Talk Your Book: The Next Big Short

Episode Summary

Executive Summary: Michael and Ben interview Jared Dillian about his thesis that private equity—and especially private credit—has become a major bubble driven by extreme demand, too many firms, and ever-higher asset prices. They agree returns likely fall, but debate whether the outcome is a slow fade or a sharp bust, with concern focused on illiquidity, leverage, and retail investor enthusiasm.

Main Topics: Jared Dillian's bearish thesis on private equity (Priority: 5/5): Dillian argues that private equity and private credit are in a frothy phase and may represent the biggest bubble in history, driven by massive growth in firms, assets, and investor demand. Why 2008 shaped Jared's market outlook (Priority: 5/5): The conversation centers on how Dillian's career began with the dot-com bust, Lehman collapse, and financial crisis, which created a lasting distrust of stocks and a preference for other asset classes. Illiquidity as both risk and protection (Priority: 4/5): The hosts and Dillian debate whether illiquidity delays a reckoning. Dillian says it can stretch losses over years, making the unwind slower than a public-market crash. Demand-side pressure and the expansion into retail (Priority: 5/5): Ben and Michael argue that institutions are already near capacity, so private managers are now pushing into wealth management and retail investors, where yield is easier to sell. Returns likely to compress even without a crash (Priority: 4/5): All sides largely agree that greater competition for deals and higher valuations should reduce future returns, even if the sector does not experience a dramatic blow-up. Where the short thesis is investable (Priority: 3/5): Dillian explains that the tradable expressions are publicly listed private equity firms like Blackstone, KKR, Apollo, TPG, and Carlyle, though he notes the biggest firms may still benefit from the trend. Broader market views: rates and election trading (Priority: 2/5): The discussion ends with a brief market outlook, including the possibility that elections may be sell-the-news events and that rising rates or recession could catalyze stress in private markets.

Key Arguments: Dillian believes private equity/private credit is in a frenzy because too many firms chase too few deals, pushing valuations up and future returns down. The main risk is structural illiquidity: losses may not appear all at once, but over years, allowing the asset class to persist longer than public-market bubbles. Michael and Ben agree that lower returns are highly likely, but they are less certain that the entire asset class will catastrophically unwind. A major concern is the move from institutional investors to retail/wealth management clients, where private credit yields are marketed aggressively and may lead to poor outcomes. The most vulnerable targets are small, lower-quality private equity firms; the largest managers may actually win from consolidation and asset gathering. Rising rates, recession, or a bond-market selloff could be catalysts for stress in private equity and private credit. Private equity’s structure—fees on committed capital and long holding periods—makes it hard for LPs to assess actual performance and exit quickly. Dillian’s personal experience with the dot-com bust and Lehman explains his distrust of stocks and his preference for bonds, FX, and commodities.

Data Points: Private equity firms in the U.S.: 17,000 - Dillian says the industry has expanded from roughly two dozen firms decades ago to about 17,000 today. Private equity firms decades ago: 24 - Contrast point for how small the industry was 25-30 years ago. Large firms with revenue > $100M that are private: 87% - Cited early in the discussion to show how dominant private ownership has become. Institutional portfolio exposure to private vehicles: 30% - Used to explain that institutions are nearing a saturation point in private assets. Potential institutional allocation upper range: 70% - Presented rhetorically as something institutions are unlikely to reach. Management fee range: 1.5% to 2% - Referenced as the fee level private equity firms can still collect even if carry falls. Private equity valuation multiple in the mid-2010s: 4-5x EBITDA - Dillian said the environment then was more favorable due to low rates and cheaper deal prices. Current private company valuation multiple: 10-12x EBITDA or more - Used to argue that deal prices are now much richer and future returns are pressured. Holding period for many portfolio companies: More than 5 years - Dillian notes this number is rising, suggesting exits are getting harder. Lehman stock collapse: To zero - Dillian described witnessing colleagues' equity and careers wiped out during Lehman's failure. Market decline during financial crisis: 57% - Mentioned as the scale of the stock market fall after the crisis. Private equity book share of Michael's time: 10% of portfolio, 90% of time - Ben/Michael used this to illustrate the operational burden and complexity of managing private investments. Interest rate example: 10-year Treasury moving from 4-4.5% to 6-6.5% - Hypothetical catalyst Dillian gave for stress in private equity if deficits and rates rise sharply. Yield being marketed in private credit: 10% to 12% - Presented as the kind of headline yield that attracts retail investors but may signal risk.

Pivotal Quotes: "I don't trust the stock market." — Jared Dillian: He explains how starting his career around the dot-com bust and Lehman collapse shaped his investing psychology. "Liquidity is the most important thing in the world." — Jared Dillian: Used to argue that public markets are superior for capital formation and that private markets can hide risk. "There is absolutely a mania of frenzy in getting investors' dollars allocated into private credit." — Michael Batnick: He describes the flood of outreach and the push from private managers into wealth-management channels.

Implications: Listeners should expect rising skepticism about private markets, especially lower-quality funds and retail-facing private credit products. Even without a crash, competition and illiquidity likely compress future returns; in a downturn, stress could spread slowly but painfully.