Identifying Market Inefficiencies and Manager Edge
Chris Carsley, our Chief Investment Officer, joins Rocket Dollar for another webinar. He talks about how to identify market inefficiencies and manager edge that can help generate excess returns and more importantly, is repeatable. To understand the concepts better, he uses KCG as an example to identify the market inefficiencies we are targeting and how we are able to build our edge and ultimately help define our strategy.
Video Highlights:
What are the different types of Due Diligence?
What is Inefficiency?
What Inefficiencies KCG is targeting?
What is Edge?
What is KCG’s edge?
KCG Strategy
“Inefficiencies exist. For example, changing government rules and regulations can cause market inefficiencies. One example that I took advantage of for years as a trader was a tax regulation inefficiency. Tax treaties between countries can create certain opportunities to generate a true arbitrage or an excess return.”
“The fund manager should be able to identify what their inefficiency is and why that’s generating an excess return.”
Watch the full video below.
Transcript
Brendan: All right. Welcome everyone to another Rocket Dollar webinar. Uh, we have Chris Carsley here, a returning, uh, guest from, uh, Kirkland Capital Group. Um, Chris, we've already done a couple great webinars, so I encourage people go look at the ones in the past too, when you get some other time. But, uh, Chris, why don't you introduce yourself or maybe some first timers here today and what we're gonna talk about.
Chris: Sure. Hi, I'm, uh, Chris Carsley and. I am the Chief Investment Officer for Kirkland Capital Group. Um, well there's my quick little background. Uh, I've spent most of my career, started off in traditional investment management, managing people's money, um, on a discretionary basis, mostly long, you know, stocks and bonds.
Uh, and then was very fortunate enough to be able to venture into the Alternative uh, space, worked in hedge funds and arbitrage trading. Worked in venture and startups. Worked for a fund to fund where my job was a little bit about what we're gonna talk about today is really going in and assessing a fund, uh, at a high level.
And one of the things that we used to always sort of identify when descending down on funds is, can we really identify two key factors is what inefficiency are they taking advantage of and their particular edge? So, we'll, we'll dive more into that. Um, but one, uh, Rocket Dollar, thank you for having me back.
And Brendan, good to see you. Um.
Brendan: Yeah.
Chris: So let's, uh, let's, let's stop talking about this guy and dive in. Uh, agenda, we'll, we'll walk through, um, some types of due diligence. What is inefficiency, what is edge, um, and then we'll give a little bit about, and use some examples of the Kirkland Capital Group of, you know, what we believe our inefficiency and edge is.
And then we'll, uh, break for some Q&A.
Brendan: Um, and one another quick primer before we get started. Uh, as far as the due diligence front that Chris is gonna talk about, whenever a client is telling us, since we've done that last webinar, they're saying, Hey, I'm really having some concerns about an investment opportunity.
Uh, you know, Rocket Dollar cannot provide investment advice, but we are often sending Chris's webinar to people. We went through a full hour on a lot of great topics. Red flags, um, really good learning, um, experiences. I would equate that webinar Chris to almost like eating your vegetables. Like it's not always the most exciting stuff, but so, so, so important.
Um, we've probably sent that to over 40, 40 people just individually just saying, Hey, watch this hour. You need to, you need to watch it.
Chris: Yeah. That's great. I mean, that was a great webinar. I mean, There's just a lot to cover in due diligence. Mm-hmm. I mean, it just can go on and on and on. I mean, there are people who do this for a living and they'll see hundreds and hundreds of funds and it, there is no shortage of work. Um, but one of the things for maybe a lot of people watching this webinar, one of the things they consider is you have to find what's reasonable for you. Um, coming in and trying to perform an institutional level of due diligence, um, can actually be extremely time consuming and actually have a great deal of cost to it.
Um, so as you're venturing into Alts, um, that's one thing to consider as well. What, what works for you and, you know, how are you gonna get through this process of, uh, looking at alternative investments? So yeah, let's, uh, let's move forward.
So generally in due diligence, um, most people really love investment due diligence. It's what most people are excited about. That's what got them interested. That's why they're looking into this deck. Um, then you've got operational and out of operational, as things became more complex, uh, and more information started flowing through to potential investors, especially on the institutional side.
You had this divergence into business due diligence. Uh, and we'll talk a little bit about that. And then one of the things that sort of is always, uh, encompassing regardless of the investment you're looking at, is some level of economic due diligence. And once you understand the investment, operational and business, you can kind of fit and perhaps even, uh, come to a conclusion of what kind of size you would want to be in whatever investment you're looking at from some of those, uh, economic findings.
Let's dive in. So investment due diligence. Um, as I said earlier, this is the exciting part. This is the, this is what you got excited about. This is the opportunity for return. Well, where's that return coming from? And one of the things that we used to always identify is that lots of people can put up returns.
Was it something that was unique or idiosyncratic to a particular process or opportunity. And that's that inefficiency is you gotta identify what inefficiency is being taken advantage of by the fund manager that is allowing them to, in particular, put up what we call an excess return. So one of the quick definitions there is you might be able to go buy an index that will represent whatever style of investment, let's just say it's an equity index, you're gonna go look at that. Well, that's the simple public low cost liquid option. If you're looking at an Alternative Investment, you need to find someone who is accessing some inefficiency that is allowing them to create an excess return that would be beyond that benchmark.
