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- [00:00]
A
Welcome back to the hurdle rate, episode 52 for the week of March 23rd, 2026. I'm Tim Kotsman. I'm here with Jeff Walton who has been talking about digital credit versus bank of America Preferreds. I'm here with Ben Workman tweeting out the equivalent of a fact sheet on SATA. Is it SATA or SATA, Ben? SATA, SATA. Okay. And Matt Cole, who's out here tweeting that your likely bias is not being bullish enough on Bitcoin over the next 20 plus years. Strategy this morning announced a new $21 billion STRC ATM program as well as a new $21 billion MSTR ATM program and program. My reaction is what punter Jeff says a lot, which is I think we're going higher. And we also have just a lot to talk about, whether it's digital credit or maybe what we'll talk about as far as liquidity versus default events in private credit. So Jeff, your reaction to ATM programs and private credit?
- [01:07]
B
Yeah, yeah, a lot is moving and never a dull moment here in this world. Obviously we've got the war in the Middle east as well and everybody's trying to figure out what's going on. Right. Everybody's got a front row seat to what's happening on Twitter. We can see everything happening in real time. And yeah, it's a pretty wild times, but you're right. Big update from strategy this week. They've got the. They announced a $21 billion ATM on MSTR, a $21 billion ATM on STRC, and they actually scaled down the ATM that they had in place on STRK. So there was previously a 21 billion dollar ATM program on STRK and they scaled that down to 2.1 billion. I think it's become very clear that Stretch is their marquee product at the moment. I think when they initially launched Strike, they thought, this is structured Bitcoin, who wouldn't want this? And they thought there was going to be material demand for that type of product, quarterly dividend, et cetera. But as we've seen, the biggest demand has come from the monthly product with a variable interest rate being STRC and the ability to keep it at a stable or a relatively low volatility position there. So not a huge surprise. And they were running up against the, they were, they're running out of capacity on the MSTR ATM, so they've re upped that back to 21 billion. So we've got $42 billion of capacity moving forward. I think continuing to watch what they've done, I think they purchased around a thousand bitcoin this last week. It was primarily from the MSTR common stock and, and continuing to build that credit quality. And this is, this is something that we've, we've been talking about for quite a while. But I'm starting to see the market start to understand this a little bit that the product that MSTR is selling, that we are selling is digital credit. In order to sell digital credit you need a strong balance sheet. You need to build the credit quality of the balance sheet. So there's a primary focus every single week. What are you doing to increase the credit quality of your balance sheet. And if the market is open for, if the market is open for business, they will be increasing the quality of their balance sheet to sell their marquee product. So yeah, I think the market's starting to recognize that, understand it and yeah, curious to get your guys thoughts.
- [03:20]
C
It's a clear signal on where they're going. And we've known this for a while, right. They've pivoted stretches their core product. It doesn't mean that they won't continue to foster the others. But when you find product market fit in in the way that they've found with Stretch, I think you have to double down on that. We recognized when we were going through the initial assessment for what type of digital credit product should we launch, you could look back at their IPOs and you could really see what the demand was across all the products. And what was clear was they need the product that has a simple message that's easily relatable to other products that investors are used to. And Stretch has fit that bill. And the less and less volatile that product becomes, the more and more it fits that bill. And so I wasn't surprised to see them draw the capacity out of Stretch, lower that one down. It seems like they're moving away from the convertibles. They obviously want to get rid of all of the convertible bonds. It doesn't mean that Strike isn't still going to have its day.
- [04:23]
D
Right.
- [04:23]
C
If the markets were ripping and this was a bull market, that's an entirely different thing because that call option in that product becomes valuable. But what you're seeing during this style of market, right, whether you want to call it a bear market or whatever, is that people are going for stability. And that stability they're finding in Stretch, it's predictable. They know how to frame it in their mind. And I think it even exposed one of the weaknesses that are in the Strife product Which is that the price can float.
- [04:53]
D
Right.
- [04:54]
C
The price is just determined by the market. You're not trying to peg it to anything. And I think there's a level of security for people that comes with knowing what the target price is for that product. And so the re upping of the program in MSTR and then moving 20 or expanding to the $21 billion of capacity on Stretch, it shows you how they're going to focus on scaling from this point forward. And it's going to mean that, that you're going to get a very consistent message from them moving forward as well.
- [05:23]
B
Right.
- [05:24]
C
You've got MSTR and MSTR to your point, Jeff, is effectively a product that builds the balance sheet. Right. It creates that capacity for them to continue to become a digital credit issuer at a significant scale. And now having the $21 billion of capacity out there on Stretch means they're there and they're ready to absorb that market demand above $100 whenever it hits. And so they've got themselves into an incredibly strong position now where they're just ready to execute with a very narrow focus for how that execution is going to happen.
