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What's the Alternative? | Episode 29| Beyond the Bank: Private Credit Confidential with Mario Valente
17 Plays4 hours ago
In this episode of "What's the Alternative," host Shana Sissel sits down with Mario Valente, Portfolio Manager and Deputy Chief Investment Officer at Stansberry Asset Management, to explore the evolving landscape of private credit. Together, they discuss how this asset class has grown significantly since the financial crisis, filling the capital void left by traditional banks. Unlike public credit, private credit offers unique challenges and opportunities, emphasizing the critical importance of manager selection and thorough due diligence.
Mario shares insights on the diverse market of private credit, from senior secured loans to niche sectors like B2B SaaS and innovative healthcare. He highlights how effective management can enhance returns through careful loan structuring and why selecting niche managers with operational expertise is essential. Additionally, the conversation addresses how interest rates impact private credit, with managers leveraging their unique positions to maintain stable returns regardless of market fluctuations.
Key Takeaways:
- Growth of Private Credit: This asset class has become an essential capital provider, particularly for markets often overlooked by traditional banks.
- Crucial Manager Selection: Choosing the right managers with relevant expertise is vital for successful investments in private credit.
- Interest Rate Resilience: Private credit can offer stability and consistent returns, even amidst changing interest rates.
- Niche Market Opportunities: Targeting specific sectors can lead to diverse and lucrative investment strategies.
Join us for this insightful discussion and subscribe to our podcast for more expert insights!
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Transcript
Fraud Issues and Industry Debate
00:00:00
Speaker
I know what's been dominating the headlines under the private credit umbrella has been some of these recent blowups in the space. For example, Tricolor and First Brands.
00:00:12
Speaker
I think what you've had happen there is you've had some fraud issues at both firms. You've had collateralization, or in other words, the same assets being collateralized more than once, which is obviously fraud. And a lot of high high profile lenders have been caught up or ensnared in those bankruptcies. I would argue that, number one, I don't know if I'd necessarily um say it's private credit.
00:00:39
Speaker
And I say that because a lot of the the cap structures within Tricolor and First Brands were actually broadly syndicated loans that falls under the commercial banking.
00:00:51
Speaker
landscape and not necessarily private credit. So I would argue, number one, I don't know if this falls under the private credit landscape. I know the media has branded it that way, but I think we can have a separate conversation about that, whether it is in fact private credit.
Introduction of Mario Valente
00:01:13
Speaker
Hello everyone and welcome to What the Alternative, the show that dives deep into the weeds of alternative investments with the experts of the space.
00:01:26
Speaker
Today we have Mario Valente with us. He is a portfolio manager and the deputy chief investment officer at Stansbury Asset Management. recently added asset manager to the Bondrian platform. We're excited to have them. He is responsible for sourcing and monitoring positions across all of the firm's strategies while serving as the principal spokesperson for the team on the investment philosophy of the firm. Prior to joining SAM in 2018, Mario was the director of investment grade research at Zazovey Associates, a multi-billion dollar investment firm specializing in convertible securities. He started his career with Citadel here in Chicago, where he was the first credit research analyst hired on the convertible arbitrage team. Mario holds a BA from Stanford, where he majored in economics. He's also a CFA as of 2011 and serves on the board of the CFA Society of San Francisco. We're very excited to have Mario here because private credit is all the rage. It's all the news. And I think... We're going to be able to dive deep into that because the background of the offering that Stansbury has with Bonrien is related to private credit on the fund of fund levels. So welcome, Mario. Thank you for being here.
00:02:45
Speaker
Thank you for having me, Shana. Really looking forward to this conversation
Private Credit Developments and Media Mislabeling
00:02:49
Speaker
today. Well, I think we'll just dive right in. Every time I watch CNBC these days, the commentators are talking about Private credit and the latest developments in private credit. This has been really eventful year in the space. There's been lots of different structures and opportunities for private credit investors and more and more broadly being offered to the average everyday Main Street investor.
00:03:16
Speaker
and And there's points and cons to that. So let's start there. like Let's talk about some of the developments this year that have happened and how you kind of view them as it pertains to the broader private credit landscape.
00:03:30
Speaker
Perfect. So that's that's a great talking point to kind of start this conversation. So I know what's been dominating the headlines, at least kind of under the private credit umbrella has been some of these recent blowups in the space. For example, Tricolor and First Brands.
