The Carlyle Group Inc. (CG) Earnings Call Transcript & Summary

[Audio Gap] Davitt. I'm the U.S. Asset Manager Analyst here at Autonomous. It's my pleasure to welcome The Carlyle Group's CEO, Harvey Schwartz. Thanks...

Patrick, great to be here. Good to see everybody. I think this was my first conference last year, so it's good to be back. Happy anniversary.

It was, yes. Happy anniversary. [Operator Instructions]

So maybe to start, Harvey, given we have most of the big alternative manager CEOs here, let's start with a higher-level macro question. I sense increasing concern with my client base that sticky inflation, higher for longer rates, slower economic growth could be particularly bad for levered risk assets. Do you guys agree with that view? Higher level, what's your outlook for inflation rates in the economy, and do you think we've achieved a soft landing?

Okay. Well, first of all everybody, great to be here with all of you again. I think something -- [ something that gets a little bit ] lost when you're in the forest is kind of really what's driving the biggest macro factors in the world. I'm of the personal view that we're in the very early stage of a pretty significant paradigm shift. And what I mean by that is many of the macro paradigms that have driven economic growth, low inflation, are either shifting or they're reversing. And so I celebrated my 60th birthday this year -- 2 grandkids now, by the way -- and -- this is a tight group. And -- so we'll just play it -- we'll play it without the coffee. The -- but if I look back over my lifetime, basically, declining interest rates, declining inflation, globalization, a couple of billion people came out of poverty, regulation was reduced. These are credible drivers of sort of reduced economic friction. And then when you take in geopolitical sort of trends over the past 30 years and globalization, all these things contribute to economic growth, more frictionless economic growth and reduced inflation. In many regards, these things are shifting and not likely to reverse back anytime soon. So if you think about just 2 very, very big ones, globalization and the geopolitical climate today versus what we've had over the past 30 years, I think these are hugely significant trends. And so when you start asking questions about, okay, well, what's the inflation outlook or the outlook for interest rates, I often get asked this question, Patrick, like, what are the riskiest things out there that I see in the world. And I think one of the riskiest things out there in the world is recency bias. So if you're looking through -- again, just my personal opinion -- if you're looking through the lens of, hey, we just went through 15 years of quantitative easing and relaxed monetary policy globally, if that's your recency bias, you're in the forest. And so what's really driving inflation, it's many factors, but it's post-pandemic, it's deficits, it's onshoring, but it's all those factors that simultaneously were contributing to deflation are in the process of reversing. And I don't think it's particularly exotic when asked, well, why are interest rates higher. Like it's almost like people are very perplexed by this. It's actually, on the one hand, quite a good thing. It's a good thing because the economy is growing, unemployment is low. I don't think as market participants, we should be celebrating, "Hey, it'd be great to go back to 0%." We ended up at 0% because we ended up in 2009. So I don't think anybody should be wishing for 0%. And if you think about what's happened structurally with deficits -- that's another reason why interest rates are higher -- that's not such a great thing, right? If you go back to, I don't know, '90s, 2000, 2.5% deficits and then pre-pandemic period 3%, 3.5%. Now we're tracking 6% on our way to 7%. So we've been in the camp for interest rates. When I was here last year, we were calling for interest rates higher for longer. That's the way we've been running the business. Now we have a pretty big edge because we have hundreds of portfolio of companies with 1.3 million employees around the world. And we roll up that data every month, and we could see very precisely, coming out of the pandemic, the inflation spike. Now when we see the inflation spike, we see it very differently than the way we see it in the broader economic news. But we would see inflation spike like up 80% because it'd be component parts that might be $1 all of a sudden $2. And what we saw in that process was operators, CEOs, for the first time really in a generation realize they had pricing power. They didn't know it. And they passed those prices along successfully. And so when we look at the portfolio of companies today, there's nothing flashing there that says imminent recession. There's nothing flashing there that says inflation is going to cool immediately to 2%. EBITDA growth is high single digits. But I think bigger picture, stepping back -- we are in the early stages of some very significant paradigm shifts, which we should all be informed by, which really in the end, I think, are actually quite good tailwinds for the business. And I say that because, as micro investors and one of the largest participants in private capital, when you go through these kind of shifts, the opportunities to deploy capital over many years, I think, are extraordinary. In a quarter, it doesn't matter because as you go through the transition, the opportunities then reveal themselves. When you're transitioning very quickly and we went from 0% to 5% interest rates, everybody is sort of like, okay, I need to digest this. And so you get a slowing of M&A, you get a slowing of risk appetite. That's all quite normal, but -- as rates settle in. But if we were sitting here a year from today and we had 2 cuts, it wouldn't surprise us. Now the good news for everybody that wants cuts, this is a Fed that knows how to cut. Like there's a lot of policy flexibility for this Fed. If they want to cut, they're going to cut. And so I don't know, I'm a little surprised people are so surprised.

