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We're joined by the firms CEO and CIO Jeffrey Gunlock. Jeffrey, thank you so much for having us here.
Yeah, it's good to be here. Glad you made a house call. Excuse me to do absolutely.
I mean, we've got this nice rug, these nice chairs, so we couldn't be happier. But let's get right to the good stuff here. I want to talk about this moment in private credit. There's been a ton of different analogies and metaphors used. One of the ones that you've used, you said only in early April on X that basically
we're in two thousand and seven for private credit. I want to talk about the potential domino effects here, because you think about any potential crisis in private credit, what is the actual read through into markets more broadly, the economy more broadly, and what does that mechanism actually look like.
I think the mechanism is already underway, and the mechanism is a decline or eliminate of trust because there's been so much reporting that is questionable in terms of the underlying activity. When I point out the one that really grabbed my attention to last fall was there was a fund that was marked at one hundred, and overnight it was marked at eighty one.
Now that is hard to understand.
Markdown by a not insignificant sponsor, one with a good reputation and a very large staff supposedly doing underwriting and due diligence and tracking and all that sort of stuff, and yet it goes down nineteen percent overnight. Now many people don't quite fully understand the ramifications of that. They think about a stock, you know that reports and it goes from one hundred to eighty one, and that's a big move, But there was a big earningsmiths or something.
These re portfolios of hundreds of loans, maybe thousands of loans in some cases, and one hundred to eighty one means either all the loans were marked out nineteen points all of them, or say, since I keep being told that everything's largely fine, let's say fifty percent of the loans are absolutely rock solid. That means that the other fifty percent were marked down thirty eight points.
What if seventy five.
Percent of the portfolio is absolutely rock solid, which is kind of what the.
Messaging has been. That's mostly all good. I remember I think.
One said no red flags, no orange, no yellow flags, and mostly green flags. Wait a minute, where's the other slice of the pie, No red, no yellow, and mostly green. What about the not mostly you know what type of thing. But if seventy five percent of the loans are absolutely rock solid, it means the other twenty five percent were marked down to twenty four right.
So but what if it's.
Ten percent of the loans upset have to be marked down to below zero?
Right?
So it's clear and when we get these markedowns, it would be awfully helpful if they would say, this is how many loans we have, This is the dollar amount of loans we have, and this is how many were marked down. Because we know the dollar amount of the markdown, it's the percentage.
So how many are there?
That would really really big issue. But I've been saying this is not just about private credit. This is something that is endemic to market cycles. This happened in the IPO of dot coms back in the late nineties. They had they had no revenue, no business plan, and they were selling for large, large prices. And then, of course in the lead up to the global financial crisis, you
had the mortgage market. The non guaranteed mortgage market exploded in size to about where the private credit market is today, a little less actually for those securitized mortgage about two trillion, you know, and it boomed, and of course that ended up blowing up. It's all because the growth is so fast.
That's what really drives it. And it can happen when there's a huge liquidity events that money is pumped in from the government some such thing as it wasn't during COVID, and sudden that money has to get deployed and it can be indiscriminate. So I use the analogy of the Wild West. This one, I think really explains it in simple terms. You've got a nice town. It's eighteen forty and out on the frontier. You've got a little town mostly farmers living off the land, and they're all God
fearing people. And they got a sheriff there. He's got a heart of gold. He's like Gary Cooper and high noon.
And there's very little crime.
You know, every now and then there'll be a murder of passion or something. But no one had even locked their doors. I don't have to worry about it. And then something happens, so maybe it's there's a discovery of gold three miles away, and all of a sudden, all the fast buck artists and con men and rapscallions they come flooding. And not everybody's a rap scallion, but a sufficient fraction of them are rap scallions, and they're coming in there to hit it big and then get out.
And suddenly there's murders. You have to lock your door, you have to barricade your door.
The sheriff is completely overwhelmedble who's going to clean.
That up this time?
I mean, who's going to be the Gary Cooper? And if I remember, at the end, the Mark Opera badge and.
Market will be the Grey Cooper.
Market inflicts the pain and so you'll end up having sales at lower prices and so forth. But the trust problem is pretty significant. I mean, it appears that many of the investors in the interval funds didn't quite understand what was going on with the gating possibilities. I'm sure it's in the documents. I'm absolutely positive it's in the documents. But the investors are being sold Tube through intermediaries. In many many cases, those intermediaries get paid a very large commission.
