Ares Management Corporation (ARES) Earnings Call Transcript & Summary

Good morning, everyone. Let's get started. This is Craig Siegenthaler from Bank of America, and it's my pleasure to introduce Michael Arougheti. Michael is a co-Founder, Director, President and also CEO of Ares Management. Ares is one of the largest alternative asset managers in the world with more than $280 billion in AUM and 2,000 employees across the globe. The firm is best known for its industry-leading private credit business, which includes its public BDC, Ares Capital Corp. Ares is headquartered in L.A. but has offices around the world. Michael, thank you for joining us today.

Thanks, Craig. Good to be here, and I appreciate you spending time with me.

So let's get started with growth. Ares' fundraising results have trended much better than you and most people projected. What do you see is driving this?

Well, it's a good question, and you never quite know what you're going to get when you put funds into the market. So I think the simple answer is retail and institutional investors across the globe are benefiting from increased allocation to alternatives. I think that's a function of persistently low interest rates, maybe concerns about volatility or valuations in the public markets. And so we have seen meaningful increases in demand for alternatives and alternative credit, specifically, which I think plays to our strength. To put that in perspective, if you look at market growth for alternatives generally, the index growth rate has been about 10%. And obviously, we're doing 2x plus that. So the markets are growing but we're taking a disproportionate share. We're able to do that because we're making meaningful investments in our asset gathering and client service infrastructure, both institutionally and in the retail market. And so today, we have about 260 people around the globe in our client service organization that are both raising capital and supporting the capital that's on the platform. And then maybe to state the obvious, but it shouldn't be taken for granted, is this growth is being supported by some pretty good performance across the board in the different asset classes. And we've always said, as we grow the business, assets follow performance. And so as our teams have continued to deliver good investment performance, I think they're seeing the demand accelerate.

And then as you look forward, do you think the current fundraising trajectory is sustainable? And also, what could be the biggest individual fund inflow-ers as we head into 2021?

Yes. We -- it's been a pretty extraordinary run. So I want to make sure that we -- I answer the question appropriately. We're -- we came into this year with a view that we would likely exceed our historical record, which was about $36 billion of AUM, and we're kind of in excess of $50 billion. That's a function of a couple of things. One is just the demand we just talked about. But two is we've grown our product set. So as the firm continues to develop and evolve, we're offering a broader, more diversified product set, and we have more funds in the market at any point in time. And so there's no single fund, Craig, that's going to meaningfully drive those numbers. And one of the things we've tried to articulate is that as the platform is diversifying, there's going to be less volatility year-to-year in the fundraising numbers just based on the number of funds that we have in the market at any point in time. The other thing that's supporting the fundraising momentum is the growth in retail open-ended fund structures and what we would call SMAs or managed accounts on behalf of some of our larger institutional clients is also raising the floor for the non-commingled institutional fundraises on the platform. So we haven't put out guidance for next year, but the secular tailwinds are strong. The demand for the product is still as good as we've seen, and the performance continues to be strong and the product diversity and what we have in the market is still there. So we're pretty optimistic that the momentum will continue.

So Michael, a lot of your peers are also seeing success in the fundraising front. How do you see the competitive landscape evolving across private markets?

Yes. Look, it's interesting because there's a big difference between raising capital and deploying it, and there's a big difference between deploying capital and deploying capital well. So this wouldn't be the first market where we've seen capital flowing in just based on the market backdrop. We feel like we've built up some really meaningful competitive advantages over the years in terms of our origination footprint around the globe, our capital scale, the flexibility of our product set, so on and so forth. And so while the markets definitely feel more liquid, the reality is that's showing up in better volumes and deployment as opposed to more competition. And if you look at our deployment figures, you'll see we've been putting up kind of record deployment, investing in really high-quality assets. And so you would maybe intuitively think that we're experiencing a lot more competition, but I think the combination of the size of the addressable market, our position within that market, we're actually benefiting more from the liquidity than experience a competitive threat. One other benefit we have, just given the size of our business and embedded portfolios, is the value of incumbency, particularly in the private credit space that we talk a lot about. And so in our more mature private credit businesses, 40% to 60% of the deal flow that we're executing on is coming from within the existing portfolio, existing relationships. And so that's a pretty meaningful competitive advantage and moat around that part of the business.

