The Keys To Repeatable Alpha
Generating alpha requires an “edge” based on inefficiency in the market. But the most valuable type of alpha is that which is repeatable, and consistent.
Chris Carsley, our Chief Investment Officer and Managing Partner at Kirkland Capital Group, joins WealthChannel’s Andy Hagans to discuss how to generate alpha in a consistent manner.
Episode Highlights
Background on Chris’ career in finance, and how it began at a young age.
Details on the unique culture at a hedge fund firm, and the specific personality traits required to thrive there.
Why generating alpha isn’t “enough” if it isn’t a repeatable, consistent process.
Chris’ unique philosophy on the best ways to find inefficiency and gain an edge in specific markets.
Why private credit is a particularly attractive asset class in 2023, especially for High Net Worth investors and family offices.
“Having that mentality that comes from the hedge fund world where you’re doing a trade but, you’re willing to take it and think outside of the box and come up with something new that could make money.”
“You’re really running through the investment due diligence, ‘Hey, how is this guy creating alpha? Can he do it repeatedly?’ And then you’re also going into the business efficiencies and the operational due diligence. You’re going through everything to ensure, ‘Hey, we understand the risks, if I’m going to deploy $25 or $50 million to this guy, do I understand what he’s doing and how he does it, and is he hitting it and sticks to his P’s and Q’s?’”
Watch the discussion below.
Transcript
Andy: Welcome to the show. I’m Andy Hagans, and today we’re talking about generating alpha, finding inefficiency, finding an edge, something that’s at the heart and soul of every active manager in my opinion. So, joining me today is Chris Carsley, who is CIO and managing partner at Kirkland Capital Group. Chris, welcome to the show.
Chris: Andy, thank you for having me. And I’ll talk your ear off about inefficiencies and edge, where do you want to dive in?
Andy: Well, it’s a great topic, Chris, because basically the way I framed it, you’re gonna give us your whole secret sauce, right? By the end of the episode, we’ll have the whole recipe, the whole secret sauce, you know, it’d be like Colonel Sanders giving us the…
Chris: There you go, you’ll be able to make your own fried chicken, you’d be ready to go.
Andy: Well, let’s start with your background. Because I think when I hear of any asset manager who’s generating alpha, 100 times out of 100, there’s always an interesting background. A lot of times it’s in, you know, hedge funds or different little corners of the asset management world. So, how did you get your start in finance?
Chris: Well, it actually started off when I was about 13 years old when I pulled up “The Wall Street Journal,” back when people actually had the physical Wall Street Journal. And I opened up to the stock page, and I don’t know if you remember those pages, I mean, it’s just a series of symbols that make no sense and a bunch of numbers. And I remember I was sitting there and of course, my parents were not really big into investing. So, I went to them and asked the question and they’re like, “Well, I don’t really know how to read that that well, go talk to our broker.”
So, I’ll date myself again here, I went down to the office and I sat down and I said, “How do you read all this?” And he started talking about all these different things and started walking me through what was possible. And I always wonder this in my path, if I hadn’t made money on my first trade, would I be doing what I did now? But luckily, I did make an investment, sold a mutual fund that my dad had, you know, $1,000 or something like that, bought an individual name, made money, and the rest is history. That led me to wanting to do this all the time because when you’re 13 and you make a couple of hundred bucks and you didn’t have to pull any weeds and you didn’t have to mow any lawns, that was something.
Andy: Oh, your dad must have really trusted you, Chris, to trust you with a trade, or did he view it as a learning experience?
Chris: Yeah, no, he walked over with me, he’s like, “Well, what are you thinking about doing in this?” And I’ll never forget the trade because you’ll laugh. My initials are CTC, Christopher Thomas Carsley, and it was a company called Contel, that its symbol was CTC. It didn’t have anything to do with my decision, it just kind of worked out. But the trade actually was Contel were bought by GE about four months after I bought the stock. Now, of course, that’s pure luck. I was not smart enough to try to gauge an M&A transaction.
Andy: Did your dad take you out for ice cream or something after that acquisition, or…?
Chris: No, he probably made me take him out, what are you talking about? He’s like, “You got money now.” Yeah, no, that was sort of my first trade. I was one of the weird kids that went into college and knew exactly what I wanted to do. I was already waking up in the morning…I’m out on the West Coast, so you’re up at 6:00, 6;30, you know, trying to figure out what you’re going to invest in and do a number of different things. And that’s how…you know, and I walked out of college and I became a junior portfolio manager, started my career in traditional asset management. So, I was running discretionary accounts for high net worth, small companies, things like that. So, very long stock, long bond, not too exciting, you know?
But that led me into the dot-com era where I was actually exposed to a number of different people in a lot of different trade groups and I was on the Microsoft campus at a dot-com event, not being a huge techie at that time, found somebody who was about as bored as I, and it turned out that he was a trader for the hedge fund that I went to go work for for eight years, which was Paloma Partners. So, that was my introduction to what I kind of call behind the curtain, but also now there was this whole world outside of just going long in stocks and bonds. There was a number of different ways to think about trading, how you’re going to make money, and that was my sort of first introduction into the inefficiencies that are in the market.