I read reporting.
If there were billions of dollars paid to intermediaries.
Selling private credit by the private credit.
Firms, billions of dollars, so they have a lot of incentive to not focus exclusively on the negatives.
Let me put it that way.
And so I have a feeling that some people who are in interval funds think and maybe this didn't read the documents. Did you read your mortgage documents when you in delivery page?
I'm actually going through that.
Who knows what's end? Didn't read the fine print? Yeah, we do.
We live in a disclosure based society. But you make a good point. I mean, you think about the fine print, did people read it? And how do you make sure that.
They read it?
But I want to talk about how this develops because we got through the first quarter of redemptions and certainly we saw some big headlines and some big numbers there. You warned about the IDEs of June on CNBC last week. I want to talk on Bloomberg about what that means. Are you expecting even bigger redemptions when you get those second quarter numbers?
I think if I went in front of a crowd of two thousand people who are somewhat familiar with private credit, and said, show of hands, who in this room thinks the redemption requests are going to be higher than in June than redemption.
Requests in March.
I believe virtually every hand would go up, because it's just human nature. When you can't get out, it makes you want to get out even more. On the panel that I did at the Milkin Conference yesterday, there's this statement made by one of the private credit people that it's really public credit that's at risk, not private credit, because since they can't get out of the private credit, we don't have to sell.
See that's one of the beauties of private credit.
So obfuscation is now a synonym for beauty. But you know, they say that because they can't get out of their private credit, they're going to sell their public credit.
They're going to sell stocks. It's going to be bad for the stock market.
They're going to sell high yield, they're going to sell bank loans, corporate bonds. And I said, you know, there's a certain intellectual attractiveness of that concept. The only problem I have with it is it's not happening at all. The stock market is not in trouble. It's at new highs, not today, but it's near the highs. The loan market's not in trouble, yeah, they're they're up near power. The
high yield market isn't in trouble. The spreads are tightened right back down where they where they started from at their lows of the year. So it could happen that that that logic may apply to the future, but it's not happening now.
And with all of the noise and all of.
The redemptions that weren't met, you'd think if there was something to that concept, we'd see more evidence of it.
And that's how does this play out?
Though, because I mean, hearing you talk, I'm having flashbacks to kind of like twenty years ago.
I mean, the same thing. People weren't reading and what was packaging.
Into these mortgage bond deals, and then once they found out what was in them, it was kind of this rush, but it was a flow moving rush, I mean first.
But this will be slower, I think because the stresses in the subprime market were being tracked by the ABX indices. We could buy an ABX trunch of double B, double A, single A, triple A, and the triple b's started to fall pretty noticeably in early two thousand and seven, and they got down to about eighty and a lot of people thought it was over, that was the end, and that was actually a buying opportunity. But obviously it wasn't a buying opportunity. But you could see it on the
screen every day. You could also see on a monthly basis, the delinquency is starting to pile up.
This is more of a quarterly.
Cycle with these with these interval funds, and so they get a respite, you know, they once they go through the painful process of gaining them, they now have I don't know, ten weeks where they have to revisit that topic again.
So we know beware.
The eydes of March is from Shakespeare's Julius Caesar and it was about it's talking about you shouldn't go to the capitol, you know. The eyes of March was March fifteenth. It turns out that the eyes of March is not always the fifteenth. It has to do with them how many days. It has to do with when the full moon is. So the eyes of June this year, I believe is June thirteenth. I looked it up one time. I thought I saw June twenty third, but I think
it's June thirteenth. Doesn't matter which one it is. Beware the eydes of March, because that's when around when the redemption requests are going to come in.
Are we going to see true default?
I don't mean like these kind of shadow of defaults or whatever the heck we're calling in those days. Are we going to see true default in any sort of meaningful way in private credit?
Yeah, you already are a are We've seen markdowns from one hundred to eighty one on a very large private credit fund. They will believe them at par if they believe they're not on the way to default. I've seen statements, not by every private credit company, by a lot of them that they say that's how they justify the one hundred to zero. Remember thee hundred to zeros that we saw last summer, You know they didn't They one day had to make a binary decision that yesterday we thought
there was a chance of this paying off. Today we don't think there's a chance with paying off one hundred to zero. It's not going back up. It's written off. And so there's plenty of write offs happening I saw today there was another fund that marked it's NAV down five percent.
