Money Stuff: Whose Money Should You Manage?

If you are good at investing, there are two classic ways to make money:

1. You can take your own money and buy stuff that will go up, and then you will have more money; or
2. You can tell other people “hey I am really good at investing,” take their money, buy stuff that will go up, and charge them 20% of the profits (or some other fee arrangement).

The first approach has the advantage that you get 100% of the profits. The second approach only gives you 20% of the profits, but it has the advantages that (1) you can get 20% of the profits on a larger amount of money (if a lot of people give you their money) and (2) if you lose the money that’s someone else’s problem. Which should you choose?

Often the answer is “both,” but you can adjust the mix. The standard considerations are [1] :

1. If you do not have very much money of your own — you are very good at investing, but young and scrappy and broke — you should invest other people’s money, because 20% of a lot is more than 100% of nothing. Whereas if you have a lot of money of your own, you can live very well off your own gains and not have to deal with pesky clients.
2. If you are very good at investing in things that have a lot of capacity, you should feel free to take other people’s money. If your particular investing skill is “I know which months the stock market will go up and which months it will go down,” there are lots of ways to make enormous bets on the stock market going up or down, so you can go ahead and take hundreds of billions of dollars of client money. If your particular investing skill is “I know which penny stock will go up today,” there is only so much money you can put into a penny stock, and you might as well use your own money.

So if you’re broke and doing stuff with unlimited capacity, you fundraise constantly. If you’re rich and doing stuff with very limited capacity, you close to outside investors and just invest your own money. The most normal way to get rich, if you are a good investor, is to start by managing other people’s money, doing it well, and taking 20%. After doing that for a while, you can stop. “The mark of true success as a hedge fund manager is to stop managing a hedge fund and convert it into a family office, in the good way,” I once wrote.

One other important consideration is that investing your own money tends to have higher returns (you get 100% of the gains instead of 20%) but also higher risk (you get 100% of the losses instead of 0%), so you have to consider your tolerance for volatility. In particular, if you are not a person but a company, and you are deciding whether to invest your own (shareholders’) money or outside customers’ money, your shareholders might prefer steady fee-based earnings over lumpy principal earnings.

The simplistic way to think about the big “alternative asset managers” — firms like Blackstone, Apollo and KKR, big publicly traded companies that got their start doing leveraged buyouts and now do a ton of private credit investing too — is that they manage money for life insurance companies. That is too simplistic — they manage money for endowments and sovereign wealth funds and individuals too — but classically life insurance companies have big pools of money that they can invest in illiquid stuff for many years, and they are natural customers for private credit managers in particular.

One way to run an alts manager is to have a sales force that calls on lots of insurance companies, signs them up as clients, and then manages their money. Another way to run an alts manager is to buy an insurance company and then manage its money. [2] The advantage of the former approach is that you can manage more money (lots of clients) with less risk (if you lose the money it’s their problem). The advantage of the latter approach is that you get all the profits, instead of 20% of them. [3]

Which should you choose? Well, you know. If you’re broke and doing stuff with lots of capacity, sign up clients. (Every big “alts manager” started out as a scrappy “leveraged buyout shop” that invested client money.) If you’re rich and doing stuff with limited capacity, go buy an insurance company and do it with your own balance sheet.

So we talked in March about KKR Strategic Holdings, a new bit of KKR & Co. that buys companies using KKR’s own money and holds them for a long time. (Instead of the traditional private equity approach of buying companies using investors’ money and holding them for a few years.) My analysis of this was:

1. KKR used to have a little bit of money (when its founders were young whippersnappers with a dream and a Rolodex), but now it has a lot of money (its founders are billionaires and the company has a public listing, a $100 billion market capitalization and an insurance balance sheet).
2. “The original private equity founders were in a scrappy business of picking low-hanging fruit; now they run huge institutions and a lot of that low-hanging fruit is gone.”

And more money and less capacity are two good reasons to use your own money rather than client money.

In the Financial Times yesterday, Antoine Gara had a story about the divergence between Apollo and KKR (which have their own insurers) and Blackstone (which is capital-light):

Blackstone has opted to stick with the traditional approach of managing investors’ money for a fee, which is lower risk but requires it to continually source more funds to manage.

Apollo has harnessed its asset portfolio to the steady stream of income produced by an insurance operation — an approach that provides it with long-term capital, but introduces leverage and makes its finances more akin to those of a bank.

Buyouts pioneer KKR has also acquired a large insurer and embraced a strategy similar to the one employed by Warren Buffett at Berkshire Hathaway. It has invested in a growing portfolio of private companies whose asset values and earnings compound within the group, but at the risk of painful writedowns if the investee companies do not perform as expected.