Andy: And Chris, could I ask you, you know, I’m always curious because I talked with a lot of asset managers and, you know, people who work at hedge funds or found hedge funds, I feel like…well, first of all, hedge funds are kind of this like big bad guy in the media, right? I’m not talking about that at all. That’s not what I’m talking about at all. But I do feel like they have a little bit of, like, a different culture of very sharp minds who are almost like intellectual…like, obviously want to make money, but almost like a competition of ideas type culture or maybe you can describe it for us. What’s the culture like?
Chris: It’s very well…I always tell people you got to have the right personality to sit in the chair, you’ve got to want to realize, “How do I create something from nothing?” sometimes. How do I go in…and I know the basis of maybe a few different trades, you know, what we traded was, event-driven trades where we had our own securities finance desk. So, we wouldn’t go in and buy stocks in relation to the event, we would go in and structure longs and shorts and really obtain some of our long exposure just by borrowing the stock. So, that gives you some of the nature but you’re correct, it’s a little bit more of an aggressive culture.
You got to earn your seat, you’re paid to make money. Obviously, within Paloma, there was multiple trade groups and we were just one of them. Yeah, I mean, you got…I guess you got to be smart, but I found it you had to be able to, one of the key lessons right off the bat was, accept failure and loss because it’s going to happen and sometimes it happens so fast that you have to make a choice of, “Do I just walk away from this trade, you know, cut bait and move on to something where I think I can, you know, recapture that loss, or is it a saleable trade?” And that was something that, yeah, nobody teaches that, you don’t go to school for that, there’s not many jobs that will walk you through that mentality…
Andy: That sounds like intestinal fortitude to me or, you know, a combination of having a thick skin and just kind of being able to handle internal pressure, external pressure, pressure, right?
Chris: It’s just pressure, I mean…and pressure came from…because it’s not like you got any sympathy. Like, when you lost money, the rest of the guys on the trading desk were definitely making fun of you. So, you had to kind of deal with it like, “Not only have I lost money, now I’m sweating even though the AC is on in the room.” You know, people are poking fun at you, especially when you’re the new guy. Yeah. You know, especially when you’re from the West Coast working for an East Coast firm, that was, yeah, a lot, a lot of pressures, a lot of pressures. You know? And that was…it made you really sort of…I made me ready, that mentality made me ready for kind of the rest of my jobs and sort of the path that I chose.
So, after working in that environment and having to be given opportunities, so I ran the Canadian trade book, and then I put a trade together that we were kind of doing a little bit, but we were sort of off lending the streets. So, it’s like we weren’t running our own book on a particular Dutch trade. And I sat down one day, it was late hours, the market was closed, everything was kind of done, everything was balanced, Ops said I was good on my cash, and so I was like, “You know what? Let’s sit down and map out this trade.”
And I mapped it out and the next day, I called a bunch of people on the custodial desks and I said, “Hey, you know, can I borrow this stock if I needed to?” And it was like, “Yeah, we got tons of shares.” And so, that kind of all of a sudden, I’m taking an idea that we weren’t really involved in firsthand and then it was like, “Wait, we can do this trade ourselves, we can put the whole thing together.” And that mentality is what really comes in the hedge fund world is you’re doing a trade but you’re willing to take it and think outside of the box and come up with something new that could make money.”
Andy: So, that sounds…I mean, if I’m using a technical term, I might call that intrapreneurship but I mean, I called it…
Chris: Yes.
Andy: Entrepreneurship, it’s really entrepreneurial mindset, basically.
Chris: It is, an entrepreneurial mindset of like, “Hey, how am I going to take, you know, this amorphous form in front of me and turn it into something? How do I move forward?” And so, that was definitely the life of a trader, you know, “What are you going to do next?” No one was there to tell you what you had to do. You just had to sit down and you had to make things happen and you had to develop relationships.
Andy: So, what is most of your time? So, working for a hedge fund, like, you know, it’s not like…executing trades isn’t that time-intensive, right? So, is it mostly reading and talking and researching? Like, what is the day-to-day work?
Chris: Yeah, reading, researching, modeling, putting together the network that’s actually going to be able to help you make a trade, you know, comes to fruition. That’s one of the things that…you know, there’s certain trades like…you know, I was just talking to someone last night about low latency and, you know, option based. I mean, yeah, you can sit in front of a computer and maybe do that all by yourself. But in the event-driven trades that we were doing, we’re often cross-border, involving borrowing stock in one country and moving it to another country and then transacting on a certain corporate event and then collapsing that trade, that was what we did over and over and over again across multiple countries, wherever we could find it.
And I won’t dive into all the trades, they’re all fascinating and most people never heard of them before, but there’s some really interesting stuff but it’s also incredibly simplistic when someone tells you how it works. But you and I would never see it unless someone said, “Hey, there’s the trade, that’s what happens.” But, yeah, it’s a…but that entrepreneurship led me to…I mean, I eventually left the hedge fund lands, we were having…it was, you know, getting close to ’08 and things were having lots of different problems. And so, I actually came back permanently to the West Coast and worked for a funder fund and they’re, you know, a multi-billion-dollar funder fund that was investing in a number of different funds all around either long/short equity or esoteric sort of special trades within the hedge fund world, so it could really be almost anything.
