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.”
A cabal against hedge funds
No candid conversation with Scaramucci is complete without discussing politics. Characteristically outspoken and very active in Republican fundraising circles, he backed Mitt Romney in 2012, served as Scott Walker’s finance manager during his abortive run for the 2016 nomination and supported Jeb Bush when Walker bowed out. In January, he wrote a Fox Business editorial in which he lamented a primary season so riven with “unbridled demagoguery” that the GOP faces either devastating defeat in the general election this fall or a seismic shift towards a currently unrecognizable new identity. “Call it a moral debt restructuring,” he wrote, “caused by the reckless behavior of a man who knows a thing or two about bankruptcy.”
With virtually all of the leading candidates for the U.S. presidency unified in their targeting of alternative asset managers in general and the tax treatment of some of their investment gains in particular, we asked Scaramucci about his position on the carried interest debate. “I am resigned to the fact that a cabal exists against hedge funds from politicians,” he replied. “There is such negative media associated with this industry, often from people who haven’t done the homework necessary to understand it. Carried interest, for instance, is much more of a private equity issue, but it still carries over to hedge funds because everyone is painted with the same brush. There is a lot of guilt by association that goes on, and in the case of some of the candidates, it comes with tremendous irony.”
His political leanings notwithstanding, Scaramucci has a fairly nuanced view of regulation. In fact, when asked to pick the most influential change on Wall Street between the first airing of Wall Street Week and his resurrection of the show last year, he chose regulation. “These days, not many people are aware of how Wall Street operated when Louis Rukeyeser started Wall Street Week,” he says. “Coming after the Depression and the recovery after World War II, it was a closed circle dominated by inertia, a clubby brokerage industry and fixed brokerage commissions. May Day 1975 changed all that, and Wall Street has never been the same.”
On May 1, 1975, the U.S. government deregulated the commission markets and allowed competition to dictate the cost of trading. Almost immediately, discount brokerage companies like Charles Schwab and Waterhouse appeared, revolutionizing Wall Street with lower trading prices and increased service, which led to a three-decade embrace of Wall Street by retail investors that directly led to massive increases in liquidity, online trading and even the creation of innovative low-cost products like exchange-traded funds.
“Capital markets are the circulatory system of the capitalist organism,” Scaramucci says. “Whatever makes that blood flow most freely is quickly embraced, and Wall Street allocates capital in a very propitious way. But heavy regulation restricts those arteries, and thus the efficient flow of that capital. No regulation is clearly a bad idea, but as the pendulum swings, history tends to repeat. Think of all the regulations put in place in the aftermath of the financial crisis: Dodd-Frank, Basel III, AIFMD, MiFID, etc. It’s easy to wonder whether it’s become excessive again, and whether all these rules will ultimately help prevent another wipeout.”
Ice cream and vinegar don’t mix
In the same vein, Scaramucci says he does not believe in a no-holds-barred approach to financial products. Liquid alternatives, for instance, are accidents waiting to happen, he says. “I hate liquid alts. I’ve begged people to stay away from them. They sound great, but they don’t work.”
Liquid alternatives have grown quickly in the past several years as regular investors have sought greater access to the complicated alternative asset management strategies normally accessible only to wealthy investors through expensive and illiquid hedge funds and private equity companies. While proponents celebrate the risk management, diversification and directional benefits of such strategies, detractors wonder about the potential pitfalls of placing relatively illiquid, complex alternative investments into the hands of generally unsophisticated investors through what appear to be liquid, publicly traded wrappers.
“The core issue with liquid alts is that you can’t always marry liquidity with alpha generation,” Scaramucci says. “Dislocations in markets take time to reset, and liquid alts do not give you the time to capture that alpha. People will sell at the wrong times and for the wrong reasons.” When asked whether this was an area in which regulation could play a role in keeping people safe from themselves, he unequivocally agreed, echoing the old saying that just because you can do something, doesn’t mean you should.
“I love vanilla ice cream and I love red wine vinegar,” Scaramucci continued. “But that doesn’t mean they should go together. It’s the same with liquid alternatives — hedge fund strategies are great and liquid investment options are great. But they don’t always mix.”
Ultimately, Scaramucci says Wall Street’s simplistic definition as an efficient marketplace belies a much more complicated story. “Rational people will do irrational things if it is in their best interest,” he explains. “If you were an institutional fixed income manager in the fourth quarter of 2008, you were selling all the subprime exposure you could because you didn’t want to carry it. You didn’t want to lose your job. Ultimately, a lot of very smart people made very irrational decisions, at least from a securities perspective, because a lot of good paper was sold off to technically wild levels. It’s been a lesson to us ever since — dislocations can cause sane people to do insane things, and it’s our job to step into markets when those opportunities present themselves.”