JACK FARLEY: US equities surged as bond yields trade sideways. Has the stock market gotten over its fear of rising yields? And how are institutional investors thinking about Bitcoin? For all this and more, I'm joined by Troy Gayeski, co-Chief Investment Officer of SkyBridge Capital. Troy, welcome to Real Vision. How are you doing?
TROY GAYESKI: Doing great, Jack. It's an honor to be on with you. I'm looking forward to talking about a wide range of topics, including markets and the economy.
JACK FARLEY: It's an honor to have you on. For everyone who doesn't know, Troy is the CO Chief Investment Officer of SkyBridge Capital, alongside Anthony Scaramucci. Troy, you have your gaze on a lot of different assets being a fund of funds, you're looking at credit, looking at structured credit, looking at equities, as well as your recently launched Bitcoin fund. Let's start off with the move that really is causing turmoil in every single asset class, and that is the rise in Treasury yields. How are you making sense of that?
TROY GAYESKI: When you think about where we were pre-pandemic and the complete collapse of yields, because of a disastrous economic outcome coupled with incredible increase in the Fed balance sheet, and also then cutting rates, again, back to zero, last time they were there was obviously after the Global Financial Crisis. Central this substantial drop in yields, it's around the 40 to 60 basis point range for a large part of last year, what's happened particularly starting with the better growth numbers in Q3 and Q4, and then the great vaccination news and now dissemination and distribution of that coupled with off the charts levels of fiscal stimulus, not only the first CARES Act, but the last package signed into law by Trump and now, another roughly 8%, 9% of GDP signed into law under Biden.
You put that all together and yields are going higher. The question is just how fast and how far. And so, we came in a year roughly 90 basis points in the 10-year, we're settling into this, let's call 1.6 to 1.8 range here. What that's doing in turn is it did pressure equity valuations a bit, but it is causing quite a bit of pain in generic vanilla fixed income, particularly treasuries, or investment grade credit right now.
JACK FARLEY: Let's get into that, Troy. Can you break down why is it that interest rate risk has hurt Treasurys the most and then investment grade? Then why is it that some forms of fixed income like high yield, and particularly CLO structured credit have proven more resistant to interest rate risk?
TROY GAYESKI: Yeah. Great. Look, when you talk about risk-free rates going higher-- remember, there's the front end of the curve, which is what the Fed controls, and then there's the back end of the curve, which basically markets price, and obviously, the Fed tries to manipulate to some extent through their balance sheet expansion but you have to remember, markets are setting the back end of the curve. And so, given the low starting point of yields for Treasurys, they have more and more duration than they really have in history.
If you have a nine-year duration, or an eight-year duration, 100 basis point move up in yields leads to an 8% or 9% decline. That is what Treasury yields are and Treasury investors have been facing really since Q3, early Q4 of last year, but it's accelerated earlier this year when you look at investment grade credit, similarly, very long duration instruments. That being said, because they're economically sensitive, and interest rates are going higher because of better economic growth, that has dampened some of the downside there relative to Treasurys.
But now, as you move down the "quality spectrum", sometimes less quality is actually better quality, what you find is-- think of high yield, we're not buyers of high yield just for the record but when you're talking about vanilla assets, at least in high yield, you came into the year around 4.5%, 4.6% yield. All-time lows, but at least you're getting something. You have much less duration, three and a half to four years, so you don't feel as much pain as interest rates go up. Then again, this is very important. If interest rates are going up because of better economic growth, what that should in turn lead to is lower default rates, because that's one of the ways that you lose money in high yield, is by defaults going up and suffering losses through bankruptcy.
Rates are going higher for good reason, spreads have tightened, or the amount that you're getting paid to own high yield versus Treasurys and investment grade, and that's helped buffer losses. In fact, it's not nothing to crow about but high yield's up about 1% year to date, whereas most fixed income is down. Now, you segue into structured credit, a lot of the strong performance of structured credit, particularly in January gets back to, one, these are very economically sensitive assets, better economy means better performance.
Two, you had not had a full recovery of those assets from the selloff in March. Some assets can recover 80%, residential mortgage backed securities, some only recovered 40% or 50%, [non-CMBS], or aircraft bonds, for instance, but they were all starting still at depressed prices and so that gives you more upside capture and better economic outcomes. Then furthermore, when you think about the housing markets as an example, at the end of March, early April, we were very confident that housing would get through the pandemic in decent shape.
That being said, even bulls like us did not think we'd see 9%, 10%, 12%, 15% appreciation of housing and forbearance requests never got nearly as high as people feared, and they've gone down tremendously. And even in the event of a delinquency or a foreclosure, it's very hard to lose money when you came into pandemic at a 50 LTV or a 60 LTV, meaning as a lender. You're lending to someone that has a 50 or 60, loan to value ratio, 40% to 50% equity. And guess what? That loan to value ratio is lower now than it was coming into pandemic.
