This Fortress Has No Moat

Fortress Investment Group (NYSE: FIG  ) , the first U.S. hedge fund to go public, is under siege. The fund posted a fourth-quarter loss of $29 million, or $0.43 per share, down from a gain of $290 million in the same period last year. If not for payments to its principal executives, Fortress would have swung to a gain of $78 million, or $0.18 per share, on par with analyst expectations. For all of 2007, Fortress sputtered to a loss of $60 million.

At year's end, it held more than $33 billion in assets, which it managed for high-net-worth individuals, pension funds, and other wealthy institutions.

CEO and co-founder Wes Edens seemed generally pleased with the results, especially in light of the recent market turmoil. With what he called "one of the great deleveraging events of our lifetimes ... [forming] the mother of all supply/demand imbalances," markets were creating incredible values, setting Fortress up for what could be some big scores once markets regain their footing.

Does that make now a good time to buy? This Fool sure doesn't think so.

Nice timing
Since its IPO early last year, shares have been on a nonstop nosedive. After its IPO opening in the $30s, Fortress has stumbled 61% to its current $12-per-share range. Rivals Blackstone Group (NYSE: BX  ) and Och-Ziff Capital Management (NYSE: OZM  ) also went public last year, and their shares have since tanked 56% and 20%, respectively.

But wait a minute -- I though these were the same investment companies that turned their directors into overnight zillionaires? What's with the huge fall from grace?

For starters, all aspects of the financial markets have come down from their euphoric highs over the past decade, especially the debt markets. Just last month, Blackstone announced that it would abandon the gummed-up debt market entirely, raising money directly from investors instead of using banks like Citigroup (NYE: C) or JPMorgan Chase  (NYSE: JPM  ) as middlemen to package and sell loans.

What little we do know about the companies in which Fortress invests isn't pretty. Gatehouse Media (NYSE: GHS  ) and Brookdale Senior Living (NYSE: BKD  ) , both Fortress holdings, trade at just a fraction of their year-ago prices.

You've been punk'd
But there might be a better explanation for the tumble. As the easy money got snatched up, going public looked like a solid way for investment-management firms to cash out incredible amounts of money at what, in hindsight, looks like the peak of a bubble.

Asset management companies require very little capital to keep their business humming along, so it's hard to imagine they'd need to go public in order to expand. Managers at both Fortress and Blackstone reaped huge fortunes from their respective IPOs, only to watch shares take a precipitous plunge over the past year. Even though Blackstone faced rough going throughout most of 2007, CEO Steve Schwarzman took home nearly $1 million per day in cash. Can you smell a bubble? I can.

When you buy shares of asset managers like Fortress, it can be easy to think that you're buying into a hedge fund. But in reality, you're buying into the back-office management company that runs the hedge fund. It's entirely possible for the actual fund to have a runaway year, but leave the management company with just a sliver of that success. What's good for the titans running these firms isn't always best for you as a shareholder, making these firms less than ideal for Foolish investors.

Keep an eye on Washington
Hedge funds' and private equity funds' successes enjoy favorable tax treatment that treats some profit as capital gains, not income. That's caused some critics to cry foul, since billionaires with megamansions can often walk away with effective tax rates much lower than the average citizen's. If favorable treatment could be repealed, asset managers' tax burden would significantly increase.

Fortress shares probably won't be living up to the company's name anytime soon. The asset management business relies entirely on financial markets for its success, and it's notorious for operating inside a black box of secrecy. The real winners will continue to be senior managers -- and those lucky enough to invest in the actual hedge funds.

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