Ares Management Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 8, 2024

There are 10 speakers on the call.

Operator

Welcome to the Ares Management Corporation 4th Quarter and Year Ended Earnings Conference Call. At this time, all participants are in a listen only mode. As a reminder, this call is being recorded on Thursday, February 8, 2024. I'll now turn the call over to Greg Mason, Co Head of Public Markets Investor Relations for Ares Management. Please go ahead, sir.

Speaker 1

Good morning, and thank you for joining us today for our Q4 year end 2023 conference call. I'm joined today by Michael Arougheti, our Chief Executive Officer Jared Phillips, our Chief Financial Officer and Carl Drake, who has moved to a new advisory role within our public markets investor relations team. We also have a number of executives with us today who will be available during Q and A. Before we begin, I want to remind you that comments made during this call contain Forward looking statements and are subject to risks and uncertainties, including those identified in our risk factors in our SEC filings. Our actual results could differ materially, and we undertake no obligation to update any such forward looking statements.

Speaker 1

Please also note that past performance is not a guarantee of future results and nothing on this call constitutes an offer to sell for a solicitation of an offer to purchase and interest in any Ares fund. During this call, we will refer to certain non GAAP financial measures, which should not be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles. Please refer to our Q4 and full year earnings presentation available on the Investor Resources section of our website For reconciliations of the measures to the most directly comparable GAAP measures, note that we plan to file our Form 10 ks later this month. This morning, we announced that we declared a new higher level of quarterly dividends starting with our Q1 common dividend of $0.93 per share on the company's Class A and non voting common stock, representing an increase of 21% over our dividend for the same quarter a year ago. The dividend will be paid on March 29, 2024 to holders of record on March 15.

Speaker 1

Jared will provide additional color on the drivers of this increase later in the call. Now, I'll turn the call over to Mike, We will start with some Q4 year end business highlights. Great. Thank you, Greg, and good morning, everyone. Hope everybody is doing well.

Speaker 1

We're pleased

Speaker 2

to report that we ended a great year of execution on many fronts with a very strong 4th quarter. Despite a difficult year for fundraising across our industry, we experienced strong demand for our funds raising more than $74,000,000,000 in 2023, including more than $21,000,000,000 in the 4th quarter. This was our 2nd largest fundraising year and it was a record amount of capital raised directly from institutional investors. We entered 2024 in the enviable position of having more than $110,000,000,000 in dry powder to invest in what we believe is an attractive vintage, providing the opportunity to drive strong earnings growth in the years ahead. In the Q4, transaction activity picked up as market participants gained greater certainty with respect to interest rates and the economy.

Speaker 2

Against this backdrop, we were able to leverage our growing investment platform to record our strongest quarter deployment for the year, which matched our 2nd highest quarter on Our Q4 deployment jumped more than 40% compared to our Q3 and we're encouraged That higher than typical levels of activity for this time of year have spilled over into the Q1. We also continue to deliver strong relative investment performance for the year and in fact our U. S, Europe and Asia direct lending strategies generated double digit returns in 2023. We believe that our consistent performance through cycles is resonating with investors and our LPs are committing additional dollars across our broad set of strategies. For the year, we drove double digit growth across many of our key financial metrics, including 19% growth in AUM and management fees and 17% growth in our fee related earnings.

Speaker 2

I'd add that our fee related earnings excluding FRPR increased by more than 20% year over year. We believe that our ability to generate this level of fee related earnings growth in a market where M and A activity was down over 35% speaks to the resiliency of our management fee centric business. Going forward, we believe that we are headed for another strong year as Jared will walk you through a little later in the call, but I do want to highlight a few key points. First, we believe that the expectation for lower interest rates and better than expected economic growth is viewed as a significant relief for the deal markets and we expect it will help drive higher transaction activity to start the year. We also believe that other factors like the aging of private equity dry powder and the demands by LPs to return capital are also supportive of higher activity.

Speaker 2

Fortunately for us, we believe that we're well positioned for a pickup and deployment activity due to the significant investments that we've made adding 230 net investment professionals since the peak in market activity in 2021. We've built an origination engine that's capable of doing much more and an increase in market activity should enable us to drive efficiencies across our greater headcount of investment professionals. Secondly, we believe that we're approaching a step function in the growth of our net realized performance income. We're nearing an inflection point in a recognition of net realized performance income from our European Waterfall Funds that have been performing and growing since 2017 and therefore we expect a ramp up this year and an acceleration in 2025 beyond. As an added benefit, if market transaction activity does in fact improve, we could see more of this income pull forward from realizations, but it's still too early to make that call.

Speaker 2

Overall, we believe our business is well positioned to operate in a variety of market environments. We're resilient in tougher, slower markets, but can see deployment and realizations accelerate during more active market environments. 3rd, we have a lot of momentum with our investors as we experienced strong demand for not only our private credit strategies, but also our opportunistic real estate, real estate debt and our secondary strategy offerings. In 2024, we believe that we're set up for yet another strong year of fundraising As some of our largest fundraisers spilled over into the New Year and we're launching several new large funds with expected closings this year. Let me walk you through some recent activities to provide insights on where we stand heading into the New Year.

Speaker 2

For the Q4, the $21,100,000,000 we raised was our 3rd highest quarter on record and just slightly behind what we raised in Q3. In our credit strategies, we continue to make great progress raising our 3rd U. S. Senior direct lending fund with another $1,800,000,000 in new equity commitments in Q4, bringing the total equity commitments to $8,300,000,000 at year end with total investment capacity of 15 point $2,000,000,000 including anticipated leverage. We've already surpassed the $8,000,000,000 in LP commitments from our previous vintage And we anticipate a final close in the Q2 with the ability to add further leverage capacity thereafter.

