Ares Management Corporation (ARES) Earnings Call Transcript & Summary

All right. Thanks, everybody, for joining us. We're excited to get started with our next session. Please help me welcome Mike Arougheti, CEO of Ares Management. At nearly $400 billion in AUM, Ares has been consistently one of the fastest-growing companies that we cover, aiming to grow fee-related earnings at over 20% per year, and has been successfully delivering on that goal over the years. With deep expertise in private credit across a wide spectrum of products, Ares remains one of the biggest beneficiaries of structural changes unfolding in the lending markets today. So plenty for us to cover. Always a pleasure to have you here.

Great to be here.

So welcome. Thank you.

Thank you. Appreciate it.

So let's get started. I mean the first question, probably not surprisingly, is going to be on private credit and really the allocation trends that we're seeing in the marketplace. And the way I would love for you to frame that is institutions still feel like generally early in that journey, maybe not so much in direct lending, but even in direct lending feels like there's some room. But if you talk to your largest institutional LPs, what's their allocations to private credit today? How would you frame the incremental upside?

Yes, it's interesting because private credit, I still think, is in the early innings, both sub-investment grade and high grade. Large global TAM, more developed in the U.S. markets, growing in Europe, almost completely undeveloped in APAC, LatAm, Africa, et cetera. So when you're thinking about this multi-decade journey that we're all on, private credit is an exciting thing to talk about, and we need to unpack exactly where the opportunity set is. Direct lending, I think, is getting a lot of attention because it's [ probably ] the easier thing for people to understand.

It's been around longest.

It's been around the longest, if you're an investor in other parts of the alts ecosystem like private equity, it's an easy thing to get your head around to understand how to take risk in the same company at a different attachment point. So it's hard to paint with a broad brush, where are people in their private credit allocation journey. But I would say generally, almost to an institution, it is increasing. And it is increasing because you have these long-term secular shifts that are happening in terms of the growth in private markets relative to the growth in public markets. It's accelerating now because of the cyclical opportunity and the relative value opportunity in the private credit markets relative to the equity markets. And so the way I would describe it, if you looked across the entire market, you'd probably have about 3% average allocation to private credit. At least that's what the consultants would tell you. This is institutional, not even touching on, I think, retail [ demand ]...

And we'll get there.

And most people will tell you that that probably has room to get to 10%. So think of it as an opportunity to triple the allocation. Some of that will be people coming into direct lending, corporate direct lending in different parts of the globe. And then for those who have been doing it a long time, we're actually seeing a willingness, now that they're comfortable with the drivers of value on the corporate side, they're moving into real estate, private credit, infrastructure private credit, alternative credit, all of the different flavors, because once you understand where the value gets created in terms of origination, scale, flexibility, et cetera, you see those patterns starting to show up in other parts of the credit space, and that's when they start to move in. So it's a pretty broad-based shift, but it's not the same story for each investor.

No. And by asset class also quite different. So look, you mentioned that the secular story and the secular growth in private markets and private credit has been, in a way, exacerbated by the cyclical things that happen, and obviously what's happened in the bank space is one of those elements that's probably driving the increased appetite to do more things in this part of the market. We've seen a number of alternative managers talk about partnering with banks and looking at opportunities that banks' balance sheet could provide to alt managers. How do you think about that opportunity for Ares in there? Are there a particular aspect of the bank lending market today that are more susceptible to private managers coming in and taking a bigger chunk of that business?