So, now you had to really open your mind and sit down and take your knowledge of how trades worked and sit in front of very smart people and almost do a little bit of reverse engineering to understand, “What are they trading?” And this is where you really get, you are capturing inefficiencies and making, you know, that arbitrage or some people would call it alpha at the hedge fund world, now you were assessing how other people were doing it. And so, you were sitting with hundreds of, you know, managers or funds doing a variety of different trades, whether it was vol, event-driven, muni arb, you know, credit, you know, multitier junior versus senior credit trades. I mean…
Andy: And Chris, to be clear, this isn’t like an index fund of other funds, right? Like, you’re actually picking winners and losers, you’re kind of evaluating the managers, the fund managers themselves and you’re…before the fact, you’re trying to sort of rank them probably and saying, “I’m going to invest with these top 5% or top 10%.”
Chris: Yeah, do they make it into the fund? What’s the allocation? And then you got, you know, cross-correlations and impact to the existing managers, you know, “Hey, if I had this guy, was does that mean?” So, you’re really running through the investment due diligence, “Hey, how is this guy creating alpha? Can he do it repeatedly?” And then you’re also going into the business, you know, efficiencies and the operational due diligence, you’re going through everything to ensure, “Hey, we understand the risks, if I’m going to deploy 25, 50 million to this guy, do I understand what he’s doing and how he does it, and he’s hitting it and stick to his p’s and q’s?”
And so, I did that for a number of years and that continued that sort of…and it was a great job because you had a core of what you were aiming for but, like, one of my tasks was to find people who could short and create alpha consistently and it’s extremely hard to do. I mean, I spent years working with a lot of managers and I did find four or five, but we’re talking about hundreds of people that I met. When you run through the attributions and the math of their longs and shorts of whatever structure they’re putting together, most people you found, you’re like, “They should just stop shorting, you’re not actually any good at it, it’s lowering the vol of your portfolio but it’s actually not creating any alpha.”
Andy: Yeah, and then even I imagine a portion of the winners over a three, five-year period or whatever, a portion of them are winning because of luck or because…you know, there’s always going to…
Chris: Or it’s beta, this guy’s. I mean, you have a lot of that going on where, you know, the market just rallies and you have someone produce an outsize return. But when you really run through the attribution and run a regression analysis against a series of best-fit indices, really complex benchmarking, you realized, “Okay, the guy just was riding the wave.”
Andy: Got it.
Chris: You know, and then when you do that with shorts, you find out…you know? And a lot of people don’t like to hear that, so we wouldn’t tell people if we…if we didn’t like their short book, it’s not like we throw it in their face, we just say, “Oh, we’re just not going to invest at this time.’
Andy: So, Chris, I gotta stop you here. This is an interesting kind of hearing about your career path. You know, the theme of what we’re talking about today, inefficiency, edge, alpha generation, and I think you said the magic word, something like repeatable or consistent alpha generation. And to me, your career trajectory, it’s already interesting because you were the manager, you were finding generating the alpha or finding that inefficiency, finding that edge initially, then now you’ve switched to a funder fund where now your skill set is in analyzing that in other people and, you know, evaluating hundreds of other managers to see which ones actually can do this consistently and repeatedly.
And like you said, it’s rare, but then at some point, you’ve decided to be a manager again, right, and to do this yourself. But I think that’s really interesting to me that you kind of started at that one end of the spectrum as a manager, but then you sat in another seat where you’re kind of still a participant but you’re also observing and evaluating other…you know, kind of like you’re a player and then you’re a coach and now you’re a player again, but you can see things through the coach’s eyes. That’s kind of what I’m getting at. I think that’s a really…
Chris: That’s an excellent way to put it. I’m gonna steal that, you know, I’m gonna steal the whole player-coach, I liked that.
Andy: So, what did you really learn then, you know, as the coach, as, you know, the person evaluating other managers? Were there any real lessons that you took home from that?
Chris: There’s tons of lessons, I’m trying to think which was to really talk about…
Andy: Well, which ones I guess informed the next phase in your career? Because obviously, now you’re at Kirkland Capital Group and you’re finding that edge and finding that inefficiency, what were the kind of the key aspects that you’ve now taken with you into your current role with your current strategy in your current fund?
Chris: I really learned…one of the things that we went after at the funder fund was we tried to focus on some of your niche strategies. People that were in fragmented spaces, they couldn’t always run billions of dollars but they could run, you know, 200, 300 million, 400 million. But those small niche players with the right team and the right background and, you know, maybe it was a system that they had or a network or a previous, you know, fund that they worked with and they sort of spun out. I mean, there was a number of people I met that worked for very, very smart people that…or even, you know, Paloma funds. That Paloma fund went from 200 million to 4 billion.
Well, when all of a sudden you’re running 4 billion, they can’t do those small trades, they’re de minimis to their portfolio now, but also you can have someone who in that hedge fund spin out and they’re doing a smaller fund and now they’re doing those small niche trades. That’s what…you know, after looking at hundreds and hundreds of people, one, there’s inefficiencies out there, the market is inefficient, and there’s some smart people who can capture things. And so, active management, if you’re looking in the right areas, it does exist, it has value, and they’re worth their fees. That was one thing you definitely learned when you looked at net of fees and you’re like, “Hey, these guys, yeah, maybe making 2 and 20, but, you know, they’re still crushing it.”
