An Alternatives Blitz Bonanza?
David Blitzer had his eye on Addy Loudiadis’s business at Goldman Sachs Group Inc. for years.
By the middle of 2013, the Blackstone Group LP (BX) dealmaker had his shot. Pressured by regulators to boost capital under new rules, the bank started looking for investors to take pieces of Rothesay Life Ltd., the insurer that Loudiadis heads in London. Blitzer, whose private-equity firm historically has to control companies it buys, was fine taking a minority stake in a Goldman cash cow. In October, he struck a $297 million deal to buy 28.5 percent of Rothesay, with Singapore’s sovereign fund taking an equal share.
Blitzer has spent the past two years engineering unorthodox deals like Rothesay that no one else within Blackstone could do. The 44-year old New Jersey native runs Tactical Opportunities Group, a $5.6 billion unit with the mandate to make investments that fall between the cracks of the firm’s other businesses. The group has bought oil tankers, developed Brazilian shopping malls, and created a finance unit for U.S. landlords, capitalizing as banks are forced to shrink, and cutting deals that were the domain of Wall Street before its retreat from proprietary investing.
“An awful lot of what Tac Ops does was either done by the big banks on their proprietary trading desks or by hedge funds in their illiquid side pockets,” Tony James, Blackstone’s president, said in an interview last month. “Both those sorts of capital have been eliminated and unless they come back, there will be tons of opportunities.”
Beating Targets
Since Blackstone’s billionaire founder Steve Schwarzman drafted Blitzer in 2011 for the newly created role, his group has evaluated more than 500 investments for the world’s largest alternative asset manager, a behemoth overseeing $272 billion across credit, hedge funds, real estate and private equity. In just over two years, the 30-person unit has exceeded fundraising targets and returns with annual gains near 20 percent. It could soon grow to $15 billion, said James.
Blitzer can thank New Jersey’s pension fund for his role. He’d returned from an almost decade-long stint running Blackstone’s European private-equity arm in 2011, a business he had started in 2002, and was leading efforts to strike partnerships with its largest investors. Blitzer was also formulating a special-situations group that could capitalize on more of the opportunities that Blackstone sees through its web of businesses.
New Scale
Around the same time, New Jersey’s head of private equity, Christine Pastore, had approached Blackstone to ask for a discount on fees in exchange for handing over a big chunk of money. New Jersey had invested more than $1 billion in Blackstone funds, including with credit arm GSO Capital Partners LP, and wanted to see if it could lower the 1.5 percent management fee and 20 percent charged on profits. The discussion turned to investments that don’t fit into private-equity mandates. Tactical Opportunities was born.
Christopher McDonough, director at New Jersey’s $87 billion investment division, said it differs from special situation funds, which usually target specific opportunities such as distressed debt or real estate, by its size and scope.
“A lot of the time special situations funds focus on one particular aspect of the market,” said McDonough. “We haven’t seen anything of this scale.”
The structure is different from private-equity and also hedge funds, which have the latitude to buy exotic or wide-ranging assets. Blackstone will invest over a period of three years, compared with the five to six years for a buyout fund. Unlike a hedge fund, the money can be locked up for more than 10 years and profits from deals can be recycled back into new opportunities.
Winning Investors
The New Jersey deal also includes lower fees, with Blackstone taking a 15 percent cut of the profit, less than the 20 percent charged by most private-equity firms.
Blackstone agreed to the terms after New Jersey committed $750 million, and more than $1 billion additionally to other private-equity funds and accounts. Its allocations to Blackstone over the preceding 12 months totaled $2.5 billion, the most in any year by a single investor.
Some of the largest institutional clients followed investing with Blitzer’s group, including the California Public Employees’ Retirement System, Oregon Public Employees Retirement Fund and New York State Common Retirement Fund, which collectively control about $500 billion in assets.
“We are very well suited as a firm to having this pool of capital that plays across the spectrum and can attack opportunities in the marketplace and do it very quickly,” said Blitzer.
Pied Piper
James said Blitzer, with his “pied piper” personality, was a natural to head the effort. He’d joined Blackstone from Wharton Business School’s undergraduate program in 1991, six years after Schwarzman and Peter G. Peterson founded the firm to mainly buy companies with borrowed money.
During his time at the firm, Blitzer has helped Blackstone invest in United Biscuits, Allied Waste Industries Inc. and the company that makes soft drink Orangina. Along the way, he’s personally bought stakes in the Philadelphia 76ers basketball team and last year the New Jersey Devils hockey club.
“When you start a new business with no money, no clients and no team, you need a leader, a personality who can bring in employees, clients and companies,” said James.
