Ares Management Corporation (ARES) Earnings Call Transcript & Summary

Hi. Good afternoon, everybody. So joining me today is Ares CEO, Mike Arougheti. We'll be doing a fireside chat format today and have a number of prepared questions that we'll be going through. If anyone in the audience would like to ask a question, you can click on the question button on the upper right-hand corner, and we'll do our best to address the questions during the presentation. So with that out of the way, welcome to the conference, Mike.

Thanks, Terry. Thanks for having us. We're having a great day.

Very delighted to have you. So let's get started. And maybe we'll start with fundraising. Last year, you raised a record $40 billion of new capital, which in itself was impressive. But having raised $30 billion through the first half of this year, you're well on your way to surpassing that level. So turning to U.S. direct lending. Your second U.S. senior direct lending fund, in particular, captured a lot of these commitments. Are you expecting more fundraising there? Or are there any other areas you're excited about?

Yes. No, look, we're fortunate that we've had a lot of fundraising momentum across all of our strategies. Obviously, direct lending being one of our core franchises. We're continuing to enjoy a lot of fundraising success. You're seeing that in our U.S. direct lending franchise with the senior loan fund as well as our junior capital fund. Obviously, we saw it earlier in the year in our European direct lending franchise and also in our Asian private credit franchise. So the momentum is platform-wide. But not surprisingly, given the strength of our track record and the appetite for yield, there's a particularly high interest in alternative fixed income product and direct lending. This fund that you referenced, the senior loan fund, is a good example of the type of momentum and growth even in some of our more mature businesses. So to put it in perspective, our first fund was about $3.5 billion of equity. We talked about last quarter that we had already raised about $5.1 billion into the private -- the successor fund. And that's a levered or some of the fund is able to be leveraged. So if you just look at the capital that we've already raised, inclusive of leverage, it's about $8.5 billion. And our expectation is that it will grow meaningfully from there. So yes, a good contributor to our $20 billion in Q2. And my expectation is you'll see continued momentum there as we get to the back half of the year as well.

All right. That's helpful color. So in the past, you've spoken about raising more capital outside traditional fund vehicles. We saw that with funds like Black Creek's non-traded REIT and your new open-ended credit alt fund. Can you share anything on your plans to build these kinds of offerings up?

Yes. I mean retail, I'll cover each of those maybe separately. But clearly, part of our long-term growth is to build off of our core strength and competitive advantages. And I think we've done a good job of that by either what I would say, expanding horizontally, meaning in our direct lending business, we'll take our core direct lending franchise and then move into an adjacent industry-specific fund like sports media and entertainment or life sciences, things like that, or a horizontal shift into a new geography. So there's a lot of expansion that we do in our core businesses to capture different parts of the market. And then there is the opportunity to kind of move vertically by either going from what is a senior-focused strategy down balance sheet or from an equity-focused strategy with good track record up balance sheet into structured equity et cetera, et cetera. So we're constantly kind of expanding the set. Part of that expansion comes with a focus on new distribution because obviously, different investors in different parts of the globe, whether they're retail or institutional, have different investment outcomes they're trying to solve for. Clearly, there's a big part of the market institutionally, particularly in the pension insurance community, that is looking for longer duration, open-ended type strategies. And we've been successful in our alternative credit business and in our real estate lending business to tap into that demand with a lot of success, particularly in what I would call high-grade fixed income strategies. So if we're able to go in with long duration, open-ended and deliver somebody 4% to 6% rates of return in what they perceive to be an investment-grade equivalent set of risks, in their minds, we're delivering them 150 to 300 basis points of excess return and that's very attractive to them. So we're going to continue to expand on our origination capability and structuring to drive more open-ended product into the institutional community for sure. And obviously, we love it just because the perpetual nature of that capital is extremely valuable to us, both as we think about investing the money but also what it means for all of our equity holders. Retail, I think we're just getting started. If you look at our AUM today, about $41 billion of our assets are in the retail channel. And that's a combination of our existing funds that are both listed and non-traded. So today, we have ARCC, which I think many folks on this call are familiar with; large, long-tenured BDC; we have our mortgage REIT; and we have our closed-end credit fund franchise. And with the Black Creek acquisition, we've added 2 growing non-traded REITs to sit alongside our diversified credit interval fund. Interestingly, with the Black Creek acquisition, we also got a roughly 90-person broker dealer. Over half of those folks are actually focused on internal and external sales of retail product. So I think we'll continue to see the acceleration of fundraising in the existing product that we have on these platforms, but now we're able to look across the platform and look at this global appetite for yield in the retail community and structure some pretty interesting opportunities in retail as well. So I think you'll continue to see new products coming to market with our brand on it.