So the industry is really pivoting into retail now. The democratization of alternatives is probably like the biggest theme in our space. What are your thoughts on the ability for retail investor allocations to rise? And then how is Ares positioned for this?

Yes. It is definitely one of the large trends. I wouldn't say it's the most powerful, but it is definitely a big trend in the business and it does speak to a couple of things. One is just the importance of yield not just to institutional investors but to retail investors as well. So we often talk about the pressures that an underfunded pension plan feel or an insurance company feels with a disproportionate amount of their investments in traditional fixed income. A retiree is filling that as well, particularly if interest rates stay where they are and inflation enters the picture. And so this demand for yield, durable yield, predictable yield is an important driver of it. And so not surprisingly, the retail investor is looking for ways to access that. But they're also looking for ways to access institutional quality product with an institutional quality experience. And I think that's been a big shift. And so if you look at how we're accessing the channel, historically, we were accessing it through traded product: so ARCC, which is one of the largest and best performing, I think, BDCs in the market; our mortgage REIT; our closed-end credit fund. I think the big transformation now, which is a combination of folks like Ares creating product for the nontraded channel, in partnership with the distribution houses that are figuring out how best to position these products within their adviser base and their client base, so we're well positioned there. We have a well-established brand and track record in the traded space. And in the non-traded space, we currently have 3 products that are all enjoying good performance and good fundraising momentum to nontraded REITs and one interval fund. To put in perspective where we are, those 3 funds raised about $1.2 billion last quarter, and they've got really good momentum. And through our Ares wealth management solutions platform, we have about 90 people deployed against the retail opportunity going from what we would call mass affluent traditional retail all the way up through to the ultra high net worth part of the market. And within that 90-person complex, it's about 52 wholesalers that are just focused on distributing and servicing product in the channel. So we've made all the appropriate investments, and I think we're beginning to see that show through in the fundraising results.

So Michael, I mean you might not be able to make this argument 3 to 5 years ago, but now Ares has scale across your business. You can see this in the size of your global distribution teams. You can see this sitting in your investing teams, too. But where do you see as the biggest scale advantages today?

Well, scale has -- we've been talking about scale advantages for a long time, Craig, and obviously, we've talked about it with you. And this is such a unique thing about alts because in traditional markets, we're all taught that the larger you get, the harder it is to develop return and that it sizes the performance and you get to replace where you're capacity constrained and so on and so forth. In alts, it's the opposite. And I think it's a function of a couple of things as scale expressing itself into the market opportunity. The first is just the ability to build bigger, broader, more diversified origination capabilities. So if you look at our platform today, we have 750 investment folks in 20, 30 offices around the globe that have been with us a long time. The amount of flow, transaction volume, idea generation that comes just from that embedded network is pretty substantial. And as you get larger, you can continue to invest in that existing infrastructure and grow it and then size begets size. So I think that the biggest scale advantage to start is just the origination footprint. I think we have a unique advantage because we've been investing in origination as long as anybody. And so those networks are not only large but they're entrenched deep local market relationships, and that allows you to invest in talent, talent retention, talent development, talent acquisition. The second place that scale shows up is just in the capital availability. And one of the unique things about the way these markets are developing, one of the growth drivers is just simply that as we're accumulating more capital, the available market is growing as we take share from the lower end of the liquid market or part of the capital markets' apparatus. And so as we've gotten larger, we've been able to provide capital solutions to a larger portion of the market, which in and of itself is driving scale. So there is value just to the size of the balance sheet, if you will, and the ability to use that size to develop a breadth of product and capability to be more impactful in the market. And then lastly is the ability to offer a broader set of solutions to the investor. We talk a lot about the value of alt in institutional and retail platforms. But given what's going on in the markets, there's also a need for people to get deployed. So it's not just a question of can you deliver me the return I'm looking for or the solution, but can you deliver it to me at scale, which goes back to my earlier comment is where we are advantaged is that we're delivering great performance but we're able to do it at scale, which means that more investors can attach to us and meet their deployment needs and their return objectives as opposed to just one of those 2. So I think this is going to continue. I think the big will get bigger. You're seeing it in investor behavior, the larger platforms, Ares included, are capturing a disproportionate share of a growing market. Retail platforms and institutional investors are shrinking their GP roster, and they're trying to do more with fewer people to drive better outcomes and more transparency into the relationship, et cetera, et cetera. So this scale story, I think, is just starting as crazy, as that may sound, given how good the growth has been. But the benefits of scale are real, so I think they'll continue to persist.

