Chris Heller - The Psychology of Niche Assets

Hello and welcome to the Private Capital Podcast. I'm Joe Riley, head of Circulus Group and network for family offices based in Greenwich, Connecticut. Please subscribe to Circulus.substac.com to stay in the loop. The term uncorrelated is used so often it tends to lose its meaning. Today we're talking to someone who seeks out truly uncorrelated assets in niches you've never thought of. For example, how do you turn a barrel of bourbon into a predictable financial instrument? And why is women's soccer a more compelling bet than a minority stake in an NFL team? Investors often confuse the unusual with risky. Chris Heller thinks that psychological bias is exactly where the opportunity lies. As co-founder of Cordillera Investment Partners, Chris specializes in exploiting the delta between perceived risk and actual risk. In this wide-ranging conversation, we dive into the heuristics of investing, the importance of creative hiring, why a background in the liberal arts might be the secret weapon and why alligator farms are ultimately a niche too far. Chris Heller is a co-founder and co-managing partner of $1.9 billion Cordillera Investment Partners. Prior to founding Cordillera, Chris was a partner at Mechanicapital Management, where he served as the portfolio manager for the Mechanic Liquid Endowment Funds. It was a senior member of the firm's absolute return investment team and investment committee. Prior to Mechanic, Chris worked at the Stanford Management Company in a variety of investment roles, and he started his career at Merrill Lynch in debt capital markets and investment banking. Chris earned a BA in economics from Vanderbilt University and an MBA from the Kellogg School of Management at Northwestern. Please enjoy my conversation with Chris Heller. This podcast is for educational and entertainment purposes only. Anything said by the guests or hosts should not be construed as legal or investment advice. Thanks for listening. What was your first interest in investing? I think it was econ classes, actually. So I didn't have any idea going to a liberal arts college in Vanderbilt what I wanted to do. I fell in love with my economics classes. I think just the way it teaches you to think, the way it teaches you about logic and problem solving. I started fell in love with it then, and that became my major. Didn't really know what I wanted to do with it. I then, as you do, started dabbling with the tiny amount of money that I had in stocks had no real idea what I was doing. But at this in Vanderbilt's industry as a liberal arts school, it didn't have a finance major. It had a business minor. So I was an econ and business minor. So I didn't learn a lot of hardcore corporate finance until I started an investment banking at Merrill Lynch. And only then started to do a little bit more in stocks, and which was fascinating because I then started at Merrill in '98 and was in here in New York in the debt capital markets and then moved over to tech investment banking and started to invest in tech stocks and just watched it all crash. Not my job being a tech investment banker, but also the tiny amount of money that I had started to invest in tech stocks also went to nothing as well. I remember I had this stock ask jeeps, which was like this early, even if I were asked jeeps, like this early, the love of the thing. I used it. I literally evaporated into nothing. So yeah, that was probably my early speed. But we don't do anything in tech. I've never been, as our IT department kind of test, I know nothing about technology and me being a tech banker was a funny place for me. I loved it. And it brought me to San Francisco, which I think was a blessing in my life, but tech was not really my forte. So you ran San Francisco, Merrill Lynch, what year was it? So I moved back to San Francisco in 2000, June of 2000. And that's when I started as my in the tech piece of Merrill Lynch. So two years in New York, debt capital markets, and then a year in Manlo Park as a tech banker. OK, so that's an interesting phase. A lot of folks don't talk about that phase, especially the spring of 2000 was a difficult period. But I'm sure you guys already had a lot of deals in the hopper. What was that like? Yeah, I mean, it was-- We had done a lot of internet stuff. I was specifically in the semiconductor group. And actually, we were doing still a lot of deals. And that lasted a little bit longer than it. We took pets.com public at Merrill. So we had a pretty strong internet group. So that was like the canary and the coal mine. That stuff all started to go self early. But I had a longer run just because I was in the semiconductor group. And actually, specifically in the semi-cap equipment group, so not actually the chip makers, but everybody, applied materials, all the people sort of servicing the semiconductor industry. And then, after three years of hardcore finance at Merrill and some banking, I was just looking-- I ended up going to Capitol Hill. I wanted to change a little bit burned out after some of the hours. That's a big shift. Always have an interest in politics, or was it just you wanted to learn how Washington worked? I had always been interested in politics, yes. But it was post 9/11, which I think just-- there was something-- I just wanted to learn everything about global politics, geopolitical things that had led to 9/11. And the Hill was a super interesting place for me. And so I had worked for three years in Beijing, and I took an unpaid internship with a congressman. I'm from Denver, so a congressman from Colorado, from the Western Slope of Colorado. Who's that? It's got McGinnis. And it was fantastic. Start as an unpaid intern and really actually enjoyed my time, but knew that getting back to finance was a place that I wanted to be. I really liked being in DC, and I liked being on the Hill, but realized pretty quickly that it wasn't a meritocracy. It was a little bit of how long you'd been there, period. And I just wanted something a little bit-- having come from banking a little bit more are charging. And so my partner now at Cordiera, she had been an investment banking, Ashley Marx, and she had been an investment banking in San Francisco at a place called Robertson Stevens. And she went to-- after her time in banking, the CEO of Robertson Stevens moved over to become the CEO and CEO and president of the Stanford Management Company, the Stanford Endowment. And so she called me and said, hey, there's this job at the Stanford Endowment. And I had no idea what it even meant to work at an endowment. Having been in banking, the tooth-- you go to a hedge fund or a private equity firm after that. I obviously went to different path, and I went into capital health for a little while. But I had no idea what endowment investing was. So she convinced me to fly out to San Francisco and interview. I had met my now wife at the time in DC, and she was not happy about the idea that I was then going to fly out to San Francisco and interview at the Stanford Endowment. But that ended up obviously changing my life in many ways. What was the interview process like? It was really with the CIO. So Mike McAfry, who was the CEO, had hired a new CIO. And I really-- it was three or four hours with the CIO-- pretty easy