In February, Kohlberg Kravis Roberts said it would liquidate two retail products that had been launched in 2012 and were distributed by US brokerage Charles Schwab.
The announcement certainly grabbed the private equity market’s attention, even though the vehicles weren’t strictly private equity. The Alternative Corporate Opportunities Fund (ACOF) and the Alternative High Yield Fund were an adjunct to KKR’s debt business and invested in a mix of securities including corporate credit, high yield bonds, convertible paper and preferred stock.
KKR has been coy about explaining what went wrong. Sources close to the firm have pointed to a “design flaw” (apparently purchasing ACOF would have meant going through an onerous vetting process). They also said that there wouldn’t have been the “daily liquidity most mutual investors expect”.
It seems likely that the latter problem was the chief reason for ACOF’s downfall. When it comes to accessing retail money, lack of liquidity is private equity’s Achilles’ heel. For most investors, buying shares in a structure whose underlying assets take years to deliver returns is a big ask. It’s harder still when the shares aren’t traded in sufficient volumes to allow for easy liquidation. These two vehicles would probably have had this limiting feature.
The firm’s suggestion seems to be that this is just a blip. Sources say that of the (extraordinary) $21 billion KKR has raised over the past 12 months, roughly a quarter has come from ‘individual investors’. “We are adjusting our product mix and packaging on the Schwab platform and we have a number of other offerings for individual investors, including private equity, under development for launch this year,” it said in a statement this week.
But others in the industry argue that there were plenty of sound structural reasons to shutter this relatively new business line – and to steer clear of it in the future.
One North American fund manager, who also raises capital from retail investors (albeit on a smaller scale) believes KKR just doesn’t need the additional hassle and expense of managing this very different investor base.
“It just requires an entirely different kind of organisation and infrastructure, as well as different terms. You’re basically competing with the mutual fund business, so you need to be able to offer things like redemptions, regular valuations, sales incentives for investment advisors and different kinds of fee structures.”
Other sources argue that the listed model is just fundamentally unsuited to an illiquid asset class that requires a long-term view.
“Our impression is that [capital from] high-net-worth individuals is not sticky money, and that it’s much more useful to have institutional partners who see private equity as a long time portfolio allocation and have that commitment,” says one mid-market general partner. “For individuals, it’s just very hard to find that discipline.”
“I’ve always been intrigued by the retail idea and you could think that its time should come – but it may never come now, based on what KKR’s doing,” the GP adds.
According to one placement agent, the fees charged by KKR for the two funds may have been part of the problem. “Knowing how [the market] prices stuff on the retail side, it’s hard to come out ahead,” he says.
All told, KKR’s decision to stop promoting these two retail products didn’t exactly come as a big shock. What’s more curious, arguably, is why a firm that appears to have zero difficulty in raising vast sums from institutions chose to bother with the retail market in the first place.