When you sit at the table with one of your LP's, and they ask you to walk them through your "liquid" portfolio; because today you are an allocator, yesterday you were a hedge fund manager, and tomorrow you might become a private equity investor.
By Alban Ramadani, Banyak Group LLC Research Associate
April 17, 2017
Easy monetary policy and an artificially low interest rate environment following the 2008 financial crisis have contributed to asset price inflation and, with the S&P 500 and DJIA reaching all-time highs, finding undervalued assets has become increasingly challenging.
In response to the current economic outlook and in search of new sources of uncorrelated returns, hedge fund’s are making heavy bets on publicly traded blue chip private equity firms such as KKR, Apollo Global, Blackstone Group, and Carlyle Group. One major player in this regard has been Chase Coleman’s Tiger Global which, according to its latest 13-F filing, holds a stake worth over $600 million in the public units of Apollo Group, Leon Black’s giant private equity firm with $192 billion in assets under management. However, hedge fund investments in private equity firms raise some questions. For example, why are hedge fund’s investing in other investment firms? Aren’t there better investment opportunities to earn above-market returns?
The truth is that most hedge fund managers have been struggling to beat the market in such a low volatility environment and as many have incorrectly positioned themselves ahead of major global macroeconomic events such as the Brexit referendum and the U.S. presidential election. From this perspective, investing in public private equity firms could be seen as a way for hedge funds to outsource their job to private investment managers and allocators to generate value. On the other hand, allocating a portion of AUM to private equity firms has many advantages, especially when the stock market is at all-time highs.
First of all, private equity investments typically offer high dividend yields which make them attractive in a rising interest rate environment. In addition, unlike other public companies which are often overly concerned in meeting short-term expectations, private equity firms are focused in creating shareholder value in the long-term and are more flexible in how and when to realize gains. Finally, the major benefit derived from the inclusion of private equity firms in one's portfolio comes from increased diversification from uncorrelated returns and downside protection during a declining economic growth environment and weak or volatile markets. The rationale behind this is simple –volatile or declining markets offer private equity managers investment opportunities at more favorable prices.