process. There were not a lot of people banging down the door, trying to work at an endowment back then. And I think I was probably not unique in the fact that I had no idea what working at an endowment was. Obviously, things have changed a lot. We were all forward now 27 years later. But back then, there weren't a lot of people that were trying to do it. And what was that shift like banking? It was pretty intense. And now you're going into manager selection. I always-- you go from being as deeply in the weeds as you can possibly be to then elevating to 30,000 feet. And that is where I really-- and if I really look at where I learned where I got interested in investing globally, was at the Stanford Endowment. And we were in banking. You're pitching individual deals for your clients that you were for. And in the weeds of the model of a single company, at the Stanford Endowment, you really lifted up to like I said, 30,000 feet. And I started to understand about different asset classes, correlations, the lack of correlations, diversification, pros and cons, sharp ratios, risk-reward of lots of different asset classes and lots of different ways to invest. I spent most of my time when I was at the Stanford Endowment kind of working on asset allocation with the CIO, not in a single asset class, which I think was an amazing training ground for just investing period. What do you thoughts on the Endowment model? I think it was really thoughtfully done when what we call it, the Dave Swenson model, came out. I think it was really revolutionary. I think it was a great way to think about investing in diversification. I think over time, what is happening or what has happened in the space is that some of these asset classes have just been codified is this is how you invest. These are the asset classes in which you invest, private equity, natural resources, real estate, long only equity, et cetera. And I think over time, the frustration became a bit that there hadn't been a lot of innovation in that space. These investments started to get the endowment started to get bigger and bigger. You start having more and more staff, more and more staff, that's dedicated to individual silos. Once you have people that are working in these silos and in these asset classes, their job is to find things. In those asset classes, they're going to go find things in those asset classes. And I think over time, it got codified. And I think the life bold for the firm that I run now was really about how do we advance the thinking a bit? How do we innovate on alternative asset classes? How do we think about things that are alternative today, not something that was given the moniker? of being alternative quite some time ago. But I do think that the endowment model as it evolved from a 60/40 portfolio to adding in lots of different asset classes when that happens originally was a really interesting evolutionary moment for investing. And I have a ton of respect for it. And we're just trying to push that modernization of the endowment and innovation in that type of investing in the alternative world forward at Cordiera. So I think there's a lot of great things that came from it, but I think there's a long way to go for it as well. At the Stanford Endowment, we went through essentially the tech crash and we've ferred it really well as did most endowments. It was like a kind of a shining moment for the endowment model that you could go through the financial crash like that and particularly being on St. Hill Road in Menlo Park in Palo Alto with the amount of venture exposure that we had and actually ferred really well because we got diversification from a lot of the other asset classes. When you fast forwarded to 2008, we really got very little diversification out of those asset classes and everything correlated to one. And that was really the beginning of the light bulb moment that was like, hey, are we really getting out of these semi or fully illiquid asset classes that are supposed to be diversifiers in the portfolio? Are we really getting the diversification that we thought we were getting? And the answer was, or resounding no. And so what are we doing wrong? What can we do better? How can we innovate here? How can we. What was the original promise of alternatives? And why are we originally trying to do this? And I think for us, it was. And we still think about this today. This is like the core of our business at Cordiera. What are the two things we're trying to do through alternatives? One, be early to things before the rest of the world finds them. And if you're early and if you're ahead of all of that wall of capital, you can extract outsized returns relative to the risks. And eventually, if it's a good idea, the world will find it and arve those returns down to a place that is normalized and correct for that level of risk that you're taking. So that was the one thing. The second pillar is really the non-correlation piece. How do we find things that sort of march to the beat of their own drummer that, as we say, are idiosyncratic risks relative to the major other risks that we have in the portfolio? And I think some of that was breaking down from the endowment model. You weren't getting the diversification and you weren't getting the really the outsized returns for the amount of liquidity that you're taking. And so, that was the genesis of our firm, really, ultimately. So when did you get first exposed to niche assets and how did that lead you to actually make the leap with your partners? Yeah. So post-08, what we really started to think about this, when that light bulb moment came on, said, "Are we getting what we thought out of this?" We said, we said to ourselves, "Hey, we should be finding today's alternatives. What are they? Things that are out there that are offering outsized returns for the unit of risk and non-correlation?" So we started to do that at our previous firm and look for these ideas. I think the thing that became apparent in this space is that we really liked the space. Intellectually, it was fascinating to be looking at these things that the rest of the world wasn't looking at. I think when I call it a space, I fundamentally believe that there should be a place in a portfolio for these types of things, which are, again, for what I think about is just today's true alternatives. So 2025's alternatives. So, again, higher returning things that are non-correlated. I think there's a fundamental place in a portfolio for that. Luckily, not everybody has that. If once it becomes the asset class that everyone has, then maybe by definition, the time is up for us. But we're out there trying to say to people, there is innovation to be had here, and there's an interesting opportunity. There's always innovation. There's always something interesting new to look at. We often get the questions like, "What if you just run out of things?" Going back to the start of investing, he went from equities to fixed income. There's always something new to do. I always had something interesting to find that the world hasn't found. And I think we just are trying to be the pioneers in doing that. And I think there's a place in most portfolios for something like this. And it's not just the non-correlation because there are a number of interesting things out there that are