This Fund Is Making a Bundle

[dstefan]

Incidentally, one of our December 2006 graduating students has been hired at Fortress Investment Group recently.

This Fund Is Making a Bundle
By JENNY ANDERSON

How much money is actually made in the fast-growing realm of hedge funds and private equity is often just an informed estimate.

No longer.

A securities filing by a $26 billion investment company provides a rare peek behind the curtain of secrecy that typically governs the world of alternative investments. Late Wednesday, the Fortress Investment Group filed to sell $750 million worth of shares to the public, valuing the company at $7.5 billion.

While the filing does not disclose individual compensation, two things are abundantly clear: money management, when the returns are good, is an extraordinarily profitable business. And the principals will make a killing on the deal.

For the first half of this year, Fortress, which has 500 employees, earned $88 million on revenue of $877.5 million. Fees from its funds totaled $185.8 million.

If finance were more democratic, every Fortress employee, from secretaries to fund managers, would make $673,000 this year on an annualized basis, up 14 percent from 2005, according to data provided by Charles Hintz, a securities industry analyst with Sanford C. Bernstein & Company.

Of course, secretaries and fund managers won't be taking home the same paycheck. And the offering will make Fortress's five principals — already wealthy from the success of the fund's performance — billionaires. They have $500 million invested in the fund. If Fortress sells 10 percent to the public as disclosed, that leaves the five with $6.8 billion to divvy up.

In an effort to minimize the risk that any of those principals will leave, they are restricted from selling shares and face a five-year lockup that requires each to give up from 70 percent of his interests in the first year to 14 percent between the fourth and fifth years.

Like most private equity and hedge funds, Fortress earns huge fees: 1 to 2 percent of assets under management to run the fund and 20 percent of profits in "incentive" compensation. Traditional asset managers make much less: about 1 percent of assets under management.

"I think the compensation is reassuring rather than disconcerting," said Donald H. Putnam, chief executive of Grail Partners, a merchant bank. "I would not want to own a company that underpaid its people."

The filing also shows just how profitable hedge funds and private equity can be. Last year, the group had revenue of more than $1 billion, earned $192.7 million and paid out $259.2 million in compensation.

For the same period, BlackRock Financial, the big asset management firm, managed $452 billion in assets, 17 times as much as Fortress. In 2005, it made about the same amount in revenue — $1.2 billion, and slightly more in profit, $233.9 million. It paid out compensation of $595 million to 1,752 employees.

Fortress was founded in 1998 and today is run by its five principals: Wesley R. Edens, Robert I. Kauffman, Randal A. Nardone, Peter L. Briger and Michael E. Novogratz. The company has grown rapidly, from $1.2 billion under management on Dec. 31, 2001, to $26 billion on Sept. 30, 2006. It operates three main lines of business: private equity funds that manage $13.6 billion, hedge funds with $9.4 billion and other publicly traded companies worth $3 billion.

The fund's returns — high by competitive standards — may be attractive to potential investors. The private equity funds had net annualized returns of 38.8 percent. The hybrid hedge funds that invest in distressed assets, including loans among other things, had annualized net returns of 13.7 percent. The "liquid" funds that invest globally in debt, currency, stock and commodity markets and derivatives had net returns of 13.7 percent. Fortress also manages two "castles," which are publicly traded alternative investment vehicles. The return for those companies on a net annualized basis is 50.6 percent.

Fortress wants to offer shares to the public, the filing says, to have capital, currency, people and permanence. In other words, it wants money from the offering to invest in the business, a stock to use to make future acquisitions, stock to use as incentive compensation and a ticker symbol on the New York Stock Exchange — FIG — that elevates it from yet another big hedge fund to a permanent institution.

Fortress will use at least $250 million of the proceeds to pay down debt. The remaining money raised will be invested in the business. Other areas it says it could expand into include infrastructure funds, real estate funds, structured debt products, funds focused on industry or geographic sectors and more traditional long-only funds, or those that do not short stocks — a bet that the prices will fall.