Yes. Again, it's going to depend on the bank and it's going to depend on the private investor. But I've been very vocal, and I'm going to say it again here, the banks are some of our most important valued partners, Goldman Sachs included. We do certain things that banks can't do just based on structural differences, right? Banks are 10x to 13x levered. They take retail deposits. They have to manage that theoretical asset/liability mismatch. The regulatory capital framework forces a certain type of behavior. In certain parts of the world, obviously, there's a policy overlay. We're unlevered. We don't have a policy over -- we coexist and we do different things. But when you really lean into the partnership, there's a lot that you can do together. And I think it's important that people understand that the banks are in the private credit business. They always have been. They were the original private credit providers. So it just -- they're owning them on balance sheet or they're lending to portfolios of loans that we originate. And that's always just a function of what's the regulatory capital framework, right, and where is it kind of best suited. So I only want to start there because when you see the types of things that we're doing now in partnership with the banks as they're navigating the new regulatory capital framework and some of that structural challenges that got unearthed in this rate environment, it's incredibly constructive, right? And it takes the form of, for the regional banks, can we buy a portfolio of loans from you at an appropriate price to help you with liquidity? Can we do a risk transfer trade with you to help free up some rate cap for you to deploy into another part of your business that's more important? Can we create a private sidecar to your balance sheet to help you monetize your customer relationship in a way that works for you because you're not ready to divest of a business that you still think is core? By the way, the same thing is happening with the large banks, too, right? Which is you have huge global origination networks direct to companies and in markets that we don't touch. And so we're having so much productive conversation there, too, just about how do we align bank origination with private capital. So it's a really exciting time in terms of this synergy between the banks and the nonbanks. And so I think the narrative of the nonbanks competing with the banks is a little bit incendiary, because it...

It sounds great as a headline, but...

It's -- it sounds great, and then you get -- yes, no, I hear you. [ I didn't just say that for you though ], by the way, I meant it.

It's So let's stay on this topic a little bit, maybe broaden it out to capital deployment broadly when it comes to credit. And I know it's going to be also hard to generalize because you guys do a lot of things in credit up and down the capital structure in liquid/illiquid. But as you look at the outlook for deployment into 2024, what are your sort of early thoughts? And that could be both in terms of direct lending and more bank-related deals and structures and trades, really, that you think [ of ]?

The different businesses we have, sometimes the way to think of it is they just work in opposition to one another, right? So if you look at 2023, M&A volumes were low. Private equity was not as active. So the new transaction volumes were down. I think for the market they were down close to 40%, for our corporate loan business at Ares it was probably down 20%. So you feel the effect of that. Now the flip side of that is you're not getting refinanced and defending your existing book, so your net exposures are not as impacted. But on the other side of the house, the opportunistic credit funds turn on, the secondary solutions funds turn on, the NAV lending funds turn on. So when we look at deployment as we've grown and diversified and scaled, you're just seeing less volatility in the deployment pace. It's just a question of geography: where is it happening? And so when I look at what is happening in the world today, I would say generally the great recapitalization is the theme, right? You have all of these owners of assets and companies that are high quality, that are either over-levered or they paid too much for them, but they're fundamentally really high-quality businesses and assets, and they need some non-dilutive form of capital to extend the duration of their ownership so that they can ultimately recoup the value loss from the rate hikes. And I think everyone kind of intuitively knows that, but that is a significant amount of installed capital that even in the absence of new M&A transaction volume will keep all of us very busy for a very long time. And that's largely where the focus is going to be. But what's unique about 2024, we're already seeing the M&A pipeline pick up through Q4, and I would actually expect it to happen in Q1, because while you still have this installed universe of companies and assets, you also have at the same time a significant amount of dry powder that's aging that needs to get invested. And now that we have, let's say, rate stability and a better shared view on what the inflation outlook is, people now can kind of start to box the variables around transactions. And so I think we're going to be in this really unique moment where we're going to see opportunistic flow continuing and the new transaction market open up, where usually it's one or the other. So I'm actually cautiously optimistic that 2024 is going to be pretty active on both fronts.

Great. Well, that's great to hear. Let's hit on credit quality. It's clearly top of mind. We've heard from a bunch of banks over the course of the last 2 days as well, and that's very topical. When it comes to private credit, there's a narrative and then there's the reality. I think one of the things that's been out there recently is some rating agencies talked about only the fact that higher quality companies will tend to borrow in public markets and it's only lower-quality companies that'll go to private markets, which -- I think I know what your answer to that is going to be, but curious how you respond to that. But more importantly, what does the credit cycle look like for private credit as we're eventually going to go through one?