- [05:56]
D
Yeah, I took this announcement as moving in the direction of, in every way of clarity of where what is the focus of strategy. And you know, ATM programs, if you're, if you're not aware you could size them whatever you want them to be. So it could be $1, it could be a trillion dollars. But you know, well, messaged framework is something that is actually executable. And when I see the, the size that Strategy announced both on, on the Common and on Stretch, I mean you look at how much Stretch they've issued a week ago. This is not a crazy sized ATM program at $21 billion. I mean it actually just makes, makes sense that there is a lot of potential capacity over the next year for them to issue Stretch and for them to issue on the common equity. And they're making it explicitly clear through these new ATM programs that this is where their company will focus. To your guys's point that this is the product, Stretch is the product. And we've been going through a similar exercise with SATA where you go to our strive.com the first thing you see is SATA. That is, that is the product, that is, that is the focus point of our firm. Right. We're going to be going out there to a bunch of traditional finance conferences and we're going to be talking about SATA and Stretch. We're not going to be focused on the amplified Bitcoin story because that traditional finance audience is less likely to be the audience that's going to say first, I even feel comfortable going all in on the volatility of bitcoin, let alone give me, you know, amplified bitcoin. That's going to be for the bitcoin maxis, right? The people that are super well informed about the debasement trade. And it's just a completely different conversation than someone that wants double digit yield with minimized volatility which is actually in, you know, the, you know, investment community is actually a much bigger audience, right. That everybody wants cash flow, they want yield. How many people are, you know, real estate investors? I mean it was like last week I did a real estate podcast because I got reached out to and they're like I just learned about SEDA and I love this product. Can you go talk to the real estate community about this product? Is like, yes Abs, absolutely. But, but we're seeing anecdotes in that direction every single week, right? And so you, you have to, you know, and I think a year ago people were probably somewhat confused, maybe less on you know, the, the true north community, people listening to y' all the time. But that strategy companies like strategy companies like Strive, we're operating companies, we're operating companies like they think of it as, you know, just a, a bitcoin holding vehicle. But now you're starting to see the evolution and the maturation on the product side of this business. And you know, I think it's great that strategies further clarifying to people where they're, they're focused, pointed and you mean you hear Saylor talk about the problem if you're distracted, right? Like, like you cannot be distracted. That that's actually a risk for every company is that they, they start to focus on the things that aren't the big idea and, and you can actually critically damage the thing that is the big idea. Stretch is the big idea for strategy. SATA is the big idea for Strive. And having that laser like focus is the best way to ensure that your company succeeds.
- [09:40]
C
And as a common equity holder, you want them to be focused on those products because those products are what's going to drive that value into the common equity as well. And I think that gets overlooked, right when you say things like, you know, the, the messaging out there in the market right now from us isn't going to be about amplified Bitcoin. Well, there's a reason for that. And that reason is that the product that we're bringing into the market with SATA or with strategy using Stretch, that is the product that enables the amplified Bitcoin story to be successful. Right. It's what drives the most value from a yield perspective down to the common holders. And so it's incredibly important to go and do the legwork to make these products popular. And right now they're unknown. Every time we have these conversations, you know, to your point, Matt, where you heard from the real estate community that they just learned about these products, the real estate community is a massive untapped market for these types of products. You know, they're typically looking at trying to get 10% returns every year. You know, that's a focus for them. But it comes with volatility and headaches and tenants and repairs and all kinds of headaches along that path. Where when you start talking about the digital credit products to people that have natively used real estate as their primary investment vehicle, they start to look at a new opportunity for when they get out of their real estate. And now with weaknesses showing up, it showed up very quickly in the commercial real estate side. Those investors have been looking for solutions for a long time. But you're also starting to see it move over into the residential real estate where prices are becoming so unaffordable that people are trying to find ways to offload the investments that they're holding onto where worried that those prices aren't going to hold. These are great landing spots. And for those types of investors, if they have to hold that capital when they exit one of the real estate investments and they have to hold it in a taxable brokerage account, then the return of capital on the dividends becomes even more important. So there's these massive markets out there that just need to be reached. And because there's only two companies out there right now with publicly traded digital credit products, you know, it's a very small workforce to go out and spread that message. And so we have to be, you know, very curated in the way that we're going to target those marketing efforts and those messaging efforts. And we've talked on one of the prior hurdle rates about how we almost did things backwards. Right. It seems like for Bitcoin you should really start with bringing a tamped down version of Bitcoin out to the masses to get them comfortable with it, to help them understand the asset before they jump into the high voltage version of Bitcoin. And what actually happened was the opposite, right? The equities that were aligned to Bitcoin that were the amplified bitcoin exposure came out first and that was how a lot of equity investors found it. Now we're going the other direction. And so I think there's a massive untapped market out there for these digital credit products. And it's just about creating that awareness now. And that needs to be the focus for these companies over the next two years, which is why you have to really narrow down in terms of what products you're going to focus on and how you're going to message them. And you just saw that happen with strategy by highlighting that stretch is the product. This is what we're going to be focused on. This is what you're going to hear them talking about. And for us, it's SATA. You know, we only have the two products, Amplified and SATA, which makes it a little easier for us.
