Ares Management Corporation (ARES) Earnings Call Transcript & Summary

Okay. Well, good morning, everyone. Welcome. We're going to get started with our next session. Next up, it's my pleasure to introduce Mike Arougheti, President and CEO of Ares Management. Ares has been consistently one of the fastest-growing alternative asset managers that we cover with deep expertise in credit and private equity, which were recently enhanced by acquisitions of Black Creek and Landmark, really propelling the firm further into real estate and secondary solutions business. At its Investor Day recently, actually, Mike and I were just saying in this room, only a couple of months ago, management laid out a long runway for future growth, committing to 20% plus FRE growth for the foreseeable future. So lots to cover. Mike and I will spend time, I think, on all of these topics. So thank you so much for being here.

Great. Great. Thanks for having me. It's good to be back in person.

So I wanted to kick things off with a macro question just given the audience and how top of mind inflation is in higher interest rates and really, let's talk on higher rates with respect to private markets business. How do you -- and again, we've kind of seen this movie before. I feel like at the end of 2019, we've talked about higher rates again and prior to that as well, right? So when you think about the directional rates, what are the expectations of the business from a fundraise and performance perspective, anything that particularly worrisome?

Yes. Look, just to quickly hit inflation. The good news is we have investments in 3,200 middle-market companies. So we generally have good data. The problem is, I think, as everybody is seeing the data is a little unclear. So we definitely have some supply chain constraints. Those do seem to be getting alleviated. And we've got significant demand drivers, and that's obviously creating inflationary moves. I will say that the wage inflation is real, a combination of just shifts in the economy and labor force participation. That's a little vexing because even if the other is transitory, that tends to be a little bit stickier. That said, we're all going into that environment with record high operating margins, and I think the ability to navigate that. So if we are in an inflationary environment because there's fundamental strength in the economy and rates are going up, that tends to set us up very well for outperformance for a couple of reasons. One, our business generally is credit-sensitive, not rate-sensitive. That's largely a function of the fact that our credit business is anchored on shorter duration floating rate assets. So as rates are moving, we tend to generate higher rates of return. And maybe somewhat counterintuitively, the investor community is buying those fixed income instruments from us with an eye on the excess return that we're generating relative to the fixed income markets, not the absolute return. So the way to think about it is as rates are moving, they're still consuming alternative fixed income to the same level. Whereas I think 15, 20 years ago, when the space was a little less mature, there is a fear that if rates moved and the returns available in the traditional fixed income market became more attractive, you would see folks allocating out of all. So we just haven't -- we haven't seen that. In a similar vein, if you look at the structure of the funds that hold these assets, many of them have fixed rate liabilities. So we actually will generate excess levered ROE. And in places like ARCC, our publicly traded BDC, we obviously have fixed hurdles as well. So as the aggregate ROE is going up in the portfolio as rates move, that tends to generate higher performance revenue and management fee revenue. I think the one thing to keep an eye on, which I think is more of an issue for traditional PE than it is for a business position like ours is obviously the valuation environment that we're in today is a reflection of the rate environment and the discount rate. We're seeing that in the public markets as well. So to the extent that we see a persistent move higher in rates, you would likely see valuations adjust. That also tends to be a good thing for our business. If you think about where the bulk of our assets sit, they tend to be at the top half of the capital stack. So a lot of that valuation pressure tends to be absorbed by the equity as opposed to the portfolios that we manage.

Great. Well, let's bring this conversation a little bit closer to Ares. I want to spend a couple of minutes on deployment. As we went through the year, it increasingly felt like there's no shortage of capital that's going into private markets. And so in some ways, deploying that capital might become a binding constraint for some of the firms as we kind of look out. You guys have been very aggressively deploying capital. You deployed $20 billion in the third quarter low and then the pace of capital deployment has definitely been scaling. So I guess first question is, how is your deployment pipeline looking in the fourth quarter and your thoughts into '22? And then second, how has Ares opportunities that evolve since pandemic really to see such a material step-up in deployment? And how are you differentiating yourself amongst creditors?