Mr. Putnam expects more public offerings of hedge funds and private equity firms will follow.

"It is categorically a trend," he said. "These companies are easier to float than to acquire. The challenges of an acquisition — it's the mating of hippos — it's a rare event."

As in many mergers, combining the egos, finances and strategies of two money managers can be challenging. "A floatation is much more straightforward and it puts a clear value on the company," Mr. Putnam said.

Publicly traded hedge funds and private equity funds are not rare abroad. RAB Capital and the Man Group are listed in London, while the Partners Group is traded in Switzerland and the Sparx Group in Japan.

Goldman Sachs is the lead underwriter on the Fortress deal with Bank of America, Citigroup, Deutsche Bank Securities and Lehman Brothers as co-managers. Skadden, Arps, Slate, Meagher & Flom is the legal counsel.

 

[Christian]

Up 67.5% on the IPO today. Does anyone see more US hedge funds following suit?

 

[alain]

I can see this happening to other funds. However, most of the hedge funds would like to keep their privacy and to not disclose their dealings. Going public would open their books to the world.

 

[Christian]

That's true, but it seems the larger the fund, the harder is to keep the secret about what you're doing. It seems like many of the large trading houses use to be private partnerships - Goldman Sachs, Solomon Brothers (although the latter went through more complications) and eventually went public.

If a company has so much capital that is is forced to trade market-shaking volumes just to make nice percentage returns, day in and day out, people are going to figure out what you're doing. I think Fortress will now have to focus on more investments that the public can see - for example private equity deals.

Anybody have any thoughts on this?

 

[Jeffrey]

Going public will place signifcantly increased regualtory burdens on Fortress as well. I feel like if I personally were looking for a fund manager in the alternatives arena to add alpha, my initial inclination would be towards managers that are insulated from those regualtory burdens and do not have to dedicate the added resources (and likely higher fees!) towards not alpha-generating activities. Am sure there are plenty of arguments that challenge that, but my senes is that as an investor, one way or another, you are paying for the added regulatory requirements.

 

[Andy Nguyen]

FIG is 31.00+12.50/ +67.57% Feb 09
This is very interesting and I'd like to get your thoughts on it.

Since Fortress is the first hedge fund in the US to go public (surely not the last), I couldn't find much info on how the IPO effects the company and hedge funds in general.

When a hedge fund goes public, is it automatically no longer governed by the security laws that it used to enjoy ? Does it no longer freely invest in risky and secret strategy ? Are they governed by the same laws as mutal funds and such ?

I know as far as the accounting and the books go, they have to disclose earning statements, quarterly reports, etc...

Do you think Citadel will follow ? My guess is that we will see lot of M&A in the future. Probably the number of small hedge funds will die down a bit in the future ?

Which one would you rather invest in/work for ? Hedge fund that goes public or those do not (assuming they pay comparable scale, of course)

 

[RussianMike]

If you get stock you want it to go public, otherwise how do you monetize that value

 

[Andy Nguyen]

If you get stock you want it to go public, otherwise how do you monetize that value

Good point. What about employees at other hedge funds ? How the compensation package is structured if the company is not public ? Are they paid cash only ?

 

[RussianMike]

I can speak from hearsay. We had a guy that worked in our company (not MFE or anything like that). He worked for about 1.5 yrs and then went to a hedge fund. His comp became 60K plus 30K bonus. His last job was analyzing/evaluating CMBS deals. As you can tell bonus is 50% of comp. The salary is low because his experience is no more than 3 yrs. I've heard of hedge funds allowing some or all of the bonus to be invested with them, again this is hearsay.

 

[Jeffrey]

interesting article in this mornings wsj discussing compression across the overall hedge fund arena....
.....too many dollars chasing too few opportunities.... one argument could connect the dots and make the assertion that fortress owners want to get paid realizing the over-crowded nature of the space will limit future ability to generate returns.... could be a statement on where they think the industry is right now

 

[Jeffrey]

... article is on C1, ahead of the tape...

