Leader of the pack

Private equity firms tend to move in packs, and so it should come as no surprise that a number of the largest houses have discovered an appetite for hedge funds recently. Typically, these new ventures have been launched with distressed investment opportunities in mind.
 
Late last month, Fort Worth-based buyout shop Texas Pacific Group announced plans for TPG Credit Management, a hedge fund fronted by former Cargill Value Investment executive Rory O’Neill.
 
In lining up the venture, TPG followed in the footstep of another private equity giant, New York-based Kohlberg Kravis Roberts (KKR), which also recently announced plans for a new hedge fund. KKR has been in the process of diversifying its investment strategy for a number of years, starting with plans for a business development company (BDC) and recently launching a New York Stock Exchange-listed real estate investment trust called KKR Financial.
 
In fact, it is KKR’s San Francisco-based REIT holding company that will oversee the hedge fund venture, which will focus, according to the firm, “on stressed and distressed opportunities and market dislocation investments”.
 
Shortly before the KKR announcement, Quadrangle Group announced a plan to work with fund manager Robert Donahue’s Harpoon Equity Management, a hedge fund specialist with distressed investment skills. .

Quadrangle, KKR and Texas Pacific follow a number of other private equity names that are also launching or planning to launch hedge funds, including HSBC Halbis Partners, The Blackstone Group, New Mountain Capital and The Carlyle Group.
 
These groups are eyeing the current distressed market in anticipation for a correction after corporate default rates hit an 8-year low in 2005. There were only 37 defaults of S&P 500 companies last year, but Standard & Poor’s is predicting an up-tick in defaults – and distressed fund deal flow – in 2006 as highly levered companies are finding capital increasingly expensive.
 
Tracking group Fitch Ratings said defaults stood at 3.1 percent at the end of last year and expects this to grow to 5 percent in 2006. Specialist investors have indicated that the lowest-rated companies are finding capital increasingly expensive, setting the stage for the inevitable “seasoning” period when companies sink or swim – or get bought by a private equity-backed hedge fund.  
 
Much like the BDC craze of 2004, which for the most part turned out to be a non-starter, hedge funds bolted on to private equity groups seem to be the flavour of the moment. Whether or not they will find the supply of deals they require, only time and credit ratings will tell.