Over the past decade, alternative assets (private equity, real estate, hedge funds, and complex debt instruments) have become increasingly popular, with assets under management nearly quadrupling.
The future is bright as well. PricewaterhouseCoopers expects total alternative assets to reach close to $14 trillion by 2020, growing by about 9% annually.
Given the complex nature of these investments, and the fact that most are only accessible to high income and high net worth individuals, many dividend investors might be drawn to publicly-traded alternative asset managers such as The Blackstone Group (BX), The Carlyle Group (CG), and Icahn Enterprises (IEP).
However, while the financial media may make these legendary asset managers seem like masters of the universe, that doesn’t necessarily mean that income investors can do well owning these complex financial stocks. In fact, many of these complicated businesses violate Warren Buffett’s top piece of investment advice to remain within one’s circle of competence.
Let’s take a look at The Blackstone Group, the largest of the private equity/alternative asset managers, to see if most dividend investors are better off staying away from this industry or if Blackstone Group’s 5.7% dividend yield could be worth pursuing for our Conservative Retirees dividend portfolio.
The Blackstone Group is the world’s largest alternative asset manager with over 2,200 employees in over 20 countries, managing $361 billion of investor capital.
The firm specializes in private equity (owning private companies), real estate, hedge funds, and investing in private debt. Blackstone earns its money by charging investors a base management fee (about 0.8%) plus performance fees (% of profits above a certain hurdle rate), which in this industry can be extremely lucrative.
In 2015, the vast majority of the firm’s revenue and operating profits came from its real estate and private equity divisions, which has historically been where Blackstone’s expertise lies.
|Business Segment||2015 Revenue||2015 Operating Income||% Of Revenue||% Of Operating Income|
|Real Estate||$1.791 billion||$948 million||42.2%||44.9%|
|Private Equity||$1.382 billion||$656 million||32.5%||31.0%|
|Hedge Funds||$590 million||$296 million||13.9%||14.0%|
|Credit||$485 million||$213 million||11.4%||10.1%|
|Total||$4.248 billion||$2.113 billion||100%||100%|
Source: Blackstone Group Supplemental Presentation
Blackstone is the biggest, most diversified name in alternative asset management, having been founded in 1985 by Stephen Schwarzman, who continues to serve as Chairman and CEO.
The company prides itself on taking a long-term approach to investing partner capital, including long lock-up periods on its funds that prevent Blackstone from having to sell at the bottom of market panics.
This has allowed the company’s funds over a five, 10, and 15 year period to generate returns of about 15% net of fees, which is among the best of any asset manager.
The long-term success of Blackstone has resulted in truly astounding growth, with over $200 billion in new capital being raised in just the last five years alone. To put that in context, this amount of new capital inflow is more than its next four largest rivals combined.
The massive size of Blackstone not just means a lot of fee income, but also serves as a major competitive advantage. Specifically, the company is a wide moat business thanks to its excellent reputation and access to some of the world’s best fund managers.
In addition, its vast capital resources mean that Blackstone can put together private equity deals of mammoth size that few if any rivals could even attempt, reducing the amount of competition it faces and improving the rate of return available.
Some examples include the 2007 acquisitions of Hilton and Equity Office Properties, which at $27 billion and $39 billion, respectively, were two of the largest private equity buyouts in history.
Better yet, Blackstone never just does deals to make headlines. For example, the Hilton acquisition was a leveraged buyout that Blackstone poured $5.6 billion of equity into.
After a seven-year period in which Blackstone turned the troubled hotel chain around, it IPO’d Hilton in 2013, netting Blackstone a $12 billion profit.
Meanwhile, it continues to sell off Equity Properties Assets and eventually expects to triple its money on that deal.
Beyond its unique ability to make massive deals, the company also gains competitive advantages from its strong brand and innovation. Roughly half of Blackstone’s total assets under management come from products and business that were not part of its mix just a few years ago.
Launching new offerings is easier for Blackstone because of its established reputation, distribution relationships with major investors, and economies of scale.
While Blackstone truly is one of the best long-term capital allocators in this fast-growing industry, there are several reasons why dividend investors should consider avoiding the stock.
The reasons are because of several important facts regarding both the industry in general and Blackstone Group in particular.
First, understand that alternative asset management is a highly cyclical and volatile industry, with fee revenues and profits rising and falling by staggering amounts based on fast-changing, unpredictable market conditions.
The same is true for the company’s margins, free cash flow, and return on capital, which are very important objective measures of whether or not management is being a good steward of investor capital.
In other words, because of the highly complex nature of its business, Blackstone investors have few ways to know whether or not the investment thesis remains intact.
They must simply take it on faith that management continues to execute well and that, over time, the growth in assets under management and fee revenues that go with it will result in higher distributions (more on this in a moment) and a greater share price.
With Blackstone Group, there are two categories of risks to consider: risks to the company and risks to investors.
In terms of risks to the partnership itself (Blackstone is structured as a limited partnership, similar to an MLP and comes with the same tax complexities, including a K-1 tax form), the world of alternate asset management is becoming increasingly competitive.
Record low interest rates and easy credit conditions mean more and more capital chasing the same number of potentially good deals, which can cause long-term returns to underperform.
This is especially true as there is a growing trend around the world to increase financial regulations on private equity and hedge funds, especially in Europe and Asia. This could lead to lower returns on Blackstone’s funds, making attracting new capital (and thus growing the asset base on which the fees are based on) more difficult.
And then there is the risk to actual Blackstone Group limited partners (i.e. regular investors). The biggest of these is that massive unit holder dilution, courtesy of the fact that Blackstone sells new units to raise investment capital (as well as raising capital from other sources).
In particular, since 1996 the unit count has grown over