There's a couple of different questions, which I'll see if I can remember that. The first -- your observation is absolutely correct. Deployment has been strong and strengthening. I think that's just a function of the liquidity in the market, the health of the economy. There's some pent-up demand for transactions coming out of the pandemic. And the private markets are clearly more liquid. You have to really contextualize the deployment, though, in terms of where is that the flow coming from. And one thing that's happening in private markets, as we and folks like us are scaling, we're able to capture larger parts of the liquid market opportunity. So if you just think about private equity, private equity and venture are capturing a larger part of that private market, universe companies are staying private longer. They have more diversity of funding choices within the private markets. Similarly, if you look at the credit markets, the private credit markets are taking share from the high-yield market, the leveraged loan market and the securitization markets. And that's been a pretty consistent multi-decade trend. So I think there's a misperception that there's just so much capital slushing around that it's creating a spike in transaction volume. There is some of that, which is just there's real fundamental strength. But a lot of this is we're taking share from the banks, the capital markets and the public equity market. And I don't expect that to change because as we're getting larger, the size companies that we can attach to is increasing. So a good proxy for that is just to look at the average EBITDA in our private credit portfolio, and you'll see that continuing to increase year-over-year. It's evident in the recent state of large private financings that we and others have been doing. And if you look at the addressable market today, high yield and leveraged loan market is just one corner of opportunity. If you look at that $3 trillion market, over 80% of it is an issue size below $2 billion; over 50% of it is an issue size is below $1 billion. So if you see this trend of private capital providers, like us, able to actually write buy-and-hold commitments for $1 billion or $2 billion plus, there's a pretty large addressable market of high-quality issuers available to us that up until now, we just weren't in a position to finance. So I would expect it to continue.

You had a little bit on my next question around the addressable market. And today, Ares and most of you are direct lending peers in space are predominantly lending and deploying capital through sponsor-backed relationships. As you think about this addressable market and the opportunity to expand either, a, beyond the sponsor backstage or even into things like investment grade or flavor investment grade, is that an area where you see yourself and some of your peers going?

Yes. I think the whole market is expanding. As private equity is growing. They're capturing a larger share of private transaction flow. So not surprisingly, even as we and others are building our nonsponsored and direct-to-company businesses. It's hard to keep pace with the growth in the sponsor business. Historically, 15% to 20% of what we do is direct-to-company. And part of the way that we differentiate ourselves even on the equity side and the credit side is through industry specialization. So in our private equity business, healthcare, healthcare services, business services, et cetera. And on the lending side, we have dedicated industry teams in sports meet and entertainment, energy and infrastructure, healthcare and life sciences, consumer. So they are sitting in these businesses, sourcing flow direct to companies and in partnership with the sponsor coverage, and that is driving increased flow. You also hit on an interesting trend, which is, as we're scaling and as the type of capital that we're able to raise and manage is growing and diversifying, we're capturing more of the capital stack. So if you go back 20 years and you say what would have meant to be an alternative credit manager, we would have been investing in small company, mezzanine investments to try to make 18% to 20% rates of return. Today, alternative credit is really anything that we can self-originate, privately structure and control that's going to deliver excess return relative to the liquid market equivalent. And viewed through that lens, we are now very active in what we would call high-grade fixed income alternatives as we're capturing a much larger share of the balance sheet. And that's where we begin to drive into places like retail and insurance because of our ability to source some of these kind of lower risk, lower-return, high-grade fixed income products.

As all of these spaces grow, do you expect the general mix to stay similar or one part could actually reaccelerate or accelerate further against each other?

It's a really good time to be in the [ odd ] space. Every one of our businesses is growing above trend and because of this size benefit that we have and because of the fragmentation of the markets that we operate in. So at least as I sit here today, if you were to go strategy-by-strategy, they're all pretty much growing meaningful double-digit rates.

High-class problem.

Yes.

So let's talk about some of the recent acquisitions, starting maybe with Landmark. It sounds like integration is off to a good start at the Investor Day. You've outlined a number of different kind of strategic initiatives that you guys could do together. Two-part question, I guess, one, maybe a level set for us where they are in terms of various fundraising initiatives? On a stand-alone basis, I know they're in the market, I think, with the secondaries in real estate, I think is coming as well at some point of time. So how are they thinking about sizing the opportunity set for the existing business? And then more importantly, what are the things you guys could do together?

