Fortress posts surprise loss

NEW YORK (Fortune) -- Fortress Investment Group is paying the price for going public. The New York-based firm reported Thursday a sharp decline in earnings as its core hedge fund business felt the effects of Wall Street's market swoon.

For the quarter ended March 31, Fortress (FIG) posted a loss of $69 million, or 74 cents a share, compared to a profit of $62.1 million in the year-ago quarter. Revenues fell by more than half, to $200.9 million, from $416.3 million in last year's first quarter.

Analysts on average were expecting earnings of 14 cents a share, according to Thomson Reuters. Fortress shares were down more than 6% Thursday - and have fallen by more than half since the company went public last year.

The stock slide points to the conundrum publicly-traded hedge funds face: the nature of their business means making risky bets that can generate spotty returns in the short term, but potentially huge gains over the long run. Hedge fund investors get that the business is volatile. Public shareholders don't.

Fortress chief financial officer Daniel Bass, speaking to analysts during a conference call after the earnings report, tried to placate investors by emphasizing the opportunities to take advantage of turmoil in the credit markets. Investors weren't soothed.

To be sure, the Fortress news wasn't all bad. Assets under management grew 46%, to $34.2 billion, from the first quarter of last year. This is an important metric because Fortress generates revenue in two ways: by charging a management fee on the money that it invests for others and by taking a cut of the profits when those investments pay off. The management fee is usually only about 2%, while the performance fee can hover around 20%.

In theory, assets under management should provide steady earnings. Fortress reported that management fee revenues across its divisions hit $145 million, up 48% from $98 million in the first quarter of 2007.

But Fortress has had a tough time putting that money to work lately. Results for its three main businesses - hedge funds, private equity funds, and real estate investments - were spotty. Its performance, or incentive, income came to $32 million, down sharply from $285 million the previous year.

The largest losses were in its hedge fund division. For the first quarter, the company's liquid hedge funds generated $15 million of pre-tax earnings, down from $30 million the previous year. Most of those earnings were generated by a 56% jump in assets under management, to $9.3 billion from $5.9 billion.

Bass, the Fortress CFO, tried to reassure investors Thursday morning. He noted the firm has $1 billion in its funds to take advantage of the credit market freeze. When times get tough, he said, assets that are volatile, under pressure, and liquidity-driven can trade for less than their true value. Bonds, for instance, are trading at steep discounts. If played right, the profit potential is huge.

The latest earnings cap a wild rise for Fortress. The company captured headlines in 2007 when it became the first hedge fund to go public. Priced at $18.50 a share, Fortress shares popped as high as $35 a share before closing on their first day at $31. Unfortunately for early investors, Fortress shares have since slid, hitting an all-time low of $10.14 in March.

Other hedge funds haven't fared much better, despite predictions that Fortress' debut would trigger an onslaught of publicly traded hedge funds. Shares in Och-Ziff (OZM) have lost about 33% of their value since the fund's IPO last November. Blackstone (BX) shares have fallen about 42% since the firm's IPO in June 2007.