew that a mutual fund could gate. 2008 hedge fund gated, tons of hedge fund put gates up. Wow, that's kind of scary as an LP, like they can just put your gate up. Funds are putting gates up now. There's some funds. I never thought about mutual funds putting gates up, but now it like not consumes me, but like this is going to happen again. I mean, I thought during the pandemic, you had no trading in corporate bonds happening, spreads widening every day. The search for yields, some of the big Vanguard, PIMCO, and I'm not picking on them. Like they became proxy like money market funds. You were getting zero in a money market fund as a retiree. You're like, I need some income. So you buy an investment grade fund or crossover fund.

• 43:14Speaker 02

  And that was effectively your money market fund, but there was no trading. You think about a money market fund. Mike Green talks about this binary of like index funds. When they get money, they buy, when they get redemptions, they sell like it's zero, one. You get a bunch of redemptions and you can't sell any bonds because the market isn't open. What do you do as a mutual fund? You put a gate up. I don't think that most investors realize, most mutual fund investors realize they're subject to a gate. It's an open ended fund. They think that they have one or two day liquidity. And if they put their notice in, they'll get their money back.

• 43:47Patrick O'Shaughnessy?

  Yeah, it's interesting to go down the line and try to think of the beliefs that are most deeply entrenched or held and consider the opposite of those things. It seems like a really worthwhile exercise for literally everyone in any kind of asset class.

• 43:59Speaker 02

  Even if your money's in the bank.

• 44:01Patrick O'Shaughnessy?

  Everyone just went through this.

• 44:02Speaker 02

  Yeah.

• 44:02Patrick O'Shaughnessy?

  It's like, wait a minute.

• 44:04Speaker 02

  How many people actually understood the FDIC insurance? I don't want to be like, oh, I mean, $250,000 is a lot of money. So it's like, most people, it's like, not an issue, whatever. You get these young founders, oh, my gosh, I just raised $10 million from my Series A and like, I'm top of the world and I put it in the bank because I'm like 24 years old and like, I don't, I don't want to.

• 44:25Patrick O'Shaughnessy?

  I'm not thinking about that.

• 44:25Speaker 02

  I want it in a safe bank. Everyone's telling me like, this is a great bank, put it in that bank, Silicon Valley Bank. And you're like, wait, I have to deal with the fact that I'm a creditor to this bank? I mean, it didn't happen, but like, that's crazy. There's just so many assumptions. But yeah, there's narratives that everyone believes. I think thinking about just the narratives and sometimes it's who's a good investor? Who's a bad investor? And what's a good investment? What's a bad investment? But then there's the structural. Lastly, I mean, I do think Silicon Valley Bank gets back to this, but there's always asset liability mismatches.

• 44:55Patrick O'Shaughnessy?

  Say a bit more about that, just like the nature of that concept.

• 44:58Speaker 02

  Well, the road to hell is paved with positive carry. So if you invest long and borrow short, usually there's positive carry. Like right now in the treasury curve, it's inverted, but most yield curves are positively slow. I mean, you think about all the blowups over time, a lot of hedge fund blowups, long-term capital, whatever, they're levered 30 to one, like, how come they blow up? Because their leverage is overnight leverage and they have longer dated assets, the assets get marked down and their margin gets pulled and they have to sell everything. That's happened.

• 45:30Patrick O'Shaughnessy?

  Time and again.

• 45:30Speaker 02

  Yeah. MF Global, it happened. I mean, that's what happened in Silicon Valley Bank. They had 10-year notes that got marked down and their liabilities to deposits were overnight deposits. They all left and they went out of business. Private credit funds. My point with the private credit funds, there is an asset liability mismatch. A lot of these funds have leverage. The leverage is to some big banks that are sophisticated. And I'm not saying that there hasn't been any diligence done. There's been diligence done, but they have lent money. Their assets are long dated loans and they do not match the financing lines that they have with the banks. So if those lines have to be paid back, they're going to be forced to sell assets to pay those back. And that's where the asset liability mismatch comes in.

• 46:14Speaker 02

  I mean, a mutual fund has an asset liability mismatch. They're giving out one day liquidity and they might have assets that might take more than one day to sell. That's a mismatch.

• 46:24Patrick O'Shaughnessy?