Yes. So I can't talk about we have funds in the market, so I won't talk about those specifically. But maybe to zoom out because it's -- Landmark is a great example of where we choose to build through acquisition versus organically. Prior to the acquisition, Ares was active in the secondary space. But I'd say what we lacked was scale. We lack dedicated pools of capital in the different asset classes. We lack the technology around certain types of structures. And a lot of the value create in secondary is just the data that you amass over decades looking at different funds and different assets. So the opportunity to acquire Landmark was pretty attractive one for us because we were able to take a 30-year track record and body of work with a lot of data, a lot of analytical edge and meaningful scale and marry it with our sourcing and our capabilities in direct investing. The reason we chose to acquire versus build is we're also of a mind that the secondaries market is going through a pretty meaningful transformational shift right now, in terms of where the opportunity is and what the growth rate will be for that market. And that's being driven by a couple of things: one, there's a pretty big move away from private equity into other pockets of the private markets, real estate, infrastructure, credit. Landmark, as you mentioned, does have a pretty meaningful track record and head start in real estate and in for secondaries, which was attractive to us. Two, it's globalizing. Historically, it had been a North American-focused business, and we're now seeing, as the private markets are globalizing the opportunity to provide secondary solutions is moving to Europe and Asia and other parts of the world. But probably most importantly is a shift away from what we would call LP-led secondaries, which is the traditional -- I'm an institutional investor. I'm looking for some kind of portfolio shift in illiquid markets. So I'm going to sell a portfolio of fund investments into the secondary space. That's LP-led. It's now moving towards GP-led, which means that managers like Ares and we've actually executed on a number of secondary transactions as a manager, the GP is looking at their portfolio and saying, on end of fund life, I'd like to own an asset longer or I'm early in my fund life. I have a high-growth company, the need for capital is going to overwhelm the size of my fund I can use the secondary market to own that asset longer and more efficiently, stake sales, NAV loans and GP preferred. So that part of the market is exploding, both in terms of the growth but the diversity of need. And that's where I think we're going to have an edge. We have the largest GP relationship coverage effort in the market, by far, across private equity, real estate, infrastructure, and it's global. And so the ability for us to plug into those 950 relationships. And in addition to marketing loans or sale-leaseback transactions, we can now talking about secondaries and that's kind of the biggest revenue synergy that I see in putting the businesses together. It's also a good indication of what we're able to do as a large platform with meaningful distribution and information edge. Landmark was effectively stuck inside another public parent. We were able to acquire the business at a pretty attractive financial price. And so typically something that strategic, you would be happy if we were strategically accretive and culturally accretive, but that happened to set up nicely just given the landscape for us to be able to acquire it pretty nice price as well.

Great. Let's spend a couple of minutes on another deal you announced today earlier this year, Black Creek. Obviously, there's a number of important things for you guys. It really expands your footprint in the real estate sector, gives you meaningful distribution capability on the retail side. And again, it sounds like the transaction is off to a pretty good start, $800 million of inflows in their open-ended nontraded REIT product last quarter. So two-parter, as well, as you're probably issued to by now. So can you talk through, I guess, some of the primary distribution footprint that's driving flows at Black Creek on a stand-alone basis? And again, similar to Landmark, what are the things you guys are most excited about doing together?

Yes. So you nailed it. This was a twofer, right? We got a very, very well-established core, core plus, vertically integrated real estate developer and asset manager in industrial logistics, which is probably our highest conviction part of the real estate market today. Top 3, top 5 market share in logistics, which is hard to replicate organically. And as a result, it comes with a fund complex in the nontraded market but also the institutional market that is scaled with real track record and real following. So if you were just the real estate part, again, strategically accretive, financially accretive and very exciting for us. What's really interesting now is the acquisition came with a very well-developed nontraded distribution capability. And what we've done is, we took their distribution capability, we married it with our sales force that was focusing on high-net-worth and ultra-high-net-worth sales into one unified wealth management solutions business that now sits within our global distribution. And the reason for doing that is we can use our brand cloud with the wire houses to increase enhanced distribution of the existing nontraded REIT product, but we can also take that footprint and deliver new product into that channel as well. So the opportunity is really twofold. It's one, right now, if you look at their nontraded distribution. It's largely through one of the wires. If you look at our diversified credit interval fund, we're on multiple wires. And if you look at our track record in the public markets, in places like ARCC, the brand that we've developed within the retail market from the wires through to the independent broker dealers is pretty significant. So we're now in the process of rolling out the existing real estate product into other wire house platforms, and then you'll start to see us introducing new products into the channel as well, but meaningful head start. The 2 nontraded REITs today are in excess of $7.5 billion. In the aggregate, our diversified credit fund is approaching $2.5 billion. And as you highlighted, in the nontraded REITs alone, we did about $800 million last quarter aggregate fundraising the channel in excess of $1 billion. And while we haven't put out the quarterly numbers, the nontraded REITs are publicly out there with about $250 million raised last month. So that's in excess of $3 billion run rate. If we do nothing more than what's already in front of us, so pretty attractive growth there.

