Ares Management Corporation (ARES) Earnings Call Transcript & Summary

All right. Good morning, everyone, and welcome to the Bank of America Securities Future Financials Virtual Conference. I'm Mike Carrier, the research analyst at Bank of America covering the brokers, asset managers and exchanges. Our next company up is Ares Management. And with us today are Michael Arougheti, Co-Founder, President and CEO; and Michael McFerran, COO and Chief Financial Officer. Mike and Mike, thanks for being here with us today. And just before we begin, just so the audience knows, there is a question portal that if you have questions, you can submit those, and then we'll get them and then we can ask them towards the end of the conversation.

But maybe just to kick it off, just given Ares' kind of unique perspective across, whether it's different markets, different economies and a pretty dynamic macro backdrop, just wanted to start with a bigger picture question. When you look at some of the divergence that we're seeing and what we're seeing in, say, the public markets and valuations versus private market valuations and then what's going on in the real economy, are there like reasons for concern out there? And obviously, the news this morning on progress on the vaccine probably makes you feel a little bit better on that side, but just wanted to get your take on that.

Yes. Look, it's a great question. I think we're all asking ourselves that question in different ways from different perspectives. We have a unique window into the world at Ares, just given how many middle market companies we touch, how many small businesses and how many consumer line items we see. And I think what you're highlighting is probably a reflection of what's going on in the economy and with the consumer, which is there's a bifurcation in the market between haves and have-nots, between people who got access to liquidity from stimulus and those that did not. And so yes, I've said before, and I think you and I have talked about it, given what we see in the private markets and the concerns around potential impact of long-term demand destruction, unemployment, commercial real estate distress, those bogeyman have not gone away. But the fact that the liquid markets are behaving in the way they are, well, disconnected a little bit from what we see happening in the real economy makes perfect sense, right? If you pump $6 trillion to $10 trillion, depending on how you want to count it, into a GDP hole of $3 trillion, that money will find its way into the markets. It will find its way into the consumer balance sheet, and that's what we're seeing. So when we look at the path forward, the virus news or not, I think you're going to continue to see an uneven recovery and an unequal recovery, both for the consumer and for corporates, for those who have been directly impacted and those that have actually not been directly impacted or who got the benefit of stimulus. So yes, I think there are still areas for concern, but unless maybe flummoxed by the behavior of the markets now that we actually have seen just the weight of liquidity that's come in to support those asset classes.

Okay. That makes sense. And maybe just a follow-up on that. You mentioned a lot of locking in, whether it's fiscal or monetary stimulus. Do you think that, over time impacts, whether it's rates, inflation, like taxes and then maybe shifting that more to like from an Ares standpoint, how does that impact either investment returns or like allocations by your investors? I mean more into alternatives or not.

Yes. It's a great question. And some of it is unknown. Candidly, I would have expected that once between now and then, the financial crisis that we would have seen inflationary pressure more than we did. So without going down the rabbit hole as to why that is around productivity or demographics, et cetera, the reality is we haven't seen it, I think, the way that many of us were taught to expect. And I'll come back to that in a second. But I'll maybe just make an obvious comment, which is interest rates have been in secular decline in this country for 30 years. And not surprisingly then, alternative assets generally, but alternative fixed income specifically, has become a critical tool for both retail and institutional investors to use to help meet their financial objectives. I don't see a scenario where rates go up anytime soon. We have so much deficit spending and, frankly, so much more to come. Low rates for longer, I think, is the base case that we all should underwrite. And if that's true, that's a pretty big secular tailwind for Ares and for the alternative asset management business generally. So we've been seeing significant allocations away from traditional fixed income and global equities into alternatives pre-COVID. Obviously, hopefully, folks have seen some of our fundraising performance through COVID. That's an indication about the durability of these assets through financial distress. But I think more importantly, the early indicators that in a low rate environment, alternative fixed income product is going to become even more relevant. Taxes, we'll see. I think with the blue wave, people were probably underwriting a base case that had higher tax across the board. Divided Congress, maybe that's muted, and that's probably good for all of us personally and from a corporate perspective. And then the big question mark is inflation. I still struggle, as a little bit of a student of economics, to understand how we have not seen as much inflation as we would have expected. But again, I think when you look across the waterfront of alternative asset product in an inflationary environment, we'll continue to outperform. And obviously, we have specific investments in our real assets business that I think we'll outperform.

Got it. Okay. That makes sense. And maybe one, just bigger picture for Ares. When you look at Ares relative to some of the competitors in the space, you guys have much more significant credit business and by a lot of majors, you'd say that credit on the private side is still much earlier on than what we're seeing in, say, like private equity. So just wanted to get your take on how you think about like the growth opportunity and the growth outlet for Ares, whether it's in some of the more, I'd say, scale businesses that you have or some of the newer areas, you mean, that are just launching or recently launched?

