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Executives

Craig Larson - Director of Investor Relations

William J. Janetschek - Member and Chief Financial Officer

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

Analysts

Howard Chen - Crédit Suisse AG, Research Division

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

William R. Katz - Citigroup Inc, Research Division

Christoph M. Kotowski - Oppenheimer & Co. Inc., Research Division

Matthew Kelley - Morgan Stanley, Research Division

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Roger A. Freeman - Barclays Capital, Research Division

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Kohlberg Kravis Roberts & Co. (KKR) Q2 2012 Earnings Call July 27, 2012 10:00 AM ET

Operator

Welcome to KKR's Second Quarter 2012 Earnings Conference Call. [Operator Instructions] I will now hand the call over to Craig Larson, Head of Investor Relations for KKR. Please go ahead, sir.

Craig Larson

Thank you, Cynthia. Welcome to our Second Quarter 2012 Earnings Call. Thank you for joining us. As usual, I'm joined by Bill Janetschek, our CFO; and Scott Nuttall, Global Head of Capital and Asset Management.

We'd like to remind everyone that this call will contain forward-looking statements, which do not guarantee future events or performance. Please refer to our SEC filings for cautionary factors related to these statements, and we'll also refer to non-GAAP measures on this call which are reconciled to GAAP figures in our press release.

This morning, we reported quarterly economic net income of $546 million compared to $747 million last quarter and $315 million in the second quarter of 2011. This translates into $0.74 of after-tax, economic net income per unit, more than double what we earned in the second quarter of last year.

The big driver of our strong results was a 5.1% increase in the carrying value of our private equity investments this quarter, which outperformed the S&P 500 and MSCI World Indices by about 800 and 1,000 basis points, respectively, and an even greater appreciation in our balance sheet investments, which were up 7% this quarter and 16.5% year-to-date.

Over the first 6 months of the year, our private equity portfolio has appreciated by about 14.5%, meaningfully ahead of the S&P 500, which is up 9.5%, and the MSCI World Index, which has increased approximately 6% year-to-date.

We're happy to review with you 3 exciting pieces of news for the firm. The first of these is the strategic partnership between Walgreens and Alliance Boots, in which Walgreens will acquire a 45% stake in Boots, creating the first global, pharmacy-led health and well-being enterprise. This transaction is a great reminder of how meaningful strategic exits can be for us, and while our work is certainly not done here, we think this is a wonderful first step. Bill is going to spend a few minutes reviewing the impact that this transaction has on our financials.

In addition, there are 2 strategic events this quarter, which we're excited to review. First, as announced in June, we've agreed to acquire Prisma Capital Partners, a leading provider of customized hedge fund solutions. And second, this morning, we've announced the formation of a partnership with Stone Point Capital to help further our third-party capital markets efforts. Scott will provide more detail on both of these strategic initiatives and their growth opportunities.

Finally, before we move on, I want to touch on something that we introduced in our last earnings call. We've decided to provide additional detail around our distributable earnings metric. As we have defined and reported this metric historically, it has excluded income generated from the balance sheet since it has been our intention to reinvest that capital in the business.

However, as we've seen some investors focus on this metric across the industry, distributable earnings under our historical definition did not represent the total cash earnings profile of our franchise, as any realized gains from the $5 billion of investments on our balance sheet would not be reflected in our reported distributable earnings.

To help better frame this, we've introduced 2 new lines in our press release. You can find them at the bottom of Page 6. The first is net realized principal investment income, and it includes realized investment gains from our principal investments, net of any realized losses, plus dividends and net interest income. This, combined with our legacy distributable earnings, equals the second new line, total distributable earnings. With the new disclosure, we hope to reflect the overall cash earnings profile of our enterprise on a comparable basis with others in the industry.

And with that, I'll now turn it over to Bill to walk you through the drivers of our performance and give an update on netting, and then we'll have Scott discuss the environment and what we've been focused on across our different business.

William J. Janetschek

Thanks, Craig. Good morning, everyone. Our assets under management was asked $61.5 billion as of June 30, down slightly from both last quarter, as well as the same time last year. Our AUM was positively impacted by the appreciation of our investments and the capital we've raised in the quarter. But this was offset by large distributions to our LPs as we continued to monetize our private equity portfolio.

We ended June with over $47 billion of fee-paying assets under management lagged from last quarter, but up 2% from a year ago. The year-ago increase was driven by capital raising in both the Private and Public Market segments. These figures do not factor in almost $11 billion in capital raised through closings to date from our first close of our North America Fund; our first close in Asia 2, which occurred this quarter; the portion of the Texas Teachers' mandate that has not yet been allocated to specific funds; and some other vehicles that pay fees only when capital is invested.

Turning to our segments. In Private Markets, fee-related earnings were $36 million, down slightly from both last quarter and last year. We do not have any termination payments this quarter, which are generated by portfolio company exits and can therefore cause spikes in our fee-related earnings. In the first 6 months of 2011, our fee-related earnings were augmented by $40 million of net termination fees associated with Seven Media, HCA and Nielsen, and this is the main reason for the year-to-date decline of fee-related earnings.

The 5% write-up in our private equity portfolio outweighed lower fee-related earnings in the quarter, translating into ENI of $175 million. This is up over 35% from the second quarter of 2011 but down from last quarter when our funds were up 9% compared to 5% this quarter.

Touching on Public Markets. Fee-related earnings were $12 million compared to $15 million last quarter and $21 million last year. The decline versus the prior period was driven by lower incentive fees, which more than offset any increase in management fees as we continue to grow our fee-paying capital in this segment.

Moving to Capital Markets and Principal Activities, fee-related earnings were $21 million for the quarter, up 5% from last quarter and up 20% from the second quarter of 2011. Despite the lower level of private equity transaction activity we're seeing, our Capital Markets business still performed quite well. We have benefited from this business's global footprint. About 1/3 of our revenue this quarter came from outside the U.S. Additionally, almost 40% of revenue was derived from our third-party initiatives.

We reported ENI of $365 million in this segment, driven by the performance of our balance sheet investments, which appreciated by 7%, outperforming our portfolio by 200 basis points. The outperformance of our balance sheet relative to our portfolio is largely due to the significant appreciation in Alliance Boots, Dollar General and HCA, where the balance sheet had additional exposure through its co-investments.

This strong performance translated into book value per unit of $9.28 at the end of June, up 7% from last quarter and the highest book value figure we reported as a public company. In total, our book value has increased 14% since the beginning of the year, including a 57% increase in unrealized carry to $660 million.

Total distributable earnings were $406 million for the quarter, which is the largest it has been in any quarter since we went public, up $570 million year-to-date, up 27% from last year. As Craig mentioned earlier, these numbers now include income from our balance sheet.