Otherwise, why wouldn't you just go buy whatever benchmark or index that was? Um, secondly, you've gotta dive in. You've gotta understand the edge and that's the team. And this is where it can get a little bit more complex. Sometimes, uh, you know, if you can't understand the investment, you should probably just walk away cuz you're not gonna be able to define what the inefficiency is if you can't understand the base of, you know, the inefficiency and where the returns are coming from.
But once you get that comfort level, you're like, okay, now I've gotta dive into what I think is really hard is the team and what is it in particular that is allowing this team, this team's edge to consistently and repeatedly generate that excess return and take advantage of that inefficiency. So those are the two big, broad categories within the investment due diligence, uh, you know, aspect that you need to really identify.
Moving on.
So inefficiency refers to the situations where market prices do not accurately reflect underlying values. I'm not gonna read the whole thing. This is the basis of the efficient market hypothesis. There are many people who disagree with it, agree with it. Um, I just listed for fun out there, there's, if you google this, uh, you can, uh, identify the weak, you know, semi strong and strong forms of the efficient market hypothesis.
But more importantly, what I'm getting at is, Inefficiencies exist. They are generally caused by government regulations. Uh, one of the greatest ones that I took advantage of, uh, for years, uh, as a, as a trader was a, uh, tax regulation inefficiency. So you have tax treaties between countries, well, that can create, uh, certain opportunities to generate ,uh, a, a true arbitrage, uh, or an excess return.
Um, there are other inefficiencies of ways certain things are built, like closed in funds, may have certain parameters about when they have redemptions or something of that nature. There are so many different little occurrences that if you have the time and eventually you hope that you find a manager that has the network to get in, understand what those are and be able to capture those on a consistent basis, you may have found yourself, uh, a very good investment. Now, one thing within inefficiencies and one thing you want to be sure to ask the manager is, well, "What collapses this inefficiency?" Uh, is it cyclical? Um, what else do you have, uh, that you're trading or doing that offsets when this trade might collapse?
Because most inefficiencies, uh, I found through my career wax and wane, they're not consistent or they're not always really wide. Um, obviously the greatest inefficiencies are usually found right after you have a large market gap. Something occurred like covid or something like that.
You're in this situation to where whatever inefficiency that you have been tracking or recognizing might be at levels that you've just never seen before. So those are the kinds of things when we are going out and you're looking at funds, the fund manager should be able to identify what their inefficiency is and why that's generating an excess return.
Um, that's some, that's a very, very simple question. Um, and if a manager really can't explain in decent detail what their inefficiency is and why they're generating return and it seems to make logical sense to you. Um, well, you probably should find yourself a new manager cause then they obviously can't define his trade or he doesn't really truly understand it.
Brendan: And, um, something Chris, I noticed is that these, uh, Skilled managers have, and skilled traders or whoever, investors have to take, uh, advantage of these efficiencies faster than they used to. Yeah. So the information age is like completely changed, that, you know, a strategy that might have worked for five years might only work for like two or six months now. It really depends on the asset class. Um, a lot of people are almost dismayed by how fast the S&P 500 is moving now. Um, and it's like you already have left the boat, so you also need to take that into a factor. It could have been a graded efficiency three years ago and maybe it's already been mined out and there is a lot of competition in that space.
Chris: Exactly. And that, that is, that is an excellent point. And I saw that happen in a multitude of trades that I did. Uh, when I was working at a hedge fund, you, you, you, you would make a ton of money. Information would get out. The nature of the trade would occur. Then well, okay, other people are doing the trade.
And you know, I think, as I've said in, you know, other webinars, you're looking at a situation of where you gotta understand is the trade, what they call a zero sum. So no matter what really occurs, there's only $1 in the trade. And if there's one person in the trade, well then they make the dollar. If there's 10 people in that trade, well then they all just, you know, pay 10 cents.
Um, it's usually shared. Um, it's, there's. What I'm saying is there's only $1. So as more people enter, the trade becomes less lucrative. So exactly to your point, Brendan. And the thing is, the information age really has created an accelerated nature. So really, really talented managers, you, you know, definitely do rise to the top because of whatever it may be, knowledge, uh, network or systems.
Um, and we'll talk a little bit about that cuz that's a little bit on the edge side of how they're gonna, you know, maintain and take advantage of these inefficiencies. Let's move on. Um, and some of this we've talked about a little bit. Um, you know, how to recognize, you know, an inefficiency. It could be, um, they have a particular network.
Um, one of the things that I love, and I've got a friend who manages a fund that does this, is uh, more of a legal arbitrage. They can go in and they can do a trade that's, um, called appraisal rights. And you can go in and you can file on the backend of M&A, uh, activity, and you can have a network and you've gotta have lawyers and understand the system and costs, and you know how the court system works.
And if you have that network, well then you can rinse and repeat this particular inefficiency within that trade. Um, another one was, uh, if you're doing different redemption rights and things like that, back in the day, you had to actually have the right phone number for the person who could give you the right tendered stock.
And so some of those were big corporate actions officers at, at large banks and things like that. So you had to have those to enact your inefficiency. So these are the kinds of things where a manager should be able to go, you know, this is what I have, this is why I can repeat this. Perhaps it's a system like we were just talking.
Um, it now takes greater reaction time. You have to be faster. You have to recognize the signs, you know, more quickly as there are more participants and more people chipping away at the rock. Um, so do they have a system or something in place that allows them to increase efficiency or speed to take advantage of their, uh, preferred inefficiency?