Yes. It's funny when you say it's for earlier. I think it might be earlier in the institutionalization of the asset class, right? And it could be earlier in terms of people's awareness of the asset class, but it's not so early, obviously, in terms of the growth and development globally of the opportunity set for us. What people, I think, are coming to appreciate, particularly going through the period of distress that we're going through now is the durability and reliability of credit, both for our private investors who are buying credit assets from us. They're seeing lower mark-to-market volatility, they're seeing durability of return and yield, and they're actually seeing the opportunity to deploy and transact at a time when the bid-ask spread on most equities and equity tranches and private assets is kind of hard to clear. So they're getting the dual benefit through a distressed period of actually having returns hold up, but also an opportunity to deploy into distress with a little less anxiety that had a price equity. What it means for us at Ares, which you see in our P&L and our ability to declare a reliable and growing dividend, is that durability of yield and that predictability deployment translates into a pretty unique P&L structure, I think, relative to a lot of other folks in our industry. We continue to grow in new parts of the market. What we learned is one of, I think, probably pioneers in this space and early adopters was if you invest in scale, which can mean scale of origination capability, scale of your capital, scale of your information advantages, the bigger we've gotten, the more we've been able to open up new markets, whether they're new geographies or new parts of the private credit space. And it's interesting because as we keep growing, we're seeing more markets become available to us that we didn't think we're there for. So in the U.S., while we've been middle market in our focus, we've actually seen EBITDA of our average borrower grow from $25 million to $100 million over the last 10 years. So what does that mean? It means the universe of available borrowers for us has grown, but our opportunity to deploy more capital has also grown by 4x, right? And that trend is continuing across the globe at various stages of evolution. We've been able to attack the private credit markets with industry-specific capabilities in things like life sciences and infrastructure lending. We're opening up new geographies like Europe and Asia. We are launching meaningful, meaningful growth initiatives in places like our opportunistic credit business and alternative credit, which are in the early stages of the revolution, given some of the post-GFC changes to the securitization market and the banking landscape. So if you think about what's propelling this business forward, we obviously just talked about the rate environment and what it means for our ability to aggregate capital and then put that capital into the market, but there's also a pretty meaningful overlay that's helping the growth of the business in terms of changing bank behavior or risk perspective, changing bank regulatory capital frameworks, which is changing the economics of many credit asset classes for the banks, solvency regulations around the insurance market that's increasing demand for these assets and so on and so forth. So I'm very bullish on the continued global growth of the private credit asset class, both supply and demand, but you need to be scaled and you need to be global if you want to have any kind of competitive advantage to take advantage of that growth.

Okay. Great. Maybe just a question on the strategic front. I feel like Ares has probably been a little bit more active than most. And maybe that's also just your size since you have more opportunity to grow both organically and inorganically. But 2 of the areas that you guys have been more active is both Asia on the insurance front. And so when you look at Asia, you guys did the Sumitomo, the SSG transaction. Like if you just step back and you say like what trends are you seeing in Asia that make it so attractive? And then why that path, you mean, in terms of those transactions?

Yes. Look, Asia -- I'm going to oversimplify it and everybody can do their work. But if you were to map out expected GDP growth over the next 20 years, you will find that the Asia Pacific region is predicted to outperform for all the reasons that we all know. So if we're going to be a global asset manager and offer global solutions to our global client base, we have to be in Asia. We have to be in Asia in a scaled, diversified way in the way that we've built our business in the U.S. and Europe. And you can't ignore it, right? And I think that if you adopt a growth mindset as a company and you think about business building, we have to be looking out 10 or 20 years with a view as to where the market is going and not be complacent. Asia is going to be very interesting for us because those markets are still developing. And the same way that we don't talk about Europe necessarily as one thing because we have people in local markets where there are different cultural challenges or regulatory frameworks, the same is true for Asia. And so in order to be successful there, we think we have to be pan-Asian, we have to be hyper local in the way that we build our business, in the way that we exploit our relationship networks there. But we have to be global in the way that we think about the business build in terms of how we bring capital into the market, types of partnerships that we can develop to scale up. And so that combination, as you referenced, of SSG giving us that local boots on the ground, 15- to 20-year track record in private credit as a first mover is highly, highly strategic for us. And then you wrap it with things like SMBC that give us real balance sheet capability and real distribution capability in the region, you marry it with our distribution and product development initiatives in Australia, and a picture begins to emerge of a pretty well developed, broad-based opportunity set and product set in Asia. So I think we'll continue to invest in that growth, particularly coming out of COVID, right? The opportunity to capitalize on global distress and global volatility is going to be important. And when you just look, frankly, at the way that the Asian markets have come out of COVID relative to the developed Western markets gives us a really unique opportunity to be moving capital and investment opportunities around the globe in response to different environments. And so getting that Asian perspective, I think, is only going to create more addressing solutions for our investments.

