Ares Management Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2024

Key Takeaways

  • Ares achieved a record $26 billion in gross capital raised in Q2, lifting year-to-date fundraising to $43 billion and driving AUM to a record $447 billion, up 18% year-over-year.
  • In Q2, Ares deployed $26 billion of capital—its second-highest quarter ever—including $20 billion in private credit with net deployment of $7.7 billion (more than double Q1), and expects continued strong activity in the back half of 2024.
  • All seven private credit strategies delivered robust performance, with LTM gross returns in double digits, while the latest corporate private equity fund (ACOF VI) generated a 22.2% gross return over the past 12 months.
  • The firm’s AUM not yet paying fees grew to $71 billion, representing $675 million in potential annual management fees, and net accrued performance income stood at $919 million—85% from European-style waterfall funds—with $60–70 million expected to be realized in H2 2024.
  • The wealth management channel more than tripled net flows year-over-year in Q2—raising $4.5 billion—and now comprises over 30% of global flows as Ares expands its product offerings and international distribution.
AI Generated. May Contain Errors.
Earnings Conference Call
Ares Management Q2 2024
00:00 / 00:00

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Operator

Please stand by. We're about to begin. Good morning, everyone, and welcome to the Ares Management Corporation's second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. You may register to ask a question at any time by pressing star one on your telephone keypad, and you may withdraw yourself from the queue by pressing star two. Also, today's call is being recorded, and if you should need any assistance during the call today, please press star zero. Now, at this time, I would like to turn things over to Mr. Greg Mason, Co-Head of Public Markets Investor Relations for Ares Management. Please go ahead, sir.

Greg Mason
Greg Mason
Co-Head of Public Markets Investor Relations at Ares Management Corporation

Good morning, and thank you for joining us today for our second quarter conference call. Speaking on the call today will be Michael Arougheti, our Chief Executive Officer, and Jarrod Phillips, our Chief Financial Officer. We also have several executives with us today who will be available during the Q&A session. 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. Please also note that past performance is not a guarantee of future results, and nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Ares fund.

Greg Mason
Greg Mason
Co-Head of Public Markets Investor Relations at Ares Management Corporation

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 second quarter 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-Q later this month. This morning, we announced that we've declared our third quarter 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 September 30th, 2024, to holders of record on September 16th.

Greg Mason
Greg Mason
Co-Head of Public Markets Investor Relations at Ares Management Corporation

Now I'll turn the call over to Michael Arougheti, who will start with some quarterly business and financial highlights.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Thanks, Greg, and good morning, everyone. I hope everybody's doing well. The macroeconomic backdrop for our business improved in the second quarter with a stronger transaction environment, solid and stable credit trends, and a recovering real estate market. The improving economic picture is driven by a combination of a better outlook for both inflation and interest rates, continued labor market strength, and increased confidence in a soft landing. Given the more constructive transaction environment, we were more active across many of our investment strategies. In fact, we invested $26 billion in Q2, our second highest quarter on record, and more than 70% higher than the same quarter a year ago.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

As we highlighted at our Investor Day in May, we're continuing to see significant institutional and retail demand globally for alternative investment products, particularly within broad credit strategies, but also in opportunistic and value-add real estate, affiliated insurance, infrastructure, and a host of secondary strategies. Q2 was our single best quarter of fundraising in our history, with $26 billion in gross capital raised, bringing the total year-to-date funds raised to $43 billion. For the second quarter, our assets under management grew to a record $447 billion, up 18% versus a year ago. Our strong deployment and fundraising activities supported a 22% year-over-year growth in fee-related earnings for the quarter. We also had another strong quarter of fund performance, as Jarrod will highlight later. Overall, we're pleased with our momentum, the firm's positioning, and the promising outlook for our business.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

As we've expected for some time, we are seeing a gradual improvement in transaction volume this year for a variety of reasons. The nearly $1 trillion in private equity dry powder that's aging, significant demand from LPs for a return of capital, a stable rate backdrop, and the improving prospects for interest rate cuts, and an economy that remains on solid footing. For Ares, looking across our seven private credit strategies in our credit and real asset groups, activity was very strong in the second quarter, with gross deployment up over 58% year-over-year. In Q2, we deployed approximately $20 billion in our private credit strategies, with net deployment totaling $7.7 billion, more than double Q1 net deployment of $3.3 billion.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Looking forward, our investment pipeline suggests continued solid activity, and we have every indication that the second half of the year will continue to be an active deployment environment. The credit quality across our corporate credit assets remains very strong, and recent trends indicate stability. As an example, our U.S. direct lending portfolio companies experienced their second straight quarter of improving organic EBITDA growth, reaching 11% year-over-year. The portfolio's loan-to-value ratio remains in the low 40% range, which is meaningfully below historical average market levels, and portfolio company leverage multiples are a half a turn lower than the prior year.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

For instance, on its earnings call, ARCC reported a decline in loans on non-accrual to 1.5% and a decline in underperforming loans. Based on the fundamentals that we're seeing across our U.S. and European corporate credit book, our outlook is for continued solid economic growth in these markets and continued favorable credit performance. That said, we're intensely focused on executing our playbook in more active and therefore competitive markets by out-originating our competition, using our deep incumbency advantages, performing rigorous fundamental due diligence, negotiating tight documentation and structures, and staying highly selective. In our real estate strategies, we're seeing market valuations and transaction activity stabilize. Operating fundamentals, such as rents and occupancy rates, remain positive for our core focus areas of industrial and multifamily, which represented nearly three-quarters of our asset value.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Within these segments, we continue to benefit from the growth in e-commerce, onshoring, and positive longer-term supply-demand dynamics. Our deliberate strategy of extending the duration of our industrial lease terms is enabling us to effectively navigate the market as near-term peak levels of supply are being digested. We're also seeing positive trends in adjacent areas such as student housing, single-family rental, and self-storage. Based upon the improving market trends, our real estate team was significantly more active in the second quarter, with deployment more than doubling the year-ago period, and our pipeline for new transactions continues to build. We also see significant investment opportunities in data centers and the digital infrastructure needed to support the enormous demands of AI growth. We're investing in digital infrastructure across our various businesses, but particularly within infrastructure, alternative credit, and real estate.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Collectively, we've committed nearly $5 billion in digital-related infrastructure, including data centers, towers, and new fiber broadband installations over the past five years. We're also focused on climate infrastructure opportunities and are actively investing in new clean energy projects, including solar, wind, and renewable natural gas. Over the past five years, we've committed approximately $3.2 billion in debt and equity investments in these sectors to meet the growing energy needs across the U.S. Within our secondaries businesses, we continue to see opportunities for new investments across our range of liquidity solutions, including purchasing LP portfolios, working with GPs on continuation funds, and providing structured solutions for both GPs and LPs. Overall, the secondary market opportunity remains robust as managers and investors alike try to manage liquidity demands in what has been a transitioning valuation environment and a slower M&A and IPO market.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Now let me provide some color on our record fundraising quarter. Across our broad distribution channels, we continue to benefit from increased investor allocations to alternatives, a loyal and expanding client base, and our growing scale. All three of our primary fundraising channels, institutional, wealth, and insurance, are highly productive, and we're seeing a meaningful acceleration in fundraising across our wealth management channel, which has more than tripled so far this year compared to last year. Our broad offering of credit strategies continues to lead the way as our benefits of scale and track record are differentiating factors. In Q2, we raised nearly $20 billion in funds, managed accounts, and CLOs within our credit group. As you may have seen from earlier this week, we announced the final closing for our U.S.-focused Senior Direct Lending Fund III, or SDL III, with $33.6 billion in investment capacity.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