 

[Andy Nguyen]

one argument could connect the dots and make the assertion that fortress owners want to get paid realizing the over-crowded nature of the space will limit future ability to generate returns.... could be a statement on where they think the industry is right now

Jeffrey, you may be right on though it would be a while for the principals to realize their paper wealth.

NEW YORK (CNNMoney.com) -- New York-based Fortress Investment made history Friday as the first hedge fund in the country to go public - and delivered nearly $10 billion in value to its five principals in the process. Source

On a more educational note, here is what I read about the effect of going IPO

If Fortress goes public, the hedge fund would allow investors to profit from its stream of investment advisory fees and incentive compensation rather than the funds it manages. And that's an innovative approach that could pave the way for other hedge funds to launch their own IPOs - a move that would further break down the walls of secrecy that surround the industry.
There are positive and negative aspects to a possible public offering of a hedge fund. On the plus side, hedge funds that face concerns over succession once the founders and principals of a fund choose to move on can rest easy by creating a more permanent institution, the Times reported.
But one downside for hedge funds is that public companies are heavily regulated and require significant disclosure - something private hedge funds can avoid.
And there are concerns over creating a structure for a public hedge fund in which investors get a good return but managers continue to make enough money to provide an incentive for them to perform.
Fortress declined to comment, according to the Times.
But even if it is mulling the possibility, the timing may not be right.
The market was volatile over the summer and may not be so accommodating currently for an offering. And bankers will have to take on the unprecedented task of creating a valuation for a hedge fund.
But it's a sign that the hedge fund industry is quickly evolving as assets have grown 3,000 percent since 1990 and the number of hedge funds have jumped to 9,000 funds managing $1.2 billion in capital, the Times said. Source

To answer my own questions of whether other hedge funds would follow and what is the risk

Hedge funds are designed to reduce risk, but this IPO has several big ones, including:
-Lack of detail on what the company invests in. Hedge funds are not required to detail their investments. "It's murky," says Francis Gaskins of IPOdesktop.
-Fickle investors. The company's performance has been strong and helped it build up $30 billion in assets. But a stumble in performance could send investors rushing for the exits, says Stiller, who thinks the risk of that is small.
-Complex structure. Public stockholders will own only about a third of the company and have 9% voting control, Peterson says. He adds that other similar deals in Europe haven't done that well.
If this IPO goes well, expect 20 or so other hedge funds to follow in two years, Weiner says. "We're on the brink of a new era." Source

 

[Jeffrey]

Thanks Andy.
Part of the articles kind of get at this idea that part of the allure and advantage that hedge funds have is their ability to operate in less regulated, more pure environment.
That CAN NOT be understated. Every bit of increased regulation and disclosure dilutes the "purity" of the alpha and over time all else being equal, I would expect it to be a headwind to investment performance realtive to other managers not in the regulatory spotlight.
Not only these increased burdens, but also the theoretical reduced incentive for performance. What used to be "2 and 20" going to the manager, is now cut by the 1/3 slice for shareholders.
3 years from now, we'll be able to look back and know for certain!!! For now, it would be a "red flag" for me as an investor.

 

[Jeffrey]

Start of a trend? Blackstone is next...

One of what will be many articles below in financial pubs this week.....

Perhaps start of a trend, and perhaps the signal of a peaking environment.
Follow the path:
- Sub-prime troubles hurt CDO's
- CDO's run into trouble and that demand from all fixe dincome products goes away.
- Rates go higher in all sectors of the bond market. Risk premiums widen.
- Cost of capital for buyouts goes higher

- This happening as equity-holders have recently shown less willingness to be poached by privtae equity. Demanding higher valuations.
- Put all of these compoennts together, with signs that the big hitters in the industry are starting to cash out, and I think it is a tell-tale sign that we are near a peak. Blackstone is the very definition of 'smart money', and if they are taking some skin out of the game, that should be heeded as a wartning sign for investors.




