All right, good afternoon, everyone. For those of you that don't know me, I am Patrick Davitt, the US Asset Manager Analyst here at Autonomous. As a reminder, we're using Pigeonhole online for the Q&A today. If you have any questions for Mike, please throw those in there, and I'll try to pepper them as appropriate. It's my pleasure to welcome Ares Management's Co-Founder and CEO, Michael Arougheti. Thanks for joining us this afternoon.
Thanks for having me.
Given we have most of the major alt CEOs at this conference, I'm starting all the conversations with a similar kind of high level questions, so we can compare and contrast easier across the group. Given everything going on in the world, let's start macro. There's a view that the Fed probably needs to force a recession to tackle inflation. One, do you agree with this view? Through that lens, what is your outlook for inflation rates and economy through the lens of everything you're seeing?
What did my peers say? I'm kidding.
We've only got one down.
What he said. I think the market's become obsessed with recession.
Yeah.
We've been talking about a recession that has yet to materialize, at least across the entire economy, for a year and a half. Maybe let's just talk about inflation.
Mm-hmm
... and the observations that I see in our portfolio, and then we can talk about recession and whether or not that actually matters for alts. I think inflation has been more persistent, but we are beginning to see it peak and roll over in certain cases. You look at the print that we just got. I think if you take out shelter, the numbers are starting to get to a palatable level. We obviously have a very large real estate business and have a forward view, and I think others who are active in the market would tell you the same. You're also beginning to see slowing growth in rents, albeit still strong, but slowing.
I would expect that some of the deflation that the Fed has been trying to push into the real estate market is starting to take hold. We're just not seeing it in the backward-looking CPI data. All of that leads me to believe that we are, you know, past peak inflation. We have a persistently strong job market, and I think that is going to be the challenge at hand for the Fed. We also know that we are approaching the terminal rate, and obviously, we're going to debate every day whether we're gonna get another hike or another 2 hikes or a pause. We're getting to a place where I think we all are gonna build a consensus that inflation has peaked.
We're on the other side, now it's just a question of, is it 0 to 50 basis points? I think within that framework of 0 to 50, the economy will hold. The consumer continues to exhibit a lot of strength. There's a disconnect that we see between the mood in the boardroom and the mood of the markets. I think that's because when you look at the earnings, we're still seeing, broadly speaking, revenue and EBITDA growth.
Mm-hmm.
Not that Ares has a house view that drives everything, 'cause we're in so many different markets with so many different asset classes. You know, our view is we may not have a recession, and if we do, it will be shallow. It could be longer than we expect because I do think that the Fed is gonna have to keep rates higher for longer. My own personal view is that the forward curve is not right.
Mm.
For better or for worse, I'd say for better, that's a really good setup for private credit. You know, we're a high, high current coupon, floating rate, short duration, senior secured asset class. That represents two-thirds of what Ares does and informs a lot of how we position. I think, you know, from the Ares perspective, the markets are trying to talk themselves into a lot of doom and gloom. The information that we're getting out of the portfolio would tell us that there's maybe not as much cause for concern and that we're, you know, we're probably on the backside of this thing.
As you look through the portfolio and the trends, is there anything that's setting off any kind of alarms? Is it still really much?
No, there's no alarm bells. I think that we have not digested this speed and severity of rate increases, so not surprisingly, things are gonna, quote-unquote, "break." When the Fed says, "We're willing to break things," that doesn't mean that we're, you know, acting nefariously or that it's gonna, you know, break the economy. Things are clearly gonna break because structurally, certain parts of the economy and financial system are not set up to digest 500 basis points of rate hikes in a year. That should not surprise people, but it also, I don't think, should cause, you know, extreme panic and anxiety.
Yeah.
I, you know, I think, again, we've lived with rates at this level before. We just haven't moved through this swift of a transition. Once we settle out at the new terminal rate and everybody knows where to price risk assets, I think we'll all be pleasantly surprised at the amount of economic activity that we're gonna see come back.
You touched on this briefly, but private credit has obviously been a big driver of growth for you and the other alts. There's still this view out there, and we kind of touched on it, that the asset classes where, you know, there's going to be a lot of credit stress, where we'll see some accidents. It's hard to push back on until it's been tested, though, to be fair, you guys have been through the GFC. Aside from CRE, which I think everyone has established is the most obvious problem, any particular pockets of risk assets you think are more exposed to the outsized losses? If it isn't private credit, where do you think it is?