Great. So maybe piggybacking on the retail discussion. Obviously, a super important theme for private markets this year that feels like has been building over the last couple of years, but really sort of exploded with everybody's focus now in this part of the market so far this year. We talked about real estate. I was curious if you could spend a couple of minutes on some of the other product initiatives that you're thinking about rolling out into the retail channel. I think on the last call, you mentioned other forms of BDCs. Obviously, you have ARCC, which is the public vehicle. There's some nonpublic options that I think you talked about exploring. So maybe let's dig in a little bit more into that?

Yes, without listing them, I think the theme in retail right now is yield. So not surprisingly, the same way that insurance companies are looking for yield in a low rate environment or pension funds are looking for yield because they have a funding gap retirees are looking for yield and they're looking for alternative yield. And so you're right, it's been building, but you now have this confluence of demand from the retail investor, right, against the rate backdrop and an aging demographic and an increasing amount of retirement. So there's a bigger focus on savings and retirement income. You have folks like us who now have the engine to develop, distribute and service the product. And the larger platforms had to go through a process of understanding how to diligence market and service these products as well. So there's been a lot of activity, and finally, it feels broke through to the other side where the manager, the investor and the distribution are all working together to grow the business. The bulk of what the retail investors are looking for is yield, and that could come in the form of alternative credit product like the BDC or the interval fund or the nontraded REIT product, which will have 4%-to 6%-type current with an 8% to 9% total return opportunity. The good news is the bulk of what we do is yield product, right? I mean, it's kind of our core strength. So there's a number of strategies that we currently manage on behalf of the institutional investor community that could easily be repackaged and delivered to the retail consumer, and that's across the waterfront. One interesting little nuance about the Landmark deal too is, private equity appetite in the retail market is significant, but it's very hard to meet that demand, simply because the traditional private equity fund is committed and then drawn down over time. So the mechanics of running a strategy like that in the retail market are challenging. So secondaries is going to become an increasingly important tool to deliver private equity exposure into the retail market. So I wouldn't be surprised if there's going to be a nice synergy now between our secondary solutions business and the retail distribution as we think about marrying those 2 capabilities.

Great. That makes sense. Shifting gears and let's kind of zoom out a little bit and talk about fundraising a little bit broadly. Being a student of you guys as business for many years now, the pace of fundraising is out, certainly surprised to the upside, but what I find more interesting than a lot of it is coming from non, kind of, flagship funds. You look at a lot of other alternatives asset managers you kind of time your flagship cycle and that's really the driver. You guys have a lot of evergreen SMA-type of structures, they just kind of continuously fundraising. So maybe talk to us a little bit about the sizing of those? How are you thinking about the growth in those type of vehicles and just the broad opportunity you see to expand these structures into other asset classes?

Yes. I think you hit -- you hit a key differentiator for us is, we're not dependent on large flagship fundraises to scale the capital base. And because of the diversity of the strategies that we run; we have multiple "flagship funds" that are in the market in any given year. So if you go back, the industry used to raise a large fund, deploy it over 3 years, start to harvest it, raise another and there is a step function of growth that was very episodic. Now it's just much more linear because of the number of flagship funds and because of the issue that you highlight, which is we have a lot of open-ended permanent capital vehicles that are creating a higher floor. The nature of those, it's pretty diverse. So it's things like ARCC, ACRE and ARDC are listed vehicles, which are back-in-growth mode. It is this whole nontraded complex of funds that we just talked about. They are what we would call funds of one or evergreen SMAs that we run on behalf of some of our larger, more strategic LPs. So things like our insurance platform where we're growing large blocks of reinsurance and annuity streams. It's our open-ended institutional business, where we have large open-ended funds in and around our alternative credit business, our real estate business. So those are on continuous offer. And so you go into every year knowing that while the flagship funds are also growing that floor is increasing. One advantage we have as well not being private equity centric is, the bulk of our funds are -- they pay on deployment, not on commitment. And I think we've talked about this a lot is just that embedded value within the P&L of -- the capital we've already raised, it's not yet earning fees. But what it also does is, it just creates more velocity, right? Because we can raise smaller funds more frequently because there's really no economic incentive for us or LPs to do it the other way around. So I think if you were to look at that the pace of fundraising part of what's happening is, while we're raising larger funds sequentially, we're deploying them quicker and coming back. And then the other benefit of those is the historical funds, unlike private equity, don't really step down. So you keep building this ballast, if you will, on the P&L as well. as we're raising funds more consistently.