Yes, Now, that I.
Think is something to start seeing more of, because it's a lot more defensible to mark a fundowns five percent three times than a mark of fun down fifteen percent overnight. You can spread it out over three weeks, you know, it's a little easier to wave your hands about it one hundred to zero overnight. And so it's pretty clear to me that the trust is starting to dissipate because everything's always one off, and it's always at somebody else.
It's Lake wobe Gone on steroids. Every firm is top Dessa.
Well, Jeffrey, I'd love to get your thoughts on some of the recent efforts we've seen to make private credit basically more transparent. Here's two different headlines from Bloomberg yesterday. One of them is Apollo to start reporting daily prices for private markets, and then you had JP Morgan creating a new index tracking sixty four hundred private companies. So there is that effort out there. I mean, do you think that initiatives like this are helpful?
It's very confusing because they started out in the early days saying this was a positive feature that we're not marketing to market, which is a strange thing because it's certainly my my institutional clients don't feel that way.
Yesterday I came up with this idea.
Maybe what I should do is go to my institutional regular investment crede bond clients and say, why don't we not prevail your portfolio every month and with the last close of the day for your performance report, why don't we use a one year moving average?
You should try it? Why not?
Because it appears that people find it attractive. Isn't that that's one of essentially the major selling points for private credit. It has what Sherman has termed laundered volatility. Everybody knows that the prices are moving. They say that private credit really earned its stripes during the lockdown, the COVID lockdown, because it held up well. Corporate credit bonds would have
held up to if you didn't mark them down. Does anybody really believe they could have sold private credit loans the first week of April twenty twenty five, say, during the tape ptenpement, they could have sold those loans.
At cost that's served of course they couldn't.
Nobody thinks that but instead of saying, yes, we could have sold them, they say, you're missing the point. We don't have to sell them, and that's what's so great about it. Well, okay, but if I use moving average marks on my portfolio of publicly traded bonds, I'll probably have three times the sharp ratio. It will be the same return ultimately over the fullness of time, but it'll look different because it won't be as bumpy. And that's kind of the number one characteristic. It was always sold
as being lower volatility. Everything's lower relative. You don't market. Nobody thinks that private equity is really lower volatilty than public equity. It's just the vehicle that it's in. And then it was sold. The second sales point was the higher historical returns. That's almost all born of twenty twenty, particularly through twenty twenty two, when the public market and corporate bonds went down fifteen to eighteen points in price
thanks to rising interest rates. You don't mark them, you've got eighteen points better performance.
Well, I am curious about one day.
There's been a lot of talk about sort of this new sort of wave of vintages that might be coming down the pike, and sort of what the what the potential yield might be on that that's off there, But more importantly, the demand. Will the demand be there in the same way that we saw, you know, seventy eight years ago when the last mantages.
I doubt you'll you'll see a repeat of the glory days when the public markets had zero yield and the private markets had both the yield and the hidden volatility. You know, if I just use moving averages, I'm actually surprised. I wonder if I can get the regulators to allow me to do a mutual fund.
This is when you're moving average price.
I kind of doubt it, but if I could, I mean, I think it would be a massive success.
Right.
Well, I do want to talk a little bit about vehicles here, because you know, you mentioned interval funds. You think about these non traded BDCs, and you think about the last year. I mean, there has been a real push to put retail and open up access.
Yeah, because the machine has kind of reached its limits. Institutional investors and I've seen it written, which is a little bit concerning to me. I don't know know exactly what they mean underneath this, but they see we need to go to retail to keep making loans. It's almost like you have to always add your investor base.
What does that sound like? Well, what does that sound like?
You you can't go forward unless you get attract more and more and more investors.
What does that sound like?
I don't know.
I think they build its not like a social security system.
Well, I'm curious whether or not you think that you know, we're going to see some of that push die down here, whether we are going to see demand from retail heading forward here.
I'm not sure it'll cool.
I think that there will be, for sure heightened redemption requests. There may be some people that think that.
