Kieran Goodwin - Imagination, Volatility, and the Pursuit of Alpha

Key Takeaways

1. The State and Future of Private Credit: Private credit has seen a massive growth from a cottage industry around the time of the financial crisis to a significant player in the financial markets. Key drivers include the search for yield in a near-zero interest rate environment and regulations preventing banks from lending to companies with more than 6x EBITDA. The growth saw private credit assets move from $250 billion in 2010 to $1.4 trillion. However, as rates rise, many loans made at 5.5%-6% interest have effectively become 11% interest loans, leading to potential stress and defaults in the market, especially in the sub-$100 million EBITDA space. The expectation is for a shakeout in the market with larger players benefiting from the consolidation.
2. Venture Capital Landscape and Potential Consolidation: Venture capital, similar to private credit, has seen a proliferation of smaller firms since the financial crisis. The barrier to entry in venture capital is relatively low compared to other alternative assets. However, the reality is that many institutional allocators are realizing that a significant portion of their returns in venture come from a very small subset of their managers. This might lead to a natural consolidation in the venture capital space
3. Role of Emotional Intelligence (EQ) in Investing: Kieran suggests that EQ, particularly humility and the ability to manage teams, plays a crucial role in an investor's success. While a certain baseline IQ is essential, the ability to relate to others, stay calm under pressure, and maintain independence in decision-making can differentiate top-tier investors.
4. Importance of Understanding Volatility in Credit Analysis: Successful credit analysts possess a deep comprehension of cash flow and the ability to identify inconsistencies in financial statements. In private credit, there are no ratings, which necessitates a heightened sense of scrutiny and awareness of potential changes that could impact the loan's security.
5. Asset-Liability Mismatch and the Dangers of Short Volatility: Asset-liability mismatches have been a consistent issue in financial history. If a firm borrows short-term but invests long-term (with positive carry), it can lead to substantial risks if asset values decline or if there's a sudden need for liquidity.Being "short volatility" implies that one is essentially betting against significant changes in the market. While this position may offer positive carry (or a consistent return), it exposes the investor to sudden and drastic market changes. This is evident in the case of firms like Silicon Valley Bank, which faced challenges due to mismatches in their assets and liabilities.
6. Imagination is Key in Investing and Business: As exemplified by Ken Griffin's success with Citadel or the rise of Tesla and SpaceX, it's essential to envision scenarios outside of conventional thinking. A hedge fund starting a securities business and making $7 billion annually seemed far-fetched, it became a reality. The mispricing of such extreme outliers, or 'long-tail' events, can be a source of significant alpha if properly capitalized upon (that’s the VC game).
7. Understanding the Game within the Game (the Meta-Game): Both in sports and investing, it's the intricate details and strategies that separate the best from the rest. The rise in the number of coaching staff in NBA teams, from 3 in 1979 to around 15 in the present day, underscores the increasing focus on the minutiae, such as biomechanics, shooting techniques, and game management.

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