Rising Stars
Blitzer tapped London-based Chad Pike, 43, Vice Chairman of Blackstone Europe and a former co-head of real estate, to help advise the unit, while Christopher James, 38, who’d worked on the firm’s 2007 initial public offering, took the role of chief operating officer. Blitzer also recruited some of Blackstone’s rising stars, including Jasvinder Khaira, a 33-year-old graduate of the University of California at Berkeley who sports purple and orange turbans. Khaira, like Blitzer, had played multiple roles in Blackstone, including working at GSO, within private equity, and on the IPO.
Blitzer wasted no time striking his first deal for Tactical Opportunities. Hunting for undervalued assets, he explored collateralized loan obligations, packages of leveraged loans that are sliced into securities of varying risk. He said he contacted Bennett Goodman, the head of GSO, to ask about the riskiest portions that offer the highest returns. Goodman backed his thesis that investors were avoiding the investments in the wake of the financial crisis even as they performed well.
Blitzer Hunting
Blitzer went on the hunt, starting with deals overseen by GSO. He found a piece of a CLO called Inwood Park that was put together in 2007 and owned by Lehman Brothers Holdings Inc.’s estate, which needed to sell assets. GSO, as manager of the CLO, helped explain the structure, and Goodman, like Blackstone’s other group heads, sits on the investment committee for Blitzer’s division. In February 2012, Blackstone invested $38 million, paying about 70 cents on the dollar. It’s already returned most of the money through distributions and as of March 31 has a gross internal rate of return of 24 percent.
One of Blitzer’s advantages over hedge funds and other investors chasing trades is that he’s able to tap into ideas from across the firm. Its real-estate business, run by Jon Gray, is the world’s largest, overseeing $81 billion in assets. The private-equity unit headed by Joseph Baratta that buys companies has $66 billion; Blackstone’s hedge-fund business, run by Tom Hill, oversees $58 billion and the credit arm manages $66 billion.
“We’re trying to mine that expertise across the firm,” said Blitzer.
‘Best Minds’
His investment group meets every Monday at noon in the Blackstone boardroom on the 43rd floor of its Park Avenue, Midtown office. For up to two hours, Schwarzman, James and other senior members of the firm screen ideas -- lucrative investments that fall outside the core mandate of each group. Teams from across the company are incentivized to pass on ideas since they get a share of the profits, said James.
“It’s the one activity in the firm when the best minds across Blackstone work together,” he said. “It’s thrilling in that sense.”
Gray’s real estate group, for instance, had looked at taking a control position in One Market Plaza in San Francisco, a two-tower complex near the city’s waterfront that it had sold to Morgan Stanley in 2007. The seller, Paramount Group, would only give up a 49 percent stake, so Gray passed the idea to Blitzer, who cut the deal in April.
Blitzer’s largest single investment for Tactical Opportunities has been Rothesay.
Rothesay’s Growth
Goldman Sachs started the business in 2007 to take on retirement obligations. It was headed by Loudiadis, who had joined Goldman Sachs’s European derivatives marketing group in 1994 from JPMorgan Chase & Co., was named partner in 2000 and had risen to be one of the bank’s top sales executives.
Rothesay promises to pay pensions if retirees live beyond a certain age. The firm receives a portion of the pension plan’s assets and tries to hedge the risk they take on with derivatives. In 2013, the business had pretax profit of 184.4 million pounds ($310 million) and was responsible for pensions at companies including British Airways Plc.
Blitzer had followed Rothesay when he worked in London and considered investing in a rival. He said he talked to Goldman Sachs executives including Loudiadis and made sure they knew Blackstone was interested if they decided to sell.
Schwarzman Target
By June of 2013 Rothesay had $9.66 billion of assets when more stringent capital rules imposed under new rules known as Basel III made holding Rothesay more expensive for the bank. By the end of the year, Blackstone and GIC Pte, the sovereign fund, bought a majority stake.
Blackstone “demonstrated their ability to combine creativity, flexibility and broad financial market expertise to analyse and execute on a complex opportunity,” Loudiadis said in a statement.
One reason for James’s excitement about the Tactical Opportunities business is drawing together the various strands and senior leaders of Blackstone. Another is the ability to keep raising money outside of traditional private equity. Schwarzman said last June he could imagine Blackstone growing to be a $500 billion investment firm.
The target isn’t as outlandish as it sounds. Blackstone has raised $132 billion in capital in the last three years, according to Luke Montgomery, an analyst at Sanford C. Bernstein & Co. in New York. Much of this has gone to newer products like those offered by Blitzer’s business.
‘Blackstone’s Edges’This is a great article demonstrating why Blackstone is a global leader in alternative investments. Not only do they have talented people managing various alternatives portfolios, they have the right governance and incentivize these managers to discuss deals which "fall through the cracks."
’’Innovation is one of Blackstone’s edges,’’ Montgomery said.
Helped by the rise in assets and gains in the value of its funds, Blackstone shares have jumped 56 percent in the past year, compared with 19 percent for the Standard & Poor’s 500 Index.