Michael, I want to take this topic a little further. So what competitive advantages does Ares have in terms of sourcing new investments for its limited partners and...

Yes, I just hit on -- so I'll make this quick because I think I covered that, but it's really about the marriage of deep local origination networks and the flexibility of our capital to go into those markets and attach to great assets in different parts of the balance sheet. Maybe one thing I did mention, which is an overlay that I do think is somewhat unique for Ares relative to some of the other platforms, is our business is very, very integrated and very collaborative across the different asset classes and geographies. And so what we're finding is, as we scale, we're actually able to find investment opportunities that sit within the boundaries of some of our more established businesses, and we're monetizing that across the platform. That's a pretty important distinction just culturally. In terms of the way that we're set up, the way that we compensate our people, the way that we incentivize behaviors is we're actually able to find opportunities that otherwise may fall to the cutting room floor, for lack of a better term, just because they're not sitting within a predefined silo. And I think that's another advantage of the scale and the culture that we've built.

So Michael, in the last year or so, we've seen a real acceleration in capital markets activity, and this has benefited your industry like other industries. But the investing side may make some nervous given the increase in public equity valuations, combined with tighter credit spreads. So how is Ares navigating this backdrop? And is investing in your view more challenging today than it was 2 or 3 years ago?

Again, challenging is a hard -- that's a hard term for me to articulate because we have so many different strategies in so many different markets. The answer is it depends. One of the things that makes the platform great is the diversity of product but also the ability to flexibly navigate markets and cycles. And so a lot of our fund structures allow us to pivot between the public and the private markets. They allow us to pivot between seniority in the capital structure and junior debt or equity. And so a lot of the way we've designed our product is to make sure that we can deliver great returns regardless of the backdrop that we're in. And great evidence of that is the performance that we were able to deliver through 2020 and year-to-date 2021. So we've always had a view that we were purpose-built to outperform in down markets. And again, back to why we're scaling, the more you navigate cycles well and deliver returns, the more proof there is that you can do it again and people allocate more capital to you. So I would say, maybe as follows: the available return generally is lower today than it was 12 months ago or even 36 months ago, but the transaction volumes are significantly higher. And fortunately, the quality of the opportunity set that we're seeing is very, very strong coming on the backs of the pandemic. So I think it's challenging in the sense that you might not be getting paid the maximum that you'd like to get paid for given exposure. But in terms of where we are from a volume and quality standpoint, it's a really, really strong constructive backdrop for us, both in terms of deployment but also in terms of monetization. You have to appreciate, I think the public market valuations, it's an interesting data point. I do think that it's reflective of the liquidity in the market. And it's reflective of the earnings momentum, and we're seeing that kind of momentum in our private portfolios as well. But I think when you start to go down the road of where are rates going, how persistent is inflation and you think about the impact to the traditional fixed income markets and the public equity markets, that's one of the drivers of the flows that we're seeing into alts is, clearly, when you're investing in short duration, floating rate, fixed income product, interest rate moves are actually beneficial. And when you're investing in the real asset side of our business, inflationary pressures tend to be positive as well. So some of the concerns that people are starting to voice around the liquid markets are actually drivers of the flows that we're seeing, I think.

