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This Private-Equity Giant Is Near Its High. It Still Has Room to Run.


Visit: Barron's

If you want to make a pile, stay in style.

The phrase traditionally means that investors should buy hot stocks that have a history of outperforming the market. A list of such stocks in recent years might include names like Tesla (ticker: TSLA) and even lesser-known ones such as Penn National Gaming (PENN) and Generac Holdings (GNRC).

Yet as the market keeps dancing around record highs, and many stocks seem incapable of declining, investors should consider broadening the concept. Think of ways to invest alongside the smartest investors—those who can best handle a sudden change in fortune—such as KKR (KKR).

The private-equity powerhouse will almost certainly find ways to stay a few smart steps ahead of the market mob, and perhaps ahead of any changes to the tax code that could increase capital-gains taxes and impede how private-equity firms distribute gains to investors.

Goldman Sachs has told clients that KKR is one of its top ideas among capital-market investments. Alexander Blostein, the Goldman analyst who follows KKR, writes that trends within KKR’s asset-management business have exceeded expectations amid solid fund-raising momentum and leading investment performance. KKR is also on Goldman’s Conviction List, which is reserved for the bank’s best investment ideas.

KKR stock is sharply outperforming the S&P 500 index this year—and trading near its 52-week high. Its strong performance reflects the fact that wealthy individuals are increasingly turning to private-equity firms and other alternative investment managers.

And why not? Private equity offers access to opportunities in real estate, private credit, distressed debt, and other more-complex, less-liquid investments that are difficult for most investors to find on their own. The great question now is how to square the ability of private-equity firms to source attractive deals with potential changes to the tax code.

President Joe Biden may end the favorable tax treatment that has long been enjoyed by private-equity firms. Specifically, investors are concerned about moves to tax so-called carried interest—which represents a significant portion of KKR’s investment earnings—at ordinary income levels.

If Biden makes such a move to help pay for his $1.8 trillion American Families Plan, private-equity firms could come under pressure. The continued strength of KKR’s stock suggests that investors believe the firm has the intellectual firepower, political connections, and resources to give it an edge if that happens.

We last wrote positively about KKR in 2020, when the stock was just under $30. Now, with the company scheduled to release first-quarter financial results on May 4, investors can consider the risk-reversal options strategy, which offers a way to buy worthy stocks on weakness and to participate in gains.

With KKR stock at $56.71, investors can sell the May $55.50 put option for about 90 cents and buy the May $58 call option also for about 90 cents. The strategy positions investors to buy the stock at $55.50 and to participate in gains above $58. (Calls give holders the right to buy an underlying asset at a set price within a specified time, while puts give holders the right to sell such an asset.)

The stock is up 40% this year, compared with 11% for the S&P 500. During the past 52 weeks, the stock has ranged from $23.43 to $56.77. At $68, the call is worth $10.

Should the stock decline below the put strike price, investors are obligated to buy it at the strike price, or to adjust the position in the options market to avoid having to buy the stock.

Originally Posted on April 29, 2021 – This Private-Equity Giant Is Near Its High. It Still Has Room to Run.

Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.

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