By Simon Kerr
Across its funds businesses Fortress Investment Group has put in some good returns this year, including from its hedge funds. Should the superior returns continue, the Group will be well placed to give better profitability to its investors, not the least from Logan Circle, the institutional fixed income manager acquired in April 2010.
The second quarter results from Fortress reflected the significant shift in the split of AUM that has taken place over the last year within the group. Logan Circle continued to accumulate assets at a faster pace than the rest of Fortress Investment Group. At the end of June the Logan Circle AUM were up 40% y-o-y at $18.1bn, well ahead of the Private Equity ($13.8bn) and Credit ($11.5bn) segments of the business in absolute size and growth rates. AUM in the remaining segment, Liquid Markets, were down 30% y-o-y at $4.4bn.
Good Returns
As an example of the good returns in 2012, the Credit Hedge Funds, the DBSO Funds, generated 7.6% net returns year-to-date through June with a 3.3% net return in the second quarter. This fund now has generated positive returns in 13 out of the last 14 quarters, as well as annualized returns of nearly 11% since its inception 10 years ago.
In Liquid Hedge Funds, the Fortress Macro Fund is up 8% net through June versus 0.8% for the Greenwich Alternative Investments Macro Index. These returns bring over 90% of the Macro Fund capital within 3% of their respective high-water marks. Total Macro Fund capital is around $3 billion, of which approximately $900 million, or 30%, already exceeds their high-water marks. The Fortress Macro Fund was up almost 7% net – Fortress Asia Macro Fund was up almost 7% net through June and nearly all of its capital exceeds its respective high-water marks.
Credit Market Conditions
With the second quarter results Pete Briger , Co-Chairman & Head of Credit at Fortress, gave some views on the conditions for trading credit in markets. “Our general view is that risk is mis-priced in Europe and in Asia against us, meaning that we think actual risk is higher than perceived risk in terms of prices in the public credit markets,” he opined. “Consequently the public securities credit markets in Europe and Asia don’t seem interesting to us.”
In the view of the head honcho for credit at Fortress the government interventions in the global credit markets are creating a lot of distortions, and “there is a lot of actual risk.” He continued, “we are seeing a science experiment play out in Europe in an accident prone environment, and the market is not taking well to our type of transitional capital. And so generally in those periods we are paid to wait, keep cash in our pockets, and as the markets turnover to reflect real market pricing of risk,or maybe more favorable pricing than the risk merits, we will become active investors.”
According to the Fortress take on credit, the prices that would be low enough to make private credit investments justifiable in Europe and Asia are ones that the potential sellers can’t stomach. “Generally financial institutions cannot sell at market-clearing prices without too serious a hit to capital.”
As for the the US, Fortress think that credit risk is priced fairly. With credit risk fairly priced in his largest market, Briger says “our alternative funds have to be very careful because we charge significant fees and we are working on an absolute return basis. And so when risk is priced fairly we make generally idiosyncratic investments rather than demotic investments. As a consequence of these views most of the risk that we have in our funds is US risk. In fact, about 85% of the market value of our credit funds reside in North America, about 7% in Europe, 6% in Asia, a little bit of the remainder in Australia and other places.”
Logan Circle Rises
Logan Circle has been Fortress’ star performer over the last year in asset gathering, and the funds of the Philadelphia-based have produced good returns across the range. Twelve of Logan Circle’s fifteen strategies outperformed respective benchmarks in the first half of 2012. And this is part of a longer term pattern for Logan Circle – since inception, 14 out of 15 strategies have outperformed their respective benchmarks.
Logan Circle has an institutional client base, and that had implications for the commercial prospects of the bond specialist immediately after acquisition. Given the change in ownership of it was hard for the consultants who work with the institutions on manager selection to recommend Logan Circle funds. According to Pete Briger Logan Circle was put on a yellow light while the consultants waited to see what would happen. The stability of the past year or more has enabled consultants to change the light to green. So the recent asset accumulation “is really stuff that has been in the pipeline, and on which Logan Circle has been working hard for the past year-and-a-half,” he explains.
The majority of the new inflows were directly from traditional pension funds or insurance companies, and “a fair chunk of it” was through the mutual fund sub-advisory channel. That leaves about 20% or so of the new flows to Logan Circle coming via consultants. “At this point there is really no direct retail stuff at all at Logan,” confirmed Briger. Further, about 25% of the capital that has come in year-to-date has been from entirely new clients of the firm; about 75% of it has been from either existing traditional clients at Logan or existing clients of Fortress’ alternative businesses. That is, Fortress is getting some traction in terms of cross-selling.
The acquisition of Logan Circle has diversified Fortress Investment Group’s sources of fee income, though at 15 basis points the typical fee levels of Logan Circle will never give the same potential profitability as the Private Equity or Liquid Funds segments of Fortress. Better yet, the accumulation of assets under management has put Logan Circle on the edge of contributing to the distributable earnings of the Group, taking account of the terms of the buy-out agreement. With Logan at a commercial tipping point for contributions to the whole Group and demonstrably a successful acquisition, will Fortress use Logan Circle as a precedent, and use its firepower to acquire other businesses in asset management?