Hedge Fund Going Public

Today's big financial news is the IPO of the Fortress hedge fund. Believe it or not, I believe this is a small piece of what will eventually prove to be the solution to what some see as a "corporate governance" problem.

In a lunch conversation with a retired Wall Street lawyer, I sketched out my thoughts on how the Fortress IPO may affect private equity, and my friend concurred. Fortress is but an early example of the eventual reincarnation of what I refer to as "corsair capitalism," in memory of J.P. Morgan. As I wrote recently, here, the original intent of the corporate form was liquidity for the "robber barons," which, as a side-benefit, provided a means by which less-wealthy people could benefit besides the titans of industry. Add in the SEC, and, eventually, you had a decent start to a modern capitalistic system.

However, the concept of "shareholder democracy" was never intended, from our current corporate form. The boards were supposed to be composed of successful business people, whose financial interests were materially entwined with the companies on whose boards they served.

Now, we are quite far removed from that day and practice. Thus, there is no modern-day equivalent among public companies for the corporate boards of eighty years ago, or even fifty years ago. Since markets tend to create solutions on their own, I view private equity as such a solution.

Private equity and hedge funds are probably now different only in term of investment. The effective structures are not all that dissimilar.

Thus, with Fortress' IPO, I think we are seeing a first step on the way to some form of equity-participation structures for the 'common' investor, by private equity firms. My lunch colleague agreed. Assuming tax considerations can be addressed, private equity firms can begin to bundle up their current holdings, monetize them as spin-offs of some type in the market, and redeploy the equity into more private deals. Everyone wins, at first.

The private equity partnerships unload and unlock the value of their earlier deals, receive fresh capital, and smaller investors are able to enjoy equity returns similar to those of the private partnerships. The only fly in the ointment will be when someone other than a Goldman Sachs, Texas Pacific or KKR does this and craters one of their equity vehicles.

It's quite a testament to the public's latent desire for 'corsair capitalism' that so many people would subscribe to the Fortress IPO, driving the price skyward, despite having essentially no control over the continued presence of the key principals, the nature of the business, risk levels, or even a knowledge of the nature of the deals underpinning the value of the equity. Nobody's screaming that there is too much risk, or insufficient disclosure, in the Fortress offering.

If that's not a market signal, what is? Barney Frank, please take note. We are witnessing the market-sourced 'reform' for currently-perceived "problems" with corporate governance. It's not about a need for "shareholder democracy," or shareholders voting on the CEO's compensation package, but, simply, the ability for shareholders, at a low-cost, to buy and sell shares, as their way of "voting." And they are "buying" little-understood Fortress, in droves.