Troy Gayeski believes that 99% of life is luck.
"People don't like to admit that but where you're born, which century you're born in, or whether you grow up in places where you have very little economic opportunity," he told Business Insider. "It's all just luck."
But hard work, mastery, and skill are things one can control, said Gayeski, co-chief investment officer of SkyBridge Capital, the $7.5 billion hedge fund that Anthony Scaramucci launched in 2005.
Gayeski, an engineer-turned hedge fund manager, has carried his life philosophy into investing. In managing SkyBridge's flagship fund of funds that invests wealthy people's money into other hedge funds, he seeks to exploit market inefficiencies and find managers who can add value via niche opportunities.
"Our thought process and philosophy has always been based on where there's inefficiency, where there's opportunity, and where managers can actually generate alpha to justify their fees and expenses," he told Business Insider.
In a market environment where stock returns are at a record high and bond yields are near historic lows, Gayeski sees "tremendous opportunities" in structured credit, which refers to packaging similar debt obligations into a pool and then selling off the resulting cashflows.
Structured credit products span from commercial real estate to consumer credits, but Gayeski is most bullish on the residential mortgage-backed securities space.
"We were very constructive on housing credit coming into the pandemic and immediately there's been some deterioration," he said. "But if you think of where forbearance requests have gone, where home prices have evolved to, where mortgage rates are, and look at where supply-demand is and housing in general. You almost couldn't have a more constructive case on mortgage credit here."
In the depths of the crisis, delinquency requests were expected to spike to 15% but they peaked at 9% and have now dropped to 7%, Gayeski explained. At the same time, home prices continue to appreciate despite the pandemic while mortgage rates have slid to a record low of 2.8%, he said.
On top of those conditions, there is an extremely tight supply of houses, between 3.1 months for existing sales and 4 months for all homes including new construction, which is pushing housing prices higher.
"We think that's a very rich opportunity with less risk," he said.
Convertible bond arbitrage, which involves taking long positions in a company's available convertible bonds and short positions in its underlying stock, is another opportunity that Gayeski plans to ramp up over the next 2 to 3 months.
"It's in a very sweet spot right now," he said of the strategy. "Depending on the month, issuance levels are growing three to six times where they've averaged the past five years."
Investors can also hedge stock market volatility with such a strategy, Gayeski pointed out.
"When you get equity sell-offs, the converts tend to behave as synthetic puts, meaning you have premium expansion," he said. "So unless you get another disastrous outcome ... even in down markets, as long as they're contained, there will be positive return expectations."
At the onset of the COVID-19, SkyBridge ramped up its holdings of distressed corporate credits, meaning the bonds of companies that have filed for bankruptcies or are on the verge of doing so, to 11%. But they stopped allocating to the strategy a few months ago.
"When you looked at more rational expectations for default, you could see $500 billion to $800 billion in default securities over the next several years," he said.
"But the fiscal stimulus and the Fed intervention have really lowered those default forecasts meaningfully until it looks like we'll probably have closer to $300 billion or maybe $400 billion in default securities. So that's something that we will more than likely start reducing at year-end."
Betting on hedge fund titans
To find the best expressions of his investment views, Gayeski and his team are betting on hedge fund luminaries with real capital.
In the multi-strategy space, the firm has a meaningful position in billionaire investor Dan Loeb's Third Point Ultra fund.
"Dan toggles back and forth from credit, equity, activism, and just passive investing and structured credit versus corporate credit, and then occasionally will take some international positions," he said of Loeb's investing style. "That looks robust mainly because of the still-very-attractive opportunities in structured credit as well as high degrees of dispersion in equity markets."
Another big name in the portfolio is Steve Cohen's Point72 Asset Management.
"The Point72 style is high-growth, mainly multi-PM, long/short," he said. "For most of the post-crisis period with the exception of 2013, 2016, and this year, you've had very modest degrees of dispersion and higher correlations between equities. You still have higher correlations but dispersions have been fairly significant, and so that strategy looks very attractive."
To execute the view on distressed corporate credits, the firm allocated capital to Josh Friedman's Canyon Partners.
"We've known Josh for years and he is a tremendous distressed investor," Gayeski said of the decision to add to the Canyon fund in April. "He has had his second-worst drawdown ever and had a lot of good value in the portfolio, whether it was structured credit or corporate credit and he's had a nice run as well."
Muted returns
With "the tremendous reflation of equities" and "fixed income offering very little return," Gayeski believes investors should set realistic goals and expect more muted returns ahead.
"The best thing to do now is to look for alternatives with high single-digit like returns and in the near term that can run circles around fixed income and give equities a run for their money over the next 3 to 5 years as well with far less downside," he said.
To be sure, SkyBridge's fund of funds was down 24.7% in March and had significant redemptions in April. The fund bounced back in July, though it's still down 19.29% this year, according to an investor letter. Its 4.6% annualized return since inception in 2003 is three percentage points ahead of its benchmark.
The halcyon days during which the hedge fund industry grew from several hundred billion to $3 trillion may be over, but investors can still generate alpha by picking the right strategies.
"It's so hard to generate returns other than just owning equities and hoping they keep going up forever. Even if the hedge fund industry can only generate 4% to 6% returns in the next 3 to 7 years," Gayeski said.
"That's going to look very good versus any type of fixed income opportunity, so on that side alone, we think that means the industry continues to offer an attractive option for institutional investors and high-net-worth investors."
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