Transcript
0:04 Today's Animal Spirits is brought to you by Teucrium. Looking to diversify your portfolio beyond stocks and bonds? Commodities are getting more and more attention as we enter 2026. Teucrium's agricultural ETFs offer a way to access the futures prices of essential crops. These funds may help manage inflation risk and add diversification to your portfolio. Ask your financial advisor or explore Teucrium ETFs on your own. Visit teucrium.com. Click the link in the show notes for more. >> [music] >> Welcome to Animal Spirits with Michael and Ben. We're live from Miami.
0:39 >> That's right, Ben. It is I don't know what time it is. It's the afternoon. We recorded a live Animal Spirits at 11:45 a.m. And we tried to do something different this time. We did some AI stuff. Listener emails sparked that conversation. Listener emails sparked a roast. Ben and I roasted each other. So this guy told me >> [music] >> that I say What do I say a lot? >> Anyhow. Anyhow. And I said, "You know what? Let's roast each other." I don't know that I say anyhow, but I take his word for it. I believe it. Um and I thought I thought the jokes were okay. I mean, listen, we're not professional comedians, obviously. Ben's certainly not. Um and I'm told So we couldn't hear it and we couldn't hear it on stage. So it was like pretty awkward. It's It felt like they landed like with a thud. But apparently, there were some laughs. We just couldn't hear it.
1:21 >> Yeah, the wind just carried them away. >> Yeah, it was the wind. It was It wasn't It wasn't our jokes. I blame the wind. So anyway, we're doing an intro because um it's Monday and last night at dinner the futures market opened and the only thing that people cared about was um crude oil futures. We're up 27%. And the S&P was down 2.2% and I'm sitting with uh friend of the show, Dan Ives. And I said to Dan, and this is true. You weren't there, but trust me, people can verify it. I said to Dan, Bitcoin's flat.
1:54 Like not to I'm obviously I'm just talking about the market. If if Bitcoin is down 8% and the S&P is down 2 I'd be like oh So you weren't worried? Not that I wasn't worried. I was worried. Like I you know I'm worried. >> Everyone on the table is kind of quietly freaking out like oh my gosh this this could be bad. >> Not me. Dan was there. Alex was there. I I have I have witnesses. Um anyway the market crude is now flat on the day.
2:15 Um the S&P has Where's the S&P? Uh futures are flatish down 30 basis points. I uh listen I I feel like the market can only take so much. Like at some point one of these punches will land. Like it just feels like they they're just we're very vulnerable. There's giving every excuse for the market to sell. It's like why not already? Why does the market keep rebounding? >> the economy. People just won't >> It's very bizarre. It's very bizarre that the buyers just keep on stepping in. Again I think that the more this goes on like we had a chart last week on the show on TCAF that showed 1% intraday bullish reversals.
2:52 1% intraday reversals are bullish. Obviously, right? Okay. But not if they keep happening in succession. So if you get a down 1% day that closes green and it happens for the first time in in a 3-month period historically that's very bullish, right? It's a sign that buyers are stepping in. The fear is overblown. But the more of those you start to stack up like eventually the market breaks. And you saw that in the previous breaks I'm not going to name which names cuz it which breaks is it the previous the particular breaks don't matter. But the market can only take so much. So we need to find stable footing. I'm happy that the markets are flat. I'm happy that the VIX came in that crude oil is flat. But my god like it's So give the bulls credit but how much can they withstand?
3:34 It's like Rocky 4. He's When all the movement >> did what did Ivan Drago say? He's made of iron? Yeah. >> is made of iron. It seems like it because all the movement is happening after hours when there's no liquidity and then the market opens and things are fine. Yeah. Bizarre. Anyway, we didn't do any market stuff on the show this week. Um so we couldn't like not talk about it cuz it was a Yeah, but we had two interviews.
3:55 We had Michael Kitces come on who talked about AI at our dinner last night. We had to bring him on the show cuz it was so compelling I thought about is is AI going to be the extinction level event for advisors? And then we talked about to Phil Huber about private credit. So, we're covering everything here. And then the roast. And then we roast each other. Duncan's going to have to do a scoreboard to see who won.
4:13 I don't know who won the roast. It was pretty even I think. Duncan says it was a tie. Um, all right, so >> baby. As always, thank you guys for listening. Personal emails, personal responses, we'll see you in the inbox. How's everybody [music] feeling? Good? All right. So, the past couple [music] of live Animal Spirits that we've done at Future Proof, whether it be here or California, I would say like B minus, like hit or miss, touch and go, so to speak. In our defense, last year >> [music] >> we did Animal Spirits live at 8:45 a.m.
4:49 after your 40th birthday party. >> Yeah, not not great planning. Although, we did get a gem out of that. That was the this guy there he is. I'm sure you guys remember. That was that landed. I see a nod. There we go. Okay. All right, so here's what we're going to do this time. We're going to change it up a little bit, make our lives easier, hopefully get a few chuckles, make this smoother for everybody. We're going to do some AI stuff. We're going to bring Michael Kitces out to engage the audience and us and give us his his take on where we're going.
