SALT Las Vegas 2016 Review

Credit opportunities highlighted amid liquidity concern

Originally published in the June 2016 issue

There were thousands of registered delegates at SkyBridge Alternatives (SALT) Conference in Las Vegas and SkyBridge Capital founder Anthony Scaramucci estimates that $2.5 to $3 trillion of allocator capital could have been present at the 8th annual event hosted by the global investment firm. SALT panellists include politicians, celebrities, and sportspeople, and leisure activities at the event included spa treatments, cycling, swimming, jogging to the Hoover Dam, and live bands such as The Killers. Philanthropy is also an aspect of SALT: a number of speakers, including billionaires David Rubenstein of Carlyle and Leon Cooperman of Omega, have signed the ‘Giving Pledge’ committing them to bequeath the majority of their wealth to charity. The Children of Fallen Patriots Foundation, which supports the surviving spouses and families of soldiers who passed away on active duty, was one charity with a stand at SALT. But in this review we focus on a selection of views from hedge fund manager panels, as well as some service providers and some one-on-one meetings with managers at the event. Many of the panellists, speakers and moderators have been selected for The Hedge Fund Journal’s biennial surveys: ‘Tomorrows Titans’, and ‘50 Leading Women In Hedge Funds’, both of which are sponsored by EY. Many panellists have also been interviewed and profiled by THFJ.

Macro and commodity views
Kyle Bass of Hayman Capital (who has been selected for our ‘Tomorrows Titans’ Survey) thinks that China’s asset/liability imbalances are the largest ever and sees weakness in Singapore and Hong Kong credit and property markets as harbingers of further economic weakness. Bass thinks we are only two quarters into the typical three years taken for banks to reach peak losses in a credit downturn. Roslyn Zhang of China Investment Corporation (who was selected as one of THFJ’s ‘Leading 50 Women in Hedge Funds’) seems more sanguine on China and in particular infrastructure. With 200 airports in China against 5,000 in the US, Zhang sees a long runway for building more airports.

Bearish Bass thought market conditions felt like April 2007, but septuagenarian manager Leon Cooperman of Omega argues that the preconditions for an equity bear market are not present: there is no recession, no substantial Fed tightening and no euphoric valuations for equities. In contrast Cooperman does view fixed income as a bubble, while Ken Tropin of Graham Capital (whose Managing Director, Jennifer Whelen, was selected for THFJ’s ‘50 Leading Women in Hedge Funds’ survey) thinks 10 year Treasury yields could compress further to 1.4% amid deflationary market dynamics.

Tropin and Chuck Yates of Kayne Anderson Capital are both bulls of gold, with Tropin liking the asset class even though he recognises it could be an overcrowded trade. Yates also thinks that oil could be undersupplied by late 2016. Differently, Lesley Biddle of Serengeti Asset Management (who was selected for THFJ’s ‘Leading 50 Women in Hedge Funds’ survey) argued that if Saudi Arabia keeps on producing large volumes of oil, the market might not balance. Mark Mobius of Templeton Emerging Markets thought that commodities in general were bottoming out, which supports his favourite equity markets that include Russia, Brazil and Nigeria.

Dislocations lead to credit market opportunities
But many panellists seemed more enthusiastic about selected credit than equity investments. SkyBridge Capital Chief Investment Officer, Ray Nolte, revealed how SkyBridge (which has been profiled in THFJ) has turned over 45% of its portfolio between the fourth quarter of 2015 and the first quarter of 2016. SkyBridge has de-risked by exiting equity and event driven strategies, including activists, and rotating back into cash-flow oriented strategies including residential MBS, commercial MBS, and structured credit CLOs, with some small exposure to student and auto loans. Nolte is biding his time before contemplating a return to high yield debt however.

A number of other panellists also identified compelling investments in various parts of the credit universe. CLO equity is popular with several managers. Chris Hentemann of 400 Capital Management LLC said that CLOs were the most interesting distressed opportunities, due to technicals and complexity. David Rosenbaum of Prophet Capital Management argues that term, non-recourse leverage makes CLOs a much safer way to amplify credit bets than relying on lenders who might withdraw facilities and could foreclose on assets. Rosenbaum has identified CLO equity yielding 20% and sees some two year paper trading at 40 cents on the dollar. Andrew Rabinowitz of Marathon Asset Management is also a fan of CLOs, and claims that a JP Morgan study ranked Marathon as number one for cash on cash CLO returns over the past three years. Emmanuel J. Friedman of EJF Capital is investing in the equity and CDOs of 7,000 smaller US banks that are outside Dodd Frank rules.

