AN INTERVIEW WITH A HEDGE FUND INSIDER

By HedgeFund.net:

Anthony Scaramucci, founder of preeminent hedge fund seeding and incubation firm SkyBridge Capital, spoke with HedgeFund.net about his idea of the U.S. government issuing sovereign equity, the tremendous opportunity that exists in emerging hedge fund managers and his company’s upcoming SALT hedge fund conference.

The event, scheduled for May 19 to 21, 2010 in Las Vegas, will include keynote speakers President Bill Clinton, former governor of Massachusetts Mitt Romney and Professor Nouriel Roubini.

Q: What is your outlook on this macro economic recovery?

A: The majority of economic data as it relates to unemployment and consumer spending is that we have been on an asset tear, and an upward revaluation of assets after the crisis primarily induced by the Federal Reserve Bank monetary policy. But, we really haven’t seen a dramatic employment recovery at this point. My belief is that the back half of the year is going to be stronger than people expect just because now the American corporation and American small business owner is probably in a very lean capacity situation. With capacity utilization being that tight and having such a lean situation, that offers more room for more workers. My bet is that unemployment will creep down in the back half of this year and we should see a fairly robust response from the economy.

Q: You mentioned something on television the other day about buying equity in America and I was wondering if you could elaborate on that further. Was that just a conceptual metaphor or did you mean that literally?

A: Actually, I think we should do that. I actually think it would be a mechanism that will showcase what the assets are of the United States. The point I was trying to make on that television show is that I’ve done the studies and actually can show you something. The governments of the world for 5,000 years have financed themselves through debt instruments. No government has ever put together an equity security.

[Chairman and chief executive of Omega Advisors] Leon Cooperman was saying the government owns Fannie and Freddie and look how they’ve destroyed that. But if you put together a security that was tied to tax receipts, tied to some user fees, you tell me, we’ve got tremendous assets in this country and my point is that if you were to take a piece of the government public you would see the brand equity or the value of the United States as a nation. There’s a $50 trillion to $60 trillion handle away from the $50 trillion in private assets that we have. So, the net aggregate base of the country is probably $100 trillion if you figure in all the soft and the hard assets that the country has.

So if you have $13 trillion in debt, yes it’s a high number, yes we shouldn’t be running these structural operating deficits, but that’s been a bipartisan problem.

President Bush had not one veto in the first six-and-a-half years in his administration, so he was a “spending-aholic” with the federal money. It wasn’t like the Republicans weren’t spending, they were spending as much as the Democrats. Now you get into this economic crisis, there was no one on the left or the right that did not suggest that the government didn’t need to step in with a stimulus.

Some other factors to consider are that there’s been a $9.2 trillion reduction in private debt since the crisis started, and there’s been a roughly $10 trillion accretion in U.S. government debt since the crisis started.

So what effectively happened was that you go from $9 trillion in public debt priced in the fives and sixes in the coupons to $10 trillion in federal debt priced at three. We’ve done an amazing interest rate arbitrage for the country. We’ve reduced private debt and increased public debt with a 300-basis-point differential.

If the government borrowed the money and they’re lending it, or they are granting it through the FHA, which is the program to help people with their mortgages, it’s preferable for the consumer to do it that way.

I’m not a debt-aholic. I’m not a spending-aholic. We have to reign in government spending. We have to gear and target our GDP so that 18%-19% of it is not allocated to the government. At 24% it is just too high and it’s very problematic and we’ve got to reign it in, and I think the White House understands it. Hopefully both sides understand that. But, what are you to do if they didn’t take the measures they took 12-18 months ago? You could have touched off a 15%-30% unemployment in the country.

Q: And that would be a pretty big hole to dig out of.

A: Exactly, and [that is] the price that we paid in terms of increasing our debt load to kind of restore confidence in the financial sector, make people feel more comfortable to go out and spend. Paul Krugman wrote a great book on turn-of-depression economics and I actually agree with a lot of the stuff he said even though I’m a right-of-center political and economic thinker. There was some value in what he was saying from the left, in terms of what you needed to do to restore confidence.