non-correlated, but they just don't offer compelling returns. And I think if you can be in that sort of part of the Venn diagram, that overlap in the Venn diagram of non-correlation and compelling returns, it's an interesting place to be. Obviously, it's not easy. We can talk through the challenges of doing what we do and how we find what we do. But I think it's a really interesting place to try to be in the capital markets. What was the first one to call your attention when it do realize that this could actually be something that you could somewhat scale? We started to look at water. We started to look at permanent crops. We started to look at specifically almonds and the water rights associated with almonds. We started to look at inverse I/O mortgages. We started to look at different parts of real estate and specialty real estate. And put together a little portfolio of these things. I think what was a moment for us that said actually we should start our own firm to focus exclusively on this is when you, and I think there are lots of people who like to look at the types of things that we look at, which is I like to look at innovative, interesting, different things as well. And for probably 99% of the world, and this was for us as well when we were looking at these things, it was like a side hustle. It was a side gig. It wasn't like your full-time job to look at it. It was something that was ancillary to what your full-time job was. And so you end up spending a lot of time on these things because they're different than what you look at every day. So it takes more time to look at it. And they can't be a huge part of whatever it is, but whatever asset class or portfolio you're running because you've got committee structures. And when you bring something strange to those committees, they're not going to let it be a huge. So you end up spending a lot of time for what are smaller deals. We weren't totally sure if we were get what kind of selection bias we were getting and looking at these niche things. Like, we weren't canvassing the globe. We weren't saying this is what I'm going to do full-time and look at every opportunity that there is and then pick the best ones within that opportunity. When it's a side gig or a part-time hustle in what your day-to-day job is, you take the things that come at you, you might pursue one or two of them without really a holistic view as to, "Huh, did I just invest in the best thing that I could have possibly found within this whole space?" Or did I just, and this is what we felt, like we were just reacting to some of the interesting things that were coming across, but there was definitely not a huge market mapping of all of the things that we could have done. And I think that was what we were really yearning for this idea of, "Let's just spend all of our time in this pond." There are inevitably going to be lots of things that aren't interesting, but let's identify, make sure we're not investing in the ones that just came at us and that they were the ones that weren't interesting. Let's find out and spend all of our time in this space in which I think we can really develop a framework for what's in the pond, what's interesting, what's not interesting, why is it interesting, and then feel more comfort that we had. We were making investments in the things that were the most attractive versus just the things that happened to randomly come across our desk, because we just didn't have time to really explore the whole depths of this off-the-beaten path. Do you mention that you looked for things that fall through the cracks at institutions? How do you distinguish between an asset that's misunderstood and an asset that's cheap possibly for a reason? Yeah. I think this is a great question. I think this gets at the core and the heart of what we do, because this idea of, do you just do weird stuff for the sake of doing weird stuff? And the answer is obviously no. That would be a really bad place to start. Let's just do it because it's different. We think about what we do first off as exploiting this delta between perceived risk and actual risk. And what I think about what we love about this space is when we tell people what we do, their first reaction is, "Holy cow, that must be risky." You're looking at weird things like that must be super risky and we love that. I never want that to be to stop being the reaction because the minute that's not the reaction, it means that we don't have the space to ourselves and we don't have an advantage and we don't have a mode around this. And we look at this space and the world tends to stay away from it. And this is really, I think, taking advantage of, from a behavior-leconomic sense, a heuristic that investors just have this basic instinct when they see something that's different. And this is not just investors. It's just human nature. And it's something that's kept us as humans safe on the planet for hundreds of thousands of years. When you see something new in your environment that you don't understand what it is, you have a fight or flight mechanism. You see it run away from it. And I think that heuristic enters into investing. And as soon as people hear, "I've never heard of that must be super risky." We love that. And in the pond in which we fish in this sort of interesting off-the-beaten path pond, absolutely, there are things in this pond that people shouldn't invest in, that are risky that you should not pursue. And it's what keeps everybody away from the entire pond, which we love. But when you find something in this space that is attractive, because there's not competition and capital around it, we find them to be some of the most interesting on a risk-adjusted basis opportunities out there in all of the investing world. And so we love that sort of this idea of why are you looking at weird stuff. I'm not going to invest in it. It sounds risky. We love that ethos and we love that mentality 'cause it keeps people away. And it gives us this sort of white space to pursue. You have to develop and we can talk about this. You have to develop systems to keep you away from the things in the space that aren't invested in for good reason, but that leads you then to the things that we think are really interesting in the space in which you can extract outsized returns for the unit of risk because there just really isn't any competition around it. - So maybe start to be very interesting to hear how you guys source but maybe even more interesting is how your sourcing has changed over the years so that your screen is unsure much finer and you can rule things out much faster. - Yeah, I think that's a big one. So one, 12 years into this, the top of the funnel is just wider and more stuff comes into it. When we first started this business, I think a couple of things is 12 years ago. First of all, nobody knew who we were and not the people, not the word, a household name now, but within the realm and in this area of esoteric off the beaten path, assets people know that we're here. So when we think about sourcing, it's really two ways. About half of our deals come from outwardly thematic things that we're looking for. And about half of our deals come from things that we weren't even looking for, but just came across our desks, people wanted to show us, they know that we invest in