This is the largest institutional private credit fund in the market and is roughly double the $14.9 billion of total investment capital that we raised in SDL II. SDL III's investment capacity included $15.3 billion in fund equity commitments, along with related vehicles, closed leverage, and anticipated leverage of up to $8 billion that could be raised over the next 12 months. We raised $6.4 billion of capital in Q2 and another $1.8 billion in July for this fund. We're also well underway investing SDL III, having already committed $9 billion of capital to more than 165 companies to date. With respect to our other large private credit institutional fund in the market, Ares' VI European Direct Lending Fund, we raised another EUR 750 million of equity commitments in the second quarter.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

This brings total equity commitments to EUR 12.2 billion today, or over EUR 18 billion of total investment capacity, including anticipated leverage. We expect to raise another EUR 1 billion-EUR 1.5 billion in equity commitments in the third quarter, with additional commitments in the final close expected in Q4. During the quarter, we also continued to raise various funds within our liquid and illiquid credit strategies across our platform. One example is the launch of our specialty healthcare fund, which focuses on direct loans to life sciences companies. We're currently holding our initial closings for this inaugural fund, and we expect to receive commitments totaling approximately $750 million in the coming weeks. We believe that this is a great start for a new product. In addition, we've priced 5 new CLOs in the quarter.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Year to date, we've already priced 7 CLOs, raising $3.6 billion, exceeding our full-year record of 7 CLOs for $3.3 billion in 2022. Overall, we've raised over $65 billion in the past 18 months across our direct lending strategies. When combined with our fundraising across our other private credit strategies in alternative credit, APAC credit, real estate debt, and infrastructure debt, we've raised approximately $85 billion in private credit AUM over the past 18 months. In our real assets group, we're aiming to hold a final close in the third quarter for our fourth U.S. opportunistic real estate fund, bringing total commitments to $2.7 billion. Based on this anticipated final close size, we expect the fund will exceed the commitments of its predecessor fund by 59%, and we believe that this demonstrates meaningful investor support for the strategy and the investment opportunity.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

We're also off to a great start with our recently launched fourth European value-add real estate fund, raising approximately EUR 600 million in the second quarter, including related vehicles, with additional capital expected for the first close in the third quarter. We also raised another $1.1 billion in our U.S. real estate debt strategy as we continue to see attractive values and compelling market dynamics with less competition in this sector. In addition to significant fundraising in our commingled funds, we're also seeing meaningful demand for managed accounts across the platform. For the second quarter and year-to-date periods, we raised $5.4 billion and over $10 billion, respectively, in new commitments in these managed accounts.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

As I stated earlier, our wealth management business continues to have significant momentum as we penetrate existing distribution, expand into new channels, market to new geographies, and broaden our product set. We're in the early phases of the largest generational wealth transfer in history, and importantly, we believe that we are seeing a very divergent trend with how baby boomers and the younger generations invest. Baby boomers manage their investment wealth primarily in stocks and bonds, but younger investors are seeking to expand their investing toolkit by optimizing their portfolios with increased allocations to private market assets. This trend could have significant positive implications for growing wealth allocations, and we believe that we're beginning to see these trends play out in our current results.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

During the second quarter, we raised more than $2.5 billion in new equity commitments across our six non-traded products, and inclusive leverage, we raised $4.5 billion. For the year-to-date period, new equity commitments totaled over $4.5 billion, which is over 3.5x the capital raised in the same period a year ago. Since our last earnings call, we've launched certain non-traded solutions with three additional global distribution partners. Based on these expanded partnerships, we expect flows into our wealth-focused products to continue to gain momentum through the second half of the year. Aspida, our minority-owned insurance affiliate, is on a strong growth trajectory. This quarter, it secured nearly $600 million in additional institutional equity from third-party investors.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

With more equity capital expected to be raised in Q3, Aspida is well capitalized and poised for continued expansion. The annuity market is thriving, with sales exceeding a record $400 billion on an annualized run rate in the first half of 2024. Aspida is benefiting from these industry tailwinds, experiencing robust flows from new retail annuity sales and increased flow reinsurance opportunities. So overall, with $43 billion raised in the first six months, we're ahead of where we expected to be in midyear, and we believe that we're in a better position to match or potentially exceed the $74.5 billion that we raised in 2023. Our strong first half puts us in an excellent position with record amounts of available capital to deploy.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Looking ahead to the next six months, our fundraising is likely to see contributions from a broader and more diverse set of funds. For the year, we expect to have 35 funds in the market across 17 strategies to take advantage of the expected growth in alternative asset allocations. And I will now turn the call over to Jarrod to discuss our financial results in more detail. Jarrod?

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Thank you, Mike, and good morning, everyone. As Mike stated, we continue to deliver strong results in the second quarter. Year-over-year growth of 22% in FRE, along with mid- to high-teens growth in AUM, management fees, and realized income. The record $26 billion we raised in the second quarter helped drive a 29% increase in our AUM, not yet paying fees, ideally situating us to capitalize on growing activity levels as the markets return to a more normalized state of deployment and realizations in many sectors. When you combine this AUM not yet paying fees with our FRE-rich earnings mix and future European waterfall realization potential, we believe we offer strong visibility for future earnings to our stockholders.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Taking a look at this quarter's earnings, starting with revenues, our management fees totaled over $726 million in the quarter, an increase of 17% compared to the same period last year, primarily driven by positive net deployment of our AUM not yet paying fees. Fee-related performance revenues totaled $21.6 million in the second quarter, primarily from our non-traded private equity secondaries product, APMF, along with select credit products that crystallized. The $15.2 million of FRPR from APMF benefited from AUM growth, which recently reached approximately $1.6 billion in total assets and was aided by a sizable portfolio purchase in the quarter. We would expect AUM growth and APMF to provide long-term tailwinds for additional FRPR generation.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

