Welcome to the Blackstone fourth quarter and full year 2012 earnings conference call. I would now like to turn the call over to Joan Solotar, Senior Managing Director, Head of External Relations and Strategy. Please proceed.
Great. Thanks, Erica. Good morning, and welcome everyone to our fourth quarter and full year 2012 conference call. I am here today with Stephen Schwarzman, Chairman and CEO, Tony James, President and Chief Operating Officer, Laurence Tosi, CFO, and Kathleen Skero, Financial Director and Principal Accounting Officer. Earlier this morning, we issued a press release and a slide presentation illustrating our results that is available on our website. We are going to file the 10-K at the end of next month. Just to remind you, the call may include forward-looking statements, which by their nature are uncertain and outside of the firm's control. Actual results may differ materially. For a discussion of some of the risks that could affect the firm's results, please see the Risk Factors section of the 10-K. We do not undertake any duty to update forward-looking statements. We will refer to non-GAAP measures on the call.
For those reconciliations, you will find them in the press release. I also want to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any interest in any Blackstone fund. This audiocast is copyrighted material of Blackstone and may not be duplicated, reproduced, or rebroadcast without consent. Moving on to the results, just a very quick recap. We reported economic net income or ENI of $0.59 per unit for the fourth quarter. That is up from $0.42 in the fourth quarter of last year. We reported the full year ENI of $1.77 per unit for 2012, and that is up sharply from $1.38 in 2011. The improvement was driven mostly by growth in fee related earnings due to higher asset levels as well as greater appreciation in the underlying portfolio assets really across the board.
For the fourth quarter of 2012, distributable earnings were $449 million or $0.39 per common unit. That is more than double last year's fourth quarter. For the full year, we generated distributable earnings of $0.85 per common unit. That is up from $0.60 in 2011. We will be paying out, well, $0.42 per unit distribution related to the fourth quarter to common unit holders of record as of February 11th. This includes the true-up from the first three quarters of 2012. That payment date will be February 19th, which hopefully you have noticed is moved up about six weeks from last year's payment date. For 2013, we have made a change to the distribution.
We've increased the base quarterly distribution by 20% to $0.12 from $0.10, and we're also going to pay out the excess net cash available on a current basis so that there won't be a fourth quarter true-up. Investors will just get the cash earlier. One final note from me, we're going to host our third Blackstone Investor Day on Friday, May 3rd. That will be in New York at the Waldorf. We'd sent out a save the date email, but if you didn't receive it and you want to attend, just follow up with me or Weston Tucker after the call. In addition, let us know if you have any questions, and we'll hopefully speak to you later. With that, I'll turn it over to Stephen Schwarzman.
Good morning. Thanks a lot for joining our call. The fourth quarter capped a successful and eventful 2012 for Blackstone. As we continued our trend of strong growth and performance against a backdrop of market volatility, political dysfunction, and regulatory uncertainty. We grew our earnings by 30% to $2 billion. Our best performance since becoming a public company. Our distributable cash rose 48% to over $1 billion. We ended the year with record total assets under management of $210 billion, up 26% year-over-year, marking yet another year of double-digit organic growth despite the fact that several of our businesses were already the largest in the world. We've grown assets an average of 28% per year over the last 20 years. Today, we remain the only alternative manager with leading scale and performance in all the major asset categories.
As a result, I believe Blackstone remains the global leader in the alternative space. As we continue to take share in all of our businesses, our scale and leadership help drive a virtuous circle of better performance and further growth. We've had consistently strong investment performance across market cycles since our inception 28 years ago. In 2012 was no exception. Our private equity funds rose 7% in the fourth quarter versus negative returns for the market. It shows the uncorrelated nature of some of these things. With strong gains in both of our private public portfolios of 6% and 10%, respectively. The private equity funds rose 14% for the full year, also beating the markets with basically all of the return coming in just the second half of the year.
Our BCP V Global Fund had a gain last year of $2 billion, almost entirely in the second half as well. Although it did not drive carry because it is currently below the preferred hurdle and is now being held at 1.2 times cost. Our current BCP VI fund and our energy fund in private equity, however, are both above their respective hurdles and are marked at 1.2 times and 1.7 times respectively, despite the fact that both funds are early in their investment periods. In addition, our BCP IV fund has $2.8 billion of capital still in the ground, and that fund is marked at 2.7 times cost, including realized proceeds for a net IRR of 37%. When private equity works, it really works, much like it's doing for our two current investable funds.
Our real estate business saw similarly strong performance in 2012, with our opportunistic funds appreciating 14% for the full year and our debt strategy drawdown funds up 13%. Our debt strategy hedge funds appreciated 18%. All of our global funds, as well as our current European focused funds in real estate, are fully in carry. As of year-end, we had accrued $1.3 billion in carry, net of compensation in our real estate business. Our BCP VII global fund, the biggest in the world, which we've been investing for about a year and a half, has already achieved a net IRR of 31%, which is actually pretty amazing. Moving on to our hedge fund solution business, which had a composite return of 9% in 2012. This is roughly double the HFR benchmark, which is what's used in the hedge fund world.
We're earning double the benchmark with only one quarter of the market's volatility, which again, is pretty unusual from a risk perspective. Our size and reputation continue to give us a competitive advantage, and we've generated consistent top quartile or often top decile returns over the last one, three, and five-year periods. As Tony told you on the earlier call, this is one reason why we're rapidly gaining share in this business. Our credit business had a truly standout year in many regards, but notably in terms of fund performance across all of their strategies. Within our flagship funds, mezzanine returned a net 26%. For those of you who really follow this stuff, mezzanine is supposed to be earning a lot less than equity returns, and this is a 2007 mezzanine fund earning 26%.
Our rescue lending fund was up 16%, and our credit hedge funds rose 13%, all of these dramatically beating benchmarks. In terms of fundraising and innovation, our consistently really strong performance across all asset classes and through all market cycles is a critical differentiating factor for us versus other asset managers. We seek to preserve and protect our investors' capital in down markets. That is a prime tenet of how we run the firm. We're here to preserve and protect our investors' capital. We harvest our gains when the markets are more constructive, which is something we've told you about over a period, and now we're moving into this period. This stability and consistency results in deeper relationships with our LPs and a greater share of wallet with them and strong long-term relationships.
We've raised at Blackstone $34 billion of capital in 2012, which is actually a pretty stunning number. That excludes the assets we acquired by buying Harbourmaster and Capital Trust. During the fourth quarter, we had our first close on our new rescue lending fund in GSO, which has already reached the size of our first fund at $3.3 billion, and we expect we'll reach the $4 billion-$5 billion this year for that fund. Also in our GSO area, we priced our third CLO of 2012. If you remember, that market was dead as a doornail two years ago, raising over $500 million, bringing our CLO and other customized credit strategy fundraising to $8.5 billion for the full year. In both credit and hedge fund solutions, our ongoing diversification continues to drive strong asset growth.