Helpful. So we mentioned it's our 1-year anniversary. So it's been just over a year, obviously, since we were here -- since you took the seat, sorry. So I think it'd be a good start after that, maybe, to update us on your key takeaways from the first year on the job, what you've learned, biggest surprises, biggest challenges, and things you're most excited about.

Sure. So how did I approach joining Carlyle? I did a lot of due diligence, spent a lot of time with the founders. I knew a lot about the firm, obviously, from my prior roles and just being in finance for a long time. Huge respect for the firm. When I joined the firm, I very specifically said to myself, new CEO, new firm, firm has been through a lot of stress with CEO succession, which is never easy for the clients, it's never easy for the teams, and it's not easy for executing strategy. So I am keenly aware of the circumstances, obviously. And my only prerequisites when I came in were, in no particular order, one, I wasn't going to make any decisions quickly at all, which was very frustrating for people like you, and I understand it, but I wasn't going to do that because I need to be much more informed about all the competitive strength of the firm and the firm's positioning. That was one. Two, I was going to spend a lot of time getting to know my clients and my partners internally on my business heads and the teams. Three, it was a prerequisite that I get the founders very involved in the business. They built the business, the teams are very attached to the founders, they had a huge amount of value. And so that was a prerequisite. And four, I said -- I was aware that everybody knew there had been friction before with the founders that got, I think, disproportionate publicity like a lot of things do. But I basically said, "Listen, I just want to be perfectly aligned with all of you, you own 30% of the company, so I want my [ compensation ] basically to be virtually all aligned with them." Other than that, I approached it -- I basically tried to drop any pre-biases and say, okay, just start with a white sheet of paper in terms of my own education. So I spent the first year approaching it that way. There pretty quickly emerged a couple of things. One, the organizational design needed to be addressed in a way that would allow growth execution to be mobilized much more quickly. And I had no anticipation of this, but in retrospect, ended up being some fairly meaningful changes. John Redett came in as our new CFO and Head of Corporate Strategy. It was really a change in job description and role, 17 years with the firm, 16 years as an investor. So internal move, changed the head of tech, changed the head of HR, changed the head of the organizational design and changed the head of global affairs, brought in someone new that I've worked with for many years to basically do everything client-facing, reorganized that, reorganized and brought in a new head of wealth. And so a big part of it was reposition the organizational design in a way that -- oh, and a new COO in transition now -- but reposition the team so the team could really unlock the energy in the company, because it had gotten a little stagnant. Two, then we started working on very explicit initiatives. We had an expense review that we started, we reviewed the entire compensation plan, made those changes, launched a whole bunch of new initiatives on the back of that and sort of really just repositioned the organizational architecture and some of the businesses, tweaked some of the businesses from an investing perspective where we had some underperformance, shut down some parts of the business, added to a lot of parts of the business. And in the end, it ended up being a great outcome. We had our best financial performance of the year -- sorry, on record, and third best fundraising year ever. I don't know if I would have felt that exactly, if I was sitting here a year ago with you. But the team really came together. I'm super proud of the leadership group and all my business heads, and I'm grateful for my LPs and their support. And then we launched the capital plan, and we've kind of completely redesigned the way we think about capital deployment. But other than that, not a lot going on.

So I guess, summing it out, what do you think you're most excited about now that you've made all these changes?

So I view my role, at the highest level, overly simplified, it's my responsibility to mobilize human capital and financial capital. I think that's every CEO's role. So one of the things that would come up when I arrived at the firm when I would talk to teams internally, they'd say, difficult to make decisions here. There's a lot of reasons why that can be the case. Having worked in a lot of different businesses, I've seen that in a lot of my prior roles. A lot of it is just unlocking the potential of the firm. So you had asked me, before I answer, I think the thing that was -- which I was quite confident of was the power of the brand, the most surprising thing about the firm is the extraordinary power of the brand. You didn't do it, but I think one of your competitors just came out with an analysis, we're the -- one of the top recognized brands from a reputation perspective in wealth. But the brand -- I know the power of working with a great brand. The brand reach and access is truly one of a kind. And so now it's just a question of how do we unleash all the strengths of the firm systematically, again, in a very disciplined way. And I think over the past year, I'm really proud of the teams for doing all that work.