However, FRPR from APMF will be more episodic and accordingly, more difficult to project spikes in FRPR like the one that occurred. As a reminder, we anticipate realizing 95% or more of our credit FRPR in the fourth quarter. I do want to point out two expenses running through our G&A in the second quarter. First, our Q2 G&A expenses were impacted by our first-ever firm-wide AGM held in May. Typically, we hold multiple investor events resulting in costs spread throughout the year instead of being incurred in a single quarter. As a result of this quarterly spike in annual meeting costs, we expect G&A expenses in the second half of the year will benefit from fewer event expenses. Second, as we continue to scale our wealth management distribution, we incur greater supplemental distribution fees.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

These fees totaled $15.3 million in the second quarter, an increase of $6.2 million compared to Q1. Importantly, these fees will be partially offset as we recoup a majority of these expenses over time by reducing employee compensation paid with respect to placement fees or FRPR for the associated funds. In the quarter, FRE totaled approximately $325 million, up 22% from the previous year, driven by higher management fees and a margin improvement of 100 basis points to 42.1%. In the second quarter, we generated more than $40 million in net realized performance income, driven mainly by credit funds, European-style waterfalls.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Realized income in the second quarter was $363 million, a 16% increase over the previous year, and after-tax realized income per share of Class A common stock was $0.99, up 10% from the second quarter of 2023. As of June 30, our AUM stood at $447 billion, up 18% from the year-ago period. Our fee-paying AUM reached $276 billion at the end of the quarter, up 14% from the previous year. Following sustained fundraising momentum, our AUM, not yet paying fees available for future deployment, increased to approximately $71 billion at quarter end, representing $675 million in potential annual management fees. Our incentive-eligible AUM increased by 17% compared to the second quarter of 2023, reaching $259 billion.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Of this amount, over $86 billion is uninvested, representing significant performance income potential. In the second quarter, our net accrued performance income declined slightly to $919 million, primarily due to a reversal of carried interest in certain corporate private equity and opportunistic credit funds due to the change in the stock price for our position in Savers Value Village. This was partially offset by growth in our net accrued performance income and our credit strategies as the performance, driven by interest income, meaningfully exceeded the hurdle rates. Of the $919 million of net approved performance income at quarter end, $783 million, just over 85%, was in European-style waterfall funds, with nearly $460 million from funds that are out of their reinvestment periods.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

For the second half of 2024, we're estimating an additional $60 million-$70 million of net realized performance income from European-style funds, with nearly all of that amount recognized in the fourth quarter. For 2025, we estimate our 2025 European style net realized performance income will be in a range of $225 million-$275 million. The slight decrease in our 2025 estimate is primarily related to one fund, where we currently anticipate our realization timing could shift from the end of 2025 into 2026. However, the total net realized performance income expected over the life of this one fund is largely unchanged.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

For 2025, it's best to assume that 60% of our annual European-style performance income will be realized in the fourth, 30% in the second quarter, and about 10% spread across the third and first quarters from this linear lifecycle. The current seasonality of our European-style waterfall realizations is primarily due to the early stage of our larger eligible credit funds that make tax distributions, which we realize as net performance income, compared to older, smaller European-style funds, which are realizing the full net performance income payable near the end of their fund lives. This seasonality will persist until several of our larger European funds start regularly realizing performance income toward the end of their fund lives, potentially beginning in 2025. Finally, I'd like to discuss our recent fund performance, which is highlighted by broad outperformance within our private credit strategies.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Across our credit group, our strategy composites all generated double-digit gross returns over the past 12 months. Our credit portfolios continue to see positive fundamental growth and default characteristics, and we believe we're very well positioned for a variety of economic scenarios, particularly as approximately 95% of our corporate credit assets are senior in the capital structure. Across real assets, we generated gross returns in infrastructure debt of 2.3% for the quarter and 9.7% for the last 12 months. As we highlighted at our Investor Day, our real estate equity strategies are delivering strong returns relative to comparable market equivalents. As Mike discussed, we continue to see positive fundamentals in our real estate portfolios, and we're beginning to see signs of a market recovery, including stable, slightly improving overall values.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Our corporate private equity composite had a gross return of 0.4% in the quarter and 0.5% on an LTM basis. The returns in the second quarter were impacted by our large position in Savers Value Village in ACoF V. However, our most recent corporate private equity fund, ACoF VI, generated gross quarterly and twelve-month returns of 7.2% and 22.2%, respectively, and has a since inception gross internal rate of return of 24.5%. Our corporate private equity portfolios continue to demonstrate strong fundamentals, with year-over-year EBITDA growth showing acceleration into the mid-teens. Now I'll send it back to Mike for closing comments.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Thanks, Jarrod. At our Investor Day in May, we highlighted the breadth of our platform, the depth of our management team, and our focus on generating consistent and high-quality growth with our balance sheet light model. We also highlighted the significant positive secular drivers influencing our business, including assets moving out of the banking system to private credit, the significant need for infrastructure investment, consolidation of GP relationships for institutional investors, growing wealth management allocations, and the compelling opportunities in secondaries and insurance. We believe that this quarter's results demonstrate the power of our platform and how we're benefiting from many of these compelling trends. We remain optimistic about the future outlook. We have one of the largest pools of available investment capacity in the alternative investment industry, and what we believe will be an improving transaction environment.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Investment performance remains strong across our key investment strategies, and we continue to see significant investor demand for our products. As always, our talented team, collaborating across the globe, drives the current and future success of our business, and I'm deeply grateful for their hard work and dedication, and I'm also deeply appreciative of our investors' ongoing support for our company. Operator, we can now open up the line for questions.

Operator

Thank you, Mr. Arougheti. Ladies and gentlemen, at this time, if you would like to ask a question, please press star one on your telephone keypad. You may remove yourself from the queue at any time by pressing star two. Once again, that's star one for questions. We'll go first this morning to Craig Siegenthaler at Bank of America.

Craig Siegenthaler
Managing Director at Bank of America Securities

Thank you. Good morning, Mike, Jarrod. I hope everyone is doing well. We were looking for an update on the private wealth channel with net flows tripling year-over-year. So at your Investor Day, you laid out plans to launch two to four more products shortly. So how's that going? It looks like infra secondaries and maybe a retail pathfinder, ABF-type vehicles to be the biggest gaps. And then, I know you're managing capacity pretty tightly with ASIF. When will ASIF join a second or third wire in the U.S.?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

So that's a lot. That's a lot of questions. I'll see if I get to all of them, and if we miss one, just let us know. Momentum continues. As we articulated, in Q2, we had $4.5 billion of capital raised across the platform. We're pleased with the scaling that we're seeing in the new products like PMF, ASIF, and ASIF. Our interval fund continues to see positive flows. And while we've seen slowing net flows in our two REITs, I think, unlike some of the peer products, we are still seeing positive net inflows into those two products as well. We are in the process of introducing new products into the channel. I would expect that the next product that we would put in would be in and around our infrastructure business.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

And as you pointed out, Craig, given the breadth of our private credit platform and the success that we're enjoying there, there may be some opportunities to provide dedicated access to certain parts of that franchise as well. ASIF continues to broaden its distribution. We have actually been approved on another distribution platform there, and so that is moving forward according to plan. A bright spot also worth mentioning that we did not highlight in the prepared remarks is the international expansion of our wealth distribution continues to accelerate, and 30%-35% of our flows are now coming from outside of the U.S. market. And so the investments that we're making there to broaden out the distribution are bearing fruit pretty early in the build-out. I think that was it. Did I miss anything?

