Scott C Nuttall, one of the heirs apparent of Kohlberg Kravis Roberts (KKR) and the head of its global capital and asset management division, leans back in his chair while dining on the 42nd floor of the firm’s midtown Manhattan headquarters and shares a dream. “Maybe someday you will have private equity as a choice on your 401(k) retirement plan,” he says, eyeballing a turkey sandwich served on a plate of fine china (the firm caters lunch for the entire company every day). “Today, if you are a retired school teacher in California you can invest with KKR by virtue of a pension plan, but if you are a corporate executive managing your 401(k), you cannot. There’s no product available.”
Nuttall, 40, is in a hurry to change that—and change KKR in the process. He’s leading the charge to open the storied private equity firm to everyone. Barbarians at the service of the masses. Already, for as little as $2,500, you can invest in a KKR mutual fund managed by the same team that runs global credit funds for some of the biggest institutional investors in the country. For $25,000, you can invest in a KKR fund that buys distressed debt.
That’s a far cry from the $10 million or more qualified investors once needed to get into one of the firm’s 19 buyout funds, where their money could be locked up for more than 10 years and net annual returns fluctuated from a 1 percent loss to a 39 percent gain.
They’ve evolved a long way already. Nine years after it tactically diversified away from a single-minded focus on leveraged buyouts, $29 billion of KKR’s $74 billion in assets fall outside its legacy private equity business. Nuttall’s group, the firm’s fastest-growing division, with $25 billion under management, includes a global corporate bond and credit business, a so-called fund of funds, which allows investors to put money into a diversified basket of hedge funds and a proprietary trading desk picked up from Goldman Sachs in 2011. Since its inception in 2004, one of KKR Asset Management’s important high-yield strategies has logged an average annual return of 10.8 percent versus 8.5 percent for its relevant benchmark.
The biggest challenge Nuttall faces is gaining acceptance among individual investors and their financial advisors. KKR has never courted the little guy. Traditionally, the firm raised most of its capital from multibillion-dollar pension funds, banks, insurance companies and endowments. These institutional investors could—and did—thrive despite delivering mediocre returns. After all, they were playing with other people’s money, often at a great remove. Retail-level financial advisors, however, live and die by the very personal trust they earn by generating decent returns on their clients’ nest eggs. It takes more than a new wrapper on an old business to win over brokers.
Which is why, on a cloudy day last November, you could find Nuttall and one of KKR’s billionaire founders, George Roberts (net worth: $3.7 billion), shoulder-to-shoulder with Chuck Schwab, the patron saint of retail investors, at the brokerage giant’s annual conference held in Chicago’s McCormick Place convention centre. Before a crowd of more than a thousand independent financial advisors, the trio took to the stage to spread the gospel of investing Main Street savings with Wall Street titans.
Roberts, the ‘R’ in KKR and the founder known for his intellect and aloofness, even spent time manning the firm’s booth on the convention hall floor, mingling with frontline brokers. Why woo hoi polloi? Because that’s where the money is: “There are huge pools of capital there,” marvels Roberts, 69. “I talked to one fellow who managed $800 million and another who managed $5 billion.”
Numbers like that add up fast. In all, there is about $2 trillion managed by independent registered investment advisors, and that number is growing at a 13 percent annual clip, according to Cerulli Associates, a Boston-based financial research firm.
The numbers become even more enticing when you look beyond advisors to mutual funds and exchange trade funds, which can also be purchased directly by individuals. According to McKinsey & Co, by 2015 there will be $13 trillion invested in these types of funds, and 13 percent of this money will flow into so-called alternative assets, a category that includes many areas where KKR has deep expertise: Private equity, junk bonds and real estate. That 13 percent is more than double the amount that was allocated to alternatives in 2010.
The money is vital to keep KKR well capitalised, as the big pension funds it relied on for decades dry up and are replaced by tens of millions of Americans managing their own retirements through 401(k)s. “The implications for alternative asset managers are staggering because the bulk of all their money has historically come from pensions that are now going away,” says Josh Lerner, who teaches investment banking at Harvard Business School. “Over the next five to 10 years, individual investors are going to be a very important source of capital for alternative asset managers, and you’ll see them rethinking their business models.”
It’s all a long, long way from KKR’s roots. The firm was founded in 1976 by three Bear Stearns alumni: Jerome Kohlberg, who headed the corporate finance department at Bear, the brash Henry Kravis and his cousin Roberts, who were Kohlberg’s protégés. (Kravis was not interviewed for this article; Kohlberg was pushed out of the firm in 1987.) While at Bear, the three men pioneered friendly leveraged buyouts of public companies. The formula: Have management borrow money against the assets and cash flow of a company, and use that money to buy a controlling stake of it. The process left the companies weighted with crushing debt loads, which was thought to be good as it prevented management from embarking on wild spending sprees and ensured strict financial discipline (conversely, it also limited innovation and growth). Through a combination of cutting costs, selling assets and paying down debt, the now private firm could be brought public again, at a higher valuation, making a small (or large) fortune for the management team—and, of course, for Kohlberg, Kravis and Roberts.
Roberts echoes the idea that KKR isn’t altering what he calls its “internal DNA”: “If you want to paint a picture of our firm, private equity will continue to be at the centre of it.” But he also admits that the makeover has been a long time coming. He distinctly remembers that in 2008, after the annual partners meeting, he gave attendees white T-shirts with two black circles on them, one tiny and one large. “The message was that the big black circle was our brain and the small black circle was what we were using of it,” says Roberts. The problem was KKR’s laser-like focus on leveraged buyouts was costing it huge opportunities. “If we went to see a company that didn’t want to do a private equity transaction we’d say, ‘Thank you very much,’ and we couldn’t do anything else with it,” Roberts says. The problem was so bad, Nuttall says, that KKR began maintaining a spreadsheet listing opportunities it had to turn down.