interesting things and not part of the funnel of things we weren't looking for, but just come across our desks is we see two to three to four deals, a week now, if you go back 12 years, when we first started this, that was maybe two to three deals a month, if we were lucky. And so I think that part of the funnel has changed. Early on, we did, you have to do this, I think, as just an exercise in pattern recognition and learning this space. We ran down a lot of dead analysis. You spent a lot of time on deals that we ended up not doing. I don't look at it as wasted time. I think you have to develop that expertise in that pattern recognition and these heuristics around things that you're not gonna do, but it takes some time. And so I think we were a lot less efficient early on. We had fewer deals coming through and we would spend a lot more time on deals that we didn't do than we are today. I think the other thing that is really helpful about being 12 years into this is we've done a lot of deals. And our best sourcing mechanism today is actually connecting the dots from deals that we've done in the past that have worked. And so either first or second derivatives of a deal that we've done before and improving on it. What can I learn from that deal? What went right, what went wrong? What made it attractive? When it was attractive, what else? What would have been maybe more attractive? How could we have structured it differently, et cetera? Just doing lots of deals makes sourcing a lot easier today. And so whether it's a deal that is almost identical to something that we've done in the past or something that is just a couple of degrees of freedom away from those deals. Those deals have also been de-rest in a way that we understand the space. We understand how to get better at it versus brand new things that we hadn't researched before or hadn't looked at. And so about half of the stuff we do today is related to deals that we've done in the past. And that's a comfortable place to be in versus 12 years ago when everything was denova. We really hadn't done anything in the space. We had to find everything brand new. We really only do about two new deals a year and two brand new deals a year, meaning in the things that we haven't done in the past. And that's a really comfortable place to be. 12 years ago we had to find, call it four to six brand new deals a year. And that's a part of place to be. You give an example of a compelling opportunity that you ultimately had to pass on. I think probably the most famous one internally in our firm is alligator farming. It was a deal obviously that we didn't have a theme generated around. But we got introduced to the opportunity and we spent almost a year underwriting and diligentlying this deal. There were lots of things that were really compelling about the space. The opportunity in alligator farming is really around the hides themselves, which is really the belly of the alligator. So that is what is valuable. The hides get sold to air mays, LVMH, et cetera. So that is the end customer. What makes this unique and what made this particular alligator farm unique or a few different things? The first is that how do you get your hands on new alligators? Incap, these are all things that you have. I had no idea that at any point I would be studying this idea. But it comes mostly from eggs. And you have to get either permitted from the state of usually Florida, South Carolina, things around the southeast and the Gulf. To go actually get hatchlings, it's not obviously easy to go get these. And you have to be permitted it. And so if you have what is close to a monopoly on the permitting to get these, you've got a big advantage. So one is just, first of all, how do you get the alligators? The second thing that is probably the most important part is that how do you get an alligator from a hatchling to roughly three to four years old where the hide is big enough to be made into luxury goods without scratching the alligator's belly. This is like the most critical part of this whole thing is that you need a pristine hide because they get graded and you need it to be both big and high quality. And so the farmer had developed a fascinating system to grow an alligator both in what you feed it, how you vaccinate an alligator. There's West Nile that runs through these populations. And so how do you vaccinate? And they had worked on a ton of work with the University of Georgia and Georgia Tech around all of these techniques around how to grow it. What you grow it in, what the surface of the pen that the alligator grows in to not scratch the belly. So 20 years of knowledge as to how you grow an alligator and don't scratch the hide is actually one of the most fascinating pieces to it. And then the last piece is the relationships that you have to have with your customers. And if you are one of the few places that is able to get alligators and grow them correctly, you end up with customers in the space that are pretty loyal. And I think that's hard to find and it ends up being a very profitable business. Where we ended up, so we got all the way really to the end here. We really liked the business and we ended up saying no to the deal from ESG reasons and ESG perspective. While it is a pretty controversial space, alligator farming has actually been really helpful in why we spent enough time on this and we didn't just dismiss it out of hand. It's been really helpful to the overall US alligator population. There's all kinds of regulations around how many you have to release back into the wild. The University of Florida is a big proponent of alligator farming done correctly because there's lots of rules and regulations and it's been really helpful in bringing the alligator population back. But at the end of the day, when we looked at some of the conditions and some of the headline risk around growing alligators and then making hides because the actual food piece of the revenue is a very small piece relative to the hides. And so we ended up saying no to the deal really from ESG perspective. What was ESG issue? How you grow gators and dispose of alligators to make hides out of them. Ranching is also controversial but at least you're eating, like at least it's providing sustenance to humans over a period of time. The fact that most of this is around just hides and luxury goods and then while the farm we were looking at was actually at the top, top end of this, the conditions in which gators are held and disposed of is not something super excited about over time. How did they prevent them from getting scratched? So it's about the temperature, so it's not just about getting scratched, it's about also fighting. So one, they developed this really interesting, the material that they put at the bottom is like this really slick material that has no abrasion to it whatsoever. The temperature of the water that you keep the gators in which keeps them as docile as possible over time. So you want them to eat because you need them to grow but you want them also docile so they're not moving around and getting scratched and then fighting with each other. And so there's this these ideal set of conditions. There's also a ton of science around what you're feeding the gators and how you're optimally growing them and getting them from size A