Total distributable earnings have more than doubled since last quarter and last year as we have started to see significant sales from investments on our balance sheet. This translates into $300 million of realized balance sheet gains in this quarter alone, which we plan to reinvest in our new business initiatives. Keep in mind, this $300 million does not include the impact from Alliance Boots, as that transaction has not yet closed.

This was an active quarter for us on a realization front, and our distribution benefited from carried interest we received from these exits. We fully exited Hilcorp and also closed on the sale of the El Paso joint venture. Because of the type of income these investments generate, they were structured in separate investment vehicles in the '06 Fund, so we were able to pay cash carry.

In addition, we earned some carry from co-investment accounts that invested in Dollar General alongside the '06 Fund. Approximately $0.02 of this distribution relates to these accounts. We also completed a Nielsen secondary offering at around 2x our money, which is in the Millennium fund and therefore generated cash carry.

In total, this translated into $0.06 of cash carry for the quarter, marking the ninth consecutive quarter where we've seen cash carry in the distribution. That carry, combined with $0.07 of fee-related earnings, equates to a distribution of $0.13 per unit.

Given the significant realizations we've had so far this year, the tax distribution that we would pay based upon activity year-to-date would be approximately $0.20 per unit. In addition, the first step of the Alliance Boots transaction will result in about another $0.10 a unit. So if there were no other realizations for the rest of the year, except for Alliance Boots, the year-end distribution would be at around $0.30. This figure can go up or down between now and year end, but given the size of the number, we thought that it was worth giving you an update on where it's been based upon what we know today.

And now on to netting. Since the timing of cash carry remains the topic where we know there is a lot of interest, I wanted to give you an update on netting holes and the progress we've made since last quarter's call. As we explained last quarter, there are separate partnerships in the '06 Fund for domestic and foreign investments, each of which have their own netting hole. As a reminder, we refer to the netting hole as the aggregate amount by which a fund investment are marked below cost, net of cash profits from sales of other investments.

Back in April, we disclosed the size of the '06 Fund's netting holes. At the time of our call, the domestic partnership netting hole and the overseas partnership netting hole stood at approximately $1.3 billion and $125 million, respectively. Remember, none of our active private equity funds have preferred return. So as long as a fund is marketed above cost in total and a netting hole has been filled, we are able to pay out cash carry when the investment is realized.

Let's walk through how this applies to the '06 Fund. The '06 Fund continues to recruit carry because it is marked well above cost, 1.4x our cost at the end of the second quarter, but 3.5x on a realized and partially-realized basis. However, as of June 30, there's still some netting holes to be filled due to write-downs and certain investments in the funds.

The domestic partnership netting hole has been reduced from $1.3 billion to about $1 billion when you factor in all the activity this quarter. This decrease was primarily driven by the gains from the June Dollar General secondary offering. To put that in perspective, the '06 Fund's remaining public positions at June 30 prices were valued at $3.3 billion. $2.5 billion of the $3.3 billion is profit, so we have a $1 billion hole versus $2.5 billion of embedded profits in our public investments alone. If we sold just 40% of the public positions, the domestic netting hole would be filled. And remember, this doesn't factor in the privately-held companies that make up about 2/3 of the remaining value in the '06 Fund domestic investments.

Turning to the '06 Fund overseas partnership, the netting hole was slightly north of $100 million as of June 30. The netting hole, however, does not reflect the impact of the Alliance Boots transaction, which we expect to close in the third quarter. Given questions on this transaction and the potential impact that this could have on netting, I want to give you a little more color on this.

If you apply the expected cash proceeds from step one of the Alliance Boots transaction, not only would we fill the '06 overseas netting hole on June 30 evaluations, but we'd have approximately $500 million of excess gains. So we'd actually pay out about $100 million of carry, or about $0.08 a unit net of the carry pool.

In addition, we have some carry-paying co-invest vehicles that are invested in Alliance Boots, from which we would earn about $0.02 of carry. In short, if step one of the Alliance Boots transaction closes, we would not only fill the '06 overseas netting hole, but we would expect to pay out a total of approximately $0.10 of cash carry per unit, and we will have returned approximately $2 billion of cash back to our investors.

We also wanted to help you think about netting as it relates to our second European Fund or Europe 2, since the fund is now valued above cost. At the end of the second quarter, E2 is marked at 1.1x cost. It is therefore accruing, but not paying cash carry. As of June 30, the Europe 2 netting hole is approximately $1.3 billion. And if you included the expected proceeds from step one of the Boots transaction to this fund, the number would be reduced to about $1 billion.

In summary, we feel good about our continued progress across our funds and remain focused on increasing the percentage of our assets that are in position to generate cash carry, distributable earnings and ultimately, cash distributions to our unitholders.

I'll now turn it over to Scott.

Scott C. Nuttall

Thanks, Bill. Well, it has certainly been an interesting last few months. As we look around the world, we've seen the U.S. consumer pull back, European sovereign concerns continue and slowing growth in Asia. This economic and market backdrop is tough to navigate, but it is providing us with compelling investment and business development opportunities.

Like past quarters, I thought it'd be helpful if I take you on a quick walk around the firm to give you a sense of the activity we're seeing across our businesses where you're going to hear a lot of consistent themes from the last few quarters, with a number of transaction and strategic announcements that helped support these themes.

Let's start with private equity. If we look across our private equity businesses, transaction activity continues to vary by region. Asia remains busy as our private equity team continues to find attractive investment opportunities. In the second quarter, we invested over $100 million in 2 investments: TVS, a logistics company in India; and China Cord Blood. We also announced an investment in GenesisCare, an Australian medical services company.

In Europe, we continue to be more active in the U.K., Germany and northern Europe relative to southern Europe. Last quarter, we closed on $150 million investment in Fotolia, a provider of digital services. Also, since quarter end, we've announced the acquisition of a majority stake in WMS, a German consumer products business.

In North America, we announced $100 million investment in Sonus last quarter. Overall though, transaction volumes in North America remained low. CEOs and boards are focused on the uncertain global economy and questions on areas like tax and regulatory reform. We have, however, seen a pick-up in activity over the last few months and are actively looking at a number of opportunities.

In addition, the capital markets are open for the right types of transactions, but it remains difficult to predict how many of these deals will actually get done.

On the private equity business development front, this past quarter, we established a presence in Latin America, with the appointment of Henrique Meirelles, former governor of the Central Bank of Brazil, as a senior adviser to the firm. We believe that his knowledge and expertise will add tremendous value to our global portfolio. We're excited about the prospects for the region as we build out our efforts, beginning with the planned office in São Paulo, Brazil.

Now turning to our private equity portfolio. The punchline is we continue to focus on growing revenues and improving operating margins. And on a trailing 12-month basis, the revenue and EBITDA of our companies grew 7% and 6%, respectively. And if you actually weight the performance by the amount of equity exposure we have to each company, revenue is up 10% and EBITDA is up 9%.

