Wall Street, Washington grapple with uncertainty at the 2016 SALT Conference

The eighth annual SkyBridge Alternatives (“SALT”) Conference took place this past week at the Bellagio Hotel and Casino in Las Vegas, bringing together a diverse group of thought leaders from the worlds of finance, economics, politics, entertainment, sports and philanthropy. This year’s lineup included esteemed investment titans David Rubenstein and Ken Griffin, prominent business and political figures Michael Bloomberg and John Boehner, and sports and entertainment personalities Kobe Bryant, Caitlyn Jenner and Will Smith, among many others.
 
The major theme emerging from this year’s gathering was the evolution and uncertainty within the financial industry and political landscape in the United States, which have both seen significant upheaval in the past several years.

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Hedge fund industry responds to criticism
 
An estimated $3 trillion in global assets were represented at SALT 2016, a good chunk emanating from the world of alternative investments. The hedge fund industry, which swelled to record size after a golden era of performance from 2000-2007, has come in for criticism and experienced heavy outflows following two years of lackluster returns. Since early 2009, the 60-40 stock-bond portfolio has outperformed the HFRI Fund Weighted Composite Index in 22 of 28 quarters, according to Morningstar. During the first quarter of 2016 clients withdrew $15 billion from hedge funds, the largest quarterly outflow and first instance of two consecutive quarterly outflows since 2009, according to Hedge Fund Research (HFR).
 
As a result of poor performance, discussions about the merits of allocating to hedge funds and the viability of the 2-and-20 fee structure took center stage at what’s been called the Super Bowl of the alternative investment industry. On a Wednesday morning panel, Roslyn Zhang, a Managing Director at China’s nearly $800 billion sovereign wealth fund, China Investment Corporation (CIC), cut to the chase in expressing her disappointment over recent hedge fund returns. With $30 billion committed to hedge funds, CIC is the world’s second-largest investor in the asset class, according to Preqin. Zhang compared the herd mentality among today’s managers to the type of groupthink usually associated with dumb-money retail investors.
 
“I’m sort of disappointed with the performance, to say the least, of the industry,” she said. "Only less than 10% of managers are actually capable of adapting to the new reality. Probably 90% of the managers think they are part of the 10% anyway," she said.

Zhang also criticized certain managers for what CIC perceives as a foolhardy bet against China’s renminbi currency, saying, “They don’t really know much about China...they just spend two seconds and put on the trade. Should we pay 2 and 20 for treatment like this?”

Zhang’s pointed comments put the managers in attendance on the back foot in attempting to justify the high costs of their funds relative to indexes and new, less expensive vehicles aiming to track alternative investment strategies. And she isn’t alone in her feelings. So far this year insurers like MetLife and AIG, as well as state retirement plans from New York to California, have announced plans to pull billions from hedge funds due to poor net performance.
 
Omega Advisors’ Leon Cooperman didn’t shy away from the question about hedge fund fees, saying, “In a low return environment, unless you are particularly exceptional you’re not going to be able to generate returns sufficient to justify the fees. People have now woken up and say they don’t want to pay 2 and 20 to underperform some index.”
 
Hayman Capital’s Kyle Bass agreed that “fees have got to come down,” with Kynikos Associates’ Jim Chanos adding he was “surprised they’ve stayed this high for this long.”
 
Graham Capital Management’s Ken Tropin said, “Expectations about a hedge fund manager’s way of conducting business has become more demanding, and perhaps rightfully so. Every hedge fund manager has had to make the effort to be much more transparent, a much better communicator and more negotiable."
 
The reality is there has actually been downward pressure on hedge fund fees for some time. Hedge Fund Research (HFR) estimates that on average today’s investors pay 1.5% in management fees and 17.7% in performance fees. While most managers expect those averages to continue falling, difference of opinion exists over whether the recent industry contraction is structural or cyclical. In the weeks leading up to SALT, Third Point Capital’s Dan Loeb said recent changes in the industry represent the “first inning of a washout” while Point 72’s Steve Cohen lamented the lack of talent available on Wall Street.
 
HFR President Kenneth Heinz told Marketwatch he believes the hedge fund industry’s recent retrenchment represents more of a speed bump than a permanent loss of market share. With just $3.2 trillion in total assets under management, hedge funds still manage only a quarter of what mutual funds do. The cyclical outperformance by index funds since the financial crisis owes largely to the unprecedented policy intervention of global central banks, according to SkyBridge portfolio manager Troy Gayeski, who said the Fed had adopted a “third mandate” to stoke global economic growth. Divergence in global monetary policy, which we have started to see in the last six months, usually leads to an uptick in relative performance for macro hedge funds. Cooperman noted a 1970 Fortune magazine article proclaiming trouble ahead for hedge funds to drive home the point that the industry’s death has been greatly exaggerated before.

