Last December business executives from around the globe made
their way to Manhattans Trump Tower to meet with
president-elect Donald Trump. But few made as big of a
splash as Masayoshi Son, head of SoftBank Group
Corp., who had Trump crowing on Twitter about the Japanese
moguls pledge to invest $50 billion in the U.S. and
create 50,000 American jobs.
Hes one of the great men of industry, so I just
want to thank you very much, Trump said of Son, who took
over as SoftBanks CEO last year following poor
performance by his predecessor. One might have predicted that
Sons first U.S. investments during the Trump era would be
in the kinds of high-flying tech companies, like Alibaba Group
Holding, that SoftBank has become famous for staking. Instead,
on February 14, SoftBank agreed to pay $3.3 billion to buy
Fortress Investment Group, the struggling
alternative-investment firm that went public to great
fanfare ten years ago but whose shares have since lost 74
percent of their market value.
Despite the slide in the firms stock, Fortresss
principals have made out well, pulling billions out of the
company thanks in part to the latest deal with
The founders got a big payday when they took it
public, and now theyre getting a second good
payday, says Myron Kaplan, a founding partner of law firm
Kaplan, Wolff & Cohen, who counsels hedge fund firms
like Elliott Management Corp. on organizational structure and
succession planning. Kaplan says Fortress has been
terrible for public investors.
Fortress was the first U.S. alternatives firm to go public,
in 2007, starting a trend that burned red-hot, then quickly
flamed out, proving over the past ten years that these deals
have been a disaster for public shareholders, which include big
mutual funds catering to both retail and institutional
investors. Among Fortresss shareholders: Allianz Asset
Management, Fidelity Investments, Wellington Management Co.,
and even the State Teachers Retirement System of Ohio.
And there is another ominous takeaway. Unlike most of its
hedge fund and private equity peers, Fortress makes its numbers
public, and they shine a harsh light on the
alternative-investment business over the past decade.
Fortresss assets have more than doubled since 2005, but
the firms net income was lower in 2016 than it was in
Fortress hasnt performed great, says Ann
Dai, an analyst at Keefe, Bruyette & Woods who says the
complexity of the firms business model also
has made investors wary. Complicated tax issues, a plethora of
esoteric investment strategies, and a dual share-class
structure that gives the principals disproportionate voting
power arent for the faint-hearted. Although almost half
of its $69.6 billion in assets under management are in the
staid, low-fee world of fixed income, Fortresss private
equity funds invest in senior-living centers and
railroads, and its hedge funds buy distressed real estate
credit. Meanwhile, its best-known macro hedge funds have
flopped, its vaunted private equity funds havent
surpassed their hurdle rates in years, and even its highly
regarded credit funds seem to have hit a wall.
Fortress co-founder and co-chairman Wes Edens may have inadvertently summed up
his firms value last fall, on a third-quarter conference
call, when he talked about the environment for Fortresss
private equity business: I think its a time to be
cautious. There are lots of things for sale, and there are few
things that are really worth buying.
That isnt stopping SoftBank. Though
primarily an Internet and telecommunications company, it
recently said it planned to parlay its hefty cash hoard into a
$100 billion investment fund. Fortresss $3.3 billion deal
with SoftBank was driven by Rajeev Misra, a former Deutsche
Bank derivatives expert who is now in charge of investment
strategy for the Japanese firm. A few years ago Misra worked
briefly at Fortress, where he developed a relationship with
Edens and Peter Briger Jr., who cochair the board of directors.
(Briger also has ties to Japan, where he previously worked for
Goldman Sachs Group.)
SoftBanks purchase of Fortress may be part of a grand
strategic vision that has yet to be articulated. But Fortress
had long been looking to sell, analysts say. Indeed, just
months after going public, the firm reportedly hoped to secure
a tie-up with Bear Stearns Cos., before the latter imploded
into the arms of JPMorgan Chase & Co. The sale to SoftBank
wasnt easy to pull off, either.
The consummation of the deal was in serious doubt as
late as February 12, 2017, according to a complaint by
the Securities and Exchange Commission regarding suspected
insider trading in Fortress shares at two brokerages in
Singapore and London (Maybank Kim Eng Securities and R.J.