It's a buye.
I would recommend against that because my experience is long, and I have a very strong memory, and I know the way these things work. You have the push first, push down, and it looks cheap by historical prices, and then some intrepid people decide they're going to take a punt on it and they buy it, and it pushes it up somewhat.
That's what happened in subprime.
Like I said, the triple BABX went down from one hundred to eighty, and then it rallied up to like ninety two or something before it went to zero. But so I think there'll be some people that think that it's a buy although there's an inconsistentency between everything's fine and our nav was marked down one percent. But this is the greatest opportunity you got to buy now because it's down a whole whopping percent. So I think there will be people that buy it and then sell it lower.
Yeah.
I am curious though, if we do end up in a crisis. There's been a lot of talk as to what capacity the government would have to even bail things out the way they did, you know, twenty years ago.
I have a really hard time thinking about a government bailout on this one. The last one they were able to wrap it up in the little guy on Main Street losing his house, right, this is the richest guys in the world making money in the wild West, and so.
They might do it. I mean it might be possible.
I modified the mortgages that was against the law and violation of prospectuses, so a lot of weird things can happen.
But I think I think to get a.
Government bail out, the problem would have to grow so large that it wouldn't be possible.
It's weird.
They could do a bailout if if it was not that large a problem, But then the public could go, what do you do? And you're just wiring wirring money to these billionaires. You've already given your tax breaks too, even though that's largely a myth, but that's the way.
That's the way the public has been.
But when you look at when you look at the fiscal situation, particularly with the interest expense continuing to rise higher than defense, I am curious what you think the Treasury Department is actually doing right now with regard to its issuance, primarily on the shorter end of the curve, and what, at least from what they've communicated, is probably going to be their strategy going forward.
Do you trust in what they're doing? Uh?
Well, trust is an interesting word.
But they're already issuing the vast majority of the treasury debt short term.
Most people aren't aware of this.
Over the last year and spent the case for the last few years, about eighty five percent of all treasury issuance is inside a one year And you know what percentage is longer than twenty years? Under two percent, actually under one and a half percent, so it's already It's funny the long end gets so much attraction attention, but it's really not the area. They're already doing it all on the short end. The big mistake was that we
didn't go much more heavily on the long end. But the yield was one you know, because now the yield's up at five, so it's up four hundred basis points. Those bonds, those one percent or thirty years, they're still down at fifty cents on the dollar still. I mean, they're still on their lows because the yield is within ten ten basis points of it's high.
But the market keeps absorbing this.
Well, maybe it's being manipulated. I mean they talked about you curve control, but rates, it has the market really been dealing with it. Because since the Fed start cutting interest rates back in September of twenty twenty four, the long rates are up one hundred basis points, right, they are up, and I think they're going to continue to go up even if there's a recession. In fact, I think if there's a recession, they'll go up even faster because people will be worried about the management of the
interest expense. And it will get to the point where something has to be done about it. And it could be that the government does yield curve control. Scott bestn't talked about yel curve control as a tool, and we used you ill curve control after World War Two for about a decade. They did in Japan for decades, so it can be done. They've done quantitative easing, so they can buy whatever bonds they want, and they could just buy long bonds and bring the yield down to whatever
they want it to be, as they did in Japan. Now, that didn't work that well from nineteen forty five to nineteen fifty five because once they stopped doing it, you went into a huge bear market and treasure yields went up to fifteen percent even on long term treasuries, and T bill rates were taken above twenty percent. So will they do that possibly, that's potential tool. I have an idea which I've already acted on in some of my portfolios where it's appropriate go on.
Which is.
One of the greatest things ever because in investment business, if you can eliminate a risk without paying anything, you should do it.
We can agree on that.
And if you take a risk, you should get paid something for it, right, Okay, So if you can ever eliminate a risk at zero or no cost, you should do it. So I was thinking, what if they go crazy and amplify and implement Scott Besson's suggestion of late twenty twenty four, which is we should lower the coupon on our foreign treasury holders and extend their maturity. Now, how do you know who the foreigners are? Foreign investors
can hide behind any entities. So that's not really an implemental, implementable idea, but it shows a glimpse into the thought process.
Do you think they'll try that like an ultralong ultra ultralong bond.
