Ares Management Corporation (ARES) Earnings Call Transcript & Summary

Yes. So deployment is a meaningful part of our -- the predictability of our earnings trajectory. I don't know if it was a disappointment, as we also said in our prepared remarks, it was actually in line with what we expected our deployment in Q1 to be. And when you look at our deployment relative to the peer set, it was actually at the very high end of the peer set particularly relative to our AUM. So I think there is some good indication that we were taking share of a smaller market. The other thing, I think, to appreciate is when you have lower gross deployment, you're also not getting refinanced or taken out of a lot of your existing exposures. So you really have to focus on net deployment. And when we go through these periods of volatility, you may see transaction volumes slow, but your net deployment disappointment is much less than it may appear. And particularly in credit where we're not reliant on those realizations to generate as much promote. We obviously reaffirmed the guidance. So while we acknowledge that deployment as a driver of earnings. What we have learned about our platform, we have so many different strategies in different markets that if, for example, new issue LBO volume comes down, we'll start to see a meaningful pickup in distressed deployment or if real estate equity deployment comes down because transaction volumes are low, we start to see a meaningful pickup in real estate secondary. So part of what we're beginning to really reap the benefits of is the broad mix of strategies that we have and our ability to deploy in any environment. So while transaction volume is still muted, we are seeing it pick up. I'm optimistic that you're going to see meaningful transaction volume pickup in Q3 and Q4 once we settle on -- on the new rate paradigm and sellers and buyers can agree on price. We see that building in the private pipelines. And I don't know if you have any of the sell-side banks here at the conference, but they would probably tell you that they are seeing a meaningful pick up in the number of companies preparing to monetize once there is consensus. So there are some good indicators that, that volume will pick up. But if it doesn't, we're still pretty confident that given our capability set and the diversity of strategies that the deployment will be there.

Yes, makes sense. Through the lens of your view, and I think most of your competitors agree that rates will be higher for longer. There's still some people out there that think will come back down at some point, particularly we have a bad recession. So what is the pitch? I mean -- so like if we were talking last year, the pitch for private credit is a floating rate and rates are going higher. What is the pitch to your clients? And how do you see demand evolving if indeed the lower rate regime [indiscernible]?

Yes. You hit on your prior question, and you saw this in -- we differentiated ourselves in fundraising and deployment. And the reason that we differentiate in fundraising is because private credit is in high demand. Interestingly, it's in high demand for all the reasons I articulated earlier, senior secured floating rate, short duration but if you have an inverted curve and you want to capture all of the excess return that's currently at the short end, a 2- to 3-year floating rate loan is a pretty good way to do that. So the shape of the current curve is actually another catalyst for people wanting to access shorter duration floating-rate credit. I probably would have given you a different answer 15 years ago because we didn't quite know how investors behave through different rate regimes. I think now when people are investing in private credit or private markets more broadly, they're investing to capture excess return relative to the liquid market equivalent. So there is always this fear that rates would go up. The available return in traditional fixed income would be adequate and it would reduce demand for private credit assets. What we've actually seen is that because we've proven the durability of that excess return, for some investors, it's adequate, but for many who have already said, "I need private credit as a core allocation", they're just going to be clipping more excess return in a market like this, where there's a fair amount of volatility and the traditional markets are range bound, that's a really nice way for them to generate excess return. For that small handful of investors who do say, "Based on my portfolio construction, liquid markets is enough for me, certain insurance companies, for example," you then have a whole section of the institutional market who were chasing return in the equity market and now say, "Oh, if I can make a 12% to 15% short duration floating rate return, I'm going to take allocations away from my equity bucket and move it into credit". So what we've now seen develop over the last 20-plus years is there's durability to the allocation. And whatever is leaving the market, you're seeing at least the same amount come in to capture the excess return because it's always about relative to what.

Yes. Makes sense. Let's move on to secondary. So I think this is one part of your business that maybe hasn't grown as much as we had hoped. You put -- as some background, you purchased Landmark to gain a foothold in that business. So it seems like there should be a big opportunity emerging as LPs seek liquidity. So do you think there could be a bigger pickup in fundraising for that business and maybe walk through the broader growth strategy?