Yes. So I clearly disagree, and I've been doing this a long time, and that narrative has been in the market since 2003 when people first started thinking about this. And the numbers don't prove it out. If you look at default rates, loss rates, total return, there's no evidence that would suggest there's incremental risk in the private market versus the public market or the private market versus the bank market. And we could debate why that narrative is out there at a different point in time. The other thing I would highlight, and I think this is so important to get through to people, is that, if you look at the private credit markets as they exist today, the bulk of the exposures -- not the number of investments -- the bulk of the capital exposures are in capital structures with real institutional cash equity that came in with a view on value below the private credit loan. And the reason that is so important is, because of the size of that equity commitment, it is a fundamental risk mitigant to the private credit exposure the likes of which we have never really seen before. And I'll come back to that because I think that is probably the most important takeaway. But in terms of companies, I think it's important. If you look at syndicated loan market, I mean, let's just make the math easy, you call it $1.5 trillion, high-yield market, $1.5 trillion, private nonbank credit market, pick your number, $1 trillion, that $700 million is in the ground. Banks, they own $3 trillion of commercial loans, they own another $5 trillion of real estate loans. So all of these companies are kind of broadly distributed into these markets, some rated, some nonrated. And if you actually look at the credit experience and the returns, private credit has outperformed each of those through every cycle. And we've gone and looked and said, okay, what does the company -- what does a company look like in the Ares portfolio? So today, in our U.S. corporate portfolio, and you can see this in our BDC book, weighted average EBITDA in our portfolio is $300 million, EBITDA, right, which means that this is a company that is probably $3 billion to $6 billion enterprise value. That's a real company that can clearly go to the liquid markets, but it's choosing not to for a reason. The average EBITDA is $160 million. Okay. If you look at the U.S. economy, I think there's 18 million to 20 million private companies. I think there's 20,000 of them that have revenue in excess of $100 million, okay? We have investments in approaching 1,000 of them. We look at 2,000 or 3,000 per year. So at least from where I'm sitting, I'm looking at a universe of companies that says the top 10% of companies in this country have revenues in excess of $100 million, which means they probably have EBITDA of $10 million. And I have a portfolio that's 10x to 15x that -- and I only say yes to 5% of the deals that I see in any given year. So that, to me, says I think I'm investing in the top 1% to 5% of the available companies in this economy. Like why wouldn't I want that? And so that, to me, just flies in the face of this idea that the private companies that we lend to are somehow fundamentally riskier. I actually think that some of the companies in other parts of the market are fundamentally riskier. They may be lower levered, but they may not be as high quality. So that's an important thing just to say, like when you really cut through what -- who are these companies, and they're coming to us because it's a better value proposition. That's it, right? And they're willing to pay for that. But the loan-to-value piece, I think, is important too, because if you then just do the math, $300 million of weighted average EBITDA, $150 million of actual EBITDA, and you say that a private equity sponsor bought that company for 15x and we lent him or her 6 turns of credit, we're at 40% loan-to-value, right? And they wrote $1 billion of equity into this company. And we could argue if the company is now worth [ 900 or 1,300 ], but it's not worth 40% of what it was worth a year ago, while it's growing. And I'm just -- if you are anxious about losses in private credit, then you should be anxious about losses in private equity. And if you're anxious about losses in private equity, you should be anxious about everything that you own in your portfolio. And I'm not saying that to be cavalier, but like that is a real problem. And so when you think about it just through the stability mechanism of a lender and an owner with a shared view on value -- and by the way, if the company underperforms or they have trouble making cash interest payments, you resolve it, right? By the way, that's a default. It doesn't mean that we lost money. That just means rates went up. And so I think when all is said and done, it always takes a cycle for more people to get comfortable with this. You may see elevated defaults. It doesn't necessarily mean that you will see elevated losses. And I think the private credit markets once again will prove to have been a stabilizing mechanism because of the value of that bilateral relationship and the value of that equity subordination. In the GFC, that vintage, we were probably 70% loan-to-value, not 40%. That's a different set up, because now if I'm looking at a counterparty and they put $0.30 to my $0.70 and they don't know if it's worth $0.70, they're going to walk away. And now I have a different set of issues. Again, we know how to make money in those situations. But walking away from $0.60 of equity in a performing company is, really hard. And so I'd just encourage people, just think through that relationship and who is incentivized to do what, rather than just digest the idea that credit risk is everywhere and we're going to lose money, because I just don't think that it's true.

Yes. Look, fair enough. Another higher-level question for you is around regulation, before we move on from the private credit topic. To an extent where private lending -- and I want to use the word lending as opposed to just private credit broadly, right, because as we talked about, there's lots of things that could qualify for that -- moves away from the banks, the regulators are clearly paying attention. It's not particularly clear what they're looking to do with that other than it's just a focus. As a large participant, a large manager in this market, how do you deal with the regulatory uncertainty? What would your response to regulatory change would be? I guess, again, it feels like there's a bunch of unknowns on that front.