European structured credit was also sought after by some speakers. Loic Fery of Chenavari Capital (which has been profiled in THFJ) also views the selloff in European structured credit as being technically driven, with €140 billion of bank deleveraging that has accelerated to the point where performing, as well as non-performing, loans are being divested. The selloff in areas such as Spanish RMBS seems particularly anomalous when credit quality is actually higher given credit enhancements, improved collateral performance and de-levering of senior tranches. Fery remains surprised that institutions are underweight of European credit. Waterfall’s Jack Ross emphasises the importance of understanding local variations in creditor rights and servicing models in each European market and for medium sized deals Waterfall negotiates bespoke terms rather than bidding in auctions.

Marketplace lending has become fashionable but some panellists seemed circumspect on the strategy. The day before SALT started it emerged that Lending Club’s CEO Renaud Laplanche had resigned. As SALT panels can be spontaneous rather than scripted, the resignation and the rising defaults at some peer to peer platforms were topics of discussion. Chris Hentemann of 400 Capital Management LLC observed that peer to peer lenders’ underwriting criteria was as yet untested in more challenging environments. Waterfall’s Jack Ross expressed a more profound concern that marketplace lending platforms could be subject to the same conflict of interest that has been associated with the subprime crisis: they can profit from originating, and then selling, loans without sharing in the credit risk, as they are not covered by the risk retention rules applying to structured credit- already in Europe and imminently in the US.

Ross is however keen on other consumer credit risks including selected consumer credit ABS, citing lower unemployment reducing defaults and delinquencies. Phil Weingord of Seer Capital Management emphasised how different segments of the credit markets move in their own cycles. Currently he views US residential property, still below previous peaks, as a good source of collateral. Morris Mark of Mark Asset Management is also a bull of US housing, pointing out that housing starts of 880,000 a year seem historically low versus a US population of 330 million.

Commercial MBS is of more interest to Clayton DeGiacinto of Axonic, and has become the biggest sleeve in Axonic’s long and short books. He thinks some CMBS backed by struggling shopping malls could be worth zero. Weingord views CMBS spreads of 450 over Treasuries as historically high and reckons they allow some room to accommodate any rate rises, while Ross finds CMBS has a substantial collateral cushion meaning that investors might get out whole even if underlying property prices declined.

Sir Michael Hintze of CQS thinks Basel III capital rules systematically undervalue some securities and views selected ‘B’ and ‘BB’ rated credits as being particularly dislocated. Hintze also thinks that in a world of rising geopolitical tensions, owning Credit Default Swaps on sovereigns such as Russia and China offers good value insurance.

Boaz Weinstein of Saba Capital Management (who was selected for THFJ’s ‘Tomorrow's Titans’ survey) identifies a disconnect between senior debt trading as low as 12 cents on the dollar, and equity valued at a billion dollars. Weinstein is constructing capital structure arbitrage trades that could profit from debt outperforming equity.

Selected stock picks
The activist panel included ‘hostile’ activists, ‘friendly’ activists and those who pursue a mix of both styles. Jeffrey Smith of Starboard Value LP has installed two directors at Yahoo but observed how finding good candidates to replace Yahoo CEO Marissa Meyer was a substantial challenge, partly because most CEOs are hired internally. Ex-Pershing Square Scott Ferguson of Sachem Head (who was selected for THFJ’s Tomorrow's Titans survey) sees 60% upside for Amserge and is happy to see fellow activist Jana Partners on the board. Teresa Barger of emerging markets activist Cartica Capital views Phillipines bank, Security Bank, as undervalued at 1.4 times book value. Clifton Robbins of friendly activist Blue Harbour Group (which has been profiled by THFJ and whose Managing Director, Lauren Taylor Wolfe, was selected for our ‘Leading 50 Women in Hedge Funds’ survey), thought cash-rich bank Investors Bancorp could appreciate from its deep discount to peers, and reflected on how a demerger had unlocked value at Babcock.

Non-activist managers included John Burbank of Passport Capital (which THFJ has profiled and who was selected for THFJ’s Tomorrows Titans survey) who sees China’s economy rebalancing away from investment and towards consumption. Passport is short of an old economy China ETF and long of Tencent, which Burbank expects to become one of the world’s largest companies. Passport’s proprietary earnings forecasts for the company are well above sell side consensus numbers as Burbank sees huge potential for Tencent to monetise mobile advertising by using its dominant position in apps. Burbank also points out that Tencent is less widely owned amongst hedge funds than are technology firms such as Facebook, but feels Tencent deserves to have performed as well as the FANG stocks (Facebook, Amazon, Netflix and Google).

From Europe, Reade Griffith of Tetragon Financial Group Limited is a cheerleader for European equities. He thinks lower oil prices and healthy inflows bode well for the asset class. Griffith became one of the latest hedge fund managers to find value in Greek banks, which he views as better capitalised and offering higher interest margins than those in Spain or Italy.