Sure. So yes, we acquired Landmark 2 years ago, almost to the day, probably. And the reason we made that acquisition was we had a view that there was going to be transformational change in secondaries. That was already underway, and it was a combination of growth in the primary market for private equity, real estate and increasingly infrastructure and credit. So we had a view that we would be able to grow the secondaries business away from private equity into other parts of the market. Two, there was a change underway to move away from LP-led secondaries, which was institutional LPs looking to sell portfolios of fund investments to manage portfolio construction and a shift to GP-led which was this whole world of GPs looking for liquidity solutions in their own portfolios. And then three, we had a view that it would globalize just based on where the capital was and the increased appetite for alternative exposures. That was a big secular view that we had. Now fast forward 2 years later, we have this massive cyclical accelerant, which I think you're referring to, which is in a world where people are feeling unable to raise as much equity capital as they want, both on the LP and GP side. Secondaries, in addition to structured equity, structured credit, private credit is going to be a big part of how we resolve the installed base of alt. So I think you will see meaningful growth coming out of this moment in time as the GPs are trying to extend duration, get to a better valuation environment, get to a lower rate environment, preserve their carry opportunity. And you're going to start to see LPs, and we're already seeing it more actively use the secondary market to rotate into the current vintage. Now what's interesting, we're seeing this in secondaries, but we're also seeing it coming out of banks. The things that are getting sold first tend to be the highest quality assets because part of the game right now is minimize the discount and minimize realized loss. And so in the continuation fund side of the business, we're seeing some of the best performing highest quality assets come to market, which is a unique opportunity. And on the secondary side, we're seeing a meaningful increase in the amount of credit secondaries because the discount on a credit book is somewhere in the 90s and discounts on equity books somewhere in the 80s and discounts on venture books is probably somewhere in the 70s. So if you're a CIO that's looking to generate liquidity easier to sell something in the 90s right now than the 80s and redeploy it into a high coupon part of the market. So I think the investment thesis for secondary is intact. In terms of it being disappointing, that's not -- again, I don't want to sound defensive, not how we think about it. We went in and bought a business with a 30-year track record. It was a great cultural fit for us at deep institutional relationships but maybe didn't bring to the table some of the things that we brought and I think that was reflected in what we paid for the business. And you can go back and look, they were doing about $97 million in FRE when we bought them and we paid about $1 billion for it. So I think roughly a 10x purchase price for a business with real presence and scale with a view that we could transform the business by extending the product set. So what have we done? We've launched a credit secondaries business, not surprisingly, given our credit leadership position. We announced a $1 billion joint venture with Mubadala to get that business off the ground and we've now launched a commingled fund into this current market opportunity, which we think is really exciting. Two, we leveraged our wealth management platform to launch a private market fund i.e., secondaries in private equity-oriented strategy for the nontraded market, that's already up to $300 million and scaling and is opening up a whole new investor base for secondaries. And then three, we're actively raising for the real estate and infra strategies where I think we still have a meaningful leadership position. So if there's any "disappointment", I think it would only be reflected in the fact that our last private equity fund was smaller than maybe some would have expected it to be or would have hoped it to be. And there's a whole host of reasons for that, not the least of which is private equity fundraising is hard right now, as everybody knows. And two, that fund got launched well before our transaction was announced and ultimately closed and had been in the market for a very long time. And that's just a tough -- tough thing to reaccelerate. So as I sit here today, we're thrilled with the acquisition. We're thrilled where and how we acquired it. We're thrilled with the product diversification. We've been adding talent, opening up new geographies. And so now we've caught this really interesting moment where, to your point, secondaries is going to really, really accelerate and I hope we capture a fair bit of that.

Sure. So I think that's a good parlay to retail because I imagine that's an asset class that might package better for retail. You're a little bit earlier in that process versus some of the other firms. So maybe update on the products you have in the market there. And do you think the high-profile fund gatings that have been much reported have shifted the discussions you're having with distributors?