All I’m saying is that asset, which is called USA Inc., if you were to put it that way, has liabilities of $13 trillion, but it has an asset that’s way bigger than $13 trillion. We are the global reserve currency we will stay the global reserve currency. We are the economic engine of the world. We have 26% of the global GDP still to this day. We have the most fantastic ability to tax in this country and we have the most fantastic ability to innovate as an economy. We are the most adaptive economy in the world.

Lastly, and this is very important as the world’s policeman, we are spending $608 billion on defense. If you take the other 190 countries in the UN and add them up, they don’t come anywhere close to what we’re spending. That can be bad, but in a lot of ways it is very good, because projection of American power is actually helping our commerce and reduces long-term tensions in the world.

Pull out of Southeast Asia and watch the Chinese and the Taiwanese and the Australians and the Japanese interact with each other. If you read the history books you know we are among the most benevolent superpowers ever.

When guys in the media are bashing the country as it relates to our debt and the opportunity we have as a nation I’ve got to get in there and explain to them an alternative point of view.

Q: I have not heard that argument made, it’s certainly out of the box. Let me bring it back to the hedge fund. Your firm focuses on emerging managers. What would you consider to be an emerging manager? The definition has been fluctuating. As a follow up to that, what makes 2010 the best time to get into emerging managers?

A: The test is always 18-24 months after, when you do the look back and say, “Hey that was a good time.” But look, when I started this business I thought it was a good time, but the look back proves that it wasn’t. We were in a very late-stage market and we were in too much foam and too much froth there was too much leverage in the entire system. In the look back, I was wrong. Sitting here in 2010, markets have delevered, banks are shoring up their balance sheets, real estate is starting to move and starting to transact.

We are in a cyclical economy and we have to accept that. For myself I think we are in a better situation for emerging managers. If 2006 was late stage, 2010 midpoint, we’re sort of early stage and here’s what’s going on:

Prop traders and prop trading groups are being shut down at banks. Large hedge funds have slimmed up their personnel either due to asset position or just trying to create a leaner organization. The result is we have a ton of talent on Wall Street, in commercial banks, investment banks, and other hedge funds, that is now migrating on the street. Many of those people are going to say “If not now, when?” And they’re going to go start their own businesses.

I like to say SkyBridge has a “SkyBridge Inside” product . . . sort of the way Intel branded itself with the saying “Intel is inside.”

We can provide cloud computing, or application service providing, or paychecks, or ADP on payroll and having people off balance sheet their payroll department to one of those firms. SkyBridge can do that for the smaller hedge funds.

We can put capital in their funds and we can give them a start. We can give them a vote of confidence we can give them our marketing department which is going to be way better and more successful than any one-off person that they can hire. We have a seven-person integrated marketing department with a 5,000 + person Rolodex. We’re doing an annual conference every year where we’re showcasing managers. We’re bringing high-net-worth people and top allocators to see them.

That’s a much better story than two guys starting out in a garage trying to make all the phone calls, or having somebody hand them a capital allocation phonebook from Goldman and starting on the first page. There’s 10,000 names but guess what? 9,000 of those 10,000 names don’t ever invest in first time funds. You spend a good time figuring out which is which. We already know. We’ve already screened and called those names. On a global basis we have a 4,000 to5,000 person database of people that we know are firmly stated check writers that seed businesses.

I think it’s a ripe opportunity for SkyBridge because there are going to be people that say “I can’t do it all. I really want to run my portfolio and manage the people in my business. I can avail myself of SkyBridge for risk management. I can avail myself of SkyBridge for marketing. I can co-brand with SkyBridge, but still have the independence and autonomy of my own company.”

That seems to be intersecting with at a lot of good value points for people, so I can see a very good opportunity right now for incubation because of the talent that is out there and because that talent wants to raise money. Why not get a boost in the arm from SkyBridge?

As for who qualifies as an emerging manager? That’s a good question, because it’s all over the map. Some people would say it’s the guy who comes out and you’re giving him a $25 million check, or he’s starting with $25 million to $50 million, he’s the emerging manager. Other people would say that since the guy’s stagnated at $200 million he’s got good performance, but he can’t figure out a way to scale himself, he’s the emerging manager.

If he’s in the Alpha 100, clearly he’s not an emerging manager, but if he’s not in the Alpha 100 then where does he stand?

