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A Poorly Defended Fortress

Since its high-profile IPO in early February, alternative-investment powerhouse Fortress Investment Group (NYSE: FIG  ) has been a volatile stock. After reaching $31, shares quickly fell to $24.25, only to yo-yo back to $31 again. The company is growing quickly, thanks to its thriving private equity and hedge fund business, but its stock may get squeezed as other alternative-investment firms tap the public markets.

This week, Fortress filed annual results reflecting the go-go boom in the financial markets. Revenues surged 46% to $1.52 billion, and earnings more than doubled to $442.9 million, or $1.21 per share.

Fortress makes money primarily by charging 2% of assets under management and getting a 20% take on the profits generated. It's a nice business, in light of the flood of capital into alternative investments, healthy returns in equity markets, and cheap debt.

Yet the alternative investments can be tricky, and the influx of capital can sometimes mask underlying problems. In Fortress's liquid hedge funds, the company picked up $56.3 million in fees thanks to an inflow of $1.5 billion in assets. Unfortunately, the fund's return has fallen 23.1 percentage points, to 18.5%, since 2005. That slump reduced Fortress's incentive income by $20.7 million.

Fortress's valuation is also frothy at 46 times earnings, which has been a factor spurring the Blackstone Group's IPO filing. The Blackstone Group is growing at a rapid clip, and its market cap may exceed those of Wall Street titans like Lehman Brothers (NYSE: LEH  ) and perhaps Morgan Stanley (NYSE: MS  ) .

Rumors also suggest that other alternative-investment firms will go public, including Carlyle Group, Apollo Management, and TPG. There's even buzz that Goldman Sachs (NYSE: GS  ) may spin off its private equity and hedge fund businesses.

By the end of the year, it's a good bet that public investors will have a variety of branded alternative-investment firms to choose from. Their financings will also soak up billions of investor capital. For investors in Fortress, that could mean further share erosion.

Lower the drawbridge for further Foolishness:

Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked 2,719 out of 25,386 in CAPS. The Fool has a disclosure policy.

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