Man Worst as Private Funds Trail Markets: Riskless Return
Shares of London-based Man Group, the biggest publicly traded hedge fund, have declined 63 percent in the past year, including reinvested dividends, the most of 32 money managers in the BLOOMBERG RISKLESS RETURN RANKING, and they had the highest volatility. Buyout and hedge-fund firms including Och-Ziff Capital Management Group LLC and Fortress Investment Group LLC (FIG) ranked near the bottom, while mutual-fund firms led by Aberdeen Asset Management Plc (ADN) dominated the top.
Managers of private funds, marketed to the richest investors, have proven to be poor picks for public shareholders because of their reliance on performance-based fees, which have been eroded by volatile capital markets since the 2008 financial crisis. All six alternative-asset firms that have held initial share sales in the U.S. since 2007 are trading below their offer price. Carlyle Group LP (CG), which sought to buck that trend with a discounted stock sale, failed when the shares sank below the offering price on May 9.
“There is a limited understanding of these firms as their business models are more complicated and earnings streams are more volatile,” Daniel Fannon, a San Francisco-based analyst covering asset-management stocks at Jefferies & Co., said in a telephone interview. Until the markets improve and the firms can show some gains, “they’re still a ‘show-me’ story for investors.”
Conflict of Interest
Investors buying the stock of a money manager share in the fees the manager receives for running funds. They don’t participate directly in the returns of the funds, instead competing with investors in the pools, whose aim is to minimize fees. That potential conflict of interest has been an issue for public asset managers since Dreyfus Corp. was sued by fund investors over its 1965 initial public offering.
Earnings of buyout and hedge funds, so-called alternative asset managers, can be difficult to predict because they get the vast majority of their fees from carried interest, or a cut of profits from fund investments, according to Fannon. Those fees can swing violently as financial markets move up or down, making the shares more volatile. The median volatility of hedge-fund and private-equity firms in the ranking was 43.6, compared with a median volatility of 41.5 for the traditional money managers.
The appeal of alternative managers may also be limited because many list on the public markets as limited partnerships rather than corporations, which gives them more leeway in restricting shareholder claims.
Most private-equity and hedge funds typically take 20 percent of investment gains as carried interest, on top of 2 percent of assets as a management fee to cover expenses. Traditional asset-management firms, which offer products such as mutual funds and exchange-traded funds, get most of their income from management fees, which are more stable.
Man Group, the worst performer in the U.K. benchmark FTSE 100 Index (UKX) over the past 12 months, slumped as losses in its flagship AHL hedge fund strategy and Europe’s debt crisis prompted clients to withdraw money. Clients pulled a net $1 billion in the three months ended March 31. The shares had the biggest price swings of the asset managers in the ranking, with a volatility of 60.1. That’s almost three times as much as the volatility of the FTSE 100 Index.
Laura Humble, a spokeswoman for Man Group, declined to comment on the company’s share performance, as did officials for Blackstone and Och-Ziff. A spokesman for Fortress didn’t reply to an e-mail and a voice message seeking comment.
The firm’s Chief Executive Officer Peter Clarke said on May 1 that Man Group is “focused on the key priorities of delivering performance for our investors, meeting client needs and improving operational efficiency across the business.”
Och-Ziff, based in New York, had the 13th-highest volatility and the second-worst total return after slumping 46 percent in the past year, including reinvested dividends. Fortress, also based in New York, fell 34 percent in the past year and its volatility was second only to Man Group at 56.8.
In the Bloomberg ranking, eight of the 10 worst firms by total return were alternative-asset managers. One the other side of the spectrum, nine of the 10 top performers by risk-adjusted and by total return were traditional asset managers. Shares of alternative managers declined, on average, by 33 percent in the past year, compared with 15 percent for stock-and-bond managers.
Private-equity firms pool money from investors such as pension plans and endowments, with a mandate to buy companies, overhaul and then sell them, and return funds with a profit after about 10 years. The firms use debt to finance the transactions and amplify returns. Hedge funds raise money from many of the same investors and have a similar fee structure. They usually don’t lock up capital for long periods, buy more liquid assets, and can bet on rising and falling securities.
Aberdeen, the top performer with a 9.7 percent total return, had the third-lowest price swings. The combination produced a risk-adjusted return of 0.3 percent, the best among the 32 companies. The company has attracted investors into higher-fee products including global and emerging market stocks.
Affiliated Managers Group Inc., a firm that acquires stakes in a diverse mix of asset managers, produced the second-best total return for the No. 2 spot in the risk-adjusted return ranking after shares were about unchanged in the past year.
Ashmore Group Plc (ASHM), a U.K. fund manager that invests in emerging markets, produced the second-best total return and the sixth-lowest volatility, for the No. 3 spot in the risk-adjusted return ranking. The firm benefited from client deposits into its funds.
The risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period of time, increasing the potential for unexpected losses.
One traditional asset manager ranking at the bottom is Janus Capital Group Inc. (JNS), the Denver-based mutual-fund company. Janus is an exception, in part because like managers of hedge funds and private-equity funds, the firm charges performance- based fees that rise or fall based on returns. The firm has also been hurt by declining assets and 11 straight quarters of redemptions as performance at its stock funds faltered. Janus had the third-highest volatility over the past year and the sixth-worst return.
Beating the Market
Asset management firms have tapped the public markets for capital for almost half-a-century, and for much of the past decades have outperformed the stock market. Franklin Resources Inc. (BEN), the manager of the Franklin and Templeton mutual funds, has delivered about 23 percent in average annual gains to investors, excluding dividends, since it went public in 1971, according to the firm. T. Rowe Price Group Inc. shares have risen at an average annual rate of about 19 percent since the firm’s IPO in 1986.
“Asset managers were viewed by a lot of people like a public utility, earning fees for the adviser every day of the week,” Geoff Bobroff, a fund consultant in East Greenwich, Rhode Island, said in an interview. That’s not the case for alternative managers because they’re so dependent on performance-based fees, he said.
Dreyfus, which is now owned by Bank of New York Mellon Corp., was one of the first U.S. money managers to go public in 1965. After the IPO, a group of fund investors sued Dreyfus executives and the company over their profits from the sale. The selling shareholders eventually agreed to settle the lawsuit without any admission of wrongdoing.
Most alternative managers in the U.S. didn’t go public until 2007, meaning they don’t have a long track record as a shareholders’ company, and their performance could turn around if stock markets strengthen. Man Group and buyout firm 3i Group went public almost two decades ago and were able to benefit from rising markets in the 1990s and the early part of the 2000s.
Man Group, which went public in 1994, handed shareholders an average annual gain of 27 percent from the time of its IPO until mid-2007, when the stock peaked, according to data compiled by Bloomberg. Since then, the shares have slumped at an average rate of 35 percent. 3i shares have declined an average annual 1.2 percent since the firm’s IPO, also in 1994.
Fortress was the first of the U.S. private equity and hedge fund managers to go public in 2007, and was followed that same year by Blackstone and Och-Ziff. Fortress has declined 82 percent since its February 2007 IPO, and Och-Ziff has lost 76 percent.
‘Valuations Were Great’
Blackstone, the largest private-equity manager, went public at the peak of the leveraged-buyout market to raise $4.75 billion. Blackstone’s IPO, which generated a combined $2.6 billion for executives Steven Schwarzman and Peter Peterson, has provided public shareholders with a 61 percent decline since the IPO.
“The valuations were great in 2007 and the markets were very receptive to the investment story,” Benjamin Phillips, a partner at consulting firm Casey, Quirk & Associates LLC in Darien, Connecticut, said in a telephone interview. “Liquidity for the executives was also a key issue,” Phillips said.
KKR & Co. (KKR), which is traded on the New York Stock Exchange, didn’t hold an IPO, choosing instead to combine with its publicly traded European fund. The firm moved its listing to the U.S. from Amsterdam in 2010 and the shares have gained 18 percent since then.
Carlyle had sought to avoid the fate of Blackstone and others with an offering price that was below the proposed range of $23 to $25 a share. The stock has fallen 4 percent since its May 3 IPO.
“We firmly believe Carlyle’s status as a public company will strengthen our capabilities,” co-CEO David Rubenstein said on a call with investors yesterday. “No doubt as a public company there will be times when we face challenges, just as there will be times when we see considerable opportunities.”
Pension fund, endowments and other big investors in private equity and hedge funds typically push for lower management fees, and prefer that the firms focus on generating performance fees. Carlyle earlier this year lowered fees for investors ready to put in $500 million or more for its latest buyout fund, people familiar with the matter said at the time.
There may not be a compelling reason to own shares of these companies largely because of the “vagaries” of the market and the fluctuations in quarterly earnings, according to consultant Bobroff.
“On the private equity side, it might not turn out too well for investors,” Bobroff said. “Clearly, Blackstone, and more recently, Carlyle haven’t been rewarding for investors who bought in at the IPO.”
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