Troy Gayeski serves as chief market strategist for FS Investments. Gayeski is responsible for research generation, positioning and conveying the firm’s alternative investment products and enhancing and expanding the current product suite.
Russ Alan Prince: Tell us about FS Investments, its history and how it cemented itself as a pioneer in democratizing alternatives.
Troy Gayeski: FS Investments was founded in 2007 by Michael Forman and his partners with the mission to bring sophisticated, alternative strategies that were previously accessible only to large institutional investors to the individual investor.
Long before the strategy became prevalent in institutional allocations, Michael and the team identified private middle-market corporate lending as a key opportunity—particularly business development corporations known as BDCs, which were created by the Carter administration in the 1980s but were still relatively obscure. BDCs were designed to allow better capital formation for small corporations and, in turn, allow retail investors to access that return stream through highly regulated, transparent offerings.
This was a very sophisticated strategy that had not yet penetrated institutions, so it was remarkable that the team was able to package it for individual investors. For several years, BDCs were the firm’s bread and butter. In 2014, Michael Forman brought on Mike Kelly as chief investment officer, and his team began building out additional strategies to advance the firm’s mission. For example, our fastest-growing franchise is now our senior secured asset-based commercial real estate lending business. The democratization of alternatives has always been the driving mission at FS, and we’re proud that the firm has continued to grow over its 15-year history, now managing over a dozen investment strategies and approaching $35 billion in assets.
Prince: Up until this year, we had been in a great environment for vanilla assets. Now, however, these assets are struggling and the 60/40 model is more challenging than ever. What makes you think alternatives matter more in the current climate than in years prior?
Gayeski: For 13 years after the global financial crisis, financial markets dramatically outperformed the real economy, particularly the labor markets. There are several reasons for this. First, the real economy was doing better than labor, partially because of globalization, partially because of the continued decline of private-sector unions, and partially because of automation. The labor share of GDP continued to drop, and at the same time, financial markets and equities did even better relative to the real economy than the real economy did relative to labor.
The main driver of that was the hyper-loose monetary policy established during the global financial crisis. We saw multiple rounds of quantitative easing and exceptionally low-interest rates for an extended period, and anytime there was a market problem, the Fed would respond by flooding markets with liquidity.
During this period, financial assets were massively outperforming the real economy and the labor market to an even greater degree. It became clear that we were due for a galactic mean reversion between financial assets and the real economy because the Fed would have to tighten policy much more aggressively than they had done in the recent past.
Inflation became a real problem, not only from an economic and market standpoint but, more importantly, from a political standpoint. What goes up, unfortunately, must come down, and we are now witnessing financial assets substantially underperform the real economy, particularly nominal GDP. We also have a hyper-tight labor market, and wage gains continue at a very rapid pace. It’s clear we are living through that mean reversion period.
After many years of tremendous performance from vanilla assets like bonds and equities, this is a period for alternatives to shine because they are focused on generating differentiated return streams.
Prince: Given your outlook on the 60/40 model and keen focus on alternatives as a firm, what are some of the most attractive alternative investment solutions right now and why?
Gayeski: In an environment like this, what we’re looking for is above-market income or total return. We are also looking for strategies that can benefit from the Fed’s tightening policies. Our motto is: “Don’t fight the Fed; high-five the Fed!”
Our advice is to focus on low beta or low equity sensitivity so as equities fall, you’re not disproportionately punished, and on low duration strategies so you won’t suffer losses when yields rise, which they are likely to continue doing. In income generative strategies, focus on floating-rate exposures like BDCs and Senior Secured Commercial Real Estate that directly benefit from Fed rate hikes.
We are also always looking for a modest risk of loss. If we do have another major market dislocation or economic dislocation like the pandemic, the global financial crisis, or the dot-com bubble imploding, you would prefer as little risk of principal loss as possible. As a reminder, risk of loss is separate and distinct from beta. Beta is a measure of mark-to-market volatility. Risk of loss is how much of your investment balance you could lose in an unforeseen market calamity. Lastly, why focus on offerings that are not user-friendly or investor-friendly when there are now a whole host of investment options that offer reasonable liquidity? If you can tolerate volatility, our publicly traded BDC, FSK, offers a 12% income stream and trades at a significant discount to NAV. If we can continue to deliver that dividend and the discount to NAV compresses over time, FSK will arguably be the greatest total return story in credit.
Prince: Any final thoughts?
Gayeski: Right now, we are in an economic and market backdrop where sustained higher inflation and nominal GDP growth are trouncing real GDP growth. We have a Fed that’s behind the curve and moving to catch up with more aggressive hikes and potentially meaningful balance sheet reductions. With the Fed aggressively tightening policy, we see the potential for future increases in fixed income yields and further equity multiple compressions, which would lead to further losses in equities.
At FS, we are proud to offer a variety of solutions that can thrive in the current environment, and we’re here to answer any questions clients might have. The time for alternatives is now!
Russ Alan Prince is the executive director of Private Wealth magazine and chief content officer for High-Net-Worth Genius. He consults with family offices, the wealthy, fast-tracking entrepreneurs and select professionals.