Most Tac Ops investments have been made as banks pulled out of businesses in the wake of the 2008 financial crisis and amid new capital requirements such as Basel III. Wall Street has also had to scale back trading because of the Volcker Rule, a centerpiece of the 2010 Dodd-Frank Act named for former Federal Reserve Chairman Paul Volcker, which seeks to stop banks with federally insured deposits from making trades that could threaten their stability.
Blitzer sees more opportunities from increased regulation, before the current financing vacuum will eventually disappear. His unit will then have to adjust, for instance by investing in public securities, he said, taking Blackstone further from its core business.
“The risk going in is that it was unproven,” said New Jersey’s McDonough. “Time will tell ultimately, but we are pleased about how the portfolio has come together.”
That's where David Blitzer and his Tactical Opportunities group comes in to scoop up risk and their performance thus far has been nothing short of spectacular. How long can they keep it up? I'm highly skeptical and think tough times lie ahead, but so far they're printing money.
As far as the deal New Jersey's pension fund struck, I like it but think they could have squeezed Blackstone even more on fees. They cut the fees to 1.5% management fee, which is fast becoming the standard, and 15% performance fee. I would have offered Blackstone $5 billion and in return demanded they cut that goddamn management fee to 50 basis points (0.5%) and the performance fee to 10%. And I would be firm: "Take it or leave it Mr. Schwarzman." Of course, he would decline because there are plenty of dumb public pension funds more than happy getting raped on fees.
What's my thinking? Basel III regulations will be a boon for these alternatives powerhouses and between you and me, Blackstone will be managing well past a trillion in less than ten years. They will deny this but the big alternatives gamble is just getting underway and many more U.S. public pension funds, facing a looming disaster and desperate for yield will be knocking on their door to strike similar deals.
But as you all know from reading my blog, I also think all this alternatives hoopla is way overdone. Once deflation sets in, pension funds praying for an alternatives miracle are in for a rude awakening. Moreover, the alternatives gig is up and the era of fee compression is just starting. That's another reason why the financial elite are doing everything in their power to fight deflation. They want to maintain their excessive fee structure but they know that in a world of low yields and low returns, it's next to impossible to defend the old fee model.
The article above also discusses Jonathan Gray who oversees Blackstone's $81 billion real estate business. Gray's team has been very busy lately raising over $3.5 billion for its first Asia real estate fund (New Jersey committed $500M and Texas teachers $100M to that fund), buying Mumbai office properties, playing the surge in California real estate, rolling the dice on hotels in Vegas, selling Boston properties to OMERS' Oxford Properties Group, and increasing its holding of Gecina along with Ivanhoé Cambridge, the Caisse's real estate arm.
There are other real estate titans that are also busy buying distressed properties in Europe and Asia. John Grayken, the billionaire founder of Lone Star Funds, will invest $350 million of his own fortune in the company’s latest fund targeting distressed assets across the U.S., Europe and Japan:
The Dallas-based private-equity firm expects to raise about $7 billion for Lone Star Fund IX, according to the minutes of a March meeting of the New Mexico Educational Retirement Board, or NMERB. Grayken’s contribution will be the most he’s invested in one of his firm’s funds and will top the $330 million he placed with a separate property fund last year.
Grayken, 57, is putting chunks of his own fortune on the line as he scours the globe for distressed assets in the wake of the financial crisis. The investments may lure outsiders to follow him and put money in Lone Star’s funds, the latest of which is focusing on non-commercial real estate loans and “asset rich” financial companies.
“We always like to see a substantial investment by the general partner of any fund,” said Bob Jacksha, Santa Fe-based chief investment officer of the NMERB, which manages about $10.7 billion of teachers’ pensions in New Mexico. “It helps promote a healthy alignment of interest.”
Jed Repko, a spokesman for Lone Star, declined to comment.
The NMERB agreed to invest $100 million in Lone Star Fund IX, according to the minutes. Other investors include the Oregon state pension fund, which will put in $300 million, according to an April 30 statement.
Money RaisedI've already covered Grayken's big bet on European real estate. While I openly question his choice of senior managers, there is no question that Grayken, Tom Barrack and Jon Gray are top real estate investors and their moves need to be tracked.
The Lone Star IX fund has raised $5.3 billion so far, according to a filing last month with the Securities and Exchanges Commission. The total amount raised so far is closer to $5.7 billion, Dow Jones reported last month, citing a person familiar with the matter.
“The strategy is to take advantage of the regulatory requirements in the banking sector and the deleveraging in the U.S. and Europe,” according to the NMERB minutes. “They feel this will continue to provide investment opportunities over the next several years.”
Lone Star will spend 40 percent of the cash raised on assets in the U.S., 50 percent in Europe and 10 percent in Japan, according to the NMERB minutes. The company’s investments since the financial crisis include Irish property debt and German financial firms.
