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KKR (KKR)

March 06, 2013 1:20 pm ET

Executives

Scott C. Nuttall - Head of Global Capital and Asset Management Group, Principal and Member of the Management Committee

Analysts

William R. Katz - Citigroup Inc, Research Division

William R. Katz - Citigroup Inc, Research Division

[indiscernible] with a lot of personal asset managers, but we haven't really had a sort of a ground-up view of what's happening -- a ground-up view of what's happened with sort of the economies around the world.

Question-and-Answer Session

William R. Katz - Citigroup Inc, Research Division

And given the uniqueness of the private equity platform, can you comment about what your portfolio companies are seeing in terms of just the big picture, in terms of economic growth. Can you go around the world to the extent you can?

Scott C. Nuttall

Sure. I'd start with the U.S. I'd say stability. I wouldn't say a real change in fundamentals, though. We're looking at overall GDP growth in the high 1s to 2% this year. Not easy to get a lot of organic revenue growth, so no big change relative to prior years on that front. But the operating environments have been more stable over the course of the last -- call 6 to 24 months or so. So we're seeing some basic stability. In Asia, China seems to have gone through a bit of a difficult period but actually, we're pretty constructive on China right now. Our companies are doing a bit better. We see more opportunity to invest. And across Asia generally, seeing quite attractive trends, certainly relative to the U.S. and Europe, so we're still reasonably upbeat about the Asian economic growth environment.

In Europe, actually our companies have done well in Europe. Our European private equity portfolio was up nearly 50% last year. And a lot of that is where we've invested capital, and we've managed to avoid some of the more difficult markets. We're actually quite constructive on Europe and are spending quite a bit of time there, both with our distress businesses and our private equity business, looking to deploy capital as some of these markets are starting to bottom out. But the overall economic environment is mixed. But generally speaking, our companies are performing quite well and finding ways to create value. So overall, I'd say the global perspective is relatively low growth and stable, with pockets of more interesting opportunity coming out of this location.

William R. Katz - Citigroup Inc, Research Division

Okay. Next question I have is just thinking about the story here a little bit. We've certainly heard a theme of allocations going up for alternative managers, that some of the traditional managers, in fact had set strategic comparative advantages to get their way into [indiscernible] into alternatives. What are you hearing from the consultant community and the underlying investors, given the markets have rallied as much as they have? Is it the denominator effect that the allocations are filling in, or is there now more upside to a move to deeper allocations and alternatives?

Scott C. Nuttall

Well, I think we have already seen the allocations to alternatives increase quite a bit. We actually did some work around the top 10 U.S. pension plans, which have, today, about a $1.2 trillion of assets. And 5 years ago, their allocations to alternatives, were somewhere between 11% and 12%, and now they're pushing 24%. And that's just those 10 plans. And if you think about it around the world, we're seeing sovereign wealth funds, corporate plans, family offices. We're seeing many different types of investors allocate more capital into alternatives. And really, there's been more of a barbelling of a lot of different investor strategies. They're trying to get kind of their beta exposure through passives on one end of the spectrum and at the other end, putting more money into alternatives to get more alpha in their portfolio. And that's how we're hearing investors investing globally now. It's a fairly consistent theme, and we've seen it show up in the allocations, and I agree with the audience's views. I think we're going to continue to see that. And the definition of alternatives will continue to expand. So we've got different energy funds, real assets, hedge funds, obviously, different credit opportunities. We're seeing quite a broadening of how people are participating in the alternatives landscape. So I think it will continue, and when you meet with consultants, we're hearing the same thing.

William R. Katz - Citigroup Inc, Research Division

So the 24%, which is doubled, if you will, is there any tension in terms of those, potentially reducing their allocations and therefore that offsets some of their growth in some of the newer areas?

Scott C. Nuttall

I have not heard that at all. And then the opposite the denominator effect on the positive side, right, is as now the Public Markets have started to move in a positive direction. The dollars of allocation, once you set your percentage, allocation goes up. And so the overall assets have increased, and so actually, we've heard a pretty consistent trend of investors around the world increasing their allocation to alternative. I have not actually -- I can't even think of an occurrence of someone decreasing, in recent memory.

William R. Katz - Citigroup Inc, Research Division

Okay. That's good to hear. One of your competitors put up a slide recently suggesting larger players, including KKR, are taking a higher share in 2012 than they did back in 2000, and I think it was something like 8% now versus 6% then. And so 2-part question, why do you think this is happening? And are there any threats to the oligopoly, if you will?

Scott C. Nuttall

Well, I think it's happening because during the early 2000s institutional investors really diversified their exposure. So they invested, in some cases, in hundreds of funds, and they had exposure to a variety of different general partners. And I think what they realized is by virtue of doing that, they ended up creating competition for their own capital. And so they would be in several funds bidding against each other, in the same process, driving the price up and therefore, their return down. I have met with a couple of different plans who have said they would get an e-mail from one GP they were invested with, saying great news, we just sold this asset for a really attractive price. And then 10 minutes later, they get an email from another GP, great news, we just bought this asset from so-and-so. So they were just trading assets to different pools, and there's a lot of friction costs. And so a number of the investors that we work with have decided not to do that anymore. They realized, through the crisis, that they didn't really know with whom they were invested, that when everything went down, they had this diversified exposure, but they didn't really understand what their partners were doing. And so there's been a push to consolidate. So they want to do more with fewer, and that means within certain asset classes, putting larger dollar amounts with a handful of players, but then also doing investing across different parts of the alternatives landscape with firms like ours and others that have abilities in different asset classes. So I think that's a big part of the reason you are seeing the share shift and yes, we're seeing kind of in our business day-to-day. And you can just look at the growth of assets of our firm, plus the other bigger players, and the assets are growing faster than alternatives, broadly.

William R. Katz - Citigroup Inc, Research Division

Is there a couple of lumpy wins in the business you participate in? Some of your peers have as well in hedging plans around the country, and most likely around the world. As part of this, is there any kind of give-up in terms of the economics of the business, and spin areas investor focus. In other words, you gain larger mandates, maybe a longer duration with them, but is there a material change to the economic relationship?

Scott C. Nuttall

There hasn't been any material change. I think frankly, from our standpoint, if investors are going to allocate us much larger dollars for a longer period of time across multiple asset classes, it's sensible that you consider some economic arrangement to incent them to do that. There have been a handful of those types of relationships developed. It hasn't materially changed the economic model of the business. I, frankly, wish there were even more players that wanted to do that, because if you could actually raise capital several billion at time across multiple mandates, it's a very efficient way to build the firm.

William R. Katz - Citigroup Inc, Research Division

Will it be the higher margin?

Scott C. Nuttall

Right, right.

William R. Katz - Citigroup Inc, Research Division

Okay. Just one more big [indiscernible] question, again maybe some of the line items -- business lines and so forth. When you think about your business, [indiscernible] as a private equity business and under your stewardship you've been actually expanding into the credit side of the equation. Then you've also added acquisitions on top of that, Prisma being the more recent one and Nephila being another one. How do you sort of see your footprint today? And then where do you take it tomorrow, if you will? Is it all de novo growth, or is there sort of more things to be done from an acquisitive perspective?

Scott C. Nuttall

Look, I think we're -- if you look at the firm today, we really still have one scale business, which is private equity. I mean, we've got about a 5% market share in about a $1 trillion industry. And the other areas that we've been building, which are in the Private Markets area, it's really energy and infrastructure, real estate, and then in the Public Markets area, it's non-investment-grade credit, all the way from high yielding loans through mezzanine-distressed, direct lending and then with our hedge fund platform, we have both the fund of funds business, we have direct hedge funds in our equity long-short effort, and we'll continue to expand that. And on top of that, we have our Capital Markets business. Basically, everything non-private equity is relatively new for us. And a lot of what I mentioned has really developed over the course of the last 3, 4 years. And so if you look at the end markets that those businesses address, they're much larger than private equity. Private equity is $1 trillion industry, these other markets are probably $6 trillion or so in size and aggregate. So we are a smaller player with, I think, a lot of growth ahead of us and in bigger markets, some of which are growing faster than private equity. And so, the way that we're thinking about the business now is we have created a lot of these efforts. We manage about $16 billion or so in credit, but in real estate, we're relatively new. And so it kind of runs in size from a few hundred million to $16 billion or so of assets. But that gives us -- we have a lot of running room across all of those different areas. And I think we'll seek to grow both organically, which is how the bulk of the growth has been to-date. But we also are more actively looking at acquisitions or partnerships to accelerate the growth within those different verticals. The Prisma acquisition, which we closed in October was the first acquisition we've really done as a firm. It took a couple of years from beginning to end to get that transaction done, so we're very careful and we try to be very thoughtful about it. But we have much more of a concerted effort on that side. But I think you'll still see the bulk of the activity, still be on the organic side, but we will pursue inorganic opportunities as well.