00:03:48
Speaker
I think what you've had what you've had happen there is you've had some fraud issues at both firms. You've had collateralization, or in other words, the same assets being collateralized more than once, which is obviously fraud.
00:04:04
Speaker
And a lot of high-profile lenders have been caught up or ensnared in that, in those bankruptcies. I would argue that, I guess, number one, I don't know if I'd necessarily um say it's private credit.
00:04:18
Speaker
And I say that because a lot of the debt, the cap structures within tricolor and first brands were actually broadly syndicated loans that falls under the commercial banking landscape and not necessarily private credit. So I guess I would argue, number one, I don't know if it's necessarily, if this falls under the private credit landscape. I know the media has kind of branded it that way, but I think we could have a separate conversation about that, whether it is in fact private credit.
00:04:46
Speaker
But number two, I think also the fraud that existed at both tricolor and first brands existed at such a widespread level that arguably you know it ensnared a lot of people And I think what you're seeing there, I would think are, it's not necessarily reflection of the economy turning south.
00:05:10
Speaker
or operationally businesses just going under, it was really just just rampant fraud that I think is is one time or unique in nature. And I think isn't necessarily what you see across kind of the credit landscape on a normalized level. I think the other- I was to say, I think what you're speaking to is the difference between private credit and non-traditional lending.
00:05:35
Speaker
And those two things often get confused. And yes I'm sure we'll dive further into that. But I think you're pointing out something really important, which is that oftentimes in an environment where saying private credit is like hot and sexy, things are getting thrown into private credit that aren't actually private credit. This is non-traditional lending, which is not the same as private credit.
00:06:00
Speaker
i That's exactly That's exactly it. that's exactly it But you know the fact that the like the media labels it as private the credit, obviously sells newspapers, sells headlines, makes it sexier, but I think probably isn't necessarily deserving of being under the private credit moniker.
Market Concerns and Structure Impact
00:06:19
Speaker
Another kind of dynamic that we've been observing in the credit landscape that kind of falls under this private credit umbrella as well is what's been going on with business development corporations or BDCs, right? BDCs, just very simply, 30-second primer, are these publicly traded vehicles, right, that either are fall under ARIES,
00:06:41
Speaker
or Blue Owl, for example, or other kind of large private credit managers where you have these liquid publicly traded vehicles that make private credit loans across a number of different verticals.
00:06:56
Speaker
Okay. And in the last three, four or five months, what's been interesting is that a lot of these BDC equities have have traded significantly down such that they're trading at five, 10, 15, 20, 25% discounts of their NAV, right? Which is pretty pretty unusual in terms of trading behavior. And so I think what the market is saying is the market is concerned about the types of loans that exist within these publicly traded vehicles, right? And rather than wait for the bad news, the market is selling first
00:07:31
Speaker
and asking questions later, right? And in some instances, some of that downward pressure in the equities is warranted. So for example, you might some of these BDCs, you're seeing kind of an uptick in PIC issuance, where loans are the paid in kind feature is triggered on some of the loan the loan packages that these companies make versus the cash pay, right? And that's obviously a red flag.
00:07:56
Speaker
But for ah for a lot of these other BDCs, you're not really seeing that, right? You're seeing loss rates remain steady. you're saying You're seeing pick rates remain steady. And so as a result, a lot of these BDC equities, I would argue, are trading extremely cheap.
00:08:11
Speaker
So that's another kind of dynamic that we've been observing in the landscape as well. Well, I think that speaks to a really important aspect of something that has become more and more common, which is the structure at which you gain access to private credit matters.
00:08:26
Speaker
I have never been a fan of BDCs because at the end of the day, they are equity beta. even if the underlying investments within them are not equity in and the same way that a bank with a lending book is still a bank equity. And the value of a BDC comes from the revenues and the cash flows of whatever the underlying business is.
00:08:49
Speaker
In this case, the underlying business is the loans. And it isn't necessarily ever going to reflect the NAV or the value of the loans per se, because it's taking into account a number of other factors that are related to the business that is the framework for which the loans are purchased or our packaged. right so That is something that you also see sometimes in closed-end funds, like traditional closed-end funds, where they trade based on the bid-ask spread and not necessarily the value of the underlying investments within them, which is how you end up with closed-end fund arbitrage because the value of the NAV versus the value of the actual the value of the closing fund shares can be changed more by the demand and the spread of purchasing and not necessarily the value of of the underlying securities. But then you have structures where and all of the value of the shares is based on the underlying mutual funds fall into this bucket.