- [12:59]
B
Yeah, fun anecdote. I got a text today from an old actuary friend. It says, why digital credit over buying cold storage bitcoin? Got to be some catch with these yield products. And my response was like, well, this is like asking, why would you buy asphalt instead of jet fuel, right? Like, well, I need the asphalt so I could drive my car, and I need the jet fuel to power my plane. Like, completely different things for different reasons, for different people. And, you know, we ended up having a whole conversation about capital allocation, just thinking about capital and duration and products and. And it was a very fruitful conversation. But to your point, it's like, these are people that are interested in bitcoin, and they have math backgrounds, they work in these roles, and they just haven't had the headspace to even think about these products. And they kind of need a reason to think about them. So, you know, just getting in front of them and talking about it, communicating, it has been. It's a journey, and we're going to be on this journey for quite a while.
- [14:00]
C
The other group that's going to get highlighted here pretty quickly, and we've been pounding this drum for a while, but it's the private credit investors. They're getting a crash course and what it means for an instrument to be liquid or illiquid. And you're starting to see that. Right before we jumped on this podcast, I got a notification on my phone for another fund that was slowing down their withdrawals. So Apollo, they capped the withdrawal request because they hit the 11% threshold. And you're starting to see this repeated over and over and over again. And, you know, Matt, you brought up a good point, which is what we're seeing right now is a liquidity issue. What you're not seeing yet are the defaults, but we're seeing the liquidity issues show up. Do you want to go in a little deeper on that and explain that to people, what the difference is?
- [14:47]
D
Yeah. So I think someone that's not following this closely, your initial assumption would be that when the gates go up, that you hear you cannot pull your capital out of any of these private credit instruments, that the underlying defaults must just be like through the roof. And we're seeing some defaults, there definitely is some defaults. But at this. And we're definitely seeing the risks. Right? You're seeing the risks on many different dimensions, one of them being AI disruptions, but the risks are there. But right now it's a liquidity crisis. And so what's interesting in liquidity crises is that there's a default crisis is just like the bonds go away and whatever, if you're in X sector and this will just say private credit. If you're in private credit, your investment's gone. And this one, in this case, when it's a liquidity crisis, that actually is something that is more likely to have contagion issues in the credit markets. And the reason becomes, and I used to see this a lot and at my old seat when I was at CalPERS is you would, whenever you would see one of these liquidity crises pop up, what would happen across the investment community is that part of your portfolio that you thought had some liquidity, it now has no liquidity. And so if you need to sell assets to fund anything. So if you're a pension and you need to fund the monthly payments of the pensioners, because now that the baby boomers are retiring, a lot of pensions now are cash flow negative.
- [16:32]
B
Right.
- [16:33]
D
They have to take their assets, um, even though they don't have cash flows, and they have to fund a liability, um, kind of has some analogies to the digital credit market. But, and, and how it actually works in real life, that there's actually examples. But anyways, they sell something. So what do you sell? You sell what is liquid. And so what that means in practice is that when as like when I was at CalPERS is that one of the portfolios I managed was their agency mortgage portfolio. And, and for those that don't know, agency mortgages are the second most liquid fixed income asset after U.S. treasuries in the world. And what you would see is that you would see credit risk somewhere completely separate and you would see the agency mortgage markets spreads widening or their price would start to sell off a little bit because they were the vehicle for liquidity. And I just think that's interesting is that that's part of the potential contagion effects that you're seeing right now. I think in digital credit will be interesting to see how that might impact other credit markets. Just a liquidity kind of cascade throughout markets is I think one of the risks that we're dealing with right now. One of the conversations I was having on this is could that filter through to digital credit or not? And my guess would be because no one knows about digital credit at this point, the answer is likely no. Right. Because the people that are investing in digital credit are more likely at this point to be individuals or places that would be unlikely. I mean, sometimes we'd even see some of the convertible note buyers buying digital credit instruments. I think they'd be less likely to be caught up in the private credit boom. But that's something to watch as a short term factor for these markets.
- [18:23]
B
I was also doing some research and we've talked about this a bit in the past as well. It's just thinking about commercial real estate and how commercial real estate is tied into private credit. Just doing a bit of research here. About 20% of the private credit market is, is commercial real estate. And you think about, okay, well what's the landscape? What's the landscape of commercial real estate? How has that changed in the last five, seven, ten years? I guess the average lease for commercial real estate could be anywhere from five years to 15 years. I don't know if you guys remember, but six years ago we had this thing called Covid and it's completely reshaped how people worked. Right? Like now people aren't going to the office as much. All, all of us on this screen are remote. A lot of people are working more remotely. There's less demand for office space, less demand to be in the cities. A lot of bad things happening in cities these days. And so a lot of these leases are now coming up for renegotiation. And so a lot of them are leaving. Right? You've got people that were in these long term leases and they're like, you know what, I don't need it anymore. My business is fully remote. And so then there's less people to fill in those shoes to jump in. And it may start to cause some issues with the within private credit relating to the commercial real estate. So it'll be interesting to see how this plays out, whether it's big, whether it's small. I know there are some rumblings about this, you know, coming to fruition here, but that's out there.