Andy: So, right away, you’re talking about more niche areas of the market.
Chris: Yep.
Andy: And that makes sense to me because once something…it’s kind of like, you know, in the real estate market, for instance, thinking about like the self-storage facilities that are in like rural areas or whatever. It’s like it’s too small of an opportunity to be on the radar of some big public REITs or just some larger player, it’s almost like not worth their time, it’s not worth their opportunity cost, or they just logistically can’t, they’re just too big. And so, a lot of times in capitalism, some of these opportunities, it’s not that the opportunity is too big or too small or whatever in the abstract, it’s more like, “Hey, this is big enough for me but I know it’s too small for Amazon to care, right?” My golden rule for entrepreneurs is like, “Never compete with Amazon, once you’re competing with Amazon, you’re in for a bad day.” So, it kind of sounds like the same concept here, it’s like, “We don’t want to compete with Amazon,” whoever the equivalent is in the hedge fund…
Chris: Exactly. I say a lot, you know, you’ll run into a lot of scenarios where it’s David and Goliath. And I understand the story that David won, but in the real world, David loses a lot, he gets squashed by Goliath. And to your point, I mean, storage is not my direct trade but you hit it right on the head, where you can find these people in smaller niche places that the big money might try to aggregate at some point. So, maybe you got somebody who tries to aggregate up a bunch of these small pieces and then that sells as a portfolio to a bigger player. But there’s a lot of value creation in that trade, you know, going small, getting in there, working with very wide spreads.
And that’s what we used to just say where it’s like, you know, “How wide is the spread?” You know, how big is this opportunity or inefficiency this person is taking advantage of? And is it sustainable? Is it cyclical? And can this guy or group of people, do they have the edge to make it repeatable? Or is this just like a one-hit-wonder song? You know, they got it right for six months and now they’re gonna, you know, fall flat on their face.
Andy: And that almost sounds to me like bankroll management or something, like, you know, playing blackjack, like, you know, I might be 52-48 on an individual hand or whatever, but the point is can I do it consistently over time? Because, you know, making money within a six-month period, that’s fine, but you can’t really build a fund around that or mutual funds…
Chris: Correct, and if you’re in for, like, maybe a one-off trade that’s only six months…I mean, that would be a short trade. I don’t know what that would be specifically. But that’s great, and now you understand as an investor what you got into. But if you’re investing in a fund, you want to understand maybe their trades are a month, maybe their trades are six months, but how are they laddering these over time? And what are they creating? And how are they creating? Because I mean, I’m sorry, one of the things that…after working with a number of high net worths, the last thing they wanted to do was be in a lot of short-term trades and then find out how they’re going to deploy their money next.
I mean, especially if you got a lot of it. It’s like, “Well, I got 100 million to deploy, you know, great, I don’t want to go into a trade that’s over in a month and now I got to find out what I do with my money the next month.” I mean, that’s way too much work. So, there’s a portion of the portfolio and I hear it from a lot of, you know, large investors, “I want to be in things that I understand, I want that exposure, I want that risk in my portfolio, and I want to basically have that for an extended period of time because I understand how it relates with my other assets.” I mean, you got a lot of things moving around, it’s a lot of work.
Andy: No, totally, I mean, that’s a theme that I hear from family offices a lot. And, you know, a lot of smart people running family offices but at the same time, I feel like…and I mean this as a compliment, it probably doesn’t sound like one, but they, like, want to dumb things down. Like, why do they like multifamily? Because they understand it and you can do a direct deal and you can own a multifamily asset for 10, 15 years, you understand how it relates to the rest of the portfolio, you understand the amount of leverage being used, you understand it, right?
Chris: I totally believe in that. I have sat in front of a few managers where they tell me what they’re doing and I look at them and I go, “I’m not a dumb person, but I have no idea what you just said. So, can you dumb it down for like…talk to a first grader and I’m the first grader?” And they try to tell me again and I’m like, “Yeah, I’m still not getting it.” And usually, that’s a pretty good sign, it’s too complex…because there’s a rule we had, you know, across our entire analyst team, you know, and we were all very smart, “If you couldn’t understand what was going on, that means that that’s just how many more multiple ways it could break that you’re not going to see.”
And that’s what you always got to think, it’s like, “Well, do I really understand the risks that are being taken? And does the manager understand the risks they’re taking and can they express those risks to me, and that they understand it and they’re doing whatever they can?” And if that information cannot be made transparent, you know, as an investor, you should probably walk away. We did. We walked away from a lot of stuff where I’m like, “I’m sure you’re super smart and you got a great trade, but I just don’t understand it.”
Andy: Yeah, if you can’t…I would say if you can’t communicate the thing, then I might question how deep is your understanding of the thing. You know, there’s examples of amazing athletes who are great at something and then they are terrible coaches because they can’t explain what they’re doing. But it’s like, hey, this is my money, right? Like, if I can’t understand it, then just walk away because there’s…not a million, but there’s a lot of managers out there, there’s a lot of offerings to invest my money, so why mess with something that I don’t understand?
