In­vest­ment Firms Open to the Masses, But Should You Buy?

The Washington Post Sunday - - Business - By To­moeh Mu­rakami Tse

NEW YORK — In Fe­bru­ary, Fortress In­vest­ment Group, a man­ager of hedge funds and private eq­uity, en­joyed a suc­cess­ful ini­tial pub­lic of­fer­ing. Now, Black­stone Group, a pre­mier private-eq­uity shop, is pre­par­ing to go pub­lic as well. And Wall Street is abuzz with prom­ise of more to come.

But are shares in th­ese al­ter­na­tive in­vest­ment firms a good deal for small in­vestors?

Some money man­agers say they wouldn’t touch th­ese of­fer­ings with a 10-foot pole. Why should they buy, they ask, when the best and the bright­est who run th­ese firms are cash­ing out?

“If I were smart enough to start one of th­ese, I cer­tainly would want to find an exit strat­egy,” said David Dre­man of Dre­man Cap­i­tal Man­age­ment.

But oth­ers say the al­ter­na­tive in­vest­ment mar­ket has not reached its peak. Many U.S. com­pa­nies with strong bal­ance sheets are still at­trac­tive ac­qui­si­tion tar­gets for private-eq­uity firms, an­a­lysts say, and in­sti­tu­tional play­ers on a con­tin­u­ous hunt for

above-mar­ket re­turns are more than will­ing to sup­ply the money.

“Fund flow from the pen­sion funds are pro­vid­ing al­ter­na­tive in­vest­ment groups with sus­tained rev­enue sources,” said Doug Couden, port­fo­lio man­ager for SCM Ad­vi­sors. “That’s good for the firms, which should be good for the stock.”

An­a­lysts say the main thing in­vestors should re­mem­ber is that buy­ing Black­stone or Fortress shares does not grant them ac­cess to the funds those firms run or a stake in the com­pa­nies they buy. Rather, in­vestors get a small piece of the un­der­ly­ing man­age­ment com­pany, whose earn­ings are largely de­rived from fees charged on the funds.

“You just have to re­al­ize that you are very much a mi­nor­ity in­vestor,” said Charles White, chief in­vest­ment of­fi­cer of ThomasLloyd Funds, which spe­cial­izes in blend­ing tra­di­tional and al­ter­na­tive in­vest­ing tech­niques. “You’re not buy­ing their ven­ture cap­i­tal in­vest­ments. You’re not buy­ing the same thing the private-eq­uity part­ners are buy­ing into.”

Helped by low in­ter­est rates and easy ac­cess to cap­i­tal, private-eq­uity firms have led multi­bil­lion-dol­lar lever­aged buy­outs of some of the most es­tab­lished names in cor­po­rate Amer­ica in re­cent years. Private-eq­uity firms com­bine their clients’ money with loads of bor­rowed cash to take pub­licly traded com­pa­nies private. They typ- ically hold a com­pany for sev­eral years, mak­ing man­age­ment and busi­ness changes, be­fore sell­ing its shares back to the pub­lic.

Hedge funds are lightly reg­u­lated, ag­gres­sively man­aged in­vest­ment pools that use com­pli­cated — and risky — strate­gies to gen­er­ate big re­turns. There are more than 9,000 hedge funds man­ag­ing an es­ti­mated $1.4 tril­lion in as­sets.

The best-known of th­ese al­ter­na­tive in­vest­ment firms have de­liv­ered an­nual gains of 20 per­cent or more to in­vestors in their funds, but those gains come at a price. Private-eq­uity firms and hedge funds charge their clients steep fees, typ­i­cally about 1.5 per­cent of as­sets un­der man­age­ment and 20 per­cent of the prof­its. (Tra­di­tional funds typ­i­cally charge about 1 per­cent of as­sets un­der man­age­ment.)