- [19:44]
D
Yeah. And one of the interesting things about the commercial mortgage market is that there's different sectors within it. And oftentimes what you'll find is that certain sectors might be doing incredibly well while others are just getting hammered. So you have, you know, you have, you have offices. So offices. You know, like to your point, Jeff, probably less demand for offices going forward already because of COVID now with AI, it's very likely that offices are probably going to get hammered over the next couple decades, and they probably already are. You have multifamily. Well, housing's unaffordable, so maybe, maybe multifamily does better. Then you have the data centers. Well, the data centers are often new builds. And so the existing stock of commercial real estate in mortgages would have very minimal exposure to the biggest growth sector for the next 10 years in commercial mortgages. Right. So you can have interesting things going on within the sector, which I think we do, but then also have legacy bonds if they held the wrong mixture of commercial mortgages that just have a lot of risk in it. And I think that's part of what you're seeing there.
- [21:05]
C
Well, you're also going to see a hit to the underlying collateral values here. I think a lot of people miss this when it comes to the differentiation that you see between residential real estate and commercial real estate is if you look at residential real estate, most of the value is going to be derived by sales comps in the area. Right. What were the sales prices? But when you look at commercial real estate, it's all basically driven on the rental incomes of them. So it's an noi divided by a cap rate to come up with what that value is supposed to be. Well, when all of these companies start pulling out of these large commercial spaces and the market gets flooded with all this vacancy, particularly in the office sector, like you mentioned, Matt, that drives down the rents because now there's so much availability in the market. So even if you keep a tenant, that tenant now has negotiating power to lower that rent. Because if you lose that tenant, it might take you a year or two to find another one. If you find another one, it's becoming very, very difficult. It's also why you're starting to see a lot of these office buildings get renovated into condos and apartments, and they just have to fully pivot these away because there's just not the demand any there. So when that noi dries up, that means the value of that real estate is also drying up. And if they can't go out and project, you know, if you're going and you're trying to refinance a building with a bank and they're going to look at, well, what are your projected cash flows that are going to come from that piece of real estate? If they can't get comfortable that one, you can fill it, and two, that you can get a reasonable market rate, you're going to have to start discounting the market rates. Those collateral values collapse. So you might find a lot of these positions are actually going to be under collateralized, which could cause, you know, an issue of its own. So the world has changed so incredibly quickly. Covid just turned everything on its head. People got comfortable working from home. There was always the thought in the early days, and I know I had this at some of the companies that I was at, where they thought people weren't going to be as productive if they were working from home. They'd be distracted by doing laundry and cooking and going out for walks or doing whatever it was they were doing. What they quickly found was a lot of the people would actually be way more productive because it's like living in the office 24 7. So if you've got nothing going on, you go sit at your computer, you start working, it might be the middle of the night. And so a lot of companies just never went back from that. Because if you find the right people that are motivated to continue to work, you actually find that they work way more than they would in an office setting where there is a start time and an end time and you leave the building and you leave your computer and that was it. So, like, things have shifted in a way where they're not coming back, right? The world's going to get increasingly digital and it's going to get increasingly remote. And I think that that means that a lot of the financial products that were built on that being kind of one of those core foundational sectors, is it's going to struggle and people are going to have to look for alternatives there.
- [24:02]
B
So here's a recent example headline. The Greenway Plaza, which is a Houston large, multi billion office complex, was appraised at 1.03 billion in 2017 and is now being marketed at a 60% discount, implying a value of closer to 400 million. So that's what is that, nine years and it's dropped 60% as a function of the rents in the office space and people wanting to be there, et cetera, et cetera. So it's happening and it's this Confluence of factors all at the same time, right? You've got global instability, you've got AI is accelerating at a pace that just completely is, you know, it's one shotting businesses left and right. You've got commercial real estate's rolling over at the same time. You've got, you know, war in the Middle east. And it's like all of these factors at the same time. And you've got this, this illiquid market that's been driven from I think about a trillion to $3 trillion in the last decade because of the insatiable demand for high yield credit products as, as the population's turning over as well. And it's just this perfect storm is brewing of all of these things happening at the same time. But luckily, you know, I think we've got a really unique product that really kind of plugs that gap and that need for future proofing. Right. These are antifragile credit instruments into the future backed by an asset already on the balance sheet as opposed to a promise into the future.