William R. Katz - Citigroup Inc, Research Division

I want to get into the individual line-outs, but just one more question on Prisma. You said something on your conference call that peaked my interest, that Prisma's seeing a lot of growth even before the acquisition. There's a lot of ways for you to grow that. And one thing that caught my eye -- my ear a little bit was the notion that you're taking share from the typical fund-to-fund model. I was wondering if you can just amplify that a little bit?

Scott C. Nuttall

Sure. I mean, Prisma's business was really built on investing in specialist managers and so kind of the smaller players that were more specialist in nature, and doing it through separate accounts. So they're doing custom accounts for institutional investors. And we found that institutions would really much prefer investing in a separate account format as opposed to a co-mingled fund. I think they've also realized that they don't need to go through a fund-to-fund to invest in a multi-strat hedge fund. And so Prisma's really built their business focused on what institutional investors want to do in terms of how they want exposure to the space. And that's really where they've seen a lot of growth. So they've been taking share really by offering that much more specialist manager-customized format.

William R. Katz - Citigroup Inc, Research Division

So is it just that the CIO or the LP is saying, we believe in the multi-strat model. We just want to have a hand in the allocation process versus giving it to a multi-strat manager, who then -- he or she, or that company may go do their own thing and then give them the net return back --

Scott C. Nuttall

Yes, I think that's right. And they also wanted the risk overlay that somebody like Prisma can provide. Because the folks that run Prisma, they have much more of an investing background. Different firms in that space have different types of talent in them, but our firm has much more of an investing background or risk-management background. And so the -- I think, the CIO of the institution is able to say, I'd like these types of risks and these types of returns, and we can customize the portfolio that fits what they're trying to accomplish.

William R. Katz - Citigroup Inc, Research Division

Okay. So why don't we dive into the private equity first, because it is the larger business and we'll get into some of the growth year areas next. Can you talk a little bit about any -- I think you talked a little bit about in your opening remarks, in terms of the macroeconomic backdrop, but were you seeing the best areas for dry powder deployment?

Scott C. Nuttall

Sure. Actually, it's been a pretty interesting environment. So we were quite busy in Europe last year, as I mentioned. We're actually taking the view that we want to invest into the dislocation, so we invested in a number of different opportunities in Europe on the continent last year. Asia continues to be reasonably active, and though that's both buyout opportunities and a minority kind of growth equity investments in places like China and India, so we continue to see opportunities in those markets. We've made a couple of investments now into a Vietnamese food company, as an example. And in the U.S., I'd say last year it was largely around opportunities that were 2 types. One, private companies, largely family-owned, where there was generational transfer issue. They didn't necessarily want to go public, so they wanted a private solution, or noncore subsidiaries, a public company. I think the Public Markets have hurt those companies that have a reasonable amount of complexity, and so we found that there were businesses that wanted to sell their hobby businesses. And some of those hobby businesses were very attractive businesses in their own right, with some scale. More recently, we've seen, frankly, that stock markets have rebounded. We've seen a little bit more activity in the public to private space, as well, both in the U.S. and Europe, whereas a year ago, I said there was very little activity on that front. We're now seeing more activity in public to private in the U.S. in Europe as well. So just anecdotally, our activity levels at our investment committees in private equity, globally, are up quite a bit over the course of the last few months, given all those dynamics. And frankly, this tends to happen when you get more of a stable economic backdrop. You've got, frankly, credit markets that are wide open. There tends to be more deal activity in private equity, at least more opportunities to deploy capital.

