Public hedge fund firm seeks longevity
When Goldman Sachs Group Inc. went public in May 1999, some on Wall Street figured it was a signal to bail out of brokerage stocks.
If Goldman was letting the public into its business after 130 years as a highly profitable -- and secretive -- private partnership, the insiders must have known that was as good as it would get.
Hardly. Goldman earned an astounding $9.5 billion last year, a 252% increase from its profit of $2.7 billion in 1999.
As for the stock, the $53-a-share price in the initial offering now looks like a giveaway. Goldman stock closed at $213.28 on Friday, up 300% from the offering price. The Standard & Poor’s 500 stock index is up all of 6% in the same period.
That’s a bit of context for the stock offering late last week by Fortress Investment Group of New York, the first U.S.-based manager of hedge funds and private-equity funds to go public.
Despite the same kind of naysaying that accompanied Goldman’s stock sale -- “Why buy if the smart guys are selling?” -- Fortress got a rousing reception from investors. Its shares soared 68% on their first trading day Friday, from $18.50 to $31.
That made Google Inc. look like a piker. The Internet giant’s stock could muster only an 18% jump in its August 2004 debut.
Any doubt that other hedge fund management companies will consider public stock offerings should have been erased by the Fortress deal. If the public market is willing to hand these firms truckloads of fresh capital, they’d be foolish not to take it.
Fortress raised $630 million by selling 34.3 million shares. Obviously, it could have sold a lot more -- and probably will, in time.
Hedge funds, of course, are those investment pools for wealthy individuals and institutions. The funds employ often-complex investing and trading strategies in stocks, bonds, commodities, currencies and other assets. They are supposed to be opportunistic and savvy in their search for above-average returns.
Only in Lake Wobegon can all the children be above average, but that hasn’t stopped investors from pouring money into thousands of hedge funds over the last decade, lifting the industry’s assets to a record $1.4 trillion.
Fortress also is a big player in private equity, the business of buying stakes in companies, or buying them in their entirety, with the expectation of improving them and selling them later for a big profit.
With its stock offering, Fortress is essentially inviting the public to share in the fees it earns managing private-equity and hedge-fund assets. At the end of 2005, the company’s then-$7.6 billion in hedge fund assets (a hoard that has since grown) ranked it the 36th-largest fund globally.
All told in its hedge funds and private equity accounts, Fortress now manages $30 billion, it says.
The firm’s profit has been growing rapidly. Fortress earned $88 million in the first half of 2006, about double what it earned in the same period of 2005, according to its financial filings.
So why cut the public in on the game? Fortress acknowledges that having a publicly traded stock allows its employees to turn their stakes in the company into income. In a partnership, it can be difficult to cash out. In a public company, it’s a simple matter of selling shares.
Fortress also says the appeal of going public is having ready access to capital markets, to raise money for expansion -- hiring managers for new investment strategies, for example.
Being publicly traded will increase the odds of gaining “permanence” as an investment manager, the company says.
That makes sense. The hedge fund and private-equity businesses are becoming ever more competitive as the number of players mushrooms. A serious shakeout is inevitable. When it happens, the firms with the deepest pockets will have the best chance of surviving -- and benefiting from the opportunities shakeouts always produce.
Charles Davidson, who tracks the hedge fund industry for Standard & Poor’s, says every major hedge fund firm has to be considering a stock offering.
“All of these guys are thinking, ‘When the market turns, we want to have as much liquidity as possible,’ ” he says. “They know there’s a cyclicality” to the investing business.
That cyclicality naturally makes investors wary of overpaying for financial-company stocks. The price-to-earnings ratio of Goldman Sachs’ shares is a mere 11 based on estimated 2007 earnings, compared with a P/E of about 16 for the average U.S. blue chip stock.
Given the risk of wide swings in earnings, Fortress’ public investors have to be prepared for a rocky ride.
They also have to wonder if their interests will be aligned with those of Fortress’ principals, who have their own money invested in the company’s funds.
Fortress acknowledges the potential for conflicts of interest. “For example, our principals may have different tax positions [from the company] which could influence their decisions regarding whether and when to dispose of assets” in funds, the company says in its filings.
Unfortunately, conflicts of interest are par for the course on Wall Street. So is the periodic scandal. The question for public shareholders is, are the long-term profit opportunities in the investment business worth the inherent risks?
At Fortress, clients’ interests have to come first, because they pay the fees that make the business viable. What’s more, public shareholders’ stock represents just 10% of the voting control of the company. The firm’s principals aren’t giving up much.
Still, how the company’s stock performs over time will be a big factor in how rich Fortress’ employees can become, as has been true for Goldman Sachs as well since 1999. So there is an alignment of interests with average investors.
(Goldman, by the way, has grown into the largest hedge fund manager and is a titan in private equity.)
For Fortress, the downside of going public is that the cloak of secrecy hedge fund managers enjoy will be partly ripped away. Much more will be revealed, quarterly, about the operations of the business than before.
But that hasn’t been debilitating for Goldman Sachs or other publicly traded investment banks that also operate in the hedge fund sphere. Their true state secrets -- day-to-day trading positions -- aren’t public record.
It might also turn out that the burden of disclosure may actually help Fortress in the long run. Christoper Whalen, at research firm Institutional Risk Analytics in New York, says the hunt for high returns is driving hedge funds “more and more to play in opaque products,” such as certain so-called derivative securities.
If its new status as a public company forces Fortress to be more cognizant of the risks it’s taking, that might not be such a bad thing.
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Masters of the trade
Here are the 10 biggest hedge fund management companies worldwide, ranked by assets managed at the end of 2005.
*--* Assets (in billions), Company Headquarters end of 2005 Goldman Sachs Asset Management New York $21.0 Bridgewater Associates Westport, Conn. 20.9 D.E. Shaw Group New York 19.9 Farallon Capital Management San Francisco 16.4 ESL Investments Greenwich, Conn. 15.0 Barclays Global Investors London 14.3 Och-Ziff Capital Management New York 14.3 Man Investments London 12.7 Tudor Investment Corp. Greenwich, Conn. 12.7 Caxton Associates New York 12.5
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Source: Alpha magazine
Los Angeles Times