5:15 We're going to bring out a surprise guest and then Ben and I are going to roast each other. Okay? All right? Cool? All right. Cool. All right. Okay, here we go. So, I got an email. We got an email a couple weeks back. Hey guys, regarding the effect of AI on jobs, one area I think you discussed briefly is how AI will affect financial advisors. I've been doing some experimenting by taking questions that you and other online financial personalities answer and asking various AIs. Its answers are very good, more thorough and often better than the human {quote} experts {quote}. Okay. Um provided for the exact same questions.
5:55 Not only that, but I can import every financial document, my personal information, my feelings about risk or market downturns, and any other thoughts I have for the AI to tailor an investment exactly for me instantly. I can then ask questions um about anything and everything further. I can have it adjusted and recalibrated whenever I want in an instant. It shows expertise in seemingly every area. Uh retirement withdrawals, tax implications, inheritance, etc. >> Clearly AI didn't help this guy summarize his email better. I Yeah, seriously. I'm almost done. Um I know you'll say people want face-to-face human interaction, and I'm not trying to be a dick, but financial advice seems like the perfect prey for AI to take over almost immediately.
6:42 Listen, you had this freak out five or six months ago, and you called me in the morning and you were like, had a hot sweat, and you were like, "What if What if AI really does disrupt financial advisors?" And I think there's a lot of people who are having that existential worry right now. Yeah. So, here's I think where I am today, and I'll probably change my mind 10 times between now and next week. But the There have This person is not your client. I mean, obviously, right?
7:07 And we are getting these questions from prospective clients. I'm sure everybody in this room is, too. Um whether they're curious or pointed, like, why would I use you or >> How do you Where do you think this industry is going? And here's where I am today. There have always been do-it-yourselfers, right? We've all spoken to them. Most of the time they don't become a client, and if they do, it's like a it's it's it's difficult for them to take their hand off the wheel. There are always those sort of people, and the tools that are available to them, it's true, are incredible. And doing a lot of the work that traditionally financial advisors would have done or do do.
7:42 I said do do. Um and uh so it is I think going to get incrementally harder because there will now be more potential do-it-yourselfers. Okay. You could say that about anything. So for example, I can go on YouTube and I can figure out step-by-step how to do anything. How to fix my sink. I will never fix my sink. Ever. Ever ever ever. Because people who value their time and are not that sort of like brain to import their documents, whatever, they're going to pay somebody for it. And that's never ever ever going to change.
8:24 Wealthy people aren't going to trust robots. And that's kind of where I fall on this. Not yet. I mean, we've got a couple of years. >> So So we had dinner last night and we we had a big discussion at the table about it. And Michael Kitces gave a resounding no. Everyone needs to settle down a little bit. So I said, "All right, you're coming on the stage to talk about us and make the advisors of the world feel better." So why don't we bring him out? Let's hear his take. Let's go, Michael.
8:51 >> [music] >> Michael, we were talking last night and you kind of said, "You guys are a growing firm. What's your biggest issue? Like what's your bottleneck? What's your roadblock?" And I said, "Well, we're Since I've joined the firm, we've gone from seven people to almost 90." And you said, "So what's what are you doing now?" And he said, "Managing people." And you said, "Is AI going to help you manage people better?" And I don't think that job is going away for AI. So maybe you could just give your take that you gave me last night about like why people need to settle down about this.
9:23 Oh, I mean, there there like there's so many parts that I have a challenge to to sort of this like AI is a threat narrative. I mean, I start right like very much where Michael, where you did. And just there's always been do-it-yourselfers. They don't hire us. They never hire us. I mean, I'm just I was listening as you were as you were reading the email like, I trusted all the different AI platforms. I ran all the stuff against all of them. I have all my financial information sorted out in documents and file folders, which I uploaded to each of them. And I read through each of the all the different analysis like, my goodness, that sounds like that took a lot of time. I guess you must like really like doing that. That's awesome.
9:59 You probably don't want to delegate that to an advisor. >> Correct. Because, you know what people who don't like handling all that stuff do? They're like, that sounds like an awful lot of [ __ ] I'm just going to hire an advisor and have them do that for me because I don't want to I don't want to do that or I don't want to deal with that or I could do that at one point, but now my life is more complex and I don't know if I really want to keep doing that. So, what about the idea that okay, fine.
10:20 The people who had wealth management advisors are probably going to still go to them. The people who had DIYers, maybe there's more of them. But, what about the idea that okay, we won't need to hire as many advisors though. The young people are never going to have a job and maybe you could go up down that road. >> I I am in that camp for the record. I think the power planner role is basically done. So, So, I always like I like to look at these things through the like the lens of history, right?
10:44 History never repeats, but it often rhymes and gives us a lot of of guidance. So, I look at this in the context of of my own career. So, the second firm I was at 25 years ago was an independent broker-dealer office, three advisors, about $1.3 million of GDC, which back then like that was a a pretty good like sizable, very successful advisory firm practice. And and they had eight support staff for the three advisors. So, we had this wonderful woman named Betty. Betty's primary job was to collect all the mail every day, open every client envelope, and pull all the paper statements so that she could file them every single client's file folders that we would be certain that we had up-to-date information for the next client meeting.