William R. Katz - Citigroup Inc, Research Division

And by the way, if anyone has a question, please just raise your hand, we'll get you a microphone. So on the other side, realizations have been picking up for the industry, to some degree, and certainly, you've talked about the netting holes, if you will. Update on realizations, and then from our perspective, in trying to model all this out, some of it we can see some of it obviously, we don't always see. What are some of like the macro guidelines that we should be looking at? Is it just post-IPO, secondary stock price performance? What do you view as a great health indicator, if you will?

Scott C. Nuttall

Sure. I'd say, we have had a number of monetization events already so far this year, and we're only a couple of months into the year. So we've seen everything from just secondary sales in companies like HCA, Nielsen, NXP, et cetera, to -- we announced that we sold our stake in DMG back to Bertelsmann. So there's been a little bit of strategic activity as well, and so it's a pretty good start to the year in terms of overall monetization activity. I think in terms of what to look for, I think you're right. We've got 25-plus percent of our portfolio is in public stocks, and again we have had a fairly steady monetization trend in a number of those names, so I think that's something to keep an eye on is how those stocks are performing. And it's been a pretty systematic process of returning capital to our investors through those names. The other thing that I think does not get enough attention, and I think, over time, people will start to understand is, the strategic exit activity. Frankly, pre-crisis, many more of our exits tended to be strategic in nature. And then frankly, during the course of the crisis, there was not a lot of strategic M&A. We all know that the M&A markets pulled back. So we're starting to see that come back a bit. Last year, obviously, we -- the big deal was the Alliance Boots sales to Walgreens, where we are seeing a little bit more activity in that regard. I would say, anecdotally, the first 3, 4 months of 2011, and then the same thing in '12, there was more activity, but then frankly, Europe went sideways. A number of CEOs got nervous, pulled back and decided to do stock buybacks or increase their dividends instead of acquisition activity. Now I think if you just think about the dynamic, it's hard to get organic revenue growth. We've got a lot of companies whose leverage is down. They have a lot of cash. Their stock prices are up. We're hopeful that that means that we'll get into more robust strategic exit environment for us, which could also lead to more exits. It's hard to tell you what to look at for that. But I think the overall M&A environment and what you're seeing, in terms of activity levels broadly could inform what could be helpful for us. And it's a very efficient exit, as opposed to an IPO and then a series of secondaries. A strategic sale tends to be much more quick.

William R. Katz - Citigroup Inc, Research Division

Interesting, Paul [ph] had mentioned the same thing on their call. And they announced earnings much later than everybody else. I think that's consistent with what we're seeing across the industry as well. A question for you, on sort of the dynamics between realizations and growth. I guess, the good news is that realizations pick up and monetize, you send the capital back to investors, hopefully, everybody's happy. Conversely, it puts a little downward pressure on fee-paying AUM. Can you talk about a little bit about, can you continue to grow fee-paying AUM if strategics pick up? Are you able to exit some more of these publicly held companies, et cetera?

Scott C. Nuttall

Sure. And look, I think the answer is we've grown fee-paying AUM quite rapidly over the course of the last couple of years. I think we can continue to do that. While you may have that dynamic, especially in terms of some pressure, the U.S. and Europe, our second Asian fund is -- has not yet turned on. So when you look at our fee-paying AUM, it's $60 billion, $61 billion at the end of the year. There's $11 billion or so that we've raised that's not in that number. So that's kind of the first way that we see a clear path to growth and have quite a bit of visibility on that. In addition, when we sell some of our companies down in the secondary market, what happens is our fee-paying AUM declines by the cost of those investments in private equity, as opposed to the overall value. So some of these names, we're selling for 3x or 4x our cost, but what happens to fee-paying AUM, it's not the gross number that you might see in a press release, it's actually the cost of that investment that will bring that down, as opposed to the aggregate value. And then on top of that, we've got all of those newer businesses that I mentioned. Real estate, energy, infrastructure, all the credit businesses, all the hedge fund businesses. They're also in growth mode and raising capital. So I think the combination of all of those things you'll continue to see fee-paying AUM growth, while we're hopefully monetizing the private equity investment and returning a lot of carry dollars back to LPs and shareholders to the distribution.