Great. That makes sense. And then just on the insurance side, I think, Ares, just given your product set, insurance clients have always been like an important statement for you. And everyone's kind of going about the insurance opportunity in different ways. You guys launched Aspida and then you doing the F&G transaction. So just how do you think about that opportunity? And why like the way that you're going about it, you take advantage of that opportunity?

Yes. As you mentioned insurance clients have been very, very critical and important to us and a large part of our growth story, and it all harkens back to what we just talked about in terms of the rate environment and the value of alternative fixed income solutions to so many people. What's unique about the insurance market, whether we're doing it direct to the insurance clients is in our P&L funds or through the growth of our annuity and reinsurance platform, it's all trying to get at the same thing, right, which is insurance the way that we're approaching it as a spread-lending business. And the way you make money in a spread-lending business is you drive down cost of your liabilities and you drive up the return on your assets. And the better you can do on both, the more attractive your product solution. And so from the asset standpoint, as you highlighted, I think that we have a unique capability in alternative fixed income that provides a pretty differentiated opportunity on the asset side. And through the use of technology and a de novo business build, we think that we can actually drive down the cost of our liabilities with a lot less overhead and a lot less infrastructure weighing in on our product setting. And so going into a market like the one we're in, we feel pretty happy to be unburdened by a back book and have the opportunity to build the business into the new market reality and the new rate environment. I think the growth in insurance appetite for alternative fixed income is only going to continue. Again, back to the rate commentary, it's getting harder for insurance companies to make the math work. And so not surprisingly, you're seeing more entrenched partnerships with folks like us, and I would expect that to continue. But let's not forget, this is a significant, significant market. And so market share gains for all of us is possible, I think, without changing the competitive dynamic in the space to the negative.

Great. Okay. Maybe let's shift over just to the fundraising side and FRE. And so if we look at fundraising this year, it's been extremely robust. I think you guys are at $28 billion and over that, if we look at the update that you gave on earnings. Maybe you just can provide a little bit of perspective on the strategies that are driving it. And the just in the COVID backdrop, how has it been with your current LPs and like re-up amounts? And then also on like prospective clients and how you've been able to still make progress on that front in a more virtual backdrop.

Sure. McFerran, do you want to take us out on that one, and I can provide some color. I got you while you were [ drinking ].

Nearly choked on water. Sure, happy to. Sorry for the tears in my eyes from the choking. The -- look, Mike [indiscernible] just raised at the end of the [ third quarter '20 ] mentioned on our earnings call that including through early October and prior to the earnings call, we were at just over $30 billion. By comparison, our biggest fundraising year in our history was 2018, where we raised $36 billion. We mentioned that could be [ towards the ] fourth quarter. It's [ turning out to be a great year ]. As far as products, [ i.e. FRE ], I think -- and specifically with LPs, wrapping all that together, this is -- there's a couple of dynamics. One, people should appreciate that our business is always fundraising. So it's not [ just a ] start-and-stop mode. This year happens to be a year where we have a lot of what we'll call large flagship commingled funds in the market or coming to the market. So that's really been a great testament to our performance and our brand for being so successful, thus far, in the fundraising with those. But when you look at the investor presentation phrase and you see the number of LPs we have, see the number of fund products we have, we're always fundraising. In 2019, we only had -- I think it was 2 modest-sized real estate funds in the market. And of our -- that -- and we raised almost $24 billion that year, with over $20 billion coming from those [ non commingled ] funds. So our business is kind of a continuous fundraise model, which is great because we're not -- the firm isn't built around that 1 or 2 mega funds that you raise and then you go quiet on. With LPs, you've seen a few trends emerge that we've talked about for a while, and I think what has happened in this environment is we've seen those accelerate. But LPs for some time have been consolidating relationships. Institutions are doing more with fewer firms. And there's a lot of reasons for that. But most notably, economically, efficiencies, strategic alliance, partnerships -- partnering. And as a result, what you're seeing is firms like in Ares that have broad capabilities. As investors come out of the platform, they extend what they do with us over time and do more and more and ends up resulting in more products being invested in and more capital being committed, and simultaneously LPs are consolidating those relationships. So Mike talked at the beginning of this about how allocation saw alternatives keep going up. And that's like an important tailwind. But compounding that for a firm like Ares is now your allocations to the industry going up, the allocations to the industry for large firms are disproportionately going up. So there's a bit of an exponential effect that's benefiting us. We think that trend is going to continue. All that's really happened during this COVID environment is that's really been accelerated. I think this is a world where clearly people weren't on planes as much and seen trying to foster new relationships as easily to firms like an Ares that already have a broad diverse LP base and also had benefited from even people that may not have invested in our funds yet because we're still bringing new LPs on the platform. We've touched so many of them via premarketing or other investor interactions. It's enabled us to be really successful in fundraising in this period, and that trend can probably just go fast.