Craig Siegenthaler
Managing Director at Bank of America Securities

No, Mike, you covered it. And just do I get a follow-up? I forget if it's one question or one and a follow-up, you guys.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yes, go ahead.

Craig Siegenthaler
Managing Director at Bank of America Securities

Okay. So my follow-up is on credit quality. And so it's nice to see a positive inflection on accruals at ARCC. You know, that's good for Ares, but you guys have always outperformed the industry. So my question's a little more industry-related. Is private corporate direct lending, is the industry past the peak in non-accruals defaults and write-downs, or do you expect the industry to continue to see some deterioration, even though your book is getting better?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah, look, I think the longer you go into a cycle like the one that we're in, you know, default rates should go up, and we've been pretty clear on that, both, you know, in our calls here and at ARCC, but we do not see them going up to a level that we would, you know, classify as alarming or approaching what we've seen in, you know, COVID or GFC. We remind people that there are things called good old-fashioned credit cycles, and, you know, defaults happen, and the market moves on. Yes, we are outperforming the market, and you are beginning to see underperformance in certain portfolios, but I would highlight, given, you know, our prominence in the market, and some of our other large competitors who are putting up similar types of performance.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

But I think on an index basis, the credit performance in the private credit space will, you know, continue to, you know, maybe outperform relative to people's expectations. I'd remind folks, and we've talked about this before, that a lot of the stresses that we've seen coming through in this cycle have been liquidity driven as a result of the run-up in rates, and not necessarily due to the erosion in earnings. And so now, you know, as we all expect that we're on the front end of the cutting cycle, even if we see earnings can, you know, recede, you're going to get some relief back from the cut in rates, so that, that'll temper future defaults.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

The setup from a capital structure standpoint, and this is probably the most important at this point in the cycle, relative to past cycles, is just significantly different. I highlighted where our portfolios sit from a loan-to-value basis in the low 40% range. I believe that the private credit market is comparable, and I would not undervalue how important the amount of equity in these structures is to mitigate future credit deterioration and credit risk. It's just a level of equity subordination that we haven't seen in prior credit cycles. And I think when the story gets written on the other side of this, that that will be a big part of the risk mitigation story. Yeah, yes, we're outperforming, but I don't read through that, there's a broad-based underperformance right now.

Craig Siegenthaler
Managing Director at Bank of America Securities

Thank you, Mike.

Operator

Thank you. We go next now to Steven Chubak at Wolfe Research.

Steven Chubak
Steven Chubak
Managing Director at Wolfe Research

Hi, good morning, Mike. Good morning, Jarrod.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Morning.

Steven Chubak
Steven Chubak
Managing Director at Wolfe Research

So wanted to start off with a question just on your M&A strategy. We saw the equity issuance during the quarter. It certainly has prompted more speculation on strategic M&A. I was thinking back to slide 36 at Investor Day. You listed a number of areas where you might look to grow inorganically: insurance, Asia real estate, global infra, digital infra, were the main four. Just how would you rank those areas in terms of priority? And with some of the macro indicators softening expectation for rate cuts, is there any improvement in valuations for potential M&A targets?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure. So, look, we have highlighted on our Investor Day where we see, if not gaps in our product and capability set, large addressable markets where scale matters, and we may look to inorganically scale up, to go after that growth. That view has not changed. The bar continues to be very high. As we've talked about, we want to see a real good, strong cultural fit. We want to see strong financial accretion, and we want to be able to have a strategic roadmap to drive value into any acquired business, similar to what we've demonstrated, with the acquisition of Landmark and Black Creek and others that we also walked through, on the Investor Day.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

I do think that the prospect for rate cuts will obviously, you know, relieve some pressure and maybe catalyze some deal flow. I can't say for sure, but we are seeing that in the private markets business generally, so I would imagine that that could flow through into the asset management space. But at the end of the day, when you look at where we've been able to do these deals, they tend to be bilateral, non-competitive. And as we highlighted on the Investor Day, when you look at the acquisition multiples, you know, they've been at pretty attractive levels, and I think we're going to stick to that type of discipline in buying high-quality businesses that we can make better at discounts to our trading multiple.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

In terms of the equity raise, I wouldn't read, read too much into that. We also talked about on the Investor Day that we continue to invest in a lot of organic growth initiatives. We're launching new businesses. Life sciences is one example. You know, we're investing up and down our wealth product set. So, you know, when you look at the size of that raise relative to the market cap of the company, that was really just to, you know, delever a little bit and position ourselves to continue to invest in growth.

Steven Chubak
Steven Chubak
Managing Director at Wolfe Research

Thanks for that color, Mike. Just for my follow-up on the gross versus net origination dynamic. Gross deployment, clearly strong in the quarter. Also encouraging to see some improvement in that gross to net origination ratio, but still indicating continued elevated levels of refi activity. You noted deployment will likely remain strong in the back half, and just want to get a sense as to how you expect that ratio will likely trajectory. Do you expect further improvement in the back half?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

I think we, I think we do. You know, we're obviously- we have a 3-month to 6-month forward view on our pipelines, and then as Cort talked about on the ARCC call, you know, the backlog and pipeline just there alone was $3 billion. And when we look at the composition of the pipelines, it is definitely skewing towards new transaction activity and away from, you know, the pure refi and kind of incumbent deal flow. We're beginning to see other parts of the platform, you know, thaw. Real estate is beginning to show increasing signs of activity, you know, after a pretty slow 12-18 months. So I would expect that deployment will hold, and then we'll see the gross to net improve.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Just as a data point, if you were to go back and look kind of at historical levels, our 2023 average gross to net was about 50%. And that's come down dramatically. And so I think that, that the trend line is in place, and I think it's going to continue.

Steven Chubak
Steven Chubak
Managing Director at Wolfe Research

That's great color. Thanks for taking my questions.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure.

Operator

Thank you. We go next now to Alex Blostein of Goldman Sachs.