Well, could you bridge us then…I mean, this is all fascinating. By the way, I love these kind of, like, rules of thumb. I mean, that’s the kind of stuff I really take away that sticks with me, so thank you for sharing that rule of thumb. But bridge us, then, to your current…you’re at Kirkland Capital Group, and how are you finding inefficiency and edge, and what’s your process now? Because obviously, you’ve been…you started doing that at the beginning of your career, then you’re obviously soaking it up and evaluating others, and to me, that’s like your 10,000 hours where you’re, like, truly getting to a deep understanding of alpha. are you choosing to apply that now?
Chris: Yeah, no, let’s back up and give you a little bit of the history in 2019. My partner, and longtime friend, we actually met in martial arts of all places, and then we never really worked together. He was always in technology and real estate and I was purely in investment management.
Andy: Well, what martial art? We’ve got to start there.
Chris: I actually trained in Hung Ga, Kung Fu, Aikido. I did jujitsu, did a little bit of Shotokan, Karate, and now I train in Shuai Jiao, which is a derivative of Jeet Kune Kudo and Wing Chun.
Andy: Okay, so grappling, striking, I mean, honestly, you sound like a hedge fund guy, a little bit of…hit you from every angle. Okay, so you met your partner…
Chris: No, I’m adaptive. I adapt to whatever I need depending on what you’re gonna do. I’m malleable. So, no, we met in martial arts. But in 2019, he calls up and he goes, “You know, I’ve created a number of these different broker networks,” loan brokers who, you know, work in single-family residential, work in commercial. And he goes, “This particular set is…they’re loan brokers that work in very small balance,” which we had to say in real estate, the word small can still mean a very large number so we sort of coined microbalance. So, you know, most of the loans that we’re looking at, most of the loans that he was having shown, 200, 250, to, you know, 1.2, 1.3 million, not very big loans, not like what you’d normally see in some of the big shops where they’re writing 25, 50, 100, if not…
Andy: And so, these, right away I’m hearing stuff that’s below the radar of a larger company?
Chris: Yep.
Andy: Okay.
Chris: And so, Brock goes, “Hey, you know, the phone’s going off the hook, no one can find any money,” they’re complaining about, you know, traditional, some of the hard money loan-to-own stuff, they don’t want to work with those guys. There’s a lot of mom and pop, you know, lenders from the local areas, you know, and some of these guys do great job but these loan brokers are saying, you know, “We’re trying to find somebody who can do it a little bit more,” you know, what I sort of called institutional. And so, I said…well, Brock, he goes, “What do you want to do with this information?” I said, “It sounds like you got something here.” And he goes, “Do you think we can create a fund?”
And so, I went in, started doing my research, I called a bunch of other lending funds of all types, which I knew a bunch, and I said, “Okay, well, send me your PPMs, I just want to read through and familiarize myself with the world.” And then what I realized…and obviously, my network is the RIAs and the investment managers, they’re all, you know, clamoring…this is starting back in like 2015 and people were already like, “Hey, how am I going to get yield? How am I going to effectively create fixed income without going on out on the risk curve?” Because let’s just be honest, a lot of guys were 100% equity and they were doing equity harvesting to create income as…you know, and that was a great trade. There’s a lot of risks…
Andy: And you can’t blame them in an era of financial repression where bonds are yielding less than the inflation rate, right?
Chris: And the stock market just going up. I mean, I’m not blaming anybody, great trade, but all these guys were smart enough to realize that trade is coming to an end, we’re just not sure when. So, they were talking about it in 2015 and, of course, we all know that the final shoe dropped in ’22. But they were trying to find…I said, “You know, there’s a lot of people looking for this trade, let’s put this together, figure out how we want to do it, you already have the sourcing.” We’re going to have to advance sourcing obviously as we’re going to grow. And he has the underwriting background, I said, “Let’s…” And I started forming, you know, how I want to run this fund and it’s very different from building hedge funds and venture funds, which I’ve done.
All of a sudden, you realized, “Wait a second, I can structure this a couple of different ways, I can do the classic fee and incentive or I can do fee and there’s origination points.” There’s all kinds of different ways, you know, to skin this rabbit. And so, we had to figure out, “Well, what do I want to do next?” So, if I’m going to build something, let’s actually build something that’s going to have long legs to it so I don’t have to be changing my PPM and my documents. So, we chose the route of, “Hey, we’re going to charge management fee and the origination points will flow to the manager, so the only fees the investors see are management fees and fund expenses.” So, it’s very, very linear, very easy for them to understand, super transparent. So, that’s the path we chose…
Andy: Is it open-ended also?
Chris: Yes. So, evergreen style, ongoing. So, we put that together. And as you said, I mean, we walked into a space where, small, I tried to go get data on this microbalance space, all your big data shops were like, “Well, I really can’t get you data on the space you’re looking at, I have to get it on this much bigger space and you just have to kind of take a guess at how big you think it is.” And I was like, “Okay, that’s troubling I can’t get the data I want, but in a roundabout way, that’s a good thing. Okay, that means there’s not a lot of eyes on this space, there’s no one really using a large database to go after this space.