00:09:51
Speaker
um Interval funds fall into this bucket and any kind of like LP fund or anything like what you're doing is based on the value because you own the assets, right? If you buy a BDC, you own the BDC. You don't own the loans in the BDC. If you buy a fund, you own part of the loans.
00:10:08
Speaker
You are a shareholder in the loans. shareholder, you own a fractional interest. That's the whole point, right? So maybe that's a great segue into talking about why structure matters when you're gaining exposure to private
Manager Selection and Due Diligence
00:10:22
Speaker
credit. And more importantly, as a fund of fund manager, where you're evaluating all the different ways that you can gain access to private credit. It also speaks to the importance of the due diligence that occurs by your team when evaluating these opportunities. Why don't we dive a little bit into what that looks like when you look at the landscape of potential investment opportunities?
00:10:43
Speaker
I wholeheartedly agree. I think structure definitely matters, right? Whether you opt to enter the space through a publicly traded vehicle like a BDC or become an LP in a private vehicle.
00:10:55
Speaker
What it boils down to in our minds is manager selection. Right. And making sure that you're conducting adequate due diligence on the managers before making your requisite investment.
00:11:07
Speaker
Right. And that's hard. It's not easy. Right. it It involves a lot of rolling up your sleeves, going into the data rooms, understanding how these managers have generated performance in fund one, fund two, fund three on a both s gross basis.
00:11:22
Speaker
in net basis, understanding how how they pay themselves, understanding their incentive structures, et cetera. And then also peeling back the onion from our perspective and really understanding, are these loss rates that they're marketing, are they real?
00:11:38
Speaker
right so like For example, we'll be talking to a particular manager, they may say over the last three funds, their loss rates have been an aggregate of less than 10 basis points. Okay, that sounds great. That sounds amazing. right As a credit investor, I love that where loss rates are close to zero, but let's peel back the onion and figure out whether or not that in fact is we agree with that number.
00:12:01
Speaker
Right. And you'd be surprised that sometimes I don't want to say there's a fudging necessarily, but we may come to a disagreement. on how, on how those calculations are ultimately arrived at.
00:12:12
Speaker
And so when, when it, when we ultimately choose our managers for our fund to fund vehicles, those are the ones where they've gone through a very rigorous vetting process where we may have started with kind of a manager's universe of probably 25, 30 managers. And we've distilled that to about five or six, right after months and months of due diligence. Right.
Expansion of Private Credit Post-Crisis
00:12:37
Speaker
I think people forget this because private credit has become such a massive asset class.
00:12:42
Speaker
Most people don't really register that the asset class didn't really come to where it is today until after the financial crisis. And did private credit exist before the financial crisis? Absolutely. Was it as pervasive as it is today and as large of an asset class? Absolutely not. It was more of a bridge loan, mezzanine debt kind of thing being done by private equity as ways to... capture other debt opportunities with private companies or or distressed securities in some way, shape or form.
00:13:12
Speaker
Private credit as it stands today is very different. It's kind of something that came out of and was birthed by the financial crisis because bank lending became less available and less substantial than it did prior to the financial crisis because of changes that were made to the banking system. I don't know that people appreciate that that no matter how large the opportunity set is, right?
00:13:39
Speaker
It doesn't change the fact that private credit doesn't, right it has a third party pricing mechanism. There's no standardization of how this price is or a market in which is used as the standard way to decide what the value of a security is.
00:13:56
Speaker
Whereas in the public markets, there is a standardization. There is a very clear, um, calculation that's done, that's mandated by the regulatory authorities, the banking system, whatever. But there's a math problem, and it's the same exact formula for everybody participating.
00:14:14
Speaker
Whereas in private credit, it's not. And again, that gets to diligence, right? You need to understand like how each firm decides how they're going to do their pricing, when they're going to do their pricing, what their comparison is and comparables. Mm-hmm.
00:14:28
Speaker
And so can you speak a little bit about that nuance and how that can really drive returns in these products that may or may not be real in the same way it happens in private equity as well?