In its prospec­tus filed last month with the Se­cu­ri­ties and Ex­change Com­mis­sion, Black­stone said its 2006 earn­ings were $2.3 bil­lion, in­clud­ing $1.55 bil­lion in fees from the funds it op­er­ates. Fortress re­ported $255 mil­lion in man­age­ment and per­for­mance fees dur­ing the first nine months of last year.

The com­pa­nies say they are go­ing pub­lic to ac­cess new sources of cap­i­tal, to ex­pand, to at­tract and com­pen­sate em­ploy­ees, as well as to pay down debt. Black­stone says it in­tends to raise $4 bil­lion with its of­fer­ing. Fortress’s raised $634 mil­lion, and its shares soared 68 per­cent on the first day of trad­ing to close at $31. (It closed Thurs­day at $28.25 a share.)

Un­til now, most in­vestors have been ex­cluded from the al­ter­na­tive in­vest­ment game by fed­eral se­cu­ri­ties law, which lim­its ac­cess to so­phis­ti­cated in­vestors such as pen­sion funds, univer­sity en­dow­ments and wealthy in­di­vid­u­als.

While the door has opened slightly for small in­vestors, any­one think­ing about buy­ing shares in al­ter­na­tive in­vest­ment com­pa­nies should be aware of the po­ten­tial risks, an­a­lysts say. As with any in­vest­ment, a com­pany’s past per­for­mance should not be seen as an in­di­ca­tion of its fu­ture re­turns.

For one thing, be­cause most al­ter­na­tive as­set man­agers are pri­vately held, there isn’t a peer group of pub­licly traded com­pa­nies against which in­vestors can eas­ily mea­sure a prospec­tive in­vest­ment, at least for now.

“I think they’re a bit hard to value be­cause of that,” said Couden, who none­the­less sees op­por­tu­ni­ties within the cat­e­gory and does not rule out buy­ing such stocks in the fu­ture.

Fur­ther­more, th­ese com­pa­nies have been struc­tured for tax pur­poses as lim­ited part­ner­ships. That means peo­ple who buy units in the part­ner­ship don’t have the right to elect direc­tors. The com­pa­nies say in­vestors should not ex­pect much dis­clo­sure about op­er­a­tions, in­clud­ing in­vest­ment strate­gies.

And when it comes to strat­egy, in­vestors should re­mem­ber that while hedge fund trad­ing meth­ods have gen­er­ated stel­lar re­turns, they can also back­fire. Last year, a big bet on the di­rec­tion of nat­u­ral gas prices by a trader at Amaranth im­ploded, pro­duc­ing a $6 bil­lion loss and forc­ing the hedge fund’s clo­sure.

In­ter­est rates are an­other fac­tor to con­sider, an­a­lysts say. The re­turns gen­er­ated by th­ese com­pa­nies’ funds may suf­fer if the cur­rently cheap cost of cor­po­rate debt rises. That could shrink the fees charged by fund man­agers and, in turn, the prof­its passed along to share­hold­ers.

An­a­lysts also say the stocks may face down­ward pres­sure if per­for­mance falls off and al­ter­na­tive in­vest­ment man­agers have to jus­tify the fees they take from the funds.

In 2006, the broader mar­ket mea­sures had ex­cep­tion­ally strong re­turns, mak­ing it tough for al­ter­na­tive play­ers to beat them, par­tic­u­larly once those fees are fac­tored in. Hedge funds re­turned an av­er­age of 12.9 per­cent for 2006, ac­cord­ing to Hedge Fund Re­search, slightly less than the 13.6 gain by the Stan­dard & Poor’s 500stock in­dex.

Robert Lutts, chief in­vest­ment of­fi­cer at Cabot Money Man­age­ment, said Fortress shares were per­form­ing well so far, but he likes to let new stocks get a lit­tle bit more es­tab­lished be­fore buy­ing.

“There are so many more op­por­tu­ni­ties than there were be­fore,” he said. “There is also more room to make mis­takes — great op­por­tu­nity means more risk."

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.