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

Episode Summary

Executive Summary: Patrick O'Shaughnessy interviews credit investor Kieran Goodwin on private credit's rapid growth, hidden leverage, and rising stress from higher rates. Goodwin argues the asset class has been “vol-washed,” vulnerable to defaults and forced selling, and may soon consolidate as bigger, better-capitalized managers gain share.

Main Topics: Private credit's boom and stress (Priority: 5/5): Goodwin says private credit grew fast because rates were zero and banks were constrained, but higher rates now strain borrowers. Vol washing and valuation opacity (Priority: 5/5): He argues private credit appears smooth because loans aren't marked to market, masking real volatility for allocators. Leverage at fund and borrower levels (Priority: 5/5): The discussion centers on fund-level borrowing, bank financing lines, and asset-liability mismatches that can trigger sales. Default risk in middle-market lending (Priority: 4/5): He expects more defaults in sub-$100 million EBITDA companies than in larger public credits. Alpha, imagination, and permanence (Priority: 4/5): Goodwin says durable edge comes from time, capital permanence, and imagination more than information alone. EQ, synergy, and investing careers (Priority: 3/5): He emphasizes humility, team fit, and complementary strengths as critical to long-term investment success. Optionality beyond markets (Priority: 3/5): He extends his investing lens to income share agreements, blockchain, AI, and even personal relationships.

Key Arguments: Private credit grew after zero rates and bank lending limits pushed borrowers to direct lenders. Higher SOFR turned 5.5%-6% loans into roughly 11% debt, squeezing leveraged borrowers. Private credit returns look low-vol because loans aren't marked to market, not because risk is absent. Fund leverage from banks can force sales if valuations fall and credit lines are cut. Defaults are likely to rise first in smaller middle-market companies under $100 million EBITDA. The asset class may keep growing, but a shakeout and consolidation are likely. Alpha from information fades over time; time, permanence of capital, and imagination matter more.

Data Points: Private credit AUM growth: $250 billion in 2010 to $1.4 trillion - Goodwin's estimate of asset-class expansion Typical direct-lending spread: SOFR plus 550 to 600 bps - Illustrates target yields in private credit Target investor return: 8%, 9%, 10%, 11% net - Returns GPs aim to deliver to LPs Borrowing leverage example: 1 to 1 - Example of funds levering with bank lines Loan-to-value cushion: 50 percent cushion - First-lien loan structures financed by banks Typical middle-market leverage: 12 times EBITDA - Historical acquisition leverage cited for PE-backed companies Debt load example: 7 turns of leverage - Middle-market company capital structure example Interest coverage arithmetic: 14.28 percent - Approximate max interest rate if all EBITDA went to debt service Loan rate change: 5.5% to 6% to 11% - 2019/2021 loans repriced by higher rates Sub-$100 million EBITDA: sub $100 million EBITDA - Segment Goodwin expects to see more defaults Bank lending to funds: a couple hundred billion dollars - Referenced Fed report estimate of lending by banks to funds Venture firm size example: $50 million, $100 million - Small-firm fundraising scale in venture Income share agreement cap: 10% or 15% - Goodwin's suggested upside share for individuals Option tail example: 101, 201, 1000 and 1 - He uses deep out-of-the-money payouts as long-vol examples

Pivotal Quotes: "The road to hell is paved with positive carry." — Kieran Goodwin: On leverage, asset-liability mismatches, and why smooth returns can hide danger "I'm a big believer that it's more important to be on the right wave than necessarily be the best surfer." — Kieran Goodwin: On career timing, market cycles, and why context matters in investing "I do think having imagination in investing is key." — Kieran Goodwin: On spotting volatility, tail risks, and asymmetric opportunities

Implications: If rates stay elevated and defaults rise, investors should expect more scrutiny of marks, leverage, and liquidity terms across private markets.