I would say this: If you’re short of $500 million in overall aggregate assets in your business, chances are that you are at the early stage of your business development. There are people that will cap themselves at $200, $300, 400 million. It’s a nice cottage business and they’ll stay in that small zone but a “non-emerging manager” to me is north of 500 million bucks. That’s how I would define it to someone.

Q: I’ve had the opportunity to work with some of these emerging managers that have become enormously successful. Are there any cases that stand out in your mind, any success stories or anyone that you’ve helped through the process soup to nuts?

A: I can give you five or six historical seeding deals that worked out really well:

1) Ziff Brothers with Och in 1994 they gave him $100 million he’s worth $25 billion today.
2) Tommy Steyer from Farallon was backed in 1988 by Hellman & Friedman they still own a piece of his business and he’s running $15 billion to $20 billion today.
3) Dinakar Singh, was a prop and arbitrage trader at Goldman Sachs before he set up a business called TPG-Axon , the TPG stands for Texas Pacific Group. They gave him the money and helped him become a company.
4) Noam Gottesman (GLG Partners) was backed by Lehman Bros and it turned into a colossal firm.
5) Maverick, Lee Ainslie was backed by the billionaire Sam Wyly, they turned into a massive firm.

Those are all Alpha 100 managers that have had incubation in their businesses.

As it relates to our businesses, we backed a manager in 2006 with $35 million and he’s now up to $780 million. Westport Capital Partners, he’s emerged, he’s gone from emerging manager to emerged. He has a diversified real property portfolio–pretty good wouldn’t you say?

Q: Obviously not every fund is going to get seed capital and there are probably high quality managers that you come across that might not be the right fit. What advice would you give to managers looking to get that $100 million, $200 million, whatever level might apply so that they can make it onto the radar screens of the institutional investors? What advice or guidance would you give to those managers?

A: I would say three things.

One: There is an answer to the chicken-and-egg question for Wall Street–performance comes first and then money usually comes thereafter.

Two: Once you’ve been able to create performance measurements for yourself and some months have passed, you’ve got to be able to plug into the emerging manager community. Whether it’s coming to SkyBridge’s SALT Conference, or it’s going to other emerging manager conferences or trying to get some help from your cap intro team and your prime broker, you have to plug into the community, because this isn’t the restaurant business. If you have great food at a restaurant, somehow the customers find you. In the hedge fund business, you can have great performance, but without some level of exposure and some level of explanation of that performance, it’s going to be impossible for you to attract money because of the 8,000+ hedge funds that are your competition. You have to plug yourself in.

Three: You may be able to day trade your portfolio, but you cannot day trade your career. You have to be able to dedicate a long swath of time to the project of starting a business. And I’ll give a specific example, SkyBridge Capital slogged it. We started in 2005 and had to slog through 2008 to get to the position we have in 2010. People have to have in their mind that they are going to be the tortoise, they’re going to be the ant and not the grasshopper, and they can’t day trade their careers.

Q: Who should attend the SALT conference and what should they expect? A: We are primarily a conference for capital allocators, wealthy families, high net worth individuals and people who allocate to hedge funds. We limit the invitations to hedge funds and service providers because I don’t want to be affiliated with just another conference with service providers talking to other service providers. Moreover, we’re not in the conference business; we’re in the relationship-management and the relationship-growing business, but we also want to position the firm as one of the thought leaders in the industry. You’re going to walk out of that two-and-a-half-day event having learned something about our political process, macroeconomics, and fraud–how to be on the lookout for it, and potentially contain it.

If you look at that agenda, it’s a two-and-a-half day university seminar on some of the most interesting things going on in our industry and the country and the world. The other thing is, I’m all about social networking, and SkyBridge is all about social networking, so we need to get people out there to meet with each other and hopefully better each other since this is a relationship industry.

The thing about Las Vegas is that it’s fairly inexpensive place to have a high-class conference and you can get there from just about anywhere in the United States for under $500. The rooms are high class, yet they’re priced at a substantial discount. You’re going to have to spend hundreds of thousands of dollars to fly around the world and if you were to meet 20 people at our conference you would have to visit four cities and spend seven days and spend $25 grand. It’s very efficient way to maximize time and create some learning.

To learn more, follow Anthony on Twitter (Twitter.com/Scaramucci) or visit the SALT Conference website at: www.saltconference.com/ .