That means even in the event this will happen, you'll see some sales, distress sales or foreclosures, it's unlikely the lender actually loses money. The last point we'd make is certain sectors, and you mentioned CLOs before, our floating rate. That's one of the things people forget about, the March period was if you were long structured credit, you were not only getting blasted because of technical reasons, you were getting hit because of concerns over defaults going higher, but you were also getting hit by the Fed going back to zero. As they cut rates aggressively, and if you're at an-L plus or a [?] plus now return, that's painful.
What we've seen so far this year is as markets have repriced out rates in the future, that means you should end up with more cash flow in floating rate securities and it really reminds us of that 2017, 2018 period. And the Fed hasn't hiked yet by any means, but they will. The question is when, 2021, we doubt. 2022, we doubt, but maybe the end of 2022, but that there's at least a path to getting up zero, which increases your long term cash flows and the potential upside of those securities.
Fixed income markets do have a tremendous amount of heterogeneity. On the one hand, you have risk free treasuries that have gotten hit the worst. On the other hand, you have credit sensitive structured credit assets tied to the residential housing market or levered loans that have clearly performed the best and should continue to over the foreseeable future.
JACK FARLEY: Okay. So, in late March, early April, you had these mortgage-backed securities, residential, RMBCS, commercial CMBS, that were trading at extreme lows, and you and your folks at SkyBridge saw opportunity there. That's been a very good trade, but it's my understanding that since then, you wrote a little bit out of structured credit, you're still sanguine on the sector still overweight it. By the way, when I say overweight it to the people at home, that means they actually own more of it. It's not like a sell side bank saying they're overweight something, it's actually real money. You're rotated a little bit out of structured credit, why is that the case?
TROY GAYESKI: Yeah. Every opportunity set, no matter how rich it is in the short term starts to mature, and you find better opportunities elsewhere. We had roughly 60% of our exposure there, the last nine months of last year. We enjoyed very strong returns. January was a very strong month for structured credit. And so, if we compare it to other opportunities, and we'll talk about some in a little bit, the relative risk reward wasn't necessarily deteriorating, it's just that you had less upside in the future given the strength you had in the past.
Even though loss-adjusted yields, which is a metric for adjusting your cash flow for future defaults, is still much higher than it is and just straight yield, those yields are coming down, coming down, coming down. And so, we took some of that capital, we harvested in new strength, and we rotated into things like Bitcoin, which is our favorite macro exposure, convertible bond arbitrage, which we feel has more upside in this environment. We did ramp up and nibble on long/short equity, not only to catch beta, but also to have some alpha potential there.
So, we're trying to build out more diversification and harvest gains in the strength and ultimately have more upside potential over the next 6, 9, 12 months, which is really easy to say. I wish it was that easy to do but we feel very confident that the shifts we made should increase forward return potential. Unfortunately, they have so far this year.
JACK FARLEY: Wow. We've got long/short, we've got convertible bond arbitrage and then we've got macro, i.e., Bitcoin. Those are three really interesting sectors. Let's start with the most niche one, convertible bond arbitrage. Could you quickly describe what it is to people very quickly, and then describe why you rotated into it? Why you saw opportunity there?
TROY GAYESKI: Yeah. Convertible bond arbitrage, the first thing for the viewer to understand is that it's an old school hedge fund strategy. It's been around 20, 30 years, but fortunately, it doesn't have that much hedge fund penetration anymore. It's really a long only dominated market, much the way it was in the late 1990s, early 2000s, which just so happens to be the last time managers enjoyed very outstanding returns. There's a direct correlation. The more crowded the market is, the more smart eyeballs beat each other over the head, and who can add more value, the harder it is to make money. That's just the way markets operate.
That was point one, is that not much hedge fund crowding, very little participation. Point two is when you think of how that trades set up, you're long convertible bonds, and you're short the underlying equity at a defined hedge ratio. So typically, for every unit of convertible long, you're short point five minutes of stock, and that creates a positively convex trading profile. When you have stock go up, the convert goes up more, because it's positive convex, very similar to call option. When the stock drops, the convert drops less. That's the term or let's call it gamma trading or convexity trading.
Again, old school hedge fund strategy, but if you're in an environment where you expect heightened levels of realized volatility, think of all the things the last four or five months that have caused realized volatility, the election, the vaccine news, oops, higher interest rates, whoa, Reddit-fueled short squeezes, all sorts of factors, then that strategy tends to benefit. We view it as something that could have equity like returns but have less downside in the event of a meaningful dislocation, primarily because you are short the equity at a defined hedge ratio.
We like that strategy a lot. We don't think returns are going to be as good in the next 6, 9, 12 months as they were the last six, but we still think mid-teens is a realistic target, which is pretty good in this environment.
JACK FARLEY: You mentioned the Reddit crowd. That's a perfect segue to the long/short strategy, which has been also a very long standing strategy on Wall Street, going long a basket of stocks that you think have solid fundamentals and will go up and hedging that equity risk by going short a basket which you don't like. We saw in late January, that one fund, Melvin Capital, really was feeling the pain.