And the progress we've made at the company level is translating into fund performance. In aggregate, our contributed private equity funds are currently marked at 1.6x cost, and it's 2.8x cost on a realized and partially realized basis. Our funds have appreciated 14.5% year-to-date, significantly outpacing the MSCI World by over 800 basis points.

In terms of realizations, we have a saying internally that if our portfolio of companies perform, exits tend to take care of themselves. Dollar General and Alliance Boots are great examples of this. Last month, we executed our fourth Dollar General secondary offering in the last 9 months, all of which were priced at higher valuations than the last, with the most recent transaction at over 5x our costs.

This quarter, we also executed some strategic exits. Most significant was the announcement of Walgreen's acquisition of a 45% interest in Alliance Boots. Boots is the second largest investment in our funds, with over $2.1 billion invested in our '06 Fund and Europe 2, plus approximately $400 million in carry co-invest vehicles and an additional $300 million of co-invest from our balance sheet.

The company has a strong management team who has driven exceptional performance since the 2007 acquisition, growing EBITDA at a 10% annual growth rate. This is a meaningful transaction for us. Last quarter, we held Alliance Boots at 1.1x our costs. It's a very complicated transaction structure. The bottom line is that this quarter, we're marking Boots at 1.9x our costs. As a result of the transaction being announced but not yet closed, we are accruing income in our financial statements this quarter based on the 1.9x valuation.

There are 2 main consequences of this write-up of Boots. The first is that our funds have been marked up meaningfully by $1.6 billion. And when you combine that with the carry paying co-invest vehicles, it's around $2 billion. This results in accrued net carried interest of more than $200 million in the second quarter.

The second is that our balance sheet has increased in value by over $250 million. Said simply, Boots contributed approximately $450 million of pretax economic net income in 2000 -- in Q2. This is all on a noncash basis since the transaction has been announced but is not yet closed.

We expect step one of the Boots transaction to close in the third quarter, which will have a substantial cash impact in Q3. We expect the 2 main components of the cash impact to be first, a carry distribution of about $0.10 per unit, which we expect to pay as part of the third quarter distribution. The second is significant cash coming back to the balance sheet of approximately $250 million, representing $130 million of realized gain, which will increase both our total distributable earnings, as well as our cash balance. This all relates to step one of the Alliance Boots transaction, and we will keep reporting back over time as we get closer to step 2.

We also closed on the sale of the El Paso joint venture to Kinder Morgan this past quarter. This JV, focused on midstream investments, was established in December 2010. And like some other recent private equity energy investments of ours, namely E3 Sources and Hilcorp, was sold at an earlier stage in its life cycle than we anticipated, but at an attractive return. After only 18 months, we sold the JV to Kinder Morgan at around 2x our cost, generating an IRR in excess of 60%.

From a fund-raising standpoint in private equity, we've had a $3 billion first close on our Asia 2 fund, a terrific start to a fundraise that was launched back in December of last year, and we remain focused on fundraising for NAXI.

Now into energy and infrastructure. Here, we continue to be active on the investment front. Back in April, we purchased proved developed producing properties from WPX Energy in Texas and Oklahoma. We invested over $130 million in this transaction, which was the sixth investment by the KKR Natural Resources Fund, or KNR.

In addition, we held closes on our KNR and Infrastructure Funds in the quarter. So at this point, including the funds and the separately managed accounts, we currently manage $4 billion of AUM across these strategies that did not exist 2 years ago.

We remain focused on scaling our energy and infrastructure businesses. Most recently, we've created an energy income strategy that will invest in less-developed oil and gas fields plus royalties in energy-related mezzanine transactions, all with a meaningful yield component.

Now turning to our Public Markets segment. Our tradable leveraged credit strategies maintained top quartile performance since inception, and our mezzanine fund and special situations vehicles have posted gross IRRs in the range of 13% to 18% since inception.

Our solid track record here has enabled us to continue to raise capital, adding an additional $500 million across various strategies this quarter. This includes an additional close for the KKR Lending Partners fund during the second quarter, bringing the total fund size to approximately $300 million.

Fundraising dialogue with our investors remains focused on our leveraged credit strategies in back loans and high yield, as well as our special situations and direct lending strategies, in particular.

In an effort to further expand our credit platform, we recently announced that we filed with the SEC to offer 2 new products in our Public Markets businesses: a high-yield mutual fund and a closed-end credit opportunities fund. Upon effectiveness, these new products will provide retail investors, including registered investment adviser clients, an opportunity to invest in alternative assets.

Our firm's most recent experience in the retail market is with Corporate Capital Trust or CCT, a business development company that we sub-advised which was launched last year. We're pleased with CTT's progress to date as we have seen AUM grow from approximately $250 million at the end of Q1 to approximately $425 million at the end of Q2. We're excited about the opportunities for us to offer our growing suite of liquid alternative products to individual investors.

Finally, in our Public Markets segment, I want to spend a few minutes on the liquid alternative space and the Prisma transaction. We've been interested in the hedge fund-to-fund space and expanding our liquid alternatives for several years now. And we think this is a business where you can benefit from having immediate scale.

Prisma's $8 billion in AUM will allow KKR to further penetrate the over $2 trillion hedge fund market, which is benefiting from growing institutional allocations. The team's track record is quite impressive, and their ability to deliver strong returns and differentiated, customized solutions to their clients has translated into AUM growth. Prisma's assets under management have nearly doubled since 2009.

We feel very good about the deal construct. We expect to pay some upfront consideration, most of which will go to take out AEGON, and all after-tax proceeds received by the management team will be reinvested in the funds and subject to a 5-year lock-up. This ensures a longer-term management commitment and aligns the team's interests with their clients.

There's also an earn-out component payable 2 and 5 years after the closing that has been structured to be accretive to the firm. All of this is subject to the transaction closing, which we anticipate in the fourth quarter.

The growth avenues Prisma provides are very interesting. It increases our breadth of liquid product offerings, supplementing our current direct hedge fund efforts through KES and our liquid credit products, increased distribution opportunities through introducing Prisma to KKR's client base as well as cross-selling KKR's products to Prisma's clients.

Just to give you some statistics. As of July, KKR has approximately 425 clients. When you look at Prisma's client base and focus on the institutional portion, they currently have about 120 clients, and there's very little client overlap with KKR. Just to give you a sense of Prisma's 50 largest clients, only 2 are KKR investors. This cross-sell opportunity which goes in both directions is exciting for us. It just gives us another way to win.

Perhaps most importantly, the transaction leverages a strong cultural fit between our 2 organizations. We have a shared vision about how to build our hedge fund platform over time by offering our clients solutions that cut across the entire liquidity and risk spectrum.