While there was a decided pessimism among many of the top hedge fund managers in attendance, weak HFRI performance numbers did nothing to keep investment professionals away from SALT, with the number of delegates rising to from 1,800 in 2015 to 2,100 this year.

MB Advisors’ Milton Berg made headlines with his prediction Wednesday that “we are on the cusp of a 30-year bear market” in stocks and bonds. The general zeitgeist from this year’s speakers was that stocks, which are sitting at all-time highs despite four consecutive quarters of earnings contraction, are at least fully valued, while sovereign credit, with nearly 30% of global developed market bond yields trading in negative territory, no longer play their customary safe-haven role. If Berg’s prediction ends up even close to coming true, then there will be few better places to turn than hedge funds. The irony in Zhang’s criticism of hedge funds is that the herd is now piling into cheap index funds while growing ever-more full-throated in its demonization of alternatives. If history is any indication, the fevered pitch of hedge criticism could portend another golden period of performance for the asset class.

Calls for better Wall Street PR

While the hedge fund industry’s performance problem could correct itself, Wall Street’s image problem is showing no signs of abating. In the opening remarks to SALT 2016, billionaire Carlyle Group co-founder David Rubenstein talked about the need for better public relations in the financial industry. Lost in the vilification of Wall Street that has become part and parcel of the bi-partisan campaign platform is the fact that finance remains the key engine of American economic growth and quality of life. It is no coincidence that the most financialized society in the world is also by far the most prosperous. Rubenstein told attendees they shouldn’t be ashamed of their line of work, and urged attendees to be more forthright in explaining how Wall Street fundamentally improves the fortunes of all Americans.

“All of us have an obligation to try to explain what the hedge fund industry and the private equity industry does that is useful,” he said. “We shouldn’t be upset about what we do. We should be proud.”

The need for better collective PR on Wall Street was echoed by former House Speaker John Boehner, noticeably liberated by his departure from Congressional service. He did something no sitting politician could ever fathom – made positive comments about Wall Street. He thinks the financial industry needs to consider taking the "banking is good" message straight to the voters, highlighting the value of credit for business investment.

“Don’t expect politicians to stop beating up on Wall Street,” Boehner said. “If you look at what Wall Street does in terms of job creation and economic growth, you have a great story to tell. But if you don’t tell it, no one will.”
 
While new regulation has decreased the probability of another systemic-level crisis, it has prevented the type of credit expansion that would accelerate the economic recovery. The abhorrence of public debt in all forms is another byproduct of self-defeating cyclicality of the herd. Large-scale debt-financed infrastructure investment, done at historically low interest rates, would have been much more beneficial to the middle class than experimentally dovish monetary policy, which has only widened the income divide.

"Not many people can save enough money to start a business on their own," Boehner said. "If you don't have banks that are lending money and helping to multiply the money supply, you're not going to grow the economy. When you look at what Washington has done to the banks over the last eight years, it's a wonder they're making any loans."
 
Former New York City Mayor Michael Bloomberg made it a hat trick of speakers looking at Wall Street through a more nuanced lens than our current crop of politicians. “We need a strong banking system,” he said. “If I were running for office, you can imagine just how good that would have been as a campaign platform.”
 
Bloomberg’s deep understanding of economic issues left the room audibly lamenting his decision to stay out of the 2016 presidential race, which he explained as a simple calculus about the odds of success, or lack thereof, for a third-party candidate. In light of research that 40% of all jobs could be automated within 10 years, he urged both the government and private sector to “find ways to make people as productive as possible and give them the dignity of a job.” If we have a singular focus on increasing productivity through automation, people are going to “set up the guillotines” because of the “rich-poor divide.”
 
Kyle Bass doesn't back down on China 
 
Hayman Capital’s Kyle Bass reiterated his bearish call on China’s yuan currency, saying conditions in the communist nation now feel like they did in the U.S. in early 2007 just before the financial crisis escalated. He says China’s official government data shan’t be trusted, but you can look at the country’s major trading partners in the region like Malaysia and Thailand to get a better picture of the true economic climate.

Bass says Hong Kong’s real estate is in “free fall” with prices having fallen 13% from their peak in September to a 25-year low. He believes the densely populated island’s economy is in worse shape than it was prior to the 1997 “Asian Contagion” crisis and the bubble in China’s credit market is “one of the biggest macro imbalances the world has ever seen.”
 
Jeff Smith speaks softly but carries a big stick
 
The overall theme of the activism panel was how American corporate boardrooms have done a complete 180 regarding their approach to activists. Management teams have grown much more receptive to constructive input, preventing the need for messy, expensive proxy fights. Activist Jeff Smith said that while Yahoo! (YHOO) gets too much attention from its media peers relative to its revenue level, the company is taking the right steps to unlock shareholder value. Smith, who famously replaced the entire Darden Restaurants (DRI) board in 2014 (sparking a huge turnaround for the stock), said he usually engages in one proxy fight per year, but hasn’t orchestrated one since 2014.