Got it. That's helpful. Now, the vast majority of your commitments in the quarters came from existing investors. Are you pleased with that split? Or are you looking to draw more investors onto the platform? And how do you think about marketing and fundraising relative to the investors you're trying to attract?

Yes. I mean the good news is, and we talked about this all the time, and we're in a market from an investment standpoint that is large with fragmented competition that sets us up well for healthy deployment, which drives our financial performance, but it's also against the backdrop of pretty persistent global demand for alts. And so if you look at our AUM growth, historically, we've been growing roughly 20% per year, which is roughly 2x the growth rate of alternatives generally. And alternatives are growing roughly 2x the pace of traditional assets. So we're capturing disproportionate share in a growing market, which we like. And again, that's a testament to the value of alternative assets in institutional and retail portfolios. I'm thrilled with the layout of the investor base, but you have to really peel back the onion a little bit to understand the experience of the existing investor versus the new investor. So when you think about the life cycle of an investor here, our goal is to get an investor onto the platform; deliver them outperformance, have them upsize in whatever strategy they've already executed with us; and then through that experience, come to understand what else we can do and begin to invest in other parts of the platform and then re-up there and so on and so forth. So if you think about the life cycle of an investor, they'll come into one part of the firm, grow in that part, and then grow horizontally as well. So if you look at capital raised, yes, about 80% of our capital is coming from existing investors, which is great. Half of our investors, though, on the platform are new. They're just investing smaller amounts because our relationship with them is not as broad. So when you look at this trend, there's a huge backlog of investors now that are "New" to the platform in the last 18 months that should exhibit similar behavior by re-upping at a higher rate and then effectively cross-buying other product on the platform. Said differently, if you look at that 80% of our existing investors and how they behave, about half of those commitments are slightly more, were actually into new strategies. So they're committing to existing, but they're disproportionately actually committing to new strategies as well. So it's a really, really positive trend for us, and we'd expect to see that accelerating.

Okay. Got it. So I think you touched on retail portion a little bit, but increased retail participation as a goal across the alt universe. Can you maybe just give an idea of how you envision the retail suite growing?

Yes. Look, I think we've all been talking about this for a long time. And I'd like to think, given our BDC track record and elsewhere that we were early in retail. Many of us are also attacking the retail opportunity through our insurance initiatives and the use of annuities and other insurance products to actually deliver an alternative outcome to a retail investor. But what we're all talking about mainly now is how do we deliver an institutional quality alternative product with an institutional quality experience to a traditional retail investor at scale, and that's where we start to talk about things like non-traded REITs and non-traded BDCs and internal funds and the like. I think at the end of the day, similar to the institutional demand, we're seeing pretty significant appetite from the retail investor. So while the insurance companies and pension funds are trying to solve for some actuarial return, I think most retirees are also thinking about the world in terms of what kind of variable yield or investment experience do I need to satisfy my retirement. And viewed through that lens, you can see why the appetite for alternatives will continue to grow, particularly in a low-rate environment. So we have a lot of things that we're working on that will supplement our non-traded REIT and our credit funds. I think the core theme will be exactly what I just said, which is how do we deliver institutional quality product, institutional quality experience. And I think in the early days, as the retail investor is developing more broad exposure, you're going to see it geared a little bit more towards alternative yield product, which is consistent with what the market looks like today. But I do think that we are on the front end of meaningful growth in that sector. Some of our peers are talking about this as well. If you talk to the large platforms, I think they would say, directionally, they would like to see the amount of alternatives in their system double over the next 5-plus years, which is a pretty significant pool of capital coming online. Back to the broker-dealer infrastructure that we have, in order to meet that demand, need a breadth of product. You need an organization that can sell the product and service it. And I think as importantly, over time, you're going to need to have a brand that stands for something in the retail channel. So to expect as this market opens up that the platforms will likely be doing more with fewer managers, similar to the way we're seeing consolidation of GP relationships in the institutional market.

Got it. That makes sense. What about growth regionally? You've been at the forefront of raising funds in Asia. Are there any other regions you're looking at?

Yes. I mean Europe is still a big growth market for us, as is the U.S. So I don't want to sneeze at the growth that we're seeing in other parts of the market. If you use Europe as an analog, we saw a trend emerging there. I think early, at least in the private credit markets, in 2005, 2006, and stood up a business that I believe now is the market leader in private credit in Europe. And there were a lot of factors that drove that view with regards to the development of the private equity ecosystem, where banks were from a capitalization and risk capital framework standpoint, how the liquid debt markets were evolving around those markets. And so we went into Europe in the mid-2000s with a 10-year view on market development and the financial crisis accelerated that dramatically because it changed the game in terms of the liquidity in those markets and how the banks were competing. We see similar trends emerging in Asia. So I can't tell you if we're going to see a similar acceleration, but we are taking a long-term view that, that market will open up to us in a similar way and that we need to be early with scale and a capability set that positions us to take advantage of the market when it opens up. And reflective of that is the fact that we acquired SSG, which is now fully integrated into the platform, which we believe was the leading private credit manager in the region that gives us some first-mover advantage to take advantage of the market as it develops. But similarly, when you think about what we do, we need to see large, diverse middle market economies. We need to see strong regulatory frameworks. We need to have a growing private equity and venture ecosystem developing. So depending on where you are across the APAC region, you're in different stages of development. But we're seeing those trends emerge, and we're pretty bullish that over time, we'll see that market evolve to look a lot like the U.S. and European market. Away from Asia, we're -- those are the 3 big markets for us. Obviously, over time, you'll start to see the African markets open up. Latin America is starting to open up, both in terms of the investment and capital raising side. So I think if you're looking 10 to 20 years out, you'll start to see those markets develop. But for now, it's going to be those big 3 in the U.S., Europe and APAC.

That's helpful. That's good color. So switching gears and moving on to deployment. You invested over $10 billion in each of the first 2 quarters of the year. So I guess, first question is, do you think you can keep this pace up? And where are you seeing the most opportunities at this point? And maybe how could that change over the next, call it, 6 to 12 months?

Yes. So I do think that we can keep that pace up and it's a reflection of the breadth of our products and the flexibility of our capital. It's also just a reflection of the diversification of strategies on the platform. So maybe telling you what you know. We've got strategies that have the flexibility to pivot between liquid and illiquid markets. We can move up and down balance sheets. We can do distressed and opportunistic investing when the market is there like it was through the pandemic. And then we can pivot those funds to take advantage of healthier markets as well. A lot of that is based on the structure of our capital. It's also just based on the size and scale of our origination networks and our ability to find things to do in any market, kind of an all-weather approach to investing. There's always a little bit of a trade-off. Obviously, the more stressed the markets are, the higher available return, but the lower the deployment rate. And so the sweet spot market is always one where you've got good fundamental economic strength and liquidity in the market, so that we can drive high transaction volumes and deployment, but not so healthy or frothy that it's a challenging market to put money to work in. And I'd say we're in that kind of environment now, which is why we're pretty confident that the deployment pace should sustain itself. You've got post-COVID recovery, central bank support, fiscal stimulus coming, good earnings momentum, lot of liquidity in the system, so on and so forth. So you saw, Q4 2020 was a strong quarter. First half of the year, similarly strong. And without talking about where we are now, I think we talked about Q2 that when you look across the platform, the backlog and pipeline across the different investment businesses was pretty significant. So at least, at the time we had good forward visibility to continued strong deployment. So not a lot that will knock that off course because I think the kind of the risk that the market is monitoring and thinking about are effectively priced in. But we are seeing an incredibly healthy M&A market, and I'd expect that to continue.

Got it. Got it. Okay. So in your second quarter results, you called out over $47 billion of capital, that would earn fees upon deployment. What do you expect the time line of that deployment? Could we see all or most of that hit your P&L for 2021?

Yes, I don't know if it's all in 2021, but maybe just to contextualize that. So $47 billion, some of that includes capital that we hold back for funds that are later in life. So the number that we tend to focus people on is $43 billion at the end of Q2, which was our capital not yet invested that was not yet earning fees. And if you look at that $43 billion, about $36 billion of it is in our credit franchise broadly distributed across our European direct lending, U.S. direct lending and alternative credit businesses. The beauty of that, which is where we're able to get the predictability of earnings growth for the company, is those dollars earn fees when deployed. And if you look at that $43 billion when deployed, it's over $400 million of management fee, which is 30%-ish of our TPM management fee revenue. So just looking at it, when you assign probability deployment, you have that embedded growth if we do nothing else other than invest the money that we have on the platform. Back to your question about deployment, if you say, we did $10 billion in the quarter and we have $43 billion to deploy, that would imply a 12-month deployment pace. What we've said historically, because some of it just depends on the market backdrop, is that it typically will revolve around an 18-month time frame. Sometimes it will be quicker, sometimes it will be a little bit longer. But importantly, given the fundraising momentum, even if we're deploying the capital that we have on the platform today, that dry powder not yet earning fees will continue to replenish itself as we get through the end of the year even if we keep up this deployment pace.

Got it. Okay. How do you think about raising successor funds? Or what metrics do you take into consideration when preparing a successor fund raise?

Look, the key to long-term success in our business, like I think in any investment business, is delivering consistent outperformance to your investors. A lot of that is getting the right people with the right capital in the right market. A lot of it also is being disciplined around timing and size of funds. And to your question, that's something that we have a lot of discipline and experience around. So whenever we're coming to market with a new fund, there is a simultaneous demand assessment that goes on. One is coming from the investment teams that are evaluating the addressable market opportunity and what they think their deployment pace could be relative to fund size. And then with that information, there's a demand assessment within our global distribution teams to say what is the investor appetite to support that deployment thesis. And that's how we typically will land on the fund size. Now not surprisingly, 99% of the time, that demand assessment is signaling an upsize in the successor fund because with success, we're able to continue to invest in people and office footprint and grow our check size to take advantage of a larger fund. One other way to think about it is typically in our drawdown fund structures, you're going to raise your successor fund when you're 70% to 80% invested in your predecessor fund. So there's a runway and a lead time to start putting that successor fund into the market. And the dynamic basically is on your predecessor fund. When you get to that 60%, 70%, 80% deployed, you're engaging actively with your existing investors about their appetite to support the successor fund. And back to the earlier comment about the 80% of the investors -- capital coming from existing investors, there's a consistently high re-up rate at a larger check size. So to oversimplify the math, if you had 80% of your existing investors in any given fund, re-up into a successor fund at a 20% incremental commitment, you are effectively going into the fund raise for your successor fund at the predecessor fund size. So then it's a question of what do we need to do to broaden out that incremental X percent of new capital to get those new investors onto the platform or to cross-sell an existing investor into that product. But because of that -- the precision of that demand assessment and our ability to see high re-ups from our existing, the velocity of our capital has been increasing over time, meaning we're able to get funds into the market quicker, and we're able to get them raised at a larger size more quickly as time is going on. Last thing I would say just about fund construction, because of the nature of what we do, the majority of the funds that we manage actually pay us on deployment, not commitment. So there's an ability to have smaller funds that may be slightly undersized, get them deployed quickly and then come back to market. And you're beginning to see that across the private credit platform. So you mentioned the senior loan fund earlier, we closed the first vintage of that fund in 2017. So it kind of came back to market 3 years later. Our junior capital fund, 2018 we closed that again. It came back kind of 2.5 years later. Our European fund came back 2 years later. So even if we have a 4- or 5- or 6-year investment period, we're finding just based on the pace of deployment against the fund size that we're able to come back to market within a 2- to 3-year window and still meet the demands of the investors, which again, is a nice place to be because there's a higher velocity of that capital.

Okay. That's very helpful. So just to wrap up on the topic of opportunities. The market and the world are obviously very different than where we were a year ago. So what are your thoughts on the state of the markets? Where do you see additional opportunities either for fundraising, deployment or even M&A?

Yes. Look, the state of the market is strong. I mean it's -- despite the headlines and anxiety that people are feeling a little bit about Delta and modest inflation, if you look at what's going on in the ground, the economy is clearly in recovery mode. The markets are healthy. Valuations are robust. Earnings are growing. You look at our portfolio performance, the nice thing about our [ scene ] is we touch 3,000 middle-market companies and EBITDA is growing at a very healthy clip. Balance sheets are delevered, the consumers delever. There's a lot that augurs for continued strength in the markets. I think the thing to watch is where are valuations, given how low the discount rate is and what happens if we find ourselves eventually in a rising rate environment. I think, candidly, that's more of an issue for equity-heavy managers. I mean one of the added benefits of being geared more towards the structured equity and credit markets is we don't have to go so deep into a company's capital structure. And so while we're thinking all the time about risk-adjusted return, appropriate pricing for the risk we take, we're still coming in at very low loans to value and very low, kind of, investment to cost relative to the current valuation environment. But I think that's going to be the one thing that folks in our business are going to have to keep an eye on. But markets are healthy. And I think that's reflected in the deployment and fundraising that you're seeing across the platform, across all of our geographies and asset classes. And again, I don't see anything on the horizon that's going to knock us off of that.

That's good color. So switching gears a little bit. A recent acquisition that opens up a whole new suite of opportunities is Landmark Partners. It solidifies our footprint in the secondaries market where there are clearly plenty of tailwinds. So can you just spend a couple of minutes just highlighting what is unique about your offering there?

Yes. We're super excited. Obviously, we closed the acquisition a mere 2, 3 months ago. People are able to see what it means from a financial standpoint. One of the exciting things about that transaction is it's both highly strategic for us. The team is a great cultural fit. We've known them for a very long time. But it's also financially accretive out of the gate, which, in our business and particularly in this market, we think is pretty unique. The secondaries market is going through transformational change right now in 3 ways that I think plays to our strength. And the reason that we chose to make an acquisition as opposed to build something organically as we think that this change is happening at an accelerated pace and we want to make sure that we're able to capture the share that we think is appropriate for us by having the right capital scale, the right experience and track record, technology and data and then the right team to go after it. Not to say that we don't have some of that organically, but just the speed to market that we get through this acquisition is pretty compelling. The way to think about that growth opportunity is in 3 ways. One is just an expansion of secondaries away from what has historically been PE-dominated into real estate, infrastructure and now credit. So the secondaries market is effectively mirroring the primary private markets. And so as those markets are developing, the need for secondary liquidity solutions is going to increase in all of those product categories. Landmark is differentiated in the sense that they are probably the longest tenured private equity secondaries manager. They've been in the business since 1989. They're on Fund 17, just to put that in perspective. But they're also early to the real estate and infrastructure business, and so we think that we have a good head start in that diversification trend away from PE. The second growth opportunity we see is just globalization. Again, as you see the private markets evolving from the U.S. to Europe into Asia, harkening back to what we talked about earlier in terms of growth opportunity, the secondaries market will grow globally as well. So as we're building our origination and capability set in Europe and Asia, we believe that we can differentiate ourselves globally in a market that has historically been more focused on North America. But probably most important is a transformational shift going from what historically has been LP-led secondaries, which means institutional investors looking for liquidity in a portfolio of fund investments to what the market generally refers to as GP-led, which is the GP is looking to use the secondary market as a financing solution or a liquidity solution to solve a specific need that they have either at the GP management company or within one of their funds. And over the last 3 or 4 years, that's taking disproportionate share of volumes in the secondary market. And the reason that's so exciting to us is in order to do that well, you need capital scale, you need deep origination into the GP community as well as the LP community, but predominantly the GP community. And given our global private credit franchise, we think that we have the largest GP coverage effort in the market. And three, you need direct investment experience because that market, as it evolves, starts to look as much like a private equity investment as it does a structured portfolio investment. And so with this shift happening, it's going to start to play to our strength in GP sponsor coverage as well as direct investing. I think that, coupled with the track record of Landmark, is a really powerful, powerful combination. So a lot of differentiation, but pretty exciting stuff.

Yes. Got it. That's good color. Now there's a lot of white space in the secondaries market, and you touched on it a little bit, Landmark is more heavily weighted towards private equity but they've diversified a little bit toward real estate. Are there any other growth areas or assets that you can envision them growing into? Or any opportunities that make sense at this time?

Yes. Like I said, I think they've got a meaningful franchise in real estate. They've got a growing franchise in a nascent infrastructure business and I think have some first-mover advantage there. The big opportunities are continuing to drive growth into this GP-led part of the market. And then I think that there is an opportunity, going back to our conversation on retail, to use the secondary market to deliver a private equity solution into the retail market. And so my expectation is, as these markets evolve, that Landmark will be a nice way for us to deliver private equity, primary and secondary exposure into the retail market as well.