Our hedge fund solutions segment reported $2.4 billion in net inflows in 2012 or $2.8 billion including the January 1 subscriptions. This represents 8% of the aggregate inflows of all hedge funds. Sometimes these calls throw a lot of numbers at you. Imagine that we've raised 8% of the aggregate inflows of all hedge funds just at Blackstone. It's in sharp contrast to the continued outflows for the traditional fund to funds industry. Through ongoing innovation of our customized solutions business for our clients, we've completely differentiated ourselves away from a traditional model. The result is that of the top 10 fund to funds managers 4 years ago, our hedge fund solutions group is the only one that has grown AUM, and we've doubled in that timeframe. Every other manager has lost assets.
I think our team there, led by Tom Hill, has really been doing something very right. In real estate, we began fundraising for our next debt strategies drawdown fund, and we also started raising our first dedicated pool of capital in Asia. Very important initiative for us. We've become the most active opportunistic real estate investor in Asia, deploying $1.5 billion over the past few years, plus building a deal team of nearly 50 people in 6 offices. This fund is a natural extension of our efforts there. We're often asked, what is Blackstone's asset mix going to look like in a few years, and what are our fundraising targets?
The hallmark of our firm continued growth is innovation, targeting opportunities that are new in the market, and launching new products to help our limited partners, where we can take advantage of these opportunities and maintain our track record of strong performance and help our investors. Our culture is built upon this. Over $70 billion of our current AUM of $210 billion come from new products, strategies, and regions where we didn't even have businesses 5 years ago. This is a business that prospers with innovation, and it's necessary. Today, we have a total of $35 billion in dry powder to invest over the coming years, and our product innovation should continue to create new and unique investment platforms for our investors who are our most valued relationships. In terms of capital deployment, we've been very active in putting our capital to work.
Our investment pace has been at record levels. It's a good thing. With over $18 billion in total capital deployed or committed in 2012, and over $8 billion in just the fourth quarter. Following a record year of issuance that we talked about earlier with Tony in both the investment grade and leverage finance markets, the financing environment for new deals in 2013 remains attractive. Credit spreads are trending at mid-cycle norms. What that means in English is that spreads have come in. We're getting to a bit more traditional relationships. With benchmark rates at historic lows, borrowers are able to lock in favorable rates. Credit issuance remains mix of funding for new LBOs, dividend recap and opportunistic pricing.
While asset prices have increased in certain sectors and regions, that happens when credit comes in like that, we are still seeing attractive opportunities in many places in the world, including energy, which has been a huge exposure for us. Distressed and over-leveraged real estate, where we're the largest in the world. India, where it's a good time to buy because it looks like it's not as strong as it's been. That's usually when you want to make your bets. Consumer finance. In credit, the search for yield continues to drive demand for products. With the Federal Reserve driving rates down to less than 2% for treasuries, people are really starved for yield, the pull back by banks has resulted in a lot of opportunities for the firm.
Now, in terms of realizations, as we think about the environment, our investors saw us preserve and grow their capital in the last down cycle. We talked about that, we weren't as popular with you because we didn't sell things at low prices to make you happy. Well, now we're making you happy. Now I think it's becoming increasingly evident that we're reaching an inflection point in terms of realizations, assuming markets remain constructive. We've had $12.6 billion of realizations in 2012, with half of that in just the fourth quarter, it shows what happens when things line up for us in terms of scale. This drove realized performance fee and investment income revenue of over $720 million for the year.
Roughly half of our performance fee revenue in 2012 was from our annual incentive fee businesses within hedge fund solutions and credit, which generally crystallize in the fourth quarter. That's when you see it. As these businesses have grown and more assets move above high water marks in the case of hedge fund solutions, the ability to generate annual incentive fees becomes much greater and much more predictable. Fourth quarter realizations picked up for both real estate and private equity as well. We sold our Sunwest Senior Living business, a $220 million investment at a multiple of invested capital of 2.4 times after a two-year hold period. When real estate works, it really works. 2.4 times your money in two years. If we did that with every piece of real estate, we'd be managing most of the money in the world.
It does happen, it isn't just an odd outcome. For real estate, given the maturity profile of our assets and the buy it, fix it, sell it approach, the underlying bid in the market to stabilized assets, particularly with low yields that people are trying to run away from and get some more current income. We expect this year and next year to be substantially higher years for realizations than in the past few years. In private equity, most of our fourth quarter realizations were in BCP V, including the sale of Alliant Insurance Services to a financial buyer at a nice profit, the public offering of PBF Energy, which is our refinery business, which we brought public at five times our original cost. I believe the price was $26 a share, now it's somewhere in the low 30s. I think it's around 32.
That's not bad performance for about four to five weeks. We also completed another follow-on sale of a portion of our investment in Team Health, an investment in BCP4, which generated a multiple of invested capital of four times our investors' money, which of course generates significant carry over time for the firm. We've taken eight companies public in the last two years, which we will sell down opportunistically, and we've had more pending, including filings for SeaWorld, Pinnacle Foods, and Michaels. By the way, at SeaWorld, we're opening a new penguin area. It's going to be absolutely fantastic, and you should definitely go down there and take your family, because I've seen what the thing looks like, and it's fun. We actually had two penguins here at the firm a few weeks ago on our boardroom table.
I'm not sure exactly what that's saying about us, but it was amusing. In summary, it's now been over five and a half years since we've launched Blackstone's initial public offering. During that time, who could have imagined it, we've navigated the worst financial crisis in memory, a deep and long-lasting global recession, and massive de-risking and de-leveraging across the globe. Despite these momentous events, we've grown assets every single year, with strong organic growth in every one of our investment businesses because of the loyalty of our limited partners and their sagacity, the fact that we protected their capital when almost no one else did. We're really focused on servicing our limited partners. We've also paid out a cumulative $4.56 per common unit in cash distributions, despite depressed realization levels.
Our growth is indicative of the secular shift towards alternatives that's underway and has been for quite some time, with increasing allocations driven by funding gaps at pension funds and endowments around the world, growth in new limited partner capital pools of sovereign wealth funds, for example, who haven't been in this asset class, who realize that the returns are much, much higher than conventional investments, and the risk, in fact, is lower. Whenever you get high returns with low risk, money flows in that direction, and that's our business. More importantly, however, our scale and performance are increasingly driving economic and competitive advantages in every businesses we're in, resulting in very large share gains for the firm.