So as we think about our hedge fund businesses today, we have a direct investing platform that consists of our KES team, which is our long, short equity strategy.

We're also analyzing other potential direct hedge fund opportunities. Hedge fund-to-fund is the next part of our platform, and the addition of Prisma is integral to achieving our hedge fund vision. We believe the Prisma team can help identify and diligence other hedge fund teams and platforms for the firm and help us grow in this space.

So what does this all mean? Well, our $8 billion in hedge fund-to-funds will complement our existing $16 billion of credit AUM, yielding $24 billion in total AUM in our Public Markets segment. We will now have a scale offering in liquid credit, alternative credit, direct hedge funds and fund to hedge funds, and will be well-positioned to help our clients interested in getting exposure to liquid alternatives.

The other recent piece of strategic news is our partnership with Stone Point Capital to capitalize and scale our third-party initiative within our Capital Markets business. We continue to see dislocation in the capital markets as regulatory concerns heighten and markets remain volatile. Dodd-Frank, Basel III, Volcker-- all impact the ability of banks to extend capital. We are committing $150 million from our balance sheet, together with $150 million from Stone Point's Trident V fund to jointly form a partnership to provide capital market services to third-party companies and sponsors to help them achieve their objectives. We will manage and operate the partnership on a day-to-day basis, and we'll share board and governance rights with Stone Point.

So it's been a busy quarter. When you look back on all that's happened, we see 3 things of note. First, we've continued to create value within our Private Equity portfolio, which is leading to more carry and more distributions. Alliance Boots is a great example of this and demonstrates the power of carry in our business model. Second, the Prisma acquisition increases our scale and relevance in the hedge fund space, which has been an important part of KKR's longer-term strategy. This development, plus the introduction of 2 investment products for individual investors, will help us further scale our Public Market platform. And lastly, our JV with Stone Point will allow us to further develop our third-party focused capital market efforts in a capital-efficient manner.

So against the uncertain macro backdrop, we feel good about the progress we're making and great about the opportunities in front of us. Thanks for joining the call and we're happy to take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question from Howard Chen with Credit Suisse.

Howard Chen - Crédit Suisse AG, Research Division

You had some great monetizations, and I realize you still have a lot of significant competitive gains associated with those positions, Scott. But how do you think about the next tier of the monetization pipeline? Maybe some thoughts on some of the more recent vintages and how close you see them to an event and monetization?

Scott C. Nuttall

Sure. Thanks, Howard. Look, I'd break it into a couple of buckets in terms of access to liquidity and exits. The first is, we obviously have a meaningfully sized public portfolio and our private equity funds. We have-- about $9 billion of our private equity portfolio is in companies that are already public. Many of which we've already started to execute secondary offerings, so that I think is kind of the most visible form of liquidity coming back. Secondly, and we talked about it on prior calls, we're seeing some pick-up in the strategic activity. Boots is a great example of that, but if you think back, we've had Hilcorp, we've had East Resources, we had -- and we've had Seven Media in Australia. There's been a series of strategic exits. And if you think about our portfolio, we're getting into the more mature phase for a good portion of our assets under management in our Private Equity business. So the transactions that were done, kind of call it 3, 6 -- 3 to 6 years ago are getting to the phase where we can start to think about monetizations. And the reason that we share the EBITDA and revenue growth statistic every quarter is that's what we keep an eye on, because we find that if we can keep growing EBITDA, we're able to find exits for those companies. So it's hard to be precise as to timing, but we feel like we're making progress.

Howard Chen - Crédit Suisse AG, Research Division

Understood. And then my second question, the firm's been less acquisitive than some of your peers. Clearly, Prisma is kind of a change in that. So I'm just curious where else do you see opportunities where it may make sense to do something via an acquisition versus pursue it or de novo.

Scott C. Nuttall

Yes, I think -- just to be clear, it took us about 36 years to do our first acquisition. And so Prisma is the first one we've actually done as a firm and all the other growth we've had has been organic and hiring talent into the firm. Look, the way we think about this, Howard, is we -- if you think about KKR today, we've got our Private Equity platform, we've got energy and infra. We have real estate, credit, hedge funds and capital markets. And as we've continued to look across our platform, really the one scale business we have continues to be Private Equity. Everything else, we have opportunities for meaningful growth. And a number of those businesses have been started in the last few years. So our tendency will continue to be organic growth across those different platforms. But as we look to scale globally across those different businesses, we'll look at acquisitions from time to time, and we will consider growing both inorganically as well as organically. But it's taken us a bit of time to do the first one. There's nothing imminent in terms of a second, but we will look across all those other platforms and see if there's anything interesting out there where there's a good cultural fit and a good strategic fit.

Howard Chen - Crédit Suisse AG, Research Division

Great. And then finally for me. On Stone Point, maybe I just need to learn a bit more about it. But I'm just curious, what does the JV exactly bring or accelerate that you couldn't do on your own?

Scott C. Nuttall

I think it's a couple of things. One, we were finding a lot of opportunity in the middle market, Howard, to provide capital to both companies and sponsors. Frankly, what we hear from our clients in that space is that the banks have pulled back meaningfully from the standpoint of providing capital. And so as we've been out with our Mezzanine business, our direct lending business and our Capital Markets businesses, we hear that as a recurring refrain. And so the first thing that the JV will provide is dedicated and incremental capital to provide services and balance sheet to that part of the market. So you'll see us underwriting debt, you'll see us underwriting equity, you'll see us providing other services to those companies. A lot of this, frankly, we were already doing as part of KKR. And Bill mentioned 40% of our Capital Markets revenues in the quarter were actually from third parties. But this joint venture will allow us to have a dedicated pool of capital and a dedicated effort against that third-party space. And so we'll be putting $150 million in, we're partnering with Stone Point, and they'll do the same, and we'll seek to grow the business together. I think the other thing it provides us is a great partner. And Stone Point has a lot of access to sponsors and companies in the middle market space. They've built financial services firms over their long history, and so I think they will be able to bring their own relationships and business to bear as we seek to grow the third-party business further. So I think -- well, we view it as an opportunity to have a great partner, have a dedicated effort in the space and really provide more capital and services to the middle market, which is sorely in need of it right now.

Operator

And we'll take our next question from Michael Kim with Sandler O'Neill.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Just first on the marks this quarter, can you just talk about the different moving parts under the surface as it relates to the public companies, the privates, as well as the Alliance Boots transaction?