Got it. Okay. So another area of growth for you is insurance solutions. You're continuing to grow with the Aspida platform in Aspida Re and then Global Bankers. Can you maybe just share your thoughts about this part of the business?

Yes. It's an exciting opportunity for us, and we're not alone in the alternative space, seeing the linkages between insurance and alternative asset management, particularly alternative credit. And I think the market has gone to a place where portfolio construction was maybe liability-driven where now there is a deeper appreciation for how differentiated asset sourcing, structuring and excess yield can benefit the insurance community. So we are seeing that play out not just in the growth of our speed of platform, but in the growth of our third-party insurance platform as well. So if you look at our assets under management, we now manage capital on behalf of probably 135-plus insurance companies across the globe, and that's one of our fastest-growing client types. The reason being, again, in this yield environment, the excess return that we can deliver for comparable risk is very valuable. What Aspida is looking to accomplish is to sit next to that third-party business and build out a two-pronged approach to building an affiliated insurance business. One being reinsurance, which is squarely up and running now under the Aspida Re brand. We launched that in earnest with the acquisition of F&G Re, and the flows there have been very, very strong and the team is building nicely, and we're thrilled with where that is. And then the second, to your point on Global Bankers is the development of our life and annuity platform. And with the acquisition of Global Bankers and another life insurance platform, we're now in a position where we'll be writing new annuities business by the end of this year, if not early 2022. And that will come with pretty significant organic growth opportunity as well. At our recent Investor Day, we talked in more detail about what that could be, and effectively showed a path just based on what we've seen in front of us, to take that business to $20 billion to $25 billion in the next 5 years, absent meaningful acquisition, which we think is pretty exciting given the economics on that growth for the public company. But we are taking a slightly different approach to our insurance business in the sense that we want it to be a meaningful part of our AUM and our strategic offering, but we don't want it to overwhelm our third-party clients. And so a lot of the growth there is being balanced with our desire to continue to deliver best-in-class service and outcomes to our third-party clients as well.

Got it. That's helpful. So Global Bankers also opens retail access to alt investments. It's been a priority for Ares lately with both Global Bankers and Black Creek acquisitions adding to your listed and non-traded vehicles. So can you take a minute to talk about why you think retail access to alts is important? And what steps Ares is taken to open up those opportunities?

Yes. So we talked a lot about that. So I won't repeat the non-traded piece of it, but I will maybe drill down quickly on insurance. Part of this is if you think about a fixed annuity, you are effectively indirectly delivering alt exposure or the value of alternative fixed income to a retail investor. The reason it's important, and this is maybe the crux of the question, why there's so much demand is you have an aging demographic globally -- which has all sorts of implications for the global markets and the global economy. But through the lens of a retiree whose life expectancy is also probably increasing in a low rate environment, they're now beginning to ask the questions of how do I make sure that I can construct a portfolio that includes alternatives and alternative fixed income to make sure that I can retire on the duration that I expect to. And so the combination of insurance product, the combination of listed and non-listed retailers, all I think, getting at that opportunity set, which is people are getting older. They are staying older longer, and that's all happening at a pretty rapid rate in the developed markets against a persistently low-rate environment globally, and it's just changing the game. So the old 60-40 for institutionals isn't working, and it's not working for retails either. And so the key is how do I construct product that can deliver a solution to the retail investor in a way that they can understand it, but also if they can buy it because they're going to be buying it with a different view on liquidity, a different risk appetite, a different check size, a different portfolio that sits alongside of it. So while we're trying, as I said earlier, to deliver institutional quality product and institutional experience, the retail investor is coming with a fundamentally -- while the need for yield and return is similar, they're coming with a different set of issues that they're trying to solve for as well relative to the institutional investors just based on what they own elsewhere in their portfolio.

Got it. That's all incredibly helpful. And I think we're just about at a time. So why don't we just end it right there?

Great. Well, I appreciate it, Terry. Thanks for the time. I appreciate the conversation, and thanks, everybody, for tuning in.

Thanks for doing it, Mike. Have a good one.

Have a good one. See you soon.