Goldman Sachs is out with a new report on asset managers. There are two really interesting pieces of data in this report. First we focus on one point related to stock performance. Unlike traditional asset managers, where valuations move alongside AuM growth, alternatives’ stocks have been more correlated with harvesting activity. As a result, Goldman’s data shows that alternatives are up 44% over the LTM, outperforming the S&P 500 (INDEXSP:.INX) by 30%. They believe the reason being investors have reacted to an improving capital markets environment and growing distributions. Capital markets activity looks better in 1Q13 to date, with sponsor-led M&A activity +21% amid seemingly higher confidence levels.
Given that the stocks have rallied, Goldman seeks alternatives offering further upside potential to performance fees and AuM growth at more reasonable valuations.
They update stockpicking framework with the following notes:
- Performance fee growth at discounts. Goldman sees upside for managers where the market does not recognize their full performance fee potential (particularly firms with large funds not yet paying cash carry).
- Ahead of what Goldman terms the “PE cliff”, theyseek new sources of FRE. Realizations are positive for alternatives’ cash earnings and yield stories. But as large pre-crisis investments are harvested, there is risk to fee-related earnings (the “PE cliff”). Firms are navigating this in 3 ways: 1) smaller, more focused funds, 2) permanent capital, and 3) strategic investments (“hidden” FRE).
- Prefer reliable, recurring distributions. Investors gravitate toward reliable distributions and value alternatives’ FRE similar to traditional asset managers’ (AM) EPS (average yield of around 2.5%). The Blackstone Group L.P. (NYSE:BX) and Fortress Investment Group LLC (NYSE:FIG)’s base distributions increases were well-received and show confidence in FRE growth. Others may also benefit if investors come to see more of their distributable earnings as recurring.
On alternatives: Goldman Prefers FRE growth and performance fees at reasonable valuations. Their key points for the largest asset managers below:
- The Blackstone Group L.P. (NYSE:BX) remains the favorite idea as Goldman expects large real estate (RE) realizations in 2013, plus the PE business should benefit from a better market for IPO’s (75% of PE portfolio still private) and progress vs. Blackstone Capital Partners V’s carried interest threshold.
- Fortress Investment Group LLC (NYSE:FIG)’s PE business is undervalued, and strong performance in Credit/Hedge Funds could drive higher estimate revisions.
- KKR & Co. L.P. (NYSE:KKR)’s “hidden asset” in its $6 bn balance sheet and expect a step-up in cash carry generation as the 2006 Fund works through its netting hole (they think this could happen in 1H13).
- Downgrade Oaktree Capital Group LLC (NYSE:OAK) to Neutral. The stock still offers compelling yield on credit fund distributions, but they expect slower capital deployment and less upside potential compared to PE-heavy names in a stronger equity market.
- Neutral on Apollo Global Management LLC (NYSE:APO), Carlyle Group LP (NASDAQ:CG), and Och-Ziff Capital Management Group LLC (NYSE:OZM). While Apollo Global Management LLC (NYSE:APO) and Carlyle Group LP (NASDAQ:CG) are seeing among the best distributions in the space, this is largely priced in (at 4.5X and 7.5X performance fee multiples, respectively) and greater value elsewhere in the space. Och-Ziff Capital Management Group LLC (NYSE:OZM) has had decent flows and performance YTD (Master Fund +2.8%), but the firm has less upside in better equity markets.
This is the second piece of data which is shocking, both in terms of volume and in terms of replacing traditional i-banks. Goldman does not provide much details on this topic, but we summarize the little data provided and have inserted a chart relating to the data.
Equity capital markets (ECM) activity has picked up with firmer markets, with private equity firms specifically benefiting from a better backdrop for secondary offerings in already-public portfolio companies. Sponsor-led secondary issuance is at the highest level ever – positive for KKR & Co. L.P. (NYSE:KKR), Apollo Global Management LLC (NYSE:APO), and Carlyle Group LP (NASDAQ:CG), which have generated distributable earnings from sales of shares of HCA Holdings Inc (NYSE:HCA), Nielsen Hldg NV (NYSE:NLSN), LyondellBasell Industries NV (NYSE:LYB), and Charter Communications, Inc. (NASDAQ:CHTR).