Private equity firms keep striving to do anything but private equity

The three most important letters in the private equity industry are no longer “LBO.” Now, what really matters is “AUM,” assets under management.

Thanks to big banks being regulated out of businesses like hedge fund investing, investors like Henry Kravis and Steve Schwarzman have been presented with a golden opportunity… and they’re putting it to work.

The hedge fund business is bigger than the private equity business, so some of Wall Street’s most seasoned dealmakers are buying their way into the former industry to increase the size of the latter one.

KKR’s deal to back hedge fund Marshall Wace is the latest example of how the leveraged buyout business is transcending into multi-strategy money management. Kravis’ investment firm is taking a minority position in the London fund with the option to increase its stake later.

The firm isn’t exactly coy about why its doing this: “Hedge fund assets, now at $US3 trillion globally, are the largest part of the alternative asset management industry,” it said in a statement Wednesday announcing the partnership with the $US22 billion hedge fund.

KKR is one of a number of investment firms whose private equity deals came back to bite its founders. Its most recent flagship fundraising took in less than $US10 billion, barely more than half what its pre-crisis funds took from eager investors a few years ago. Now, up-and-coming LBO shops are offering better terms and better performance to investors and luring more cash away from the biggest managers.

Plenty of other private equity firms have bought into the hedge fund business this year. Activist investor Jana Partners sold a minority stake in itself to a private equity investor in March.

And Blackstone backed hedge fund Magnetar Capital, a $US13.6 billion investor, earlier this year. That wasn’t the only one for Schwarzman this year. Blackstone seeded, and later invested more into, another hedge fund: Senator Investment Group, which runs around $US7 billion in assets.

Already, thanks to Schwarzman’s massive ambition in real estate investing, private equity isn’t even the leading moneymaking line of business at Blackstone. That, now, goes to the firm’s real estate division, which now routinely raises funds as big as its flagship private equity vehicles.

Private equity investor Apollo Global Management counts a handful of hedge funds among more than 100 subsidiaries in its annual filing, but doesn’t break out performance figures.

Some hedge fund bets have gone belly-up. Carlyle Group, which has enjoyed solid performance in its private equity funds in part thanks to its strategy of taking on smaller transactions than some of its competitors, has also operated hedge funds that underperformed and caused some reputational damage to the firm. Other moves by Carlyle into investment firms beyond the scope of private equity, like its addition of a secondaries business in the form of AlpInvest in 2011, have added both AUM and shine to the firm’s standing on Wall Street, however.

AUM really is the name of the game. Despite outpacing competitors’ stock performance in the years since the financial crisis, Schwarzman is openly lamenting what he feels is an undervaluation of Blackstone’s stock. In the time Blackstone’s stock outperformed all other listed competitors, the firm also grew its AUM more than any others — in part through hedge fund investing, which represents $US68 billion of the firm’s activity.

As long as regulators keep giving so-called private equity investors room to go where investment banks and insurers can’t, Wall Street should anticipate more hedge funds will be bought out, or bought into, by CEOs like Kravis and Schwarzman.

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