There's always unknowns. I would start with the simple statement that we are heavily regulated. We're just not Fed regulated, but we're regulated by the SEC, the FSA, the MAS, the CFTC. Certain parts of our business are regulated by FINRA. Certain parts of our business are regulated by the state insurance commissions. So we're regulated. We're just not a bank, right? So we've got to start there, because when you say we're not regulated, it's not true. Number two, I go back to what I said to you earlier, we're taking a different set of risks for a different set of clients and a different set of structures than other people are. So I argue, as an American and as someone who practices in the capital markets, if you have a levered structure with an asset/liability mismatch, you should have a lot of risk governors on. If you're unlevered and you're match funded and you don't have a mismatch, then you should have more degrees of freedom. And generally, I think most people, including the regulators, understand that. And so I don't know exactly what the regulatory overlay would be. And there's this idea that there's a lack of transparency in private credit. And I would say, well, to who? Right? So the banks that lend us money, they have perfect transparency and therefore the Fed actually sees the loans that are against the loans that we make. Our investors have perfect clarity into the risk that we're taking on their behalf more so than if they were buying public securities, right? They're getting monthly financial information and line item detail on what they own. So again, and this idea of like transparency, I would also say, to who? Like, who needs it and why? And the more transparent we can be in terms of the types of risks we take on behalf of our clients, great. We don't have any problem with that. So I think a lot of this, like it always does, is just going to come down to increased disclosure, increased education of all the market participants. But I don't know what the regulatory construct would be, frankly, to manage the relationship between an asset manager and a private client, a sophisticated institutional client. I think when you get into the world of insurance, different regulatory paradigm. Get into the world of retail, different regulatory paradigm for the right reasons. But we'll deal with it. If it happens, we'll deal with it, because I think at the end of the day, the capital markets are efficient and the capital will find its way to the places that it needs to get to. And if we have an increased regulatory burden, then I do think that's going to favor the larger managers, who can afford to comply. And like we've seen in other parts, that would probably mean that the cost of capital goes up, even if it shouldn't, but it would, and then we all have to deal with that.

And we've seen that sort of consolidation in pretty much every other financial services vertical, where the larger companies just get larger on the back of that kind of regulatory [ regime ] All right. Let's talk about fundraising a little bit. So Ares having clearly a very successful year of fundraising. I think you're at $53 billion in for the first 3 quarters, expected to raise over $65 billion for the full year. With that backdrop, let's talk a little bit about '24, as you kind of -- especially as you wrap up the 2 larger credit funds, the 2 flagship credit funds you have in the marketplace right now, what are some of the expectations for fundraising next year?

Yes. We've haven't gone through the full budgeting process. And the only reason I don't, like -- a, I can't give you the forward-looking information, but b, some of it is going to depend on how we close up this year, because, as you highlighted, we have a number of large funds that are in the market that will cross over a little bit into next year. But we've had a very successful year with a number of flagships getting to the hard cap. I think we were at $53 billion, $54 billion, to your point, through September, we were closer to $58 billion, $60 billion through October. And now it's just a question of what's going to be the year-end cleanup, and some of that will find its way into 2024. The good news is we have another handful of what we all call these flagship funds coming into the market in 2024, our fixed infrastructure debt fund, our third opportunistic credit fund, our third junior capital fund, we're still raising our seventh buyout fund. So there's going to be ample things on the institutional side. And then what we're seeing year-over-year is the floor, meaning the minimum, is going up because we now have a number of traded and non-traded retail products that are continuously offered. We have a number of open-ended products that are obviously continuously offered. If the CLO market ever comes back, things like that obviously contribute to the growth. So it's always going to be range-bound, but the size of that range is narrowing. I think we'll have an opportunity to put the number into the market in the new year once we see what we close and we have a general sense for allocations. But I think based on the performance in the underlying funds and the nature of the discussions we're having, I'm optimistic 2024 is going to be another great fundraising year.

