KKR Hedges Its Bets.

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Author: Rosenbush, Steve

NEWS ANALYSIS

The private-equity giant adds a new hedge fund to its portfolio, marking its second foray into publicly traded investment vehicles

Private-equity giant KKR, known for its record-breaking RJR Nabisco buyout in the late 1980s, is moving deeper into the world of hedge funds. On Feb. 28 its KKR Financial LLC unit announced the launch of KKR Strategic Capital Fund. "It is anticipated that the fund will primarily focus on stressed and distressed opportunities and market dislocation investments," the firm said in a brief statement.

The fund, which will also make loans directly to businesses that are in search of equity, marks KKR's second foray into publicly traded investment vehicles. It previously launched KKR Financial (KFN), an NYSE-listed real estate investment trust, or REIT.

The launch, first reported by Institutional Investor, is the latest sign of consolidation between the private-equity and hedge-fund worlds. Private equity has been incredibly lucrative - and attractive -- in recent years [see BW, 2/27/06, "Going Private"). The stock market has been volatile since the 2000 crash, and the increased scrutiny of regulators, after scandals at Enron and other companies, has also encouraged investors to look to the private markets.

MARKET MIRROR. But private-equity returns are getting harder to obtain. The obvious targets have been eliminated, and there are more and more buyers on the scene, according to Adam Sokoloff, co-head of private-equity coverage at investment bank Jefferies. Private-equity players, armed with expertise in many sectors, came to realize that it makes sense to pursue assets in the public markets as well, Sokoloff says.

Hedge funds, for their part, are also looking to diversify, after having had a good run of late. Hedge funds traditionally have held positions for much shorter periods than private-equity players do. But, in recent years, hedge funds have accumulated so much money that they need multiple outlets for the capital. As a result, they are behaving more like private-equity players, assuming ownership and managerial control of companies.

So large private-equity and large hedge-fund players alike are morphing into money managers with multiple assets across a spectrum, according to Sokoloff . At his own firm, his coverage has broadened to include both hedge funds and private equity. For example, private-equity giant Texas Pacific has combined with hedge fund Axon Capital.

KKR's hedge-fund moves mirror shifts in the larger market. While equities peaked in 2000, fixed-income markets didn't peak until about three years later. Since then, fixed-income investors have been looking for alternatives for their portfolios, points out Stephen Leist, chief operating officer of MCF Asset Management. Among the options favored were distressed companies and real estate.

EXPANDING ECONOMIC ROLE. Indeed, KKR and others poured billions into real estate investment trusts. Though risky, many REITs generated double-digit returns, while risk-free money markets offered returns of basically zero [see BW, 2/13/06, "Getting a Slice of the Commercial Market"]. REITs, while still profitable, have seen their returns slow down as money-market returns have increased. Some large investors no longer see real estate as worth the risk, given the higher returns of safer options [see BW Online, 2/27/06, "Getting a Bead on the Housing Market"].

For investors like KKR, that makes distressed debt increasingly attractive. And they're also lending money directly to corporations, much as banks do. "Commercial banks are going to face more competition from hedge funds in the future," predicts Leist. That means large, diversified financial companies like KKR could play an ever-expanding role in the economy going forward.

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By Steve Rosenbush