And I was like, “Okay, that’s a good thing in a roundabout way.” Obviously, the brokers were looking for a change, borrowers were looking for a change. And then when I went out and talked to a bunch of people, there were people who lent in this space but it wasn’t a core to their business. It wasn’t what they did every day. They had big shops, they lent big money, and, you know, “Hey, Andy, I just did a $50 million loan for you,” you come in and like, “Hey, Chris, can you lend me $1 million on this little side project I’m doing, you know, with a buddy of mine?” “Sure, why not?” That was kind of their attitude towards the space. It was like…
Andy: And these big shops, they probably have, you know, fixed costs or just overhead to even evaluate any deal where I can’t have 50k invested in due diligence and underwriting a $1 million loan, right?
Chris: It’s just not worth it. They’re too big, it’s de minimis to their portfolio, you are correct, they don’t have the operational systems and the cost efficiencies to warrant even really caring about it. It doesn’t move the needle, and that’s fine and a lot of those guys are my friends. I mean, I know guys that they’re too big and then they’re like, “Oh, you’re gonna go into that space?” And I’m like…but I also heard there’s a lifecycle in private debt with real estate. People start their fund, they operate in this tiny space, and I don’t know if it’s value to the investor they’re hunting or ego of “I want to run a big fund,” and they get big and then they go out of this space, they no longer do it.
So, we heard that from a lot of brokers as well, “All of a sudden, I had a fund who was…you know, or a group that had, you know, money ready for me to borrow, and now they’re gone.” And so, these brokers and these borrowers are constantly trying to find new people. And I said, “Well, I’m gonna put my hedge fund hat on.” When you find a fragmented space that’s got a lot of inefficiencies in it…I mean, obviously, we all understand the inefficiencies of the private debt world regulations out of Dodd-Frank in 2009-’10. I mean, that’s what created private debt and launched it to the level we see today.
Andy: Yeah, I mean, is this…broadly speaking, Chris, is this like a space that regional banks, local banks used to fill and then now they…?
Chris: If you go back in time, perhaps. But as their, you know, lending guidelines were tightened and tightened and tightened and still continue to be tightened because their cohorts keep on blowing up, which we all recently realized, and that’s actually what’s going on right now is another tightening. We’re seeing tons of loans in this little tiny space that I don’t think we’d normally see, but it actually started before the announcements of Silicon Valley Bank and Signature. We were seeing loans in November and December that I was like, “Where is this demand coming from? Have we done more marketing that I’m not aware of?” And Brock is like, “No, this is coming in.”
Andy: And Chris, from what I understand, it’s like for every dollar of capital you have that you can loan out to someone who’s qualified, there’s probably like three people, three companies, there’s just so much demand for credit even from companies that are creditworthy. Do you find that there’s like a supply and demand mismatch?
Chris: There is a total supply and demand mismatch. That is at the heart of what’s going on in this microbalance space, is there’s a lot of demand in these tertiary and secondary markets for the ability to borrow to purchase, borrow to refinance, and there’s just not enough money flowing there.
Andy: Well, is that…I mean, that in and of itself…I don’t know if I’d call that alpha, maybe it is a form of alpha, but that already gives you pricing power, right? That already gives you, I’m imagining, a couple of hundred basis points of like…well, because what happens when there’s a supply and demand imbalance, right, prices will adjust.
Chris: Correct, you have pricing power and you also have contract power. We have enough demand that we write our contract and it’s written our way and if you don’t like it…I mean, we’re pretty fair because we’re not a loan-to-own shop, we don’t have a lot of tripwires in our loan documents, so we usually don’t have a lot of pushback, but some people will…you know, “Hey, I’d rather do like a two or three,” “We do 12 months and it is what it is, take it or leave it, I don’t really need to negotiate with you.” And they usually take it because they realize, “Well, okay, I’m the one that can’t find the money, these people have it for me, I kind of have to do what they’re doing.”
Andy: So then, Chris, how do you scale that, though? Aren’t you against the same problem that every other shop that, you know, has private credit fund, that, you know, you’re filling this huge need, which, by the way, is serving a good for society, like helping provide capital to these kind of small-midsize businesses that need it? So, great product, but then actually, how do you scale it? Or is the plan just to stay small?
Chris: Well, I mean, define small. I mean, I thought you hit on the…there’s two sides to every coin. If you find something and there’s inefficiency and there is an ability to create an excess return, one of the things that I’ve found through looking at hundreds and hundreds of…it doesn’t matter, hedge funds, venture, whatever, if you have something really niche, the other side of the coin that is your limiter is your capacity. You’re not going to wake up and go run a $2 billion, $3 billion shop and stay in this niche, you just can’t do it. So, one of the things that we sort of targeted is, “Hey, we’ll go see if we can run this fund at 80 to 100 million.”
And what we’re always assessing is available money to deploy in our fund to what we call the wave that’s in our face, you know, for all you surfers out there. I mean, it’s like, “I want to wave this in front of me.” I want to understand that, “Okay, it’s going to crash on me and that’s okay,” and what that means to us is there are loans that I probably would do if I had the money but I’m not going to be able to do because I don’t have the money. So, the demand is greater than my supply. And what we’re trying to gauge as we grow, “Can we keep that wave over our head?”