Great. Perfect. Well, let's talk about the wealth management channel. It's an important driver strategically for you guys over the next couple of years. And you've obviously made a lot of progress there. You've launched a non-traded BDC now. ASIF, it's off to a pretty good start. I think its run rate is about $150 million to maybe $200 million per month since July, and I believe you're on a single wirehouse so far. So let's talk a little bit about how you are broadening out distribution of the existing product and what else perhaps you have in the pipeline and kind of how you think about rounding out the wealth footprint?

Yes, it's important. We are very focused on building the product and the capability there. And I think we have a very good head start. And I think that, similar to other parts of the market, that market is consolidating quickly as well, as the large platforms, I think, are looking for folks like us who can bring brand, product, performance, scaled wholesaling capability, scaled client service capability, continuing education for their advisers. And what we are, to your point about product, I think they also want a family of funds so that, as that brand relationship builds and grows, there's economies of scale for everybody. And we're well on our way. We have 125-or-so people in our wealth management business. We are active with one of our products on, I believe, close to 45 different platforms, wires, RAs, et cetera. And the goal is you broaden out the product and then you penetrate the different channels. So to your point on ASIF, which is our non-traded BDC, we launched that in the channel in August. It's up to about $2.7 billion as of last reported. On the one wire, to your point, it's been about 150 to 200 a month. And then we're going to add new platforms into 2024 and we continue to scale that. We almost have a full product set, which is actually kind of a nice place to be as you just think about the touch points with the channel. We have 2 non-traded REITs, both at scale, and unlike some of our peers, actually net inflows for the year. So while those aren't growing the way they were a year ago, on a relative basis we've actually had a positive experience in the channel in 2023. We talked about the non-traded BDC. We have a diversified credit fund that's crossed over $4 billion in AUM and is now meaningful size and continuing to raise. We launched something that we call the Private Markets Fund, which is actually interesting. It's a private equity secondaries product. We put that into the market earlier in the year. It's ramping and it's starting to hit a nice inflection point in terms of its size and the breadth of the distribution relationships. And we launched a European private credit vehicle to complement the non-traded BDC in the U.S. So that's 7 products, almost all of which are scaling -- at scale. And I think that scale is important because, again, that the proposition to the retail client is institutional quality management, institutional brand, institutional performance and institutional scale into the retail market. And so I do think there's going to be a move to fewer managers with larger funds, even though these are semi-liquid, I think that scale is important to navigate the liquidity needs of the client. So we're excited about where we are.

Great. Let's talk a little bit about another strategic priority for you guys, which is the insurance channel. I think it's about $11 billion in AUM today with your -- through your partnership with Aspida. You have plans and targets to get that to $25 billion by the end of 2025. Aspida had some nice improvement in the organic growth, and that's something we've talked about in the past as well. So let's spend a minute on your outlook for organic growth at Aspida from here. Any early thoughts on DOL and the impact that could have up or down with respect to distribution of fixed annuities?

Yes. So it's doing exactly what we want it to do. We're on track for the $25 billion. The organic engine has been built and is delivering exactly the way that we want it to. The reinsurance side of the business is also well developed. We've got a great series of seeding relationships there, and that's growing. Given what we're able to do on the asset and liability side, I think it's quite unique that we can grow organically the way that we're growing without any legacy, right? We kind of have this de novo fully tech-enabled LifeCo that is a nice complement to what we do on the credit side, but we've been public. Our ambitions for that company are less than some of our peers just in terms of the over-indexing to insurance. It's an important part of the business, but it's not the business.

It's not the business, right.

Part of that is just again back to diversification of the client base and the funding base, because we have $50 billion of our $400 billion of AUM is with third-party insurance partners, and they're valuable partners to us and we think about them similar to the way we think about the affiliate. So I think it's on track if not maybe even ahead of pace. Capital raising is going well there, as we've talked about. Third-party equity, we're using third-party equity. Obviously, we have a meaningful commitment in it. But when all is said and done, we will be a minority investor in that platform, obviously, with the benefits of the affiliation. DOL, that's been around now for, gosh, 7 or 8 years already. When it first came out in '15, '16, nothing materialized. I think largely that's a conversation around commission rates and high commissions, which is not really the way that we approach the business. So it's something that we're digesting and monitoring, but at least in terms of the product set that we have and the distribution model that we utilize, it's not something that I'm terribly concerned about.