Alex Blostein
Alex Blostein
Managing Director at Goldman Sachs

Hey, guys. Good morning. Thank you for the question. I wanted to start with a bit of a discussion on wealth distribution fees and kind of how those dynamics are evolving. So really nice momentum, obviously, on gross sales, and you have a couple of other products and platforms on the come. What kind of changes are you seeing, if any, from how distributors charge for that? We've been hearing there's been maybe a little more kind of harmonization on placement fee structure. So how does that play out? I know there's a little bit of a higher fee that Jarrod that you highlighted on the call as well, $15 million. Was that a 1x placement fee from some of the closed-end funds, or we should expect a just kind of generally higher run rate G&A expense from distribution?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Maybe, Jarrod, why don't you handle the second part? Yeah.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Yeah. Sounds great. So Alex, that, that is actually kind of a run rate based on what we did on the wealth management channel for the quarter. So as we see more fundraising in that channel, we would expect to see more expense there. The one thing that I will remind you, which I, I also had in my prepared remarks, is that, as we calculate the part one or the FRPR, depending on the product, we do recoup those amounts out of employee expenses first. So then, it, it really is about a, about a 40% impact of that overall cost that flows through in terms of a, margin or G&A expense headwind.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

But I view that as much as you can view an expense as a positive, I generally view it as a positive expense because it means that we're continuing to fundraise and that we're continuing to build, a base in those products which we can scale off of. And the fact is, we're still in the very early innings of these products, so as we build more scale there, these, these numbers will be smaller and smaller in relation to that scale.

Alex Blostein
Alex Blostein
Managing Director at Goldman Sachs

Got it.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

I think your question, Alex, in terms of, in terms of harmonization, I think there's. The simple answer, without going into all the nuances, is yes, directionally, I think there is more harmonization. There's a fair amount of nuance in that answer, just in terms of the different products and the different channels and geographies and investor share classes. But I think as the market matures and, you know, there's more product proliferation, that you should expect to see more normalization of the, of the structures.

Alex Blostein
Alex Blostein
Managing Director at Goldman Sachs

That makes sense. And then, Mike, too, one of the things you said earlier when it comes to deployment in your prepared remarks, you highlighted, I think being a little bit more selective, maybe I'm paraphrasing a bit. But as you sort of think about the competitive dynamics, whether it's from syndicated markets or from other direct lending players, I guess, how are you guys approaching sort of the major buckets of where you're deploying capital right now, either by sponsor-based or, you know, direct to, companies and, and sort of size, where you find yourself still, you know, generating compelling enough excess returns, given the space has gotten more competitive? Thanks.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah, we do. And I thought that Kipp and Cort did a nice job kind of talking about the competitive positioning on the ARCC call, but it's probably worth reminding folks here. We have a very unique origination advantage. I think we've been doing it longer than anybody in the market. We do it at a scale that is difficult for people to rival. It is broad-based geographically. It's broad-based by strategy. It is sponsored and is non-sponsored. We have eight highly developed industry verticals that are originating direct to company.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

And I think most importantly, and most differentiated, is we have the ability to invest up and down the size spectrum of company in the middle market, competing with certain folks in the lower middle market day-to-day, in what people would call the core market, and then the larger end of the market. Whereas I think some of our peers, you know, are probably more focused on that upper end of the market. So when we're having this conversation about the reopening of the syndicated loan and high yield market, that's, that's okay for us. You know, if you look at our CLO performance as one, you know, one example, we've already achieved a record level of fundraising in our CLO franchise in the first six months of this year.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

So we're kind of on both sides of that opportunity, and when the liquid markets open up, we see meaningful growth and capital velocity in our liquid business, and when they close, we take advantage of that, and we try to capture share at the upper end of our market. But what you saw in the deployment from ARCC, and I think it's showing up in the pipeline as well, the ability to pivot down market and capture excess return there is really, really unique, and I think that's a big driver of our ability to deploy in any market environment. And then lastly, and we talk about this a lot, is just incumbency. You know, when you look at the size of the portfolios that we manage around the globe, 40%-60% of the dollars that we're putting out are into incumbent relationships.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

And so you saw that through 2023, in what was a slow, you know, M&A and new issue market, we were still deploying at very healthy rates because of the value of that incumbency. So probably a long-winded answer, but I think the deployment continues to be broad-based. We have a lot of flexibility to move around the markets, liquid to illiquid, up and down balance sheets, sponsored or non-sponsor, and, and, you know, we'll continue to do that.

Alex Blostein
Alex Blostein
Managing Director at Goldman Sachs

Great. Super helpful. Thanks.

Operator

We'll go next now to Brennan Hawken with UBS.

Brennan Hawken
Brennan Hawken
Senior Equity Research Analyst at UBS

Morning. Thanks for taking my questions. Well, we know that markets can sometimes overreact, but at least based upon what they're telling us this morning, we are increasingly likely to see rate cuts. And they're actually telling us we might see more than just 25 basis points in a meeting, which seems like long odds, at least initially, but whatever. So could you remind us about the sensitivity to a 25 basis point drop in short-term rates on FRPR and what the likely offsets would be to that impact?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure. Let's go a little bit deeper than just FRPR, because I think it's important for people to understand how it rolls through the different components. But this, again, is where the structure of our P&L and the structure of our balance sheet, I think, is going to differentiate. And we talk a lot about the importance of balance sheet light versus balance sheet heavy, to smooth out the volatility that you see from sharp changes in valuation and rate moves. So if you were to look at the composition of the P&L, first and foremost, we've obviously been a beneficiary of of rates staying high on the part one, part of the P&L. There are public disclosures in the ARCC Form 10-Q that, you know, walk people through what the sensitivity is.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

But the good news is, what you'll see there is if there's a 100 basis point decline in rates, just based on the structure of the compensation there, that would have roughly a $9 million impact on FRE. So cut that, you know, by four for your 25 basis point question, which is sub 1%. But importantly, when rates come down, we typically see transaction volumes pick up, and that decline in part one is typically offset by increased volumes and increased transaction fees. So our experience has been in that part of the P&L, that, we've been net beneficiaries. When it comes to FRPR, it's also important to understand that there's a lag effect to your specific question. So typically, when we see rate decline, just based on the structure of our investments, there's usually a six, you know, 6-month lag effect.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

But if you were to look at 2024 positioning, if we saw a 25 basis point rate cut in 2024, that would probably have a $500,000 impact on our FRPR. So again, you could multiply that by whatever, whatever number you want. And then again, the future impact is going to be a function of what does it mean for earnings, performance, valuations, et cetera. But the, the 2024 impact is, is de minimis. With regard to our disclosures on European waterfall, I think it's important that people understand that when we're making those calculations and giving you the guidance that we're giving, we're already using the forward yield curve in that guidance, so no surprises there.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

But, you know, in terms of how we expect that to roll through the portfolios, the expectation for cuts is already baked in. From a balance sheet standpoint, obviously, balance sheet light, we don't expect any material impact. And in fact, obviously, given that we borrow under a pretty sizable floating rate revolver, we should see a net benefit from lower interest expense. And then maybe just to wrap all that together, like I said, we expect that the future decline in rates will spur increased capital markets and transaction activity and velocity of capital, which we think is a net add. So I feel really good about the rate positioning and, you know, to the extent that rate cuts start sooner than the market originally had underwritten based on today's jobs report, then so be it.