Sure. So let's see where to start. We have a number of products that are already in market. We have 2 nontraded REITs that have good long-standing track record and performance, total AUM there is about to $13.5 billion. We have a credit -- diversified credit interval fund, which is about $4 billion. We have this private markets fund that I referenced was about $300 million, and we recently launched our nontraded BDC with initial capitalization of $1.5 billion. So call it, give or take, $20 billion in a diversified portfolio of strategies with good performance and growth prospects. So that's pretty meaningful given where the retail market opportunity sits today relative to the TAM. We have a pretty unique platform, and I've said this publicly before, the market opportunity is quite significant, but it is not available to everybody. You need the combination of people, wholesalers, client service folks, et cetera, that can actually service the large platforms and the RIA channel. To put that in perspective, we have probably 120 people in our wealth management business around the globe that are building product and relationships in that channel. Only the largest managers will be able to make that investment and support it through different market environments. Two, the platforms are going to require not just great service but they're going to require a broad product set because the pitch to the adviser and ultimately to the client is invest behind brands that were up until this point available only to the institutional client, but you need to be able to choose where you want to -- where you want to invest real estate, real assets, private equity, private credit. And then I think brand is going to become increasingly important. I think the good news is we have been managing BDC, ARCC and putting a lot of our institutional product into this channel for 20 years. And so given all the investments we've made in people and product, we're doing it already with a lot of brand awareness in the channel. The gating, I would just -- I would rephrase it because the funds that you're talking about have not really been gated, right? So they are structurally designed to allow for 5% liquidity per quarter for a reason because I think that the investment managers, the allocators and the clients all recognize that if you're going to put less liquid product in a semi-liquid wrapper that you need some mechanism for orderly liquidity where you're not fire selling assets to the detriment of those investors that want to stay in the fund. So I think we should all be careful that we're not talking about this as gates going up because that has an implication of underperformance that we're not necessarily seeing in the channel. And implies that somehow the funds aren't doing what they're supposed to do, but they're actually doing exactly what they're supposed to do. Orderly liquidity in an illiquid asset class. So yes, there was some disruption in the market at the end of last year into early this year because of that phenomenon. It's hard to know exactly how much of that was investor dependent. There were certain geographies where investors were owning these products with leverage. They got margin called. So there's a technical thing at play here that we don't quite know how to -- how much to attribute. Two, the funds that are seeing that occur are largely real estate oriented and you can't turn on the television or open up the newspaper and not see an article about all of the pending challenges in the real estate market. So there's also a part of this that is probably just a commentary on people's appetite for CRE exposure. But when we look at the experience that we're seeing in the BDC as an example, I don't think that there's an indictment in the opportunity in the channel. I think you're going to see rotation away from certain brands to other brands, away from certain asset classes to other asset classes, and we'll keep growing through this.

No, that makes sense. On the nontraded BDC launch, I think it's launching -- you obviously have a great brand name, but it's launching in a fairly crowded market of at least all the surface what look like similar products. So how do you think that can differentiate itself from all the other nontraded REIT products being sold to retail investors right now?

We're going to find out. It's always hard [indiscernible] totally modest. But we are, by far, in my opinion, the best BDC manager in the market. We have a 20-year track record of outperformance at ARCC. We've grown that business through various cycles. And I think we've earned a lot of credibility, not just in the private credit markets, but in the BDC structure. And so while we've been slow again, back to some of the ways we think about business building to bring the nontraded BDC into the market, I would say that people are -- have been hoping that we would for those that wanted to access our capability in that form versus the traded form. So it's still early. Obviously, we'll keep you all posted. But I think our brand and track record are pretty unique. And again, while the market will seem crowded, and I don't want to sound disparaging, putting a fund in the channel and scaling it with good performance is different than registering a fund. And we're in this moment in time now where -- and I get this question a lot about private credit, there's all these people raising private credit. How are you going to compete? There's all these BDCs. The reality is you have a lot of people rightfully so, given how attractive the asset classes are raising their hand to try to be in the business, but that doesn't necessarily translate into dollars raised and sustainable growth and you have to kind of look at it through that lens as opposed to a number of people who are raising their hands. So I think there are a lot of funds that are either in the market or registering, but I'm not quite sure that they are going to scale. Time will tell.

That makes sense. I have one from the audience on the pad here. It kind of goes back to what we were talking about at the beginning. But in terms of underwriting, are you still seeing a lot of cov-lite loans out there? I guess more broadly, do you feel like the market is still pretty aggressive in terms of underwriting terms? And how has that evolved?

Yes. So it's a great question. The pendulum always swings from borrower-friendly to lender-friendly. We're coming off of a decade-plus borrower-friendly market, and it has very quickly swung aggressively to a lender-friendly market. So not only are new underwriting is coming in at lower leverage with higher fees and higher coupon, but the documents are significantly tighter across the board, covenant levels, baskets, et cetera. So you're not really seeing a lot of that bad behavior in today's market. It's not to say that it's gone forever because the pendulum always does swing. But at least in terms of the underwriting, again, why are people so excited about this vintage is because you're attaching -- given the debt service constraints on the owner is you're attaching at a very low leverage level with very high rates of return and very tight documents. And so that tends to last a while, right? And then it will eventually swing back. The other thing I do want to highlight in and I've said this before, covenant-lite has not demonstrably underperformed covenanted loans. So it's not something people want to hear because it sounds like it's just bad underwriting and bad risk taking. But if you look at how covenant-lite loans performed in prior down markets, they've actually done as well and in certain cases, better. And the reason is, number one, only the best borrowers tend and the best owners tend to be able to access covenant-lite loans. There's a positive selection bias in terms of who gets those structures. And two, a lot of value destruction within the credit markets generally happens when you have a syndicate of borrowers with different structures, different agendas and therefore, a different path to value creation. So when you have covenant-lite loans, what it actually forces people to do is to freeze in place and it allows the owner of the business, the management team to actually maximize the value of the enterprise for the collective good of the equity and the lender. And so sadly, and I don't want to say this true for a lot, but sometimes lenders don't act in their self-interest. And a lot of times, the covenant -- covenant-lite loans are actually getting resolved to the benefit of the lenders, even though the equity is driving the outcomes. It will be interesting to see how that plays out in this cycle because a lot of these loans are owned in CLO structures that can't own downgraded securities and can't reinvest into new capital structure. So if we are going through a world where new money needs to come in to resolve some of these covenant-lite situations, there could be some knock-on effect in terms of how that impacts performance of certain CLO managers but -- long-winded answer, but no, the underwriting is about as good as we've seen now, and it's tightened up considerably.