A small number of short ideas were also unveiled. US airlines cannot sustain 20% margins, according to John Lykouretzos of Hoplite Capital Management, who envisages excess capacity, expects trade unions to secure wage hikes, and also sees higher oil prices ahead.

Seasoned short seller Jim Chanos (who also runs strategies seeking long alpha) was short of Cheniere Energy. He is of the opinion that Cheniere’s projected 2020 EV/EBITDA valuation is roughly double that of peers, and that its 100 year asset life estimates are aggressive. Chanos also raised concerns about the accounting policies of Alibaba, specifically that its earnings are unclear because affiliates are not consolidated. Chanos may well be ahead of the curve: a few weeks after his comments at SALT, the SEC announced it is investigating precisely this issue and requesting information on Alibaba’s consolidation policies.

Liquidity concerns persist
Yet short selling theses were heard far less often at SALT than were concerns about financial market liquidity. The argument that various banking regulations such as Dodd-Frank, as well as capital adequacy and solvency rules, have reduced broker dealer inventories and therefore liquidity is well rehearsed. But Omega’s Cooperman attributes weaker liquidity to a market phenomenon: the rise of passive investing – simply because index trackers turn over portfolios and trade far less often than do active managers. Though futures have seen rapidly growing volumes they could also be feeling the impact of thinner markets. Hintze of CQS cited a JP Morgan study suggesting that in 2012 it took 8-9,000 S&P futures contracts to move the market by one point whereas now it only takes 1-2,000 to have the same market impact. For Hintze this is only one sign of the general trend in less liquid markets for tails to be much longer than they once were. Canyon Capital’s Joshua Friedman argued that technicals are driving credit markets more than fundamentals, and he finds that indicative bids can be unreliable. Hayman Capital’s Bass observed that liquidating both equity and credit positons in 2015 took longer than expected. Rubicon Capital’s Paul Brewer views seven standard deviation moves on no news as a clear signal of poor liquidity. Brewer argued that managers running $20-30 billion cannot generate good returns and he sees the industry coming round full circle to its roots in smaller boutiques.

Thus the majority of opinions voiced on the topic at SALT seemed to concur that liquidity continues to deteriorate. But in some quarters of the credit markets, liquidity might even be improving. Kenneth Griffin of Citadel pointed out how bid/ask spreads on interest rate swaps have dropped by 50% over the past 15 months as the surge in clearing makes markets more transparent. Griffin is also somewhat optimistic on potential for new entrants to improve market liquidity. Citadel invested in BATS years ago and would welcome IEX Group being approved as an exchange (but argues that IEX’s proposals around broadcasting orders could make it harder for investors to execute large volumes without adverse market impact). Friedman of EJF Capital LLC also hopes that new market entrants such as smaller banks outside Dodd Frank, insurance companies or sovereign wealth funds might inject liquidity into repo markets, which he claims are pressured by Federal Reserve rules.

Liquid alternatives
Concerns about financial market liquidity fed into a discussion about which strategies are most appropriate for liquid alternatives. Troy Gayeski of SkyBridge Capital argued that daily dealing vehicles imply a liquidity mismatch for strategies including structured credit, distressed debt and volatility arbitrage. Gayeski also observed that managed futures and CTA strategies housed in daily dealing funds have not sacrificed much, if any, returns.

Tropin of Graham Capital Management thought that exchange traded instruments were the best fit for liquid alternatives. Tropin also said he was cautiously optimistic about a good outcome to the SEC’s 18f-4 proposals on derivatives and leverage for regulated investment funds including ‘40 Act funds.

The growth potential of liquid alternatives remains clear. David Saunders of Franklin Templeton Investments’ K2 Advisors (which has contributed articles to THFJ) pointed out that retail investors lag well behind institutional investors in the adoption of alternatives. Indeed, Pershing Prime Services is seeing strong interest in setting up liquid alternative vehicles, including ’40 Act funds, from many of their asset manager clients. Pershing have patented a tri party custody solution. This is not a triparty repo, and its features include PrimeConnect40, anautomated mechanism for sweeping collateral between prime brokers and custodians.

Insurance dedicated funds
Regulated liquid alternative funds are one of many vehicles that can accomodate hedge fund strategies. Insurance-related structures are another type of wrapper that is also attracting growing interest, partly for tax reasons. Hedge funds have been setting up reinsurance related vehicles for some years. Insurance Dedicated Funds (IDFs) are another structure that can be relatively tax efficient for taxable US investors. Michael Gordon, Chief Executive Officer and President of Lombard International, explained how criteria over investor control and diversification must be met to retain the tax benefits of IDFs. Lauren Katz of Goldentree Asset Management said clients were attracted by the tax advantages of IDFs, and in particular the potential to switch funds without crystallizing taxable gains.