Okay. That's a nice segue into the big changes you've highlighted. First, the compensation structure, probably one of the most tangible actions you've taken thus far, moving to tie more compensation to performance fees, thus boosting the margin on fee earnings. So how should we think about the cadence of getting to that new 30% to 35% FRE comp ratio target? Does it depend on a big improvement in the realization outlook? In other words, are employees committed to these new ratios even in a low realization environment like we're in now?

So one of the most important things in our business, all of us who are in the same business, is compensation. And when I first showed up, I got 2 questions pretty much every meeting from anybody who was interested in the stock, and they just repeated and repeated it. One was when are you going to change the compensation plan, and when are you going to buy back stock. And what I would say to people on the compensation plan is you're really talking about, having been in this industry for long time, you're really talking about the spinal cord of the institution. And so you have to do these things, most importantly, with an exceptional level of care. So we spent an enormous amount of time thinking through how to do this, because we want this truly to be, as we described when we announced it and internally and to all of our clients, a win-win-win. We want better alignment from a performance perspective, our investors with their clients, our clients, they want it, our clients want it. So that's a win. We -- I personally hugely value the couple of billion dollars that the firm has in carry, but we know from a multiple perspective that The Street values that fee stream more, and that's fine because we can deliver more fees. And so it's a win across the board. The execution is the piece that we want to be super thoughtful about. So the reason why we introduced it the way we did is because this is not something where we're not going to allow it not to be a win-win. And the only way that happens is if we overaccelerate this because we press too hard on the gas pedal. So this is going to be a super systematic orderly transition, and we're going to be patient with it. So you shouldn't expect us to -- as we described when we announced it, you shouldn't expect us to hit this as a goal like oh, we're going to do this by X quarter, because this is a very methodical, systematic change and we're going to do it with care.

Got it. The other big tangible change you made was on capital return with the new $1.4 billion [ authorization ] and what sounds like a firm commitment to use it. On the other hand, stock comp remains a big bugaboo with many investors I talk to. So taking those 2 offsets together, do you expect to meaningfully reduce the share count? And what is a reasonable cadence to think about putting that $1.4 billion to work, given the price is now meaningfully above where you announced it.

Bugaboo, is that like a technical research term?

It is.

Okay. Yes. So well, this is like a proof is in the pudding thing. So I went back and had studied what you just referenced, effectively, which is since the day the firm went public, I think every year there's been dilution in the firm, and last year was the only year we reversed it, since the new team was in place. I'm super focused on how we think about the capital deployment. And again, this is a first principles exercise. It's truly just about our capital, again, going back to my responsibility and the team's responsibility in terms of financial resources and talent. In terms of the financial capital, these are -- I think of every dollar as a precious resource. And so we're going to be very disciplined about the deployment of that capital into growth, that deployment of that capital in how we manage it to shareholders and if we do things that we feel are really accretive from an inorganic perspective. And the way we designed this plan was we wanted to have enough flexibility to have a meaningful impact if we need to. And that's why we came out with the $1.4 billion. I think the first quarter John's in the firm, I think we bought back around $150 million. I think that's almost as much as we ever bought back in a year as an entire firm. And I think the most we have ever bought back as a firm was the first year I showed up. So this is a pretty big shift in terms of the way capital management is being deployed now. Internally, everybody should understand it's a very big shift also. So John and the team have put in a whole different approach to how we think about marginal capital deployment in terms of business selection. So this is bigger than just the $1.4 billion -- but obviously, that's quite important -- but it gives us a lot of flexibility. And that's the key. So the key is where do we want to be on any given moment on the efficient frontier of buying back stock versus deploying it back into the business, and we give ourselves that flexibility. In terms of forward path, because that's really what you want to know, I'm not going to give you one, but -- I got it. But let's just address the obvious. But because I want the flexibility, along with the team, to toggle, right? If we see accretive opportunities, we're going to invest in those, and we're continually going to invest in the business, but also -- we want to be very cognizant of how much float is out there. So we're a little bit constrained by float. And so we don't want to be unnecessarily driving the price up.

Got it. Let's move to private wealth, a topic that everyone is focused on. How are you thinking about differentiating Carlyle's product from the others that have probably been in the market a lot longer. You often mention the brand as a differentiator, but your major peers also have that. So how do you see the global wealth strategy playing out over the next few years?

