Equity analysts at Keefe, Bruyette & Woods (KBW) have lowered their ratings on the stock of Fortress Investment Group (FIG) and Och-Ziff Capital Management (OZM), saying they view the two firms as having lower growth potential compared with other alternative asset managers.
In a research report issued 10 July, managing director Robert Lee said that “while both stocks remain very cheap on many valuation metrics, in a peer group of cheap stocks, we see better long-term values in other alternative asset managers with superior growth prospects”.
Spokesmen at Fortress and Och-Ziff declined to comment.
Many alternative asset managers’ stocks have been hammered lately amid market volatility. Fortress’ stock is trading at about $4 currently, half its $8 value in August 2015. Och-Ziff’s stock is trading below $4, down from about $13 last July. Och-Ziff is particularly troubled because of an ongoing Department of Justice (DOJ) investigation and fines related to transactions in Africa.
While many alternative asset manager stocks look cheap, which may signal a “buy” to investors, not all undervalued stocks are created the same, Lee cautioned. “If I look at the broader universe of publicly-traded alternative asset managers, a lot of them are cheap and inexpensive, but I would include Fortress and Och-Ziff in a group that’s struggling for investor acceptance. Investors would rather focus on managers that, over the coming year or two despite headwinds, seem poised to generate underlying growth,” Lee told PDI.
He admitted that Fortress’ credit business has been performing well, though the firm has been challenged in other areas. Last year, Fortress let go its once high-flying hedge fund chief, Michael Novogratz, after a protracted period of poor performance.
“In the case of FIG, while the credit business is performing well and distributions could remain reasonably healthy, if highly unpredictable, given incentive generation from credit and as balance sheet assets are realised, we don’t believe the stock will get much credit for distributions off the balance sheet and growth overall remains constrained,” Lee wrote in the report.
At Och-Ziff, the DOJ investigation and poor performance of the firm’s largest flagship multi-strategy hedge fund is weighing on the manager. “Continued lackluster multi-strategy hedge fund performance combined with weak and/or accelerating outflows on top of the continued overhang of the DOJ investigation led us to conclude that other alternative managers offered superior risk/return at this time,” Lee wrote.
Och-Ziff has ambitious growth plans in other areas, such as European CLOs, a BDC and energy investments. Lee noted that the firm has enjoyed better performance in credit lately, though the regulatory challenges at the firm might still leave it hamstrung in pursuing new areas. “It takes time to launch new strategies and if your legacy strategies are struggling from a near-term performance perspective or from a fundraising perspective, it can outstrip any success on new products,” he said.
KBW’s report also said that The Blackstone Group, Oaktree Capital Management and KKR are among their top investment picks. While some performance measures at these firms have shown weaker financials during times of market volatility and energy declines, strong fundraising, and the commencement of investment periods on those funds, should lead to growing management fees.
KKR’s economic net income (ENI) was badly impacted by market volatility in the first quarter, posting a $506.9 million loss, though Lee said ENI isn’t necessarily a good measure of financial health. “ENI is a highly flawed earnings metric as it’s heavily influenced by mark-to-market changes and assets on your balance sheet,” Lee told PDI.
“Because KKR has more investments on its balance sheet, notably First Data, it had an impact on the reported ENI number, but a mark is mark, it doesn’t necessarily affect cash flow,” he added.