11:29 She would also check to make sure there were any paper checks in there cuz heaven forbid you hold on to one of those for more than 24 hours, for anyone who's in the business. And then, uh she would then prepare um Morningstar Principia Pro reports of all of the mutual fund holdings in our clients' portfolios, so that we could have review meetings with them. So, Betty's job doesn't exist anymore. Right? Betty's job is Orion, or Black Diamond, or uh one of the other portfolio management software platforms that pulls all the information, money moves electronically, um statements are continuously updated.
12:07 Frankly, it gives much better performance reporting than Betty did. I mean, we didn't actually report on a client's portfolio performance. We pulled the report for each fund in their uh portfolio and showed them fund reports, cuz we actually like didn't even have tools to do the calculation, and Betty was not doing that kind of math. So, Betty's job is gone, right? We can say like it got technology'd away. So, then let me reflect on that for a moment. Um First of all, if I adjust for inflation, Orion for three advisors today costs more than Betty's salary used to.
12:41 So, we didn't save any money on this technology transition. We have I would argue much better end result to the client, like the the the end experience for the client is much better. The portfolio management process is better. The there's like all sorts of quality improvements here, but we didn't we didn't make any margin. We didn't save any dollars directly. And when I look at that on like a whole long list of changes that had played out, if you then go back and just look at like industry benchmarking studies back then, cuz uh this was when Mark Tibergien and Moss Adams like just started coming out with with industry benchmarking studies, and the median and back then, like the median advisory firm had was charging 1% fees, and today they charge 1% fees. The median advisory firm had about a 40% overhead expense ratio, plus or minus five points. Today, the median advisory firm is a 40% overhead expense ratio plus or minus five points. The median advisory firm had about 30% margin and the median advisory firm today is about 30% margin. So, nothing changed. Like, I mean, we weren't even using the internet. I mean, it was technically 2001 we had the internet, but like no software ran on it yet in our business. Like, we had the internet, the smartphone, robo, AI, like all of this technology automation, and we charge the same fee for the same overhead expense ratios, for the same for the same margin. We did slightly change staffing.
14:04 A three advisor firm today does not have eight support staff. So, we did shift some of the jobs a little bit, but in general, the jobs rotated up. Like, Betty was pure admin. We have fewer admin now cuz we actually have more paraplanners and associate advisors doing all of this like higher-level, more complex work than what Betty was doing. >> do you think all the note-taking and the email stuff that's going to do for you, is that going to give advisors at least more efficiency to have more clients?
14:30 No. Well, so So, if I look back to like the firm of 25 years ago, it's like same same same advisory fee, same overhead expense ratio, same average profit margin. Almost every metric of a firm today and a firm 25 to 30 years ago is the same, except one major metric is really materially different. Average client load. And it's dropped massively. I mean, for anybody who remembers back in the business 20 30 years ago, I mean, like everyone had like 200 to 300-plus clients. The The first firm I was at, there was like a guy who'd been there for 30 years and he had two offices. His office and his client file office. His client file office was the bigger of the two offices cuz the dude had like 1,500 clients, which was basically 1,500 people he had ever met and sold a product to over the preceding 30 years, and we called them clients. But, the only thing that's actually shifted is client loads went down.
15:24 >> Because we do more services. Because we do more services. Because we go deeper, right? Average Average revenue per client went up. We offer a deeper value proposition than what we did because the technology lets us go deeper into more and be more awesome for clients. But to me, I mean it's just it's the striking thing when you look at the landscape. The The only material thing that's changed in our industry in 30 years of technology evolution, it's not fees, it's not margins, it's not overhead cost, it's client loads, and they went down.
15:51 Very steadily in a straight line for like all the years of the benchmarking data. They didn't They didn't go up. Because when we get the time I mean, for most advisors you uh uh early on any any clients or revenue you can get is good cuz you're like just trying to make it and survive. And then eventually you get like you get past survival stage, you get past like Maslow's hierarchy of like you know security survival needs.
16:17 >> [snorts] >> And some other priorities start kicking in. You say like I I make pretty good money now. What do I you know, okay, I got some tech it saved me a little bit more time. What do I want to do? Like A, go get another client. B, go to my kid's soccer game. B. Right? It's always B. Yeah. >> Yeah. So what happens even as technology starts to lift up, working hours go down slightly once advisors are at a crucial crucial level of income that they feel comfortable and safe. Or if you're like, no actually like I would do want to work a certain number of hours. I'm enjoying the work that I'm doing. I don't go get another client. I go deeper with the client I've got. Like there's always some clients like I would love to be more proactive with some of my top clients. I know I should be calling them more and doing more things for them and I'm kind of time constrained because of all the other stuff. So what do I do if I do actually manage to free up a new moment? I don't go get a new client once I'm at a comfortable level. I go deeper with the clients that I've got. All right. So uh last question, we've got 2 minutes for this. McKinsey did a study recently about the future of AI and the advisors and the work etc. And one of the things that they listed, I actually thought it was a decent report, was that advisors are going to become more life coaches, offer all sorts of other adjacent things. That was the one thing that I said, "I don't know that I believe that part of it."
17:32 What was your thought on that? And if there's anything else in the report that you wanted to rip apart, feel free. I I do think directionally it's probably right. Um I mean, just life coach is kind of a loaded term. There's a lot There's a lot to that. But the I mean, the general arc is clearly more services. I mean, we're already seeing it, right? The By our Kitces research data, like one in six advisory firms has brought tax prep in house for at least some subset of their clients. Like, that was no one 10 years ago unless you actually came from a CPA firm and just already did that for your clients. We're going deeper on tax. We're going deeper on estate.
18:13 You know, CFP marks used to be like a special differentiating factor, and now that's basically like a mandatory expectation for young people coming in today. So, that's becoming a new floor, and then you're supposed to go and get deeper beyond that. So, the the increasing depth and the increasing service expansion I think is real. If you want to get kind of you know, a little bit meta to it all. Okay, when we live like lives of one When we live lives of wonderful financial abundance because AI is making the world better and more rich, and then we're just trying to figure out what the hell do we do with our lives and purpose on Earth when I don't necessarily need jobs in the same way and money is abundant, what do I do? I'm like, I guess I have like a lot of life life coaching questions at this point about [laughter] what the heck is my purpose on Earth. More More generally, I mean, I think a lot of us have had experiences that there comes a point at least for a subset of clients where if they're still in accumulation mode, they're trying to get to a certain accumulation, and if they get to a point where where feel like they're financially safe and sufficient, other other questions start cropping up about what am I doing, where do I want to spend my time? It's why retirees often have crises of purpose and meaning. Uh what do I do if I'm no longer attached to work that was meaningful for me? So that that dynamic still exists and I think continues and if we make the other stuff simpler and easier, I do think directionally we probably spend more more time there, but I don't know if that means like full-on life coach. That's that's that has some other All right, this was awesome. Thank you for doing this. Your your uh report that you did on the stage this morning was fantastic. For people that are listening who didn't were weren't able to be here, is that available?
19:51 >> yeah, yeah, it's it's uh it's available online. So if you text advisor tech all in word like advisor tech to What was it? 33777? Uh you should get it. If for some reason the text didn't get sent doesn't work, kitses.com/wellbeing Okay. uh has the the printout of the full So advisor tech to 3377 33777 Okay. Okay. All right, Michael, thank you. Awesome. My pleasure. Thank you. Do you feel better? Uh Nicole um Nicole and Nicole, do I feel better? Uh I feel great. I mean, we're in Miami.
20:20 Oh, the AI stuff. >> Um How are you doing today? Do you feel better about the advisor space? Because there are a lot of AI pilled people, I'm not going to mention any names, Chris, who think that no, this really is going to change the world and it's going to make everyone more efficient and we're not going to need advisors and >> You know, I think Michael's point this morning about when advisors get to a critical mass and they're serving 80 households and a lot of their um redundancies are stripped away and now now they have all this time, they don't want 50 more clients.
20:49 Like that nobody wants seven meetings. It's as Michael said, it is exhausting. It is draining. You have the time back and you're going to do other things with it. So I I feel great about our space. I think this is a wonderful industry, a wonderful career. The the clients need us, they value us. I don't think that they're looking to replace us and if they are, then fine. They're not your client anyway, or you're not doing what they need. And do better.
21:10 >> for everyone, and I think the people who don't use an advisor, they're going to have a better experience. I think so, too. Okay. So, we're going to talk about private credit today. It's been in the news a lot. And I guess let's just start here. Phil, Wait, we got to start with the fact that we a middle-aged man came out to the wrestling music. >> Yeah, I did. >> [laughter] >> Phil, what did you do?
21:30 What did I? I didn't do anything. >> did you do? >> [laughter] >> Causing all these headlines. How busy have you been lately? Busier than normal, I would say. So, let's start here. >> Yeah. What do you think >> Introduce Phil for the people. >> sorry. Phil is a good friend of mine. I just feel like everybody is in my inside my brain. I guess that's not true. So, Phil is the something something. What is your title?
21:48 >> Uh head of portfolio solutions. All right. So, Phil is head of portfolio solutions at Cliffwater. And Cliffwater is the um OG of private credit, the first index creator, correct? Correct. >> Biggest allocator, biggest I mean, 30 something billion dollar portfolio. Bigger? Yeah, about uh almost 40 billion across uh two two credit funds. And yeah, we've been allocating in the space for almost 20 years now. All right. So, if advisors are allocating to private credit, there's a very good chance that they're using Cliffwater. Not to brag, right? Okay.
22:22 So, there's been a lot of smoke and um for a lot of different reasons. What do you think is What is the thing that you see repeated over and over by the media who is just dying for a meltdown? Like they dying for a meltdown. What is the one thing that you see you're like, "THAT IS BULLSHIT." LIKE THAT PART IS NOT TRUE. >> WAIT, what did you do to the Financial Times? >> There's no one thing. There's many things, and we'll talk about all them.
22:44 The the summation of what they're all trying to Yeah, the summation they're all trying to arrive at is private credit is in a bubble. And much in the same way Michael Kitces just hopefully alleviated any concerns people have of AI uh uh you know, uh making advisors obsolete. Uh I'm here to say that private credit is not in a bubble. A lot of what you've been reading over the past 6 months or so is conflating a variety of different issues that have nothing to do with the actual health of the private credit ecosystem. And we can touch on a number of those. What I'll say is that this didn't start 6 months ago. There has been a steady negative drumbeat in the financial press around private credit for at least the last 6 years. And I think in the last 6 months it's been turned up to 11.
23:25 Why is that? Because well, you have an asset class that well, we know it's been around for over two decades. It's relatively new to a lot of investors, advisors that given the growth that it's had over the past 5 plus years. And so naturally it attracts a lot of attention and I think the FT and Bloomberg and financial press broadly and increasingly a lot of Substackers have come to the correct conclusion that if you write a negative headline or a negative story about private credit You know you know >> you'll get likes and clicks etc. People see the yield and they go it can't be real. There's no way that it's got to be fake. That can't There's no way the math works out. So I think I think people have been skeptical from the start as they learned about this asset class.
24:01 Part of the position we sit in and having the benefit of this index that we have that has history dating back to 2004 is that we can measure how the asset class has performed over two decades, over many different market and economic cycles and have an understanding of okay, what have total returns been, what is income been, what have realized credit losses been, historical default levels etc. So we have a good base rate to go off of and I think what you're seeing now is anytime there's a write-down or a default the article wants to attach that to oh jeez, this thing is blowing up. There's a canary in the coal mine. There's cockroaches.
24:35 To level set with everybody, you have an asset class, the middle market that has over 10,000 unique borrowers in it today. If you add to that another call it maybe 1,400 or so borrowers in the broadly syndicated loan market you and you use a historical default rate which has been the average over 20 years of about 2%. Guess what? You should probably expect over 200 defaults in a given year. Obviously there's going to be years where there's more, years where there's less. Right now, defaults are below average still, which you wouldn't know better reading the headlines. And so, if you try to treat every default as if it's a something that's a harbinger of the next financial crisis, I think you're going to be disappointed. It is weird like the the negative momentum is feeding on itself.
25:13 And you're seeing massive redemptions. You saw it at at BlackRock this week. You saw it at Blackstone. And it's it's just very bizarre because the equity of these companies are getting demolished. All of the publicly traded BDCs are trading at a severe negative discount to their NAV. So, there is I think the primary concern is a lot of these portfolios are heavily based in software. BCRED was 26% and the nature of the borrower, yeah, the defaults look fine today, the fundamentals of the portfolio look fine today, but clients are worried about what is it going to look like over the next five years. So, I think that's 100% valid. I think they should be worried. I also think though that a lot of the let's use the publicly traded markets as a as a benchmark, they're pricing it in.
26:06 So, it's weird like they're pricing in some of the worst potential scenarios that we've ever seen. And we haven't seen it yet and it's just like a bizarre sort of environment. Is is there anything is is any of the stuff that people reporting that like the one people keep saying is, "Oh my gosh, 25% of the loans are software related." And that's a big thing I think like is any of it valid? The criticism is any of it valid?
26:27 >> Yeah, one more thing, Phil. No, but because those negative headlines about the software defaults like it's not going to stop, Phil, today. Phil's having to defend himself more than Daryl Hannah for love story. Any JFK Jr. people out there? Anyway. But it's it's >> But it's But it's But it's going to these negative headlines about the AI stuff like that's going to continue and it's just going to continue to scare people. Yeah. So, I'll I'll try to tackle it a few ways. So, we'll start with software. It's the the technology probably the largest sector of the index that we have the index we see it's the biggest. Why is it the biggest? Well, historically it's had it's been the sector with the lowest default rates. There's a reason why lenders have liked it. Obviously, the software as a category is going through a period of transition. I'm not of the mind that software is not a going concern. You know the Winnie the Pooh meme? Yeah.
27:10 Getting [ __ ] wrecked. Period of transition. AI AI will absolutely disrupt certain software companies and many will thrive and utilize it to their advantage. What obviously that re-rating has already taken place in the public stocks that have been wrecked. Uh senior lenders to companies are in a very different position than the equity in front of them. Often what gets left out of a lot of these private credit related headlines is any mention of private equity which is where most of this financing is going to private equity back companies who are in the first loss position. And so if you are a a private credit bear and you're not a equal if not more bear of private equity, you're not being entirely forthcoming or truthful.
27:49 >> that is an interesting point because KKR, all of these names that are getting destroyed, it's always like the private credit headline. It's like, wait a minute. KKR is like the private equity shop and the equity of KKR is getting smothered. Right. And and so I think what's happened software re-rating like as a lender to these businesses, you don't benefit from the growth. You you're you're you're lending for yield. You're not necessarily in in need of the upside long term and while the terminal values of a lot of these businesses are challenged, hence why they're now being valued lower and they're not being treated like these low risk annuities.
28:25 Um you're not you're not you're not lending it to them on a perpetual basis. And you near term cash flows are not necessarily at risk. And so to be paid back at par as a lender requires a pretty um aggressive set of assumptions. Let me ask you this. So that's a this is a very important part of the story. So the the rates are floating, right? So when rates went up in 2022 and these companies were able to withstand it, everybody loved it. No defaults, my bonds got killed, the loans paid me high yields, and everything was copacetic, all great. Um but the duration of some of these loans, so let's say that like it's it's 5 years, whatever, right? You owe us money, you pay us back, and then good.
29:05 But where does the where does the demand I guess who knows? Where does the demand for loans come after that? And if these companies are healthy today, I think that's what people are worried about. It's like, "Yeah, the loans look fine The fundamentals look fine today, but I'm worried about what is this middle market If Salesforce is down 60%, what is this middle market software company going to be like in 3 years? How are they going to pay us back?
29:26 >> Again, it's going to vary by company, and they'll have to, you know, again, they're they're going to see what happens when they need to go refinance. The loans themselves historically in this asset class, while they might be 5 to 7 years in in term, typically they have an effective maturity of 3 or 4 years. So, what part of what also gets left out of a lot of these conversations is relative to say private equity or real estate or venture capital, there's a lot more organic liquidity in this asset class. Typically, most you know, if you if you have an average effective maturity of 3 4 years, but you know, about a 30-year portfolio is repaying on an annual basis. So, you have an like a natural source of liquidity just from maturing loans. So, this asset class relative to I would say any private market asset class is the best suited for semi-liquid evergreen structures.
30:10 Is is there any credence to the fact that listen, there's so much more money that's in this asset class now, and there just because of it there had to be poor poor lending standards for some of these funds. Maybe not you, but maybe other funds like they have have And those are the ones that are going to blow up and they're going to go, "See, look." That's not new. There has always been a dispersion of of really good lenders and not so great lenders. That's not new. There's over 300 direct lenders in the marketplace. We've been again, we've known all of them for years now.
30:37 We have a ABC rating system for lenders, and we think about 50 of that 300-plus kind of meet our A-rated standards. So, there's always going to be a bifurcation of you know, the better the better performers and the better lenders and the ones that run into issues. And so, I think again a credit cycle will expose some of those weaker lenders that maybe >> Don't have those anymore. Credit cycles We've literally had >> Well, that's the other thing. Again, again, like there's a difference between a bubble and a credit cycle. And I think this term bubble gets thrown around so much this these days. And to me, a bubble implies, you know, valuations or prices that make no sense for any future, you know, return expectation.
31:10 When you actually look at where spreads are today both on an absolute basis and in relation to broadly syndicated loans, they're tighter than they were a couple years ago, but they're not at levels that would indicate okay, you're not being compensated for the risk that you're taking. Here's the problem with this asset class. And it's it's not the loans per se. It's the people that are buying them and the people that are selling them. Because the advisors might understand exactly what's going on, but the client is going to see the headlines. And they're just going to say, I don't care. Like And the advice the advisor's not The advisor's not going to like stand up for private credit. It's like, fine. Let's let's get our money back before everybody else wants it. And that's one of the fears that I have is that it's just going to be this thing that is a slow death by a thousand cuts for lack of a better word.
32:00 The the the constraints on liquidity in these vehicles and again, it varies. It's a little bit different for BDCs than it is for interval funds versus others, etc. Those are there for the benefit of remaining shareholders. And as much as as redemptions are a bit elevated today versus history, the vast majority of investors still have conviction in the asset class and like having these guardrails in place so that a fund is not necessarily forced in a position where they need to sell illiquid assets to meet redemptions. A big part of managing these vehicles effectively is having a thoughtful liquidity and liability management program implemented. Some do it much better than others. You do I think there's a perception out there that to meet redemptions, these managers have to sell private loans to meet investor redemptions. The ones that do their best job have the last thing you want to do is ask for money when you need it. The best run evergreen structures have built out liquidity management programs that are not predicated on holding a bunch of public credit securities that they can sell at a moment's notice. It's in through building out significant revolver capacity, working with a variety of different lenders. Like each of these structures has different amounts of leverage they can incorporate the fund level. Some of that is to maybe offset fees a little bit so investors can, you know, capture more of the expected return. Another is it's a sort it's a flexible source that you can utilize in order to meet investor redemptions by tapping into the those credit facilities that most funds have.
33:24 Right, so you're not just doing a fire sale because these things are liquid, so it's harder to sell them. Right, you should be you you should know you should build the liability management program around understanding that there are going to be periods of stress, there are going to be periods of inflows slowing, outflows going up. You want to be able to withstand what are likely going to be, you know, in hindsight cyclical periods, and if you can weather those without being a force seller, you should come out the other side stronger. And I think if we're sitting here in a year, hopefully we're looking back at that this was a great proof point for the asset class and for these structures that they can and do work. Doesn't mean everyone's going to work. Again, there's going to be dispersion in terms of fund performance, but again, these mechanisms are in place for a reason. It's to protect remaining shareholders, and I think the other thing that gets tossed out in some of these articles is that if a fund has to prorate investor redemptions, the authors love to throw out, "Oh, the fund is gated. They're not letting the No, most people are getting most of their money out Right. even when funds are prorated. It's not like 100% of their their capital is trapped. That's just not not the case.
34:26 >> I have a question. So, let So, here's here's I think where I'm at with this with this asset class. If software is a third of the index, I think that a lot of these companies will have stress. >> Not a third, but go ahead. What is it? About like a little over 20%. >> Okay. So, I'm making this up. Let's say that default distress hits 10%, which is high, right? Like what what was the GFC?