Great. Michael, that's helpful. I wanted -- and this response might be a longer run, but I wanted to circle back on your 3 recent strategic acquisitions: so Landmark, Black Creek, SSGA. So could you -- would you mind walking us through each of them and just explain what attracted you to them?

Yes. I apologize because you're right, this is probably going to be a long one, so I'll try to keep it succinct. We've talked a lot about organic and inorganic growth opportunities. And generally, as we've gotten larger, we're finding it easier to build businesses organically as we marry people and capital and leverage the competitive advantages that we've already talked about. But from time to time, we will make acquisitions where we see a large addressable market that is growing, where we feel that we want to enter that market, either with a greater sense of urgency or greater scale that we could do just building it organically. And I think in each of the 3 cases of Landmark, Black Creek and SSG, that was kind of the case. And the view is when we make an acquisition, we wanted to be strategic and bring something to the platform that we don't have in terms of capability or product, but we also want to have a pretty strong view that we can drive value to the acquired company in terms of distribution information, so on and so forth. And most importantly is we need it to be culturally accretive, which is probably the hardest part of it. I think in -- the good news in all 3 cases, great cultural fit, highly strategic and, as you're beginning to see in the results, financially accretive as well, which in this valuation and market environment, I think, is getting tougher and tougher to do. So maybe taking them one at a time, Landmark, we're super excited about. We had a view that the secondary market broadly is going through a secular shift and it's really along 3 lines. One is it's going away from historically what has been an LP-led business to being a much broader set of LP-led and GP-led capital solutions. That speaks to some of the strengths that we have globally in the GP side of the market and the direct investment side of the market, which is why we're excited about it. Two, that market has historically been private equity centric. But as the private markets continue to scale and the capital in those markets is growing, I think the secondary market for infrastructure, real estate and credit will also grow. And I think the combination of Landmark's leadership position in infrastructure and real estate, coupled with our capability set there and leadership in credit, should be a pretty meaningful driver of growth. And then third is just the globalization of the business. Historically, it's been a fairly North American-centric business. But again, as the distribution of capital in the private markets globalizes, I think you're going to see a continued global expansion in supply and demand for that product as well. And that sets up for growth for us just given the global footprint that we have. So market leader, 30-year track record, good track record of performance, strong innovation track record in places like infrastructure and real estate. And so it checks all those boxes that I talked about in terms of the financial accretion and the strategic accretion. And we're making really good progress on the growth front there having closed it just a couple of months ago. One quick aside, which may be a nice segue into Black Creek, is we also believe that private equity and secondaries will eventually need to find its way into the defined contribution and retail part of the market as well. And so the Landmark acquisition, coupled with our retail capabilities, we think, sets us up to when that trend finally emerges. Black Creek also very, very exciting, and you can see what we're doing there now having shown folks both the financial and fundraising momentum that we have last quarter. But what they brought to us was 3 key things. One was the expansion of our real estate franchise into the core, core plus part of the market. Part of what we try to do in each of our end markets is to be able to capture as much of the addressable market as possible, and that's a function of being able to attach to different parts of the risk/return spectrum and the balance sheet. And so our real estate franchise, while it's been growing and well positioned to delivering good performance, it tended to be more skewed towards the opportunistic and value-add part of the market. And so this gives us a broader product set to talk to our investors about and to fish around in the markets that we play in. Two, it brings a leadership position in industrial logistics real estate, which is probably our highest conviction part of the real estate market today, and it brings a leadership position in that market with a deep vertical integration. So it has a unique capability set, and we're already seeing the value of that as we learn from them and roll out that structure across a broader part of our real estate market. And then third, it came with a pretty well-developed and successful retail distribution and client service apparatus that has now been folded into Ares Wealth Management Solutions and will serve as the foundation for us to distribute the nontraded REITs on the platform but expand that product set as well. Again, check all the boxes: great cultural fit, integration has gone smoothly, financially accretive for sure and strategically accretive as well. And then last is SSG, sorry, gives us a beachhead into Asian private credit. That is a market that, long term, we are very excited about. Obviously, Ares has developed a leadership position in the U.S. and European market. We had a view just based on the cultural challenges in that market and some of the regulatory challenges in the structure of the market that was better to go after the long-term opportunity in Asia through an acquisition versus organic. And again, we're 1.5 years into that and very pleased with where that stands as well.