William R. Katz - Citigroup Inc, Research Division

Okay. 2 more private equity. First one is, one of the things I come down a lot in talking about these stocks, generally, is how to model IRRs. Right? Willing to put a 20-multiple on the asset manager book, it's not a high-teen multiple of return on the IRR of a private equity [indiscernible], so I'm curious on that. But how to think about that? Can you -- one of your competitors said a mid-teen, upper-teen type of return, is generally a reasonable baseline. Is that fair? Is that too pessimistic, too optimistic in your mind?

Scott C. Nuttall

In terms of private equity returns?

William R. Katz - Citigroup Inc, Research Division

Right.

Scott C. Nuttall

I think it depends on the market. So some of the names that we invested in Asia. We always look at it relative to the risk that we're taking. So if you got business with a high level of recurring revenues in a developed market, maybe you're talking about high teens net. We tend to think in terms of net returns, which would translate to 20-ish plus gross. There may be opportunities in more emerging markets, whether kind of Asia, Latin America, where we may look at it and say, we really need to be in the mid-20s to be able to justify the risks that we're taking. Or there could be some investments that have more of a commodity or cyclical aspect to it. We may look at it in the same manner. So it really depends on the amount of risk we're taking. But generally speaking, overall in private equity, we're really still striving for high teens, 20-plus percent returns, and it just means some of the markets will actually try to push for a higher, or demand higher of our teams to build and make the investment.

William R. Katz - Citigroup Inc, Research Division

Okay, and just last question, private equity. You're in the market for a couple of different funds. Maybe you can sort of talk, specifically, if you care to, which I doubt you're going to do, or more generally about the capital-raising environment. And then the second part of the question is, one of the focuses of the firm has been to diversify penetration of the LP base, globally. I mean, can you sort of tie that -- those 2 questions together...

Scott C. Nuttall

Sure. Look, I think the environment just continues to improve. Frankly, when we came out of the crisis, everybody was in their bunker. Folks had moved into treasuries and there was frankly, very little interest in longer-data, locked-up alternatives funds. You fast forward now, several years later. We had a 24% return in our private equity funds last year. We gave them -- LPs back $9 billion in cash, which is the biggest number we'd ever returned. We've had a very consistent series of strong years and good performance out of the portfolio. And so, LPs are, not surprisingly, the more flush with cash. As we talked about, they've got higher allocations to the alternative space, and they're more in a mood to put more capital to work, and we add the overlay of what we said in terms of consolidating the number of relationships they have, that's a helpful backdrop for us. In addition to that, there has been a -- I'd say a continuation of the trend. We've seen LPs want to invest capital in Asia. They're underexposed to emerging markets relative to where they'd like to be. They like energy. And frankly, anything with a yield. Because if you think about it, the job of most institutional investors today, they're trying to generate an 8% return. And if they look at the last decade of return, very few of them have managed to do that. And so they're looking and saying, boy, if I could generate a 7% or 8% running with some equity upside, that's pretty interesting. And so as we've been seeking to scale the firm into some of these newer areas, a lot of it, and virtually, basically, everything we have XPE, has either liquidity or a current yield attached. And so the way -- the reason we've been able to grow organically the way we have is, in part, because of the investors' interest in those spaces. So I think you're going to see capital rotate into all of those different fees. And it's part of the reason, for example, our Asian to private equity fundraiser is going so well, is that we just kind of hit it at the right time, with a lot of interest in getting more exposure to Asia.

William R. Katz - Citigroup Inc, Research Division

Actually, before I leave the private equity and move over to Capital Markets, what's your reaction -- maybe put the slide back on, if you guys don't mind, on the netting hole for this guy? Right. Any sort of thought process over that that we should be thinking about, that given your comments, that you observe it's steadily, continuing to exit it as it [indiscernible]?

Scott C. Nuttall

That is a great question that I'm not going to answer.

