Nephila Capital investment generates estimated 20% ROE for KKR: Citi

by Artemis on June 3, 2014

An estimate from Citi suggests that KKR & Co. L.P.’s (Kohlberg Kravis Roberts) stake in the insurance-linked securities and reinsurance-linked investment markets largest asset manager Nephila Capital, could be generating it an ROE of 20%.

The private equity and buyout giant, KKR, invested in ILS manager Nephila Capital in January 2013, acquiring a 25% stake in the ILS markets longest-running and most established manager. At the time of the investment, Nephila Capital’s assets under management stood at approximately $8 billion, a figure which has now grown by 25% to $10.027 billion at the last count.

KKR recently closed down its equities hedge fund strategy unit, KKR Equities Strategies, which Citi noted was a disappointing outcome but was not expected to impact KKR’s revenues dramatically. The KES unit has been liquidated, returning capital to investors, with KKR blaming the lack of scale achieved, which no doubt meant the profits generated were not that attractive.

Reports suggest that the equities strategies unit only managed around $500m in assets in May, a third of which was from KKR employees and the firm itself. As a result the strategy perhaps wasn’t proving very profitable at this time and KKR would rather focus its efforts on more profitable niches it has successfully built, in other, more alternative asset classes.

One of those niche asset classes where KKR is seeing considerable success is in insurance and reinsurance linked investments through the firms 25% stake in Nephila Capital. The firm would like to replicate this success with other stakes and investments in future.

KKR is reported to have commented in the wake of the closing of its equities unit; “As our hedge-funds business has evolved, we have decided to focus on our hedge-fund solutions business, the building of strategic stakes and seeding effort modeled after what we did with Nephila Capital, and scaling our credit-oriented hedge funds.”

According to an analyst note from Citi the investment in Nephila Capital has proved particularly successful for KKR. Citi estimates that KKR’s investment in Nephila Capital is likely generating it 20%+ return on equity (ROE), which far outstrips the single digit ROE that the equity strategy was generating.

Figures reported in a KKR management statement earlier this year would seem to support that estimate, although we can’t confirm Citi’s numbers. Two things are clear from this though.

Firstly, the ILS and reinsurance linked investment business is a profitable one, profitable enough to attract the likes of KKR and make them a very healthy return on their investment, while demonstrating that a strategy to step into niche markets by investing in leading teams is a valid one.

Secondly, KKR co-chairmen and co-CEO’s, Henry Kravis and George Roberts are shrewd investors and got into the ILS space with Nephila Capital at a time of strong growth which helped it to secure its place as the leading ILS manager.

It was impeccable timing, given Nephila’s strong growth around that time and the subsequent softening of the reinsurance market. KKR is now positioned where it can benefit from any bounce back in reinsurance pricing with a stake in a market-leader, as well as being set to profit from Nephila’s continued expansion as a growing provider of reinsurance and risk capital.

Other articles on the KKR – Nephila Capital relationship:

As Nephila hits $10 billion, its contribution to KKR grows.

KKR & Co. L.P. and Nephila Capital, the benefits flow both ways.

KKR aims to help Nephila Capital accelerate its growth.

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