Speaker 2

Our 6th European direct lending fund raised another €1,300,000,000 in equity commitments and a €2,500,000,000 leverage facility during the Q4. With over €550,000,000 closed thus far in the Q1, our equity commitments for this new fund now total €11,000,000,000 And with anticipated leverage, the fund has over €16,000,000,000 of investable capital. We've essentially matched the size of the previous vintage and we expect further upside into a final close later in 2024. Pathfinder 2 held a final close in October, only 7 months after its first close. The fund received $6,600,000,000 in total commitments surpassing our $5,000,000,000 target.

Speaker 2

The fund hit its hard cap and was almost 80% larger than its predecessor fund. And as with its predecessor fund, Pathfinder 2 is structured with a unique charitable tie in whereby at least 10% of the carried interest will be donated by Ares and the team to support global health and education initiatives. To date, the Ares Pathfinder family of funds have generated returns that would result in approximately $19,000,000 of charitable contributions. We raised another $900,000,000 in equity commitments for our 4th U. S.

Speaker 2

Opportunistic Real Estate Equity Fund, bringing total commitments to over $2,000,000,000 exceeding the previous vintage. Within real estate, we also raised another $500,000,000 in debt and equity commitments in our European real estate debt strategy, bringing total assets to approximately 2,400,000,000 Within private equity, we raised $1,400,000,000 of commitments during Q4 and will continue our fundraising throughout most of 2024. In secondaries, we held a final close for our Real Estate Fund 9 raising $3,300,000,000 in commitments inclusive of affiliated co invest This latest fundraise matched the size of the predecessor fund, which was the largest real estate secondaries fund closed in the market to date. We now have completed the top 2 largest real estate secondaries fundraisers which puts us in a great market position. Fundraising in the wealth management sector continues to be an area of focus and we see significant growth potential here over the next decade.

Speaker 2

We're starting to see an acceleration within the wealth management channel as our broadening set of products is attracting a growing number of distribution partners. For the Q4, we raised $1,300,000,000 in equity commitments. For the full year, we raised $3,600,000,000 in equity commitments nearly $5,000,000,000 including debt commitments. According to 3rd party industry data, we were ranked in the top 3 among the public alternative managers and overall wealth management fundraising in 2023 as we were able to gain market share in a difficult environment. Our Momentum in the Q4 has carried over into January as we had our largest month ever for wealth inflows totaling over $600,000,000 across our 6 products.

Speaker 2

Now after putting in place the infrastructure over the past 18 months, we're also set to see our international fundraising efforts materially increase in the first half of this year. Let me walk through an update on a few of these wealth products. Our non traded BDC, ASIF raised nearly $500,000,000 in equity commitments during the Q4 and our European equivalent ASIF raised over $150,000,000 closing on January 2. During January, these two funds raised an additional 3 $50,000,000 in the aggregate, which underpins our expectation for continued strong fundraising in the wealth channel during 2024. Within Private Equity, we're now seeing a significant ramp in our Ares Private Markets Fund or APMF, which launched on its first wirehouse in September and raised roughly $240,000,000 in the 4th quarter.

Speaker 2

And with over $800,000,000 in assets today, the fund is continuing to gain scale and momentum. Our 2 non traded REITs raised $273,000,000 combined in the 4th quarter and more than $1,300,000,000 for the full year. Both funds continue to generate positive net flows for both Q4 and the full year as we meaningfully perform the overall non traded REIT market on a net flow basis. Another area of high strategic focus is our affiliated insurance business. ASPEDA finished the year with nearly $12,500,000,000 in assets, more than doubling its $6,000,000,000 in AUM at the beginning of last year, And we remain on track with our target of $25,000,000,000 in AUM by the end of 2025.

Speaker 2

ASPITA has now achieved operational scale and is generating attractive returns for both annuity holders and the SPITA equity investors. We had very strong deployment in the 4th quarter totaling $24,000,000,000 matching our 2nd highest quarter on record. 4th quarter deployment across the credit group increased 60% over the 3rd quarter driven by strong results from our U. S. And European direct lending and alternative credit groups.

Speaker 2

Jared will discuss our fund performance in more detail, but our investment portfolios continue to be in excellent shape. We continue to see strong EBITDA growth across our credit and private equity portfolios. And in fact, we saw an acceleration of EBITDA growth to approximately 8% year over year within our U. S. Direct lending segment.

Speaker 2

Our corporate credit portfolios, which were more than 95% invested in senior debt at the end of the year continue to have low defaults and lower than historical levels of loan to value. Our global real estate portfolio continues to experience resilient fundamentals due to our allocation to the best performing sectors with 50% of the gross portfolio in industrial assets, 24% in multifamily and another 13% in similar adjacent sectors like student housing and self storage. We're meaningfully underweight in U. S. Office at about 4% of our total real estate portfolio and less than 1% of our AUM.

Speaker 2

Our opportunistic real estate and special Opportunities teams recently formed a joint venture with a leading owner and investor in commercial real estate in New York. The JV has commitments of $500,000,000 And we'll seek to invest in high quality distressed office buildings in New York as capital for the asset class has become increasingly scarce. And now, I'd like to turn the call over to Jared for additional commentary on our financial results and our outlook for the year. Jared?

Speaker 3

Thanks, Mike, and hello, everyone. Despite a difficult market backdrop for deployment monetizations, we experienced double digit year over year growth nearly every key financial metric, including management fees, fee related earnings, realized income, AUM and FPAUM. Our management fees increased 19% for both the Q4 and for the full year, driven primarily by strong deployment of our invested capital, within our global direct lending and alternative credit strategies. For the 4th quarter, FRE totaled $369,000,000 an increase of 10% from the Q4 of 2022 despite a steep decline in FRPR from real estate funds that contributed $65,000,000 in FRE in 2022. For the full year, FRE exceeded $1,000,000,000 for the first time in our company's history and increased 17% from the prior year.

