Chuck Jaffe: Barbarians at the gate want you to enter
Private-equity giant KKR is starting two mutual funds — a huge departure from the buyout industry's standard practice of allowing only institutions and the superwealthy to get in on its deals — with a target market of individual investors.
In the 1980s and 1990s, the one thing every investor dreamed of was the chance to put their money with Kohlberg, Kravis & Roberts, the leveraged-buyout firm that was part of seemingly every billion-dollar deal that defined the merger mania of the time.
They were the "Barbarians at the Gate," the masters of the universe and just the biggest deal around. While KKR — as the company was renamed — has remained an enormous private-equity investor and a linchpin in countless big deals, the legendary firm has always been outside the reach of ordinary investors.
KKR is starting two mutual funds — a huge departure from the buyout industry's standard practice of allowing only institutions and the superwealthy to get in on its deals — with a target market of individual investors.
According to registration documents filed last week with regulators, KKR will use its savvy in distressed securities in the KKR Alternative Corporate Opportunities Fund — a closed-end fund that will invest in stocks and bonds — and KKR Alternative High Yield Fund.
KKR is far from the first private-equity manager to open a fund for ordinary folks. There has been an explosion in recent years of traditional funds not only trying to replicate the strategies of hedge funds, but run by money-managers known mostly for their expertise in the private-equity world.
You can see why the fund business would be attractive to any private-equity or buyout firm that isn't necessarily making money at its core business in this troubled economy. If a firm can open new funds and attract significant assets, management gets a fat, steady paycheck.
As much as people decry the excesses of Wall Street today, insiders reflect on the 1980s as "the Greed Decade." To see KKR and other firms aggressively promoting hedge and alternative-investment strategies to Main Street investors should make astute individuals hide their wallets.
It's not that anyone can suggest the new funds will automatically be bad.
For example, the Blackstone Group, another big Wall Street buyout firm, opened Apollo Senior Floating Rate (AFT) just over a year ago, and the closed-end fund has been a star since. It's up about 17 percent year-to-date, ranking in the top 10 percent of its peer group.
With funds in registration, the only word coming out of KKR is what's in the paperwork, and that is as promising a read as you'd get from any firm entering the marketplace with a sophisticated new product.
Still, when the barbarians open their gates to you, it might be time to wonder if you are being led to slaughter.
Plenty of mutual funds with hedge-fund strategies have been terminally mediocre, and there's a long list of hedge-fund managers whose results running traditional mutual funds is unimpressive.
Just as important, however, is that investors are likely to have to pay up to own these funds and their alternative strategies.
A recent study by two University of Pennsylvania researchers showed that investors typically believe high-priced mutual funds can deliver investment miracles.
Past studies have shown that the best predictor of fund performance is a low expense ratio.
What researchers Jill Fisch and Tess Wilkinson-Ryan showed was that investors ignore costs because 1) they want to buy into a great past track record, 2) they underestimate the negative impact of higher fees because they a few extra percentage points just doesn't seem like it could add up to much.
Paying more for simple stock-picking — basic money management by a pro — is a folly, according to the Penn study.
"If you're paying a higher fee because you think it somehow gives you the best stock-picker, you're not going to outperform the market or get your extra money's worth," said Fisch.
"The question is whether they are offering access to something different, whether it's higher cost for a higher strategy. ... The more you get outside of the mainstream investment strategies, the bigger the risk-reward trade-off."
That means, according to Fisch, that the new KKR funds and others might be worth taking a chance if their funds bring their real expertise to bear.
When management is expert at evaluating "the types of investments that the rest of the market struggles with, that's when someone would have a reason that justifies paying more," Fisch said.
Clearly, a firm like KKR is expert in the kinds of distressed securities its new funds will trade in, and its record in buyout deals is impeccable.
But, as Fisch also noted, the problem is every firm that comes to market with a new fund claims expertise, and every manager charging above-average costs claims to be worth the extra fees.
Ultimately, only a select few fund managers have ever proved to be worth higher fees.
That's worth remembering now, with more barbarians coming to the mutual-fund party.
Chuck Jaffe is senior
columnist for MarketWatch.
He can be reached
or at P.O. Box 70,
Cohasset, MA 02025-0070.