Thank you, Michael. Very comprehensive. I know it isn't easy going through 3 transactions in parallel. So thank you for that. I have one here on insurance. But I also wanted to just remind the audience that if you want to ask a question, you can write it in, in the box below the videos, and I can ask Michael here. So please feel free to ask questions. Michael, coming back to insurance, we've really seen the alts grow AUM from insurance companies. And there's a variety of different strategies out there. You have your own strategy. So how -- so what is your strategy in insurance? And how do you view it as different than your peers?

Sure. So just quickly to zoom out, the reason we're all talking about insurance in the context of alternative asset management is exactly what we talked about earlier, which is if you can deliver excess yield relative to the liquid market alternative to an insurance company client that's highly valuable, particularly when rates are persistently low and potentially going up. At the same time, if you think about this retail trend or, as you said, the democratization of alternatives, in many respects, annuities and fixed index annuities as a way to deliver alternative credit value into the retail market through an annuity and insurance wrapper. And so this insurance conversation is really the convergence of those 2 trends that we already talked about, which is retail demand for alternatives and the value of alternative yield to the broader investment landscape. We are very pleased with our insurance businesses. We have a dedicated team of folks in Ares Insurance Solutions that focuses on servicing the needs of our third-party insurance client which are quite substantial. We manage money for close to 150 global insurance companies, and that's been one of the fastest-growing client segments for the firm as well as our growing affiliated insurer in the form of Aspida, and Aspida, similar to some of our peers is building at the same time a reinsurance platform and annuities platform. Our view, and you asked about what makes it different, I think that we are focused on maintaining a pretty healthy balance between our affiliated insurance company and our third-party clients. We think there's great value in that. And we've also been pretty clear with the market, so just based on the way that we think about our balance sheet construction that we want to run a balance sheet like model. And so what that means is that while we will continue to grow both the third-party business and the affiliated business, we are likely to grow that affiliated business with third-party capital next to our own balance sheet capital as opposed to going heavy into the balance sheet, which I think is differentiated relative to some of the peer approaches.

Thank you, Michael. We have a question here from someone in the audience on the investing side. Can you share what you're seeing from a deployment standpoint into year-end? Because it seems like sponsor activity doesn't seem like it's slowing up at all, and that's historically been a big driver of direct lending deployment in particular.

Yes, it's a good question. I think the backdrop for continued momentum in sponsor activity and corporate M&A activity is strong. We had a very, very good quarter of deployment last quarter where we put about $20 billion to work across the platform. And not surprisingly, a good chunk of that was in our private credit business and a good chunk of that was in our sponsor lending franchises across the globe. The best place I can direct you is just some of the backlog and pipeline information that was put out by ARCC, which is a pretty good proxy for where we see the forward calendar. And I think your question is right, which is the momentum should continue. Markets are very constructive. Transaction volumes are good. And so I think the setup is good for continued deployment.

I have another question here on the defensiveness of Ares' model. And this is something I think a lot of people aren't thinking about now, but like locked-up AUM, never for a seller. Maybe remind us kind of the defensive qualities of the Ares business model.