“Everybody’s doing the same thing on the front of the house,” says an executive of one large private capital group, referring to the everyday dealmaking of large private capital groups. “It’s the back of the house where the differences emerge . . . and these are pretty radically different businesses.”

Part of the difference is that getting 100% of the profits (and losses) is more lucrative, but getting 20% of the profits (and 0% of the losses) is safer, and the firms have different preferences:

Blackstone has balked at owning an insurer over fears that its investment business would have to cover policyholder losses in the event of a market collapse, and the more onerous regulation that writing insurance brings. It also contends that a fee-based model is more transparent and predictable and that its shares will command a higher valuation. It allows Blackstone to pay out most of its profits in dividends, with [founder Steve] Schwarzman having received billions in such payments.

“Done right, you should get more growth in a balance sheet heavy strategy,” says [Morgan Stanley analyst Michael] Cyprys.

“But investors historically have tended to favour capital-light business models from a valuation standpoint. You don’t have that principal risk and exposure.”

And there are some incentive-alignment arguments:

“For some, ‘capital-light’ has become code for ‘heads we win, tails we win and hopefully our clients do OK’,” said Jim Zelter, president of Apollo Global Management, referring to a private equity business model that focuses mostly on running other people’s money in return for a fee.

But there also might be different views about capacity:

Apollo and KKR’s embrace of insurance assets and leverage stems from their belief that lucrative deals will be in increasingly short supply, leaving them needing to squeeze more from each investment they make as owners alongside their clients.

That’s actually kind of weird? Obviously KKR and Apollo are not just in the business of investing with their own balance sheets; they manage tons of outside funds too. (Apollo has a $395 billion balance sheet and $785 billion of assets under management.) And there is a huge push to sign up individual investors for private-market alternative investments: If you think that “lucrative deals will be in increasingly short supply,” do you need to go find lots of new individual investors to buy them? Actually I guess that’s the best time to sign up the individual investors.

I want to clarify part of what I wrote yesterday about Fannie Mae and Freddie Mac. I laid out the situation, which as I see it is:

1. The US government controls Fannie and Freddie (in conservatorship) and would like to return them to private hands.
2. Right now, the legal situation is approximately that the government gets 100% of Fannie and Freddie’s profits forever, and the existing common and preferred shareholders of Fannie and Freddie get nothing.
3. Everyone expects that to change, and it probably will.
4. But — and this was my main point — the government has a lot of negotiating leverage there, because, again, right now the legal situation is that the government gets 100% of everything forever. There are good reasons for the government to give that up, reasons of fairness and efficiency and capital markets access. But the shareholders can’t force it. They don’t have a ton of leverage, other than political leverage. If the government wants to keep more value for itself and give less to the shareholders, it pretty much can.

That was my point, but as I wrote: “I do not make the rules! Those are the rules! A lot of people do not like those rules, and that’s reasonable.” The fact that the government gets 100% of Fannie and Freddie’s profits forever is the result of historical contingencies that many people find unfair, and I have a lot of sympathy for that view. Essentially, the government bailed out Fannie and Freddie in 2008 with a deal that gave the government 10% interest on its money plus 79.9% of the equity of Fannie and Freddie, and only later — in 2012, when Fannie and Freddie’s situation had much improved [4]  — did the government change the terms of the deal to give it effectively 100% of the profits forever. (We discussed this in detail in January.) If it hadn’t changed the deal, by now Fannie and Freddie would have more than repaid their bailouts with interest, and the shareholders would have a nice recovery. The shareholders’ argument now is roughly that the government changed the deal unfairly in 2012, and should change it back now, both for fairness and to make Fannie and Freddie viable as public companies.

That’s fine. I don’t think that’s unreasonable at all. [5] I am just saying that, right now, the legal situation is that the government gets 100% of Fannie and Freddie’s profits forever. If the shareholders can persuade the government that that’s unfair, or that the government would be better off by giving up some of those profits to the shareholders (also not unreasonable! [6] ), then obviously the government can give some of those profits back to the shareholders. It doesn’t have to. It probably will. But we talked yesterday about reports that the government’s “goal may be to generate as much cash as possible for the US, potentially to help fund tax cuts.” And giving up some of the value to shareholders — even if that would be fair — could conflict with that goal. 

Anyway here is an X post from Bill Ackman on the subject (using “F2” as shorthand for Fannie and Freddie):

F2 shareholders don’t have their hands out. The opposite is the case.  Hundreds of billions of dollars of funds that belonged to F2 were unilaterally taken by the government years ago, and the companies never received credit for these payments. 