34:47 12? Yeah, so here this is actually a great exercise to go through. So, we hit our index goes back to 2004. So, I I I'm going to ask a question. What would you think is the calendar year with the worst index returns? And it's not a trick question, I promise. Okay, 2009? 2008. Okay. Like as everybody would expect the GFC, the epicenter of the biggest recession and crisis we've seen in years, the index was down about 6 and 1/2% in 2008. Do you know what credit losses were in 2008?
35:14 About 60 bips. Wow. So, why why is that the case? Well, because as as much as the naysayers will try to say that all these lenders are holding every loan at par until it becomes a zero, that's not true. We see in practice that unrealized losses in loans, in other words, value is being marked down, are done so in anticipation of expected realized credit losses in the future. Often the market actually is over aggressive in marking down loans. So, what happens typically is that some some loans price for default and defaulting and there are credit losses.
35:46 A lot that were priced, if they don't turn into a realized loss, it becomes a gain. And so, the real credit losses in the crisis, that three-year period were in 2009, 2010. I think there was about 7% roughly credit losses in 2009, about 3% in 2010. Do you know what the index did in those years? It was up meaningful double digits in both those years. The don't question So, in other words, you're the the income is the consistent piece of returns, and then you have the dynamic of unrealized and realized losses. The realized losses should follow unrealized losses. In other words, like a much in the same way that a a bank has loan loss reserves, again, lenders are I think thoughtful about marking positions that are at risk accordingly, and And of them turn out to be to be realized losses, but that happens after the fact. And so >> us >> buying Blackstone right after >> Everything that guy just said is [ __ ] >> [laughter] >> So I I think when you have to have a long-term perspective in the asset class. I think what happened when when rates went up in 2022, a lot of new money flooded in, yields were at 12 plus percent, and everyone expected that to be like the baseline of what they expected returns. The reality is this is more of an 8 to 10% return asset class.
36:49 And when when yields when spreads came in, when base rates went lower, and returns weren't the same that they got, yeah, you have some capital exiting that was maybe temporary in nature and a bit more touristy. Those that really understand the long-term nature of it is that yes, you're going to not it's not always going to be sunshine and rainbows. It's still credit. There's a reason you're paid significantly higher yields than the risk-free rate, than public credit, etc. over time. So we think it's a risk that you can thoughtfully mitigate by working with great lenders and by building a maximum lead of our portfolio.
37:19 >> right. All right. All right. We get it. >> [laughter] >> We get it. Yeah. All right. So I I I don't think that in 3 years we're going to look back and be like, "Could you guys believe what we did with private credit? That was a crazy bubble." I also think that there's there's obviously smoke. Like, duh. Um I don't know if that turns into a fire. I think I'm a little bit I think I'm I'm I'm team Phil on this one. Um all right, Phil. Thank you.
37:40 >> Thanks, Phil. >> get to stand for the roast? You want You can stay. >> [laughter] >> Yeah. Maybe I can separate you two. No, I'll get off. Um all right. Okay, so here's Thanks, Phil. So in thinking about what we were going to do to to have a few chuckles, we got an email um last week and I was like, "You know what? Let's do this." So what was the email? Okay, in case no one in Michael's life is calling him out on this, I figured I would. Haven't counted the transcript, but feels like Michael has used "anyhoo" as a transition at least 15 times over the past three episodes. I didn't even notice.
38:11 >> I didn't realize I was an anyhoo guy. >> You're an anyhoo guy. So Michael said, "Yeah, let's let's roast each other." And I said, "Okay, this is like when the Eagles broke up. Um this might be the last Animal Spirits we do." Uh but we're going to I guess before we start, my I have 8-year-old twins uh George and Kate and they are big into roast battles. That's what they do at school now. They roast people and they're really not good at it, but they found out we're going to do this and they got really excited and they wrote out roast for us. So we're going to warm up the crowd a little bit by reading some of their roast. Okay?
38:38 And they roasted both of us. Oh, okay. >> This is from my son George. Michael, you're so lazy your favorite sport is sitting on a couch. That's not bad. Okay. Michael, I'll do one. Dad, you're so short you can high-five an ant. That's not bad. Um Michael, you're so broke when burglars broke into your house you had to help them look for your money. Hey. Um Dad, this is my daughter. Did you get dressed in the dark or did you do that on purpose?
39:06 That could have been both of us last night maybe. Michael, the Kate went really hard into the bald stuff. Your bald head is so shiny it looks kind of like the sun. Michael, your head hit the sun hit your head today and suddenly we got a lighthouse. And finally, both of you. Your stories are so bad not even chat GPT can understand it. All right. All right. That's All right, George and Kate. All right. Um all right, you go first.
39:32 We'll we'll do like a back and forth. >> Let me have it. Okay. All right, I'll go first. Um Okay. Sorry, sorry, sorry. By the way, comedians are safe cuz AI stinks at comedy. >> So bad, yeah. I tried it, too. Okay. >> [clears throat] >> Last night at dinner when oil spiked 27% Ben said, "Zoom out." And then asked the waiter for another Diet Pepsi. >> [laughter] >> All right. I mean the easy one I got feedback from our team. I said, "What do I roast Michael on?" And the easy one was every time we do the podcast you were on social media watching one of your 36 tabs that open. You're on Slack and you're just constantly ignoring me.