Um, and one is, well, I think this is, knowledge is not everyone has knowledge of particular inefficiencies. Um, so this is gonna be part of your quest is you're gonna learn a lot as an investor doing due diligence. You're gonna become knowledgeable on a variety of different trades. Um, but on the manager's side, You know, they should already all have a deep knowledge.
It should be one of the given. Check the boxes that they've done this before and they know how to, uh, you know, recognize and capture that inefficiency. Um, there's a lack of data. It still exists. Um, I know we're in the information age and everyone's collecting data, but there are certain pockets out there where it's very difficult to get enough data.
Um, and sometimes if you have a lack of information, That will, you know, like the good old days, uh, it'll allow you more time and perhaps a wider inefficiency to take advantage of. That kind of goes hand in hand where it's, you know, that network or lack of data can create that limited access, uh, inefficiency.
So there's only certain people who can play in that. Um, One good example I had historically is we used to do a lot of different, uh, arbitrage through securities finance. Um, and I was approached when I left that shop. They said, well, hey, could you go repeat the trade, uh, that you did for this other fund?
And I said, yes, I know how to do everything. And I said, but I have a question for you. Do you have billion dollar balance lines and credit limits with every major bank, you know, around the world? And of course, their answer was No. Okay, well, yes, I'm aware of a number of different inefficiencies and a number of trades that people are taking advantage of, but for people like us that don't have those large credit limits, you just can't participate.
Um, and so that's something that some managers out there, and it's usually reserved for some of your bigger managers. They'll have access to something. It's just something others can't get. And so that might be part of their inefficient play that they're taking advantage of so they can go do a trade that the people just do not have the infrastructure in place to pull it off.
Um, and I'm sorry. Yeah, Brendan.
Brendan: Yeah, I, I've noticed, uh, some clients will come in and, you know, they'll ask, they'll start doing their first couple Alternative investments and they say like, well, how does Rocket Dollar get my data, like into the portal, like how do I get statements? And a really, uh, not a very satisfying answer, but a realistic one is a lot of investments that people do in the Alternative space just don't have nearly a, uh, a 10th or even hundredth of the data that the public markets do or the crypto markets do, which are crypto was kind of designed from the beginning to also have live updating data that people could view and look at. So if it's real estate, if it's private investments. Yep. Um, uh, you know, some people make whole businesses now, they'll just create a database for an Alternative Investment that did not have one yet before then. Then funds can come in and trade that investment more aggressively. When in the past it was very slow. Not a lot of liquidity, not a lot of, yeah. And you know, that can be scary as an Alternative investor. You could go into a market where, Your manager might verbally know a lot, have a lot in their head, but there's not a lot to, um, uh, to verify that you can just search online and Google very quickly.
So then you have to kind of defer to personal referrals and experience who've worked with them before. You know, see, does their knowledge really measure up or are they just correct, you know, faking that, uh, High amount.
Chris: Yeah. I, I mean even, even in my initial steps of doing due diligence on the space of micro balance bridge financing, um, I was very amazed.
Um, it was a good and a bad thing. I was amazed at how much data didn't exist. You couldn't actually get very precise numbers or consistent data on a lot of the questions I was asking for my own due diligence before I even started the fund. Um, now the other side of the coin is, well wait a second, if I can't get it, and that means other people can't get it.
Which means, okay, we might be in a space where there's a lack of data inefficiency. And then that comes down to my partner Brock, who'd actually worked in the industry for, uh, you know, a number of years. He had that network and knew how to build systems and things like that to overcome, um, the fact that you couldn't really do a lot of research or pull information.
So, um, and then, yeah, so I mean, there's. It comes in lots of flavors. I mean, and I know we're talking about real estate, but this happens in venture. This happens in a variety of different Alternative spaces. Um, and each story will be slightly different, but end at the same place. Um, where, wait a second.
Okay. This is, this is a, uh, a story I've heard before. It just, uh, took a slightly different path. So if you do this enough, you'll start to recognize a pattern of these inefficiencies, um, or a lack of them. Um, And then lastly, fragmentation. So, This kind of encompasses a little bit of lack of data. Um, you'll find niche markets, um, that there's just, there's a supply and demand imbalance.
It's just, it's broken. There's no one group that, or, uh, you know, some form of oligopoly that controls a set section. It's very, very fragmented. And a particular investment space is run by a multitude of participants. Um, that itself, um, can create, uh, excess returns when things are very fractured. Um, and there's no, you know, thousand pound gorilla in the room sort of dictating which way things go.
Moving on. Next slide. Um, well, yeah, we talked a little bit about this. Um, so we don't have to go into, I mean, our, our, we're obviously taking advantage of a fragmented market. Um, we've got a lack of participants. We've got, you know, Lack of data. Uh, there's a supply and demand imbalance, more so now than you've ever seen in the micro balance, real estate bridge financing.
I mean, almost any private debt. These inefficiencies would now, uh, apply. Um, they may not have applied heavily, you know, a year and a half ago. But, um, you're starting to see, uh, like I said, two tailwinds coming forward where, you know, fed raising rates. Banks under pressure. Um, you know, the private debt world really got it started in 2010, uh, with the Dodd-Frank Rule and the changing regulations.
And we're now back at that table where there's whispers of further regulations. We've already seen a number of different bank failures, and the one thing is when banks start to fail, all the other banks, well, they turtle up. Quickly cuz it's about being defensive, controlling, and, uh, securing their deposits.
Um, and in those efforts that creates a lot of, you know, opportunity, uh, and excess returns to be created, you know, by, you know, participants, which, I mean, we're taking advantage of it. And I know a ton of other people in private debt and that's not just in real estate. I know venture debt guys are having a heyday.
There's lots of opportunities in this space. Next slide.
Edge now, I think this is more difficult because inefficiencies, um, can be broad patterns and they can be, one of the things that we used to always do in inefficiencies is when you get down to the math, you could look at return attributions. You could break things into pieces, and in fact, if you're, you know, you're looking at a long, short hedge fund, one of the things that we would day one ask for is give me a breakdown of your attributions of long returns, short returns, and your net exposures. With that information and a number, number of different indices, you can actually really start to assess are these guys making their money on the long side, short side, you know how often the breadth of that, uh, you know that, that return capture and arbitrage.
So you can do a number of different things and that makes it easier to understand. When you get into edge, you're now having to kind of wade through a different level of due diligence. It's a little bit more on the operational and business side. You're assessing teams, you're assessing available networks and, uh, and systems to understand is this a group of people who, uh, one of the things that, you know, people want to understand is well, Can these guys live through this current time?
Have they seen a cycle before or is this their first cycle, um, that they've seen? And how are they performing and how do they perform earlier? And as Brendan said earlier, one of the key things sometimes to get into edge, you might actually have to go out and really verify, get reference lists, um, you know, go get their service providers, make sure they're actually working with the service providers they list out.
How long have they been listing their, um, in, you know, sometimes. They'll answer some questions around like, oh, well, how seamless and quick, you know, does the team supply information to their fund administrator? Those are, you know, you may or may not get those answers. Um, you know, service providers get a little squirrely sometimes, um, even if they've been given, you know, authorization to talk about a relationship. Um, so you may not get as many answers as you'd like from some of those reference checks, but that's where you're gonna have to get in there. You're gonna have to do that verification. You're gonna have to go in and, you know, if they did background checks, uh, on their team members, Hey, can I, you know, can I see those background checks?
You know, can I, you know, what, what information? If you don't ask, you're not gonna get it. So you might as well ask and, you know, some of your bigger funds, Well, their attitude is they may not share it. Um, um, some of your smaller funds, um, might be much more open and transparent to share information, um, as they might be growing, especially if they're an emerging manager.
Um, they're gonna be far more open to answer questions and supply information. This is your opportunity to get in there and really assess, you know, now that I understand the investment, how are these the guys that are going to make this happen? You know, what's the breadth of their team? What's the depth of their team?
You know, are they, if the trade requires international, uh, capabilities, you know, okay, what are, what's in the other offices? Who's in the other offices? Um, That's one of the things that you have to be able to dive in and assess this edge. Does the trade take a certain network, like we explained earlier? Um, or is it more reliant on a particular system?
Now, sometimes I go after systems anyways, because in today's age, the deployment of technology, we've already seen this in IOT and a variety of other things, and finance is always a little bit behind the curve with regards to deployment of technology. But you know, it's one of those things where you want to go in and well, what technology is being deployed just to increase efficiencies in operations at the company. How are they using today's technology to better streamline their business operations? Because if you're spending a lot of time doing manual labor, well then you're not spending your time going out there and working your network to understand where the next trade might be or how, uh, you know, I've got a trade that's flat, how do I go out and widen that spread?
I mean, those are the things that your manager should be doing. Um, instead of trying to figure out like, okay. Why can't I get, you know, Excel to add up a column for me? Um, so that's, uh, that's, that's edge. It's a little bit, like I said, more qualitative, you know, so you've just gotta get in there and ask the questions.
Brendan: And I think you mentioned this a bit, but depending on how competitive their space is, um, some, you know, like you said, the smaller managers might be willing to share a very established fund, might be afraid to give away certain information because they feel. If they do, their competitive neighbor right down the street might just pump you or some operative pretending to be a client, trying to invest. Uh, so you know, these funds, some funds compete all the time over information, employees.
Chris: Exactly.
Brendan: Strategies, edges. So if you ever do get a bit of hesitancy, just understand that sometimes that could not always mean they're trying to hide it from you.
It could be that they're trying to hide some key parts of their strategy from another manager and just asking a clarifying question. You know, why can't you tell me that? They might be able to be honest with you and say, look, that's the secret of the fund. We can't really give that out versus here's what we can tell you.
Chris: Yeah. And there, there's definitely certain, like anything that's a zero sum or generating true arbitrage, um, it, it, you're gonna have a secret sauce. You're gonna have something that's unique that they're gonna be less inclined to share. Um, so yeah, I mean, you're gonna run into that, especially your larger, more established, you know, funds.
Um, probably your smaller guys, there might be. I ran into a few that were capacity constrained cuz their real edge, um, and their ability to generate alpha was on the short side of their book. Um, and so they had to be very careful what they were saying or how they were saying it. Um, because they did have some unique tactics within shorting.
Um, and shorting is very, very difficult. Most people completely suck at it. Um, if you do enough of this, you'll look at enough long short hedge funds. They should probably just short stop shorting. It's, yeah, it, it, it adjusts the volatility of their portfolio, but it's a detractor in the actual alpha generation of most fund managers.
There are some out there cuz I found, uh, a few of them, but it's super hard and they're gonna be reluctant to tell you sometimes. And that's, that's okay. You've gotta, if you're not comfortable with that, then move on to the next investment. Um, but if it's something you feel like, Hey, I can size this appropriately and I can put it in my fund, in my fund, and I understand that there is this secret sauce, um, then that's okay.