Yes. I think we should talk about business model and then maybe just quickly assets, but you highlighted and the best demonstration of the durability of the model is how we performed through not just the GFC but the pandemic. And so it's always good to get tested and be able to demonstrate the stability and the capability. If you go back through the GFC and now through COVID, those are actually the 2 fastest periods of growth in the firm's history. And it's a combination of a couple of things. One is the long-dated nature of our capital. And so we are not a force seller of assets, and we don't see outflows. And in fact, what we see is unlike traditional asset managers, we have lower mark-to-market volatility. And while we don't see outflows, we see inflows because when the markets get choppy and volatile, the investor community is looking for ways to come in and take advantage of that volatility. And so not surprisingly -- but it may be counterintuitive, and you saw this through 2020 and 2021, as the markets got volatile, we're actually seeing fundraising momentum increase, not decrease, which is somewhat countercyclical. In terms of the product itself, we already talked about the diversification, but it is important to appreciate, that flexibility I talked about of going public versus private, senior versus sub, is all part of the competitive advantage of how we navigate cycles as well. But mind you, given the strength of our credit platform when you think about where we attach to a given asset and the risks that we take, generally speaking, in those situations, we're going to be somewhere between 50% and 80% of the capital structure, meaning that there's somebody with a view that there's value to be had significantly below where we attach. And so we have durability in the structure of our funds, but we also have durability in the underlying asset because we're not going fully into the equity. And so a lot of the volatility that you would expect to see is muted just because we're higher up the balance sheet.

Michael, one more for me here, but I was wondering if you could talk about succession planning. And it's like this is not a -- the biggest issue for, I think, Ares. It's a bigger issue for some of your competitors. But maybe talk about the qualities, you have a younger, kind of flatter management team. So maybe kind of talk about some of the differences at Ares versus some of your competitors.

Yes. I don't know. I can't really speak to the competitors, but I think you do hit on something that I think makes us unique and I mentioned it earlier, just in terms of the integrated nature of the business and the collaborative nature of the business. The culture of Ares is not a star culture either in the ranks of senior management or the ranks of our senior PMs. I think that we've all been working together as partners a really long time in building something that we think is special together. The bench is very, very deep across all of our investment and non-investment functions. And we've learned, as an investor ourselves, that the most important the thing any company can do is great succession planning. And so not surprisingly, it's something that we spend a lot of time on at every level of the organization, identifying the leaders of tomorrow, investing in them, making sure that they're getting the development and exposure that they need. You're right. We are a younger management team, but we've been doing this a long time. So the interesting thing for us is we are going to have to be talking about succession planning earlier in people's careers than certain other public companies may, just given the longevity of the team despite the age, which I think is a really good thing just because of the energy that we can bring to the company as we do that. It's pretty unique. So look, we've been fortunate. We went through a CEO transition. It was seamless. I think it went very well, and I'm -- was really happy with the support that I got, transitioning from being the COO and President to the CEO. We've gone through a couple of CFO transitions. That's been seamless. We've transitioned leadership in a number of our investment groups, that's been seamless. We've been able to integrate acquisitions which demonstrate a little bit just kind of how we -- how good we are in organizational integration and organization design. So yes, I think it's a strength of ours. It is something that the industry is dealing with because a lot of these businesses have been around for 30 years, and they were founded by a small group of partners that were fairly homogenous. And we've all grown to be large global organizations with a much more diverse workforce and a lot of different growth avenues. And succession planning is -- it should always be front and center but I do think that the industry probably faces some unique challenges just given where it's come from and how quickly it's grown. But I couldn't be happier with the way that we've handled ourselves at every level. And a lot of the succession planning that we're doing, you all don't see, right? You see what's going on at the management company, but day-to-day, it's front and center as we just think about talent development here.

Great. And Michael, it looks like no more questions from the audience, and I'm also out of questions. So on behalf of everyone here at Bank of America, we just wanted to thank you for participating. And I know we said this in February, but we hope to see you next year in person.

We're ready. As soon as you're ready to have us, we'll be there.

Great. Well, Michael, thank you very much.

I appreciate it.