to size B. So just a lot of science and then again vaccinating them, right? How do you keep a lot of these sort of diseases out of there? But ultimately is not a position in our portfolio but it's a legendary one for us that is certainly off the beaten path because of some supply demand dynamics, drivers that were not really correlated with the overall market and was not something that institutional investment was focused on in any way. In many ways it had the hallmarks of a courtyair ideal but there are things that you can get along and get further along. You also talk to your investors around their level of comfort with something like this and at the end of the day we just made the decision that after a lot of work it wasn't their ideal for us. One of the things that struck me when I was looking at your portfolio, I was often asking myself the question, is this a value play or is this a growth play? It's what is your mindset when you're going in there? Can we turn this into an industry or can we just reap the profits of a very small niche? Yeah, it is less the latter. We always are investing in things that have within growth potential to them. But at the end of the day I think what we find and interesting opportunity, what we focus on most, is there a reason that, again really about valuation, is there a reason that we're getting interesting entry value here? Because the institutional investing world, there's not a lot of capital and a lot of competition around it. So we focus a lot on the market. on our entry price, which is really the driver of our returns and also the driver, what we think, mitigates the risk here, right? The fact that we are not competing against other private equity firms, institutional investors for the most part, where we have to have an LOI in within two weeks and a deposit down within three weeks, otherwise we're going to lose a deal, is what allows us to really spend the time underwriting and getting that sense for value. What is it that we're buying today? And what is it that we could realistically exit this position for in the future? And I think critical to our investment philosophy is that exit to your question can't be like, hey, there's no exit today. But hopefully if we hold this thing for five to seven years, there will be an exit five to seven years from now. There's lots of things that get shown to us that are that that we say no to off the bat. So if we do have a real exit, we would deal, there has to be a viable exit today that exists within the state of whatever industry it is to exit the position. Otherwise we can't do the deal. So for example, when we first started looking at music publishing, this is 12 years ago, first of all, music was an unloved asset class a bit of time. We're coming off the heels of piracy and Napster and the value of music was from an actual valuation, multiples paid for cash flows, but also just generally the view around the value of the IP of music after piracy and Napster was that this was a dying industry. So we like looking at spaces like that where there's a value potentially in that. And particularly looking at the publishing side of the business and not the master recording side, we thought there was great value relative to cash flow on that side of the business, but how were we going to exit it if, if obviously this was a fairly unloved industry? All no institutional capital at that time. Obviously the industry has changed quite a bit. There are lots of private equity firms now focused on music, but at the time almost nothing. So the exit, as we underwrote it, was that we were going to aggregate a portfolio of IP and music copyrights and then sell to the music publishers, the Sony ATVs, Warner Chappell's universals of the world, and that there would be, you can aggregate portfolios that are really interesting, multiple. Ten times, even less than ten times cash flow was called NPS and that publisher share a cash flow at the time. And then if you got it to a certain scale, you'd be able to exit it to the industry players that were already there today. What turned out happening is that the institutional investing world private equity firms found in the space for reasons that at the time it cash flowed well and it, the yields that were provided, if you're buying something at a ten times, multiple, it's yielding at ten percent and interest rates at the time were two to four percent. And so the world found this space fairly quickly and we were able to exit into a market that was totally different than what we underwrote the exit for initially. And we like that. There's oftentimes upside to an exit, but we have to be able to underwrite a deal at the time that we are making the deal. And so what does the ecosystem look like today and what's a viable exit at the time we enter it? And really what we do fundamentally for a living is we go out and try to find places that the world is not looking so we can get a better entry valuation and then underwrite a viable exit if we're able to provide some growth usually. Most of what we invest in, we always describe ourselves as really asset-based investors. So we do own operating companies, but those operating companies are really rooted in assets. So we own a boat marine company, while it is an operating company which is really important at the heart of it are the ownership of a lot of underlying assets. So we like to own assets that the rest of the world is not looking at. Get really what we think is an attractive entry valuation for not having competition. Usually build some growth in and provide growth to the assets or some structural reason why those assets appreciate over time. Whiskey and investing in whiskey barrels is a really good example of this. That there's a structural aspect to that which is interesting that the valuation of the assets grow over time just because of the way that the industry works. The assets are the barrels. Yes, the barrels exactly. Yes. That is an industry where what's called the aging curve of a whiskey barrel. So which is just the price of a barrel of whiskey at any given age in its evolution, what will itself or what can, what will be bought by a craft brand for. That is what's called the aging curve. And that is since really whiskey as an industry has existed, older whiskey is worth more than younger whiskey. So this you have this sort of structurally positively sloped aging curve to that space, which is what we find phenomenally compelling about that industry. The question is how steep is it any given time? Sometimes it's flatter and sometimes it's steeper. We obviously like to invest in environments where that aging curve is structurally steep, meaning we can buy things by new, what's called new fill whiskey for what we think a really attractive price and that once you get it aged in the US, you really are trying to age it to four years old because that is where you don't have to put an age statement on your bottle at retail anymore. So that's really what brands are looking for anywhere from two to four years old. We really try to age it to four years old. So we look at that aging curve in the US from zero to four years old and we really make an assessment as to how steep is that aging curve, which is really about how we can make our money. For example, you can have a flat