The Hedge Fund And Private Equity Stock Train Wreck

Date: Tuesday, May 8, 2012
Author: Nathan Vardi, Forbes

When some of America’s biggest hedge fund and private equity firms started to sell ownership through initial public offerings a few years ago, many investors rushed to buy the stocks. The hedge fund and private equity industries had produced Wall Street’s biggest fortunes, billionaires like Stephen Schwarzman, David Rubenstein and Daniel Och. There are now some 50 hedge fund and private equity billionaires—it seemed to make sense for investors to want a piece of the companies that made them rich.

But investing in hedge fund and private equity stocks has largely been a disaster for years. Blackstone’s 2007 IPO priced at $31; today the shares trade hands for $13. Fortress Investment Group sold shares in its IPO for $18.50; today the stock trades for $3.50. Sure these IPOs took place at the hedge fund and private equity top in 2007, but things are not getting better. Shares of New York hedge fund firm Och-Ziff Capital Management are down 43% in the last year. Fortress just reported that first-quarter profits fell 45% and Blackstone’s first quarter economic net income was down by 24%.

Then there’s Man Group, the world’s biggest publicly-traded hedge fund firm. It trades on the London Stock Exchange and has been a public company for a very long time. But it has never experienced times like these. Last week it reported $1 billion of net outflows at its hedge funds during the first quarter and its stock is now trading at its lowest levels in over a decade. Amid all this stock market carnage, it’s little surprise that Carlyle Group had to list its shares at a big discount just to pull off its IPO last week. Even so, there was no IPO pop and the stock has remained flat in its early days.

What’s going on?

Dan Primack, a top-notch private equity reporter, thinks Wall Street doesn’t know how to value private equity firms because investors focus too much on management fees that publicly-traded private equity firms generate and have a backward-looking mentality when it comes to rich performance fees. Since Primack thinks private equity firms are set to realize returns on their portfolio investments in the near future, he thinks these stocks could be a bargain. He’s not the only one who thinks there is an opportunity here. David Einhorn has directed his Greenlight Capital hedge fund to take a 5.5% stake in Oaktree Capital, a private equity firm that recently staged a disappointing IPO.

But there is an alternative view. The market might be sensing that the private equity and hedge fund party is over. Hedge funds, on average, lost money last year and failed to beat the U.S. stock market. So far in 2012 they are, on the whole, struggling to keep up with lowly S&P 500 index funds again. The financial engineering tricks the private equity industry relied on for years are to a certain extent gone and the M&A market is cool.

The other problem for these stocks is that the market may no longer trust them. Publicly-traded private equity and hedge fund firms have a dual loyalty. They not only work for shareholders, but also for their limited partners, the individuals and institutions that invest in their funds. Those interests don’t always align. In the case of Blackstone, shareholders don’t elect directors because the company is listed as a master-limited partnership.

Last week nearly one-third of Man’s shareholders did not back the re-election of one of its board members amid a backlash against CEO pay. One shareholder asked Man Group CEO Peter Clarke: “Sir, does it really seem like a $7 million sort of year to you?” Dan Och, chief of Och-Ziff Capital Management, made $170 million last year as a result of cumulative dividends that were the bounty of a 2010 that saw his flagship hedge fund perform well, but trail the S&P 500 index. Schwarzman and his Blackstone co-founder, Peter Peterson, sold a combined $2.6 billion of stock in Blackstone’s IPO. Carlyle Group used the money raised in its IPO to extinguish $500 million in debt that the firm originally took on to pay co-CEO David Rubenstein and his partners $400 million in dividends. Stock market investors need to be convinced that hedge fund and private equity firms can also work for them.