Och-Ziff Capital Management (NYSE: OZM) is an alternative asset management firm with approximately $22 billion in assets under management (AUM) as of Jan 1, 2009. The money is spread across four hedge funds, with the OZ Master Fund, the flagship, accounting for roughly $19.8 billion. Och-Ziff Capital Management went public in late 2007 and is one of very few publicly traded alternative asset managers, along with its peers, FORTRESS INVESTMENT GROUP (FIG) and GLG Partners, Inc. (GLG). Och-Ziff is a diversified, multi-strategy fund, which invests in many sectors and with a mix of investment styles. Its areas of expertise include risk arbitrage, convertible arbitrage, credit and distressed investing, private investing, and real estate. As with other hedge funds, its revenues come from Management and Performance Fees. Management fees equal between 1.5-2.5% annually of the assets under management, and are set and charged at the beginning of each quarter, based upon the amount of assets under management. Performance fees, also known as incentive income, generally equal 20% of the net returns earned by the funds, and form the majority of the firm’s revenues. This poses a problem in bad markets, as the funds have high-water marks that prevent the manager from receiving performance fees unless the fund is above its previous greatest value.
As with all investment firms, Och-Ziff’s performance is closely linked to the performance and volatility of the markets in which it operates, and in its ability to produce excess returns after adjusting for risk, known as alpha. The OZ Master Fund has produced annualized returns since its inception of 16.5% with approximately one-third the volatility of the S&P 500, as measured by the standard deviation of the returns. Moreover, unlike many hedge funds, Och-Ziff uses very limited leverage, the practice of borrowing multiples of the firm's assets under management to enhance returns. Och-Ziff is the fifth-largest hedge fund firm in the world, and is one of the fastest growing, with assets under management growing at a compound annual growth rate (CAGR) of 44% over the last four years, from $11 billion in 2004. Many analysts expect that its 13 years of experience and its large size will be valuable as new capital tends to seek out large, established funds, especially in turbulent markets, letting it maintain its high rate of growth in assets under management.
Och-Ziff was founded 13 years ago by the Ziff family and Chairman and CEO Daniel Och, a veteran of Goldman Sachs Group (GS). Chairman and CEO Daniel Och controls the company through a proxy that gives him the right to vote all the Class B shares, which comprise 79.1% of the shareholders' combined voting power. In addition to control of the company, Daniel Och is also the key investment professional of Och-Ziff, and all of their funds contain provisions that reflect this, such as allowing investors to redeem their money if Daniel Och ceases to oversee the fund for any reason, making his continued participation key to the company's success. Och-Ziff manages $33.3 billion across four funds with approximately 135 investment professionals. The four funds and their returns since inception are as follows:
|Fund||AUM (billions)||Net Annualized Return Since Strategy Inception|
|OZ Master Fund, Ltd.||$19.80||16.50%|
|OZ Europe Master Fund, Ltd.||$6.40||16.00%|
|OZ Asia Master Fund, Ltd.||$3.90||14.40%|
|OZ Global Special Investments Master Fund, L.P.||$2.10||14.40%|
In contrast, in the 10-year period since the OZ Master Fund's initiation in December 1997, the S&P 500 has returned 11% annually, and with an annualized standard deviation of 14%, while the OZ Master Fund has had an annualized standard deviation of 5%.
The firm is structured as a holding company, with Och-Ziff Capital Management holding 19.2% of the equity of Och-Ziff Operating Group, which is structured as a partnership, with Daniel Och, the Ziff family, and other partners controlling 80.8% of the Operating Group. This structure preserves the tax benefits of hedge fund managers, whose income from the performance fees is taxed at the 15% capital gains rate.
The firm was profitable from 2003-2006, but lost money in 2007 over expenses related to a reorganization conducted to ready the firm for its Initial Public Offering. The majority of its revenue comes from incentive income, which would hurt revenues if the funds fail to perform, due to the high-water mark and the possibility of increased redemptions. Moreover, owing to Och-Ziff’s structure, while it reports large amounts of Other Income, that income from the funds is mostly paid out to Daniel Och and the other partners and has no benefit to Och-Ziff Capital Management.
With the large number of hedge funds (9,767 to be exact), the turbulent markets, and the increasing correlation of hedge fund returns with the broader market, investors, especially large institutions like pension funds, are avoiding small new funds in favor of larger, more established funds that have a record of delivering non-correlated returns. New managers are finding it difficult to raise money, and the number of hedge funds started in 2007 declined 50% from the 2005 peak, but 2007 still resulted in a net increase of 589 funds. Meanwhile, large hedge fund managers continue to draw in capital, with the Man Group, the world's largest, adding $4 billion in May and June 2008 alone. Och-Ziff has a record of positive returns with low volatility, which has led to an annualized growth rate of 42% for the five years from December 2002 to December 2007. These characteristics, combined with its large size, leads analysts to expect it to benefit from this trend.