Mike, can I -- just an overlay because I think you highlighted something that's important, right? We talked about it qualitatively, but I think it's so important for people to understand the organic growth engine as we cross-sell our existing investors into this plan that Mike talked about, because you asked about it, Mike. If you look roughly in any given year, 50% of the number of investors that come on to the platform are new, but they typically represent about 20% of the capital. And so if you just think about this organic growth mechanism, we get somewhat onto the platform in a strategy through one part of our business. They have a good experience. And 2 things happen: they upsize in that strategy and then they start getting cross-sell -- sold or they cross by other parts of the platform. And that combination sets us up for that 20%-plus growth from the existing investor base as they're getting bigger in core strategies and then trying new. So the whole way that the distribution engine works, to Mike's point, is we capitalize on that trend. But once someone's on the platform, they tend to grow meaningfully with us. And if you look now at our institutional direct AUM, it's about $127 billion, right? $107 billion of it, so now almost all of it are folks that are in more than 2 funds. And if you look, you've got about $71 billion of it, right? So well over half, almost 60% are folks who are in more than one strategy, meaning that they were a private equity LP, now they're a real estate LP and so on and so forth. And about 30% of our investors are across more than 2 of our strategies. So we know from past experience that as we bring new investors onto the platform in numbers, that's going to continue to grow both horizontally and vertically. And I think that's an important piece of it is just to look at numbers as well as dollars.

Okay. Great. And then maybe just a follow-up on that. When you had the fundraising, obviously, that's a driver of your management fees over time in FRE. And I think the last one [indiscernible], the 15% plus growth on an annual basis. And then from a margin standpoint, you mentioned getting up to around like a 40% over the next couple of years. Just curious, because if I look at the kind of the step functions with you guys, you're kind of in the 20s, then you went to 30%, then you went to 35%. Now you're going to 40%. And so it's moving fairly fast, but it also makes sense because the fundraising has been more robust. So just wanted to -- what's driving that? Is it some of these areas that are gaining scale [indiscernible] going off? Just wanting to get your perspective on that.

There's a few things. One, we've described before, Mike, how the nature of our business is the expenses attractively run in front of the revenue growth. So think about all the we're capital raising today. Most of that capital is going to pay us on invested. So as we deploy, the revenue activates. However, think about the expenses tied to all that capital, the investment teams to be in place to deploy it, the capital raising teams are out there, capital raising, the noninvestment functions that were compliance and the accounting and technology and everything else, all that's in place. So what happens with the AUM not yet earning fees on, expenses are already embedded in the model. As that revenue comes on, it's actually coming on at a much higher margin, usually. The business is operating again. And as the business is contained, what you've seen is, in recent years, as the growth of our business has been fairly driven by all capital that pays us uninvested, you've seen that kind of linear growth of not just FRE, but the margin going with it as we continue to put money to work and continue to be successful with fundraising. It's the whole life cycle of what we do. The reason we've -- it's the teams that got complemented that are good for the long term. We want to emphasize, we hope people appreciate is while we continue to have revenue that comes online and that drives margin growth, we're always investing for the long term. I think that's something that, hopefully, people have seen the benefits from through our continued fundraising success and expansion of our business and our growth. A portion of what we make goes back into the business. And we're always building out new teams and capabilities and some teams we've talked about, some teams looking forward to talking about in the future. But we're always investing for not just today and tomorrow, but really Ares 2025 and beyond. And that's always been the mindset of our firm, and I think it's really served us well. That's why you haven't seen periods of growth going flat and then growth again, those stairstep functions, because we're continuously benefiting from growth of yesterday's investments. On the margin, what I mentioned on the call was you're accurate. I said we expect [ this ] FRE margin of 40% or better within 3 years. I also said that we expect the margin should be able to expand based on what's in front of us at 150 to 300 basis points a year. So to your point on how the margin seems to be growing faster than maybe that 3 years is like if it can expand to 300 basis points a year, you're at 40% in less than 2 years. What we didn't want to do, though, was this stuff happens organically as the business grows, it continues to just execute in our model. We don't want to force a margin outcome by doing anything unnatural, but it would -- we just -- we know it will come in the course of time. It's just us executing on what we do. But the 40%, I think, is out there to be had. And right, we achieved 35% faster than I think we said we were a few years ago.