William J. Janetschek

Okay, sure, Michael. This is Bill Janetschek. We drill down on the details. When you take a look at our public portfolio, we were actually up about 0.3%. So even though the S&P was down 2.8%, we still, even just on our public marks, over-performed. When you take a look at the private, if you actually excluded Boots, then the most part, our private portfolio would be relatively flat to a little down. So overall, the way to think about it is we got a significant uplift in this quarter from the Boots write-up from $1.1 billion to $1.9 billion, which Scott mentioned earlier, as well as a little bit of an uplift on our marks on our public positions.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Got it, that's helpful. And then more of a bigger-picture question, but as you start to increasingly scale some of your newer complementary businesses like hedge funds, energy and infra, real estate and the new retail funds, how much success are you having getting existing clients to invest with you for a new strategy? Are they comfortable with your ability to generate returns across businesses where you might not have had a track record or historical expertise?

Scott C. Nuttall

Thanks, Michael, it's Scott. We've had quite a bit of success on that front. And one of the things we monitor is, kind of, our cross-sell statistic, which continues to move up. But we've been quite pleased. What we used to do historically, frankly, before we expanded into these newer businesses, it's been 8, 9 years ago now, is we used to just talk to the private equity staff within institutional investors. And what we've done now is we've moved up meaningfully, and now we're talking to chief investment officers, we're talking to heads of fixed income, real assets, equities, real estate, the public side and the private side. And so we've been able to kind of share our expertise and our perspectives with institutional investors in a much broader fashion. And so the conversations have really changed. Whereas before, it was solely PE, now it's how should they think about asset allocation, where is the world going. And we have our macro team, which is spending a lot of time with investors on that. And then we really plug them into all of KKR. And so we've been really pleased with the receptivity of our investor base to several of these newer businesses. And as we've scaled capital across credit, energy and infrastructure, hedge funds, et cetera, we have seen quite a bit of support from that client base.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Okay, great. And then just finally, I haven't talked about it in a couple of quarters, but just can you give us an update on KES in terms of fundraising and maybe some performance trends you're seeing there.

Scott C. Nuttall

Sure. KES, the reason we didn't mention, not a lot new this past quarter, Michael. So there's not a lot to report. Frankly, given the choppiness of the markets, we decided a quarter ago to pull back a bit from third-party marketing. As you know, we started with our own balance sheet capital, raised some external capital and then decided, let's just focus on performance. We've been really happy with the performance so far. The team is meaningfully outperforming the equity long short peers in what's been a really choppy market. So as we kind of get back into the marketing mode in future quarters, we'll give you a fulsome update. But our perspective on this is, if we have the performance, dollars will flo,w, and that's really been the focus the last few months.

William J. Janetschek

And Michael, just putting a number on that. Right now, as of June 30, capital that's managed by KES is a little north of $400 million.

Operator

And we'll take our next question from Bill Katz with Citigroup.

William R. Katz - Citigroup Inc, Research Division

Okay. Most of my questions have been asked. But just sort of curious, as you think about where you are now in the life cycle platforms and these external additions plus sort of scaling some of the other nascent businesses, what's your thought process on the growth of fee-related earnings? Is there some still heavy lifting to do on expenses, or should we anticipate a little margin improvement for FRE?

William J. Janetschek

Well, I'll tackle the expense question first, and then maybe I'll slip it over to Scott as it relates to the revenue growth. But if you take a look on where we've been on expenses, year-to-date, we're actually, for the first 6 months, down slightly. And that's with, remember, bringing on a lot of people in 2011 and 2012. So we've been pretty deliberate on managing expenses. And I don't think you're going to see a whole lot more margin improvement as it relates to expenses. On fee-related earnings, obviously, we've just launched a lot of these platforms. And so when you take into account a few years from now, we're hoping that the second fund is going to be bigger than the first fund. Take for example, Mezzanine Fund or infrastructure. So you know how it works, Bill, in that you have an existing fund. Once you go through the investment period, you're going to receive a post-investment period beyond that fund, as well as then taking on to your fee-related earnings a new fund at an investment period fee. So we hope to see significant growth on the new initiatives that we've launched. Another point is that we've brought on a real estate team, and the goal is to eventually launch a fund. Right now, there's no income being generated from the real estate team as it relates to fee-related earnings. But again, we were optimistic that we're going to be raise a fund and bring that strategy online, and that will actually increase fee-related earnings as well.

Scott C. Nuttall

Yes. Bill, it's Scott. I guess the way I would think about it is we've invested a lot in establishing these new platforms. So we have a significant amount of expense running through our income statement with the associated revenue not there yet. So most of that has been done. We are still investing in some areas. We're still focused on building our distribution team. In our Client and Partner Group, we're continuing to look for new direct hedge funds. We're continuing to invest in real areas, like real estate. But I would tell you that I'd say the vast preponderance of the investment ahead of revenues is done. And as we raise first-time funds, and to Bill's point, critically second- and third-time funds, we'd expect there to be positive operating leverage.

William R. Katz - Citigroup Inc, Research Division

That's helpful. And so big picture question with the sort of push into retail. Can you talk a little bit about how that came to pass, whether that was sort of a pull-forward from the retail distributors or your decision? And what kind of anticipated growth would you be thinking for in there?

Scott C. Nuttall

Yes. I think it's hard to get specific on growth. Maybe the way I'd characterize it, Bill, the way we think about our strategy for distribution generally is historically, we focused exclusively on institutions. And the way that we think about the world, there's $35 trillion, give or take, of third-party managed assets held by institutions. And so that's predominantly been our focus, in trying to be more relevant to that group. But there's also over $20 trillion in retail hands. And historically, KKR had not spent time talking to individual investors. About 18 months ago, we started a high net worth and family office platform and started the process of actually talking to individual investors directly for the first time. And that has actually proven to be quite successful so far, and so that's been a very good experience. And so that's kind of part 2-- is high net worth family office has been kind of a more recent focus. And we spent a lot of time thinking about the retail space as part of that because the vast preponderance of that $20 trillion that's out there is actually in individual hands. And you've heard us talk on prior calls about why we want to have more liquid alternatives. One of the reasons is it's -- we think it's of interest to institutional investors, but we think it's also highly of interest to individual retail investors. And so what really drove this was our broader thinking about where pools of capital are in the world and what those pools of capital need right now in this very low rate environment and this volatile stock market environment, and we think a lot of the products that we offer in the alternative space could be quite relevant and helpful to those individuals. That's really what drove it. And so this is an initial foray. It is hard to predict where it's going to end up for us, but we think it's a big market, and we're going to work away, and we'll keep giving you updates.

Operator

And we'll take our next question from Chris Kotowski with Oppenheimer.

Christoph M. Kotowski - Oppenheimer & Co. Inc., Research Division

Maybe I missed it, but I wonder if you could give us an update on the commitments to NAXI. In the beginning, you said something like that there was $11 billion of committed funds that is not yet in fee-paying AUM. Did I get that right, and is that including NAXI, or what was that?