curve which says I'm going to buy a new fill whiskey brand new, newly distilled whiskey today and four years from now, it'll be worth just a little bit more than what I bought it for. It's a flat curve or I can buy new fill whiskey and four years from now, it will be worth many multiples of what I bought it for. The whiskey window is about four years versus like Scotch would be 12 years or 28 years and you don't have that kind of time. It works in Scotland as well and we do things in Scotland but at a different part of the aging curve, but you can play what's interesting about Scotland because of its weather, we just looked at a cast last year that the producers think will be the first 100 year old cast of Scotch. In the US, you can't age something for 100 years because of our weather. It evaporates too quickly. So you're right. In the US, we're really playing from zero to, oh, we'll call it zero to eight years, but really the prime of the aging curve that we're playing is zero to four years. In Scotland, we have a lot more degrees of freedom. You can play the front end right now. We're playing things in the 35 to 50 year old range because of events that occurred in the late 80s and early 90s and they were starting to shutter and there's a recession in the UK and starting to shutter some really quality distilleries. So there's a steepness to the aging curve in Scotland right now in that 35 to 50 year range that we think is really attractive. Are you getting these lots through relationships or is there an auction market? Is it inefficient? Relationships. Particularly in the US, I think we are one of the larger institutional players and I've been doing this for eight years and it's really the moat that is around what we do which is, and the relationships are really twofold. One, where are you buying your whiskey from and at what price can you buy that new fill whiskey? Those are really relationships that are called contract distiller so the industry has changed quite significantly over time so it used to be, the industry is really vertically integrated. So the three parts of the whiskey industry and the supply chain of the whiskey industry are really distilling which takes a couple of weeks. Aging, which is what we were describing, which is how long do you age it and that's really where we come in. We really think about what we do is just inventory financing for the third part of the chain which is brands and which are the brands are really distribution marketing. And so we sit in the middle of this and we have patient long term capital and we provide a service to the industry that allows craft brands really to exist. So if you think about the current bourbon boom which really started in the early 2000s, the demand is not for the big brands though there is certainly demand for Jack Daniels, Jim B, MakersMark, etc. It really is for these craft brands. Craft brands can really, it's an asset light model. It's really expensive to build a distillery so call it 50 to 250 million dollars to build a distillery which these brands don't have the capital when they start to do. And so the industry changed quite significantly to white label contract distillers who have scale that then produce whiskey for these craft brands but the craft brands don't have to, they don't have to build a distillery and pay to build a distillery. But they want to buy, what we call juice, they want to buy aged whiskey, they want to buy whiskey that is aged. They don't want to go to a contract to stiller and say, hey, here's X amount of millions of dollars to buy new fill whiskey that I'm not going to be able to use for four years. They need to be able to start generating revenue quickly. And so we sit in the middle and we buy from the contract to stillers. We age the whiskey and then we sell it to those craft brands so that they can immediately take it and put it into a bottle and start generating revenue. And so we really just think about it as inventory finance. We are a kind of a necessary part in the aging process for whiskey and we have kind of a private equity cost of capital for providing our balance sheet to these craft brands which can vary depending on how steep that aging curve is or how much we can sell a four year old barrel of whiskey to the market for. And what are the economics for you? Why was this so appealing? - The thing that made it appealing to us is a lot like what we find in the deals that we like to look at. One, the returns were compelling, particularly when we first started to look at. - Just to be clear, there's like a coupon aspect to this, correct? And then there's the actual asset. Like you can resell the barrels, I assume. - So then there is not a coupon aspect to this. It's actually negatively cash flowing. When you own the barrels, there are carrying costs to it. Which is another aspect to this that tends to keep other investors away. You have to have the right type of balance sheet like we do to be able to fund the negative carrying costs. Because you're not getting cash flow along the way. Most investors like to look at things that have a coupon and they're getting paid along the way. So here you have to pay store of costs, so you have to keep it somewhere and then insurance costs. So obviously where these are distilled and where they're stored, floods, tornadoes, natural disasters, so you have to ensure it. So that's the negative carrying cost that happened along the way. So you're really buying it for a price A, you're paying some structural carrying costs along the way and then selling it for a price B. What we like about it is that price B is the idea that there's a structural positivity to that aging curve. That price B is usually higher than price A in the industry. - Is there a whiskey futures market? - There is not a whiskey futures market. It's all privately negotiated deals. We've bought and sold whiskey both ways, meaning spot, we just buy it. We don't know who we're going to ultimately sell it to at the back end. But we know there's enough demand on the back end to find a buyer. And there are certain environments where we much prefer to do that. Because the second way to do this is forward sell. Meaning we know exactly which brand we're going to sell it to. And so we have a sort of forward offtake, but you have to take a discount in pricing, typically, to do that. And so when we know there's enough demand on the back end, we won't forward sell the barrels. In certain other markets, which the last two years have really been those types of markets where less demand on the back end and just less demand on the whiskey space generally, we do like to forward sell. But there's no market for it. How much do you have to consider demand in a market like that? Do you have to worry about secular forces in the industry, the consumer decides that they don't want to drink whiskey anymore? But I assume the part of the industry you're in is essential. You spent a lot of time thinking about it, right? Obviously, when we under wrote this deal for a year before we ever did anything back in 2018, you think about both sides, the supply side and the demand side. And ultimately, I think what we do for a living is assess the risks and then decide are we getting compensated for taking those risks. The demand side is certainly a risk