Speaker 3

Of course, our year over year FRE growth was partly impacted by the fact that we did not generate any FRPR from our non traded REITs as we expected. Our FRE excluding the FRPR specifically from our real estate non traded REITs increased 25% over 2022, a little ahead of our 20% plus guidance that we provided a year ago. Our FRE rich earnings remain a key differentiator for Ares as FRE again accounted for more than 90% of our realized income in 2023. Our FRE margin totaled 41% for the quarter and 40.9% for the full year. Excluding FRPR, which has a lower margin due to the contractual compensation ratio we've discussed in the past, Our core FRE margin was 41.8 percent for the 4th quarter, which was up 120 basis points versus the comparable margin a year ago.

Speaker 3

With over $74,000,000,000 raised in 2023 and an available capital balance of over $110,000,000,000 we expect to see continued margin expansion as we deploy our capital. We continue to believe that we're on track to reach our goal of roughly 45% core FRE run rate margin by the end of 2025. Let me turn to our fee related performance revenues or FRPR. FRPR totaled $180,000,000 in 2023 compared to $239,000,000 in 2022. In the 4th quarter, FRPR from our credit group totaled 160 $6,000,000 which was about $46,000,000 above the high end of the guidance we provided on last quarter's conference call.

Speaker 3

A large part of this outperformance was driven by higher than expected loan pricing as a result of tighter credit spreads as well as positive currency movements into year end. The remainder of our FRPR was generated in our secondaries group from APMF, a retail focused product. We are excited about the momentum for APMF and could see growing contributions to FRPR as the sun scales. As I mentioned, we did not generate FRPR from our 2 non traded REITs during 2023. And both a REIT and AIREIT will need to make up for negative returns in 2023 before earning any FRPR.

Speaker 3

Fundamentals across these real estate funds remain resilient, however. We will likely need to see interest rates moderate and cap rates stabilize before these funds can generate additional FRPR. For this reason alone, it is more likely that we would see FRPR from the 2 non traded REITs resume in 2025 as opposed to 2024. Our realization activity increased significantly in the 4th quarter compared to Q3, with realized net performance income totaling $77,000,000 in the quarter, including $57,000,000 from European style waterfall funds. For the full year, nearly 70% of our realized net performance income came from European Waterfall style funds.

Speaker 3

In addition, we also generate net realized performance income from incentive fees, which recur on a regular basis, but are not derived from perpetual funds. In 2023, we generated $27,500,000 in net realized performance income for non European style incentive up from $20,000,000 in 2022. As I talked about before, the European style falls are relatively predictable within a given time horizon, but can vary as to the exact quarter in which they'll be received. With the 4th and second quarter is $13,000,000 that was pulled forward into this Q4. That said, our expectations for the next 2 years are modestly higher with approximately $420,000,000 of net performance income from European style waterfall funds.

Speaker 3

Of this amount, we expect approximately $145,000,000 in 2024 $275,000,000 or more in 2025. Over the long term, we're targeting more than $3,500,000,000 net realized performance income over the life of these European style funds already raised. As we've discussed, the timing of the early fee recognition and partially on market transaction activity levels. In 2023, our balance of net accrued performance fees increased 10% to $919,000,000 and nearly $700,000,000 of this amount was in EU style waterfall funds. The increase largely driven by the deployment of incentive eligible AUM that yields in excess of the hurdle rates leading to growth of our incentive generating AUM and the compounding of higher floating rates, particularly in our private credit funds.

Speaker 3

Realized income for the Q4 totaled a record $434,000,000 And for the full year, realized income exceeded $1,200,000,000 a 12% increase in 2022. For the full year 2023, our effective tax rate on our realized income was 9.1%. Last year, we benefited from tax deductions related to the exercise of options by employees. These options were granted as part of the IPO and are set to expire on the 10th anniversary of our IPO this year. As a result, only attributable amount of these options remain unexercised And accordingly, significant related tax deductions associated with the options will not recur.

Speaker 3

Therefore, we anticipate an effective tax rate on our realized income to be in a more normalized range of 12% to 15% in 2024. As of year end, our AUM totaled nearly $419,000,000,000 up 19% over the previous year and was driven almost entirely by organic growth. Our fee paying AUM totaled nearly $262,000,000,000 at year end, an increase of 13% from year end 2022. Our available capital totaled $111,400,000,000 So we have nearly $63,000,000,000 of AUM not yet paying fees available for future deployment, representing over $621,000,000 in incremental potential future management fees. As Mike highlighted, our portfolios continue to perform very well.

Speaker 3

For the full year, we experienced double digit returns in our U. S, Europe and Asia direct lending strategies as well as in our special opportunity strategy. Within real assets, our infrastructure strategies performed in line with expectations, delivering a high single digit return in volatile markets. In real estate, our returns were impacted by higher cap rates and interest rate volatility, which pressured valuations. However, the underlying property fundamentals remained resilient and we believe we are well positioned to generate strong performance once cap rates stabilize.

Speaker 3

For example, in 2023, our industrial portfolio saw 50% rent growth on same store new and renewal lease rates and our multifamily portfolio continued to see positive rent growth. Now let me provide some comments on our go forward outlook and our new dividend level. We anticipate that our fundraising momentum will continue with additional closes in our large fundraisers in process, as Mike stated earlier, Coupled with recent or expected launch this year of 4 more significant fund series across our strategies, we expect these larger fundraisers will be supported by our ongoing and growing inflows from smaller commingled funds, wealth management funds, insurance, SMAs and other open and closed end vehicles. In fact, we expect to have approximately 35 different funds in the market across 17 of our strategies in 2024. Although it will be unlikely that we match the amount we raised in 2023, we expect it to be another strong year and we are already well ahead of our pace reach our target of $500,000,000,000 in AUM by the end of 2025.