Brennan Hawken
Brennan Hawken
Senior Equity Research Analyst at UBS

All right. Thanks for that. That was very helpful, Michael. In your prepared remarks, you indicated signs of recovery in real estate, which is certainly encouraging to hear. Could you maybe drill down a little bit into that? What parts of the market are you beginning to see those signs? How broad-based is it? And how much of that encouraging signs might have to do with the idea we could be getting some relief on the interest rate side, which has been a bit of a headwind for that business.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah, I think, I think that's a big part of it. Obviously, you know, the real estate business is one of the more rate sensitive, parts of the alternative landscape, and so getting rate stability, if not, you know, rate reduction, that, that does have a flow-through impact to transaction markets. And so I think some of the falling that you're beginning to see, even ahead of the rate cuts, is anticipation of, of rate reductions. The segments of the market that we focus on, just to remind people, in order, are industrial logistics and multifamily. About 50 industrial, 25% multis for three-quarters of our book. And as we've been talking about all through this rate hiking cycle, the fundamentals at the property level, in those markets have continued to be quite strong, and the secular demand drivers are still intact.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

So, you know, there is some fundamental strength that pushes through the transaction volume once you start to see the rates come down, and that's part of it as well. The real estate debt business, I'd also say, has been a bright spot for us. Obviously, as we've seen in other parts of the private credit landscape. As the banks are de-risking, the private markets have been able to come in and be a pretty reliable capital provider at some pretty attractive rates. And we have seen a meaningful opportunity developing in our U.S. and European debt business as well, where we're seeing some pretty healthy deployment.

Bill Katz
Bill Katz
Senior Equity Analyst at TD Cowen

That's great. Thanks for that color.

Operator

We'll go next now to Bill Katz at TD Cowen.

Bill Katz
Bill Katz
Senior Equity Analyst at TD Cowen

Thank you very much for taking the questions. Good morning, everybody. So Michael, in the opening remarks, you sort of talked about the sort of the shifting demographics of investing with younger folks more interested in alts. How are your conversations going with some of the retirement gatekeepers, particularly in the 401(k)/target date fund area? Is there any building receptivity to opening up sleeve to the alternatives?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

So the answer is, we have dedicated teams and efforts underway here to make sure that our product is ready for that market when it opens. To your point, I think some of those logical channel partners are open and hoping to see the DC market open to privates and alternatives. You mentioned target date funds. I do think that will be one way that that they find their way in. There are obviously going to be some, you know, call it legal and regulatory headwinds, to those markets opening up as quickly as maybe we all would like them to see. But when they do, we'll be ready, I guess, is the best that I can say. But, it is going to be a slow path, but one that we're cautiously optimistic will open up in due time.

Bill Katz
Bill Katz
Senior Equity Analyst at TD Cowen

Okay, and just one for Jerry. I hate to belabor it. Can you go back to just the offset on the comp side? I wasn't particularly following that related to the distribution. And then just stepping back, maybe give us an update on the flight path to the 45% margin for this year, and then the sort of sequential rises look out through 2028. Thank you.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Sure. The first part of the question there, when you think about these distribution fees that we pay, what we make sure is that we don't pay out comp on our part one or FRPR before we've recaptured those. So typically what you've seen in part one and FRPR is a 60/40 split, so a 40% margin there. You'll see that those ratios, we're actually having a better margin, and that's a result of us making sure that we're quote, unquote, "repaid" for those distribution costs prior to paying any employee expenses. So that means that the house is kind of sharing 60/40 the expense with the compensation pool.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

I'm happy to walk you through more on the mechanics there, but that's essentially the way it works, is we just take the total amount that we would otherwise earn and reduce from it the expenses. In terms of margin, and we talked about this in Investor Day, our focus is first and foremost in high-quality growth, and sometimes high-quality growth comes with a cost prior to we see seeing revenues for it. In doing so, though, we know that because of the way we're built, generally, you'll see margin expand based on our deployment. So we walked through, and I walked through it at Investor Day, is that we'd be somewhere in the 0-150 basis points in any given year.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

If you look at where we're at now, I think we're about 130 basis points up over last year. As we continue to see deployment, we'll continue to see expansion of that margin, but it's going to be kind of at the speed of what the deployment is. You'll have some times where it'll spike, and you'll have some times where it'll be more flat. Certainly, a little bit of these distribution fees coming in is somewhat of a tailwind or a headwind to it. And as I mentioned earlier in my response, that as we build scale in those products, these are 1x fees as you raise them, so they don't recur annually. There will be a smaller percentage of the overall management fees that we are earning from these products going into future periods. That's another way that margin will expand moving forward.

Bill Katz
Bill Katz
Senior Equity Analyst at TD Cowen

Thank you very much.

Jarrod Phillips
Jarrod Phillips
CFO at Ares Management Corporation

Thank you.

Operator

We'll go next now to Ben Budish at Barclays.

Ben Budish
Ben Budish
Equity Research Analyst at Barclays

Hi, good morning, and thanks for taking the questions. Maybe first on the state of competition and credit. Mike, you talked about some of the areas in which you're leaning into some of your advantages. Some of the media headlines would indicate that, you know, loan documentation is either becoming looser or more flexible in response to competition. I was wondering if you could talk to the degree to which you're seeing that things like increasing inclusion of, of, you know, pick optionality, things like that. To what degree are you seeing that, sort of increase in, in the deals you're doing?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

I'll try to give a simple answer to a, you know, it's not actually a simple question because it goes back to some of my earlier comments just about the structure of the market. So in my oversimplified view of, you have a lower middle market, traditional middle market, and upper middle market, I think it's safe to say that generally in the lower middle market and traditional middle market, you have seen very little, if any, of the large market, structural deterioration find its way into those markets.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

When you start to get into the upper end of the middle market in competition with both the liquid markets and the larger credit providers, you will see some, but not nearly to the same extent as the traded markets, some deterioration in structure, which I would argue in many cases could be said to be appropriate because they're higher quality, you know, sometimes larger borrowers that can command that type of structure. But most of the things that people should be concerned about in terms of the liability management loopholes and things that the media tends to focus on, those are really not present in the middle market. I think there's been an extraordinary amount of discipline despite the perception of increased competition on documents.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Kipp and Kort, again, on the ARCC call, addressed this as well, in saying that when you look at where we're turning transactions down, it's largely going to be over documents. And it could be some fairly, you know, simple or seemingly simple things that we will pass on if we don't feel that we have the ability, you know, to exercise our creditor rights when we need to, the way that we need to. So I do think the media is probably overblowing it relative to the broad middle market. And even at the upper end, in relation to the liquid market, it's really not that pervasive. I think PIK is a different question, and again, not to go down a PIK rabbit hole. PIK, in today's market, is not necessarily an indicator of structural deterioration.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