00:14:40
Speaker
Right, right. that That's a great point. I think, you know, for us, obviously pricing mechanism and pricing avenues matter, especially as you're talking about these esoteric investment vehicles that there may own there may not be any bids, right, for these particular securities. But as we think about manager selection, another thing that comes to mind, and this is kind of at the forefront for us as we think about the managers that we ultimately select for our fund-to-fund vehicles, is to what extent do these managers have expertise in the verticals that they're lending to?
00:15:17
Speaker
Right. And I would say in almost all cases, the managers that we've selected, the C-suite, the CIOs at these managers in their prior lives were operators in the very same verticals of the businesses that they're lending to.
00:15:33
Speaker
That gives us great confidence that and because we're lenders and we're credit investors, what's top of mind for us is return of principal. Right.
00:15:43
Speaker
Capital. Right. Yeah. It's nice if we could see equity like returns, but that's almost secondary to the return of capital dynamic. Sure. Right. And that return on capital dynamic is reinforced by understanding whether or not the CIO at the manager really has an understanding of how to evaluate the credit worthiness of the software company that they're lending to the medical device company that they're lending to, right? And we tend to shy away from generalists, right? From managers who don't necessarily have the requisite expertise to understanding the verticals that they're lending to.
00:16:22
Speaker
And I think that's what kind of gives us our particular edge as we filter down ultimately the managers that we've selected for our fun-to-fun vehicles.
00:16:33
Speaker
So let's talk about private credit as an asset class. um In the same way that traditional public credit has all different types of credits underneath there, right? You've got your floating eight bank loans, which sounds like we were kind of talking about in the beginning. We have our traditional issuance of fixed income bonds with extended durations. um And you have your investment grade, your non-investment grade, you have mortgage-backed, asset-backed securities, so on and so forth What does that landscape look for in private credit? What are the different nuances there?
Private Credit Structures and Interest Rate Impact
00:17:10
Speaker
So just like that, right? You see, you have different managers that either kind of focus on the top of the capital structure. So first lien, see your secured debt. And by the way, that is a space where we operate, right? As when we formulate our managers for our fund to fund vehicles, that's really the only part of the capital structure that we want exposure to.
00:17:32
Speaker
Now, below that, there are managers that focus on preferred lending, second lien loans, et cetera, junior equity. And as you kind of move down the cap structure, right, there's more risk, more reward.
00:17:46
Speaker
Those are not the types of managers that we focus on, right? We think we have a better understanding of how managers in the senior secure space make loans.
00:17:57
Speaker
And again, like I said, return of capital is paramount for us, right? And we feel like return of capital is more likely to occur when our managers invest at the senior secure level.
00:18:08
Speaker
So all of our managers that we've selected in our fund-to-fund vehicles, that's all they focus on. But at the same time, you have managers that invest at the senior security level that have the requisite vertical expertise and the companies that they lend to.
00:18:23
Speaker
And then on top of that, they structure pretty unique loan packages where there is some form of of equity upside, typically in the form of of participation of warrants. Right. And so that that can add pretty meaningfully right to a cash coupon loan package where you may have 10 or 11 percent.
00:18:42
Speaker
But in an instance where you have portfolio companies that may do a second round of financing in 18 or 24 months, you may have a portfolio company that's probably acquired by their equity sponsor.
00:18:54
Speaker
Right. That provides an opportunity for those warrants to go in the money. and add meaningfully to total return at the end of the day. sure Right. So, so though that's the kind of flavor, those are the managers that we tend to migrate towards as we think about hiring managers for our fund to fund vehicles. Okay.
00:19:12
Speaker
Can you talk a little bit about the impact of interest rates on the area that you play in? um I know when I talk to a lot of private credit managers, There's a lot of influence of how interest rates and interest rate policy does affect traditional fixed income and the duration aspects and all of those things that need to be considered.
00:19:32
Speaker
But in private credit, it's not nearly as impactful as a lot of people might consider. can you get Can you talk to our audience a little bit about why that is? That's a great question. And that's a, that's a question I get quite a bit from perspective LPs, right?
00:19:47
Speaker
So let's talk about what happens when interest rates go down. Right. And so the fear is, oh my gosh, because these loan packages are floating, you know, what I thought was in, I thought it was getting a 10% one day and now it may go to 5%. The answer is no.
00:20:01
Speaker
Right. And the reason being is because a lot of these loan packages, especially from the managers that we've selected, these loan packages have floors. Right. It's not any different than if you've got a floating rate mortgage. There's there's always a floor to that too.