  I guess in this case, the positive carry thing, it's just always going to be that way because the natural slope of the curve is what it is. That's probably going to always last. So you just want to be mindful of.

• 46:33Speaker 02

  Yes, you want to be.

• 46:35Patrick O'Shaughnessy?

  Breakdowns.

• 46:35Speaker 02

  Like, how is an investor, you're getting back to your alpha. Like, where is the alpha coming from? And is it a time alpha? Is it an informational edge? Is it a liquidity? I mean, there is, you can get alpha in liquidity. But if the alpha is coming from an asset liability mismatch, they can work for a long.

• 46:51Patrick O'Shaughnessy?

  Long time.

• 46:52Speaker 02

  Long, long time. I'm not saying they're all terrible. Depends how much leverage. If private credit, if defaults don't come in, let's just say Q1 was an outlier and we don't hit a recession and defaults drop off. Then maybe the private credit funds will never have to deal with it.

• 47:08Patrick O'Shaughnessy?

  Do you think it's fair to say that most people and the natural inclination is to be short volatility?

• 47:14Speaker 02

  Oh, yeah. I mean, short volatility is positive carry. Honestly, when you say someone wins the lottery, even though a lot of people that win lottery end up spending all the money. If you've been a financial advisor, one of your clients came in and said, I just won a billion dollars. You'd be like, well, you should take X percentage of it and put it in T bills. You have carry. T bills are 90 days, whatever, but like a little bit short volatility that the federal government is going to keep rolling instead. Anytime you're lending money, you're short vol. I mean, it comes back to the nature of if I'm lending money as a private credit fund, as a bank, as an individual. I just don't want the assets to go down of that entity. So I. I want everything to stay where it is.

• 47:58Speaker 02

  If I'm lending money and I have 50% loan to value, I have a 50% equity cushion. It can go down a little bit and I'm fine. But I don't want volatility. I don't really care if it goes up. That's the thing, you know, asset volatility, it can go up. All of a sudden, a billion dollar company is worth 2 billion and you've only lent 500 million. Oh, that's great. As a lender, if you had to choose, would you want volatility or no volatility? Not knowing which kind of volatility you're going to get, upside or downside. You're like, I want no volatility. I don't get benefit of the upside.

• 48:27Patrick O'Shaughnessy?

  How do you think about incorporating long vol in your portfolio or in your life? You said earlier, the key to vol is imagination. So many of the amazing things in life happen outside, maybe the bounds of what we would expect or think are possible. So how do you think about incorporating the concept of more long volatility exposure? Just in general, both financially and otherwise.

• 48:51Speaker 02

  I worked with an options trader and this was like talking about listed options. He's like, you should never sell an option that was less than 10 basis points. He was just like, that's too out of the money. You don't want to be short that option. But if you reverse that and you're like, is there possible to buy 1,001 options? 1,001 payout, 5,000, 10,000? Yeah, I mean, in our lifetime, I haven't hit on any personally. I don't know if you have. I've seen a ton that have happened. Whatever you think about Bitcoin, it was public for many years where you could be up 10,000 times your money. And a bunch of other crypto. I think that's one of the reasons that Tesla has such a fandom is that there are so many people,

• 49:33Speaker 02

  probably more than any other stock, where people have made 50, 100 times their money. Elon can do no wrong. So thinking about how is the market pricing the probability? And I think once you get beyond that 100 to 1, 200 to 1 realm, it becomes really inefficient.

• 49:52Patrick O'Shaughnessy?

  The pricing of the options are inefficient in your favor to be long of all.

• 49:55Speaker 02

  You should definitely not be short those. It's silly to be short those if you can find them. And I'm not saying you should just go out and try to buy 5,001 options, but.

• 50:03Patrick O'Shaughnessy?

  You're saying it's mispriced.

• 50:05Speaker 02

  I'm just saying like, yeah, as you get to the bounds of listed options, I see more and more mispricings as opposed to like at the money options. So that just tells me that like, it's really, really hard. The log normal curve doesn't work. Yeah. Option pricing, thinking about movements makes sense. When the outlier happens, the 10 standard deviation move, the 15 that we're never supposed to see, and we see them all the time. Then it's interesting to think about. Is there a pond that might have a bunch of those options in it?

• 50:35Patrick O'Shaughnessy?