in this space. And we've seen demand destruction in the whiskey industry for all kinds of reasons that people are speculating about. For us, we really just think about it as whiskey cycles tend to move in generational cycles. We're about 20, 25 years into the current bourbon boom. Nobody really wants to drink with their parents' drink. And so we're starting to see demand when we first got into this industry was, the industry as a whole, kind of high single digits. And for the space that we play in, which is the premium sector, high teens to low 20 growth rates. Today that has subsided pretty substantially. But what's interesting about the space is what we really liked about it is that sort of structural downside protection that older whiskey is always worth more than younger whiskey. And so you can do a lot of research around what is the price point at which I'm buying this barrel and has a four-year-old, five-year-old, six-year-old barrel ever sold for less than that price point. And we get a lot of comfort from this. It tends to be a space where I think about which is, I don't stay up, I don't stay awake at night in the whiskey space thinking we're going to lose money. It's just a question of how much, or how little was it just a waste of time to do this? Because we just stored this stuff for five years and we just didn't make enough money to really meet our cost at capital. So the end of the day when our diligence here was very limited downside with at moments in time really attractive upside and at moments in time still upside, but maybe less attractive. And if you're going to be in those times, you got to structure your deal slightly differently. And that's the way that we've done it for eight years and it's been a really quintessential now part of our investment portfolios over time. Because of that sort of natural downside protection with really attractive upside in parts of the cycle. When you were at Merrill, you learned a lot about models and fonts. And you learned to recognize a lot of patterns. You learned to get up to speed with various industries very quickly. I'm wondering how hard is it to train someone to look at this space? How much of this is art versus science? This is a debate we have internally all the time. It's a nature versus nurture debate around hiring. And I think where we've come to over time is that this is almost not trainable. We look to hire highly creative people. And people who have been properly trained in modeling, what we do is still financial. We still have to model. But that may have not been and had traditional experience and traditional investing shops. Because we just have to think about our world differently and you have to be willing to roll up your sleeves and do a lot of research in spaces that maybe there is not published research in. So really first hand, get into the industry, talk to many people over almost a year to understand it. And there are certain people that are cut out for that. And then I think there are certain people that sort of creativity and finance is not exactly where they come from. Maybe as an example to this and we have just a phenomenal group of analysts at the firm. We're doing a, we're looking at something in the legal space. And one of our junior analysts, phenomenal has just thrown himself wholeheartedly into data around law firms. Like each sleeve's breathes data about profitability of law firms, rates, charge, it's unbelievable and has built a data pack that I think is unmatched in the world about data around law firms. Just because he's super interested in it and wants to spend the time in it. And I think that's the thing that is not trainable. We are not always in a certain industry. I'm not, we're not trying to always hire healthcare profession. We do lots of different industries and every day when we come into work, I don't know what I'm going to be looking at. I'm going to be looking at a sports deal. I'm going to be looking at a whiskey deal. I'm going to be looking at boat marines. I'm going to be looking at wireless spectrum licenses. And so you have to have employees that are fast-ciled and just have a thirst for diving into new topics that is just not trainable. And I think over time we've come to that, to that conclusion. And it's a really hard thing to interview for. We've evolved over time how we interview, what case studies we give people, personality tests that we give people. I don't know that we've gotten it perfect. But I think the first is just an acknowledgement of, we can't just bring anybody in. And hope we can train them. They have to have some innate creativity in this space and a passion for looking at obscure things and diving in deep and spending a lot of time on it. It's during the indicators, the test players, they like puzzles. I don't have a magic bullet. I wish we had a magic bullet. People from liberal arts schools tend to be interesting who have done things in poetry, reading, etc. I think is really interesting for us. Why? We're trying to get at what is the creativity ball. Like what is it that leads you to just be interested and creative? And I think a passion for reading is really not a perfect indicator, but I think it's proven over time to be what people major in I think is interesting. And maybe not their major because I think to have ended up in finance. We don't really hire people right out of undergrad. So they have to have some requisite modeling. But what do they minor in? But they minor in classics or Greek mythology, etc. I think those are really interesting places to look and how people articulate why they did what they did and what path they've taken. I spend a lot of time in interviews and I don't interview nearly as many people as you do Joe, but a lot of time in interviews digging into the why. Why did you do this? And getting beyond everybody has an answer for that they think an interview he is going to ask and they have that like first initial response, but really spending time on the why on the give me your history, give me what made you passionate about this. How much time did you spend on it? How much time outside of work in your personal life? Do you spend on what types of pursuits? We haven't gotten it perfect, but I think that idea of someone who's just innately creative and just innately interested in random things is helpful for us. So many cool things we could talk about, but the niche sports I think might be something that people don't know a lot about. So as I mentioned earlier themes and thematic investing is a big piece of what we do and sports has become an interesting theme for us over time. We've done interesting quirky financings in the sports and media and entertainment since the beginning of our firm. And one of the things that's really interesting to us about sports is the innately non-correlated nature of sports, viewership, dollar spent on sports. There has though been a lot of institutional capital recently raised in the sports space. So it is not a place like whiskey or like early on boat marinas or music publishing where there is not capital. And so we look for what we call the nooks and crannies of sports. So the thing not buying a minority steak in the Dallas Cowboys are the New York Yankees, but what are the other interesting ways that we can participate in what we