OBrien) ahead of the announcement.
Both Fortress execs and Son are appropriately ecstatic about
the deal. SoftBank is an extraordinary company that has
thrived under the visionary leadership of Masayoshi
Son, Briger and Edens said in a public statement.
We anticipate substantial benefits for our investors and
business as a whole, and we have never been more optimistic
about our prospects going forward.
Son said in the same statement, Fortresss
excellent track record speaks for itself, and we look forward
to benefiting from its leadership, broad-based expertise and
world-class investment platform. Neither Fortress nor
SoftBank responded to requests for comment beyond those public
SoftBank is paying a huge premium for Fortress, having
agreed on $8.08 per share when the stock was trading at $5.83,
with a book value of $4 per share. That has led some analysts
to applaud the deal. Fortress wasnt getting credit
in the public markets, says JMP Securities analyst Devin
Ryan. This transaction gives them a bigger partner to
grow their business at a faster rate.
A source close to Fortress says, The sale seems to
reflect the principals belief in the business model and
investment platform, but probably a profound skepticism that an
alternative manager will ever be ascribed a premium valuation
in the public markets.
It has left some hedge fund veterans scratching their heads.
Culturally, it is such a disconnect, says Bruce
Ruehl, a former executive at hedge fund consulting firm Aksia.
Fortress has virtually no footprint in the high-tech world, and
the Japanese record in asset management isnt strong. Yet
the pressure on alternative-investment firms to sell will
continue, Ruehl reckons, given that they are under siege.
Theres tons of fee pressure on any products sold
into the institutional space, he explains.
Ive seen a lot of cycles, but this one is
different. You better be doing it well and have some kind of
hook that really differentiates you.
Fortress is arguably not in the top tier of
alternative-investment firms, but even the star managers
have hit hard times. Last year investors yanked more than $70
billion from hedge funds, according to Hedge Fund Research, as
the industry underperformed the broader markets for the seventh
year running. A few big names, like Perry Capital, shut their
doors, and regulatory woes hit firms as diverse as Omega
Advisors, which faces insider trading charges, and Och-Ziff Capital Management Group, whose
African subsidiary pleaded guilty to bribing foreign government
officials. Even industry legends like Paul Tudor Jones are
slicing their firms fees, and the pressure shows no signs
More firms will shrink, disappear, or if theyre
lucky, like Fortress be gobbled up. The Japanese
arent the only foreigners who are circling. A subsidiary
of Chinas HNA Capital, an aviation and shipping
conglomerate, was part of a consortium that agreed to buy out
Anthony Scaramuccis stake in $12 billion fund of funds
SkyBridge Capital so he could work for the White House. It was
an opportune time for Scaramucci to sell, as SkyBridge had lost
money for the past two years.
Fortresss woes exploded into public
view in 2015, when Michael Novogratz, one of the firms
principals and an industry luminary who had joined from Goldman
Sachs, retired after shutting down his Drawbridge Macro fund
following wrongheaded bets on everything from Brazil to China.
The Novogratz departure made headlines, but in fact the
problems at Fortress had been brewing almost from the time it
The year Fortress tapped the public markets, 2007, was an
auspicious time for hedge funds, which had just burst into the
public consciousness: Institutional investors like pension
funds had started piling into them after losing money in the
stock market crash earlier in the decade. Multibillion-dollar
fund launches were not uncommon, banks were trying to gain a
toehold by taking stakes in top funds, and a mystique of riches
surrounded the highfliers. Although the Fortress IPO was priced
at $18.50, it was oversubscribed, leading to a market debut at
$35 per share. Both Blackstone Group and Och-Ziff Capital
followed suit, debuting later that year at $31 and $32 per
Fortress had quickly grown assets during the hedge fund
heyday, amassing $29.7 billion by the time of its IPO. The
firms initial valuation of $7.5 billion was 37 times its
2005 pretax income, an indication that investors thought
theyd found the next great growth stock. Instead, it was
a market top indicator. Fortress principals Edens, Robert
Kauffman, and Randal Nardone (all from UBS), and ex-Goldman
stars Briger and Novogratz became billionaires on paper, owning
more than 77 percent of the stock.