So I think, again, this is one of these megatrends where wealth is coming into the space, and it's not just a U.S. phenomenon, it's everywhere in the world. We were the first to launch a partnership in Korea last October in terms of distributing wealth products [ in ] credit. And so this is a global phenomenon. I'm not a big TAM person. I never like the TAM argument. I do think there's a real TAM argument here just because the migration and the interest in differentiation in terms of how wealth advisers are thinking about working with their clients in wealth is [ real ], and I do think there's so much to play for globally in terms of the TAM, where, however you want to cut the numbers, I think the opportunity set is huge for the industry. In terms of the brand, we've been in the wealth space for many, many years and we've raised over $50 billion in the wealth space. And that is in part, like Carlyle brand is so recognizable and the reputation is so strong. I think to be successful you need a couple of things. You need brand recognition, you need a very keen understanding of what the wealth advisers want for their clients. And I'm going to come back to that in a second. And then the third thing you need is a portfolio of solutions that those wealth advisers can look at and use as a toolkit, and you have to perform. And performance is not optional. And that means in all respects, what they expect from a performance perspective, what you advertise, how you deliver it, how you reinforce it, how you support it with knowledge, how you provide liquidity, all those things. And I do think we're really, I think as an industry, in the first inning of this. And I know this because about 6 months into the role I started spending a huge amount of time in this space. So much so, for people to understand, that I've met with hundreds of advisers at this stage, one-on-one, groups. I really wanted to understand from them exactly what they need for their clients. And there's a lot of ways you can approach this marketplace. And our strategy may evolve over time and certainly will evolve over time, but the way we're thinking about it is a core suite of a credit solution, which for us is CTAC, a secondary solution, We have this extraordinary business that you all know about AlpInvest, tremendous track record. That's a new solution for wealth clients. And then in '25, we'll likely come out with a private equity solution. That's kind of like the cornerstone of your toolkit. And let me just run through, for example, CTAC. CTAC is basically a horizontal slice of everything we do in credit, last year like a 14.5% return. CAPM, which is the secondaries product we launched a year ago, first year returns 17.5%. But if you're a wealth adviser, you cannot possibly as a firm create every product that wealth adviser wants, I actually I think that's a completely misguided strategy. And you can't be pushing products. These are our partners. So we're on a platform. We're on a platform -- these are partners for life. And what we want to have is key partners we work with where we get the benefit of our historical performance, the iconic power of the brand, and then alongside this suite of core solutions -- and there'll be feeder funds, like there's always been, because we talk to a lot of wealth advisers, and they don't like the open-ended products. They'll say, listen, I like the one-off things for my client. And so you can't be all things to all people, but you have to be enough things to enough people. And that's how we're thinking about it.

On that point, KKR made a bit of a splash last week with its announcement of a partnership with Capital Group to build retail products for more the mass affluent market with more liquid credit combined with the illiquid private credit. Do you think this is a path Carlyle could take as it seeks to broaden the franchise, or think it makes more sense to do this internally or neither? Do you even want to do the mass affluent?

I think that, again, this gets back to where we are in the first inning. This partnership that we established in Korea a year ago actually targets basically the mass affluent, and we work with a firm KIS there. And so -- and their private wealth clients, and they have extraordinary franchise, and they're great, great partners. I think that the ecosystem of finance is fascinating because of the way it changes all the time. And again, this goes back to these paradigm shifting things. One of the paradigm shifts is that if you went back, I don't know, only to 2000, 1999, for those that have been in the business that long, people paid like $0.03, $0.04, $0.05 to trade a share of stock. And then no one could have predicted the advent of ETFs, again, but put yourself in the mind of the wealth adviser or the wealthy client. They want to avail themselves with the whole toolkit. So you're going to see insurance -- more insurance wrapped product. You'll see retirement-based product, but they want to have the full solution kit for their client, and it's really about paying attention to that. And so I think we're going to see a number of partnerships evolve over many, many years. And I think, again, it's all about providing incremental alpha and portfolio diversification to that end client through that -- through those partnerships. And yes, I expect you to see us do more and I think the industry [ will do more ].

Quickly before we move on. This is something I think investors are very focused on, CTAC and CAPM. Where are you in terms of the breadth of distribution? And is there a...

So right now we're [indiscernible] so right now it's predominantly U.S., although going international, RIAs in the U.S. and a number of platforms. I'm under some restrictions as it relates to CAPM, but we shortly are announcing a couple of more platform partners. David Rubenstein and I did a whole tour up and down the West Coast 3 weeks ago right after Milken, meeting with wealth advisors. And I got to tell you, that's super important because you really get to hear what is most important to them. And that's what makes this durable. And I think these partnerships are exactly that, incredibly valuable partnerships.