Brendan: There, there's a fund in Chicago where their whole first floor of their office is just for guests. The second floor, not a single guest is ever allowed unless you're a verified employee. Like this is the kind of secrecy that Yeah,
Chris: Sometimes, yeah. Um, deal with, I, I did, I did have one occurrence when I visited a fund.
Um, they were just getting started. They are a major powerhouse now, but, um, I entered their office when they were just getting started and, um, They're like, yeah, you can't sit on your trading desk cuz you used to be a hedge fund trader. And I was like, okay, here's another way to think about that. If I can spend an hour with one of your traders looking at two or three different set trades and you think I'm skilled enough, I'm very honored. You think I'm skilled enough to reverse engineer your entire process that I could walk out the door and repeat what you're doing?
Um, here's my thoughts on that. One, I'm not that smart. And two, that means you don't have quite the inefficiency and edge, you should, if I could reverse engineer your trade that quickly. Um, so if you really feel peckish and you want to go after someone, you can use that line. Uh, it worked for me. I did get up on their trading desk and as I knew it, um, I was one of maybe two or three that ever stood on their trading desk, but there again, it was in their early days.
I guarantee you right now, um, if you tried to do that with that fund, I would just tell you to have a nice day.
Brendan: So it was a great story. Sorry. We can continue here.
Chris: Let's do it. Um, yeah, I mean, some of the edges that, you know, we deployed, we've talked about a lot of these different aspects. Um, you know, we've obviously got, um, my experience on the investment management side, analysis and risk management, um, and then Brock's history in underwriting and developed an actual network, uh, within, uh, you know, Obtaining and sourcing loans and bridge financing, um, Brock's other skill that is brought to the table is really the implementation of efficient systems and technology.
So we are a relatively small shop and we kind of run ourselves like a technology startup in the finance space. So we are always trying to push the edge and look at new systems, uh, for increasing efficiency. Um, I'll skip that alignment one. Um, you know, Go to, you know, process and procedure. We're very big on process and procedure.
Um, so much of the fact that, you know, our little tiny fund, we already have a due diligence questionnaire that we've created. Um, it's something that's very easy for us, uh, to update when new employees come in. Um, we have, uh, just an entire writeup of, you know, SOPs, uh, in place. So all their procedures that they need to do to understand their job, um, we're very, very big on following process and procedure.
So the combination of that process and procedure with technology allows us to achieve a lot. Um, with very few people. Um, and that alignment. Uh, one of the things I think is really important is really looking at the standpoint of saying, listen, we're in investment management, so we've got investors as clients, but on all the way, on the other side, we've got the people who are borrowing money from us and we want to create an alignment all the way from that borrower, through a broker, cuz we source all of our loans through loan brokers, into the fund management, all the way to the investor. We want a complete alignment and a lot of that is created through transparency and even the way we put our loan docs together. The broker and the borrower, everyone is in the same camp.
Everyone's being taken care of. Everyone can see how the process is going to work. Um, and so that, that efficiency, uh, and that belief in alignment of our entire aspect really allows us to create repeat business. And it also allows us to be incredibly transparent with our investors and, you know, that actually at the end of the day builds comfort, trust, and better returns over the long term. So there's a number of different things that we're deploying on our edge. Let's jump to the next. Um, we've hinted at this a couple different times. Um, you know, we, we are, uh, our fund is a, a real estate income fund. We invest in micro balance, uh, You know, first lien mortgages, uh, they're all bridge, so we do 12 month loans.
You know, we have run a very conservative valuation since day one. So that's been exceedingly, uh, helpful in this time where you've seen rising cost of capital, definitely putting pressure on valuations. So we've been able to ride easily into that issue. We've got short loan duration, so we're not really trapped in anything long to where we had booked up a five-year loan at a lower rate.
So as rates have gone up, we've been able to increase rates and bring better returns to our investors. Um, we don't have an incentive fee, so those fees flow directly to the investors. So as we write loans at a higher gross rate, um, that increased rate is, you know, flowing directly to the investor's pocket.
Um, everything we do is senior debt. We got defined exit strategies, you know, Everything. We don't do any raw land or construction cuz uh, especially in this time period where people are talking about default rates, uh, increased default rates coming into, you know, a potential recession. Well that's okay.
We run relatively low LTVs and we don't, like I said, don't do any raw land or construction. So if we have to end up taking a property, it is something that's income generating and we try to maintain pretty good diversification across property type and geography. So, I mean, that's really a quick rundown of, you know, what we are doing.
Um, I didn't know if anyone had any questions or Brendan, you had further topics you wanted to dive into about, um, inefficiencies and Edge. I mean, you really can talk hours depending on what strategy you're looking at. Um, cuz there's different inefficiencies in venture, in hedge funds and in private debt. Um,
Brendan: Yeah, and I think we, we, we touched on it a little bit, um, but I know you helped us write a blog article recently. Can you just repeat again like this, I don't think some investors know how bad the credit crunch really is right now. So, you know, the Fed has pulled back that's causing banks to pull back.
And, you know, America has a lot more regional or small banks than a lot of other countries. So most other, uh, you know, England, Canada, Germany, you know, they have like a couple major banks that do pretty much all the business. In America, there's, I believe it's four or 5,000 of, you know, banks in the entire nation.
And every one of these regional banks has a book of business where they go and they do lending to various local businesses, parties, houses, mortgages, et cetera. But local businesses, whether they're real estate or other type of businesses, are getting a lot more pushback and trouble from those, um,
those lenders. Right, Chris?