- [25:35]
D
One of my favorite things about the digital credit products is that every single risk that we're talking about here is something that is likely to benefit the underlying risk of digital credit in Bitcoin. Right? And so you think about diversification of risk. I mean we cover a lot of the liquidity advantages of digital credit, which are massive. Right, but, but you think about a diversified portfolio, the amount of whatever you want left, tail risk that is existing in the credit profiles of income investors around the globe is increasing drastically. Right, like, like these are used to your point Jeff. Companies that are getting one shotted, you know, the, the chance that defaults are going to happen with the existing holdings of a lot of credit investors are increasing.
- [26:30]
B
Right.
- [26:31]
D
How much are they increasing? You know, time, time will ultimately tell. Well what benefits in this world of abundance. Obviously it's bitcoin as we talk about all the time. Right. And so if you're a credit investor, well they would, someone might say, well why don't you just buy bitcoin? Credit investors can't buy Bitcoin. Like I, I've never met a credit investor that I know that manages any material money that actually has Bitcoin as an investable product in the mandate that they're managing against, have, have, have not met. One would have loved for that to be the case. When I was at Calpers, like, like that didn't, didn't matter. Like if we were going to invest in Bitcoin, we were going to have to create a Whole new asset class in the mandate to consider investing into preferred equity. That's, that's no problem. That's in the mandates of a ton of portfolios at any, any institutional investor. Right. And so you, the frictions to invest in something and obviously they need cash flow. It just, it just works and it's, it's a great hedge to these risks that we're talking about and obviously with an attractive yield, right. People like double digit yield. But when you actually start underwriting the risk and say does this fit in your portfolio? Does this in. I mean we're obviously convicted investors, right. Like I would say we're the group of investors that diversifies less, that goes all in, that wants amplified Bitcoin returns, that, you know, Bitcoin's in a, you know, I'll say it's in a bear market and we're all just chilling because we, how much higher we think it's going to go and you know, is the bottom in, is the bottom not in? I don't really care. Give me every single week I can to buy Bitcoin under 100k and I'm going to be happy. Right. And that's kind of more the mindset of this group. But the other group is how do I have diversified hedged portfolios that provide opportunity to make return over here if something might not earn. And those are the perfect investors for digital credit. And I think it is, it is a great innovation for these risks that people are starting to see.
- [28:49]
C
Yeah. And I think this entire cycle that we've gone through, call it over the last decade, it's also changed the mindset of both the investors but also of the companies. So when you think about signing into a long term lease, you're committing to a level of permanence with that. And so now if you're a startup company who used to always, you know, they would always be the ones that set up the flashy office spaces to impress investors when they would come in. But if you're building a SaaS product now, you can't be comfortable enough to set up that type of permanence and take on that type of cost. On the other side, the people that used to buy these buildings buy this commercial space. What happens when the market gets weak like this that people don't think about is for them to now go get another loan to refinance it or to get a new loan to buy a new building. What the banks start to do is require personal guarantees. So that means you as an individual are now pledging your assets against that loan as well. So the push back when the real estate markets were always good, was that you would want to get the loan, but it's solely secured by the building, no personal guarantees. You know, I didn't have the same personal liability that I would have when the market turns bad. And I learned this because I was in commercial distressed credit during the global financial crisis. When it turns bad and capital's hard to get, valuations are very fluid where they're requiring a lower loan to value on there, but they're also requiring personal guarantees. You've got to put your own skin in the game. Which means if I have to foreclose on this building, if you cannot get the tenants you say you're going to get and you stop making those loan payments, yes, I'm going to take that building and I'll go sell it, but it's going to get sold at a fire sale price. Because I also, as the bank, I'm not trying to fill that with tenants. I'm just trying to get rid of the real estate. Which means my shortfall is meant to come out of your personal assets. You need to cover that shortfall. So there's a totally different risk profile for those types of investors to continue investing in that sector, which means you now have to look for something different if you're not comfortable taking that risk. And I think a lot of people would now say that they're not, because this isn't one small market cycle where, yeah, there was a cause that drove down real estate prices, but we believe they'll come back. This is a shift. This is a complete shift in the way that businesses operate, which means the demand for that space might not even come back. So you have to have a lot of conviction now to be able to go down that path. And if you're doing that with the intention to earn, you know, a 10% return every year, well, now you can go buy digital credit and get eleven and a half or, you know, twelve and three quarters, and you've got none of the personal guarantees on the other side, you've got a balance sheet of assets backing it that you can watch 24 7, 365. You can sleep at night, you know, like, it's a very different situation to be in. So I think that we discount a lot that change that's happening in that market and the amount of capital that was going into commercial real estate that's going to need to find a new home. And that's just one area that's applicable where you can find a product like digital credit and say this is a better alternative for me. You've also got all the other ones that already exist for credit investors out there where these are just better products. But this impacts more investors than. I think people understand this shift in the market.