I don't think they'd get many buyers for it. I think what they'll do instead is a restructuring of the existing.
Debttholders as possible.
I'm not saying this is a thirty percent chance even, but what if they say, you know what our interest expense is now three trillion dollars. We had a recession, rates have gone up. We're now we're showing thirty year bonds at six percent. We can't afford it. You know, we're drowning here. So let's just say, every maturity bond
is outstanding, same maturity, won't buy their extending. They could extend them, but you don't want to get people super mad, So you say, we're not going to extend your maturity, but we're going to drop the coupon to the following the lower of the existing coupon and one. So you would take the entire trot stock of treasury debt, which has an average coupon about.
Four, and you take it down to be one.
So it would bring the interest expense down seventy five percent overnight. And so you would go from three trillion dollars to one quarter of that, so down to seven hundred and fifty, and so you'd be half of where you are now. So that would be the ultimate way of kicking the can down the road. We always see saying we're running out of road. Well, that would be a new road that's being paved. We can kick it down.
Now.
What would happen, Well, of course bonds, the bond holders would be super mad.
The ones that owned the sixes.
That were issued ten years ago was thirty years, They would go down like seventy points and all those bonds would be worth thirty and the government would not be allowed to borrow for generations, which is the solution to our to our debt addiction. We could do that. So what did I do when I thought of this idea some time ago? Actually two years ago now, I said, I called up I was on the road talking about the potential for this, and I said, you know, you're
talking too much and you're not acting enough. So I called up my treasury desk and I said, in certain funds, including our flagship fund, I said, you know, I want you to go through our treasury book and analyze all the maturities, and I want to keep every maturity the same.
Because we like our yield positioning.
But I want you to take what we own and swap it for the lowest coupon existing in that cohort. Now, not only do you don't have to pay penalty for that, you pay a little liquidity penalty, but our fund is so liquid.
It's not an issue for us.
You pay a little bit, but you actually pick up yield. You actually pick up yield because the ones e'es and the one and a half ski's out there, they're off the run. The on the runs trade at the lowest yield so you actually pick up yield, so you're being paid to eliminate a risk. And I took the coupon in our long bucket of treasury from four and three quarters.
To one and a half. So if that blows up, I'll be a hero too.
I'll be a hero, just like I was in the global financial crisis, because when you sidestep something and people go I could have done that, because you're actually not paying a penalty for doing so. We'll see if the ones seas and twosies start rolling tomorrow.
Well you're going to be the first person we call if we do see that sort of restructuring. But we only have a few minutes left with you, and I do want to talk a little bit more about positioning because you told our colleagues Joe Wisenthal and Tracy Alay. I believe it was back in November that you would recommend a twenty percent cash position basically to hedge against some sort of market inclusion. Is that still your recommendation? What is the ideal allocation right now?
I kind of like twenty percent in cash. I've had allocations higher than that at times. I just think markets are very very high. I mean yields I think are going to rise. I've said that earlier this year. People were betting on two three rate hut cuts this year, and I said on national media, I said, you know, if you're buying risk assets on the back of only two rate cuts, is your high conviction idea, You're.
Backing the wrong horse. We're not going to get rate cuts this year.
And now I think that narrative has become not uncommon, that we're not getting rate cuts and maybe we'll get a rate hike. But cash, I think you can deploy it at lower evaluations on risk assets and higher yields on fixed income. I've liked commodities for a long time. I like about a twenty percent position. I personally have a higher one, but for most people, twenty percent position and something that's real assets. And the Bloomberg Commodity Index is perfectly fine for that.
It's doing great, it's been super.
Strong, it's new high, it's above all moving averages. It's due for a pullback, but it's so broadly diversified, and so many commodities are under upward pressure based on the oil prices, particularly food commodities, which I relieve and filtered for three, so.
I like that. I go on and off on gold. I was a very big gold Bowl.
Entering twenty twenty five, and I was asked when it was at twenty nine seventy, I was asked on National TV, do you think it's going to go above three thousand?
And I said, what kind of a forecast is that? Is it going to go up a percent?
I mean, come on, I said, it's going to go above four thousand by the end of this year twenty twenty five, and I went to fifty five hundred.
Jeffrey, this has been a wonderful conversation.