I'm excited, as you can tell, not always excitable, but I'm excited right now about our leadership positions we've built and reinforced for each of our businesses, including the remarkable people we have here at the firm. It's really a fantastic team of experienced people who are on a mission to do well for you and to do well for our limited partners. I believe that as a combined firm, we're better positioned than ever to identify and make great investments, deliver very solid outperformance, and drive good returns for our public market unit holders. With that, I'll ask LT to take over with a review of our financial results.
Thank you, Steve. Good morning, everyone, and thank you for joining our call. A few thoughts on AUM and growth. The fourth quarter of 2012 provided a strong finish to another solid year by Blackstone by almost any measure. All of our investment businesses generated double-digit growth in assets for the third straight year, propelling total AUM up 26 percentage points to a record $210 billion at the end of the year. 90% of those assets came from pure organic growth, with the remainder reflecting assets we strategically acquired to broaden our investment capabilities. Over the past 24 months, Blackstone has had $96 billion of gross inflows and $61 billion of net inflows, with the difference coming from the $35 billion in capital we returned to our investors. A few thoughts on earning drivers.
Fund performance and sustained value creation are the primary drivers of Blackstone's business model and our financial performance. Our 2012 revenues grew 24% to a record $4 billion on a 36% increase in performance fees to $1.6 billion and our continued fee revenue growth to a record $2.2 billion, which was also up 14% year-over-year. That continued strong revenue growth, combined with margin expansion, helped generate $2 billion in full-year earnings, up 30% from the prior year. An important sign of continued momentum can be seen in the components of our $2 billion in earnings, as net realizations and fee earnings increased to almost 60% of the total earnings, reflecting record asset growth in an increasingly favorable environment for realizations.
The combined net realization and fee earning components of our earnings have more than doubled since 2009, with the sharpest increase coming over the last year, particularly in the fourth quarter. The depth of that increase is evidenced by the fact that the $724 million in realization revenue was generated by over 200 distinct transactions. Across more than 60 funds in the last year alone. At the same time our earnings continue their fast pace of growth, we continue to make critical investments in capabilities across our platform, including expanded fund offerings, global opportunity origination, portfolio operations, LP marketing and support, and technology and risk management. All of which have helped generate sustained double-digit organic growth. We have made these disciplined investments in growth without sacrificing profitability, which resulted in 50% margins for the full year and reached 55% in the fourth quarter.
In periods with healthy incentive fees, there's meaningful operating leverage to Blackstone's business model. A few observations on the balance sheet. Blackstone finished the year with $6.7 billion or $5.95 per unit in total cash and investments, of which $2.3 billion is in cash and liquid investments. Another $2.2 billion is in highly diversified investments, primarily in private equity and real estate, which grew as carrying values increased and are now being held at 1.3 times cost across more than 250 distinct assets in over 95 different funds and structures. Strong value creation drove our current performance fee receivable, net of compensation expense, to a record $2.2 billion or almost $2 per unit. The majority of that receivable is driven by more than $80 billion of assets under management in our mature funds, which are currently paying performance fees as investments are realized.
Newer funds still in their investment period are also accruing performance fees that will set the stage for future cash realizations. Couple more comments on distributions. As Blackstone's earnings have steadily grown and diversified over the last few years, it affords us the opportunity to increase our quarterly base distribution by 20% to $0.12 per unit. Additionally, to create better alignment and timing for our unit holders, we will distribute cash earnings above $0.12 per unit in the current quarter as earned. Finally, we will also accelerate the payment of our quarterly distribution by nearly six weeks. In this case, we'll be paying our fourth quarter distribution on February 19th for record holders as of February 11th. We anticipate that investors will better value the higher quarterly base and the accelerated cash flow.
In closing, 2012 was an exciting year at Blackstone in which we have continued to see returns on the investments and decisions we have made over the last several years. Now almost 1,800 people strong in 25 offices globally, we have invested record levels of capital since the crisis at what we believe will prove to be attractive levels. Today, despite these activity levels, we still maintain an additional near record level of available capital to invest in new strategies and ideas across the firm's businesses at an interesting time in global markets. All of us here at Blackstone have worked hard together to put the firm in this position, and we are more focused than ever, not on what we've accomplished so far, but our outlook and what we have yet to achieve.
On behalf of everyone at Blackstone, thank you for joining the call, and we welcome any questions you may have.
If I could just, before we take questions, we have a very large number of folks on the call, and we now have 17 analysts covering us. If you can, at least for the first round, just limit it to one or two questions and then just put yourself back in the queue. That would be great. Okay, let's go forward. Erica.
Ladies and gentlemen, at this time, if you wish to ask a question, please press *1 on your touchtone telephone. If your question has been answered or you wish to withdraw your question, please press star followed by 2. Please press *1 at this time to begin. Our first question comes from the line of Howard Chen with Credit Suisse. Please proceed.
Hi. Good morning, everyone.
Morning.
Morning.
Morning, Howard.
Morning. Steve, over the past few quarters, we've heard a tone of caution from you and Tony, you know, given the low level of rates, the rallying equity markets, the fragility and the recovery and these policy risks that we've all been talking about. Today we're hearing a markedly more positive tone, or at least that's what I hear. I'm just hoping you could add some color and maybe, you know, what you all see across the market and your portfolio companies, that's maybe changing that mindset a bit.
Yeah, I think, Howard, that you do detect a different tone. Maybe, maybe I had one more cup of coffee than I should've. But we're seeing strength in the housing sector, which is certainly something new in the last five years or so. That's an asset that is typically the largest asset that most Americans own. There's virtually no place where housing is going down, and there are many, many places where housing's going up. I think that's an area of real significant change. If you look at autos, you're also seeing, you know, almost a doubling from the bottom in terms of auto production. That's saying something about something.
Third, from traveling abroad pretty extensively, the impact of potential energy independence on our country here in the U.S. is viewed Forget how we view it here in the U.S. View it from the perspective of people abroad as a really
Paradigm changing type of change. Assuming that nothing goes wrong with approvals to do fracking, and we keep producing these very large amounts of natural gas, that this is an engine that could really drive with real future growth in ways that are really wholly unanticipated. On the other side, you see these mediocre results from the fourth quarter in terms of GDP. Not every area that we're involved with is showing that kind of growth. Some of that softness comes out of government spending and some other things. We don't have a free pass.
What we are seeing with our business is that the spread between illiquid securities and the returns we can make, and what people typically can get, not necessarily from last year in the last half on the stock market, but on fixed-income instruments, is so huge that it's driving our business in terms of flows. That compression will also increase the value of assets. May make it a little harder to set up some things, but it takes this huge amount of assets that we have in the ground where we've been improving these things. It'll create, in all probability, a pop in all those asset values that you'll see washing through our financial statements. That's the reason why you're hearing more enthusiasm from me. I'm sure Tony will give you something a bit more sober. It's the nature of our personalities.