Big Buyout Firm
Prepares to Sell
Stake to Public

Blackstone Would Add
To Its Financial Clout;
A Sign of Market Peak?
By DENNIS K. BERMAN and HENNY SENDER
March 17, 2007; Page A1

NEW YORK -- The king of private equity is expected to go public.
Blackstone Group, the lucrative partnership that has grown rich taking public companies private, is in advanced stages of planning an initial public offering of roughly 10% of its management company, according to people familiar with the matter. An offering of that size would conservatively value the entire enterprise at $40 billion.
Such a move would give Blackstone even greater financial clout, including more money of its own to invest in deals. But it also may signal that Blackstone partners think the financial market has hit a peak.
An IPO would offer everyday investors the benefits -- and risks -- of sharing in a business that historically has been the sole preserve of sophisticated institutions and wealthy individuals. The largest private-equity firms have had massive, 100%-plus annual returns in recent years, bringing one household name after another -- from Hertz to Burger King -- under private ownership.
Private-equity firms either buy companies or divisions of companies on behalf of their own investors, take them private, and then sell them off within a few years. A Blackstone IPO might well be followed by other well-heeled private partnerships -- whether hedge funds or buyout firms. Should that occur, it would signal a significant shift in the capital markets, which have become dominated by these firms that have prospered because they have access to cheap credit, aren't subject to the regulations governing public companies and pay the executives at companies they acquire handsomely.
Blackstone and several rivals have been exploring IPOs in the wake of the successful stock-market listing of hedge fund Fortress Group in January. The speed of Blackstone's decision is surprising and may reflect the belief of Stephen Schwarzman, Blackstone's co-founder and chief executive officer, that market conditions are worsening. Both Mr. Schwarzman and Blackstone President Tony James have in recent weeks been privately and publicly warning about a turn in financial conditions, especially in terms of their own firm's ability to finance acquisitions via cheap and ever-plentiful financing offered by Wall Street banks.
"They're monetizing the reputation that they've built," said Colin C. Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth University's Tuck business school. "That often means you're at the top."
By going public, Blackstone would gain a source of permanent capital, since money raised from on the open market never has to be returned. Blackstone then wouldn't need to depend on endless rounds of time-consuming fundraising from its usual investors: public and corporate pension funds, endowments and wealthy families. It also would get a powerful advantage over rival bidders since once it has listed, it could offer its stock as well as cash to finance acquisitions. That could enable it to outbid competitors, whether other private equity firms armed with cash or industrial firms that often use stock to partly pay for acquisitions. Blackstone already boasts the largest private-equity fund at $20.6 billion. It has $55 billion of capital under management.