Speaker 3

Keep in mind that our fee related earnings trajectory is more dependent on the pace of our deployment rather than fundraising activity. With a record amount of dry powder, we're well positioned for higher deployment if market activity levels remain stronger. This leads me to our dividend. At the beginning of each year, we set our quarterly dividend at a fixed level for the coming year. Based on the significant outperformance, our fee related earnings relative to our dividends and our strong growth prospects for FRE this year, we've elected to increase our quarterly dividend $0.93 per share on the company's Class A and non voting common stock, a 21% increase compared to 20 20 Finally, we continue to be on track with our 2021 Investor Day guidance of FRE and dividend per common share growth of percent or more through 2025.

Speaker 3

And I'm pleased to announce that on May 21st, we will hold another Investor Day to coincide with the 10 year anniversary of our public listing the New York Stock Exchange. At that time, we'll provide an update on our business goals and objectives. I'll now turn the call back over to Mike.

Speaker 2

Great. Thanks, Jared. In closing, we believe that we're very well positioned for the year ahead with a record amount of dry powder, a more promising market outlook, an expanded and more diversified investment platform and a strongly performing portfolio. The investments that we've made in new personnel, New strategies, new vehicles and new distribution across the platform over the past few years are beginning to contribute more meaningfully to our business. For example, we're seeing momentum in our insurance, wealth management, infrastructure, secondaries and Ares Asia platforms.

Speaker 2

Our fund performance also continues to be a source of differentiation and our brand is strengthening with our investors and prospective portfolio companies. Collectively, our business is positioned to deliver strong relative returns for our fund investors, drive further growth in assets under management and create better operational efficiencies in the years to come. And as Jadar mentioned, when you combine our strong FRE growth prospects With the inflection point that we're now reaching with our European waterfall realizations, we're poised to generate meaningful realized income in the years ahead.

Speaker 1

I continue to believe that one

Speaker 2

of our greatest differentiators is our people and our culture. And as always, I'm so and grateful for the hard work and dedication of our employees across the globe. I'm also deeply appreciative of our investors' continuing support for our company. And with that, operator, I think we could now open the line for questions.

Operator

Our first question comes from Steven Chubak with Wolfe Research.

Speaker 4

Hey, good morning and thanks for taking my questions. So I wanted to start off with one just On the all credit outlook, just given some expectation that Basel III endgame proposal could get watered down, I was hoping to get your perspective on the deployment opportunity in all credit. Do you still see a substantial opportunity in areas like ABF and Redcat trades Despite some of that potential softening and what are you hearing from your bank partners specifically?

Speaker 2

It's a good question. We've talked about this before. Obviously, we were early I think in identifying the growing opportunity in alternative credit. I think it's important that people appreciate like so many things happening in private credit right now with both secular and cyclical. So a lot of the secular trends that have been driving more capital formation in alt credit actually started post the GFC with the dismantling of the larger securitization apparatus on the street and the proliferation of smaller finance companies in the wake of the GFC.

Speaker 2

And that trend, call it, the first wave has been very much intact for the last 10 years and has given us a nice backdrop to grow what we think is a market leading business there. Obviously, now with Basel III and some of the challenges that I think we all saw emerge in the banking sector generally early last year, there is an accelerated cyclical opportunity, obviously to partner with banks largely in our all credit business to help them navigate some of their balance sheet challenges and that's been a keen area of focus, but not an exclusive area of focus. We talked on our last call about a sizable partnership transaction that we did with Pac West. We were public about a recent trade that we did on the transfer side. And those dialogues are ongoing and continuing.

Speaker 2

And I actually think that they will continue regardless of the resolution of Basel III Endgame. I think what we learned coming out of the struggles in the sector We're largely structural. And once we get past this first phase of balance sheet repositioning, I think you're going to have a lot of banks regional, super regional and GSIBs just rethinking core businesses and balance sheet positioning and we put ourselves out there as a proven partner for them as they go through that. So I think It bodes well for continued deployment and we had a very strong 4th quarter in all credit. We're seeing that activity level over into the New Year and I'd expect that to continue.

Speaker 4

That's great. Appreciate all the color. And for my follow-up, Jared, I I was hoping to dig into some of the drivers of the dividend increase and especially in light of some of the constructive comments you made on FRE and deployment, Just given the magnitude of the increase, assuming a normal 75% payout, some modest share creep, it does imply close to 30% FRE growth in the coming year. Just wanted to get a sense if that's a reasonable expectation for FRE expansion. Maybe just help unpack some of the drivers of that FRE uplift?

Speaker 3

Sure thing. And I think when we set our dividend policy out Back in 2021, one of the things we articulated was that we pegged it with FRE, but didn't necessarily match it perfectly to FRE. So, as FRE grows, so do we expect the dividend to grow. And for the last couple of years, as I think everyone knows, we've had paced FRE growth against the dividend growth. And so certainly, that gives us a bit of a tailwind as we're determining what the dividend is.

Speaker 3

And as we look forward and we expect a positive year of deployment, especially with what we saw in the Q4 and what we've seen in terms of some of the trends so far this year, that gives us A lot of assurance in setting our FRE expectations as well as the dividend expectations for the year. And then you combine that with some of the EU waterfall guidance that we provided and we know that we'll have adequate coverage in terms of what we generate for the year to establish that. So it's not necessarily a one for 1 and

Speaker 5

we haven't historically targeted a

Speaker 3

75% or a 90% we targeted a 75% or a 90% ratio of what we would pay out for our dividend. So, we feel good at that 20% or more level. And we feel like that it is indicative of the positivity we have around FRE growth as well.

