Firms getting hooked on fee income stream
Alternative investment managers are renewing their pursuit of permanent capital, or at least longer-term capital, to ensure reliable streams of fee income and take advantage of foreign investors' push into alternative asset classes.
The renewed push marks the second stage of a quest that started about a decade ago when some managers started going public, sold stakes and launched publicly traded vehicles, such as business development companies. The permanent capital was used to add new investment strategies or accommodate succession planning.
This time around, managers are employing strategies to include everything from longer, 20- to 25-year funds, to strategic portfolios that have no end date in which capital is invested across alternative investment sectors, to general partner investment in, and managing the money for, insurance companies and lenders. These capital sources provide a more consistent source of fee revenue over a longer period of time, managers say.
Long-dated and permanent capital vehicles allow managers to own performing companies for longer, said David Fann, president and CEO based in the New York office of private equity consulting firm TorreyCove Capital Partners LLC.
What's more, fundraising is "incredibly robust," Mr. Fann said.
"(There are) lots of new sources of capital from the Middle East and Asia, all with much lower investment return expectations, willing to do something different," he noted.
For publicly listed alternative investment managers, the consistent asset base and fee revenue these vehicles bring "can be a good thing for your stock price, too," Mr. Fann explained.
Predictability is the reason analysts and shareholders prize management fees over carried interest, industry sources say.
Permanent or semi-permanent capital sources are accounting for an increasingly larger portion of alternative investment managers' assets under management. For example, Apollo Global Management LLC has nearly $100 billion in permanent capital as of Sept. 30, about 41% of the firm's total AUM. That's up from $86.8 billion a year earlier and $11.5 billion, or 7%, three years ago.
Apollo's largest source of permanent capital is Athene Holdings Ltd., an insurance company that sells fixed annuities. Apollo, which took Athene public last year, not only owns the company but also invests Athene's capital.
In a third-quarter conference call, Joshua D. Harris, New York-based co-founder and senior managing director of Apollo Global Management, said the money manager is expanding and renaming a permanent capital business in Europe.
The business, called Athora, "is a strategic platform established to acquire or reinsure blocks of insurance business in Germany and broader European life insurance markets where we believe there is a need for capital," Mr. Harris said during the call.
Athene and Apollo are minority investors in Athora as well as long-term strategic partners, Mr. Harris said. Athora has an $8 billion investment portfolio and $2.5 billion of equity to invest, he said. Apollo earns an advisory fee of about 0.1% per year on the assets it manages.
The Blackstone Group LP, The Carlyle Group LP, KKR & Co. LP and CVC Capital Partners also are focusing on permanent or longer-lived capital sources.
"Permanent capital is a goal," said Hamilton E. "Tony" James, New York-based president and chief operating officer of Blackstone Group. "It's important for the firm and beneficial for investors.
Indeed, Blackstone is shifting more of its assets under management into long-duration and permanent capital vehicles, Mr. James said.
"Assets under management in these products are stable, and grow over a longer time horizon," Mr. James explained. "We can realize our carried interests in a steadier pattern, without having to sell the assets, or return the capital to investors."
Blackstone's long-duration vehicles have grown to 15% of its $285.7 billion fee-earning AUM as of Sept. 30, Mr. James noted. Blackstone had $387.4 billion in total AUM as of Sept. 30.
Investors benefit because they can put money to work and continue earning "compelling returns" longer without the J curve — the early years of a fund's life when returns are low — or "friction costs" of constantly reviewing alternative investment firm fund offerings, Mr. James said.
In the third quarter, KKR closed on about $7 billion in total commitments for two long-duration — 20- to 30-year — strategic partnerships, including a $3 billion commitment from the $181.3 billion New York City Retirement Systems.
KKR now has $12 billion in total commitments in strategic investor partnership capital.
KKR's view of strategic partnership and permanent capital has evolved, said Joseph Y. Bae, New York-based co-president and co-chief operating officer of KKR, in an interview.
In addition to using its balance sheet, KKR has about $5 billion in additional permanent capital from a real estate investment trust it took public this year and a business development company, said Scott C. Nuttall, New York-based co-president, co-COO and director of KKR, during the firm's third-quarter earnings call.
"We're focused on growing that $5 billion figure," Mr. Nuttall said.
KKR executives are also focused on expanding strategic accounts of $3 billion or more each with a small group of limited partners, Mr. Nuttall said. Most of these separately managed accounts invest across KKR's alternative asset classes and have 20- to 30-year lives.
KKR earns management fees and carried interest, and many accounts allow KKR to recycle some of the profits back into the accounts, rather than distribute them, Mr. Nuttall said. In exchange, investors get a fee break.
KKR is also investing its balance sheet capital alongside capital of a few large investors in what it calls core private equity partnerships, Mr. Nuttall said during an earlier, second-quarter earnings call.
In March, KKR teamed up with the C$270.7 billion ($212 billion) Caisse de depot et placement du Quebec, Montreal, to acquire insurance broker and consulting firm USI Insurance Services for $4.3 billion.
"We have more visibility on our revenues and capital base now than ever before ... not just for the next 10 years, which is typical for us, but for the next 20 to 30 years," Mr. Nuttall said. "This is a strategic priority for us."
KKR has also used its balance sheet to seed new investment strategies and make relatively sizable general partnership commitments. For example, KKR committed $1.4 billion to its recent U.S. private equity fund, the $13.9 billion KKR Americas XII Fund. It also committed $800 million to its most-recent Asia fund, the $9.3 billion KKR Asian Fund III and is by far the largest investor in the vehicle, Mr. Bae said.
"Our balance sheet is an enormous strategic asset," Mr. Bae said.
Rather than raise longer-lived, separately managed accounts, Carlyle closed on $3.6 billion for its first 20-year or longer fund, Carlyle Global Partners, in October 2016.
CVC Capital Partners, meanwhile, has $4.4 billion in its Strategic Opportunities fund, also a longer-lived vehicle of about 20 years.
The fund is CVC Capital's first and only longer-term fund, sources said. The $342.5 billion California Public Employees' Retirement System, Sacramento, committed $1 billion to the strategy in 2015.
CVC Capital executives declined to comment.
Greater flexibility sought
Another attractive feature for managers is that permanent capital vehicles "are geared toward wealth maximization through the power of compounding at the best long-term rate, and (are) therefore less focused on shorter-term performance," said Michael McCabe, partner in the New York office of alternative investment consultant and money manager StepStone Group LP.
And managers can own their best portfolio companies longer, he said.
"Often times, (in a traditional fund) the best-performing companies are the easiest to sell and therefore are the first to leave the portfolio, whereas companies that struggle tend to linger on in the fund," Mr. McCabe said.
Longer-lived fund structures is "a fundamental departure from the current paradigm of investing with GPs, who define a clear exit strategy as part of their investment thesis," he said.
It also gives managers capital they can count on, especially in a downturn when capital is scarce, he explained.
While these strategies might also come with a break in fees, there is a downside for asset owners that are not big enough to invest hundreds of millions or billions with one manager.
"Those LPs who have the flexibility and governance to pursue investments with an unlimited time horizon will drive a bifurcation in the market: permanent capital sources and everyone else," Mr. McCabe said.
Smaller asset owners will have fewer choices of investment vehicles, basically commingled funds, sources said.