This Fund Is Making a Bundle (NYTimes, 11/10/06)

November 10, 2006
This Fund Is Making a Bundle
By JENNY ANDERSON
How much money is actually made in the fast-growing realm of hedge funds and private equity is often just an informed estimate.
No longer.
A securities filing by a $26 billion investment company provides a rare peek behind the curtain of secrecy that typically governs the world of alternative investments. Late Wednesday, the Fortress Investment Group filed to sell $750 million worth of shares to the public, valuing the company at $7.5 billion.
While the filing does not disclose individual compensation, two things are abundantly clear: money management, when the returns are good, is an extraordinarily profitable business. And the principals will make a killing on the deal.
For the first half of this year, Fortress, which has 500 employees, earned $88 million on revenue of $877.5 million. Fees from its funds totaled $185.8 million.
If finance were more democratic, every Fortress employee, from secretaries to fund managers, would make $673,000 this year on an annualized basis, up 14 percent from 2005, according to data provided by Charles Hintz, a securities industry analyst with Sanford C. Bernstein & Company.
Of course, secretaries and fund managers won’t be taking home the same paycheck. And the offering will make Fortress’s five principals — already wealthy from the success of the fund’s performance — billionaires. They have $500 million invested in the fund. If Fortress sells 10 percent to the public as disclosed, that leaves the five with $6.8 billion to divvy up.
In an effort to minimize the risk that any of those principals will leave, they are restricted from selling shares and face a five-year lockup that requires each to give up from 70 percent of his interests in the first year to 14 percent between the fourth and fifth years.
Like most private equity and hedge funds, Fortress earns huge fees: 1 to 2 percent of assets under management to run the fund and 20 percent of profits in “incentive” compensation. Traditional asset managers make much less: about 1 percent of assets under management.
“I think the compensation is reassuring rather than disconcerting,” said Donald H. Putnam, chief executive of Grail Partners, a merchant bank. “I would not want to own a company that underpaid its people.”
The filing also shows just how profitable hedge funds and private equity can be. Last year, the group had revenue of more than $1 billion, earned $192.7 million and paid out $259.2 million in compensation.
For the same period, BlackRock Financial, the big asset management firm, managed $452 billion in assets, 17 times as much as Fortress. In 2005, it made about the same amount in revenue — $1.2 billion, and slightly more in profit, $233.9 million. It paid out compensation of $595 million to 1,752 employees.
Fortress was founded in 1998 and today is run by its five principals: Wesley R. Edens, Robert I. Kauffman, Randal A. Nardone, Peter L. Briger and Michael E. Novogratz. The company has grown rapidly, from $1.2 billion under management on Dec. 31, 2001, to $26 billion on Sept. 30, 2006. It operates three main lines of business: private equity funds that manage $13.6 billion, hedge funds with $9.4 billion and other publicly traded companies worth $3 billion.
The fund’s returns — high by competitive standards — may be attractive to potential investors. The private equity funds had net annualized returns of 38.8 percent. The hybrid hedge funds that invest in distressed assets, including loans among other things, had annualized net returns of 13.7 percent. The “liquid” funds that invest globally in debt, currency, stock and commodity markets and derivatives had net returns of 13.7 percent. Fortress also manages two “castles,” which are publicly traded alternative investment vehicles. The return for those companies on a net annualized basis is 50.6 percent.
Fortress wants to offer shares to the public, the filing says, to have capital, currency, people and permanence. In other words, it wants money from the offering to invest in the business, a stock to use to make future acquisitions, stock to use as incentive compensation and a ticker symbol on the New York Stock Exchange — FIG — that elevates it from yet another big hedge fund to a permanent institution.
Fortress will use at least $250 million of the proceeds to pay down debt. The remaining money raised will be invested in the business. Other areas it says it could expand into include infrastructure funds, real estate funds, structured debt products, funds focused on industry or geographic sectors and more traditional long-only funds, or those that do not short stocks — a bet that the prices will fall.
Mr. Putnam expects more public offerings of hedge funds and private equity firms will follow.
“It is categorically a trend,” he said. “These companies are easier to float than to acquire. The challenges of an acquisition — it’s the mating of hippos — it’s a rare event.”
As in many mergers, combining the egos, finances and strategies of two money managers can be challenging. “A floatation is much more straightforward and it puts a clear value on the company,” Mr. Putnam said.
Publicly traded hedge funds and private equity funds are not rare abroad. RAB Capital and the Man Group are listed in London, while the Partners Group is traded in Switzerland and the Sparx Group in Japan.
Goldman Sachs is the lead underwriter on the Fortress deal with Bank of America, Citigroup, Deutsche Bank Securities and Lehman Brothers as co-managers. Skadden, Arps, Slate, Meagher & Flom is the legal counsel.