Operator

Our next question comes from Craig Siegenthaler with Bank of America.

Speaker 6

Good morning, Mike, Jared. Hope everyone's doing well.

Speaker 1

Good morning.

Speaker 6

So, our first one is on ACF. It raised around $2,000,000,000 last year, and it sounds like that momentum carries on in January with another 350. So, I wanted to see if you could give us an update on how many platform shelves the U. S. And European vehicles sit on today?

Speaker 6

Forms do you expect them to be on by year end? And also overall, how important is your long term track record with ARCC in terms of speeding up the

Speaker 2

Sure. Good question. Just to clarify, Craig, the 350 was Both ACIP and its European counterpart, but obviously strong numbers relative to the momentum that we saw building into the end of the year. I do think that both ASIF and ASIF are benefiting from our long successful track record at scale in the public markets, obviously as the market leader in direct lending And having run BDCs through cycles, I think that that is definitely a tailwind. And I think if you look at the early fundraising momentum that we're enjoying in both of those funds, it compares well to competitor product.

Speaker 2

One of the reasons that we are so excited right now, both of those products are actually only on one platform. We had our first wealth closing in ACIP in August, and we actually now are expecting to add a significant number of new partners throughout the year both in the U. S. And overseas Europe and Asia. So I think you'll see that selling group increase dramatically as we get and our expectation is that we'll probably add 2 or 3 there as well in Q2 or Q3 of this year.

Speaker 6

Mike, that's great. And let me just stick with the semi liquids here with AIREIT and A REIT. How do you expect redemption requests to trend, as it looks like investor sentiment real estate may have reached And also we did receive some positive guidance on redemptions from your major competitor 2 weeks ago. And then following decline in redemptions. How quickly do you expect sales to snap back, just given that they're currently depressed?

Speaker 5

Yes, it's interesting. I think and

Speaker 2

we said this in the prepared remarks, we're quite pleased with our performance relative to the rest of the non traded REIT product in 2023, which was a difficult year just given performance headwinds and some of the redemption conversation around some of our larger peers. But if you look at the performance of both of the REITs, we actually had positive flows in the quarter and throughout the year, which I think is an outlier. I think that's a combination of the positioning of those funds. There are some unique attributes in terms of our 1031 exchange product that I think is a little stickier. Those funds are less leveraged.

Speaker 2

So we're going into 2024, obviously, having seen reduced sales, but having positive net flows in both of those products. And My expectation would be that as some of the peer performance improves and people begin to feel like we're hitting bottom on cap rates and interest rates that you'll begin to see sales pick up there. So again, it's still early. Our experience in January would tell us that sales are still there, but I think once we get to a place where interest rates are moderating and the redemption narrative within the peer set has moderated, then we'll Our sales accelerate as well.

Operator

Our next question comes from Patrick Davitt, Autonomous Research. Hey, good morning everyone. How are you?

Speaker 7

My first question is on Kind of first quarter trends, the ARCC call highlighted current refinancing boom could be a headwind for net deployment in the quarter As M and A deal volumes are still picking back up, what are you guys seeing in terms of that give and take between new deal volume and refinancing outflows as the broadly indicated on how yield market opens back up. And in that vein, are you seeing borrower interest in direct linked shift at all yet? Thank you.

Speaker 8

Sure. I want to clarify some of

Speaker 2

the comments that were made on the ARCC call because that is not how I would interpret the commentary. There is a give and take in the market generally that when the markets are accelerating in activity, the banks will get more active, syndicated loan and high yield market will open up and the CLO machine will turn on. That's not necessarily a bad thing because that means that transaction activity is picking up and there's an opportunity to drive higher volumes and higher fees. I think it's important that people appreciate at least from the Ares and AR 2C perspective is that we continue to have a very, very strong focus on the traditional middle market. It's a very big part of what we do the globe.

Speaker 2

And I think there's a little bit of a misunderstanding that a lot of the growth has come from share gains from the syndicated loan and high yield market. And as long as we've been doing this, yes, there are moments in time when the loan market is closed and at the higher end of the middle market, Private credit providers can take share. And then obviously when the markets heal, activity levels pick up. But Unlike some of our larger peers, we are not dependent on a transfer of market share from the liquid markets in order to continue to drive the growth and performance that we've seen. So to clarify, I think the commentary, I would say the enhanced levels of Activity and the turning back on of the deal market writ large, I think right now is significantly more of a positive than a negative.

Speaker 2

There are significant, what I would call, mitigants to refinancing in the private markets, Unlike the liquid markets that tend to just be price driven, a lot of that is just relationships. So if you look at our deployment, for example, in 2023, 57% of our deployment in 2023 was to incumbent borrowers. That relationship is critically important and is actually protective of the portfolio. And then when you look at the amount of upfront fees, call protection, etcetera that exist in these private credit instruments, even as spreads are tightening and capital is flowing into the liquid market, the economics refinancing take a while to find their way into the market. So I think as we're sitting here today, I would say it's actually a Net positive, we're seeing increased transaction activity, more liquidity in the market, and I think that's generally a good thing.

Speaker 2

So I heard some of the commentary on the call yesterday. I don't think that we're looking at a return to normal in the liquid markets as bad for the Ares Credit Business. I'd also highlight that we are one of the largest liquid credit managers and CLO managers as well. So from the Ares management perspective, as that market opens up, we're a big beneficiary as well.

Speaker 7

Great. Thanks. And then a quick follow-up. Obviously, we get a ton of detailed data on U. S.

Speaker 7

Direct lending portfolios. But could you give us a little bit more detail on how the European portfolios are tracking versus the U. S? And are you seeing any signs that these portfolios could diverge versus the strong outcomes we've been seeing in the U. S.