Scott C. Nuttall

Sure. Chris, it's Scott. The $11 billion that we referenced was really made up of 4 components. The first is the $6 billion initial close that we had announced in NAXI earlier this year. Then there's the $3 billion first close that we had for the Asia Fund. The third component, the $1 billion or so of the Texas Teachers strategic partnership, has not yet been committed. And then the fourth component is a kind of accumulation of a series of mandates that we have where we don't get paid economics until the dollars are actually invested. And so think of that as committed funds, and as we make investments, the fees will turn on. And so that's the $11 billion. And then on top of that, once we close the Prisma transaction, there'd be another $8 billion on top of that number. So that's kind of what you can think of as AUM that is coming on a gross basis. But more broadly, maybe across fundraising, generally, I'd say the way we look at the world right now, people want Asia, they want energy and they want yields. So if you think about what's happened this quarter, our energy business, we had KNR and infra closed. We've now got $4 billion in that platform, quite a bit of institutional receptivity to what we're doing in the energy space. Credit, we continue to scale that business, and you can see the fee- paying AUM continue to grow there. So it's all consistent. Our Asia Fund, we had a $3 billion first close after 6 months. It was, frankly, a faster and larger close than we had anticipated. And so just to give you a sense, we're really happy. 45% of the investors in that first close are brand new investors to KKR, period. That's only about 13% of the capital, but it's 45% of the number of investors. So the Asia 2 fund is off to a great start because we've got a lot of folks working behind that. But your question on NAXI, we had our first close in February. We were quite pleased with that first close, given the challenging environment for this type of fund. We have until February 2013 for a final close, and so we're working our way on that. Our perspective is it's a great time to be investing in North American buyouts. But the selling process is a bit prolonged because we're still investing the 2006 Fund. So as investors think about making commitments it's -- there's no rush per se. So there's been no material close in February, and we'll give you an update next quarter. It's just hard to predict where things will end up.

Christoph M. Kotowski - Oppenheimer & Co. Inc., Research Division

Okay. And do you ever have interim closes before the final close, or between the first and the final, or is our next data point in February 2013?

William J. Janetschek

No. The next data point where we'll really communicate a number to you will be for sure on September 30, because on September 30, that's when the investment period will end for the '06 Fund and the NAXI fund will turn on. And so just to give you some clarity on what the fourth quarter is going to look like, we'll report to you what the NAXI number is as of September 30.

Christoph M. Kotowski - Oppenheimer & Co. Inc., Research Division

Okay, great. And I wonder, so you have about $1.5 billion in uncalled commitments left in the '06 Fund. Do you anticipate that -- is that primarily there for other newly initiated transactions? Or is some of that reserved for follow-on transactions in companies that you may already be invested in?

William J. Janetschek

Chris, this is Bill. You're right. You're referring to -- on Page 19, we've got about $1.5 billion of dry powder in '06. About half of that, we're going to keep for reserve, and the other half, we're going to use to make probably 1, 2, maybe 3 investments in between now and the end of the investment period.

Christoph M. Kotowski - Oppenheimer & Co. Inc., Research Division

Okay. And then, any -- are there any updates you can give us on some of the companies that are marked below cost, either in terms of fundamentals or refinancing efforts on some of them? If you can, you can, but...

Scott C. Nuttall

I don't think there's a lot of incremental detail we can provide, Chris. Some of those companies will be reporting their own earnings in the next couple of weeks.

Operator

We will take our next question from Matt Kelley with Morgan Stanley.

Matthew Kelley - Morgan Stanley, Research Division

So I just wanted to ask about -- as you think about how to fund future growth beyond -- obviously, you've been busy in the last quarter or 2 and with today's announcement, but how do you think about your balance sheet investments, how mature they are? And could we see another wave of potential future growth once some of those investments get into kind of exit mode, especially from the KPE investments?

William J. Janetschek

Matt, this is Bill. Obviously, if you take a look at our balance sheet, we've got about $5 billion invested in, predominantly, private equity investments. But that percentage has come down quite significantly since we've gone public. Over the next several quarters, we would hope to and anticipate more realizations off our balance sheet, and that would give us more liquidity. But right now, if you take a look at where our balance sheet stands today, we've got about $1.2 billion in cash, and we've got reported commitments in the press release of about $600 million. But when you think about all of the other things we've mentioned either today or on prior calls, where we've committed $300 million to real estate, we made a significant commitment to NAXI, which isn't reported in that number, same holds true for Asia 2, as well as commitment to Special Situations, as well as making a commitment to the energy strategy. That number tallies anywhere in between $1.6 billion and $1.7 billion. So although on our balance sheet it looks like we're liquid, we are liquid but with a lot of commitments. What I will tell you is that we will -- and we have monitored the liquidity on our balance sheet. And to the extent that if it ever got to a point where we couldn't deploy capital at a very attractive rate of return, we would think about making a tweak to our distribution policy. But for what we've got in the pipeline right now, we don't think that, that policy is going to change anytime soon.

Operator

And we'll take our next question from Marc Irizarry with Goldman Sachs.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Just sticking with the balance sheet for a second. Can you guys help us understand, obviously, it's a lot of capital that you have at the GP level. In some of the new strategies, do you expect that you'll start off with bigger co-investments than you -- in the new strategies such as real estate? Were you going to start off with bigger co-investments in more your own capital sort of devoted for those strategies? And how should we think about the returns that you can generate on that capital versus returning it to shareholders?

Scott C. Nuttall

Sure. Mark, it's Scott. I think the answer is yes. The newer strategies, we are dedicating more balance sheet capital to them. For example, real estate, we've committed $300 million off the balance sheet ahead of having a fund basically to build a portfolio and start to build a track record in that space. And then we'll go out at some point and talk to third-party capital about joining us in that endeavor. Same thing in energy. We've committed $300 million to a variety of different energy strategies to continue to scale the energy and infrastructure business. And as we've launched new credit funds, you've seen us do the same thing. So we do view the balance sheet as a real competitive and strategic advantage for us, and we've been using it to scale a number of our businesses organically. And it makes a big difference. When you go talk to an institutional investor and you tell them that we're going to commit $300 million, do they want to commit $100 million? It's much more compelling than if we ask them to commit $100 million and we commit $300 million. So we found that it's helping to drive this new business formation and accelerate our growth. In terms of how we think about the returns, we really like the returns we're getting off our balance sheet. I mean, you heard in the first half, our balance sheet's up 16%-plus, and that's just in 6 months. And so we have a number of investments there that are still seasoning. We think there's a lot of upside in those balance sheet investments. And frankly, when we look at the ROE we're able to get from seeding new businesses, if you think about just seeding a new fund with $100 million in capital and if you only raise $1 billion of external capital and you work through the math, the ROE is something like 40% or 50%. And so we really like those economics, both from what we already have and what we're doing with the capital, which is why we're pursuing this strategy.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Great. And then I guess a question maybe for Bill. I guess we've got a good taste to what the gross AUM will look like in terms of the $11 billion in shadow AUM, if you will. What about the outs from some of the distributions? How should we think about sort of what the fee paying AUM would look like, net of maybe the Boots transaction? How do you sort of enter this quarter in terms of fee paying AUM?