Now, when that wave starts to kind of meet that equilibrium, well, then you probably have some indicator, a way to, “Okay, we might be close to our capacity, or is this something that’s in the market that created a slow in demand for lending?” You’ll have to assess that at that time. But that’s something that we’re watching very closely because when I did my assessments of the market, I kind of came up with 80 to 100. But I’ve met a lot of people that have told me, “No, no, I know guys that can do 200, 300, or 400 million in that space,” and I’m like, “Okay, I’ll see when I get there.” So, that’s sort of a live discussion but…
Andy: I see. So, I think we both agree, you know, not that I even know that much about it, but this probably doesn’t scale to a billion or more because, at that point, you’re a different organization to manage that amount of capital. So, you kind of are…you kind of choosing deliberately, “We want to be smaller, we want to be more nimble, we want to be more scrappy,” if I can use the term. I mean it as a compliment to be…
Chris: And I want to stay in that little inefficient space. I mean, there’s one thing is where I had somebody asking me about CMBS and its impact and how I thought that affected me, I’m like, “Okay, you have to understand, there’s a whole, like, giant skyscraper that is private debt, those guys are on the top floor, I’m in the basement.” I mean, there’s so many big things, and in a lot of the news you read, there may be some kind of beta impact, there may be some kind of trickle-down and we keep our eye on that. But you’d be amazed, some of the big guy problems don’t really trickle down to the guys in the tertiary markets.
You know, one of the things that people were talking about, it was like, “Wow, you know, it’s a big deal when you’ve got this cap rate move from four to six.” Totally agree, but I don’t think I’ve written a loan to anybody who was at a cap rate of four ever. I think when we were assessing valuations and what they’re putting together, I think one of the lowest cap rates we saw was a nine. Most of these guys are double digits. You know, they’ve got a big spread in their, “Hey, I’m gonna purchase this mixed-use property,” and you run through their math and we run our own models on it and we’re like, “Okay, this guy could drive, you know, a freighter through this spread.” So, me charging them, you know, in today’s world, 13 and a half or something like that, it doesn’t affect them.
Andy: Yes, so what you’re talking about, I think, is kind of like something going from mid-high risk to high risk or low-high risk to mid-high risk or however we want to call it, that’s a lot different than something going from low risk to medium risk or low risk to high risk, or, you know, use whatever verbiage you want. But you already kind of knew, like, when you’re looking at double-digit interest rates, we’re already thinking 24/7 about how things go wrong, right? Like, it’s just like the nature of underwriting in that space, so it’s like, “What changed? This is the world we live in,” versus when you’re underwriting it at a four cap, you have a totally different set of assumptions.
Chris: Correct. I mean, we’re recognizing…I mean, the one thing that we’re really after is, “Are we getting you enough money to complete your project that you say you’re going to complete?” One. “Do we believe you can get stabilized in 12 months?” Now, which is interesting is we’ve got a lot of loans that have stabilized recently but the banks are not jumping up to write loans right now. And so, this year has been a little different where, “Hey, I need an extension,” or, “Can I refinance within your own shop because I’m going to need another bridge loan?”
I mean, I was working with…unfortunately, a lot of borrowers, they kind of hang their hat on one bank and I’m like, “Okay, you should probably get more than one bank because you’re never sure, I mean…and you need to play them off each other and one guy might be, you know, favorable when another one’s not.” But we’ve had a few borrowers that, you know, they’ve done nine different properties with one bank but all of a sudden, the world’s changed, they pulled the rug a little bit, and now they’re looking at it like, “Crap, I can’t get conventional financing, you know, because the bank changes the rules in the last month,” even though maybe their DSCR rate is perfectly fine. So, I mean, from our standpoint, we’re actually loving it because we’re putting loans out at risk-reward levels that we’ve never seen before.
Andy: Because it’s like you’re the only guy showing up on the football field, right? It’s like, “Hey, free Super Bowl ring, you just got to show up on this football field at noon,” and no one else is showing up.
Chris: No one shows up, so when they hand the ball to you, you just run down the field and score the touchdown, yes.
Andy: Chris, I just love that, it’s so refreshingly honest. I mean, you’re a super sharp guy, I can tell just from our conversation and from your career, you’re a super sharp guy. But your game plan, you know, it’s not predicated on some…like you said, some idea that I can’t even understand because it’s so esoteric or complicated or whatever. You’re playing in this space where banks aren’t playing that’s too small for some of these larger institutional players, it’s fairly simple. When you operate in that space, there’s so much demand for your product, you have extreme pricing power. It doesn’t mean you’re taking advantage of people but as you said, when you issue someone a term sheet or whatever it’s called, you know, “Here’s the contract, take it or leave it, you know, not to be a jerk but if you don’t want this loan, there’s three guys standing behind you who do want it.”
Chris: And you hit it right on the nose. I mean, it’s like we even have problems where we have to be very upfront with borrowers like, “Hey, you need to get your paperwork and really be serious about this because we have multiple people coming up.” And it has happened where a guy came in later who wanted money, “Yeah, you came in first but we don’t run chronologically, if this guy is on it and he gets it, he uses the money that would have been gone for your loan because we don’t have endless money.” I mean, we’re relatively small, you know, we had to…we launched in January of 2020, so that was really fun.