"They can use this to further institutionalize their business and make sure Blackstone is around 100 years from now, versus relying on any one personality," says Christopher Bower, chairman of Pacific Corporate Group.
Blackstone's plans were reported earlier by CNBC.
Blackstone's management company, a partnership of about 60 investors, has been on a buying spree and owns everything from Madame Tussauds wax museums and Mrs. Paul's fish sticks to the country's largest office landlord, Equity Office Properties Trust. Blackstone has separate arms that invest in hedge funds and advise corporate clients on mergers and restructurings.
The personal wealth created for Blackstone partners by a public offering could be staggering. Much of the proceeds of any initial offer will likely go to the Blackstone's two founders, Pete Peterson, a former commerce secretary under President Nixon, and Mr. Schwarzman, with the bulk going to Mr. Schwarzman. Mr. Schwarzman, who is said to be worth upward of $10 billion now, could double that.
Around Blackstone, the joke for years has been that the firm is like a pool table with one leg shorter than the others -- so all the balls gravitated to that corner. That leg was said to be Mr. Schwarzman, who often keeps half of a given fund's returns since he holds the biggest stake and is its biggest rainmaker.
Mr. Schwarzman, along with Henry Kravis of Kohlberg Kravis Roberts & Co., has become a poster child of the private equity world. But while Mr. Kravis is associated with the early, raw days of private equity in the 1980s, Mr. Schwarzman is considered the new "King of Wall Street," as he was dubbed on a recent Fortune magazine cover. His recent 60th birthday celebration, which featured singer Rod Stewart and was emceed by actor Martin Short, was the talk of New York society.
Such a high profile, though, could cause a public backlash in an environment when anger is rising over what is seen as excessive compensation for top executives and a widening income gap in the U.S. In addition, should small shareholders buy into Blackstone's IPO, it would expose them to some of the risks of private-equity funds. That could attract more attention in a Congress controlled by Democrats. Lawmakers are already discussing ways to potentially limit how much money pension funds can invest in hedge funds, thereby limiting the risk a fund blow-up could indirectly have on its retirees.
More important, some Senate staffers are examining whether to change tax rules in such a way that would force hedge funds and private-equity firms to pay higher taxes on their massive profits. Every time a private-equity firm sells one of its companies, whether to a single buyer or through the public markets, 20% of the profits go to the management company. Investors in private-equity firms also pay management fees of about 1.5% of the money under control. So when Blackstone recently raised $20 billion, it pocketed about $300 million in fees.
In addition, private-equity firms pocket an array of fees from the companies they buy. Just for sealing the deal to buy Equity Office Properties last month, for example, Blackstone got to share a success fee of $400 million with its investors. It gets additional fees for arranging financing for its portfolio companies and for monitoring them.
There would be plenty of irony in a Blackstone public offering. Mr. Schwarzman has for years evangelized against the failings of public-market ownership to companies he hoped to acquire. In a series of recent public appearances, Mr. Schwarzman has been unsparing, calling public stockholding "a broken system" and criticizing the 2002 Sarbanes-Oxley corporate-accountability law as having "taken a lot of the entrepreneurial zeal out of a lot of corporate managers." Quarterly earnings reports for public companies, he has said, create a "tyranny."
Blackstone's plans may point to a much deeper shift in the financial markets. The lines between public firms and private concerns are continuing to blur. The next few years, a number of Wall Street denizens say, might see the creation of hybrid companies that exist simultaneously in the public and private spheres.
Indeed, Blackstone's decision is likely to lead to a race by others to follow suit. Carlyle, KKR and TPG -- the former Texas Pacific Group -- have all been considering a similar step and may be forced to imitate a Blackstone IPO if only to have equal firepower in competing for attractive targets.
The frenzied demand for the Fortress listing showed investors are willing to pay up to tap into the magic of alternative investment firms. At the same time, though, when markets are volatile, the advantage of going first may be considerable. Blackstone, Carlyle and TPG learned this lesson last year when Blackstone's arch rival, KKR, listed a fund in Europe that would invest in its deals. Demand was so strong that KKR expanded the offer from $1.5 billion to $5 billion. That left little demand for anything that followed, to the frustration of rivals which then abandoned plans to launch similar units.
So far, Boston-based Bain Capital has been about the only large private-equity firm to show little enthusiasm for going public. But senior people at Bain concede they may be forced to consider such a move if all their competitors do so, according to people familiar with the matter.
The Fortress experience also offers a cautionary tale, however. Just one month ago, Fortress stock was listed at $18.50 and soared to $35 on its first day. Its now trading at $25.83, so investors who entered the stock at the high point have lost a third of their money.

 

[RussianMike]

A good case as far as it being the top of the market, however, Goldman was going public in '99 and that would have turned out to be a good investment. I also dont like the comment in the article about Congress and not allowing pension funds to invest in hedge-funds etc. I personally do not like mutual funds because of their inability to short stocks, etc. I think hedge funds are much better in this regard.