I would encourage people to think about it as a way for private credit managers to capture excess return at a time when base rates are high. So if you are thinking about prudently structuring your leverage and managing to a sustainable interest coverage ratio, and not constraining the cash flow of a company, and constraining their ability to execute their business and growth plan, then PIK is the way that you are going to capture excess return and support your borrowers. So you have to differentiate between PIK that is intentional at the outset, versus maybe PIK that is used to, you know, reduce default, et cetera, et cetera. But again, that's not really the same as some of the other structural deteriorations that people like to think about.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

And again, when you look at our approach to PIK in the corporate credit book, it's more of the former than the latter.

Ben Budish
Ben Budish
Equity Research Analyst at Barclays

Got it. Very helpful. Then maybe just a quick follow-up. Just given the size of the latest SDL fund, how do you think about sort of the future of the fund structure there? You know, does it make sense to continue to scale up these drawdown funds, or to what degree will you continue to maybe raise, you know, to an outsized degree, from more perpetual strategies that could potentially be more scalable? Thank you.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah, I think this is a, this is a place that we've been quite vocal. You know, Craig brought it up earlier, as we said, that we were kind of tempering growth despite the, the high growth in places like ASIF. You've seen us raising equity and scaling ARCC, and now you're seeing, you know, an SDL 3. We have learned over the 30 years that we've been doing this, that it is critically important that you are diversified in your distribution and funding sources. We have a pretty good handle going into any, you know, year or years as to what we think our deployment capacity is, and we structure our capital to meet that deployment capacity. So SDL has been investing already. As we've raised, we're about $9 billion in the ground on that fund, so it is deploying at the expected pace.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

But we never want to be beholden to one fund or one channel, because in different parts in the cycle, those will open or close. So if the non-traded market sees a slowdown in appetite, we want to make sure that, you know, we have other forms of capital that can actually meet the deployment demand. Similarly, as we get closer to end-of-fund life on some of our commingled, you may see us turn on managed accounts or the public entities. It's critically important that people understand that that diversity of funding is a big driver of how we actually create value here, and we'll continue to do it. So I don't think we'll ever give up on, you know, this, this complement of funds that we have: open-ended, closed-ended, perpetual offer, campaign, traded, non-traded. It's a big part of how we run the business.

Ben Budish
Ben Budish
Equity Research Analyst at Barclays

Understood. Thank you.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure.

Operator

We'll go next now to Ken Worthington at JPMorgan.

Kenneth Worthington
Kenneth Worthington
Senior Equity Research Analyst at JPMorgan

Hi. Thanks for squeezing me in at the end here. We're almost 18 months beyond the regional bank crisis. I think Ares considered the opportunity to come in various different phases for Ares over time. What phase would you consider us to be in now, and what do you see as the opportunity for Ares kind of going forward? Does a more benign interest rate environment alter the opportunity set that you see going forward?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah, I wouldn't say that it alters the opportunity set. I mean, just to reiterate, I think what you're referring to, we've talked about the different phases. One was obviously an early phase, where there was just certain portfolios that were distressed, or certain balance sheets that were distressed, that needed resolution, either through asset sales or risk transfer transactions. You know, there's still some of that going on, but, you know, given the continued strength in the economy now, the prospect for rates, you may see less of that. There still is a pretty significant amount of assets sitting on bank balance sheets that will need to get resolved, either for credit reasons or regulatory capital reasons.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

And so, you know, I don't think that means that the types of deals that we were seeing are not going to happen. They just may not be happening at the same velocity. We are now, I think, transitioning to the next phase, which we've talked about, which is a much more sustained opportunity, is that in the wake of that crisis, in the wake of increased regulatory capital pressure, you will begin to see more of these assets finding their way into the private markets. And, that's actually a more consistent opportunity set for places like our alternative credit business and our real estate lending business, to name a few. So I think that transition is underway. We're seeing it in the composition of our pipelines.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Even with rates coming down, just given some of the, you know, acute stresses on certain bank balance sheets, I wouldn't rule out that you'll continue to see, you know, a decent amount of portfolio trades and continued risk transfer deals as well.

Brian Bedell
Brian Bedell
Director at Deutsche Bank

Okay, great. Thank you very much.

Operator

We'll go next now to Patrick Davitt at Autonomous Research.

Patrick Davitt
Partner at Autonomous Research

Hey, thanks. Good afternoon now, everyone. This still might have been asked, but maybe a broader macro one. It strikes me that everything you're saying today is a pretty dramatic contrast with what the market thinks is happening today. So from what you can see across your borrowers, PE companies, et cetera, against the jobs report today, do you see this as an overreaction, or do you think there's a real potential evolution towards seeing a path to slower economic growth, and thus more cuts than maybe you and your competitors have been talking about just a couple months ago? Thanks.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah, well, we've talked about this a lot. I mean, the best we can do—we don't have a crystal ball, but we have data that we see in our private market portfolios that is telling us something different. And we've been consistent on that. So two years ago, when the markets were calling for a recession, we weren't. And so we try not to get worked up as long-term investors into any one singular headline. We obviously already talked about that if rate cuts get pulled forward, both in terms of timing and magnitude, I think the business is very well positioned, you know, for that transition. But we are not seeing anything in our private portfolios that would argue for what we're seeing in the market today.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

You know, it's interesting because as a private market practitioner that runs a public company, I'm often struck at just the volatility and schizophrenia that you can see in the interpretation of data that comes out of the public markets. And month-to-month, good news is bad news, and bad news is good news. And today, I guess, okay news is bad news. We just try to look at the facts as we see them and make sure that we're well-positioned. But I personally feel, you know, I feel like it's an overreaction, but we'll keep collecting data and react accordingly.

Patrick Davitt
Partner at Autonomous Research

Okay, I'm calling out. Thank you.

Operator

We'll go next now to Michael Cyprys at Morgan Stanley.