You know, Brock, not coming from the hedge fund world or any kind of fund world, we had, you know, some great conversations of like, “Well, hold on to your britches and pull up your suspenders because this is gonna get really interesting.” You know, we’re launching in a left-tail event, but I truly believe we had a product that people desired and it turned out right. So, we bootstrapped it. I mean, we put our own money in and we just started writing debt, and our first debt was April of 2020. I mean, we were kind of dealing with anchors and investors not coming in in March, you know, totally expected the phone calls when the guy calls and he says…you know, I said, “You’re not coming in,” he goes, “How do you know that?” And I go, “No one calls in the middle of a left-tail event with good news, nobody.”
So, yeah, we’ve managed through that but, I mean, you had the right product, you’re in a little niche space, and you just have the demand, you know? And a lot of that demand and a lot of building that network of sourcing…I mean, this is Brock’s way of doing. I mean, he’s done this before. I mean, he makes it look easy but, I mean, you know, it’s a lot of work because we really…we want to align everybody. Obviously, we want to be super transparent, we want to align with our investors, but we want to align all the way down of the chain to the borrower.
I’m not trying to take your property. Yeah, if you screw up, I mean, unfortunately, I gotta protect my investors, so I’m gonna have to foreclose on you but we will do a lot to help you out. And then we’re even aligned with, you know, the brokers. You know, Brock was telling me stories about like, “Hey, brokers sometimes don’t get paid.” So, we embed that entire process into one transaction so that everybody who did the work, everyone who got the trade done gets paid, full stop. And so, you know, trying to maintain that alignment all the way from the borrower through the broker to us to the investor, I mean, it’s a lot of work but, I don’t know, I think it pays dividends oftentimes.
Andy: Totally, it’s long-term thinking, long-term philosophy, I 100% agree. And we’re almost out of time, Chris, but I wanted to ask…so this is the Kirkland Income Fund, I wanted to ask, you know, who are your typical investors? What’s the investment minimum?
Chris: Investment minimum is 100,000. Typical investors, we’re a 506c exemption, so everyone has to be accredited but that encompasses a lot of, you know, high net worth, your ultra-high net worth, small family offices, some multifamily offices that we’re talking to. And I think after three years of business and the size we’re at, I mean, we’ve had one RIA come in and we’re talking to multiple more. So, as we continue to match, you know, the say and the do and the numbers are coming in and obviously, people are recognizing the opportunity set within this little niche, you know, they also love the idea that we’re putting up some amazing numbers and we’re not using any leverage yet.
So, those are our base investors. And it’s kind of shifting to some bigger investors a little bit more on the institutional side but, you know, we’re ready for that. I mean, we already put ourselves on Schwab’s platform, Fidelity’s platform, TD Ameritrade, so it’s like, you know, wherever you need us to be…I mean, operationally, just because of my background, I’ve kind of built this little tiny institutional sort of class fund, you know, we have all the bells and whistles, we just don’t need to use them all the time.
Andy: No, I love that. And, you know, I’m not surprised that, you know, you’re having success, both with individual high net worth investors, family offices, now all the way up in institutions, because I say, my quote, “Income never goes out of style,” right? And I think in today’s environment, with some of the eye-popping yields in private credit that are still very well underwritten, that still have a very strong collateral margin of safety, it’s just a very attractive product right now. I have to say there’s a huge interest in it, a huge appetite for it from our audience. I mean, I talk with a lot of listeners, viewers, folks that attend our events, there’s just a huge appetite for this sort of yield…
Chris: Yeah, and there’s lots of different forms. I mean, obviously, we’re doing the private credit backed by real estate but there’s a lot of people looking for income and there’s a lot of ways to obtain it and it just depends on what your risk appetite is. You know, I know some people in venture debt that they’re looking at some open field to play with because, you know, the king fell off to the throne, and so now people are like, “Hey, how do I get in there as a private lender and who do I talk to,” that I never would have been able to talk to because, you know, you always had the big venture-related banks in the way. So, I mean, there’s lots of opportunity out there and, you know, I wish all those guys good luck. It’s not what I do but I know that they’ve definitely got some opportunity.
Andy: Totally, and, you know, nothing against banks but I love entrepreneurs stepping in to fill the void, really just entrepreneurs being entrepreneurial and helping other entrepreneurs. To me, you know, it’s one of the best parts about our country and, you know, seeing…even times like this, we’re living in interesting times, but seeing how private credit is kind of coming in to fill in the gap with 506c funds and other sorts of products, to me, it’s really cool. It serves a larger purpose in our society, it helps our economy, it helps everyday people, so I love it. And that being said, Chris, where can our audience of family offices and high net-worth investors go to learn more about Kirkland Capital Group?
Chris: Certainly, you can go to our website, which is just, you know, www.kirklandcapitalgroup.com. That’ll get you introduced to all that. You can obviously find me on LinkedIn. I know Carsley doesn’t sound like a terribly rare name, but it is. So, if you type in “Carsley,” you’ll definitely see my picture with all my, you know, CFA, CAIA, and everything else. Reach out to me, let me know how you heard and everything else because I do get pinged a lot, so just let me know, “Hey, I was listening to Andy’s podcast and love to connect,” love to talk to you about whatever you want to talk about.
Andy: Absolutely, and I’ll be sure to link those in our show notes as well. Chris, thanks again for joining the show today and sharing your insights.
Chris: Yeah, thank you, Andy.