Chris: Yeah. Yeah. No, I mean, uhs a couple different things. I mean, we can, let's, let's start from the big world that you know, all the headline news and I just, um, In my newsletter that just went out in May. If you can get access to that I really talk about this subject a lot and actually have some pretty interesting charts.
Um, in the, in the, in the big dollar world where you're talking like CBS, which, you know, those loans usually average in the two to 300 million range. You're looking at a situation where you're coming up to what they call a debt cliff. You're looking at an issue where there is a lot of debt. In the, uh, billions of dollars is coming due, and it's all gonna have to be refinanced, and it's gonna have to be done at a much higher rate.
And you're also looking at a situation of, well, how badly is that gonna hurt the assessed valuations of a, of a number of different properties that represents. Now most of these headline news and most of this CMBS issue. Um, That's like your gateway city. Your, uh, you know, like Seattle or any kind of like Atlanta, major cities are struggling from this standpoint.
You can, there's almost no news, you can't look up about New York or San Francisco and see hotels failing, um, office buildings completely empty. So there's definitely a problem in the very, very large world. Um, and you know, that big dollar amount in, in the, in these gateway cities. Um, there, there's a, a, there's gonna be a, a, a prolonged issue. Um, people are now gonna have to figure out what are we gonna do with these office towers. Um, cuz it's a pretty complex problem and it's a big dollar problem. You can't just have, you know, Brendan and I can't come together and write a check and, and solve this problem on a building.
I mean, it's just too big. You're talking about institutional level. Now, coming down the curve, you are starting to see where, um, you know, a lot of people are stepping into Mez debt trying to do longer term, two to five year, you know, covering that middle ground for people who need to refinance. Um, we have seen a ton of loans refinanced. We've seen a ton of people need extensions. We've seen a few loans even in our portfolio. Luckily they've paid every single month they've been performing. We love the borrower, we love the property. So we actually just internally refinanced it, and you're starting to see that more and more, um, because that normal exit from that conventional lender, whether that was a community bank or a regional or super regional bank, so They're just not at the table the way they were, um, before all of the Fed hike and credit crunch in 2022. It just, you know, we started seeing it in November. Where we were, you know, Brock and I would often talk about, well, what is this loan? I mean, it would come from a major super regional, and it was a multifamily that was fully occupied and the guy's like, well, I need a bridge loan because I, I now have to increase my DSCR rate to 1.25 or 1.3 before my bank will now finance me.
So it's not that banks aren't lending, they're just making it harder to lend. Um, and I'm sure some out there are kind of closed off entire sections of their book. Um, but that is definitely occurring. Um, you know, as it comes lower and lower. Now that creates opportunities in our space, in the micro balance space where we're seeing loans we normally wouldn't have seen.
Um, so there's, you're taking lower risk based on the quality of the borrower, the type of the property and the situation of the property. Yet you're still out there charging, you know, double digit rates and they kind of have to move in and accept this. Um, it's not great for them. Um, but it shouldn't break the bank for them either if they're already at a performing level.
Um, so there are opportunities on the back of this, but this credit crunch is not over. Um, I know the Fed's battling between, Hey, do I raise rates and fight inflation because if I raise rates, I'm just gonna exacerbate the credit crunch. Um, so. It's a tough situation and the decisions they have to make, um, there will be pockets of opportunity.
But if you're in a big ETF that's looking at, um, major office buildings in gateway cities, you've probably already taken a pretty good hit. Um, And who knows when you'll be recouping that in one form or another. Um, that's gonna be a tough space. Um, so yeah, I, I hope that answered your question, Brendan.
I mean, it, it is, it, it is, it is prolific, but, um, most of the pain and suffering right now, um, it is really in your, in your, your, your bigger debt areas.
Brendan: Okay. Um, yeah. And we had a question come in from Jason. Lemme just, I'm gonna read it quick and then,
Okay. Um, all right. So this is about an international investment, but I think it's more on the due diligence on the edge side. Okay. Um, so Jason asked, I'm looking at a private equity company based in Germany as an investor. Mm-hmm. What should I consider with regards to being a US citizen, investing through my IRA, um, and then providing my legal status outside the US as a qualified investor, what to consider to be tax efficient. So I'll handle the IRA side and then maybe we can just talk about due diligence and
Chris: Sure. Yeah.
Brendan: A little bit international. So Jason, uh, a lot of people come to us because they can invest internationally. Uh, you can do that with a self-directed IRA.
Investing in a professional fund is usually the easiest. We find it's a lot harder for people to do a deal, kind of more on the private handshake level. Uh, you know, in America you can just go up and draw a contract. But your bank transfer will go through immediately. When you go to another country, um, just sending the money to Germany is a little bit harder. To Germany, a major Euro country, is quite easy. Um, once you get to other countries like India, Italy, you know, it starts to get more and more difficult. Mexico and Canada are not too bad, but as people spread out around the globe. So, uh, Chris, I guess to make this question relevant to you and the material we've been discussing today, have you ever kind of considered international investments in kind of the extra due diligence or like maybe an international edge that you've had to look at?
Chris: Um, yeah. I mean, We've, we've done investing in, you know, I, I would often fly to the UK and various areas looking at a number of different funds, um, that we are investing in over there, um, more in the hedge fund space. One of the things I would say is, you know, on onsite verification becomes monumentally more difficult, um, for most investors. So that's, that's a, that's a problem. So you've gotta go in and you've gotta figure out, how am I gonna complete verification at a level that makes me comfortable. And a lot of that is gonna be, you know, investor references. That's gonna be one of the things you should get a hold of as well. How many other US investors do you have? Can I have access to a number of those people to understand the process and procedure? How has information been disseminated? Have they been comfortable with the transparency? Um, and then assessing the inefficiency, really, that comes down to, uh, you, you've gotta understand.