Yeah, I didn't have any coffee this morning.
See you anyway.
Okay, great. For my follow-up, just circling back to Europe. Steve I know , you spent a significant amount of time. You've noted in the past the irony that the distressed assets haven't really moved because the marks would be too onerous for the institutions that hold them. Given the rallying that we've seen in asset prices and the seemingly improved Basel III readiness that some of these management teams at least talk about, are you detecting any kind of change in that bid-ask in the region?
The asset class that will trade the most is in real estate, not corporate stuff in terms of loans. Real estate still has some of the issues that you mentioned. On the other hand, what happens is different countries decide at different times that in some cases when those assets have gone into operations which are no longer just private sector when banks collapse and things get sold. Some of those are starting to move. For example, we just bought a good-sized hotel in Dublin where we think we can do quite well, but we have to fix it all up and so forth. We're seeing a steady flow of those. Basel III makes it somewhat hard for financial institutions across the board to just blow things out.
I think in a funny way that as those assets increase in value, it will make it easier for some of those assets to move because they'll result in less write-offs. We have to make sure that if we are the buyer of those, we can improve them enough to make our returns.
Great. Thanks for taking the question.
Your next question comes from the line of Michael Kim with Sandler O'Neill. Please proceed.
Hey, guys. Good afternoon. First, Steve, you touched on this earlier, but just on the realization front, things obviously stepped up towards the end of the year. Just curious to get your take on sort of the trajectory going forward as you kind of look across the private equity real estate and credit businesses, just some of the drivers behind the continued step-up.
I'd like to throw that over to Tony because I can give you that answer, but nobody knows that answer, right? That's really the problem. It should be an acceleration just given where real estate markets are moving. If the stock market stays up, we'll see more and more of this in the private equity area.
Well, I think Steve answered the question. Basically, just to separate those 3 into categories, I don't see a lot of realizations near term in credit. We've had some pretty good realizations. The challenge, of course, with a lot of our credit businesses are refinancings. Now we're getting money back that we'd like to keep out there earning high returns because companies are able to refinance cheaper. With respect to private equity, we had 3 big realizable sizable realizations at the end of the year. We've got 2 IPOs on file. We've got a number of other public companies that we're discussing accessing the equity markets. I would say that private equity will be driven heavily by the stock market as things now look at.
We don't have a lot of strategic discussions going on. We do have a lot of our companies looking at equity financings, and equity, and the distributions that'll flow from that. Real estate is where I think you'll see the big activity in terms of dollar scale, because those assets are lumpy. We've had them a long time. We've had a lot of assets that we've held since 2007. There's a very good bid for those assets because cap rates are low, and a lot of people want the security of hard assets. Even though the economy isn't all that strong, the lack of building in commercial real estate means that commercial real estate results are very strong. Commercial real estate results are much stronger than the economy, if you will.
We're seeing stronger operating results in real estate than we are in our companies.
Yeah.
Which means that we're going to push those along further. In other words, the investments have matured quicker, then we've got a very good bid for them. I think that's where you'll see the activity, and I think you can expect 2013 to be bigger than 2012, and I don't really want to be much more specific than that.
Just want to add one more thing. We're now of the size where both BAAM and GSO have contributed pretty good incentive fees, and those crystallized in the fourth quarter. There's a bit of seasonality to it and assuming regular performance, that should continue.
Understood. Then maybe one for LT. Looks like both base and performance fee compensation stepped down in the quarter. Was that just a function of maybe lower fundraising activities on the base side then maybe more of a shift in the mix of funds generating on carry this quarter?
It was a shift in the mix of funds, particularly with respect to where you see most of that occurring was in BAAM and GSO where they had very strong incentive fees. Typically, when you have a very strong incentive fee quarter, the base compensation number will be slightly lower.
Okay. Thanks for taking my questions.
Your next question comes from the line of Patrick Davitt with Autonomous Research. Please proceed.
Hey, good morning, guys. There's increasing concern about a 1994-like scenario in the credit markets. Given how big you've gotten in that business, could you speak a little bit how you prepare for a risk like that in terms of managing the risk in your portfolio of credit assets?
Yeah, I think our people in our credit area are reasonably wary of sort of the level of interest rates. The Fed has been very aggressive, as we all know, in terms of buying government debt and keeping interest rates low until they like where the level of unemployment is, which is lower than where it is. At some point, that's going to reverse, that's going to be one unhappy day for people who are very long. That's going to happen. The only problem is nobody knows exactly when it's going to happen, but you know it's going to happen. Given how low interest rates are, there's a reasonable chance that you can get hurt if you're really not in floating rate, if you maintain a current position, and you don't structure yourself well. We've been significant sellers of some of that exposure.
That's the way we're dealing with it, I'd say with caution. Just to flesh that out a bit, our guys have moved their portfolios shorter in duration. They've moved from fixed to floating. They've moved up the balance sheet, and they're sitting on a lot of cash. On the portfolios where you can move. With respect to the drawdown funds which are long-term illiquid securities, their securities are much higher rate, 400 to 500 basis points above the rate that bonds in the high yield market trade because the spreads for liquidity have widened out. If the market backs up, you'd actually expect the spreads to contract a little and they'd be somewhat protected, number one. Number two, their debt to cash flow is three to five times cash flow versus five to seven in the public market.
They tend to be less levered and have bigger equity cushions. We've taken an approach that's, I would say this market reasonably defensive, and has still been able to earn some pretty good returns.
Okay, great. That's very helpful. Thanks. Finally, in BCP V, it looks like the realized net IRR fell to 1% from 31%. Can you talk about the dynamics driving that?
I think you might be on BCP V mixing a couple of numbers.
Oh, okay.
Patrick, if I can for a sec, BCP V is now at 1.2 times total MOIC.
Yeah.
I think maybe you're just transposing numbers.
I'm looking at the 3Q press release that shows a 31% net realized IRR for BCP V.
Yeah, that's just the realized piece. That's on six.
Oh, okay. It says five. I'm looking at it right now. We can talk about it offline.
I think you're just looking at, you're comparing total fund to realization.
Maybe there's a typo, but we can talk about it offline. Yeah.
Our next question comes from the line of Dan Fannon with Jefferies. Please proceed.
Thanks. I guess, just thinking about investment opportunities, it sounds, based on a lot of your commentary, you're pretty optimistic about what's out there, as well as looking at 4Q pace of activity accelerated. The $12 billion of AUM not earning fees today, kind of the flow-through into the management fees over time, any ballpark on how we should think about that?