The founders also cashed out. One of the more brazen aspects
of the deal was that $250 million of the IPO proceeds was set
aside to pay off a term loan facility that had been used to
make a onetime capital distribution to the principals the
previous year. In total, the five took $1.66 billion out of the
firm before the IPO through dividend payments and private stock
sales, including a 15 percent stake sold to Japanese bank
Nomura right before the offering.
The deal caused a stir and some hand-wringing in the
industry. Writing about the Fortress IPO in the 2009 edition of
Pioneering Portfolio Management, Yale University
endowment chief David Swensen criticized the firms
principals for the conflicts of interest inherent in their
deal, and joked that a section on greed was absent
from Fortresss SEC offering document.
At the time of the IPO, Fortress had $17.3 billion in
private equity funds, $9.4 billion in hedge funds, and $3
billion in real estate. The large asset base was achieved in
part by using loan proceeds to invest in the funds, leveraging
assets in a way many funds do not. Many of the funds
investments were not publicly traded, making their valuation so
suspect that some investors shied away from them. In fact, in
its IPO prospectus Fortress acknowledged that the value of 29
percent of its assets was based on internal models with
unobservable market parameters. Even many of its hedge
funds, specifically the credit funds run by Briger, were
To say 2007 was the top for Fortress is an
understatement. Shares started falling almost immediately out
of the gate and by January 2009 had sunk to $1.00, a decline of
97 percent from the peak. With the financial world in collapse,
Blackstone and Och-Ziff also suffered huge declines: Blackstone
ended 2008 at $6.26, down 80 percent, and Och-Ziff fell to
$5.19, an 84 percent drop. Since then Blackstone has performed
the best, but its still up only 3 percent from its 2007
launch. Och-Ziff has fared the worst, down 90 percent from its
October 2007 debut.
At Fortress troubles first surfaced in the macro funds run
by Novogratz, a man known for his glitzy lifestyle, complete
with a Tribeca duplex once owned by Robert De Niro and a
flamboyant wardrobe featuring diamond-studded belts and cowboy
boots. Of all of Fortresss products, Novogratzs
were the most liquid, yet he had a two-year lock-up on
investors money. Before the crash many hedge funds had
adopted this feature, which at the time allowed them to avoid
registering with the SEC. But because his funds were run out of
a publicly traded firm, Novogratz had no such rationale, and
there was no issue with liquidity.
The losses of 2008 threw that bit of arrogance into stark
relief. Although Fortress had put up the gates to keep
investors locked in when its funds suffered double-digit
losses, it was forced to open them eventually, and some $4.6
billion was redeemed between 2012 and 2014 in the firms
liquid hedge funds. By 2015, when the macro fund fell 18
percent leaving it with an annualized return of 2.8
percent Fortress was forced to shut it down, with only
$1.6 billion left. By the end of 2016, the firms hedge
fund assets were about half of what they were at the time of
the IPO, and Novogratz was gone.
The shutdown of Fortresss macro funds was a big loss.
The hedge funds had charged investors as much as 3 percent in
management fees and between 20 and 25 percent in incentive
fees. But last year Fortress earned only $1 million in
incentive fees and $14 million in management fees on its liquid
hedge funds, down from $16 million and $138 million,
respectively, in 2014. Total incentive income for the Fortress
macro funds was less than $100,000 and $3.8 million for 2015
and 2014, respectively; management fees sank to $34.7 million
in 2015 from $63.3 million in 2014.
Private equity, run by Edens, was originally considered
Fortresss crown jewel. Between 1998 and 2006 those funds
netted 39.7 percent on an internal rate of return basis,
according to the IPO prospectus, but such returns have
disappeared. Essentially, we view that business in
runoff, says Keefe Bruyettes Dai. Its
more or less a shrinking asset pool.
