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Private-equity giant KKR, known for its record-breaking RJR Nabisco buyout in the late 1980s, is moving deeper into the world of hedge funds. On Feb. 28 its KKR Financial LLC unit announced the launch of KKR Strategic Capital Fund. "It is anticipated that the fund will primarily focus on stressed and distressed opportunities and market dislocation investments," the firm said in a brief statement.
The fund, which will also make loans directly to businesses that are in search of equity, marks KKR's second foray into publicly traded investment vehicles. It previously launched KKR Financial (KFN), an NYSE-listed real estate investment trust, or REIT.
The launch, first reported by Institutional Investor, is the latest sign of consolidation between the private-equity and hedge-fund worlds. Private equity has been incredibly lucrative - and attractive -- in recent years (see BW, 2/27/06, "Going Private"). The stock market has been volatile since the 2000 crash, and the increased scrutiny of regulators, after scandals at Enron and other companies, has also encouraged investors to look to the private markets.
MARKET MIRROR. But hedge-fund returns are getting harder to obtain. So they are diversifying their assets. "With more and more capital to be deployed, it's getting harder for hedge funds to obtain acceptable returns purely in liquid securities. So they are deploying some of their capital in longer-term lockups where they have expertise," says Adam Sokoloff, co-head of private-equity coverage at investment bank Jefferies. And private equity players are moving into hedge-fund territory for much the same reasons. As a result, large private-equity and large hedge-fund players alike are morphing into money managers with multiple assets across a spectrum. At Jefferies, Sokoloff's coverage has broadened to include both hedge funds and private equity. For example, private-equity giant Texas Pacific has combined with hedge fund Axon Capital.
KKR's hedge-fund moves mirror shifts in the larger market. While equities peaked in 2000, fixed-income markets didn't peak until about three years later. Since then, fixed-income investors have been looking for alternatives for their portfolios, points out Stephen Leist, chief operating officer of MCF Asset Management. Among the options favored were distressed companies and real estate.
EXPANDING ECONOMIC ROLE. Indeed, KKR and others poured billions into real estate investment trusts. Though risky, many REITs generated double-digit returns, while risk-free money markets offered returns of basically zero (see BW, 2/13/06, "Getting a Slice of the Commercial Market"). REITs, while still profitable, have seen their returns slow down as money-market returns have increased. Some large investors no longer see real estate as worth the risk, given the higher returns of safer options (see BW Online, 2/27/06, "Getting a Bead on the Housing Market").
For investors like KKR, that makes distressed debt increasingly attractive. And they're also lending money directly to corporations, much as banks do. "Commercial banks are going to face more competition from hedge funds in the future," predicts Leist. That means large, diversified financial companies like KKR could play an ever-expanding role in the economy going forward.
Rosenbush is a senior writer for BusinessWeek.com in New York
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