Although a large part of hedge funds' appeal is how lightly they are regulated, a couple of setbacks lately have tightened the regulation somewhat, and hedge fund managers expect more to come. The Children's Investment Fund(TCI), a London-based hedge fund, recently lost a lawsuit filed by CSX, the railroad company. The judge ruled that the use of certain financial derivatives by hedge funds to give them an economic stake without ownership of the stock was a violation of SEC laws requiring the disclosure of large positions in the stock. While TCI is an activist fund that takes a stake in companies and then agitates for change, this ruling could potentially affect all managers, as they could not take large stakes in a company in the form of these derivatives without disclosing their holdings. Moreover, the ruling has prompted calls for tighter laws from Senator Charles Schumer of New York. Moreover, in Britain, the main regulatory body, the Financial Services Authority, has instituted new rules requiring hedge funds to disclose short positions in companies that are undergoing rights issues, a type of capital raising. Furthermore, it has also issued rules that require funds to disclose derivatives positions similar to those in the US lawsuit. Furthermore, alternative asset management firms, whether private equity, venture capital, or hedge funds, all benefit from tax laws that consider the Incentive Income, the 20% of returns, to be capital gains, not income. As a result, they are taxed at the 15% capital gains rate and not the higher income tax rate. Many people consider this to be a massive loophole, and there has been persistent pressure to change the laws to prevent this. If such a law were to be passed, it would severely impact hedge funds. As Och-Ziff is structured as a partnership, even though it is publicly traded, such a change in the laws would hike its tax rate, hurting its net income. FORTRESS INVESTMENT GROUP (FIG) would also suffer from this, but GLG Partners, Inc. (GLG) is already structured as a corporation, and pays the higher corporate income tax rate, and would thus be unaffected. While people have been calling for this change for a while, analysts and hedge fund managers believe the addition of an election to the equation makes this and other regulations more likely, leading to an increase in lobbying efforts by hedge fund managers to forestall this.
For the most part, hedge funds have held up fairly well during the credit crisis, avoiding the hundreds of billions of dollars in losses suffered by the banks. However, returns have still decreased in many cases, owing to a combination of bear markets and decreased leverage, as well as the large number of funds and amount of money in the industry. All three publicly traded funds actually use much less leverage than the average hedge fund, Och-Ziff even less so, and also have money from the IPO, as well as a publicly traded stock to use if they need capital. Och-Ziff also benefits from a reputation for providing strong returns in bear markets. In the S&P 500's five negative-return months in 2007, it decreased 11.4%, while the OZ Master Fund returned a slightly positive 1.4%, beating the S&P 500 by 13 percentage points. Moreover, three of the Och-Ziff funds, except for the Asia fund, have positive returns for the year through June 30, 2008, a period in which the S&P lost 12.80%. Nevertheless, Och-Ziff's assets under management decreased by $504 million in June, indicating that the downturn might hurt capital inflows and fund returns.
The hedge fund industry manages around $2.6 trillion in assets across nearly 10,000 funds, making it an increasingly crowded and competitive field. Within the field, managers fall into very distinct categories on the basis of investment styles and strategies, such as short-bias funds, that focus on short-selling stocks, or global macro funds, which make bets on price movements in the equity, currency, Interest Rates, and commodities markets. Moreover, the majority of the funds are privately held partnerships that provide very little information to the public, making revenue and net income comparisons difficult. Moreover, the investing styles also make comparisons difficult, as some hedge funds are far more volatile than others, or use much more leverage to produce their returns.Of the three publicly traded alternative asset managers, Fortress manages private equity funds, hedge funds, and two real estate management vehicles, making it a substantially more diversified firm than Och-Ziff. However, the private equity arm is vulnerable to a decline in lending in turbulent or bear market environments as a result. GLG Partners, Inc., the other firm, is more similar to Och-Ziff, managing approximately $24 billion in hedge funds that employ a mix of investment strategies and little leverage.
|'||2007 Revenue||2007 Net Income||Assets Under Management||Compound Annual Growth Rate (5-year)|
|Och-Ziff Capital Management||$1,501,975,000||($915,026,000)||$33.3 billion||42%|
|Fortress Investment Group||$1,081,490,000||($59,803,000)||$33.2 billion||72% (3-year)|
|GLG Partners, Inc.||1,040,118,000||$92,262,000||$24.6 billion||45%|