Great. You mentioned insurance. So I want to spend a couple of minutes on that. Aspida has about $3.2 billion of AUM with Ares. Ares, I think has about 30% of that amount. So not a huge dollar amount, but it's an important growth strategy for you as you've obviously described in the past. You went through sort of a transition in that business and now it sounded like it's back on its front foot, growing organically, but also looking to expand further and reinsure more. So what's your outlook for both kind of organic and inorganic initiatives there? And then when it comes to inorganic, how much of Ares's balance sheet are you willing to sort of expand to support their inorganic initiatives?

Got you. You keep that there's like 5 questions.

We have only [indiscernible], I'll try.

Yes, we're definitely on its front foot. We chose -- that's one that we chose to build largely organically, but we used M&A to acquire the tools that we needed to set the business up for success. And we are now seeing through our existing reinsurance flow agreements pretty meaningful flows in that business. As we've talked about, our annuities platform is up and running. We'd expect to be writing new business in 2022. At our Investor Day, we put out a forecast that we expected the business to $20 billion to $25 billion by 2025, and that was largely just based on the organic opportunity. The inorganic opportunity is pretty significant in terms of the reinsurance flow but also on the life side, and I think we'll continue to look at that. Obviously, like we do with our own business when we're looking there, it's really a question of buy versus build and what that looks like. In terms of our balance sheet exposure, we had funded the initial business build. Our goal and hope is that we'll be able to expand the business in partnership with our LPs as opposed to being balance sheet heavy, which is a little bit of a departure from the way that some others are going about the business. But that said, the ROEs are very attractive. It's highly strategic to the rest of our business in terms of product development, the ability to play in that high-grade fixed income part of the market. So if the growth requires incremental balance sheet investment, we would absolutely look at it, but that's not how we're drawing it up.

Yes. It makes sense. All right. Next question is around capital, just kind of dovetails on your comments around insurance and I'll try not to do this a multi-parter, but now that I'm reading the question, I think it's going to be a multi-parter. So when we're thinking about just the cash flow generation of the business over the next several years, we talked about FRE growing north of 20%. We talked about -- we haven't talked about it, but you guys talked about before performance fees becoming more recurring in nature, just given the European waterfall style of a lot of your credit funds, just again, giving you a lot more visibility into free cash flow. How are you guys thinking about dividend growth from here, buybacks? And anything else from an M&A perspective, you think might be still interesting?

Yes. So look, it's -- we're in a really nice spot from a balance sheet liquidity standpoint, very low net debt, a lot of revolver availability at low cost, a stock that's attractive. And so a lot of optionality on the balance sheet. But as we've said before and I'll say it again here, our view is that we want to be a "balance sheet light asset manager." And so when we're using the balance sheet, it's typically to drive growth in the fee engine. And when we converted to a C-Corp, we put out a pretty simple capital framework, which was that we would use our FRE, which was growing at a pretty high rate to fund a sustainable and growing dividend and that we would harvest our performance-related earnings, which tend to be a little bit lumpier to reinvest in the growth engine. And that could be hiring teams, opening up new office footprints, seeding new funds, opening up new distribution channels, so on and so forth, acquisitions. And that strategy hasn't changed. But what you highlight is, given the success of the business, we're seeing more of that performance income start to come in. You see it show up on the balance sheet and the growth in our accrued performance fee, which is an all-time record. And this phenomenon in our business, which is somewhat unique to the platform that we run in '22 into '23, you're going to begin to see some of this European waterfall performance income and roll through much more predictably and consistently. I'm not sure that will change the capital framework, but it will give us more optionality on things like the dividend and buybacks. So we'll cross that bridge when we get to it. But I think that the key message is, balance-sheet-light is absolutely the way we think about the business. And we've found no shortage of opportunities to use the capital to grow. And I think that we'll continue to present themselves. One other interesting thing about buybacks, there's actually kind of an embedded buyback structure in the way that we use stock compensation. So effectively, when we deliver equity compensation, investing to our professionals, it gets delivered net. And so if you really think about the way that, that flows through when we're delivering that stock, it's coming through net, which effectively reduces share count. And so while that's not a use of cash in terms of share count neutrality, it has a similar effect as buying back stock.