00:20:15
Speaker
There's always a floor to that. Although the floors for the managers that we've selected have higher floors than my mortgage provider, for example. That kind of gives our LPs confidence that performance will be maintained as rates go down, right? What's also great about is as rates go down is as rates go down, generally speaking, right?
00:20:37
Speaker
Capital markets windows become a little bit more open. right And so you may have opportunities for these companies to refi out, which is fine, but they have to pay some type of refi penalty. right and Or what happens is typically their equity sponsor might do another round of financing, or you may have more M&A activity in the particular space. right And all this bodes well for the warrants that are typically attached to these loan packages. right Let's talk about the other extreme, right? As rates go up, if you're in a floating rate package, you're a floating rate investor. That sounds great, right? Because maybe after three, six, 12 months, your loan package is restruck from 10 to maybe 11%, 11.5%.
00:21:20
Speaker
Sounds great, right? But you also have to keep in mind, too, rates go up, capital markets windows probably start to narrow, right? right And so you have to keep that in mind that you're lending to best of breed companies.
00:21:33
Speaker
You have to make sure that these companies can still pay off their loans as rates go from 10%, 11%, to 12%. So it I think in my mind, it provides kind of greater emphasis or scrutiny on the managers to make sure that they're lending to the appropriate, to the right portfolio companies in a rising rate environment.
00:21:55
Speaker
right Yeah. Absolutely. I had one manager talk about this once where he said that you know they're serving a market that is underserved and where it's hard to get access to capital.
00:22:06
Speaker
And In that respect, that means you have a lot more control over the interest rate you charge because you are competing with a small, you're kind of the only game in town for some of these firms. And so you get to choose and be highly selective on who you lend to.
00:22:23
Speaker
And then you get to be highly selective and say, I don't need to lend to you. These are my terms. You can either them or leave it But you're in need of capital and the resources and access you have is pretty limited. So I might be one of three guys that can offer you anything.
00:22:39
Speaker
And so how about the capital? So in a rising rate environment, it's not as much of an edge per se, but in a falling rate environment, it is an edge because it doesn't change the access to capital problem. So it can...
00:22:54
Speaker
I would think and tell me if I'm wrong here, lead to some stability and the cash flow and potential income associated with these products. That's true. That's true. You know, other dynamics that portfolio companies consider as they approach our managers, right? Number one, in addition to what you described is expediency, right? So, you know, a lot of these portfolio companies may need capital in the next seven, 14, 21 business days, right? Which is a very fast operating timeline.
00:23:23
Speaker
Our managers can move in that type of speed, but that costs, right? There's a cost to that. Number two, number two a lot of these portfolio companies, they want to be able to raise capital quietly.
00:23:36
Speaker
right They don't want their competitive competitors to know or other parties to know that they're raising capital. They want to do it in a direct lending way so that this isn't syndicated.
00:23:48
Speaker
Word doesn't get out that company ABC is trying to raise capital. and And for that kind of that level of quietness, that also costs. Right. And so all of these factors kind of contribute to this dynamic of, you know, cash pay loans of being 10, 11, 12 percent.
00:24:04
Speaker
Right. Because for the company, they may think, OK, we only need this form of capital for the next 12, 18, 24, 36 months to kind of get us through this next leg of growth.
00:24:15
Speaker
And then think about maybe perhaps raising equity and refine out our debt structure. Right. right Yeah, that makes a lot of sense. And again, private credit markets have some clear advantages in a lot of ways, especially for the smaller business.
00:24:29
Speaker
When we talk about private credit today, and this is kind of the interesting part, most of the time when you see anybody on TV talking about private credit, they're talking about, was it
Role of Private Credit in Small Business Lending
00:24:39
Speaker
overbought? Is there too much interest in there? Is it fair value? like Are you really going to get good returns from that? And I think that comes from the fact that the vast majority of the high profile deals that are out there that we talk about are like upper market lenders and the number and the the large asset managers that raise funds are raising billions and billions of dollars that they have to find a home for and they're not doing that and two million dollar loan sizes or four million dollars but the number of companies that would be seeking capital in private markets in those numbers is small so those really big firms
00:25:14
Speaker
are chasing so a small number of deals that would actually qualify to put money to work. But as you get down market, and this is where I think it gets interesting, no one talks about this. Everybody talks about so much money in private market. Look at how much Apollo raised or Aries raised or whoever, right? and look how much money that they put to work in private credit. and But they're really talking about an area of private credit where most private credit transactions don't occur.