Well, you, you had mentioned private equity, so okay, they're a private equity company, investing in corporate, you know, in, in, you know, the equity stock of a private company. Great. What's the nature of that portfolio? Look up those companies that are, you know, in the portfolio. See how those are going forward.
Try to get the information and understanding of what they are looking at and what they think. Why do they invest in those companies? What is it that they have network wise that will give them access to something that's not already flooded or easy for other people to, uh, you know, obtain. Now if you're dealing with a very, very large PE fund, well, there's a saying.
It's like, okay, that might be safer in some areas and easier to do due diligence, but they may not be that high on the inefficiency scale. Um, now there again, I, that's just generally speaking, larger funds are like trying to turn an aircraft carrier. When you start turning, everyone can see it turning and it takes a while to turn so they can't really move quickly.
And a lot of people can come in on their trades, which generally lowers your, you know, excess return. Doesn't mean they're not, you know, putting up a good return. It just makes it very difficult for them to go unnoticed, uh, and create a true inefficiency. Now being of size, I'll just switch gears and go into sort of more the venture side, being of size and having the notoriety and then what they call network capital in the, uh, venture space is probably one of the most consistent and well known inefficiencies that the larger venture, uh, shops have.
Um, what's allowed them to continue to see the best deals they're putting, you know, they're getting access to the best companies, the best startup teams, um, because they've got the big checks and they've got a history of performing well. So if you're gonna start up a company, do you eventually wanna take money from someone who's really gonna be able to have the pockets there to nurture you at every step of your company?
Of course. So that's called, uh, inefficient inefficiency called Network Capital. In private equity, you can make, kind of the same assessments of like, okay, well do they have that inefficiency in place? Do they, do they have the ability to get the best deals and why? And you know, and understanding that network capital.
So, I mean, that's one of the biggest things. I, I mean, but you got, there could be something unique to Germany, um, and that can be assessed. I don't personally know, I've never dove into Germany, uh, in, in, in one way or another. So I can't really speak to a, uh, specific country inefficiency. Um, but there could be one there as well.
And that's something worth noting.
Brendan: And I, I'd say I tell this to every international investor. I just say, you know, I just ask like, have you been there? Uh, have you lived there? Yeah. Have you, do you know someone there that you're very deeply close to that's knowledgeable there and most, you know, most investors that are excited bringing us an international deal do have that experience.
I would say it's best to stick to what you know, especially when you're checking a country barrier, because checking on that investor network becomes many times harder. And also for you to get a good judge of like, well, who else is investing into this fund? Um, Seeing really sophisticated, smart investors go, you know, get excited about an opportunity, then you're kind of following them.
If you can't determine who's really coming into this fund, like Chris is saying, asking who's an American investor? You're gonna have a lot of trouble verifying that, and you're going in like a little bit blind. And then you might find out, uh, a year or two in, you're going, wow, there's a cultural difference or a market difference in this country that I had no idea about.
I wish I would've known that three years ago when I first kind of jumped into the opportunity. And I think that, that, that ties back to any, um, investment in, in America in our borders, is if you have absolutely no clue about this asset class. You need to start small. You need to dip your feet, um, dip your feet in, maybe do a smaller investment, really learn the space.
Um, you know, as I've done like a new real estate deal, myself and my own personal portfolio, you learn so much about that entire industry in the first two years of that investment. It's best not to jump into six more until you really learn that lesson. So do one investment in Ger Germany. Don't do 12 all at the same time.
Chris: Yeah. And, and one thing that just came to mind also is, um, as I mentioned earlier, one of the efficiencies can be rules and regulations in particular to a country that's not the same as the US. So that's another thing that you're gonna have to, you know, dive in and understand. Is that a component? Of what this fund has available to it as a possible, uh, inefficiency as a particular rule or regulation mm-hmm.
Uh, in Germany or whatever country you're looking at. Um, that helps this trade, um, you know, that we maybe don't have in the US.
Brendan: And, uh, Chris, I'd like to bring up a really good topic. I thought about myself as. In Alternative investments, there's kind of a stratification of, there's big accredited only deals and then there's small retail deals, and sometimes I've noticed, you know, the edge sometimes of a particular platform is, you know, some of these retail platforms have really good deals and some don't, frankly. But sometimes I see like the only edge is, well they're just cutting this investment for smaller people. And sometimes, you know, if I don't really know their investment that well, I have this, uh, fear or you know, cuz I've considered investing myself in some of these.
Well, is this platform getting the best deals or are they kind of giving the scraps to the retail clients just because we can cut this up into $500, uh, a thousand dollars, $5,000 increments. So do you, would you kind of talk about an edge just as far as check size? How does the minimum investment in the check size really change things for the investor and how they look at this process?
Chris: Well, anyone tells you size doesn't matter, you know? As I always say, one of my hobbies is martial arts. You've never fought a 300 pound man. Uh, size matters. Um, yeah, one of their punches will knock you across the room. Um, but, um, all joking aside, it is always a concern of what, as I mentioned earlier, that network capital, in the venture space “Are they getting the best deals?”