Well, first of all, it doesn't need to be anything, right?
Right, exactly.
This is the thing. Again, it's there are certain credit cycles-
Yeah
... where, you know, we have a credit cycle. It doesn't need to be a thing.
Right.
I'll give you my view on where there's potential risk, but I do think we should pause here, maybe just given our presence in the private credit markets, and talk about this idea that private credit is somehow this shadowy corner.
Right
... of the financial markets, where all of this opaque risk exists, because that narrative has been in the market for as long as we've been doing this. You mentioned the GFC, but the team at Ares and some of our peers, we've been investing in this asset class for over 30 years. Not only did we get through the GFC and COVID, and the taper tantrum, but we got through long-term capital. We got through the Asia debt crisis. We got through the dot-com blow. This is a cycle-tested, tried and true asset class. The simple reason is, like I said earlier, it is a senior secured, short duration, floating rate asset.
If you go back and audit the track record, you'll see that private credit has actually outperformed high-grade fixed income and leveraged finance assets in every prior cycle. I don't know where that's coming from. It could be a little bit of a FOMO or a, "Hey, I wish I weren't chock-full of.
Yeah
fixed grade, you know, fixed income, high-grade bonds right now." There's really no evidence to prove that. I think that probably the biggest misunderstanding, and this may be as a segue into where there's potential risk. The bulk of the private credit markets, whether we're talking about corporates or infrastructure or real estate, are underpinned by cash equity from a sophisticated institutional equity owner and a sophisticated management team. We are going into this current cycle with more equity subordination in all of these capital structures with better underwriting than we've ever seen. If we're going to have a conversation about risk in private credit, it has to start with a risk in private equity.
It has to start with a discussion of risk in infrastructure equity, and it has to start with a discussion of risk in commercial real estate equity, because the math would simply tell you that if we're talking about real losses in the private credit asset class, you will have blown through $2 trillion-$3 trillion of institutional equity.
Mm-hmm.
People don't like to talk about that fact, and that I don't know why. CRE, clearly, you know, challenged in certain sectors, and appropriately so. We don't need to belabor how difficult-
Yeah
the office market is. Again, back to how bad is it out there? If you look at what we're seeing in our multifamily portfolios and industrial portfolios, there's a lot of fundamental strength.
Mm-hmm.
We're at high occupancy rates. We're releasing at a very high clip. We're releasing at percentage increases, you know, that are meaningful. When we talk about real estate, we can't just say all real estate is bad, because a lot of sectors in the real estate market are performing well, and a lot of geographies are outperforming. The office experience in Miami is fundamentally different than the office experience in San Francisco right now. There is going to be challenges there just because there's real structural headwinds. The only other place I would highlight where there's potential risk, again, I don't think it's systemic, is how long will the lower-end, lower FICO score consumer hold up? I think they've proved to be surprisingly resilient, but we are beginning to see delinquencies tick up in auto portfolios as an example.
There's a question mark, I think, still to be put out there, is as they deplete their COVID savings.
Yeah
... even with a tight labor market, will they continue to spend at the rate that they've been spending? I, for one, believe that they will prove to be more resilient than we may expect because the job market is so tight. Our experience would tell us that when people are well-employed, feel confident in their employment and in their mobility, if that's what they choose, they're gonna spend money. That maybe goes back to your earlier question, is will inflation be stickier...
Right
... at a lower level, but still high enough that we need to hike? We're not really seeing alarm bells or red flags or, you know, meaningful, what I would call systemic risks that are popping up in the market right now.
Are there any aspects of, not necessarily in your portfolio, of direct lending or leverage lending broadly, that compare negatively to kind of the pre-GFC product?
I think you have to ask yourself right now, what's going to be the durability of venture lending?
Right.
You know, we were, for example, in the venture lending business 10 years ago, and got out of that business. We actually sold our business to Hercules, for those who know Hercules. The reason we got out of that business is we realized that the primary underwriting was that you were effectively building a bridge to the next fundraise. Unlike corporate direct lending, real estate, it was less about the fundamentals of the business plan, and it was more about cash runway, and can I get to the next series of fundraising? On the heels of some of the challenges that we saw through the SVB crisis, some of the issues that we have with denominator effect in the venture equity community, I think there's some turbulence there that, you know, may present itself.