- [32:24]
B
Absolutely. And I've got maybe, Matt, this is a question for you. And I'm thinking about the private credit market and I'm thinking about correlation to the rest of the credit market. Because if there's some slight concern about the private credit market, you would think that concern, if that's AI or if that's commercial real estate or whatever that may be, you think that would also translate over to the public market. But there's been, I guess just the less maybe buzz about it on X, I'm thinking particularly the lowest tranche of investment grade bonds. So anything that's like triple B or triple B minus, anything like that. And I was doing some research on this last week and I was looking at companies like Apollo and Athene, and these are companies that are kind of capitalized on private credit, yet they've issued investment grade debt into the market. So there's some kind of correlation risk, I think, between the two. If there's any default, obviously we're seeing liquidity concerns right now, but no default concerns. But if there's default concerns, how do you view that kind of lower tranche of investment grade? I mean, how would you have viewed it at CalPERS? And if something falls out of being investment grade, if it goes from investment grade to junk, how does that impact a capital allocator's decision making? I mean, is it one of these like fire, sell it immediately kind of things and then who's buying it on the other side of it? I'm just trying to wrap my head around the rating agencies. Do we think the rating agencies are moving at the pace of change of technology? And how, like what's the downstream impact of that in the public credit market?
- [34:09]
D
Yeah, so the downgrade risk, it's really going to depend on the type of investor. You might have a better perspective on this than me, Jeff, of the insurance market. But at a pension there's actually a desire to be more out the risk curve because they're underfunded and they're having trouble to get their 7% hurdles. And so one of the things that you were seeing at CalPERS was an increase in their allocation to high yield relative to other fixed income because the yields in traditional fixed income were just not attractive. Right. And so if when you Start upping on a, on a percentage basis the allocation to high yield. If something falls out of the investment grade. Well it would fall out of that. Now for a place like CalPERS, these are actively managed funds and so you wouldn't necessarily have to sell. You would have be able to have a out of index actively managed high yield position. But you might want to sell. And so let's say that they wanted to sell. It would most likely have just filtered into the high yield bucket at CalPERS, right. Where like they, they want to increase the size there and they'd be more than happy to hold a, a higher high yield allocation and so unlikely. You definitely wouldn't see forced selling there. You might see just, you know, selective selling. Let's say that you just didn't like the credit there anymore because something happened then you might sell it because even though it gets downgraded, you might have a bearish view on it. But other than that you wouldn't. But I think other sectors, I mean you look at like, like the banking sector, well the, the capital controls for like the risk allocation for a high yield investment would be greater. Right. Like the amount of capital you have to hold against an asset if it's high yield would be greater than if it's investment grade. So it would have impacts there. I'm guessing it would probably would in the insurance industry.
- [36:10]
B
Right.
- [36:11]
D
So it just, it just depends but doesn't have to be some drastic changing in the cost of capital. And then I guess the last part would be, you know, a company like an Apollo or someone that might have a lot of private credit risk on their balance sheet, but issues investment grade, you would likely see that be more correlated with the default risk of the investments than, than the liquidity risk of the investments. Because there as like a, you know, a balance sheet holding type sort of company would be more likely to have naturally viewed this as a long term investment than a investment where they were looking to get liquidity from it. So I would, I would imagine, you know, I was happy to be proven wrong. I would imagine that they're not a place that would need to sell these instruments and, and potentially depending on the view of the credit risk, could actually be one of the buyers of, of this. Now it looks like right now with the gates going up that they just can't find enough buyers for the amount of liquidity that wants to go up. Right. That's why you're seeing things like 11% of Redempt request are being met. But historically a place like that, equity capital would be a place if the view was this is just liquidity and not default. Right. If it's viewed as default risk, then all. All bets are off. Right. But if it was viewed as just liquidity without default risk, the equity would be a natural place to absorb some of that liquidity. But, you know, we're not seeing that. So I don't know. It does make me question what the view a little bit more is of these experts of the default risk here.
- [37:57]
B
Yeah, Well, I mean, a lot of people are selling, right? People are going to the exit door to get liquidity. But why? I mean, there's got to be some underlying concern about the default risk. Right. Like, there must have been a change mechanism, understanding that the default risk probability. Right.