Yes, I'm hearing that from a lot of people. Let's move to capital. You've been one of the more acquisitive alternative managers over the years. Are there any major verticals or geographies that you think are still a priority? Or is it really about pivoting to organic growth now?

I think we're -- all the acquisitions we made have brought some really unique capabilities to the table and using the secondaries example that we just talked about, we're opening up new markets with the acquired platforms. And so we do have a bias towards investing in organic growth right now. It's easier. It's a higher ROE. We have greater control over outcomes. And so I feel like we've got a really good set of capabilities in a really broad set of markets that we can continue to drive. That being said, when you go into markets like when we're now, it tends to catalyze a lot of interesting conversations. Managers who are poorly capitalized or their balance sheet is not quite right or they're challenged on the fundraising. So I think we're going to be opportunistic if the market shows us things that are interesting and that they underwrite well, but definitely a bias towards organic, right now.

Got it. Makes sense. A new one from the audience. Is there a sustainable long-term illiquidity premium for private credit versus public liquid credit? Or is competition and narrowing spreads going to eliminate that?

My own personal view is there will be a durable illiquidity premium. The premium that makes its way into these loans is illiquidity premium, but there's also what I would generally call complexity premium and service premium. And without going down a rabbit hole, when people are borrowing in the private market, let's say, even 150 basis points over where they would execute in the loan market, we've seen historically, it's been more than that, but even if it's 150 basis points. When you look at how they drive value in those investments, the top of the list is earnings, cash flow NOI growth multiple expansion because of that growth, amount of leverage and cost of leverage is actually significantly lower. So it's not to say that sophisticated institutional borrowers aren't price sensitive. But if they can get better execution, and pay for the flexibility to execute the business plan, they're going to generate higher returns. And that's, I think, why you see so many people borrowing in the private market and paying that premium over time because it's actually value creative. There's another nuance that a lot of people don't talk about is a lot of these markets now converge into unitranche and stretch senior type loans, the borrowers get to pay down over time, their blended cost of capital, which is in the old days, if you were doing bank bond executions or bank mezz, you're always paying down your lowest cost of capital. And so when you run your model, your cost of capital was increasing over time as you were executing on your business plan. So there's actually just some arithmetic that makes the private credit instrument more accretive to the IRR in a leverage structure.

Makes sense. Perhaps to conclude, I think a lot of people have a view that we're heading towards a recession and in particular, through the lens of a lot of the questions we had tonight are worried about leverage credit. So through that lens, why do you think we should be buying your stock now particularly after such a good run of outperformance?

I always hate answering that because my job -- and I'm a large shareholder, my job is to run the business and deliver growth. So I'll tell you why I think we're differentiated and I am an investor by trade. There are very few businesses that I know of, and we invest in thousands of businesses that have strong durable secular tailwinds of growth, right? Our market generally is growing, and we are capturing a disproportionate share of that growth. So we're a growing company and a growing market. There are very few businesses that I know that generate 40% EBITDA margins with 20% to 30% plus growth. That's a very unique animal, particularly when you're in a market where you are seeing secular growth tailwinds and burgeoning leadership. So I think the stock has been differentiating itself, right? If you look, we've been the best performing alt. I think we are actually the best-performing financial stock over the last 5 years in terms of total stock return. And I think that's a reflection of really good execution against this growth model. I think right now in this moment in time, I would just say all of that is intact as expressed through our guidance on FRE growth, dividend growth, et cetera. But now you have this real moment where private credit and alts are in higher demand, which should drive more predictable fundraising and more predictable deployment. So again, we always think about the world through the secular and the cyclical. I think we've demonstrated now hopefully over 25 years that we can deliver pretty consistent, predictable high growth but we're about to go through another transformational cyclical shift, which is going to highlight some of the value of the strategies that we've rightfully so over-indexed too, and that's -- that would be my pitch.

It's a good one. Thank you. Thanks Mike.

Thanks, everybody. Appreciate it. Thanks.