Firm’s public stock sale pulls hedge funds out of shadows
The secretive world of hedge funds and corporate buyout specialists took a big step into the mainstream Thursday: For the first time, a U.S.-based manager of such funds became a publicly traded company.
Hedge funds and buyout firms cater to wealthy, sophisticated investors who are looking for big profits and are unafraid to take sizable risks. The initial public stock offering by Fortress Investment Group of New York allows any investor to potentially get a piece of the profit generated by these burgeoning businesses.
Once regarded by some as pirates of the financial markets, hedge funds and buyout specialists increasingly are seen as established investment firms on par with Wall Street brokerages and mutual fund companies.
“It’s the natural evolution,” said Charles Gradante, a principal at Hennessee Group, which helps investors pick hedge funds. He expects more large hedge funds to follow with stock sales of their own.
Some analysts, however, say Fortress’ willingness to go public -- raising money by selling part of the company -- might be a signal that the industry will face a growing challenge attracting capital from its traditional base of well-heeled investors.
“These are very smart guys. If they’re selling, I probably don’t want to be buying,” said Steven Persky, head of Dalton Investments, a $1.1-billion hedge fund firm in Los Angeles.
Competition in the industry already is fierce, with more than 9,000 hedge funds holding $1.4 trillion in total assets. Earning the above-average investment returns their clients demand is certain to become harder as more funds chase the same ideas, analysts say. That may dim the funds’ long-term growth prospects.
But in the near term, the same mystique that has persuaded rich individuals, pension plans and others to trust their money to hedge and buyout funds may trigger a stampede for Fortress’ shares when they begin trading on the New York Stock Exchange today.
Late Thursday, the company raised $630 million by selling 34 million shares to investors who had placed orders for the stock. The shares were sold at $18.50 each, the top end of the $16.50 to $18.50 range Fortress had hoped to get. That is a sign of robust investor demand.
Hedge funds have exploded in number and financial power over the last decade. The term “hedge” has become a catchall for these portfolios that can pursue a dizzying array of complex investing and trading strategies in stocks, bonds, commodities, bank loans and other assets.
The goal is to rake in much more than what mutual funds and other traditional investment vehicles typically earn with plain-vanilla stocks and bonds. And only the financially comfortable need apply: Federal rules restrict hedge funds to clients with at least $1 million in net worth, a measure aimed at preventing middle-class investors from losing their shirts.
The last few years also have seen the rise of corporate buyout funds, known as private equity funds, which seek to buy undervalued publicly traded companies at bargain prices, make them more profitable and ultimately sell them for substantially more than the purchase price.
Fortress, founded in 1998 by a group of then mostly thirtysomething financiers, is a player in both the hedge fund and buyout arenas. The company, which has $30 billion in assets in its various funds, is led by Chief Executive Wesley Edens, 45, an Oregon State University graduate whose Wall Street career began at brokerage Lehman Bros. in 1987.
In financial filings for its stock offering, Fortress says it has generated an average annual return of 39% on its private-equity investments since 1999 and annual returns of about 14% on its hedge funds since their inception in 2002.
The company’s new shareholders, however, won’t directly get a piece of the same action Fortress offers its clients. The investors are buying a stake in the company, not its funds.
And Fortress’ stock performance will depend on whether the company can keep its clients satisfied -- and thus keep lucrative management fees rolling in.
As a stockholder, “you’re paying the principals in advance for a cut of the fees they hope to make,” said Adam Sussman, an analyst who follows the financial services industry for consulting firm Tabb Group in New York.
One key risk is that Fortress’ performance could slip markedly, triggering an exodus by its clients and causing assets and fee income to plummet.
“In the hedge fund space, investors are very impatient with returns,” said Thomas Whelan, president of Greenwich Alternative Investments, a hedge fund research firm.
What’s more, Fortress acknowledges in its filings that by becoming a public company regulated by the Securities and Exchange Commission and the New York Stock Exchange -- forced to disclose more about its financial dealings -- it may lose some ability to maneuver under the radar. Secrecy is a hallmark of successful hedge-fund and private-equity investing.
“Once you have public investors, life is different,” said Christopher Whalen, an analyst at market research firm Institutional Risk Analytics in New York.
That may become more of an issue as competition increases in the hedge-fund and private-equity businesses and genuine bargains in stock, bond and other markets become harder to find, Whalen said.
For Fortress, the benefits of selling stock apparently outweighed the downside. The company said one advantage of going public was gaining another route for raising capital for its growth, beyond relying on private investors.
Several European hedge funds already have gone public. One, Partners Group of Switzerland, has seen its share price rise 132% since its offering nearly a year ago.
Another goal, Fortress said, was to “provide financial incentives to our existing and future employees.” With their stock publicly traded, Fortress executives and others now can easily cash out some of their ownership stakes.
But they aren’t giving up much control. Public stockholders are getting a different class of shares from those held by the company’s principals. The executives will retain 90% of stock voting power in the company, ensuring that public investors have little influence on how the business is run.
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Hedge funds got their name from the basic strategy many of them used during the industry’s early years decades ago -- hedging, a means to limit the risk they took in placing their bets on stocks, bonds and other assets. That might have involved buying one stock -- betting that its price would rise -- while “shorting” the stock of a rival company, betting that it would decline.
Many hedge funds still employ hedging techniques. But with their assets soaring, the funds’ strategies have become vastly more complex and often entail high risk. They have become major investors and speculators in stocks, bonds, currencies and commodities worldwide.
Secrecy has been a fundamental element of the funds’ success. Because they are private investment pools, they aren’t subject to federal or state regulation and don’t have to disclose what they’re buying or selling -- not even to their own investors.
Source: Los Angeles Times