Michael Cyprys
Michael Cyprys
Managing Director at Morgan Stanley

Great. Good morning. Thanks for squeezing me in here. Just wanted to ask on the non-sponsor business that you guys have. Just hoping you could share an update on that, just in terms of non-sponsor direct lending. Remind us of the size of that platform and some of the initiatives that you have for broadening that out, particularly as banks are looking to run with more capital-efficient balance sheets. And then just curious how you'd expect the pace of activity there in non-sponsor to evolve over the next 12 months, as compared to your larger sponsor direct lending business. Thank you.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure. As I said, we have, right now, about 8 industry teams that we deploy across the private credit business. They are originating direct to corporate, and they are supporting our sponsor-led originators and deal teams when a sponsor is actually investing in, you know, in a company in that industry. So it's kind of a double benefit of that we're actually able to increase our non-sponsored origination, but also, I think, do a better job underwriting in some of these, some of these markets. The non-sponsored business, just given the size of the markets and the importance of sponsor, will continue to grow on an aggregate dollar basis, but I'm not sure that we'll, you know, we'll get it to a place where it's kind of gonna overwhelm, the sponsor-backed opportunity.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

But order of magnitude, just to give you a sense, if you were to look at our non-sponsored origination just in our direct lending business, and there's a pull-through effect to other parts of the business, it's probably somewhere between 5%-10%. So it's meaningful aggregate dollars, but it's not gonna, you know, move the needle, you know, in any given period. It's highly differentiated, particularly in some of these core verticals like sports, media, and entertainment or life sciences, where we've, you know, been early both in adding people and capital. So-

Michael Cyprys
Michael Cyprys
Managing Director at Morgan Stanley

Great.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

We'll keep making those investments. We'll keep making those investments.

Michael Cyprys
Michael Cyprys
Managing Director at Morgan Stanley

Great. Thanks so much.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure.

Operator

We'll go next now to Brian Bedell at Deutsche Bank.

Brian Bedell
Brian Bedell
Director at Deutsche Bank

Great. Thanks, thanks for squeezing me in also. Maybe, Mike, just to follow on the last couple of questions on deployment as we sort of move into the back half of this year and come into 2025. Just in this, I guess, you know, only a couple of days in here, but a very recent environment, obviously, where sentiment is shifting negative. To the extent that we have more market volatility and at least temporary financial stress in the system, how could that impact your deployment, you know, plans is for the second half? Would that actually help you because potentially bank sponsors, you know, would pull back, or would it freeze up deployment temporarily, potentially?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Yeah. So the way I think people need to begin to understand the deployment is the deployment geography will change, right? So if you go back and you look at, you know, 2023, where new transaction volume was constrained, you would have seen increased deal activity within the incumbent portfolios and in places like opportunistic credit, alternative credit, and secondaries, because they're going to be that liquidity provider into the dislocated market. Then you transition to a healthy market, you'll see volumes ramp up in the liquid side of the business and new issue volumes increasing in the direct lending market. And if we go into a more volatile market and banks pull back, you know, et cetera, then you, you'll shift it again.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

So because of the diversity of strategies that we manage and the diversity of geographies that we manage them in, the volatility of deployment is, you know, reducing over time. And so, yes, I continue to believe that just based on the weight of capital, the aging of the installed base of private equity, rate cuts having a corollary impact on valuations and the cost of capital, I still think that we're going to see pretty healthy deployment into the back half of the year, today's market move notwithstanding. But if for whatever reason, the market's got, you know, got too nervous, then we're going to find other parts where our capital is going to be more relevant, and we'd kind of be deploying there as well. So I think we're in a really good spot.

Brian Bedell
Brian Bedell
Director at Deutsche Bank

That, that's helpful. And maybe just one on retail. Any interest in doing a deal like, you know, what we saw with, obviously, KKR and Capital in terms of a hybrid structure with with retail products to a much wider distribution, or you like your strategy as it is now?

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Well, as of now, that's just a headline. I don't know if anybody really knows what that deal actually looks like, so I can't opine as to whether or not we would do something like that or not. We have partnered with more traditional asset management platforms over the years through various sub-advisory agreements and partnerships to bring private markets into some of those portfolios, and that's been a, you know, a part of our diversification of distribution historically. So I would expect that type of thing would continue. We would be open to it. I think I would just go back to some of our comments around our investor day, is that we are very focused on what I would call high-quality growth.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

What I mean by that is sustainable growth at high fee rate, high margin, where we are maximizing the value of our origination. Because at the end of the day, the binding constraint to growth and profitability for anybody in our business is going to be our ability to source unique assets. And how we then deliver those assets to our clients, whether they're institutional retail, you know, is, is another side of the equation. But from the Ares Management shareholder perspective, our goal is to make sure that we maximize the profitability of that origination. And so I don't, again, not knowing what those partnerships look like, you know, it is very expensive to originate and portfolio manage the type of assets that we do. They do require a high fee rate, which is why our average fee rate is 1.1%.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

And so we have to be very careful that when we start talking about private markets within traditional portfolios, that people don't, you know, go down the rabbit hole of, of thinking that they can access difficult to access, non-correlated, unique private outcomes, you know, at, at public market rates. So we, we think a lot about it. We have very deep relationships with, with many of the traditional managers at the highest levels of the firms. You know, but the, the calculus as to whether or not to enter into any partnership like that is going to, you know, really go back to what I said earlier, is: What's our capacity to deploy? And is there benefit in diversifying the distribution into that channel against that deployment? And, and so I think that's a TBD.

Brian Bedell
Brian Bedell
Director at Deutsche Bank

Great. Great, that's really helpful. Thank you very much.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Sure.

Operator

Gentlemen, it appears we have no further questions today. Mr. Arougheti, I'll turn things back to you, sir, for any closing comments.

Michael Arougheti
Michael Arougheti
CEO at Ares Management Corporation

Great. We appreciate it. Thank you for the great questions and the time today, and we look forward to speaking with you again next quarter. Enjoy the rest of the summer.

Operator

Thank you, Mr. Arougheti. Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of the call will be available through September 2nd, 2024, to domestic callers by dialing 800-839-4012, and to international callers by dialing 402-220-2981. An archived replay will also be available through September 2nd, 2024, on a webcast link located on the homepage of the Investor Resources section of our website. Again, thanks so much for joining us, everyone, and we wish you all a great weekend.

Executives
    • Greg Mason
      Greg Mason
      Co-Head of Public Markets Investor Relations
    • Jarrod Phillips
      Jarrod Phillips
      CFO
    • Michael Arougheti
      Michael Arougheti
      CEO
Analysts
    • Alex Blostein
      Managing Director at Goldman Sachs
    • Ben Budish
      Equity Research Analyst at Barclays
    • Bill Katz
      Senior Equity Analyst at TD Cowen
    • Brennan Hawken
      Senior Equity Research Analyst at UBS
    • Brian Bedell
      Director at Deutsche Bank
    • Craig Siegenthaler
      Managing Director at Bank of America Securities
    • Kenneth Worthington
      Senior Equity Research Analyst at JPMorgan
    • Michael Cyprys
      Managing Director at Morgan Stanley
    • Patrick Davitt
      Partner at Autonomous Research
    • Steven Chubak
      Managing Director at Wolfe Research
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