40:11 It's kind of hurtful. Um >> [laughter] >> Was there Was there a joke? That's it. Okay. Um Oh man, [snorts] my my my accent's not great. All right. The first uh the first thing that Ben bought when he opened up a brokerage account in 1994 was a target date fund. And that's not a joke. That's just literally the truth. >> No, it actually is. Sidebar, I didn't know you were actually writing jokes like you're comedian. I'm giving real things that you do. Oh, okay. All right. Go.
40:43 >> Okay, I Apparently we didn't just All right. Um You use the word ostensibly more than any human being I know. And maybe it's jealous cuz I've never been able to use that word, but you really use that word a lot. Ostensibly. Oh, yeah. Really? Yeah. 5% of people use that word. >> Chris, do I? Ostensibly. I do Okay. All right. Um All right. Ben has a new book coming out called Risk and Reward: How to Handle Market Volatility and build long-term wealth. This is his fifth book about doing nothing.
41:13 I just saved you $30 and 200 pages. >> [snorts] >> Ben has published more words about index funds than Vanguard's entire legal department. It's 20 bucks. Uh Uh All right. Um Duncan can attest to this. We when we record the show, um I I think Michael was potty trained at gunpoint because he gets up so fast to go to the bathroom in the middle >> [laughter] >> Anyway. Every once once a show. Uh All right.
41:44 All right. Um Most of you know this, Ben is a big fashion guy. He actually He looks like he was dressed He's like a male Jessie Spano today. That's not funny for the listeners, but that's how you look. Um Ben has been dollar cost averaging into JC uh into J. Crew pastels since 1997. The closest Ben gets to active management is a Stitch Fix account that delivers him a package of new clothes every month. Ben calls it buy and fold.
42:13 That sounded like an AI joke. Come on. >> Nope. Nope. That's not bad. >> [laughter] [gasps] >> Um I I'll just give a couple here. You've literally never once got a saying right. Grain of sand um or you call that a grain of Is it salt or sand? It's grain of salt. It's not a grain of sand. Um you have absolutely psychotic taste in movies. Just [laughter] the people who like the same movies as you are psychos.
42:39 Sam Roe likes my movies. Hey. Hey, Sam. >> [snorts] >> Uh all right. What got >> Um speaking of movies, Ben loves coming-of-age movies. He shares his love for the genre with Stephen Hawking. >> [laughter] >> Okay. Okay. All right. >> All right. By the way, Michael had to remove a Jeffrey Epstein joke from his list. Um let's move on from that one. Um Whenever my favorite thing Michael does is when we have a talk-your-book interview and someone comes on the screen and Michael notices that the guy on the other end is bald. His face lights up and he uses the same icebreaker every time. Nice haircut, eh?
43:15 Nice haircut. And uh And credit to you though, it works. It gets the person >> Every time. Nobody's ever said All right. Yeah. Everyone everyone smiles. Uh all right. We'll end with this. A good way good way to bookend the show. >> one more. Okay. Well, it's my end. Okay. Ben wants to ban AI, right? I Is it going to make us more depressed? Probably. I'm not quite sure what you're so afraid of. Jack Bogle discovered buy and hold 50 years ago and you still have a high-paying job.
43:48 Fair. Okay. All right. Um Last one. Thank you. Thank you. Thank you, Hamilton. Yeah. Wait. Um You a lot of times you call Chris and Josh and Barry your partner. Um and it's but you say it in a way that makes it sound like you're in a long-term committed monogamous relationship, but you're not going to actually do the vows until like all the polar bears are saved or something. Your partner My partner, Chris. It sounds like you guys [laughter] are in a relationship.
44:16 All right. That's all I got. >> [laughter] >> All right. All right. We'll do better next time. Thanks, guys. Thank you. >> [applause] >> Didn't you have an announcement to make? Oh, yeah, yeah. Whoa, whoa, whoa, whoa, whoa. Okay. Thank you, Ben. All right. So, that was just good-hearted fun, right? We're still friends? Yeah, I'm I didn't storm off the stage. We're good. Okay. So, Ben is obviously one of the best financial writers of this generation, and we are the greatest generation of financial writers. So, ostensibly one of the greatest writers of all time.
44:48 You're going to notice it now that I told you. >> Yeah, I'm never That was my last time. Um all right. So, we we started a software company called Exhibit A, where we build the charts. Chart Kitten team build the charts, and the advisors just upload their logo. You know the spiel. You get the charts in your own color. We do a chart of the week. There's 150 charts in the library. It's great stuff. One of the things that we just announced today, actually, is that this guy um is going to be writing a monthly report for the platform that you all can white-label with the platform uh to share with your clients. So, still going to be using charts, still your your labels and all the disclosure and all that good stuff, but we've had a million people over the years ask about how do you find the time? How do you do this? And now you can have them. Ben AI.
45:34 Yeah, people said I love the charts. I just want you guys to provide some commentary, too. So, that's what we're going to do. All right. Thank you, everybody. Enjoy the rest of the conference. >> [music] [music]