- [38:20]
D
You'd think likely. But the problem where this becomes. And I think this is because of, I would just call it like, inappropriate marketing of they put these illiquid instruments in a perceived liquid vehicle. Right. Like we talked about how you have Apollo trying to issue digital credit on chain, and it's like, okay, what is the goal of trying to issue digital credit on chain? Right, Right. Is it because they're very bullish on crypto, or is it because they're looking for more like exit liquidity? Right. Like, I view it more as, like, a sign of. Of likely exit liquidity when you see illiquid instruments being put into wrappers that have perceived liquidity that the underlying doesn't have. Right. And so, and so the, the point of that is that you're selling to a buyer base that typically doesn't underwrite the credit risk of the instrument. Most people that are buying private credit in a liquid wrapper probably don't have credit analysts underwriting the credit risk of the underlying private credit instruments. I think that's probably mostly true in almost every instance. If that's true, then when the gates are going up, it's a natural question to say, you know, is the institutional investors that are actually underwriting the private credit, are they also looking to sell these illiquid instruments or is it more. These liquid vehicles with more retail investors that didn't understand what they're buying and they're starting to wake up and they're realizing, hey, I thought I just bought this thing and I could get out whenever I want. Like, I can't get out. And they're just freaking out. Like, I don't know the answer to that at this point, but that is definitely a possibility. Right? That they thought they had liquidity, now they don't, and that are just like, just give me my money back. Like, I don't care about this 8 or 9%, 10% yield. Like. Like, I want my money back.
- [40:36]
B
Yeah, yeah, yeah. Okay. Interesting perspective.
- [40:39]
C
Yeah.
- [40:39]
B
I mean, from the insurance angle, you brought up regulatory or rating agency constraints. Like, if an instrument gets downgraded, that means the relative proportion of, like, the leverage ratio that you can have against that capital increases. So if it goes from, say, triple B down to double B, your cost of capital for that specific instrument may double, let's just say. And so the. The relative leverage you could take against those instruments on your balance sheet just drops. So what that means is that puts strain on how much future business your insurance company may be able to write or how much additional reinsurance you may have to purchase in order to hit your capital requirements based on the regulatory and rating agency framework. I know a lot of the insurance companies do have, like, buffers that they operate within so that if there is changes in the market like this, they can absorb that. That's kind of the point of the design, but I guess it really depends on size and scale. And if there's. I guess if the rating agencies see concern for any one reason, and this will play out over a long period of time.
- [41:51]
C
Yeah. What I think is interesting about kind of that marketing angle with investors not knowing what they're buying. You know, you might not realize as an investor how much you value liquidity until that liquidity gets tested. And what starts to happen is you. You get that contagion effect. It's the same thing, like when you would start to see those news articles pop up about someone went to withdraw money from the bank, and the bank told them they had to, you know, come back in a couple of weeks because they didn't have it. And everyone starts getting nervous going, well, I wonder if they have my money. So they go to the bank and they try to take their money out. I think you get something similar in these private credit funds where you start to see these headlines pop up going, well, they're not allowing the redemption. You're going, wait a second. I thought this was a liquid instrument that I could get in and out of. I wonder if the private credit fund that I'm in has the same problem. And so you start getting all these requests for redemptions, whether they're real redemptions, like people actually wanted their money, or if it's just people getting nervous, it starts to really grow that headline. And when that happens and when you start to see these headlines accelerate and it's more and more of these private credit funds that are having these liquidity issues, you start to rethink your positions as an investor. And I think that's probably the likely outcome for a lot of these private credit investors right now. They're actually realizing that while they thought they were there for the returns, what they were actually there for was the returns plus liquidity if they needed it. And it turns out that they've got one and not the other, and they're hoping they've got one. But right now they're getting a little nervous about whether the returns are going to be there as well.
- [43:28]
D
The last data point that I think is interesting to highlight here of just trying to understand the spectrum of how much of this is liquidity crisis versus a credit crisis is you can look at high yield. So if you look at as an example, the Hygie ETF, which is the largest high yield ETF right now this year, it's off about 2 points off of its high. So it was like 81, now it's 79. So whatever. A little over 2% decline in Covid, it was down about 25% in late 2021, early 2022, it was also down north of 20% from peak to bottom. And so you haven't actually seen a high yield credit repricing event yet. Right? I mean like, even, even that 2 percentage point decline bond yields have been selling off. Right. Which would have a factor in high yield instruments that have some duration to it. And so we really have seen almost no credit repricing in the high yield markets of note in ones that you do see it even, you know, if you take Covid or 2022, those sell offs did not have a material, material default risk correlated to it because in Covid you had the Fed step in so quickly and clean UP Markets in 2022, you also saw a healthy, a healthy rebound. And so the kind of default adjusted yields for high yield, those were great buying opportunities. And so I think it's interesting that you haven't seen that here with high yield signals, a lack of a broad default risk across all markets and likely a liquidity crunch that we're really filtering through, which I think is going to be a great selling point for digital credit. That's actually one of the strongest points to it is the relative daily liquidity because these are publicly traded instruments that they have right in the midst of a credit liquidity crunch.
- [45:38]
B
So Matt, I hate to put you on the spot, but I'm going to ask a question about Hygie because I'VE been trying to wrap my head around this as well because it's incredibly liquid. I'm looking at the volume today it traded about $6 billion. The A is about 80 billion, so about 7 and a half percent it's traded today about 7 and a half percent of the assets under management. But what backs up Hygie is a significant pool of, of high yield bonds. And those bonds aren't necessarily, it's like a diversified pool of those bonds, but those bonds aren't necessarily trading. So is there like a risk layer that sits above this that's providing that kind of like buffered liquidity? Like I mean this, this instrument has a composite yield of 5.7%. What's going on here?
