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Carlyle Group's Potential Sore Spot

A year ago, Carlyle Group LP revealed its intention to ramp up its credit business. It's still very much a work in progress.

While the Washington-based investment firm posted third-quarter earnings that beat analysts' expectations, one metric stands out: Funds within its $32 billion credit arm haven't actually added to the firm's future carry potential for the past two quarters. It means that those funds are likely not generating returns above a pre-determined hurdle rate, so there are no new performance fees that Carlyle can lay claim to.

Carlyle is still committed to building what it describes as a "world-class" credit platform -- or one that is at least a little closer in size and success to its rivals. So far, though, its hiring of folks like debt-investment veteran Alex Popov -- who now heads up the firm's credit-opportunities business -- hasn't done much more than lift its compensation expense.

On the earnings call with analysts on Tuesday, soon-to-be co-CEO Kewsong Lee acknowledged that it'd take a little time for its investment in talent to pay off, while CFO Curtis Buser reiterated Carlyle's belief that growth in its credit business can underpin the firm's fee-related earnings in the future. But judging by the stock's more than 3 percent decline in intraday trading, not all its investors are willing to be so patient.

Admittedly, it has only been two quarters. But if the lackluster performance among its credit funds continues for a prolonged period, the firm's incoming co-CEOs may need to consider tempering the expansion of that segment. In a worst-case scenario, long-lasting mediocre results may lead to a weakened track record, an inability to raise specific credit funds despite the Carlyle brand and could even force an embarrassing retreat from that business. That's an outcome they should strive to avoid.

It'll be somewhat of a balancing act, though: Co-founder and outgoing co-CEO Bill Conway clarified on the Tuesday earnings call that his successors would have their bonuses tied solely to the dividends paid to Carlyle's shareholders. Considering that carried interest is a key contributor to the distributable earnings (which are then dispersed as dividends), as long as its credit funds are contributing some carry, they'll be adding value. Still, the executives' long-term incentives (which are likely loftier) are tied to other metrics including investment performance, fee-related earnings and fundraising, which may prompt action on their part to curb future fundraising of certain funds if performance isn't up to scratch.

Ensuring that the firm's push into credit is successful will likely be the biggest challenge for Carlyle's inbound co-CEOs when they step up to bat on Jan. 1. Nearly every Wall Street analyst wished them luck in their new roles. They'll need more than that.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. It'd be tough to exit these businesses quickly because of the long-term nature of these funds