think is a growing category in sports and that we think is going to attract more capital. It's already starting to happen, but in the future, even more institutional capital, what are ways that we can participate in this space? And so there's really three themes that we've identified within sports that we're interested in. The first is we believe there is more capital coming into sports. So what are the service providers? What are the toll takers in sports that we don't have to bet on a team or a league or a sport to be successful? We just are toll takers in an industry, the sports industry where there is more institutional capital coming into it. So what do I mean by that? You think about brokers. This is a highly brokerage space deals within this space and there's more and more deals happening. The brokerage space is going to be successful. Consultants, there's a lot of consultants in and around sports, both for investment consultants around what is a good investment, but also on field, on pitch performance consultants. What striker should we recruit? What formation should we play if you're in European football law firms? I think every time a deal gets done in the sports space, there's two maybe more law firms involved. And are there pure play law firms out there dedicated to sports? So one of the things that we're focusing is just this idea, professional services and toll takers within sports and more deals happening. The second is women sports. Obviously women sports has become much more prolific over time. People talk with the Caitlin Clark effect, etc. Which leads to opportunities and risks within sports. There are some things that have probably gotten a bit overvalued in women sports, but we still think the tailwinds and where we are right now in the early innings, no pun intended, of women's sports is a really interesting place for us to be looking. We like places that are not venture risk. And this is generally, I would say, about sports, which is we see lots of deals that are, hey, here's a new interesting idea in a women's sports or other. It can make a lot of money in the future as long as we get the right meteorite deal. That is a purely venture like opportunity that could work out very well. But sports begins ends with meteorites. And oftentimes you're taking too much venture risk. And binary risk in are you going to get an interesting media deal or are you not going to get an interesting media deal. So when we look at sports for women and the third category, which I'll get into in a second, we like to take places where that's that risk is off the table. So we're not like brand new stuff within women's sports. There's also some things like the WMBA that have been very well established on the high end of the multiple and expensive place. And we want to try to find that place in the overlap of the vent diagram where we're not taking binary venture risk. We're not overpaying. And so we found some really interesting things in the US women's soccer market, which is established, very well established. But still in the beginning stages of benefiting from a lot of interesting industry tailwinds and still not overly expensive. And then the third part in sports that we're looking at is this idea of new formats and leagues. The consumer, the way that my children consume sports today is fundamentally different than the way that I consumed sports when I was a kid. My kids cannot watch an entire football game. They can't watch an entire baseball game. They digest things in clips and quick hit YouTube, TikTok, etc. So you can think about there's lots of interesting new leagues and formats that are dedicated towards that type of consumption of sports. So ballers league and Kings league in European football, which is a much shorter game. And it's got a little bit of a gamification to it. Like in the middle of the game, a dice gets rolled and whatever number comes up is how many people play. If the four comes up, we play four on four for ten minutes. The fans get to vote on rules, etc. So all of these sort of new formats around sports are interesting to a new consumer. And then the democratization of distribution of content, meaning it used to be that you had to, you were either distributed through CBS, ABC, NBC, Fox. And if they decided that they didn't like your sport, it was never going to see the light of day. Today, many sports have many different distribution through you to all kinds of different channels that they can be distributed, which then makes those leagues or sports viable through sponsorship, through all kinds of other things. So we, the pro triathlon organization is a vestment that we have. All kinds of reasons were attracted to it. One of them is that none of the revenues that we care about or need are related to a media right steel. They have revenues generated from sponsorship, which we think is really interesting. They have revenues generated from mass participation, health, consciousness, all kinds of things are a tailwind to this and lots of people participating in triathlons and paying entry fees from 50 to 250 dollars depending on what the experience is. And it's also a sport that has long term contracts for hosting fees. You get a lot of city. The way that the sport works, it's a little like Formula One and their big events in London, Sydney, San Francisco, Singapore, Qatar, Doha. And their long term contracted hosting fees that those cities pay for the sport. But it also has a incredibly loyal following that sponsorships in sponsorships is a key piece of this because the people who follow triathlons are a really wealthy demographic and that they are adamant and ardent fans of triathlon and watch it through distribution channels that are different. I'm sure there's a lot of companies like this who are coming into the space. Obviously, all these streaming and the sponsorship. So how are you going to differentiate between the ones that you think will succeed and the ones that might be less? I think the one and again, this investment is in a private company that is the pro triathlon organization. So in triathlon, it's the business models that we think makes sense without making a huge leap on a binary outcome of meteorites. Do you have a viable business model that generates revenue today and there might be some upside to a media deal but that is pure upside and that we can underwrite this deal with the revenues that come in today without that leap of faith. And there's surprisingly not a lot of deals in the sports space that have that. Most things that we see is like I described. It's, hey, new sport, we're going to get this, if we can just get enough capital, we'll put on some events and then we're going to get all these meteorites that are going to come and that's going to be your exit. And that is an investment that I think works for some people with a different risk tolerance than we have. We have to look at businesses that generate cash flow today in viable ways that we can underwrite in the near term and if a media deal happens to come, that would be pure upside to under our underwrite. Chris Heller, thank you for joining us and sharing your insights. Thanks Joe. Really appreciate it. If you enjoyed the podcast, please leave us a review on Apple podcasts or share it with your friends. Thank you.