Some of the biggest U.S.-based buyout firms — including Kohlberg Kravis Roberts & Co., Apollo Advisors LP, Texas Pacific Group, Bain Capital LLC and Madison Dearborn Partners LLC. — are considering adding hedge fund strategies to their list of fund offerings, sources say.
Looking to grow beyond their U.S. buyout roots, these firms and others are leveraging their names, brands, reputations and fund-raising networks to generate the fees needed to expand.
"I think the motivation is to take advantage of existing client relationships," said Stephen L. Nesbitt, chief executive officer of Cliffwater LLC, a new Santa Monica, Calif.-based alternative investment consultant.
What's more, many institutional investors might be fully allocated to private equity and so now money is flowing into hedge funds, Mr. Nesbitt said. "I would think that (the firms) would want to take advantage of that."
Blackstone Group, New York, and Carlyle Group, Washington, made the move into hedge funds years ago. "Blackstone and Carlyle started with one thing — private equity — and they have broad offerings and they manage them very well," said Bradley T. Atkins, chief executive officer of consulting firm Franklin Park Associates LLC., Conshohocken, Pa.
So far, officials at the firms said to be moving into hedge funds are mum.
"We have not started a hedge fund," said Ruth Pachman, spokeswoman at New York-based KKR. "Our policy is not to comment on speculation." Michael Gross, founder and chief executive officer of Apollo, New York, did not return phone calls seeking comment.
Owen Blicksilver, spokesman at San Francisco-based TPG, said the firm "does not publicly discuss its strategy." Officials at Boston-based Bain and Madison Dearborn, Chicago, weren't available for comment.
Sources would not say what kind of hedge strategies the firms might employ.
Institutional limited partners — the pension funds, foundations and endowments that invest in private equity — won't be thrilled that the senior executives managing their private equity commitments are turning their attention to starting a new business unit, consultants said.
"As a limited partner, it gives some discomfort. There is no obvious benefit to the limited partner," Mr. Atkins said. "It could create conflicts between the two investment mandates in terms of investment decisions and allocations of investment resources."
In order to make the strategy work, of course, buyout funds will have to hire a group of hedge fund managers.
"There's not much in the due diligence process for hedge funds that overlaps, except it has the same fee structure," Mr. Nesbitt said. "To be successful they would need to hire people with different skill sets."
"It is significant that the business of private equity funds or fund of funds has become mature and they want to diversify," Mr. Nesbitt said.
Kelly DePonte, partner at San Francisco-based Probitas Partners, agrees that with the exception of distressed debt — where hedge funds and private equity players often compete — there is little similarity between hedge fund and private equity strategies.
What it does show is that private equity firms have grown so large that to continue their development, these firms need to expand their investment offerings beyond U.S. buyout, he said. For example, Blackstone and Apollo have real estate funds, KKR is making venture capital investments, and all three are active in Europe.
"I'm not sure if this demonstrates any maturing of the private equity industry per se, but it does demonstrate that some of the more mature players in the buyout sector such as KKR, Blackstone and Apollo have become so large that to grow larger they need to expand very much beyond their original U.S. buyout roots," Mr. DePonte said.
"Pursuing hedge funds — even on a multimanager basis — requires a different skill set than private equity, with much more of the hedge fund world dependent upon trading strategies and when to exit or rebalance a position and not how to exit or how to add value to an underlying company holding."
Already, hedge funds are becoming involved in consortia with buyout funds in deals, and hedge funds are holding positions in portfolio companies in which private equity firms own an interest. For example, Greenwich, Conn.-based hedge fund manager ESL Partners is heavily involved in the turnaround of Kmart Holding Corp., Troy, Mich.
What could be a roadblock to convergence, however, is the Securities and Exchange Commission's expected rule changes that might require hedge fund managers to register as investment advisers, said David W. Watson, partner and chair of the private funds group at the Boston-based law firm of Goodwin Procter LLP. Such a registration would be anathema to private equity managers, which do not register as advisers, since it would subject them to periodic inspections, filings and a whole range of rules.