Makes sense. Moving to credit. You've tripled the size of this business over the last 5 years. but a large part of this business is still CLOs and Fortitude. So where do you see the biggest opportunity to kind of grow this business, increase the diversification? And can you do that organically, or do you think you could -- would have to do more tactical M&A or maybe just lift out teams from other firms?

So super comfortable with the organic footprint. If you, again, step back for a second, what's really happening. So the word private credit, I think, has become a little bit confused. But let's just think of ourselves as an industry as credit providers. There's no particular mystique about private credit. But as credit providers now, this has really gone from, over a 20-year trajectory, from direct lending to sponsors, mostly middle market sponsors, to a full build-out of the CLO business, the direct lending business, asset-backed finance and opportunistic credit. And we're in all of those spaces, growing quite nicely. A lot of this is about, again, the ecosystem of finance -- and not to, like, become a technocrat, but if you look back at what's happened over the past 20, 25 years, 40% of the companies go public as often as they used to, or the population of the companies is down 40%. And if you went back again like to '99, 2000, back then, a company, from the first time they got capital, private capital, might go public in like 3 or 4 years. Now it's 11 years. So this trend is reinforced, the need for private capital is reinforced by the fact that companies are much more likely to stay private. And then you have some other overarching big, big factors, which is the regulation of the banking system and the fact that the more efficient capital provider is often the private capital provider, us and our industry. And so this is really just the ecosystem of finance finding the efficient deployment of capital. And we want to be in that full breadth, and we are. So our asset-based finance business after 3 years is over $7 billion. We're in some extraordinarily interesting flows. It fits quite nicely with the Venn diagram of Fortitude and the insurance complex because you need all that expertise. But I would argue a lot of the firms are growing because of their insurance franchises, just like we are with Fortitude, and -- but it's about having that full breadth across the capital structure. And again, that gives us the ability to create solutions like CTAC, which touch across that whole horizontal. And I like that because it gives more diversification and less concentration for the wealth adviser. Again, when you're -- from the CLO through asset-based finance through direct lending through opportunistic credit, I like that for the wealth client. I personally own it.

Good. That's a nice segue to insurance, obviously. You've taken a little different tack in the insurance opportunity than some of the other large alternative managers with the Fortitude partnership. Could you contrast maybe how you're approaching this channel relative to the others, how you see it growing from here and to what extent you have the breadth of asset management capabilities to fully service the insurance opportunity?

Well I think we've already demonstrated we have the asset management capabilities to service it. So I would knock that question off. But I think the strategic question of fundamentally for the industry, with this convergence of asset management and insurance companies, is the degree to which how much do you want to be a vertically integrated insurance company. I think that's the big strategic question for the industry, and I think the answer to that will be defined over 5, 10, 15, 20 years. I think that the -- again, not to be boringly technocratic, but I think the question that really needs to be asked is: what is the source of financing and how diversified is your financing? One way of talking about the wealth space is a way which I think is most important, which is what's most important to that customer and that client and how do you deliver expertise to that client. The other way of thinking about it is a channel. The other way of thinking about a channel is it's a source of funding. And so I think the fundamental question is, strategically, is where do you want to sit? And where is the efficient frontier of diversified funding sources? And I could define those as institutional capital, I could have a subset that's insurance related just because of the duration nature of it versus, for example, pension fund and their own statutory requirements, where they operate in the cap stack, less in, for example, equity, more in private investment grade and the wealth channel. And across all those, how do you want to think about the diversified nature of your funding? And then within that, what's the benefit of being more like an insurance company on that spectrum versus not? And I think that's a super important question, which people will take a different tack in the industry as we go through it. I think there's a fundamental question linked to that, which is -- can be phrased as how capital heavy do you want to be versus capital-light. So I've mostly operated in a capital-heavy model, as all of you know, because I was -- I ran the trading business at Goldman, and I was responsible for the balance sheet. And I've lived through the cycle of capital-heavy is the single best model in the world, and then I woke up in 2008 and nobody liked capital-heavy. So I think that, again, cycles determine these things, but not a quarter. But what I like about what I've stepped into is the foundation of our credit business and Fortitude gives us huge operating flexibility. I don't have any particular strong view on any one model, but I do know that we can pivot very significantly from this model because we're at the capital-light end. And so I like our current position quite a bit.

Great. Let's -- so moving to...

Did you get any of that or no?

Yes.

I was just kidding. No, the audience just got so serious, I had to [ lighten up ] little bit.