That strategy backfired as one stock they were short, GameStop, just absolutely surged to extreme levels. Then it went back down and then is now up in a range. Interestingly today, actually, they announced that they could sell up to $1 billion of extra shares. Troy, what can you tell me about the long/short strategy in a post GameStop world?
TROY GAYESKI: Great points you made before, the first thing we would say before we get into more detail is remember, when you're long and short, you're trading one risk, systematic risk or beta. We make money when markets go up, we lose money when markets go down. For other risks, and one of the risks you're taking is that, hey, your shorts melt up in your face for whatever reason, you pick the wrong baskets, in the long and the wrong basket in the short. You have big basis risk that opens up.
There's no free lunch. Every strategy has pros, every strategy has cons. Fortunately, last year was a strong year for long/short equity. And by the way, we had very little on so we're not even talking our book compared to the industry. We were underweight that. What happened is because you had this huge dispersion initially between growth names and things that benefited like Zoom, for instance, from stay at home versus old economy, REITs would be an example that were getting pounded or banks. You had huge dispersion, and there was an ability to add alpha, then as we moved into the late stages of the year, that started to reverse.
So, you need dispersion to generate returns, but it doesn't necessarily mean you will, and most of the post Global Financial Crisis period, it's been challenging for this strategy with last year being one exception, 2013 being another. So, as we've legged in there, we tried to focus more on high growth, low net tech and healthcare, because our expectation was that alpha wouldn't mean revert.
And those are two of the few sectors where you have enough dispersion that you can actually be long and short and have a chance to make money, fancy that, and you can actually add alpha through your security selection process because of the complexity of the names. You think about you have 5, 10 baggers, because it's a successful cancer therapeutic or a complete bust in Phase 3 trial. That has been our focus.
Now, with regard to GameStop or AMC, unfortunately, what you had was a variety of hedge funds that just were too crowded to shorts. You should never be short a stock with over 100% of the float short. That's really a no, no. What this has caused the industry to do is to further reevaluate, so most we're looking at online chats in Reddit and understood that retail participation had been growing, it wasn't like January 15th, selling retail investors showed up, well, that's been trend for three years. But to refocus on that move up in market cap for your shorts, because as you move up in market cap, it takes that much more buying power to drive a short squeeze, minimize crowded shorts.
Again, that should be Shorting 101, but this is a good kick in the teeth for the industry to remember, and also when in doubt, there's nothing wrong with using an index or an ETF. If you're really trying to minimize beta or systematic risk, and you can't find any good shorts, maybe because the economy is recovering or earnings are getting better than you estimate or you're worried about these retail Reddit-fueled rallies, hey, use S&P futures, use the Qs, something to take out risk. Then lastly, be more diversified in your short book.
Because that way, if something crazy like that happens, the damage is minimized. Luckily, most of the extreme price action did mean revert to some extent in February. We don't expect 2021 to be nearly as good for the generic long/short fund as it was in 2020, but we still expect those managers to generate much better returns in fixed income or high yield albeit with more volatility month to month.
JACK FARLEY: Thanks for that, Troy. On the topic of dispersion, what do you make of the ongoing rotation from growth stocks into value stocks? Do you think that rising yields have been a catalyst for that? And what's your outlook going forward?
TROY GAYESKI: It's a great question. If you don't mind, I'll take you back to late August September. As we were interacting with various long/short equity managers or managers across any strategy, one of the big pressing concerns was okay, growth has really outperformed value and cyclicals. You know this is going to mean revert, it's just a question of when and to what degree, so you better not be over your skis in any particular risk. If you're long global growth names and you're short value, you better keep an eye on your risk there because when that mean reverts, it can be very, very painful.
And so, what started to happen in November after the terrific vaccine news first came out, which we should all just remember how thankful we are for the modern technology, you started to see that occur, but all assets went up. You were in a bull move, value started outperform, but hey, growth is doing fine too, so no really big deal. It really wasn't until Q1 and really March where you saw that basis widen out, and so you look at various indices, but roughly 20% outperformance of value versus growth for the first quarter, which is a historic level.
As we looked at this further, interestingly enough, over every time horizon from the pandemic, whether it's April 1st, May 1st, June 1st, value actually did outperform growth, which is somewhat shocking given fundamentals have not recovered fully even close. We're not going to sit here and call the end of that trend. However, value and cyclicals did get really fully priced towards the end of March. You started the last few days of March seeing a little bit of let's call it "normalization" to the pre Q3, Q4, Q1 trend where growth started to reassert itself.
You look at today for instance, the NASDAQ's outperforming again, big cap tech is outperforming again after underperforming for quite some time. And so, it's always dangerous to call the end of a short term trend, but the longer term trend has been people are more willing to pay for growth in the slower growth environment. It does look like that start starting to reassert itself. In particular, as you point out, this is coincided with a stabilization of Treasury yields.
If the 10-year is going to 2% or 2.25%, you probably see different price action, but we have had a historic move 40, 50 basis points to 1.7 plus or minus, 90 basis points plus coming into year two same range. We have moved pretty far in Treasury yields, so