You could argue that that is a corner of direct lending.
Yeah.
I would keep an eye on that.
Okay. That's helpful. Let's move to the addressable market, as it sounds like, private credit is setting up to continue taking share from more traditional sources. I guess, firstly, are you seeing more opportunities to disintermediate more traditional borrowing markets, like even investment grade or high yield from the banks? Then within that, it seems that ABS is the big incremental opportunity that everyone's talking about out of the regional banking failures. Is that your view as well? Any other areas you're seeing opportunity from the bank dislocation?
Sure.
Yeah.
That was a six-part question.
Yeah.
I'm going to give you a 10-part answer to a 6-part question. I think you have to first. Let's just frame what is the relationship between the non-bank lending community and the banking community? Yes, over the last 30 years, we have, quote, unquote, "disintermediated" the banks in certain corners of the lending market. While we've been doing that, we have become some of the largest clients and borrowers of these same financial institutions. The fact that we've been able to take that share doesn't mean that the risk is not good risk. It just means that the reg cap framework in banks doesn't make it as profitable for them to support the business versus us doing it.
From a return on equity standpoint, it's more efficient, both in terms of the absolute return, but also just the way the business is run, to support the growth of the non-bank lending channel. If you were to, if you were to map the growth of Ares, for example, you would see a near perfect correlation to the growth in wholesale funding coming from our banking partners. It's again, there's this narrative that we're taking from the banks. We're actually growing together, but we're doing it in a way that works for our investors and works for their investors, and I think that will continue. With regard to the high yield market, we have clearly, as a private credit market, taken some share from the leveraged loan market and the high yield market.
Doesn't mean that we've taken all of it or that those markets won't continue to grow, but at the lower end of both of those leveraged finance markets, there's an opportunity for borrowers to get better execution in the private markets. There's a whole host of reasons why they would choose to do that. We've been, you know, over the last 10+ years, taking share from what I would call the lower end of those markets as we've scaled, and I think that trend will continue. In terms of what we expect going forward, you know, I think this is going to be a transformational shift, yet again, in the banking landscape and the non-banking landscape. It will happen in a phased approach.
If you think about the issue that has been raised by the current crisis, is not what's good risk or bad risk, it's who's a natural holder of certain types of risks. What we have learned is that the liability structure of the bank balance sheet has some structural issues with it when you can lose $40 billion of deposits in four hours. Doesn't mean that there's credit issues, but it means that you have to rethink the liquidity framework within the banking system, if you're not willing to put blanket guarantees on deposits, which I'm not quite sure that we're going to see that day. That probably means banks need to simplify their business models. Probably means that they need to deleverage.
It probably means that they need to shorten duration to try to mitigate this asset liability mismatch that we now know exists. Each of those are going to present different opportunities for us. The first thing that we're seeing, which is today, is the opportunity to work with the banks, again, as a collaborative partner, to help resolve some of the mismatch. That could be portfolio purchases, it could be working with them on, you know, various reg cap trades just to free up better liquidity, help them improve their ROE. We're doing that collaboratively. Again, we're not going in and taking advantage of regional banks in distress. We're in there as a real, meaningful capital partner. I think that is gonna be phase one. That, in and of itself, is gonna be a huge opportunity for us.
phase two is once they get through that initial process, I think will be a reevaluation of what's core
Mm.
What's non-core, and that's different for different banks. Some banks who are over-indexed to consumer lending or to auto lending or commercial real estate, you know, they're gonna adjust.
Yeah.
That's gonna be a function of risk management and reg cap. When that happens, that means that some of those businesses that are non-core will find their way into the securitization market and the ABS market. I think, yes, ABS is a huge opportunity that will come out of this, because a lot of those non-core businesses will prove to be in this realm of structured credit and.
Mm
... and structured product. I think you have this spin up of all of those businesses in a specialty finance market. The next phase is really, what does the world look like after all of that is done? Where you have fewer banks, less leveraged banks, more simplified bank balance sheets, and more simplified asset origination and risk management. That's when private credit will continue to take share, just in the regular way, lending business, because somebody is gonna need to go in and provide the
Right
capital that the economy requires. I think there will be, you know, a series of opportunities, some of them, you know, cyclical and some of them secular.
