Despite ongoing predictions by finance industry observers that the lines between public and private asset management increasingly will blur, it was not until the formation of TH Lee, Putnam Capital earlier this month that these prognosticators could point to any conclusive evidence.
The joint venture between Thomas H. Lee Co. and Putnam Investments (BUYOUTS July 19, p. 3) seems to blend important features of public and private securities firms, perhaps cutting a path for other mainstream asset managers, such as mutual fund companies, to offer their clients access to alternative investing, and in turn giving alternative asset managers, such as buyout firms, access to stock market wisdom and to the vast distribution networks of the public-market behemoths. This distribution may be particularly helpful for large established buyout firms that have families of funds and are perpetually raising capital.
On paper, the synergies ascribed to marriages like TH Lee Putnam seem great. But professionals who have stood in the small space where the circles of public and private securities overlap say realizing any synergy is a more complicated affair. The distribution networks of large financial institutions are not easy for buyout firms to tap, because although demand for private equity products is strong, sources say, the illiquid nature of private equity investing makes it difficult for most full-service asset managers to dabble in this investment class.
Rather than marking a trend, the TH Lee Putnam deal may turn out to be an anomaly. In general, most large asset management firms do not seek out partnerships with private equity firms and instead offer their clients alternative investment opportunities through in-house initiatives. The most important benefits to flow from the TH Lee Putnam venture, sources say, include a huge equity infusion for Thomas H. Lee Co., increased fees and carry for both firms and bragging rights for Putnam as it attempts to expand its operations internationally. As for synergy between the two worlds of asset management, to paraphrase Rudyard Kipling, it may be that public is public and private is private and seldom the twain shall meet.
One placement agent says the track record of private asset programs at public asset management firms is “horrible,” largely because of conflicts over how to pay the alternative asset managers.
To be sure, asset managers at mainstream firms all report that interest in alternative products is high among both institutions and individual customers. “Mutual fund customers have reached a level of affluence where they’re more sophisticated,” says Jeff Benjamin, a consultant at fund research firm Cerulli Associates. “They want the status that goes along with alternative investing.”
Mr. Benjamin adds that hedge funds are the most sought-after investment by these customers.
In response, asset managers that historically have focused on mutual funds increasingly now are offering alternative assets to their clients. Last year, for instance, firms including PaineWebber, Warburg Dillon Read and Salomon Smith Barney ramped up in-house alternative programs. Rather than invest corporate money, these initiatives will sell private equity partnerships to outside clients. Bear, Stearns & Co. runs funds-of-funds, venture capital funds, hedge funds, and currently is planning to launch a buyout fund with a target of $1 billion. According to Gwyneth Ketterer, a managing director at the firm, the existence of in-house alternative investment offerings can strengthen a firm’s asset management business. “Asset managers want to know that there’s a full-service firm behind them,” Ms. Ketterer says.
The head of asset management at a major financial institution, who declined to speak on the record, said managers who sell mutual funds and related products to their clients can benefit by cross-selling alternative products under the same corporate logo. “Institutionals like to deal with a salesperson who’s been calling for 10 years,” the executive says. “We can say, We manage high yield for you, how about a venture fund?’ Now we have one relationship and two products.”
Give the Investors What They Want
While partners at Putnam and Thomas H. Lee Co. say details of the joint venture have yet to be finalized, TH Lee Putnam holds out the prospect of one-stop shopping for Putnam clients. Backers of the venture have said it may offer every alternative asset under the sun, from timber funds to Internet growth funds. Scott Sperling, a managing director at Thomas H. Lee Co. and the president of TH Lee Putnam, has said his firm’s role in the venture mostly will be to select management. Executives from both firms have said they are not yet sure how extensively Putnam’s investor network will be tapped to raise the planned TH Lee Putnam funds.
The formation of TH Lee Putnam has led to speculation by some industry observers that other large asset managers are looking to partner with buyout firms. These rumors are based in part on recent investments made by financial institutions in buyout shops-earlier this year, Credit Suisse Group bought a 19.9% stake in E.M. Warburg, Pincus & Co. In 1998, American International Group Inc. bought a 7% interest in The Blackstone Group. These deals, however, may have had more to do with attaching a value to the buyout partnerships than with preparing the way for asset management collaboration. Sources interviewed for this article said they were aware of no other partnerships-in-the-making between mainstream asset managers and buyout firms.
Hicks, Muse, Tate & Furst Inc., for instance, one of the firms rumored to be pondering an arrangement with a mutual fund company, has not considered this option, according to a source at the Dallas-based firm. Neither has another source of speculation, The Carlyle Group, according to a spokesperson for the firm. A partner at Bain Capital, speaking off the record, says no partnership with another asset manager has been discussed at the Boston-based firm.
Not that firms like Bain and Carlyle aren’t interested in expanding-the trend among big buyout shops to build families of funds is well under way. What remains to be seen, however, is whether mainstream managers like Fidelity Investments can use these private equity firms to outsource an alternative asset management program that is marketable to its clients.
On paper, the synergies ascribed to marriages like TH Lee Putnam sound great. But professionals who have stood in the small space where the circles of public and private securities overlap say realizing any synergy is a more complicated affair.