I got you. My last question before I turn it over to the audience around M&A. So you guys have obviously been acquisitive over the years, and the strategy has really been branching out into newer areas to give you scale there faster, right? Look, when I think about what you did in Asia, we talked about real estate, we talked about secondaries. Given you have footprint in so many verticals now, should we think about more adjacent M&A relative to sort of what you already have? Or there still kind of wide space you want to expand into from kind of completely new asset class geography vertical perspective?

Probably the latter. There are very few, what I would call gaps in the product set now or the distribution capability. So a lot of what you should expect would be tuck-ins or adjacencies. There are a couple of big addressable markets like global infrastructure, where we're probably subscale and maybe there's some interesting things to do there. But for me, the nice thing about the M&A that we have done is, again, financially accretive, a lot of revenue synergies, both ways, and opening up new strategic markets and growth areas quickly, but not high risk. And they're not high risk because of the way that we're structuring and buying these companies in terms of the price and the alignment with the teams and the sizing. So it's not a coincidence that these acquisitions tend to be in this $5 billion to $10 billion, $15 billion range against our close to $300 billion of assets. So you can meaningfully move the needle to the upside, but you're not taking real franchise risk when you make these acquisitions. So the larger we get, even the meaningful ones start to look like tuck-ins, but those are kind of the sweet spot for us.

Yes. That's great. All right. A couple of minutes left. Why don't we see if the room has any questions? Do you have a question raise your hand, and we'll have the mic come around? Go ahead, Rob.

You've seen a couple of traditional asset managers acquire assets in sort of your core vertical of private credit direct lending and maybe seek to try to leverage their distribution position. I wonder if you could sort of compare and contrast that effort. Maybe they have a larger footprint in retail today than you do, but you guys have the product expertise?

Rob, I can't -- we can't hear you up here.

You try that again.

How about now?

There you go.

Okay. Sorry. I just -- you've seen a couple of traditional asset managers acquire alternative assets focused in sort of your neck of the woods. They might have more retail distribution. You guys have the track record and product expertise. Can you just contrast the approaches and any competitive impacts?

Sure. So it should come as no surprise that the traditional asset managers will want to get into the alternative space. I think some have tried organically without success, and now we're turning to acquisition to try to capture the opportunity. So the reason I say not surprising is if you look at the alternative market, putting aside the fact that top managers are growing at 2x plus the rate, the alternative market is growing at 10% plus, and the traditional market is growing in the low single digits. So and in the alternative space, you don't fight outflows, you don't fight mark-to-market volatility, et cetera, et cetera, and fee compression. So that said, they're 2 totally different businesses in terms of how you manage money, how you manage people, what the compensation structures are, where you raise capital. So the overlap is, to your point, going to be in this burgeoning retail opportunity, and I think the question is, does an alternative manager with core alternative capability, have a higher probability of success selling that institutional quality product to the retail channel versus a traditional manager who has retail distribution, adding [ ALTs ]. Talking my own book, I think that we'll have more success in the channel just because ultimately, the folks were making the decision to onboard those funds are the ones that want true [indiscernible] , right? So not to say that there won't be some share gains, but I'm not as optimistic maybe that they're going to be able to really compete with the pure-play ALT managers. But it is a real vote of confidence, if you will, for the value of ALTs in a solutions business now that the traditionals are saying, "Okay, I can't build this organically. I've got to go buy it now, if I want -- if I want to have an opportunity to deliver this to my clients."

Great. Well, thank you very much. I think we're out of time. Mike, thanks so much for being here.

Thanks for having us.

See you again. Yes.

Me too. Thank you.