00:25:39
Speaker
They occur much farther down. It's the companies that are like your bakery on the corner or the small business service provider, the local gym provider startup environments. Those are the folks that are largely going into these markets because the banks don't really lend. SBA loans take forever.
00:26:00
Speaker
And they might have an urgent need for capital. So they're going to these private credit lenders to get deals done quickly and at these smaller sizes. But most people don't realize that the vast majority of the businesses in the US economy fall in that bucket. There's like 75% of All the business in the U.S. s are small businesses. It's 25% that's being chased by these really big funds and these big operators. Where do you play? You're talking about senior security, but where in the market are we talking?
00:26:33
Speaker
Middle market, lower middle market, where? Average loan size. Are you looking at that? Are you diversifying across that? And what's your thought process and where the opportunity stands today? Right. So, so great point. So let me kind of paint you a picture in terms of how we think about it. So for example, most, if not all of our managers and our fund to fund vehicles are niche managers for those exact reasons that you described, right? Number one,
00:27:00
Speaker
their prior operators and the very verticals that they're lending to. But number two, they understand that there's a lot more demand in that space for five, 10, 25, $50 million dollar loans, right? All the managers that we've selected, we're talking about fund sizes, sub 500 million, right? Where they have no problems to deploying capital.
00:27:23
Speaker
Our anchor manager, for example, in our first fund. They're based in Texas. And all they do is they specialize in lending to B2B SaaS companies in the US, where EBITDA is anywhere from 25 to 100 million annualized very niche space, but you'd be surprised at how many software companies actually fall under that umbrella.
00:27:49
Speaker
right They have no problems screening for potential portfolio companies for which they might provide capital to. They've been doing this for the last nine plus years.
00:28:00
Speaker
Their performance has been exemplary. Loss rates near zero, right? And that's kind of a great example of number one, why they're our anchor manager in our first fund-to-fund vehicle.
00:28:12
Speaker
ah Number two, that's exactly the kind of manager that we're looking for, right? Niche managers that kind of play below the radar of the Aries and the Apollos, right? And have no problems deploying capital to the very verticals that they used to work in a prior life.
00:28:29
Speaker
Yeah, we have another private credit manager on our platform, very different from your offering, called Meriwether Group Capital. And Meriwether... Again, to your point, very niche.
00:28:41
Speaker
So they do asset heavy, non-technology in the Pacific Northwest, an average deal size between one and a half and $2 million. dollars The number of businesses that are out looking for capital that fall in that is massive. And Jamie will tell you any day of the week, on an average month, they see somewhere between 50 and 100 potential deals and they might do two.
00:29:03
Speaker
And that's because they can afford to be picky. Right. And to your point, if you are in a real niche space, it may seem like, wow, there can't be much of a universe, but surprisingly there is. And you don't have to do a hundred deals. You're only trying to deploy 50 to a hundred million dollars and you can do 55 million dollar, million fund. Like that's a very small subset of opportunity. So you can be very particular and you can really, really do the risk assessment and in a way that being a former operator, you would understand the inherent risks to the potential of a default and those spaces. Where else do you see opportunity? SAS seems to be one that's very popular. I see that a lot, but where else do you see opportunities right now?
Niche Strategies and Healthcare Lending Innovation
00:29:51
Speaker
So another another manager that we love that's actually our anchor manager for our second vehicle, they're a specialty private credit fund that focuses on innovative healthcare care lending, right? So they make senior loans, senior secured loans, first lane to innovative commercial stage companies.
00:30:10
Speaker
businesses right that are addressing unmet needs in healthcare, like improving patient outcomes, lowering costs, increasing access to care. And to be clear, they only invest in commercial stage businesses, right? So eliminating the binary risk that's typically associated with clinical stage companies, right? Right. And this is a business model that has worked extremely well for them over the last 10 plus years.
00:30:38
Speaker
um And again, they're also in a prior life, they were prior operators in this kind of healthcare, care in the healthcare care space. And they're able to structure very unique warrant packages attached to their loan packages such that total returns, right, are kind of in the low to mid teens on a net basis.