Speaker 7

Portfolios? Thanks.

Speaker 1

Yes. It is remarkably similar.

Speaker 2

If you look at the EBITDA numbers that were quoted for the ARCC portfolio, it's about an 8% year over year EBITDA growth that had accelerated from 6% in the prior quarter. If you look at the European direct which is actually pretty amazing year over year EBITDA growth was 18%. LTVs are a little bit higher. They're kind of in the 48% range in Europe versus 42, 43 in Europe. Interest coverage is a little bit higher in Europe, 1.8 versus 1.6.

Speaker 2

Yes. But if you just take all of the different ways to articulate credit exposure, they're largely similar, But we're seeing a surprising amount of momentum and resilience within the fundamental revenue and EBITDA portfolio in Europe right now.

Operator

Our next question comes from Ben Budish, Barclays.

Speaker 5

Hey, good morning. This is Nick Benoit on the line for Ben this morning. So in the prepared remarks that non accruals continue to remain low. I believe, Kit noted on the ARCC earnings call yesterday, the non accrual rate, historical non accrual rate is about 3%. So how do we kind of think about the macro backdrop non accruals to return back their historic average about 3%?

Speaker 5

And do you kind of think there's been almost a reset in the direct line portfolio where normalized non accruals will lower for longer?

Speaker 2

It's a good question. I think Kipp articulated it well, which is just by definition given the rate backdrop and the assumption that rates will stay higher for longer, I think you will see an uptick in defaults, but that's not necessarily a bad thing. And what we keep trying to focus people on is the structural improvement in the leverage lending market, particularly the private credit market in terms of the amount of equity subordination in a lot of these capital structures. And so if you look at loans to value of 42% or 48% and you look at the structure of Equity market, there's about $3,500,000,000,000 of private equity sitting at the bottom of a lot of these capital structures with $1,000,000,000,000 of dry powder to protect value. And so I think part of what you are seeing is that even if there's a non accrual, Many of these are unlike prior cycles where you have fundamental underperformance at the company level.

Speaker 2

They're being driven by higher rates for some of the better performing companies that were able to access more leverage. And those are a lot easier to resolve both in terms of modification and amendment, but they're also the 1st places that you see capital coming in from the private equity sponsors to protect the value below you. I would say the industry is obviously running higher than we are. I think that we continue to outperform from a credit standpoint. But we're at peak rates.

Speaker 2

The economy continues to be strong. So if rates stay at this level, I'd expect them to tick up a little bit, but I don't think that we're going to return

Operator

Our next question comes from Alex Blostein Goldman Sachs.

Speaker 9

Hi, all. Thanks for taking the question. This is Luke on for Alex. I wanted to get a

Speaker 2

sense for how you're thinking about the growth

Speaker 5

trajectory of the business outside of credit.

Speaker 9

And if we can dig into of the business outside of credit. And if we can dig into secondaries in particular, you alluded to the state of LP liquidity across the industry. How does that factor in? And outside of that, what do you view as key drivers of growth for the business? Thanks.

Speaker 2

Sure. Obviously, we have been diversifying the business for a very long time now both in terms of asset class fund structure, distribution channel, geography and a lot of those investments as I highlighted in my concluding remarks are now bearing fruit and have significant momentum. Credit as well is not one thing here, right? So when you look at our credit business, it's a host of strategies liquid and illiquid around the globe at various parts of the capital structure. And while many people feel like those businesses are maturing, if you look at the way that these funds are structured and the way that the performance is stacking, we still think that we have significant growth across the credit spectrum.

Speaker 2

It's an interesting comment on secondaries Because right now, if you look at the balance sheets of all of these assets, whether it's a buyout or a piece of real estate or an infrastructure asset, everyone is dealing with the same challenge, which is fundamentally strong over levered balance sheet and a liquidity challenge. And so for the first time in a very long time when we're going through the market transition, the problem or the use case is the same in every market that we're in is how do you bring capital into these companies and assets in a way that minimizes dilution, expands duration and runway for the asset owner and allows these businesses to not just kind of get to the other side of the rate hiking cycle, but to accelerate out of it. And that's taking any number of forms. It could be through direct lending where we're making a 1st or second lien loan. It could come through our opportunistic credit business where we're doing debt and structured equity investing.

Speaker 2

It could be PE where we're coming in with some kind of minority equity and then it could be secondary. So I think the investment thesis for growth in secondary is again Secular and cyclical. Secular growth is being just driven by the growth in the primary markets on a global basis. And the cyclical opportunity is this need for creative solutions to resolve the installed base and we are seeing Volumes pick up pretty dramatically across the secondary's landscape, and I think we are uniquely positioned given the fact that we have funds in real estate infrastructure, private equity and credit that could come into these situations at various costs of capital and be a really good solution provider. And maybe stating the obvious just given the depth of our GP relationships in each of these markets, Corporate and real assets, I think that we have a really strong origination advantage.

Speaker 2

So we are working hard to continue to raise capital in that business. As we talked about, We had a very successful fundraise for our leading real estate practice. Our PMF, which is our non traded fund continues to scale into the opportunity, we're having very meaningful early success in the growth of our credit secondaries business. So Yes, we're enthusiastic about the growth opportunity in the secondaries market and our ability to capitalize on it. And it's actually a really interesting example of an acquisition that we've made and transformed and repositioned into a new market.

Speaker 2

But I don't think it's just secondaries again. I think it's going to be the full product set that's going to be coming into this market try to resolve some of these situations.

Speaker 9

Sure. Understood and appreciate all

Speaker 2

the detail. That was great.