Got it. It doesn't sound like you're losing too much sleep over that. Let's talk about your financial targets. So at your Investor Day a couple of years ago, which I just think you guys did it here. Like you might have done it here?

We did. It was so...

Like that was that post-COVID haze... It was okay. Yes, we were all actually looking it more casual than that but -- than this. But I vaguely remember that. So you set the target's FRE growth of over 20% per year through 2025 and get into a 45% FRE margin. The opportunity set back then was good, but I would argue the opportunity set for private credit today is better than it was when you set these targets. So talk to us a little bit about how you envision sort of sustainability of these targets beyond 2025 and if there could be upside to them?

The good news is we're going to have another Investor Day May of next year.

And is it here again?

I don't know where. I think we're doing it at the St. Regis. But we'll update that. It's time, right? I think we've executed well against all of those goals. I think when we set the targets, people thought that they were pretty ambitious, and I think we've delivered on them. And I agree with you that the strength of the business, the diversification, the scale, the breadth of capability, the number of investments, there's a lot that exists here now that we've built organically and inorganically that did not exist in 2021. We're going to have to take a step back and really look at just the development of these markets and [ I'd ] say that will be pretty soon when we'll come out and refresh as we get close to the end of the first set of guidance. But it's a fun time to be in our business because, as we said, you've got these huge secular tailwinds that are still at play. And at this specific moment, you just also have this big cyclical opportunity. And I think we've been fortunate with good performance. We're now going into this vintage, which I still think is going to be one of the great vintages, with $100 billion of dry powder. And for our size and our market position, that's going to be very, very differentiated.

Yes. Very powerful. Great. A couple of minutes on the clock. If anybody has questions, just raise your hand, we'll get a mic to come around. Yes, one, in the middle there.

You mentioned geographies in the beginning, and I think you've opened a presence in Tokyo and a Brazilian partnership now. So could you just elaborate a little bit on geographically how you think about distribution, and strategies that could be relevant?

Sure. Our goal over time will be to have the full product set in each of the relevant geographies, but the markets are developing at a different pace, which is just a commentary on the state of the bank market, regulatory framework and creditor rights, adjacent capital markets and the depth and breadth of those markets. So a lot of what you'll see us doing is going to be a reflection of where we think the market is in its development. If you look at Europe as an example, we moved into Europe in earnest in about 2006, and it was credit led. We began to see the developments of the private credit market there, and now we're fully developed. So if it's a strategy that Ares runs, it's in Europe. We're now similarly making that push into APAC. It is still credit led. But up until this point, it has been largely opportunistic credit led, just because those markets are less developed, there's less regulatory certainty in those markets, and so a higher risk, higher return strategy was appropriate. But even in the 5 years that we've really been building that business in earnest, we're already beginning to see a maturation of certain markets, like Japan, Korea, Australia, New Zealand and even India now, where some of the more traditional products that we manage are relevant. And so for us, it's more about the investment side than the fundraising side. We have very entrenched fundraising relationships in that region, and now it's about bringing the capability. So I think the first market that you'll see scaling out of the ones we're not in is going to be APAC broadly. LatAm is a good example of a market that is not quite ready for prime time for us. But we're beginning to see some of the patterns emerge again that would tell us that the private markets will continue to grow, particularly private credit. And you're also beginning to see changed investor behavior, right? Just as a quick example, Mexican pension funds, up until recently, were not actually able to invest aggressively outside their home market, now they can. You're seeing little things that are beginning to show that the central banks, governments, pension regulators are beginning to open up to market participation. So what we chose to do there was to actually invest in that opportunity early through our partners at Vinci, who we've known for, gosh, a dozen years. We think they're as good as it gets in that market. They've got local relationships. They understand the cultural nuances of doing business there. And we'll learn through that partnership as they'll learn from us. And then I think when we see that the market has developed, that's when we would do something else. So I think you're -- it's really going to be a function of how evolved is the opportunity set relative to what we do, how open is that market to third-party capital. Because in a lot of these places, it's just, when you factor in inflation, currency and regulation, it's hard to say that it jumps off the page as a great relval, but it will, and we want to be first. So that's kind of how we're thinking about it.

Great. Well, thanks for the question. I think we're at time. So Mike, thank you so much for being here.

Thank you. Appreciate it.

Really great to talk to you.

You, too. Appreciate it.