Mm-hmm. You know, a lot of your competitors have made a big deal about all of these ABS origination platforms they've built-
Mm
... with various brand names, and I think you have similar capabilities, but haven't talked about it in the same way. Could you maybe compare and contrast how you can address that opportunity relative to maybe how other people are talking about it?
Yeah, you have to think the reason people are excited about it is, one, it is a huge addressable market. Our view is that the alternative credit business, as we talk about it, is potentially a $4 trillion market that is going through transformational change. The reason it's exciting to us and others is, it opens up this whole world of high-grade-.
Mm
... fixed income alternatives, which up until this point, that hasn't really been the purview of alternative managers. We now know that with third-party insurance clients and affiliated insurance clients, that we can actually leverage our origination in these markets to originate...
Mm-hmm
... lower yielding, high-grade fixed income alternatives, and that's really valuable. Somewhat of a different model in terms of how it scales, how you fee it, and how you raise capital around it, and everyone is approaching that opportunity differently. But I think we would all agree that the TAM is large-
Yeah.
That scale will matter. That being said, it's a pretty unique capability set, and there aren't that many people who have it.
Mm.
I think with so many things in the alternative space, there will be a handful of people who have the marriage of talent and capital scale and flexibility to go after this opportunity. I think we're high on that list. We have one of the largest alternative credit businesses in the market. We currently have about $25 billion under management with 60 people. It's one of our fastest-growing credit businesses, and I would expect we'll be a big beneficiary of this. The bulk of that, to date, has not been in the high-grade fixed income.
Right.
It's been in the more traditional parts of the market, so we can scale.
Mm-hmm.
We can scale into that. Not to ramble, we have not had the view, just in terms of the way that we build businesses, to outsource originations or-.
Mm
... portfolio management to other people. If you look at the way that we've systematically built the business, if we see a sustainable investment opportunity in an asset class or geography, we will put a team together, we will make an acquisition, we'll capitalize it. Our whole investment thesis, and I think we've proved this out, is we wanna drive as much synergy on an integrated investment platform as we can. The idea of building, you know, affiliated origination platforms has just not been the approach.
Right. Right.
that we're taking.
That's a good parlay into a question I was gonna ask later, but insurance is obviously an important channel for that theme. A couple of your comps have kind of taken a balance sheet-heavy approach to that. Maybe compare what you're doing to that model, and through the lens of this ABS opportunity, do you think you can compete without having the kind of, like, balance sheet warehousing capability?
Sure. Our approach is quite different in a couple ways.
Yeah.
One, we are balance sheet light, meaning, you know, our view has been that we are being asked by all of you to deliver sustainable growth in our FRE by growing our management fee revenue and our management fee EBITDA. We've been doing that at a very high clip. Our view is, if you do that for as long as we've been doing it, that has a certain valuation implication.
Mm-hmm
... versus a balance sheet-heavy model, where you're being asked to take investment risk. I think when you look at the divergence of performance in this current market, that tells you all you need to know, is that the market understands that if you are balance sheet heavy, that you have to absorb the devaluation that's occurring, given the rise in rates right now. Not surprisingly, you're seeing outperformance in both our fundamentals and our stock, and I think that's a pretty telling thing.
Mm.
It's not to say that one is better or worse, but they're fundamentally different.
Mm-hmm
... value propositions. I think that as we've built our business and offered investment product institutionally and through the retail channel, those that want to access our investment product have lots of ways to do it.
Mm.
We feel that, you know, having a pure-play asset manager that's growing its third-party business with a series of funds, institutional and retail, traded and non-traded, gives those that would like, the opportunity to get diversified access to the investment product. We'll let them make that decision. The other thing is we've been very focused on third-party insurance clients. They're one of our most important, fastest-growing, strategically valuable clients and partners, and our view is that we do not want to overwhelm that part of our business. If you were to look at, you know, our five-year plan that we put out at our Investor Day, you would see that with significant growth and scale, that our insurance business would've gotten us to 5% of our AUM. Roughly $25 billion on a $500 billion AUM denominator.
If we exceed that because this market opportunity becomes so you know, transformed.