For some of the reasons we've mentioned, that is to say that general M&A activity is not all that high right now, and similarly, equity markets have come up and yields are low. It's not an easy environment to put a lot of money out. I would think that in our credit business, for the reasons I mentioned, we're being cautious. In our private equity business, the general level of deal activity is lower. Again, the debt has pushed up prices. We're being cautious. In real estate, we've had just been on a massive investment program with over $9 billion last year. That level is some kind of historic record and is clearly not sustainable. There's still plenty of stuff to do, particularly in Europe, which is lagging the U.S., and increasingly in Asia.
I wouldn't be counting on continuing to put out $9 billion a year. I think the wheels would come off this place.
Okay. I guess just clarifying the change in the distribution policy with regards to the holdback. Is it just a timing thing, or as you look at the size of your balance sheet and the need, the investment opportunities you see from a corporate perspective, have they changed at all?
No, they haven't. All we've done is we've raised the base level of dividend because our business has grown, and we feel like we can basically give investors confidence that they'll get at least $0.12 a quarter, regardless of what all else happens in the world. We've just taken that true-up we had at the fourth quarter and just spread that over the course of the year so people got their money earlier, and we didn't have such a one big payment that some of us worry might distort trading patterns or whatnot of the stock. Investors will get what they earn quarterly instead of having to wait towards the end of the year.
Great. Thank you.
Our next question comes from the line of Matthew Kelly with Morgan Stanley. Please proceed.
Morning, guys. Specifically on real estate, it looks like you've invested about $2.1 billion in BREP VII in the fourth quarter and maybe $3 billion-$3.5 billion over the second half of the year. With a little over $8 billion left there, are you guys close to or thinking about, at this point, raising BREP VIII? I know that's kind of a leading question, but just curious how far out we may be based on the pace of investments you're making now.
We think that's still a ways out there. As I say, we don't expect this level of investment to be sustained. As you know, we have some other real estate products in the market, and some of that will also affect the pace of investment of BREP VII. For example, right now, if we do an Asian deal, 100% of it's funded by BREP VII. Once we're in the market with an Asian fund, once we have the Asia fund, the Asia fund and BREP VII will share the deal. I think it's a ways off still.
Okay. The follow-up from me would be just in terms of BAAM, you mentioned that you raised 8% of funds for hedge funds last year. Going forward, I know that you guys have been able to take a lot of share in that space. You've been growing, industry's been shrinking. Do you think that accelerates from here, or are we kind of status quo and you take a little bit more share? How are you thinking about that going forward?
I think the hedge fund solutions business as far as BAAM is a business that particularly thrives on innovation. If you're just doing the exact same thing that you were doing before, it won't be so happy for you. We have a lot of really interesting things going on in that area. We've got a terrific team. We've got a number of new products that will be in the market this year that we think are going to be very well received that will keep that business growing. About 60% of our growth in a given year typically comes from our existing investors who are looking for different approaches, different solutions, and when we bring products to the market, to the extent we've done a good job historically, we get a pretty good hearing.
I think it's really about introducing new things and managing what you got really well.
Great. Thanks, guys.
Our next question comes from the line of Michael Carrier with Bank of America. Please proceed.
Thanks. First question, you mentioned a few things on the seasonal side, just in terms of the crystallization of some of the performance fees in credit and BAAM. The two other items I just wanted to get some color on is in BAAM, just the flows this quarter, usually it's relatively weak, and then it starts to ramp up. Any color around that in terms of what you're seeing? And then just on the fee-related earnings, obviously a strong quarter. Some of that was driven by advisory and transaction revenues. Just what you saw in the fourth quarter, any lumpy items in the outlook, kind of going into 2013?
On BAAM, they are lumpy, as you noted. We actually have a good pipeline going into 2013, not surprisingly, because 2012 was one of our best relative performance years. I think that was the issue there.
I'll take a whack at some of that, and LT, maybe you can fill in around me here. There were a couple of questions in there. In terms of the BAAM's got a couple of very interesting products in the market, and we think that they'll continue to gather assets. I'm personally hopeful that we'll do as well next year as we do this year. I don't see any reason why we wouldn't. We think there's a long runway ahead, I know the BAAM guys are talking about, I shudder to Well, significantly greater AUM. Let's just put it that way. I don't want to put a number on that as a long-term goal. I mean, very significantly greater. With respect to the seasonality of the business, all of our businesses are seasonal, actually.
One of the things that happened this year with the whole fiscal cliff negotiations and the tax rates going up, is a lot of companies raced around and tried to do things to beat the end of the year. That might be selling assets, it might be paying dividends, it might be one thing or another. It also might just be companies wanting to refinance to take advantage of low interest rates, not knowing what would happen with a fiscal cliff and not wanting to have the risk of that happening. Our M&A, for example, business, had the best fourth quarter in history this quarter. There were a lot of closings. It was a rather frenetic fourth quarter, and it was pretty much frenetic across the board, I would say. BAAM and GSO got the performance fees we talked about.
M&A and the advisory businesses had a bunch of closings. Although those businesses still have pretty good backlogs. Private equity had three, I think, significant realizations, two equity financings and a sale of a company. Real estate, both realizations and closings ramped way up. All businesses really sort of got hot in the quarter.
Okay. That's helpful. Then just as a follow-up, just on BCP 5. You've obviously seen some improvement in some of the performance. When you look at some of the key industries, the investments that you made, is there anything that's changing or anything that's improving to a level that you feel like it's worth bringing up, just in terms of the outlook of some of those areas? Because obviously, it's hidden in terms of exactly what's going on. The environment is improving, and just any color on that is always helpful.
Well, Michael, it's a big portfolio. It's got 30 companies or something in it. It was up 7% for the quarter. The whole portfolio is doing well. It's not one thing. It's a combination of steady growth and the pay-down of debt. With the way LBO works, those two things create equity value. Interestingly, LT can probably tell you, our public portfolio, we have a bunch of public holdings there, of course that goes up with the market, I think our private portfolio is up more than the public portfolio. In the fourth quarter, actually, the public was up more than the private.
I think as you look at that, it's really about growth, it's really about valuation level. To the extent that you have a robust stock market over the next year or two, I don't know whether you will or you won't, to the extent that you do, we share in that, in effect, disproportionately. We do that because we have our companies on leverage. Really, it's leveraged equity. That's very helpful. To the extent that the U.S. economy or foreign economies, where we have those type of assets, and I'm talking more in the private equity area now than some of our other ones, then we benefit from that kind of recovery as well. Those are two macro drivers that really affect us.
Okay. Thanks a lot.
Our next question comes from the line of William Katz with Citigroup. Please proceed.
