Hard times for the smart money
Blackstone just celebrated an unhappy one-year anniversary as a public firm. But alternative asset managers Fortress and Och-Ziff are also struggling.
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| Shares of three top alternative asset managers have all stumbled since going public in 2007. |
NEW YORK (Fortune) -- It has been a tough first year for the Blackstone Group since its initial public offering. But other newly public alternative asset managers have also struggled.
Much like the house that Steve Schwarzman built, shares of Fortress Investment Group (FIG) and Och-Ziff Capital Management (OZM) have declined precipitously since their market debuts. That's led some to wonder if Wall Street will ever embrace these stocks.
Fortress is down about 55% since it went public in February 2007 and Och-Ziff shares have lost about 33% of their value since they debuted last November.
As for Blackstone Group (BX), its stock is down 48% since going public a year ago.
These firms have made fortunes in the past by taking companies private and later selling them for big profits. But with the leveraged buyout market starting to dry up, wary investors are worried about performance going forward.
"We just lived through an unprecedented cocktail of liquidity and low interest rates," says Tanya Beder, founder of SBCC, an advisory firm focused on risk management, derivatives and private equity workouts.
"Some deals consummated by these firms couldn't have been done in a different economic environment; and the jury is out in terms of how all the deals done during he bull market will play out," Beder added.
But Beder thinks that these fears point to a misunderstanding that some investors have about the alternative asset business.
Blackstone, Fortress, and Och-Ziff all raise separate funds (Wall Street speak for pools of money) for a diverse array of investing strategies, including leveraged buyouts, hedge funds, real estate investing, distressed investing, and sometimes lending.
So while a bad leveraged buyout is never a good thing, it is rarely an event that can destroy a firm or its overall ability to make money, Beder argues, because of the companies' diversification.
For example, a bad LBO typically takes at least five years to bear rotten fruit. In the meantime a better deal secured using money from the same fund can offset the damage.
On top of that, a distressed investing fund should perform well even if a private equity fund stumbles while a real estate fund should create a long-term opportunity for gains that balance out the choppiness of hedge fund performance.
Another financial services expert points out that now that each of these firms are public companies, they should be able to attract even more top managers to run the various funds.
"They can pay the most talented professionals with stock and stock options, a compensation arrangement that has historically created tremendous wealth. These employees are what will allow these firms to generate significant returns," Ron Geffner, a partner who oversees the financial services group at law firm Sadis & Goldberg.
Still, the likes of Fortress, Och-Ziff and Blackstone face other significant challenges.
The collective herd known as Wall Street -- mutual funds, institutional investors, retail investors, and stock analysts -- is notoriously obsessed with short-term results. Investors often favor companies that beat earnings forecasts and offer steady growth.
But the alternative asset business model runs counter to what Wall Street finds attractive. The worth of a private equity or real estate investment is nearly impossible to estimate until it is actually sold back onto the market, an exit that won't happen for years. The same is true for the distressed investments
There is no guarantee that any of those bets will ever be winners; and even if someday they are worth much more, the windfall will likely come in an ungainly lump. Plus, given how uncertain the credit markets are now, the value of these investments could continue to drop and show losses for an extended period of time.
All three firms have publicly stated that their stocks are suitable only for long-term investors who can stomach wild ups and downs.
But in an era when other financial services companies have been severely damaged by off-balance sheet entities and structured bonds whose values are impossible to judge, it seems unlikely that companies that demand so much faith and offer so little transparency will thrive.
To be fair, the declines of all three stocks should come as little surprise given that all the major investment banking stocks have been hit hard in the past few months. Shares of Lehman Brothers (LEH, Fortune 500) have plunged 56% this year while Merrill Lynch (MER, Fortune 500) has lost nearly 30% of its value.
Even Goldman Sachs (GS, Fortune 500), a company that has largely avoided the worst of the credit crunch, has seen its stock fall 12% this year.
However, if Fortress, Och-Ziff and Blackstone are to win over Wall Street, analysts think they'll have to look more and more like the big investment banks.
The big banks keep investors coming back for more, in part because they operate businesses with relatively easier to value returns, like brokerages and also because age has bestowed upon them a venerable air.
Perhaps this is why Morningstar analyst Ryan Lintell says it's too soon to tell how stocks like Blackstone, Fortress and Och-Ziff will fare in the long-term.
If they can make it through this downturn and weather several more financial storms, then fickle investors may eventually come to view them in the same manner that they view the likes of Goldman Sachs and Morgan Stanley during bull markets.
But it's unclear if this credit crisis is over yet. And given what has become of former Wall Street darling Bear Stearns, none of these stocks will be picks for the faint of heart. 
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