William R. Katz - Citigroup Inc, Research Division

Guess there's no point in putting the slide back on then. Okay. Look, you can't blame a guy for trying.

Scott C. Nuttall

I appreciate the effort.

William R. Katz - Citigroup Inc, Research Division

We'll keep trying.

Scott C. Nuttall

He had a question.

William R. Katz - Citigroup Inc, Research Division

We have another question then? Great. Excellent.

Unknown Analyst

While we're on Asia, obviously it's a huge market for every one of the asset management folks, whether alternative or traditional, and yet we've heard countless number of speakers talk of how you do your due diligence, how you get comfortable with concerns of -- China specifically, control economy, rule of law, obviously not what it is, here in the States. How does KKR get comfortable due diligence-wise? How many opportunities are you looking at? Everyone understands the long-term growth opportunities, but short term, intermediate term looks very challenging. So how do you do it?

Scott C. Nuttall

Sure. The way that we do it is we go very local. So we need to have local teams on the ground. People that grew up there, have been doing business there for a long time, know which entrepreneurs to partner with, know which entrepreneurs to avoid. You need have the right relationships with the relevant government officials, so we know what is actually coming from a regulation standpoint or sense for where the risks might be. And so we have -- we found that you have to be very local in your approach to the business. So when we started our Asian platform, we had one person move from the States who's of Korean descent. We had one of our Australian colleagues who is in our London office and those are the only 2 people that were kind of born-and bred KKR. Everyone else we hired, 100 people, give or take, were local, whether it's Chinese, Indian, Australian, Korean, et cetera, Japanese. So we've built a very local team. There are many ways to lose money in Asia. And so, you don't want to be the kind of big global firm, who says we know how to do things. The way we invest in Asia is quite different than the way that we invest in the States. Most of Asia is not going to be a traditional controlled buyout market. You have to partner, its growth equity. Most of the deals that we do in that part of the role do not have any leverage, right? It's much more growth equity in nature, as -- but you need to be able not only to get in but also get out. And so that's one of the things that we spend a lot of time in on the way in, and we make -- could we make sure we have a path to exit here. In terms of the types of deals we're doing, there are a few controlled buyout-type markets, the deals we've done in Australia, Singapore, Korea. And we've done one deal in Japan, that was more controlled in nature. In terms of number of deals, India and China has been the greatest number and those are almost exclusively minority growth investments. And so it gives you a sense for how we're thinking about it. But you have to be very specific to that market and understand those dynamics, and you have to be on the ground. You can't have people fly in and fly out. We have 16 offices at KKR, 7 of them are in Asia. And that's all since 2006. Yes?

Unknown Analyst

Scott, can you update us on how your portfolio of companies are positioning with respect to a lower rate backdrop by the equity involved in refinancings and extensions?

Scott C. Nuttall

Yes, we've been very active in terms of refinancing the debt of our portfolio, so I think it's probably a couple of things we've done. One is we've been proactively pushing out maturity. So we have a couple -- about $200 billion of debt in our private equity portfolio. In the last couple, few years, we've extended maturities on over $120 billion, $130 billion of that debt. So we have been very proactive in terms of extending maturities in this environment. And that's gone quite well. The second thing we've been very thoughtful about is how much floating rate exposure do we want to have. So we actually do all this in a centralized way through our Capital Markets group, and so we've also been very active in terms of hedging our LIBOR risk across the portfolio and locking in kind of lower rates for the duration, in some instances of the floating rate component of that capital structure. So those are the 2 things that we're most focused on, in terms of how we're preparing ourselves.

William R. Katz - Citigroup Inc, Research Division

I'm going to jump around a little bit because I've spent a lot of time on private equity business, and I apologize for not getting to some of the other questions. In terms of margins, you spend a lot of money in terms of not only new offices, but I think also just be infrastructure sales and support and things of that nature and also front-running on -- not front-running, front-loading some expense on the credit growth, Capital Markets growth. How do you think the incremental dollar plays out here, in terms of money coming in? Is there a nice margin story here to be had, or will you look to reinvest some of those revenues back to the business to drive further growth?

Scott C. Nuttall

Look, I think we've been in investment mode in a lot of these different businesses. Where you tend to see more of a step-function change in the margin, is when you started the strategy and you go from fund 1, which frankly, you need to bring the team on before the dollars, largely. It takes a long time to raise external capital for a first-time fund. Got to get it invested. If you do a good job of that you earn the right in a fund 2 to potentially raise a much larger quantum of capital. So I think where you'd start to see more of that show up, though, is when we get to fund 2 or -- and fund 3, and a lot of these newer strategies that we've started. For example, our Asian private equity business. We're just now going to turn on in the not-too-distant future our second fund. Fund 1 was $4 billion. We announced on the call we think fund 2 will be $6 billion. And then you know the way our business works, it's not like you just go making money from the $4 billion to the $6 billion. You actually still make money on a good chunk of the $4 billion, at a lower rate, and then the new fund turns on. So that can actually create quite a bit of incremental revenue, with not much change in your overall cost. So it tends to be that dynamic. And as we kind of get from first-time funds to the second-time funds, across these different strategies, I think that will help. In the near term, I don't expect a significant amount of change because we're still investing in some things like our sales force, continuing to build out our real estate team as we find more opportunities in that market. So we're still investing in certain places, but the quantum of investment is lower relative to, frankly, the ability to scale some of these newer businesses over time.

William R. Katz - Citigroup Inc, Research Division

You did a very good job of sort of transferring some of the value of the company and the balance sheet to funding some fee-paying AUM growth drivers: credit, real estate, equity long-short. Some of that might still be early stage, but can you talk about where you are and potentially leveraging that into larger external capital?

Scott C. Nuttall

Sure. I think it really varies by business, okay. So let's just talk through them in various different stages. So our energy and infrastructure platform, this is in effect the investments we're making in energy and infra outside of our private equity fund. So it's oil and gas, direct investments in real assets. It's infrastructure investments on a global basis. We're in the process of raising an energy and income fund. We've allocated a meaningful amount of balance sheet capital growth strategies. We like that as an investment because it's generating a current return. In addition, frankly, it's allowing us to raise third-party capital more quickly. And a lot of the ways that we use the balance sheet is we say, okay, we really like it, so we're doing it with our own money. We'll put up $300 million into a strategy, start doing deals, and then we'll go see an investor and say, do you want to put up $50 million? Got to do it with us. It changes the fund-raising dynamic. So that business has now gone from 0 to almost $5 billion of fee-paying assets in a pretty short period of time, in part, by leveraging the balance sheet. Real estate is at an earlier stage. So real estate, we started by just allocating $300 million off our balance sheet and we started doing transactions. Brought on the team, led by a guy named Ralph Rosenberg, who's been long time in Goldman Sachs, and then Eton Park. And Ralph and the team have already done 6, 7 real estate investments using the firm's balance sheet capital. What we'll now do, at some point here, is to use that portfolio and bring in some third-party capital alongside our own. So we'll kind of potentially club together some capital from third parties and use that as a way to start to build a broader real estate capability for the firm. Credit, again, is at a different stage. So while we manage a meaningful amount in credit, broadly, we have a number of new funds. Mezzanine is new. Direct lending, we're on our first fund. Special situations, we managed nearly $3 billion in that strategy, and we're out with another fund. We're using the balance sheet, again, alongside our LPs, to give them more confidence and move more quickly with us in those strategies. So you get a sense of the team. I think they are going to be situations like Prisma. That's another way we use the balance sheet, is to make acquisitions where we think there's a very attractive return. We're not going to need to put a lot of our balance sheet capital alongside business LPs because they have an established track record. It's very strong. But what we did use is the balance sheet to get us into that business and have the ability to grow from here, on an accretive trade where, frankly, we have few related earnings, day 1. And so, we see a lot of different ways to deploy the capital, to both scale organically and to drive the acquisition strategy of the firm.

William R. Katz - Citigroup Inc, Research Division

Just one, maybe 30 seconds on Prisma. Are you seeing any kind of early wins, if you will. I know it's relatively young in terms of the acquisition timeline, but any early feedback on LPs or Prisma or KKR legacy?

