Liquid diversification

Carlyle's recent buyout of credit hedge fund Claren Road suggests the firm is diversifying revenues with more liquid instruments in advance of an anticipated IPO bid next year, writes Pete Gallo.

The Carlyle Group this week revealed plans to take a majority stake in the $4.5 billion credit hedge fund Claren Road Asset Management, the latest evidence that private equity players are tapping into business lines that can offer added liquidity and diversify revenue streams in still unforgiving post-crunch markets.

The 55 percent stake in Claren will effectively add an array of more-liquid credit exposures to Carlyle’s portfolio. Credit hedge funds managed by Claren include Claren Road Credit Partners and the Claren Road Credit Masters Fund, regulatory filings with the SEC show. Carlyle shuttered its first in-house hedge fund in 2008 as the credit crisis took a toll on returns and sent investors running for the exits.

This week’s deal also sets the stage for a possible Carlyle IPO filing in 2011, where having diversified revenue streams may matter most in the eyes of investors. The move puts Carlyle on par with private equity rivals The Blackstone Group and Kohlberg Kravis Roberts, the two private equity groups that have successfully completed public listings of their managment companies as well as added hedge funds to their platforms.

Rivals KKR and Blackstone first began drawing up IPO plans in 2007 prior to the onset on the credit crunch. But only Blackstone made it through the gate that year, debuting at around $35 per share and most recently trading at just below $14 on 7 December. KKR’s New York Stock Exchange IPO came just this year, with the stock trading at $10.50 for its July debut, trading most recently at about $13 per share. 

The interest in hedge funds, in KKR’s case, was really about rounding out their portfolio.

Sandler O'Neill analyst

“The interest in hedge funds, in KKR’s case, was really about rounding out their portfolio. I’m not sure additional liquidity was added on any scale that would make a difference in how the company was perceived. But certainly active trading added diversity to their platform as a whole,” an analyst at investment bank Sandler O’Neill told PEO. 

Private equity groups aren’t alone in this thinking. Even traditional asset managers are seeking to diversify revenue streams via acquisitions in both private equity and hedge funds. Earlier this week, $275 billion asset manager New York Life Investments revealed it would be acquiring a 60 percent stake in Private Advisors, a $3.9 billion Richmond, Virginia-based firm that operates a hedge fund of funds and a private equity portfolio that weighs in at about $970 million.

Interestingly, Carlyle hasn’t limited itself to hedge funds as it seeks alternative revenue streams. The Washington DC-based firm has also been looking at investment opportunities in transaction-based businesses like investment banking. In fact, Carlyle took a minority stake in the investment bank Sandler O’Neill in November.

“The fact is that there are a lot of opportunities across the credit spectrum, and [hedge] funds, and distressed [funds] and private equity are still quietly amassing excess capital for buying opportunities and forced refinancing,” an analyst at a New York-based distressed fund told PEO. “I think there is a natural fit between private equity and credit [hedge] funds from that perspective – the difference is a matter of duration of investment.”

Not everyone is convinced that diversifying revenues through hedge funds will have a meaningful impact on how a prospective Carlyle IPO might be received.

“I expect the reception will be extremely tepid, at this point, for any private equity company that come to market with IPOs anytime soon – even for a brand name,” market analyst Scott Sweet of IPO Boutique told PEO.  “Investors are concerned that [underlying] portfolio companies are carrying too high a debt level to justify investment. That’s the biggest factor. But there is also a sense that [private equity] investors are not taking enough of a hands-on role in the restructuring of companies.

“What is hurting perceptions is that they are sitting on 2006 and 2007 investments that they can’t move and that there is too much cash. And there is still a good amount of toxic debt that needs to be worked out. So debt level is the biggest factor – not just price,” Sweet said.