  Stop me if I'm stretching here, but do you think this same concept applies outside of finance and markets?

• 50:40Speaker 02

  Yeah. Well, think about like just finding a spouse or partner. There's so many people that you could be compatible with and you find someone, they're a great person, a lot of alignment. But there just isn't that one spark where you're like, you know what? This is a great partner that this person checks so many boxes, but like, there's not that one spark. But then you find that person that checks all the boxes and has that like one spark. You see people that find those people and they're like, wow, I didn't know that was possible. The right combinations of people and organizations. I'm a huge believer in synergy when it comes to relationships and that's optionality to me in a sense.

• 51:23Patrick O'Shaughnessy?

  Explain that a little bit more, the idea of synergy and relationships, what exactly you mean by that?

• 51:28Speaker 02

  Well, can I use a basketball?

• 51:30Patrick O'Shaughnessy?

  Of course, let's do it. Familiar ground for both of us.

• 51:32Speaker 02

  Yes. I'm a big Duke Coops fan and I think J.J. Reddick, he's controversial, whatever. I understand why people don't like.

• 51:40Patrick O'Shaughnessy?

  Great podcaster.

• 51:40Speaker 02

  Yeah, he's a great podcaster. He's really insightful. He's a bright guy. And he made a point about the Celtics team. He's like, yeah, Jalen Brown and Tatum, Jason Tatum, who's a Duke guy and I'm a fan of. They're too much of the same player. So they aren't synergistic in a sense, you can't get mismatches. You do a pick and roll with those two, doesn't matter. Whereas if you do a pick and roll with Jamil Murray and the Joker, now you've got two mismatches.

• 52:07Patrick O'Shaughnessy?

  Chaos, yeah.

• 52:08Speaker 02

  Yeah, it's total chaos. So it's like, if you and I have the same talents and we get along and we're compatible, I don't know if we have synergy, though. Do I make you better? Do you make me better? That's, I mean, I guess the synergistic effect, having the right combo. You can't have all leaders and you can't have all introverts. I mean, it's gotta be some mixture.

• 52:29Patrick O'Shaughnessy?

  Yeah, I love that idea. I think of the Joker and Jamal Murray as the paradigm you want to go after for sure. Say a bit about goal orientation as a concept in investing, where I think in investing, it's especially in liquid securities or something, where there's less salesmanship, you can just press buttons to buy and sell. We think of this like incredibly like intellectual pursuit. You're just reading and studying and thinking all day. At least as I saw, it was less about goals. It's less about like an operating business where you're setting up things you want to accomplish and then knocking them down. What role do you think goals play, if any, in a successful investing career or process?

• 53:07Speaker 02

  I was more of the mindset, it was like more of the infinite game. Graham Duncan likes to talk about. That was my mindset. Unsolvable puzzle that you toil that every day and you made some headwinds. And if you kept your process right and your disciplines, you were going to get some nuggets that were fulfilling and there would be some alpha there. Like you were kind of mining for alpha in a sense. It's hard to set goals with respect to like every day, I want to get this much alpha or what have you. Yeah, it's like fits and starts and you're on the right path. But there is a process of understanding when to cut bait and this isn't a good idea. This isn't a good position and let's press here. So I do feel like it's more the infinite game.

• 53:52Speaker 02

  I do feel like, I would say, some of the hedge fund investing is a little different than the other alternative asset classes, where it is more how much can we manage and how big can we make this? And that may work. Again, going back to the Blackstone and their real estate business, I feel like they've shot the moon using Game of Hearts analogy. Like, I feel like they do, they have all the cards, they see everything. Their flow is better than everyone else's and like they've got a good sense.

• 54:21Patrick O'Shaughnessy?

  Scale is okay. It's okay.

• 54:22Speaker 02

  Scale is good. Yeah, scale is good. But when it comes to private credit, I don't know if that's right. I think you might be reaching a bit and justifying lending at top of cycles to, again, companies that don't have the hardest numbers. And why are you making this loan? Well, because we need to raise the money to be the number one player. We want these GPs to come to us first. That's where I think goals can get in the way a bit.

• 54:51Patrick O'Shaughnessy?

  Have you learned any other interesting lessons from, I guess, sports is where my mind goes, basketball even more specifically, about teamwork or performance from having spent so much time watching and studying sports?