Speaker 9

I guess if we turn for my follow-up to credit real quick. With the outlook of perhaps a lower rates environment

Speaker 2

at least relative to where it is today,

Speaker 9

How do you think about a potential shift in LP demand within credit? And is there a level at which lower interest rates become a more of a headwind for fundraising or does the spread above base rates always make an attractive asset class from LP perspective? Thanks.

Speaker 1

Yes. I think you answered your own question.

Speaker 2

I mean, our experience would be that The investor base is buying the excess return available in these markets relative to the public market equivalents. They're buying lower volatility. They're buying non benchmarked exposures. They're buying active management. But ultimately, we have not Seeing changes in investor demand through the different phases of this rate cycle or prior.

Speaker 2

We've been doing this Very long time and rates go up, they go down, defaults go up, they go down and we haven't really seen impact on investor demand. I think we're now at a point in the development of these markets, while they're still growing, they are becoming core exposures in most investor portfolios, both institutional and retail. And I wouldn't expect that as rates move that we're going to see capital flowing out. One could argue maybe if rates come down that it could spur increased demand just because of our ability to continue to drive differentiated deployment access and spread, but that's TBD.

Operator

Our next question comes from Michael Cyprys with Morgan Stanley.

Speaker 1

Hi, good morning. Just wanted to circle back to some of your commentary Deployment pace of activity continues to pick up for you guys, nice growth in the quarter. It sounds like the strength is continuing into the first So I was hoping you could elaborate on some of the areas of strength where you're seeing the biggest improvement in deployment, how you expect the deployment backdrop to take shape here in 2024 relative to 2023?

Speaker 2

Mike, it's a good question. And again, I'll just reiterate what I just said. Every part of the business is turned on right We have $110,000,000,000 of uninvested capital, which may sound like a lot, but if you look at our 2023 deployment, we deployed close to $70,000,000,000 of capital and what most people would argue was a tough deployment year and that was down from a little over 80 in 2022. So I think we now kind of know what the guardrails are given the depth of the platform and capability set that we have. If you look at Q4, specifically $24,000,000,000 against Q4 2022, which was about 22,000,000,000 So we had a strong Q4 as well year prior, and I think that's a typical seasonal pattern that we see.

Speaker 2

But Q1, at least in the early goings, feels like it is going to be higher than it normally would be given seasonality. And that's causing, I think, us and others to feel optimistic about activity going into at least the first half of the year. But it's really across the board, because a lot of what we're doing in each of our businesses Across credit, real assets, PE, secondary, like I said, is really coming into a market that is starved for capital with a big installed base of institutional equity that needs a solution. And so I wouldn't really highlight any one as jumping off the page, Mike. It's really again, it's across the board, which is quite unique from a deployment setup standpoint because normally when we're talking about cycles or even different outlooks for rates for the economy, 1 or 2 businesses will pop out.

Speaker 2

But that's not what we're seeing. They've all been pretty consistent year on year and quarter on quarter.

Speaker 1

Great. And just a follow-up question on Asset Based Finance, I was hoping you could talk about the opportunity that you see in Asset Backed Finance, big space. Maybe just talk about more specifically where you'd like to expand the steps you're taking To add more capabilities particularly here in 2024 and which parts of the ABF market do you see the biggest opportunity set for Ares?

Speaker 2

Yes. I mean, I think we have probably one of the largest capabilities across the various asset classes in Asset Based Finance. And it's always hard to say where the opportunity set It's a function of what's happening in the broader market. But I think we are one of the few platforms that has dedicated in house origination and portfolio management capability across the broad waterfront. And I think it's important that when we talk about Asset Based Finance and Structured Products that we are differentiating between the investment grade side of the market and the non investment grade side of the market, meaning the bottom half of the balance sheet.

Speaker 2

And I think that we have by far the largest capital base and team against the what I would call the non high grade part of the market. So some of our peers have appropriately articulated there will continue to be growth in the high grade part of the space. We are participating in that as well. And I think there will continue to be growth in the non investment grade part of the market and I think we have a real leadership advantage there. Back to the earlier Question just about banks and liquidity and risk transfers.

Speaker 2

We are very active on portfolio acquisitions, Partnerships, risk transfers, fund finance, all of the things that are coming out of the transition in the banking market, I'd say are prominent right now and I would expect that to continue. So maybe Without getting into too much detail, I would say that that's probably where we're seeing the biggest amount of flow, as opposed to saying which corner of the asset based market we find most attractive because again, that's always a function of structure, price and kind of where we are with our counterparties.

Operator

Our next question comes from Brennan Hawken with UBS.

Speaker 8

Good morning. Thanks for taking my questions. I was hoping to drill in on FRPR. So it sounds like Momentum, you guys feel good about the momentum in secondaries and APMF and real estate clearly got the message that That's on hold. So how should we be thinking about FRPR and credit?

Speaker 8

It seemed as though the spreads tightening in the year end. So that's probably not something we should count on. So is it possible to quantify how much of an impact that had? And then how should we be thinking about FRPR and the sensitivity to rate cuts if the forward curve plays out and we see lower policy rates?

Speaker 3

Sure. Thanks for the question and good morning. Overall, I think you caught on with the spreads and that that is a component and that certainly benefited us at the end of the year here. But it's not the main component. The main component is the interest rate aspect of it, which has been a pretty big tailwind for this year.

Speaker 3

Now, the advantage that we have there in terms of looking into this year is that we actually benefit on a lag Because the average reset on these interest rates happens about every 6 months. So we still haven't even necessarily felt the full impact interest rate increases across the portfolio. So, the same way that you think about that lag on the good, it actually happens as interest rates are declining, there's a lag till that impact occurs as well. So, interest rate reset actually doesn't have a huge impact on the overall balance. We would expect that we could be at or near similar levels if interest rates Essentially, we're not cut significantly and rapidly.