Okay. Good afternoon, everybody. Just would like to talk a little bit about the potential for realizations. Just wondering if you could comment on in prior cycles, because I think since you've been a public company, it's probably been a little more lumpy, but in private cycles, maybe the relationship between the yield of ENI, so in other words, fee-related earnings and realizations relative to ENI in prior cycles. Within that, I don't know if you could even talk to that in particular business lines like real estate and/or private equity at this point.
Generally, if you assume a two times MOIC and a four-year going-in investment period and four years coming out, it'll be a relationship of two to one over the life of the fund, net earned carry to management fees. Historically, we've actually done better than two times. We've been closer to two and a half times, the ratio was even greater.
Okay. That's very helpful, actually.
Let me just make a note, too. There's marks, which are in ENI, of course, and then there's realizations, which are when those are crystallized and then ultimately paid out. Usually, when we actually realize an investment, there's a mark-up.
Even though we carry our investments at fair market value, but conservative accounting is what it is, and we try to be consistent on that. When there's a lot of realizations, you also will have a tendency to have mark-ups in ENI. In both real estate and in private equity, our realized events are usually at a pretty significant premium to our carrying values as of the prior period.
Typically, over a cycle, that's run historically in the 20%-30% area over the mark. Some of that's just the timing that we're selling into a particularly good time, and so that would sort of affect that sale. As we look at our own business, and everybody looks at these things differently, but we assume that when we're selling, we will have a better outcome than the mark. In almost every example, that really is the case. That is the way it tends to work in the vast majority of cases. It's not an equal distribution in terms of above and below historically.
Bill, as I mentioned in my comments, we went back, and we looked at exactly that through all the cycles back a long time. What Steve and Tony just pointed out is absolutely true, that you do have an uptick in the market at the time of exit. What we looked at was over the last few years, you've seen a strengthening of the component of our total earnings related to realizations and cash earnings. As I mentioned in my speech, it's about 60% for the full year 2012, up from the high 40s in the last two years. It's an indicator of basically what we call the different components of earnings.
Right. I appreciate that. Okay. Follow-up question is just, if the realization cycle picks up a little bit, I think you saw this dynamic in the fourth quarter. Fee-paying AUM were relatively flat, notwithstanding the strong year-on-year growth. If it's a little hard to put the money to work, and you're returning a fair amount, what's the outlook for fee-paying AUM? Could we expect that to flatten out a little bit in the short term here as we move into more of a harvesting period? Do you think you can still grow that simultaneous with a pickup of exits?
Well, it's a couple things. You're right, obviously, when we have realizations that it's net. I gave some stats in my speech that you're looking at $96 billion of gross inflows, net of $35 billion of return capital and realizations gives you the $61 in growth. I think the third of the fourth quarter had two factors, is that if you look on the press release on page 21, it goes through the earning roll forward. You had very strong inflows, frankly, in the fourth quarter of $7.3 billion. The issue was you really had realizations and returns of capital of eight, and those really canceled each other out. Looking forward, as Tony went through and Steve went through, there's a lot of things that we're working on. There's a lot of new products. There's a lot of innovation across the firm.
We wouldn't describe it as a flattening at all.
Okay. All right. Thanks. Take my questions.
Your next question comes from the line of Marc Irizarry with Goldman Sachs. Please proceed.
Okay. Just staying on the theme of the fee-related earnings. LT, can you talk about the $12 billion not yet earning base management fees? It's obviously spread across a few different buckets, but how should we think about the pace of either the drawdown of that capital or just the fee rates on that and what that means to your fee-related earnings?
If you look at that, Marc, the way to look at it is the majority of that, let's say more than half, $7 billion of the $12 billion is related to our credit funds. That's capital that's been raised, committed, and will begin paying fees when it's deployed. You'd expect that to kind of steadily work its way in over time. The same is true of the hedge fund solutions piece. They have drawdown structures within hedge fund solutions that will also draw down over time. Real estate and private equity is more transaction-driven, where over time they have reserve capital and other capital that they will deploy that'll come in. It's at full fees in all those cases, and the pacing, we think, will be relatively steady.
Just want to add one more thing just to the prior question on the trend. If you looked across estimates, generally speaking, realizations were underestimated, and therefore fee-paying AUM was overestimated. There's, of course, a relationship there because it's gross inflows less paying back capital and then if there were any outflows, which obviously in drawdown funds you wouldn't have. It is something to keep in mind as we're expecting accelerated realizations, particularly in real estate and fundraising in some of those businesses, step function. There's going to be quarterly periods where you'll have differences, and if you're selling a ton, you absolutely will see a flattening, if not a slightly declining trend in periods. Over time, we think the industry's going to have greater flows. We're going to continue to gain market share, we still see a positive trend.
There absolutely could be periods with flattening to decline.
Okay, Steve, just a question on scale, in areas maybe where, if we could take this route, places maybe where you sub-scale right now. Also, can you talk about some areas maybe where you don't see adequate capacity to grow? Maybe some areas where there's a lot of growth geographically, strategically, and areas maybe where the capacity is somewhat constrained at this point.
Well, the way we think about it is in each of our businesses. In private equity, there's currently a lot of room to grow in the energy complex. We've got a fund that we've started that is absolutely shooting the lights out. It's like a, IRR of 100% and 40%-50% invested in one year. The opportunity to grow that business very substantially is just right in front of you because, with that kind of investment record, and we've been doing this for, I guess about 13, 14 years, we've never had a loss. It's a pretty remarkable performance, and I would expect that to be significantly increased as we go ahead in the future. That's sort of like a pioneering step out, if you will.
I think over time, we'll find other areas that are natural areas of concentration where we do things like that. We've got our Tac Ops business that started with some of the staffing led by David Blitzer from private equity, where there's a very large capability to expand that kind of business. That's the only place in the firm where we mix private equity, real estate, credit, and hedge funds in one product. In real estate, there are just so many different areas to grow given the record that we have. I think Tony talked about the geographic expansion in Asia, which can develop a lot of different ways. We're already in Europe and the U.S. We have other opportunities of managing. We've got Mezzanine, which is principally a U.S. business, so that can expand geographically.
We also have managing the prospect, if we choose to do it, lower type return real estate. At the moment, we're focused on the highest types of returns, and there's a massive market of sort of, people who are actually seeking lower returns with less leverage. The prospects there are really very substantial. In the hedge fund area, I think we've answered your question on that. It wasn't your question, it was someone else's question on it. In credit, we're actually quite geographically constrained to the U.S., which is quite curious. Part of that is because of rule of law and the ability to perfect security in other places. We've moved. Tripp Smith, one of the three founding partners at GSO, was nice enough to go over to London, which most people would not think is hardship duty. It's a fun place to live, actually, London.
We're going to be developing a bunch of products for that market. There are people who do lend higher return money in Asia. We happen not to be part of that group. Longer term, that's a terrific opportunity given the growth there. Each of our investment businesses has a lot of white space, if you will, to be growing and expanding the business, which is important, not just for the reasons of this phone call. It's important to provide opportunities for our younger people as they grow up.
The best thing we can do is take people who are trained in our core businesses and put them in these other businesses because they know how the firm looks at risk and reward, you're just not dealing with people that you hire who don't have the same culture and the same focus on capital preservation.
Great. Thanks.
Next question comes from the line of Jeffrey Hopson with Stifel Nicolaus. Please proceed.
Okay. Thanks a lot. On the housing comments, I guess a recovery is good for your existing investments, but curious if you can tell us if you still see values there. Then in terms of interest rates and credit, et cetera, I hear you saying you're still defensive, but I'm curious why you wouldn't want to, I guess, extend your own credit, and perhaps even add leverage at the company level at this point.
Okay. Well, let me take housing first. As Steve mentioned, housing's getting a lot better, but it's still way off the peak, and we still have a huge number of foreclosed homes that have not worked through the system. We still have a lot of stressed people barely able to buy a home and need to rent or not able to pay their mortgages. In my view, we're a ways away from anything where you'd sort of feel like things have fully normalized. I think what Steve was just saying, we're coming off, like the body didn't even have a pulse, and now it's gotten a pulse, and that should be sort of a tailwind for the economy. We agree with that. There's still plenty of opportunity in the housing area. Our housing business is in 12 cities.
There are a lot more cities to go to. They're not all as far along as the cities we picked, which is why we picked the cities we picked. Lots of opportunity there, bottom line. In terms of the firm's own balance sheet, we did a debt issuance a couple of months back we thought were pretty great rates and pretty great maturity. Retrospect, we were wrong. We should have waited and done it now. At the time, we were looking at near historic low rates, and somehow they've gotten even lower. We're not intending to leverage up this balance sheet. We're in a business that doesn't need a lot of current capital. I actually think we're entering a phase with these realizations and divestitures that Steve was talking about, where we're going to actually throw off more capital than we need.
The only place we use capital is when we co-invest with the LPs, and as we put those funds out, the capital goes out, and then when we harvest the investments, the capital comes back. I think we're going to be more in the phase where we're getting more capital back than is going out. We're sitting on cash. We have a strong balance sheet. We want to keep a strong balance sheet. I don't see the need to, or the desire, really, to lever up.
Okay. What about at the investment level, your individual company investments, would they want to extend, I guess, maturities?
They're actively doing that daily. I think we have four or five refinancings on the debt side going on as we speak. In some cases, they're of course, using some of that added capital to pay dividends. In other cases, they're just lowering their cost of capital by refinancing existing debt. Some numbers that are in those realization numbers are dividends from relevering the companies.
Got it. Okay. Thank you.
Your next question comes from the line of Robert Lee with KBW. Please proceed.
Good afternoon, guys, and thanks for your patience in taking all these questions. I had a question. You've raised, as LT has pointed out, and you've all pointed out, you've raised a lot of capital over the last several years, greatly expanded the number of strategies. As you kind of look at pools of capital, are there specific, whether it's institutional asset pools in Asia or high net worth pools here in the U.S. or Europe that you think for you guys are particularly untapped? Maybe kind of refresh us on some of your initiatives on trying to tap those pools of capital.
I'd say we're a lot of places. The greatest opportunities for us is cross-selling our products to pools of capital. Since we're the only firm that really has this kind of scope, that we have a lot of opportunities to do that further. In that regard, the easiest marketing you have are with people who you're already invested with who like you. They trust you. They know the firm. As we come up with a continual number of new products, this is a natural way to go.
There are also new entrants who are not in some of our products who will be doing it, we have a pretty good competitive position to be able to be sort of first in, just because the investment performance record has been so strong over a long period of time that we also have a really good brand name that makes these people comfortable. I think there's another trend that is also helpful for us, that almost all of people who put money into the alternative area are looking to simplify their lives, not make them more complex. They're looking to reduce the number of managers and move to the high-performing ones. We qualify in that bucket in basically every business line that we're in. That also gives us a natural ability to pick up share.
We're taking advantage of all these trends that are going our way. Sometimes we open up a whole continent. In other words, we were the first people, basically, other than domestics, taking money in private equity from South America. That's going to be a growing area. It's not the biggest GDP area in the world. As different parts of the world move to alternatives because of the performance characteristics, we know the people. There are a whole variety of accounts that we visit that we don't have money from yet. We're going to get it because they're going to want to put it out, and some of them are early.
Yeah. Let me just jump in there too, Robert. The obvious parts of the world which have big positive cash flows are accumulating lots and lots of resources. Sovereign wealth funds all over the world. It's not just necessarily the China ones. You think there's all kinds of smaller countries with a resource
heavy with much of the energy revenues driven that have lots of capital. For the most part, in my own view, they're underrepresented in our kind of products, and we'll be shifting more towards that, and we're seeing that happening, and it comes in fits and starts. That's one area where I think you'd expect to see foreign investors in general, but particularly sovereign wealth funds, take more and more share from us, of our products. Secondly, is high net worth individuals. If you look at high net worth individuals across the board, they're 3%, 2%-3% invested in alternatives, whereas institutions are 20%-25% invested. There's obviously a long way to go there before we or any of our industry is really fully represented in the high net worth channel. I think that's another big target of opportunity for us.
All right. Great. That was my only question. Thanks for taking it.
Your next question comes from the line of Roger Freeman with Barclays. Please proceed.
Thanks. Just two questions. Probably missing something here, but in your comments before, you were talking about the markups on investments when you sell them, and I think you said most of that in private equity was concentrated in BCP 5 in the quarter. I'm just wondering why the threshold of the pref didn't improve more. I think it was 13% last quarter, then 12%. I'm surprised it wouldn't be a 3% return. Maybe the math's wrong, but wondering why it wouldn't have been up more.
I think, Roger, there's two concepts that you're mixing. The first one was Steve made a comment about that traditionally, and we've done research going back almost 20 years, that traditionally the mark that we have before we go into an exit event is typically 20%-30% below. The reason for that is under the mark-to-market rules, you can't take into consideration things like auction premiums, et cetera. There's an inherent conservatism, if you will, built in marks. That's true in real estate and private equity. Real estate transactions take longer to get done, so typically you have an earlier price indication.
Separate and apart from that, what I think was Tony's comment about that in the fourth quarter of 2012, BCP 5 had very strong returns, about 7%, and that actually pushed the total change in enterprise value necessary to cross the threshold down from 13% last quarter to 12% this quarter. We're making progress against that. They were two totally separate things, and I apologize if they got confused.
Okay. All right. That's helpful. With respect to sort of the general M&A environment, you obviously had a strong quarter in advisory. Wondering, 1, if that was more sort of restructurings versus maybe more traditional M&A type advisory. 2, do you think that the, at least for corporates, for strategics, the environment, the clarity has improved enough to kind of get the impasse start to thaw with strategics not wanting to sell because of the political and other uncertainty, or is debt ceiling pushed off to May still a big overhang?
Okay. On the fourth quarter, it was M&A that had the big quarter, and it is a lumpy business. We had a couple of very big transaction close with big fees. Their backlog built too, and their backlog's not only the biggest it's been in a long time, but the best quality in terms of likelihood of the deals closing. That business is doing pretty well, but I don't think you should read too much into that as to whether it's an indicator of the overall M&A market, because we're a small player in that market. Restructuring actually had a decent quarter, and frankly, for us, it was probably a bigger pleasant surprise because we expected in this part of the cycle when troubled companies can finance out of their problems, that business to be much slower than it actually has been.
They had a great year, and it's a credit to those guys to get a near record year in an environment when I think their whole restructuring industry is very slow. Sorry, Roger, what was your other question?
No, just, I guess extrapolating from your point of view going forward.
Well, I'd be curious as to what Steve thinks about that. I've noticed that we have some people saying, "Oh, it's going to be a big M&A year," and some people who think it's not going to be. I'll let Steve comment on that.
I think there's still a bit of an overhang from this political stuff. It's very hard making decisions when you don't know what's going to happen with the sequester. You don't know what's going to happen with overall GDP. You don't know whether the government's going to get shut down on a continuing resolution. These are not confidence-inspiring uncertainties. When you think the economy's going up and you pick up your newspaper and you find out that in the fourth quarter it's actually declined GDP, it doesn't make you run out to your board and say, "Let's expand into this." I think as Tony has said, there's a wall of cash in the corporate community, and if there's something that's cheap, you'll do it.
Is there enormous optimism that would make you want to buy extra capacity when there's still a lot of slack in the economy? I don't think so. There are some interesting things that you've got value investors or whatever they're called today. They used to be called raiders. They have a more elegant name.
Activists.
Oh, yes, they're activists. We can actually learn something from these guys in terms of renaming themselves, since private equity doesn't apparently have as much attractiveness as a marketing name as activists. Not that we want to be activists, which we're not, but just a name change makes these guys better. There are some discontinuities that create some flow in that business. I think on balance, we're in a better position for M&A activity. I don't see us until the governmental stuff gets straightened out, and people know what the rules of the road really are going to be, that we'll go into a really accelerated period. I would guess, since you put it to me, that sort of M&A activity will be up somewhere between 10%-20% this year. I don't think it'll be at the same level.
I don't see us as part of a V here on M&A activity. I'm not talking Blackstone.
Right
on a broader basis.
Right.
Okay, thanks a lot. Appreciate it.
I don't know, Tony, you disagree or no?
Our last question comes from the line of Chris Kotowski with Oppenheimer. Please proceed.
Yeah. Just had a question about the credit business and how the incentive and carry is structured there and how one should think about it in a rising rate environment that Steve talked about earlier. Are they benchmarked against the performance of high yield? Are they benchmarked in terms of absolute returns? If it's the latter, then during a rising rate environment, could one anticipate a nuclear winter for performance and carry in the credit business as that happens?
Actually, I don't think so because if you look at the composition of their business, they've got a giant CLO business, basically, we're the largest owner of leverage bank loans in the world. Okay? This is like a big deal. Those loans float up. They're not going to get hurt with that. In fact, it's a great place to hide, and we've got some products if you'd like to put some of your own money in it. That's a good thing. On our drawdown funds, we don't make mezzanine loans and rescue loans that are meant to be out long enough that basically you get crushed when things go up. Usually what happens is that when interest rates go up, it's often in response to an increasing economy.
When your economy's increasing, people will finance us out of those positions with higher stock markets and companies that get in better financial shape because their credit has improved, which enables them to flee us, because we're basically custom manufacturers of credit extension, and go to more normal types of areas. The rates on the money we put out when it's fixed are pretty high. We don't have to force ourself out at a bad time. We actually don't have as much risk. We have more risk in our hedge fund, which is, I guess, about $3.5 billion. We try and keep that hedged, actually. That's why we call it a hedge fund. We try not to have that kind of exposure. It's not like we're a long junk bond manager as principal who's about to get buried.
That's not the construction of our business.
Let me comment a couple of other things there. First of all, the hedge fund doesn't have any hurdle at all. It does have high water mark. The drawdown funds have set hurdles. They're not tied to benchmarks. They're fairly low in relation to the spread that they earn. The environment where interest rates go up, I think, will be a relatively strong economy, and that's when the Fed will allow rates to come up. In that economy, the drawdown funds have substantial equity interest, usually in the form of warrants on their investments. They're not usually just buying a fixed income security without an equity kicker. What's tended to happen is it's not a bad thing when rates go up for them so much because the duration of their holdings goes out.
Right now they're being refinanced and having to put that money to work out. They lock, they get high interest rates longer, and their equity interests become worth a very substantial amount of money. A high proportion of the return is sort of the equity options they get for free when they put money into a distressed company or a private subordinated debt company. A strong economy has an offset there. With respect to the senior debt business, a lot of which Steve mentioned was floating rate, was CLOs, a lot of it's also separate accounts and things. When rates goes up, those rates float up, and they actually earn more money. They're protected from the marks.
If you look at the rate increase periods in the last six rate increase periods, you'll see that the best performing fixed income asset class, which had significant positive performance, was floating rate senior secured debt. Investment grade debt actually had negative performance. High yield debt, because of the high interest rates, had small positive performance. Floating rate senior secured debt had, like, 6% or 7%, my recollection is, positive returns in rising interest rate environments. I think as Steve started off in saying, I don't think it's going to be a problem.
Just as a follow-up, if you think back to your experiences in 1994 when you had the big increase, any other major pitfalls or opportunities that we should be thinking about in terms of your experience back then?
Well, I can say this, speaking for me, and Steve and I are both old enough, I'm afraid, that we were actually doing this back then.
We were doing that, unfortunately, way before then.
Yeah. The returns to the private equity world were spectacular then.
'94?
back then. Of course
Wow
the leverage ratios were huge, there was a lot of sort of, the markets weren't as efficient. There was less competition. I don't know. Lessons are hard to draw on that one, I think.
Okay. Fair enough. That's it for me. Thank you.
Great. Thank you, everyone. Weston and I are around to take follow-up calls.
Thank you for your participation in today's conference. This concludes the presentation. Everyone may now disconnect.