EXCLUSIVE: Fortress' Novogratz says "easy meat" days are over

NEW YORK (Reuters) - Booming markets have helped Wall Street rebound from last year's meltdown, but the easy money has already been made, Fortress Investment Group LLC President Michael Novogratz told Reuters in an interview.

From the edge of the abyss, most investment banks and hedge funds have roared back this year thanks to equity markets that have surged 60 percent from their March lows and healthier credit markets, said Novogratz, who manages $4.6 billion through Fortress' (FIG.N) Drawbridge global macro hedge funds.

But the post-crisis surge cannot last, he said. A still-shaky economy and volatile stock markets with no clear direction will suck the wind from the sails of investment banks, trading houses and the hedge funds, he said.

"Mark my words: Next year will be far harder for Wall Street to make money," Novogratz said. "The easy meat is off the bone."

Markets typically rebound about 60 percent after big financial crises, said the former Goldman trader, who helps manage one of the world's largest private equity and hedge fund firms with $31 billion of assets.

"The average rally after the last 17 crashes is 60 percent, exactly where we're at right now. It feels sensational and unprecedented, but this is the average bounce after you crash," Novogratz said on the sidelines of a "State of the Market" panel sponsored by Piper Jaffray Co (PJC.N) and New York nonprofit Youth I.N.C.

Such fertile conditions will not last; a correction of 15 to 20 percent may hit stocks within one to six months, he warned.

CHOPPY MARKETS

Bumpiness will only help the hedge fund industry, which saw assets plunge last year amid falling prices and a wave of withdrawals. A period of volatile markets, tight credit spreads and low interest rates will fuel demand for the "absolute returns" promised by hedge funds.

"The hedge fund business will be bigger in three years than it was before. When you go into slow-growth periods after a crisis, you typically have big up moves and big down moves in markets that go nowhere," said Novogratz, who rarely grants interviews.

The Fortress Drawbridge funds struggled last year, falling 20.3 percent, slightly more than the average hedge fund.

Most of Drawbridge's losses stemmed from betting on credit markets that were being pummeled by one of the worst financial storms in decades, Novogratz said. In some cases, exposure to credit seeped into unexpected areas of the portfolio.

"I underestimated how fast I needed to simplify my business and how difficult it was to turn a big battleship," said the veteran global macro trader.

Like many hedge fund firms, Fortress froze redemptions. It also placed illiquid assets in a separate "side pocket" to be sold off over time.

That plan worked: The side-pocket fund generated gains of 25 percent, and most of the assets were sold.

"We did what we said we would do. The mere fact we had to do it cost us, cost us in terms of credibility," he said.

Novogratz said he and Fortress have worked this year to rebuild frayed relations with clients. The redemption freeze was lifted on January 31, at which point clients sought $3.3 billion -- more than a third of assets managed at the end of 2007.

CHALLENGES AHEAD

Recovering from last year's downdraft remains a serious challenge across the hedge fund world. Many fund remain well below previous high-water marks and so cannot reap incentive fees -- typically 20 percent of fund profits.

Novogratz estimated that among funds that find themselves 20 percent of more below their previous peaks come January, as many as 75 percent will be shut down.

The Drawbridge funds have made some progress this year, recouping losses and winning back clients. Drawbridge focuses on easily traded instruments and provides more transparency.

"I had a sign on my wall that read 'Long Simplicity, Short Complexity,'" Novogratz said. "We made some pretty dramatic changes to simplify our structure and liquify the business."

Novogratz reduced the number of people he managed and the number who assess risk. He has also adopted a more negative outlook.

"I've got less risk on than I did three months ago. I don't see the market cracking, but I think the next trade is probably a down trade," he said.

Markets will retreat because banks remain stingy with credit, the "shadow banking" system no longer exists as an alternative, and robust U.S. economic growth will not return until late 2010 or even 2011, he said.

"The economy will be fine over the next three to six months, and then people will look ahead and worry this has all been a big sugar high," he said.

(Reporting by Joseph Giannone; editing by John Wallace)