Scott C. Nuttall

I think the early feedback is quite positive. For example, Prisma had never really raised capital in places like the Middle East, very little activity in Asia. So the Prisma team is very busy, partnering with the KKR sales team around the world, going to see our investors and beginning that dialogue. The early indications are quite positive. Same thing I'd say on Nephila. Very early days we only announced the transaction in January, but a lot of interest from our LPs on that product as well.

William R. Katz - Citigroup Inc, Research Division

Okay, just one more on the balance sheet. You're doing a very nice job of seeding these investments. And I think your CFO, Bill Janetschek, on the call, had said, look, we still have all these GP commitments we have down the pipe as well. Is there a natural tipping point, though, that there's enough sort of cash flow from operations, so to speak. It may not be exact, by the way I think about it, but that you can now allow some of these distributions to flow down to the unitholder rather than sort of input -- indirectly recycles the fee-paying AUM, which ultimately [indiscernible] the distribution, so a quicker timeline to support the yield?

Scott C. Nuttall

Yes, look, I think the way that we look at it is as a distribution policy matter. We pay out all of our fee-related earnings, and we pay out all of our carry in the distribution. We also do make a pretty meaningful distribution off the balance sheet. So last year, we distributed nearly 40% of the realized gains off the balance sheet, and using the other 60% to fund the commitments we've made to funds, fund acquisitions and develop these new strategies, as I mentioned. So today, as we look at it, we have cash on the balance sheet, but when we actually look at the commitments we've made to our own strategies and the uses of funds that we have internally, we don't feel like we're sitting on a bunch of excess liquidity. If that analysis changes, we'll take another look at it. One thing that we also do with our capital, that I didn't mention, is we support our Capital Markets business, which we haven't talked about. That's a pretty unique business for us. It allows us frankly to make money -- make more money from, frankly, the deals that we're doing, because we can speak for more capital. So when you look at our AUM the way I look at it, is pretty understated. I think AUM is a fairly dangerous metric for businesses like ours, because we kind of also look at our balance sheet that's invested in everything we do. It's $7 billion, and we own 100% of the economics together on that, but it's almost like having a $35 billion permanent capital private equity fund. We get 110 cents of their -- of the upside instead of 20 cents. Our Capital Markets business also changes that metric, as well, because we can syndicate excess product to our LPs or to third parties. We syndicate the mutual funds, the hedge funds that like to invest alongside us. Oftentimes we get an upfront fee or we can retain a carry, and that doesn't show up in the AUM either. And so we use our balance sheet to also drive those economics. As you can see in our segment financials, that's a very high-margin business for us, given we have 35 people driving that business globally and we make a lot of money from it.

William R. Katz - Citigroup Inc, Research Division

Okay, and then we're running very short on time and it probably ask for a longer answer than the clock is suggesting there. But I can't help but ask the question. One of your peers made a provocative statement recently saying they wouldn't be surprised to see a publicly traded asset management company by a publicly traded alternative management, or vice versa. So what's your reaction to that thought process?

Scott C. Nuttall

I have 3 seconds.

William R. Katz - Citigroup Inc, Research Division

Well, we built in a buffer. You can answer this question.

Scott C. Nuttall

Well, I -- could happen. It hasn't happened to date. I think those types of transactions are hard. You've got a cultural dynamic that you really have to get right or you could risk both franchises. I could articulate a lot of strategic rationale for distribution, frankly, relationships with investors, being able to work across the entire AUM of the investor universe. I can articulate that, but I think it really comes down to the personalities and whether cultures could fit in that type of a combination. And that's hard. And if you think about it, most large-scale asset management combinations haven't worked as well as people might have hoped. And so you've got a dynamic where a lot of firms have been built, over a long period of time, and I think very few are going to want to basically bet the ranch on trying to get something like that right. So never say never, but I'm not expecting a flood of those deals anytime soon.

William R. Katz - Citigroup Inc, Research Division

I know there's a lot more that would have liked to have chatted with you. But we ran out of time. But thank you very much, Scott, great conversation. Thank you.

Scott C. Nuttall

Thank you, all.

William R. Katz - Citigroup Inc, Research Division

I appreciate it.

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