The lighter side of cannibalism

More US private fund managers are taking minority stakes in their industry peers and there are benefits for buyer and seller alike.

Three New York alternative asset managers – Blackstone Group, Dyal Capital and Goldman Sachs’ Petershill programme – have been on a feeding frenzy. Through a series of transactions, each have taken non-control positions in several other alternative investment firms and are on track to beat last year’s total for such deals.

The phenomenon is not new, but this extremely well-resourced group has helped drive a new spate of deal activity. Blackstone Strategic Capital Holdings oversees more than $3.3 billion in permanent capital. Dyal closed its $5.3 billion fund, Dyal Capital Partners III, last year and has already returned to market, seeking another $5 billion for its fourth fund. Goldman Sachs – the only one of the three willing to comment for this article – closed its latest Petershill fund in February at $2.5 billion.

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“Demand is building from institutional investors,” says Jeff Hammer, managing director at advisor Houlihan Lokey and co-head of the firm’s illiquid financial assets practice. “The predictability of the income stream from funds with long-term, locked-up money presents an attractive investment opportunity.”

Transactions tend to result in stakes of 10-33 percent, says one fund manager that sold an interest. The reason, the manager adds, is that Blackstone, Dyal and Goldman want to write cheques that “move the needle”.

For the seller, meanwhile, a small stake of 3-5 percent is unlikely to have a big enough impact to make the deal worthwhile. Goldman Sachs’ Petershill didn’t start by targeting private fund managers. When it launched just before the global financial crisis, it was taking minority stakes in hedge funds, but has since expanded its book to include managers operating closed-end funds.

“Private equity offers stability with locked-in management fees,” says Hammer. “Hedge funds are more volatile as the value of their assets ebb and flow with market conditions, and so do their fees. That said, hot hedge fund managers can offer significant fee upside through performance in any given year.”

Hedge funds, on average, have posted lacklustre performance in recent years, returning 0.79 percent through June, according to Hedge Fund Research’s HFRI Fund Weighted Composite Index. One-year returns stood at 5.67 percent, while three- and five-year returns were 3.63 percent and 4.44 percent, respectively.

For its part, private equity has performed much better. Preliminary results for the first quarter were 2.96 percent, according to the Cambridge Associates Private Equity index. For the three months ending 31 December – the most recent period with final results – the asset class returned 5.07 percent. It had a 12-month return of 17.49 percent, and three- and five-year returns of 17.49 percent and 11.79 percent, respectively.

On the capital-raising side, hedge funds saw $30.3 billion of inflows in 2017 – the highest on record – though that does little to offset the $111.6 billion in outflows the industry suffered in 2016, according to research firm eVestment.

Playing catch up

By contrast, private credit and private equity fundraising has been in rude health. PDI data show that private credit had a record-breaking fundraising year with $206 billion raised. Private equity raised $455.4 billion – the most since at least 2012.

The focus on closed-end capital is the result of illiquid managers playing “catch up” with firms overseeing open-ended vehicles, one industry source says: “There’s clearly different nuances partnering from a liquid manager and an illiquid manager.”

One manager that invests in the space posits that private equity funds have been more attractive than hedge funds.

“We would start with the premise that they’re just different asset classes,” the market participant says. “There’s challenges in the [hedge fund] space, but there’s a lot of firms that have been very successful. The locked-up capital [of closed-end funds] just requires a higher valuation.”

Investor advantages

LPs have come to appreciate indirectly owning minority stakes in other alternative asset managers because, for once, it allows them to receive a portion of private fund fees rather than pay the levies.

“[Through minority stakes in alternative asset managers] the investors also see the fees they are paying to these managers,” says another fund manager who invests in the space.

“When you offer these LPs to sit on the same side of the table of the GPs, it can be a pretty compelling trade.”

In addition to the management fee and carried interest income streams, LPs will also see the gross return from the given fund manager’s GP commitments.

“[The phenomenon is] partially driven by LPs looking for deeper and deeper relationships on their GP side,” says Goldman managing director Christian von Schimmelmann. “They are encouraging private equity GPs to expand into credit, which requires capital.”

The investment proceeds are typically used for one of three purposes: succession, larger general partner commitments to the firm’s funds or product expansion.

“Other reasons why people might do it in today’s environment – to the extent that there’s market dislocation – the winners will have substantial balance sheets with cash,” says one fund manager that sold a stake, noting that alternative investment firms historically have not had large balance sheets.