And one of the things that's assessed in emerging venture a lot, um, is deal sourcing. How are they getting the best deals and why? Or in particular are they hunting in an area that the big money doesn't care about? So you might have a perfectly great deal, but it only takes, you know, a couple million dollars to pull together so you can actually get, um, fractionalization down to a small dollar amount and still achieve the raise.
Um, so I mean, it's one of those understanding the sourcing, a aspect of, okay, if I'm looking at a particular platform or I'm looking at a particular manager that's, uh, is emerging, understanding how they're sourcing and, and why those deals are worth having is super important and can supersede the, uh, the, you know, the, the check size.
Um, but, um, you do always worry, uh, that am I just getting the Class B, class C type deals? And that's across everything. Am I seeing, you know, on venture, am I seeing the companies that are worth having if they're small. Now there's a lot that are, um, I know, I know a few. Um, but you've gotta dive in and assess that.
Am I, uh, getting a good real estate deal? Well, Yeah, you, you might be getting one. I mean, we write relatively small checks, you know, I think our average check size is about 550,000 and people are like, well wait, I mean now, and of course they're not thinking that now cuz no one wants to be in the mega trades.
But, um, We, we get a lot of questions around, well, why these loans, why secondary and tertiary markets? Um, and we would talk about how we're sourcing those and why these trades are not any less risky, uh, or more risky in any way than some of your bigger trades. A lot of the factors are the same. And, and in, in a lot of cases we are going in and writing loans against a property that could be at a 10, 12, 14 cap because that particular regional area, you know, an hour outside of Atlanta, things weren't driven to a two or three cap. They stayed at, you know, eight or nine or 10 and now have gone, you know, up in, in, in the recent time period. So there could be nuances where, um, you gotta dive in, you gotta understand, wait a second, where does the small check actually still have power?
Um, but. It is and Brendan brings up a very good point. I mean, there is, um, you always have to be wary, am I working with someone who's just getting the, the, the subclass deals cuz he couldn't get the better deals. Well, here's my answer to that is Define “better”.
Brendan: Yeah. And, you know, for terms to recognize, like some people call it like a sidecar or an SPV of they'll be raising a huge, huge, huge, huge sum.
And then it's very difficult to, you know, they deal with big institutional investors that have whole teams and you know, they might have six parties, just very giant, you know, 300 million each. It's very difficult for that firm to suddenly pivot and deal with 200 retail investors, you know, that have checks of 10,000 or a hundred thousand or whatever, just much smaller than they're used to. So you'll see some, um, big alternatives on, uh, do, what's called a sidecar, an SPV, and put all of the smaller checks into that same deal. So you're kind of along for the ride of the bigger manager. And then you'll have other firms that frankly don't want to be anywhere close to that. They'd rather be in the small pond, with less competition, um, you know, kind of hiding away from those big management firms that could snatch up their deal and just take it away from 'em. Uh.
Chris: Yeah, I mean, you, there's good and bad to being, you know, around the feet of, um, you know, a, a large animal, well, you probably protected from other predators on the outside, but you also can just get stepped on.
Mm-hmm. Um, and so it's something. To really dive into the documents and the understanding, you know, and this is getting kind of a little bit more on the due diligence side, um, not really an assessment of inefficiency or edge, but if you're going in through some type of feeder structure and you know, running side by side with, um, the behemoths into a trade, um, it does give you some level of solace that, your due diligence is supplemented with, you know, other people who are descending with multiple people in their team to complete the due diligence. But you need to understand not only that comfort, but you know, do you have the same rights? Do you have the same fees? What side letters are in place? Um, do they have liquidity preferences?
If things go bad, they get out before you do. Um, things like this. I mean, those are the kinds of questions you just gotta sit down and think like, wait a second, how can I get hurt when I'm the smallest guy, uh, in the room?
Brendan: Yeah. And, uh, just asking these questions about, you know, how big a manager is compared to their competitors getting a better sense.
We'll help you just give a bit of a story and then talk about their edge of, you know, are, are they putting your money in the right place and are they coming with the right check size that think is gonna give you an advantage to join them along that.
Chris: Yeah, most definitely.
Brendan: Um, so. Okay. Uh, any, any more questions, uh, from the audience that we'd like to talk about?
Kind of covered a lot. These are a lot of different topics, but this edge and inefficiency, it's a great, you know, something people are considering every, every month, you know, every time they're trying to make a move with their self-directed IRA.
Chris: Yeah. I mean, and in the alts world, these are the two things, and it gets fairly complex, but at a very, very high level, if you can identify who's someone who has, um, And, and efficiency and can create an excess return.
And they have the edge to, uh, consistently and repeatedly provide that. Uh, you may have found something.
Brendan: Yeah. So now everyone's going into AI now and everyone's gonna have five AI funds tomorrow. But, um, all right, Chris, thank you for coming by and stopping for another Rocket Dollar webinar. Uh, this is great.
Chris: Appreciate it.
Brendan: Um, really great material. Appreciate you talking about these high level topics.
Chris: Yeah, and Brendan, as always, great to chat with you.
Brendan: All right. And then we have, uh, I'm, I'm gonna, uh, it's recording on my screen, so I'm going to bring up the contact, uh, on the slides again. Um, and if you just look at that on YouTube, you'll be able, uh, we're gonna have this recording up within 24 hours on YouTube.
Um, there's also, uh, you can contact Kirkland at their email up on the screen or go to their website and reach out to Chris to talk with them further. Thank you, Chris. Thanks for stopping by.
Chris: Thank you very much everyone. Have a great day.