Sachem Head Capital Management's Scott Ferguson chimed in on the topic of executive pay, saying, "Sometimes severance is the best investment ever made if the company needs a CEO change." He pointed to a CEO change at Canadian Pacific (CP), a major activist position at his previous firm, Bill Ackman’s Pershing Square Capital, as a major positive catalyst. "It was a tremendous investment getting rid of him," Ferguson said. "No one is crying about the dollar amount paid [$48 million]."
 
Ken Griffin doesn't mince words on IEX, hedge fund talent
 
Citadel’s Ken Griffin, one of the most successful hedge fund managers of the last twenty years, has been waging a very public battle with current dark pool operator IEX over the its application with the Securities and Exchange Commission (SEC) to become an official stock exchange. At issue is IEX’s proposal to implement a “speed bump” the company says will even make things fairer for retail investors. Griffin doesn’t buy into the marketing hype surrounding IEX created by Michael Lewis’ best-selling book on high-frequency trading, “Flash Boys.”
 
"IEX is portraying itself as a firm that levels the playing field against fast-trading firms, but what is interesting is the way the market structure works is that the fastest firm still wins the trade. Everyone faces the same delay in execution time — it's a level playing field. The fastest firm wins. What IEX does is they knowingly broadcast stale prices that will influence trading at every other venue in a way that I believe is materially detrimental to the stability of the US trading markets."

Griffin also disagreed with Steve Cohen’s recent assertion that hedge fund talent is hard come by these days, discussing how Citadel fortified itself with great talent laid off by other firms after 2008. “Every new generation of managers has this great story about how it’s never been so difficult to find talent,” he said. “The best talent is talent you go out and find. You need to avoid adverse selection. The talent you want to hire is the talent you want to pull from someone else.”
 
Mark Mobius positive on emerging markets, warns about peer-to-peer lending bubble
 
On Friday, Templeton Investments’ Mark Mobius expressed very positive views on emerging markets, saying times of uncertainty are the best to invest. He believes commodities have hit rock-bottom and economies depending on them have been granted a reprieve. In addition to select emerging market commodity stocks, he likes beaten-down consumer-oriented stocks like appliance, food and beverage and telecom companies. Pressed for specific markets where he is most bullish, Mobius pointed to Russia, which he said could really “blow the roof off” if economic sanctions get softened in the future, and Nigerian banks, which prompted one member of the audience to tweet: “Nigerian banks? While we’re at it, why not Syrian real estate?”
 
Mobius echoed Chanos’ concerns about the rise in shadow banking in the U.S., saying peer-to-peer lending companies are his best guess as the next bubble.
 
John Boehner enjoying private life
 
Former Speaker Boehner’s comments about the current political environment provided further proof of his newfound zest for private life. He doubled down on criticism of former GOP Presidential candidate Ted Cruz, saying that after calling his former Senate colleague “Lucifer in the flesh” he actually got blowback from satanic organizations for "giving Lucifer a bad name."
 
Boehner discussed his dealings with President Barack Obama, saying, “We always had a pretty good relationship” but were “handcuffed by our parties in terms of what we could actually do.” He is proud that under his speakership the federal deficit fell as a percentage of GDP, but lamented “the problem is when you’re the leader, you still need followers. A leader without followers is a man taking a walk.” He thinks the U.S. tax structure, the most complicated in the world and one that the IRS doesn’t even understand, is ripe for reform.

In regard to the elephant in the room, Donald Trump's ascendancy to the presumptive Republican nominee for President, Boehner took a more pragmatic approach than those in the GOP establishment’s “Never Trump” movement. The enthusiasm for Trump’s nationalist rhetoric and Bernie Sanders’ message of wealth redistribution, he said, is a reflection of the raw anger Americans are feeling as a result of political gridlock and economic stagnation. Boehner said he wouldn’t be surprised “if Joe Biden arrived in a parachute inflated by Barack Obama to save the [Democratic] convention.”
 
Although Trump wasn’t Boehner’s first choice, he applauded the businessman for earning the delegates need to secure the nomination and warned that pundits are underestimating his prospects in the general election. “Anyone who thinks Donald Trump can’t win — just watch,” he said, adding, "We may not be unified around Donald Trump, but we need to be unified about winning the White House."
 
Paul Ryan is just being cautious on Donald Trump in a bid to help shape the nominee’s policies, Boehner said. He predicts greater party unity as November draws closer, “Things are going to get smoothed over.”
 
Most of all, Boehner is just happy about no longer having to deal with the far-right “knuckleheads” in the House Freedom Caucus, saying, “Every day when I read the news I’m reminded of how happy I am that I’m not in the chaos.”