Rattner on the Credit Bubble

well known WSJ article ($), but finally you have a PE professional come out and speak about what is happening in the nutty high yield debt market.

The subprime mortgage world has been reduced to rubble with no lasting impact on another, larger, credit market dancing on an equally fragile precipice: high-yield corporate debt. In this fast-growing arena of loans to business -- these days, mostly, private equity deals -- lending proceeds as if the subprime debacle were some minor skirmish in a little known, far away land.

How curious that so many in the financial community should remain blissfully oblivious to live grenades scattered around the high-yield playing field. Amid all the asset bubbles that we've seen in recent years -- emerging markets in 1997, Internet and telecoms stocks in 2000, perhaps emerging markets or commercial real estate again today -- the current inflated pricing of high-yield loans will eventually earn quite an imposing tombstone in the graveyard of other great past manias.

In recent months, lower credit bonds -- conventionally defined as BB+ and below -- have traded at a smaller risk premium (as compared to U.S. Treasuries) than ever before in history. Over the past 20 years, this margin averaged 5.42 percentage points. Shortly before the Asian crisis in 1998, the spread was hovering just above 3 percentage points. Earlier this month, it touched down at a record 2.63 percentage points. That's less than 8% money for high-risk borrowers.

Mark Cuban does not like fund IPOs

off-the-cuff but accurate portrayal.

Hedge funds obviously don't want their big investors to withdraw, so they work incredibly hard to make sure they outperform their peers. As the number of funds has grown, so has the difficulty to outperform. There are so many funds chasing the same deals in every area of specialty that the funds keep on investing in riskier and riskier deals. All in hopes of keeping their "money happy"

Bottomline is that hedge funds scramble hard each and every day to make their big investors, some of which can leave on the drop of the hat, happy.

Appeasing hedge fund investors is a very, very different business than making shareholders happy.

If a shareholder sells their share of stock, the hedge fund wont really care. Sure, they want the stock price to go up. They own shares of stock in the fund, and as the stock price goes, so goes some percentage of their networth. That should be enough for them to do whatever it takes to increase the stock price, right ? Maybe

Increasing the price of a share of stock is as much marketing to create demand for the stock as it is earnings of the fund.We also call this increasing the P/E of a stock. There are dozens of ways to increase the PE of a stock that is showing a profit. Hedge fund investors care about 1 thing. Cash. Money that is returned to them. Shareholders care about the price of the stock. One is capital returns, the other is capital appreciation.

That difference is just common sense, but its significant.

more comments

The hedge funds that are staying private have to be licking their chops. Competing against public hedge funds that have to deal with reporting and disclosure requirements is a lot easier than competing with a company that is stealth in their actions. They also know that despite proclamations to the contrary, the public funds will certainly change how they approach investing to make the market happy. The earnings of public funds impact the brand of the fund. If earnings are good, its business as usual. If earnings are bad, and / or the stock underperforms, then the public fund's brand , and their ability to raise money is diminished.

Finally, the IPO also seems to put public shareholders on the opposite side of the ledger of those that have invested in the fund directly. Shareholders participate with management in the earnings of the fund, while those who put cash into the fund participate in the returns of the investments of the fund. Of course, the higher the return on investments, the greater the income of the fund itself and the numbers allocated to public shareholders. But fund investors returns are also a function of how much or how little management takes off the top. This isnt a problem when things are going great, but its always a problem when things aren't going great.

This post isn't expert commentary. Its just a friendly heads up based on what I see.

Blackstone To Get Change in Tax Treatment

There is a reason why private equity used to try to stay more or less private...

WASHINGTON -- Senate tax writers Thursday proposed a bill to subject publicly traded partnerships engaged in investment management, such as Blackstone Group and some other private equity and hedge funds, to corporate taxes.

The bill by Senate Finance Committee Chairman Max Baucus (D., Mont.) and Sen. Charles Grassley (R., Iowa) is intended to prevent further corporate tax losses from certain hedge fund and private equity dealings.

From the WSJ

The Classic Sell Signal: MBAs want in to private equity

Not just the ahead-of-the curve ones, but all of them apparently.

Business schools are bullish on private equity.

Amid the recent flurry of deals to take public companies private, M.B.A. programs are offering more intensive private-equity courses and strengthening their connections with buyout firms to help students land jobs. At the same time, schools are trying to lure junior employees of buyout shops to their M.B.A. programs to groom them for higher-level positions in private equity.

"Private equity is the sexy industry where the money is being made and where many of our applicants want to be," says Rose Martinelli, associate dean for student recruitment and admissions at the University of Chicago Graduate School of Business.

Full article in the WSJ Career Journal