Speaker 3

And if spreads stay essentially the same and FX rates essentially the same. That would be with the same basic base balance, but we do continue to raise funds as well. And so as we raise funds within those SMAs and those perpetual capital vehicles, that does give us the opportunity to increase the amount that we can earn as

Speaker 2

Jared, I would also add as we talked about earlier that as rates come down with that lagged effect that usually means the transaction activity is picking up and structuring and underwriting fee contribution flowing through some of those vehicles that generate FRPR would be an offset to the lagged effect of rates declining.

Speaker 8

Excellent. Thank you for that color. I'd like to follow-up on the point around competition. So, Mike, you were pretty clear in addressing why you don't think the levered loan market is a substantial risk, but we have seen a lot of firms raising money and moving aggressively to grow their private credit So why is it that other private how do you view the increased capital coming into the space from competitors? And what's your expectation for spreads and the potential impact on spreads from all that competition piling in?

Speaker 2

I've been pretty vocal on this and I think that you kind of have to distill the signal through the noise in terms of the amount of capital and new entrants into private credit. So first, it's important if you look at the growth in private credit markets over the last 10 years, It's basically grown at the same compound annual growth rate as every other market that folks participate in. It grows linearly, so it grows in a different way. But if you just look at the actual growth, it hasn't actually outpaced. It's not frothier.

Speaker 2

If you look at the structure of the private credit markets and you say that the biggest users of private credit across the private credit spectrum are institutional equity owners, There's still a significant shortfall of supply of private credit relative to the demand. So just if you use the private equity market as an example, there's about $1,000,000,000,000 I mentioned of dry powder in the private equity market today against maybe $200,000,000,000 of private credit dry powder. So you've got 20% private credit raised against the private equity installed base. And if you said that roughly fifty-fifty debt to equity, you need to see $1,000,000,000,000 of private credit capital formation just to satisfy the private equity capital that's been raised and you see similar trends emerging in infrastructure and real estate. So there's plenty of room for growth.

Speaker 2

3rd, I would just highlight

Speaker 1

and if you look at

Speaker 2

the actual numbers, the preponderance of dollars that get raised and deployed are in the hands of a few large long tenured incumbent lenders. That has been the case. That consolidation trend is accelerating and there are meaningful benefits to scale in private credit, the ability to originate and invest in broader origination teams around the globe, the ability to have flexible capital scale to drive better deployment in different market environments and so on and so forth. So if you look at number of people raising their hand that are We're in the private credit business. Yes, that has increased.

Speaker 2

But if you look at where the dollars are flowing and the dollars already getting deployed, The competitive dynamic is not that different. And as I talked about earlier with regard to the syndicated loan and high yield market, I do think that there have been some new entrants that have not been building entrenched origination networks for the last 30 years that see the easiest place to deploy in the larger part of the market, taking advantage of challenges in the liquid market. And I do think that deployment will be tougher there than in the core middle market. But if you look at the core middle market, the competitive landscape is pretty unchanged. And if you just look at the deployment numbers that we articulate for our business, you look at our direct lending business last year, In the Q4 alone, we did $14,000,000,000 of deployment, which is larger than most private credit managers' total AUM.

Speaker 2

So we're I don't want to sound immodest, but we continue to execute well given all the competitive advantages we have and I think we'll continue to do so.

Operator

Our next question comes from Mike Brown, KBW.

Speaker 5

Hi, good afternoon. Maybe I'll start with a quick follow-up on that FRPR question. Is the answer really the same relative to your Part 1 fees in your credit business? So again, as the base rates come down, can that just be set by greater capital markets and structuring fees. And if that is the case, is that handoff one for 1 in terms timing and magnitude?

Speaker 3

Yes, to the first part of that question. But In terms of 1 for 1, again, there's a bit of a lag. So, you can end up with a current interest rate that's ticking a little bit higher because it hasn't reset Yet against a macro backdrop that allows for more transaction activity that could actually be a tailwind in your favor. But generally, they're pretty close to 1 to 1. They're going to interact together.

Speaker 5

Okay, great. Thanks, Trey. And then on Pathfinder 2, so you meaningfully surpassed your $5,000,000,000 target. You hit the hard cap there. What is the potential for this strategy long term, you're quick back in the market to raise Pathfinder 2.

Speaker 5

As you progress through the vintages, are there enough Such that this could be one of your largest fund strategies over time?

Speaker 2

I would say, yes, but we should just clarify that I would say fund families, right? So one of the things again that I think is important as you're scaling any of these private credit businesses to make sure that you have different funds for different parts of the market, whether it's different cost of capital or Borrower needs or geographic nuances. So the Pathfinder family has been scaling good performance and I would expect will continue. But sitting next to Pathfinder 2, for example, is an open ended core fund That has a lower cost of capital and the ability to invest in a different part of the market. That is similarly scaling well with good performance.

Speaker 2

We obviously have our affiliation with ASPITA that is scaling AUM within the alternative credit business. We have a number of third party insurance SMAs and partnerships that are growing. So I would just clarify that the alternative credit family of funds, yes, is Growing nicely, continues to scale and I think is one of the biggest growth opportunities that we have here. But you won't just see it within the core Pathfinder flagships, it's going to be the whole family of funds that surround it.

Operator

That does conclude the Q and A portion of the call. I will now turn the call back over to Mr. Aragay for any closing remarks.

Speaker 1

No, I don't think we

Speaker 2

have any. Again, we appreciate everybody's continued support and interest and we look forward to speaking again next quarter. Thank you.

Operator

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available through March 8, an archived replay will also be available on the webcast link located on the homepage

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Earnings Conference Call
Ares Management Q4 2023
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