I first wrote in this column about the money to be made from investing in listed hedge funds and private-equity firms in January. Then there were just a handful of these so-called alternative asset managers, all listed in London, and I thought they looked cheap. Businesses such as Bluebay and Ashmore were growing their earnings at 40%-plus per year, yet were valued at about 15 times current year earnings. This looked to me like dotcom growth at old economy prices and so it has proved.
Since then, the share prices of Bluebay and Ashmore have almost doubled and the dotcom analogy has started to take a more alarming turn. The flotation of US asset manager Fortress in February was described as the hedge-fund industry's "Netscape moment", recalling the initial public offering of the internet browser in 1995 that marked the start of the dotcom bubble. Since then, the $30bn Blackstone float in June and the planned listing later this year of KKR, Och Ziff, Citadel and GLG have added to fears of a new dotcom-style frenzy. If the insiders are all looking to cash out, surely it's a sign we've reached the top of the market?
I don't think so. Here are five reasons why I don't think the hedge-fund and private-equity floats mean the boom is coming to an end and may even mean it still has some way to go.
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1. Most firms that have floated have done so for good reason. Blackstone needed to find a way to let its 82-year-old founder to sell out. Bluebay had a private-equity investor that needed an exit. But among London's hedge funds and private-equity firms, I detect little appetite to cash out. Unlike the dotcoms, few need fresh capital and their founders don't need to take money off the table. KKR's founders aren't selling any shares, so they've a lot to lose if the deal fares badly, damaging KKR's reputation.
2. Unlike the dotcoms, companies such as Blackstone and KKR are not seat-of-the-pants start-up operations but established businesses with phenomenal track records. Until recently, many hedge funds were reluctant to float because they didn't think the market would adequately value their growth prospects. Indeed, many of the younger, fast-growing London hedge funds believe that even at current multiples in the mid-teens, that is still the case, particularly in the UK that's one reason why GLG is listing in New York.
3. This confidence in growth is justified. Institutional investors are turning their backs on traditional fund managers, whose tendency to track indices they blame for the dotcom debacle. Pension funds and insurers are instead allocating huge sums to hedge funds and private equity, which promise to deliver absolute returns whatever the state of the markets. This switch has a long way to run. UK institutional investment in alternative assets is still negligible compared to the US, where some forward-thinking investors, such as Harvard's Endowment Fund, allocate up to 30%.
4. The one area of debate is what multiple to apply to the performance fees that can make up a large part of the total earnings of these businesses. Clearly, a big downturn in the markets would hit private-equity profits on existing deals, but would also make it easier to buy new companies on the cheap. Hedge funds, on the other hand, should thrive in such conditions. And most firms looking to list have a spread of businesses, so if one does badly, another should make up for it.
5. Finally, even if this does turn out to be the top of the market, that does not mean the enthusiasm for hedge funds and private equity is misguided or wrong. It is the nature of all booms that people glimpse the future, but get optimistic about how quickly it will arrive. People lost money in the aftermath of the railway boom, the radio boom and the dotcom boom, but all those technologies went on to fulfil the hopes vested in them. The same will ultimately be true of the financial technologies fuelling the boom today. But I don't expect the boom to end just yet. After all Netscape's initial public offering took place a full five years before the dotcom bubble finally burst.
A doomed housing market?
A despairing piece by Will Hutton in The Observer about the UK housing market has convinced me that if any market has reached the top, it is this one. Hutton argued that the world had now divided into two: those over 35 who owned property and everyone else. Prices had already reached five times income and would reach ten times by 2012, he argued, which meant anybody not already on the ladder is doomed.
This kind of talk is always tempting fate particularly at the end of a week that saw interest rates rise to 5.75% and over-stretched borrowers coming to the end of their two-year deals and seeing 30% jumps in their interest payments. In fact, prices in many parts of the country are already falling. If the doom-mongers are finally proved right and the market falls 30% or more, it will be those of us just over 35 who are mortgaged to the hilt who will be needing Hutton's sympathy, while the under-35s will be laughing all the way to their cut-price homes.
Simon Nixon is executive editor of Breakingviews.com