• 55:05Speaker 02

  With respect to sports, I think the fact that the competition is always so fierce. I mean, if you think about, let's just go, it doesn't matter. I mean, NBA or NFL, the staffing, how come the staffs keep getting bigger and bigger? You watch a NBA game, there's like 15 guys that are coaches now. I think in 1979, the NBA went to like free coaches or something. And the NFL is the same, literally because it's the game within the game. There is just the little nuance of where do you get the advantage? I mean, remembering Bill Belichick wanted a left footed punter because the ball spun the opposite way. And it's a kind of an experiment where like everyone is playing by the same rules, same cap, same schedules.

• 55:50Speaker 02

  How do you get an advantage? That's where I do feel like the best, as far as investment management, those firms never took for granted their lead. And if you see it in sports, why were the Pittsburgh Steelers a dominant franchise? Well, they were the first ones to really scout historically black colleges. They crushed it there. Billy Bean, obviously everyone knows, but like there's always some alpha that they're mining, it feels like, to get to a better result in what should be like a 50, everyone should be 500 in a sense. So I do think, yeah, in investment management, like the firms that have always pushed the limits of like what makes sense and let's experiment.

• 56:33Speaker 02

  I mean, I think Jeff Bezos was thinking about his analogy. I'm saying, hey, you can wait for your fat pitch, but the difference between baseball and business is that in baseball, you can always hit a grand slam. Here you can hit a 10,000 run.

• 56:47Patrick O'Shaughnessy?

  Right.

• 56:47Speaker 02

  Home run, right? Which is like imagination and volatility.

• 56:50Patrick O'Shaughnessy?

  Yeah, it's incredible to think about. I actually don't know the answer to this question. I saw that I noticed this the other night at the Warriors game. It literally is like 15 guys with the same like gear on or whatever. It makes the seating all weird because the players end up sitting like further down. And it's all this block of coaches. What are those guys doing?

• 57:08Speaker 02

  They all have a shooting coach. Now there's like a big man shooting coach and a three pointer guy and like there's multiple shooting coaches. Trainers that are just biomechanics, making sure everyone's loose. I mean, they all have the equivalent of offensive and defensive coordinators, plus the game management coach that just, hey, timeouts, fouls. How many fouls we can give? Again, then the position coaches. Yeah, there's just so many. At the margin, if you think about it, the Warriors, I don't know, it's worth $6 billion. NBA teams are 10x in the last 10, 15 years. At the margin, like, should you be paying a guy 300 grand as an extra coach? Yeah, like, why not?

• 57:47Patrick O'Shaughnessy?

  Yeah, yeah. Yeah, it's an amazing thing to watch and consider. I love the idea of like the game within the game. And I think it's a really clean analogy to investing. You dig in on some of these amazing investors and the degree to which they'll go to learn more, understand better.

• 58:01Speaker 02

  I mean, Ken Griffin.

• 58:02Patrick O'Shaughnessy?

  That place is unbelievable. If you dig in there, like, you kind of can't believe what you find.

• 58:06Speaker 02

  He takes nothing for granted. He made no assumptions. If you said that to anyone at Goldman Sachs, there's going to be a hedge fund that is going to start a securities business and dominate equity trading and equity options and make $7 billion in a year doing it. And it's going to be private. They'd be like, what are you talking about? That's like so silly. And he did it.

• 58:30Patrick O'Shaughnessy?

  Imagination is the key recurring thing here.

• 58:33Speaker 02

  I've only met him once and his imagination was definitely striking. And rarely does like the first thing you notice about someone about like their imagination.

• 58:44Patrick O'Shaughnessy?

  Well, I think it's a great place to wind down the conversation, the notion of thinking about imagination in everything, mispriced options everywhere is just a powerful, wonderful thing because of what could be possible. I ask everyone that I interview the same traditional closing question. What's the kindest thing that anyone's ever done for you?

• 59:01Speaker 02

  I mean, it's kind of cliche. It's my parents. I went to a college and they were like middle class and economics never came up. They're like, do whatever you have to do. They did that with my brother and sister and they just always had belief in us. That unconditional support is the kindest thing.

• 59:21Patrick O'Shaughnessy?

  Wonderful. Kieran, I always so enjoy our conversations. Thanks for your time. If you enjoyed this episode, check out joincolossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.