Interestingly, Grayken doesn't seem to be the least bit worried about the euro deflation crisis. According to the Wall Street Journal, Commerzbank is in the final stages of selling its $5.3 billion euro portfolio to Lone Star and J.P. Morgan:
The deal, which one of the people said may close within a month, would the largest property transaction in Spain since the country's real-estate burst six years ago and illustrates foreign investors' renewed appetite for assets in the financially stressed euro-zone countries in Europe.According to the article, Blackstone, Cerberus and Apollo were also bidding on 'Project Octopus' but Lone Star apparently outbid them. Interest in Spanish real estate has picked up considerably over the past year, which tells you global investors are betting (praying) for an economic recovery in periphery Europe.
Under the terms of the proposed deal, known under the code name Project Octopus, Lone Star would acquire the majority of the loans in the portfolio, while J.P. Morgan would acquire a minority and provide the financing for the deal, one person said.
But while some alternatives powerhouses are cranking up the risk, others are finding it much harder to source deals. Sabrina Willmer of Bloomberg reports, Oaktree Said to Cut Fund as Distressed Deals Diminish:
Oktree Capital Group LLC (OAK), the world’s biggest distressed-debt investor, cut the $3 billion goal on its next control investing fund by about 40 percent as it struggles to find deals amid an economic recovery, according to three people with knowledge of the matter.
Oaktree told prospective clients it reduced the target to about $1.8 billion, said the people, who asked not to be identified because the information is private. The Los Angeles-based firm plans to shorten its investment period on Oaktree Principal Fund VI LP to three years from five, the people said.
Given the lack of traditional distressed opportunities, Oaktree is spending more time on European nonperforming loans, shipping, commercial real estate and energy, said Ronald Beck, a managing director at the firm, on a panel at the SuperReturn U.S. conference in Boston this week. He pointed to anemic default rates and high-yield bonds trading above par.
“You have to be very sector-specific,” Beck said.
Alyssa Linn, a spokeswoman at Sard Verbinnen & Co., declined to comment on behalf of Oaktree.
Opportunities for distressed funds are getting scarce as the Federal Reserve has held interest rates near zero and global corporate defaults remain low. Global corporate defaults fell to 66 last year from a peak of 266 in 2009, according to data from Moody’s Investors Service. A Bank of America Merrill Lynch index of U.S. high-yield bonds shows the debt trading at an average of 105.72 cents on the dollar as of yesterday, almost double the low from late 2008.
Slower Pace
“Financing is readily available and there’s little corporate distress,” John Frank, managing principal of the firm, said in a November earnings call with analysts. “Against this backdrop and in light of generally elevated asset prices, we continued our harvesting of profitable investments across our strategies.”
Oaktree, which started marketing the fund more than a year ago, in 2013 pushed back fundraising because its 2009 pool was deploying capital slower than expected. That fund was about 79 percent invested at the end of March, according to the firm’s first-quarter earnings report.
Fund PerformanceSo, I caution all you pension funds hungry for yield to proceed cautiously and manage all your risks, especially your risks in illiquid alternatives, very carefully. If my hunch is right, Jon Gray, David Blitzer, John Grayken, Howard Marks and many other big players in alternatives are going to find the next ten years a lot tougher to produce outsized returns they've been accustomed to.
Oaktree was originally seeking a similar-size fund to its 2009 and 2006 pools, which gathered $2.8 billion and $3.3 billion, respectively. Those funds were producing net internal rates of return of 8.5 percent and 8.2 percent as of March 31, according to the filing. That compares with returns of 17 percent and 7.7 percent, respectively, for all distressed private-equity funds in those vintage years, according to London-based research firm Preqin Ltd.
Oaktree’s fund, while global, will focus mainly on investments in the U.S., a person briefed on the matter said in February 2013. It will seek to buy equity or debt in distressed or stressed businesses with an eye toward eventually taking control of the companies.
Howard Marks founded Oaktree in 1995 with Bruce Karsh and five other partners from TCW Group Inc. The firm, which managed $86.2 billion in assets at the end of March, has raised funds devoted to non-control distressed, real estate, corporate debt and mezzanine investing.
Oaktree shares fell 1.2 percent to $50.58 at 3:04 p.m in New York, extending the drop this year to 14 percent.
Below, Howard Marks, chairman of Oaktree Capital Group LLC, talks about investment strategy, risks, and financial markets. Marks speaks with Stephanie Ruhle and Erik Schatzker on Bloomberg Television's "Market Makers," and discusses how public money is supporting risky investments.
Mr. Marks tells his investors to "dare to be right" but in my experience, most pension fund managers are too busy managing career risk and that's why they all herd to the same funds and investments. That's fine by me as it presents me, elite hedge funds and private equity funds with great opportunities (read my recent comment on whether a stock market correction is overdue).
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