F2 shareholders are simply seeking credit for payments that have already been made to the government so that a release from conservatorship can occur.  Credit for these payments through the elimination of the accounting balance of the government's senior preferred stock will enable F2 to achieve their full values in the stock market, maximizing recoveries for the government and minority shareholders. Furthermore, we believe that F2's exit from conservatorship will enable the GSEs to operate more successfully and efficiently, with more stable management and at lower cost, greatly benefiting our housing finance system.

Seems reasonable. [7] I don’t make the rules, and the shareholders have some good arguments for changing the rules, but it seems helpful to be clear on what the rules are.

If you are a US public company and you do a monopoly, you will get in trouble with the government. But also, because every bad thing that a public company does is also securities fraud, your shareholders will sue. “You were a monopoly,” they will say, “which injured us, so give us money.” A plausible answer is “no, we were a monopoly for you, our being a monopoly made more money for shareholders, we got in trouble specifically for making too much money,” but nothing works that way. The Information reports:

Google has agreed to spend $500 million over 10 years and create new compliance committees to settle shareholder litigation accusing it of antitrust violations, according to court documents filed Friday.

Shareholders led by pension funds in Michigan and Pennsylvania sued Google’s parent company Alphabet and its board of directors for breaching its duty to shareholders by exposing them to antitrust risks. Under the settlement, which still needs to be approved by a federal judge in California, Google would create a new board committee and management-level committees for compliance and regulatory issues.

The settlement doesn’t settle either of the two antitrust cases the Department of Justice has won against Google over the past year, on search and advertising technology. 

Right there are the antitrust cases, in which the Justice Department is standing up for consumers against Google’s monopoly power, and then there is the everything is securities fraud cases, in which shareholders say “ahem we are victims too.”

By the way I use “everything is securities fraud” as a general rubric here, but in fact 80% of everything-is-securities-fraud cases are securities fraud cases and the other 20% are shareholder fiduciary-duty cases. The general theory is the same, though; it’s that every bad thing that a public company does can be reframed as being bad for shareholders.

The old view of exchange-traded funds was that they were liquid, tax-efficient wrappers for stock index funds. The new view of ETFs is that they are consumer-friendly wrappers for absolutely any imaginable investment idea. If the category is “every possible investment idea,” you will find some ideas that you do not like. At FT Alphaville, Steve Johnson does not like a Pudgy Penguins ETF, and sure, who could blame him:

A company called “Canary Capital” — yeah, us neither — has become the first asset manager to file with the US Securities and Exchange Commission to launch an ETF that would contain non-fungible tokens.

According to the prospectus, the mooted fund would “invest” 80-95 per cent of its assets in Pengu, which, apparently, is the “official token of the Pudgy Penguin project”. A further 5-15 per cent will be held in Pudgy Penguin NFTs, alongside a sprinkling of solana and ether.

Yeah, I mean, if you want to buy a particular non-fungible Pudgy Penguin because you think it is cute or rare or for whatever reason you’d buy an NFT in 2025, you should buy your favorite Penguin and hang it on your virtual wall or whatever; the ETF is not a collectible in the same way the NFT is. But if your investment thesis is “ehhh NFTs wave it in,” I guess this is a convenient way to wave it in. The NFTs are, you know, kind of fungible.

Ages ago people used to spend a lot of time worrying about bond market liquidity, bond ETFs, and the “liquidity illusion.” The theory was roughly (1) bonds don’t trade that liquidly, (2) ETFs trade very liquidly, (3) if everyone in a bond ETF wants their money out at once, the ETF will need to sell the underlying bonds, which will be hard and (4) this will be a surprise to the bond ETF investors who got used to the liquidity of their ETFs. This concern has receded, but I look forward to people worrying about Pudgy Penguin market liquidity. “The ETF trades every millisecond on the stock exchange, but it owns rare penguins that trade by appointment, and if everyone sells the ETF at once” etc. etc. etc. fire sale of Pudgy Penguins, contagion, the whole thing. You truly do not need to care about this but now, with the ETF, you can.

US Borrowers Face Higher Interest If Trump’s ‘Revenge Tax’ Becomes Law. Global Investors Have a New Reason to Pull Back From U.S. Debt. Trump Signs Order Doubling US Steel, Aluminum Tariffs to 50%. BlackRock Escapes Texas Oil-Boycott List After ESG Retreat. Citi scraps restrictions on dealings with gun merchants. Shareholders lash out at $33bn take-private of Toyota subsidiary. Americans Are Finally Saving Almost What They’re Supposed to for Retirement. Singapore’s Temasek cuts back on start-up investments. AI Is Helping Executives Tackle the Dreaded Post-Vacation Inbox. Even the Trumps Are Confused About How Many Crypto Offerings They Have.

If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks!