SkyBridge CEO on Investment Themes, Manager Screens and Regulatory Regimes (Part I)

May 27 2016 | 6:37pm ET

SkyBridge CEO on Investment Themes & Manager Screens (Part I)
By Steven Lord, FINalternatives

SkyBridge Capital’s Anthony Scaramucci is not your typical hedge fund executive. While most successful managers approach interaction with the media with a cautious mix of reserve and reticence, Scaramucci is the opposite; engaged and ebullient, he is a rarity in the upper echelons of institutional finance — very good at what he does, and very willing to talk about it. 

An alum of Harvard Law School and Goldman Sachs, Scaramucci originally started SkyBridge Capital in 2005 to focus on seeding other hedge funds before migrating the firm toward a fund-of-funds model that allocates investor capital to a variety of managers. In 2009, he hosted the first of what has become one of the investment industry’s signature annual gatherings, the SkyBridge Alternatives Conference (SALT). 

The hedge fund-of-funds space has been rough going for the last several years. Assets under management have grown in only one year out of the last five, and the segment lost $12 billion in aggregate capital during 2015 according to industry data provider Preqin. A total of 97 hedge fund-of-funds were liquidated globally last year against only 28 launches, and notable institutional investors have indicated plans to further reduce allocations.

Nonetheless, SkyBridge has grown to around $12.5 billion in assets under management, with Scaramucci remaining a very public figure through it all. He appears often as a commentator on various financial networks, and famously revived the late Louis Rukeyser’s Wall Street Week television show in April 2015. 

True to both Scaramucci’s form and the style of the original show, the rebooted program pairs the most compelling financial and economic issues of the day with top-tier investors, managers and policymakers as guests. Yet, it comes at a time when the public’s general perception of the hedge fund industry is strained by oversized media coverage of lavish lifestyles, gargantuan pay packages, no shortage of bad actors and underperformance. Meanwhile, the business model is challenged by incessant pressure on fees and an increasing tendency for the largest managers to attract the lion’s share of new investor capital.

Scaramucci chalks up many of these trends to the lingering effects of the financial crisis. “For those of us who were there and managed through it, it feels like the financial crisis happened yesterday,” he says. “Before the crisis, smaller managers could attract capital because investors felt they were faster to seize opportunities and could be much more flexible. But as we learned, they also can go to zero quickly, throw up gates, etc., so there is a natural tendency for the average hedge fund investor to gravitate toward larger organizations with more established track records. From a behavioral finance perspective, it’s like a form of post-traumatic economic stress. It takes 10 to 15 years to roll off that memory.” 

At the same time, however, Scaramucci sees opportunities in the two-speed nature of hedge fund capital flows. “In some ways, we’re in fashion, not finance,” he says, adding that its not always beneficial to view the markets from a tactical lens. “After something like the financial crisis, long-term opportunity loses out to short-term pain, and creates the ability for funds like ours to position strategically. If I have the opportunity to pick up a dollar for 60¢, I’m willing to be as patient as necessary to do it.”

Current Investment Themes

That said, there is no question the current environment is challenging. For a fund like SkyBridge, the overall goal is to generate high single-digit, low double-digit annual percentage returns with one third of the market’s overall volatility. Within an investor’s portfolio, Scaramucci says, SkyBridge wants to be that wedge (5% to15%) that helps provide return but reduces risk exposure at the same time. And he freely admits that SkyBridge will underperform the broader markets during strong uptrends. “When things are great, we’re not that needed,” he notes. “But when things go off the proverbial rails, we’re in there with a decent return.”

Scaramucci is quick to add that he tries not to reinvent the wheel, and does not stray very far into esoteric strategies or the flavor-of-the-month approaches that can flame out as quickly as they arrive. Instead, he says, Skybridge looks at five or six major themes each year, and concentrates on two or three of them. 

For instance, SkyBridge generated headlines late last year when it redeemed around $1 billion from event-driven strategies at high-profile Paulson & Co., Third Point and JANA Partners in favor of funds that focus on income generation. The step was not taken because his overall opinions about these managers had changed, Scaramucci explained, but because the environment for them has shifted. 

“When we entered event-driven strategies a bit more than a year ago, we felt there was a good dynamic for asset managers to make money with them,” Scaramucci says. “There was a ton of cash sitting on the balance sheets of S&P 500 companies, and legislation like Dodd Frank had strengthened the rights of minority shareholders. Plus, since the crisis, things like stock buybacks, acquisitions and mergers have driven a good portion of the bull market, so together, that meant to us stronger leverage and an attractive playing field for event-driven and activist asset managers.” 

Scaramucci’s thesis played out well during 2015, with $4.6 trillion in M&A activity. However, although he still sees some level of attraction to the segment, other areas are more promising going into the second half of 2016. 

For instance, SkyBridge is exploring opportunities in structured credit, where collateralized loan obligations (CLOs), commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS) are cheap both technically and fundamentally. “Spreads in structured credit have gapped back to 2011 levels,” Scaramucci explains. “The fundamentals are basically sound, yet there has been this massive technical overselling. The last time there was such a dislocation in this market segment, we saw 20% to 40% moves the other way as things snapped back and normalized.” 

The Dislocation Game

Dislocations are a recurring theme in SkyBridge’s hunt for those dollars on sale for 60¢. “We’re trying to find things that are dislocated from their normal state,” Scaramucci explains. “For example, exploration and production companies can make money at $60-$70 per barrel, but will have a hard time if prices remain in the mid-$30s for a sustained period. 
At some point, their production assets can’t produce enough to sustain the company’s current capital structure, and eventually you’re going to be looking at a completely dislocated scenario. We’re not in this market at the moment, but it’s a good illustration of how opportunities can arise,” he says.

The trick, according to Scaramucci, is figuring out the right approach and the most appropriate financial instruments to take maximum advantage of the dislocation. Sometimes, the situation requires a very opportunistic approach to what may be a very strategic shift. For instance, SkyBridge is currently active in the trust preferred space, taking advantage of the recapitalizations underway as global banks shore up their balance sheets ahead of crisis-inspired risk capital requirements. “Because of things like Basel III, commercial banks are being forced to rapidly improve their regulatory capital ratios through the sale of certain types of securities,” Scaramucci says. “However, they have to offer them at very attractive 
discounts to get them placed in the current environment, which in turn presents a wonderful opportunity for us to earn incremental yield in a low-rate environment while participating in the increase in principal value down the road.” 

Global macro is another area currently of interest to Scaramucci, despite the headwinds faced by macro managers last year. Buffeted by intense volatility in broad economic themes like interest rates, currencies and equities, well-known global macro managers such as Brevan Howard, Fortress Investment Group and Bain Capital have suffered billions in redemptions and, in some cases, are winding down major funds. Nonetheless, Scaramucci feels the long game is on his side. “We have exposure to macro managers because there are key relationships in the world that are ultimately unsustainable,” he says. “The Chinese yuan, for instance, will have to revalue as the country shifts to a consumer-driven economy from a manufacturing-driven one. The disparity in central bank policies is another unsustainable area—the Fed is pushing U.S. interest rates upwards while the Bank of Japan and the European Central Bank are going negative, and quantitative easing is underway everywhere but here.” These long-term scenarios can provide astute managers with tremendous tactical opportunities within broader strategic moves, he adds.

Where Art and Science Intersect

But what makes an astute hedge fund manager? As a fund of hedge funds, Scaramucci sees more than his share of pitch decks and tear sheets, so we were curious about what SkyBridge considers the single most compelling trait in a manager. The answer: Battle tested.

“This is where the art and the science intersect,” Scaramucci says. “The numbers are important and quantitative analysis is necessary, but I look most at how a manager has performed under stress and adversity. To paraphrase Mike Tyson, everyone has a plan until you get punched. I’ve endured five or six market cycles and come out stronger in each case. How a manager performed when things were really tough is probably the most important thing I look for.” 

Dealing with adversity isn’t limited to new or smaller managers, either. Scaramucci considers the punches just as valuable when really good managers have really bad years, such as the double-digit losses sustained in 2015 by Bill Ackman’s Pershing Square, Ray Dalio’s Bridgewater and David Einhorn’s Greenlight Capital. “All of these managers have taken lumps before and thrived,” he says. “I expect the same thing to happen again,” although Scaramucci points out that even highly experienced hedge fund managers can get themselves into trouble when the fundamental analysis does not fit the fundamental reality. Case in point: Embattled Canadian pharmaceutical company and former hedge fund darling Valeant Pharmaceuticals.

The punches don’t always come from the markets, Scaramucci also notes. Some managers are extremely successful from within the environs of a large institution, but fall flat when they try to go it alone. “Managers that leave big banks to go off on their own are not always a good idea,” he observes. “They’re used to having all the little details—everything from compliance and fund administration to technology and office space—handled for them by people with years of experience operating successfully in these areas. There can be some nasty surprises lurking there.”

Scaramucci wants managers that recognize, either through experience or intuition, that they don’t have all the answers. “As Socrates said, there is value in recognizing when you know nothing,” he says. “That’s the essence of what we’re looking for in a manager.” 

Part II of this article, which originally appeared in the June issue of Modern Trader, will appear in due course on FINalternatives. 

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