William J. Janetschek

Well, Mark, you are right. When Scott gave you the AUM and fee paying AUM, that is the growth on mind with both the NAXI and Asia 2. What will also happen is when Asia and '06 goes from the investment period to the post-investment period, we're going to be getting paid not on the investment capital rate but the post-investment capital rate, and it will be on just the capital that's invested at that time. And so just to give you an idea on NAXI in particular, when NAXI comes online based upon what we've disclosed to you of the capital raised to date of about $6 billion and the '06 Fund rolling from the investment period to the post-investment period, that will happen in the fourth quarter of 2012. You're going to see fee-related earnings stay relatively flat on that crossover. With regard to Asia, we've already mentioned that we've already raised $3 billion on our first close, and that fund won't actually come online until we invest through the rest of the Asia Fund. And so that could happen maybe in the fourth quarter or the first quarter of 2013. But there, we haven't sold many investments in Asia. And so the step-down of the assets, of fee paying assets under management isn't going to be a significant drop. And what we are going to do is pick up the entire capital commitment to the Asia 2 in the quarter that, that crossover takes place.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Understood. And then the -- when you said flat for the fourth quarter, does that assume the '06 Fund, does that assume that the Alliance Boots cost base is out or that Alliance Boots is out of the '06 AUM?

William J. Janetschek

Mark, I don't want to get too granular on the question. I mean, what I'm saying to you is just directionally, and that would be taking into account the Boots.

Scott C. Nuttall

Yes, I think, Mark, to be really clear, what Bill was talking about is the management fee impact, the revenue impact, of the '06 Fund rolling into the NAXI fund. So we're not suggesting to you that we think fee-related earnings are going to be flat in the fourth quarter. We don't know what they're going to be in the fourth quarter as we sit here right now, given transaction activity is going to drive a lot of that. It's purely a management fee revenue point based on the $6 billion that we've announced and disclosed so far.

William J. Janetschek

Right. And clearly just on the impact from '06 and '06 going from the investment period to the post-investment period and NAXI turning on.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Understood. And then Scott, I don't know, can you give us just a little more on Prisma? I don't know if there's any financial details that you could share with us or the transaction itself. Just trying to get a sense, I guess, of-- with all the capital that you do have for at the GP, how you think about the restructuring these deals or sort of what -- what sort of -- what your tolerance is for how much capital you want to spend on the acquisitions?

Scott C. Nuttall

Sure. Look Mark, we haven't disclosed the details of the acquisition. So I'm not going to be able to give you any economic numbers, per se. But the way we think about it is in some of our businesses, we do think that acquisition can be an interesting way to get some scale. And the Prisma acquisition is one that, frankly, we've been working on for the better part of 2 years. There is a historical relationship between the principles of Prisma and some of the senior folks here at KKR. So there was a real familiarity with the individuals, and frankly, a cultural similarity that made this feel quite good to us. The way that we think that these transactions should generally be structured as with a lot of value on the back end as opposed to a lot upfront. And so that's generally the construct we've come up with. So a lot of the value is in the earnouts, which have been structured to be highly accretive to us. And as we think about growing the rest of the KKR through acquisition, I think you'll find that we'll probably pursue a similar approach, some upfront value but more on the back end so their incentives are in line with all of ours.

Operator

[Operator Instructions] And we will go next to Roger Freeman with Barclays Capital.

Roger A. Freeman - Barclays Capital, Research Division

Just to come back to the-- sort of the cash balance commitments, et cetera. I mean, as you kind of look forward, as the KP investments liquefy, I mean, did you think that the way that you're thinking about this is, is that you'll be growing new funds, et cetera? That eventually, you'll have $5 billion-plus, maybe less, some capital used for upfront payment on acquisitions, but the bulk of that is going to be sitting alongside various funds that you have launched or are launching.

Scott C. Nuttall

Yes, I think that's generally right, Roger. I would say it's probably 3 uses. The first is to seed new businesses and invest alongside our institutional and other partners in our vehicles. The second would be to support the growth of our Capital Markets business, where we do selectively take some capital risk to drive the fee growth. And the third would potentially be to the prior discussion, acquisitions. So I think you'll see the balance sheet probably over time look more like the distribution of our AUM. Right now, it's highly private equity-focused because of the legacy KPE strategy. But over time, I think you'll see it be far more diversified, and our hope is also to start to generate a more recurring yield.

Roger A. Freeman - Barclays Capital, Research Division

Okay.

William J. Janetschek

And Roger, you've seen that to date from when we went public, I had mentioned this earlier, if you take a look at the components of our balance sheet, we're much more diversified today away from private equity than when we were -- when the transaction closed because I think when we actually closed the transaction, 97% of our balance sheet was in private equity. And now we've provided the details to you, yet you could see that, that percentage away from private equity has increased significantly.

Roger A. Freeman - Barclays Capital, Research Division

Right, okay. And then just more broadly speaking on reg opportunities. You mentioned -- and your Stone Point comment kind of reminded me of something I was thinking about with Blackstone last week. Some of the other businesses, traditional businesses within the dealer space, I'm thinking commodities, for example, other structured businesses, are getting a lot tougher, given, particularly, Basel 2.5 and 3. And I'm wondering if any of those types of businesses can be of interest to firms like yours that can be structured inside of funds. And one of the things that Tony James had said, which was a fair point, is that putting a business inside of a fund in a traditional sense, do you have some sets on those? And how do you put an ongoing business into a fund. I'm wondering if -- how you think about that or if you did something you think about and whether you could do it if you could provide some sort of secondary liquidity for investors, either that you would provide or facilitate a secondary market and actually have a fund that just kind of continues to run.

Scott C. Nuttall

Sure. Roger, it's Scott. I think -- look, the way that we think about this, it's frankly consistent with how we think about all of our strategies as a firm. And the first question that we ask is, can we do it well by having it integrated with the rest of KKR? And frankly we're good at. And so providing capital to middle market corporates and sponsors up and down the capital structure is very straightforward, something we understand. We've been providing capital to companies for 36 years. That's something that's right down the middle of the fairway. When you get into some of these more esoteric businesses, different trading businesses, commodities, other things, frankly, it stretches the strategic logic to such an extent that I don't think you're going to see a lot of activity from us there. We're going to continue to stay focused on things that, frankly, go back to those core principles that I mentioned.

Roger A. Freeman - Barclays Capital, Research Division

Okay, helpful. And then on netting holes, just quickly, when you cross those, say, in a European Fund, do you automatically -- do the cash -- does the cash carry automatically kick in? Or is there discretion if you're kind of close but yet over where you decide to hold back on the distributions just to keep a buffer.