- [46:26]
D
So in, in the bond markets, what you'll find to your point is that they trade otc, right? Not, not on an exchange, but the, the dealers, the banks, there, there's actually deep liquidity to buy high yield. If there's like, let's say you wanted to sell whatever 10 or 20% of a, of some random high yield issuers bonds, well, if the broader credit market was not being stressed, you likely could sell that at like a reasonable spread. Even though you might be, you know, two months worth of volume in a single day in an instrument. Just because there's, you know, there's, there's teams of people that are underwriting these risks. But what's, what's interesting is that you're actually seeing a lot of institutional investors like pensions. I believe CalPERS actually seeded a new high yield ETF recently. And the reason is, is that it takes something that's illiquid and puts it, you know, in a, in a more liquid wrapper. And when it's an index. So like when it's an index like this and there's no gates. I think a viewpoint of a lot of institutions is that unlike private credit, if this thing reprices, it's actually because of the liquidity, right? You're, you gave deep liquidity that it's likely caused by a repricing in the underlying. And so they actually sometimes prefer it to be in that ETF wrapper because it takes a non exchange product and all these high yield bonds and it puts it on an exchange, but there is no gates in an etf. And so unlike these private credit instruments, if someone said give me 50, they own 50% of it and they say give me my money back. 50% of that nav is being sold. And so it's actually a better product from a pricing transparency Perspective is that there's no ability to close the gates.
- [48:38]
B
So can you give some perspective of that 2020. I mean you witnessed the March Covid impact with HYG and this type of instrument. You cited it like I guess what, what happened, what happened there? Right. You've got I guess a lot of people trying to reprice the credit risk or getting liquidity and there's no buyers on the other side of it. Yeah. Can you give us some perspective on that?
- [49:01]
D
So Covid, you had a, you had a dual pronged attack on the fixed income markets. So you had a liquidity crisis where the entire capital markets just completely shut down. Right. But then you also had default risks skyrocket. You had no one, you know, when in the early days of COVID no one knew, like, are we all gonna die? Like, like we're all, we're all going home. And you see these crazy videos coming out of China that, you know, some of them are real, some of them aren't real. And, and you know, you're all, everyone's prepping and trying to figure it out. So like, like the unknown nature of that just meant like. And then the global economy shut down. Is this like, like all these high yield companies are like, are they just done? Like, like we don't know how long we're going to be locked down for. Right. The, the, the Fed hadn't fully stepped in to support the markets at that point because they're trying to assess exactly the measures that they're going to need to take. And so what you saw is you just saw spreads in the bid ask. Spreads just widen like, like crazy. I mean even for U.S. treasuries, U.S. treasury market bid ask just completely went nuts and so no one knew how to price it. And so you saw in the HYG chart here during COVID what you see, and this is pretty typical for a lot of charts is you see it just completely fall off the cliff, right? Like down like 25% almost instantly and
- [50:27]
C
then
- [50:30]
D
it slingshots back up also pretty quickly.
- [50:34]
A
Right.
- [50:34]
D
Took longer to get back to where it was than, than it did to fall. But like it, it was a pretty quick recovery, right? As, as the market, seven months to reprice risk. Right. But, but that is a, a dual instant liquidity and credit repricing in the markets.
- [50:50]
B
Fascinating, fascinating. Putting a liquid wrapper around illiquid instruments in a liquidity and credit crisis. It's just an interesting analysis looking back at these periods of time and trying to wrap your head around how they function.
- [51:10]
D
I mean, 25% move in bonds is nothing to sneeze at. And meanwhile, if you're not following, a lot of this audience probably does follow. But even though the US treasury market had a liquidity issue, the yields of Treasuries plummeted to zero. Right. Which means the price went up.
- [51:33]
B
Right.
- [51:33]
D
And so you had the price on a relative basis of performance, the underperformance was substantially greater than just the 25% notional decline that you saw in the ETF. Right. Like high yield. Got absolutely smoked during COVID Makes sense.
- [51:48]
B
Fun times, fun times, fun times. A lot going on. Digital capital and digital credit are the future.
- [51:55]
A
Ben, any closing thoughts or we're wrapping it?
- [51:58]
C
No, I think we are entering uncharted waters here and I think there's going to be a lot of reevaluation of portfolios and people are going to look for the best landing spot where their capital is treated the best from all the different dynamics we just talked about. So it's 2026. It is the year of digital credit.
- [52:18]
A
Absolutely. Well, thank you everyone for watching episode 52. We have a massive untapped market in an increasingly digital world. For Ben Workman, Jeff Walton and Matt Cole, I'm Tim Kotsman and we will see you next week right here on the Hurdle Rate.