00:30:57
Speaker
right So again, very different from your B2B SaaS vertical, but also similar in that it's a vertical, right that's the only one that they're focused on where they're targeting EBITDA levels of 25 to 100 million annualized. right And again, may sound it may sound small, but in fact, it's not at all. right They have no problems whatsoever filtering for companies to lend to. And I think what you mentioned a few minutes ago, the problems with the areas of the world,
00:31:27
Speaker
is that they have a lot of capital to deploy, right? And it's a waste of time for them to do it in piecemeal 10, 15, $20 million dollar segments. They're only looking probably at $100 million dollar plus deals. you're Now you're talking about a much smaller subset, and that's a problem that we don't want our managers to have. Right. You also have to broaden.
00:31:49
Speaker
like You can't be niche anymore at that point. Because if you're niche, yes like let's let's use the example of like dental clinics, right? like There's a million dental offices in your local area.
00:32:01
Speaker
Probably 150 within five miles of your house, right? So if you're a niche manager that only lends to Dental clinics in the northern suburbs of Chicago, you got thousands of potential fish in that pond.
00:32:18
Speaker
But if you're going to do dental clinics, but you got to put a hundred million dollars to work, then you got to expand to a national level. And then you got to expand to only these very large practices, which means you probably only have like a hundred potential companies that could need you.
00:32:34
Speaker
And only maybe 20 of those companies that actually have a need for capital at this time. And then yeah, you Aries are competing for the business of those 20 with Blackstone and KKR and Apollo. And so now they have a lot of managers, but a small subset. And that's like the worst scenario you have whenever you're dealing with lending. You wanna have a very large pool of people who need capital and a very small pool of people you're competing with to give capital.
00:33:12
Speaker
So right to your point, you gotta think about those subsets and those niches and like the more you have to lend, the bigger the pond of of verticals there are. You can't be just a SaaS.
00:33:25
Speaker
You can't just be a dental clinic lender. You have to be broader because of that, right? Yeah, exactly. There's also another type of manager that I want to highlight a little bit, which is very different than in the managers that we've retained that focus
Secondary Markets and Retail Investor Access
00:33:41
Speaker
on verticals. So for example, one of the managers that we've selected in our recent fund to fund vehicle, we're very fortunate that we found them, is that they focus specifically on secondaries. Right.
00:33:54
Speaker
Right. So they provide liquidity and capital to GPs and LPs who have to exit their private credit investments for one reason or another.
00:34:04
Speaker
Right. And it it may not have anything to do with whether the GP or LP believes that the underlying credit worthiness is eroding. They may just need to have access to liquidity tomorrow. So there's a distress situation. And so they're looking for liquidity providers, right? To satisfy that. Whether, you know, whether you're an LP or whether you're Harvard University and you don't have funding from the federal government anymore, you've got to sell some GP stakes in some of your private credit funds.
00:34:33
Speaker
this secondary fund manager is there to provide liquidity, right? And so they've been doing this for the last probably seven and a half, eight years. And we think that's a great compliment to the other managers in our vehicle that do focus on the verticals, right? To have this kind of secondary liquidity provider that can also generate returns that we think is a little bit idiosyncratic of what our other managers are doing in the same space.
00:35:00
Speaker
Right? Yeah. So I know we're coming up on time, but there's one topic we haven't touched upon. And because of the nature of like how you invest, I want to kind of pull out to more of a macro level and talk about the importance of private credit as a capital provider. and the overall capital market system. And the reason I want to have this conversation is because one of the biggest trends in private credit right now is all about access.
00:35:26
Speaker
And how close can you bring private credit to being publicly traded? And there is real risk associated with that. Because when you have an asset class that you don't have to mark to market daily, that all of a sudden you have to mark to market daily, that creates a a problem and but the role it plays in the capital market structure. Can you talk a little bit about why private credit has grown in the last, you know since the financial crisis? So almost 20 years now, which is crazy when I actually think about that.
00:35:56
Speaker
can't believe it's been that long. But it's been 18 years since the financial crisis you happened. And so we've seen this grow, but it's grown because the capital markets required a capital provider that no longer existed when the banks changed. So can you talk a little bit about the inherent risk that we need to really consider when we think about how close can we get public credit to a public market outlet?
00:36:24
Speaker
I think there's been a lot of focus in the media in terms of how fast private credit has grown and probably how large the market is currently. But as you take a step back and think about, okay, in a relative context, how how big is it really?