William J. Janetschek

No, I mean it's quite mechanical. What we've got is based upon the partnership agreement. When we sell an investment, you take a look at the portfolio. And if any portfolio investment is carried below cost, you have to return capital to our LPs or rather until that number goes to 0. Once you cross over that point, the rest of the profit is going to go 80-20. So we know exactly what the netting hole is each and every fund at the end of each quarter. And as long as we have a realization, we satisfy that netting hole. The remainder goes out 80-20, and that turns into a cash carry.

Roger A. Freeman - Barclays Capital, Research Division

Okay. And lastly, you talked -- you mentioned Brazil and establishing spreads there. How are you thinking about that opportunity set? I mean, could we see a Brazil fund in the next year or 2?

Scott C. Nuttall

Hard to predict. It's nothing planned in the near term, Roger. It's -- I think what you'll see us do is invest in that part of the world out of the North American Private Equity funds, and NAXI is predominantly going to be investing in that part of the world for us in the near term.

Operator

We will take our next question from Robert Lee with Keefe, Bruyette, & Woods.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

This is -- most of my questions have been asked, but I'm just curious to know with the Alliance Boots transaction, has that at all impacted, or changed or influenced any of the conversations you've had with-- whether it's fundraising and the NAXI or any of the others? I mean, or is it really just kind of that's what the perspective LPs perspective is, so it's kind of business as usual? Or has that somehow influenced how people are thinking about the space and return profiles and opportunities?

Scott C. Nuttall

Robert, it's Scott. I think people were pleasantly surprised, would be my characterization. We've been giving our investors updates on how Boots was performing operationally. But as I said, it was held at 1.1x cost last quarter. It's a 2007 investment, a very large investment. We have been saying for the last several years to our investors that we actually feel quite good about the investments that we made in the 2006 and 2007 period, certainly relative to the market and even on an absolute basis. If you think about Dollar General, HCA, Nielsen, now Boots, we've had a number of very good investments from those periods. So I think they've been pleased with that. The biggest source of capital for Boots was the 2006 Fund. And so as we talked to investors about NAXI, one of the things I mentioned is investors like Asia, they like energy, they like yield. North American buyouts has not been as in favor as some of those other asset classes. But as we've had our conversations continue with investors in NAXI, it helps to underscore the point we've been making to them that we see a big opportunity in buyouts. And so I think it is going to be ultimately somewhat helpful as we continued those discussions and that you've seen the '06 Fund move from 1.3x cost to 1.4x this quarter. And the other thing I'd say is cash back helps a lot in fundraising. And we are giving a lot of cash back to investors, and so we think that will ultimately yield positive results for us over time as well.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

And maybe just one follow-up on the energy yield strategy you mentioned. I just wanted to clarify, is that a separate fund that you're out starting to fund raise for, or was that a component of kind of the recently raised -- some of the recently raised energy strategy?

Scott C. Nuttall

This is a newer strategy. It's a bit of a different approach than what we had in KNR. The KKR Natural Resources fund was really kind of more proved, developed producing assets. So think of it as you've already developed the underlying opportunity and you're just extracting the commodity. This strategy energy income is going to be royalties, which is a somewhat different space, and we have a joint venture there that we're so far funding off our balance sheet and through KKR Financial, and also proved undeveloped producing. So think of it as fields that are at an earlier stage in their life cycle, so higher potential returns but meaningful cash yield. So it is different than what we're doing in KNR.

Operator

And we'll take a follow-up question from Bill Katz with Citigroup.

William R. Katz - Citigroup Inc, Research Division

Tough to think I have one, but I actually do. Actually 2 questions. First is, as you talk to institutional clients, has there been any sort of structural shift in their appetite for alternatives at this point in time? And separately, coming back to your discussion on the balance sheet, and I was just sort of looking through it during the Q&A here. Is there a point-- and I appreciate what Bill was saying about in terms of sort of near-term cash flow needs, but is there a point where you reach that you could actually get to assume a self-fulfilling recycling of GP commitments to the point that you can actually start to transfer some of the yield to unitholders, if you will, rather than sort of early investing into fee-related earning initiatives?

Scott C. Nuttall

Bill, it's Scott. I'd say in terms of the question about structural shift in appetite for alternatives, we think that there is a structural shift. So of the $35 trillion of institutional assets I mentioned that are managed by third parties, by our accounting, about $4 trillion of that is in alternatives. And so we think that we were going to continue to see the other $30 trillion, some portion of that shift into alts. And if that happens, you don't need a lot of shift on a percentage basis to have a meaningful impact on the $4 trillion figure. And so we do think that there's an ongoing structural shift. And on a weekly basis, we're seeing institutions increase their allocation to alternatives as they seek ways to generate return. And that shift to alternatives is broad-based. It's private equity, it's real assets. It's a variety of different credit opportunities. It's real estate, and it's hedge funds. And so we've seen a meaningful shift, and we do think that alternative asset allocations are going to continue to grow from institutions that are already in the space. And frankly, we're also finding that institutions that don't invest in alternatives are starting to. Because they look over the last 10 years, and they have had no return from their public equity strategy and their fixed income bucket maybe has generated 2% or 3% for the last decade. And their liabilities are growing at 8%, and the math doesn't work. So we think that is going to result in a pretty meaningful shift in assets over time, at least as it's relevant to the $4 trillion that's currently in the market. So we're excited about that. And that's why you see us positioning ourselves to get in the way of those close. Because as we look about it around the firm, we've had quite a few offerings in the illiquid space, and now with Prisma and KES and a lot of what we're doing in credit, we've got more offerings in the liquid space, and that's where a lot of the flows are going, we think, in the near term. With respect to your question on the balance sheet, it's hard to predict how things are going to evolve over the long term. Right now, the balance sheet is pretty fully invested and very fully committed and invested. So that is not something that we're thinking about today. But over time, if the balance sheet generates a meaningful yield, and we have, frankly, usage for the capital that aren't as high return as they are right now, we'll consider whether or not it makes sense to pay out some of that yield to investors, but that's down the road. We're not thinking about that right now, given all the opportunities we have to grow at the firm.

William J. Janetschek

Right. And Bill, we talked about this on occasion. Remember, keep in mind that 65% of KKR is owned by KKR executives. So to say we're not focused on this point would be an understatement.

Operator

And gentlemen, at this time, there are no further questions. Mr. Larsen, I'll turn the conference back over to you for any closing comments.

Craig Larson

Great. Thank you, Cynthia, and thank you, everyone, for joining our call. We appreciate your interest. Bye-bye.

Operator

Ladies and gentlemen, this will conclude today's conference call. We thank you for your participation.

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