Michael Forrester, a director of marketing at Fidelity, says the money management giant would like to offer a broader range of alternative and private equity products, but partnering with an outside firm is not its style. Fidelity currently manages hedge funds and real estate funds, as well as a venture fund that invests the firm’s capital. “There’s certainly an appetite,” Mr. Forrester says. “Unfortunately, we don’t offer a broad spectrum of [alternative] products. That’s not to say that someday we won’t develop some of them. We’re constantly evaluating new ideas in these areas, but you can always think of another product.”
Like Fidelity, State Street Corp. is expanding into alternative investment products through in-house initiatives. The Boston-based mutual fund giant, which caters mostly to institutional clientele, currently is raising three funds with private equity components through SSGA Global Alliance, a division designated to introduce “value-added strategies” to the corporation’s mutual fund core business, according to John Snow, the division’s managing director.
State Street decided to delve into private equity in part because the company felt this type of long-term investing was suitable for retirement-oriented customers, even though liquidity is a concern for many State Street customers. To address these concerns, SSGA Global offers a hybrid product with a three-year lock-up-private equity funds typically require a commitment of five to seven years.
Mr. Snow says private equity investing will become more widespread, perhaps even reaching the elusive 401(K) market, as the secondary market funds develops. And for the foreseeable future State Street will offer these private equity funds through State Street Corp.
A Case of Culture Clash
Mr. Forrester, who joined Fidelity in 1992 initially to head up the firm’s nascent alternative investment program, says cultural differences between alternative asset management and mutual fund management make it difficult to manage both types of assets under one roof. For instance, mutual fund managers in many cases earn fees of less than 1% of assets under management, with bonuses for superior performance. Partners at buyout firms, by contrast, can earn fees of as much as 2% of assets under management and 20%-in some cases even 30%-of profits. In fact, sources say one reason large asset managers are branching into hedge funds and their ilk is to attract top talent who want access to the higher fees of the private equity world.
One placement agent says the track record of private asset programs at public asset management firms is “horrible,” largely because of conflicts over how to pay the alternative asset managers. Indeed, State Street set up SSGA Global as a separate company in part to avoid tension over compensation issues, Mr. Snow says.
For at least one asset management firm, having mutual funds and private equity under the same roof proved to be too broad a business plan to support. Private equity and mutual fund firms seeking to diversify into non-core areas may want to consider the case of Warburg, Pincus & Co., the war horse venture capital and buyout firm, which, in addition to selling part of its private equity business to CSFB, also sold its entire mutual fund business to the Swiss conglomerate earlier this year. “The businesses were more different than they were alike,” says Douglas Karp, a managing director at Warburg Pincus.
“Mutual fund customers have reached a level of affluence where they’re more sophisticated,” says Jeff Benjamin of fund research firm Cerulli Associates. “They want the status that goes along with alternative investing.”
Mr. Karp says there was minimal sharing of distribution between the public equity and the private equity arms, largely because the long-term nature of the private equity products did not appeal to most mutual fund customers. “There was some useful overlap on skills. It was nice to walk downstairs to talk with the mutual fund guys” about the market for initial public offerings, Mr. Karp adds.
Do Synergies Really Exist?
Warburg Pincus, which originally offered mutual fund products to its client base, eventually decided to divest itself of the business because its mutual funds were not keeping pace with the firm’s more successful venture and buyout investing. Mr. Karp estimates the interaction between the firm’s two arms produced synergies only about 5% of the time.
Notwithstanding the forecasts of difficulties in realizing synergy, developments at TH Lee Putnam will be closely watched by buyout professionals. The deal represents a search for a permanent source of capital, Mr. Karp says, which private equity firms increasingly need as they grow their funds in size and quantity.
Dan Blanks, a managing director at Hicks Muse, agrees: “We would certainly like to find a way to increase our network of investors,” he says. “We would like to raise larger funds because we spend our money so quickly.”
One hope Hicks Muse has is that repeat investors will relax a traditional constraint against comprising more than 10% of any one fund.
Mr. Blanks says the TH Lee Putnam approach to expanding distribution is innovative. He notes, however, that Hicks Muse already has relationships with public asset management firms through investment pools. For instance, managers from Donaldson, Lufkin & Jenrette and Salomon Smith Barney pooled together private clients specifically to invest in Hicks Muses’ fourth fund. Those two limited partners make up approximately 10% of the $4.1 billion vehicle, Mr. Blanks says.
DLJ also has pooled retail investors to invest in Thomas H. Lee Co. funds, according to a source familiar with the firms.
A Singular Deal for Tom Lee
Whether or not TH Lee Putnam marks the future of private equity, most sources agree the deal is a good one for both parties-or “brilliant” as one asset manager puts it.
At the very least, the partners at Thomas H. Lee Co. reportedly get $250 million for giving up 20% of the partnership. Putnam will find it easier to recruit top managers if it holds out the prospect of involvement with hedge funds, as well as other alternative products, says an asset manager at a competing firm. The manager added that Putnam is in the process of expanding abroad, and the firm will have a leg up on the competition if it can claim to have access to “exotic” alternative investments.
In short, sources say, both firms stand to gain from the deal. And if those gains also include distribution synergies, asset managers from both private and public market circles are sure to take notice.
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