00:36:39
Speaker
And the answer is, it's barely getting to the same levels as broadly syndicated loans or the high yield debt market. Right. And it's basically filling a vacuum where commercial banks have stepped away from over the last 17, 18 years.
00:36:54
Speaker
And you've had savvy lenders step in. Right. So they're not necessarily creating new credit that wasn't there. They're just simply filling a vacuum. Right. Number one.
00:37:05
Speaker
But number two, as I think about, yes, I understand the concerns that the markets or folks have about the democratization of private credit, right? Is it ethical? Is it right for folks to have access to this illiquid market?
00:37:20
Speaker
And my answer would be, You know, there's a reason why institutions like life insurance companies, pensions, endowments, allocate so aggressively to alternatives over the last 15, 20, 25 years versus retail.
00:37:36
Speaker
I'm sure you know, right? I think institutions allocate probably 25 to 30% of the portfolios to alts. The average retail investor, probably 5% or maybe less. And the reason being is because I think the institutions understand what it means to add alts to a greater portfolio, right? To an economics nerd like myself, what you're talking about is a shifting of the economic frontier upwards and to the left. So what that means is by adding more diversification to a portfolio, you have the potential to increase your returns while lowering your risk. Right.
00:38:12
Speaker
right And they've done this time and time and time again. And so by by introducing the same dynamic to the retail investor, right? Yes, it's more illiquid. Yes, the marks are less frequent.
00:38:24
Speaker
But at the same time, there are a lot of benefits that to be had, right? From adding an idiosyncratic asset class like alts or private credit to publicly traded portfolio strategies that have baskets of publicly traded stocks and bonds, right? So ultimately, i think it's a good thing, right? The democratization of alts and specifically private credit for the retail investor.
00:38:48
Speaker
Yeah, I agree with you. I think my bigger concern is that the desire to make it so available to the retail investor is potentially forcing it into structures it's not meant to be in.
00:38:59
Speaker
And to your point, i I think having access is one thing, but just because you can doesn't mean you should. and if you're somebody who really insists on liquidity, well, then there's a trade-off.
00:39:11
Speaker
right? Then you can't invest in an illiquid asset class that has potential for higher income streams, yields, things of that nature, diversification benefits and the like. But that doesn't mean that I need to force an illiquid asset into a liquid structure just because I want to say, well, I want to make it accessible to everyone. I think that's my bigger concern if you want to get philosophical about it. But I fully agree. And the reason I started Bondrian all along has always been because during the financial crisis, when I was working at a hedge fund of fund and I was in this world for the first time of my life and I started to see, yeah, a lot of stuff blew up.
00:39:46
Speaker
But on the other hand, there was a lot of stuff that was working that was inaccessible to the average investor. And I felt like I don't understand why my dad can't invest in this stuff. he should be able to. There's a risk benefit to some of this. And he is being kept away from it, not because it doesn't have value and not because it's attractive risk adjusted return, but more because he just doesn't have enough money.
00:40:09
Speaker
And then that really became a question of, as we kind of think philosophically, is it fair? You know, how do we like the haves and have nots? So I think you bring up very interesting points. And it's always good to have somebody who's kind of looking at it from a higher level, fund-to-fund managers, I think that's the biggest benefit is you get to see, you're not so in the weeds in your particular vertical that you can see a bigger picture. And so for those reasons, I always like having folks like yourself on.
00:40:40
Speaker
Thanks. I appreciate that. Well, i appreciate your time. it was great to have you. We'll put contact information in the show notes if anybody's interested in learning more about Stansberry's offering in the private credit space. Stansberry itself is an advisor. At the end of the day, they also service families and individuals in their wealth management and financial planning. So they fully understand the advisor market and the clients that live in it. I think that's unique and wonderful. And that's why we love partnering with folks like yourself.
00:41:10
Speaker
With that said, our audience knows the drill. Like, subscribe to our podcast, leave a comment, tell us what you want to hear about. you have questions for Mario, we can send them along. Please let us know. But until the next episode, i am Shana Orzik-Sissel, founder and CEO of Boundary and Capital Management. and Thank you for joining What's the Alternative?
00:41:32
Speaker
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00:42:02
Speaker
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Speaker
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Speaker
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Speaker
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00:43:05
Speaker
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Speaker
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