One major problem, the analyst notes, is that the
portfolios returns havent been high enough to push
them over their hurdle rates so that Fortress can start
charging incentive fees. Last year the firm said most of its
private equity vehicles had hurdle rates of 8 percent. We
dont have any intention to lower the hurdle rates,
Briger said on the third-quarter conference call, responding to
questions from analysts. I think in terms of private
equity credit, if youre really not going for
substantially higher than 8 percent gross, our view would be
why are you actually going out and investing in those types of
investments, just given the illiquidity risk?
In 2016, Fortress received no incentive income from its main
private equity funds, compared with $2.9 million in 2014.
Management fees also fell to $93.8 million from $136
million as funds matured and no new ones took their
place. The firms third private equity fund, launched in
September 2004, reaped management fees of $9.9 million and
$13.8 million for 2015 and 2014, respectively. But there have
been no incentive fees for years: Returns were a respective 5.8
percent, 6.9 percent, and 4.8 percent in 2012, 2013, and 2014.
Last year the funds annualized return was 2.0 percent,
and a fourth fund was in the red on an annualized basis.
The immediate future doesnt look much better,
according to Briger. Our investing pace today in terms of
[private equity] investments has slowed significantly, he
said on the conference call. We have a bunch of dry
powder, and I would say we need a better environment to be
investing in the types of things that produce the types of
returns, the types of PE incentive, than we are seeing
Fortresss credit funds, run by Briger, have been the
best performers in recent years. Last year the Drawbridge
Special Opportunities hedge fund gained 9.7 percent,
annualizing at 10.7 percent, and its offshore equivalent gained
5.9 percent for an annualized 9.5 percent. Brigers
private equity credit funds also have been strong performers,
with double-digit annualized returns.
But their future is unclear right now, and this has led
Fortress to return capital to investors. We are in a
period of time where the opportunity set is low, Briger
said in November, adding that Fortress had given back 20
percent of the capital in the offshore credit fund. We
would look to do that in our credit hedge funds to the extent
that we were building up more cash than the opportunity set, in
our judgment, necessitated over some medium-term period.
Part of the problem, he said, was the lack of big investment
themes in credit. Theres nothing that is
thematically interesting, he told analysts.
Everything that were doing is idiosyncratic, based
upon the specific circumstances of a transaction or an
investment, and it is unlikely that thats going to change
in the real short term.
The inside joke about hedge funds is that
by bulking up assets they can make enough money from management
fees so that profiting from their investment acumen that
is, earning incentive fees becomes practically
irrelevant. Asset gathering is the name of the game. But
eventually that quits working. Investors pull capital, and it
becomes harder to raise it.
Asset growth at Fortress was flat in the years after it went
public, so in 2010 the firm grew by buying a fixed-income asset
management firm, Logan Circle Partners, which now accounts for
almost half of its assets under management $33 billion
of $69.6 billion. But managing fixed income throws off little
in fees, analysts point out: Logan Circle has barely been
The bottom line for Fortress is that its revenue and income
have continued to shrink even as markets have come back. Total
revenue was $1.2 billion last year, down 4 percent, or $50.1
million, from 2015. Since 2014 net income has fallen 25
percent, to $181 million. Pretax distributive earnings, which
analysts look at, fell 19 percent between 2014 and 2016, to
$362 million. They peaked at $551 million in 2007. In 2005,
before it went public, Fortress grew profits at an annualized
rate of more than 100 percent. That year it booked net income
of $193 million on less than $30 billion in assets and $1
billion in revenue.
To many observers the Fortress saga proves that publicly
traded alternatives firms arent a good idea. One problem,
attorney Kaplan says, is the conflicting demands of running a
hedge fund and operating a public company: When
youre running a hedge fund, youre trying to
maximize value and return for investors in the fund, but if
youre a public shareholder, your interest is fees being
as big as possible. Instead of running a fund strictly for the
benefit of investors, now youve got shareholders to be
responsible to. Fortress doesnt seem to have done
well by either.
As Kaplan puts it, Its pretty clear now that
public ownership is not the future of hedge funds. And
this time around, the principals cant take the money and
run. They will have to reinvest 50 percent of their sale
proceeds in either their own funds or those of SoftBank. With
the sale of Fortress to SoftBank, the cycle appears to have
come full circle.