Yeah
it became 50 of 500, that would be a big insurance affiliate, but still only 10% of our business.
Right.
There's a lot of merit to the insurance strategy. It will be a big grower for us, but we will have it as one piece of a much broader and diversified funding and source for us.
Right. I think that's a good pivot to the strong growth outlook. Your tone on the 1Q earnings call was noticeably more constructive than most of the other alt managers. You stuck with your 20% FRE growth guidance and expectations of exceeding last year's fundraising goals. Firstly, how dependent is this growth outlook on deployment picking up? 'Cause I think that was probably one of the few disappointments in the 1Q results. How is that activity tracking so far in 2Q?
Deployment is a meaningful part of our... the predictability of our earnings trajectory. I don't know if it was a disappointment, as we also said in our prepared remarks. It was actually in line with what we expected our deployment in Q1 to be. When you look at our deployment relative to the peer set, it was actually at the very high end of the peer set, particularly relative to our AUM. I think there was some good indication that we were taking share of a smaller market. The other thing I think to appreciate is, when you have lower gross deployment, you're also not getting refinanced or taken out of a lot of your existing exposures, so you really have to focus on net deployment.
When we go through these periods of volatility, you may see transaction volumes slow, but your net disappointment is much less than it may appear, and particularly in credit, where, you know, we're not reliant on those realizations to generate as much promote.
Mm-hmm.
We obviously reaffirm the guidance. While we acknowledge that, deployment is a driver of earnings, what we have learned about our platform, we have so many different strategies in different markets, that if, for example, new issue LBO volume comes down, we'll start to see a meaningful pickup in distress deployment. If real estate equity deployment comes down because transaction volumes are low, we start to see a meaningful pickup in real estate secondary.
Mm-hmm.
Part of what we're beginning to, you know, really reap the benefits of, is the broad mix of strategies that we have and our ability to deploy in any environment. While transaction volume is still muted, we are seeing it pick up. I'm optimistic that you're going to see meaningful transaction volume pick up in Q3 and Q4 once we settle on the new rate paradigm, and sellers and buyers can agree.
Mm-hmm.
can agree on price. We see that building in the private pipelines, I don't know if you have any of the sell side banks here at the conference, they would probably tell you that they are seeing a meaningful pickup in the number of companies preparing to monetize.
Right
... once there's, you know, once there's consensus. There are some good indicators that that volume will pick up. If it doesn't, we're still pretty confident that given our capability set and the diversity of strategies, that the deployment will be there.
Yeah, makes sense. Through the lens of your view, and I think most of your competitors agree, that rates will be higher for longer, there's still some people out there that think they'll come back down at some point, particularly if we have a bad recession. What is the pitch? I mean, like we were talking last year, the pitch for private credit is this floating rate and, you know, rates are going higher. What is the pitch to your clients, and how do you see demand evolving, if indeed, you know, the lower rate regime wins again?
Yeah. You know, you hit on in your prior question. We differentiate ourselves in fundraising.
Right
... and deployment. The reason that we differentiate in fundraising is because private credit is in high demand.
Yep.
Interestingly, it's in high demand for all the reasons I articulated earlier: senior secured, floating rate, short duration. If you have an inverted curve and you want to capture all the excess return that's currently at the short end, a 2-3-year floating rate loan is.
Yeah
... you know, good way to do that. The shape of the current curve is actually another catalyst for people wanting to access shorter duration floating rate credit. I probably would have given you a different answer 15 years ago, because we didn't quite know how investors behaved through different rate regimes. I think now, when people are investing in private credit or private markets, more broadly, they're investing to capture excess return relative to the liquid market equivalent. There's always this fear that rates would go up, the available return in traditional fixed income would be adequate, and it would reduce demand for private credit assets. What we've actually seen is that because we've proven the durability of that excess return, for some investors, it's adequate, but for many who have already said-
Yep
... "I need private credit as a core allocation," they're just going to be clipping more excess return. Which in a market like this, where there's a fair amount of volatility, and the traditional markets are range-bound, that's a really nice way for them to generate excess return. For that small handful of investors who do say, "Based on my portfolio construction, liquid markets is enough for me," certain insurance companies, for example, you then have a whole section of the institutional market who were chasing return in the equity market.
Mm-hmm
Now say, "Oh, if I can make a 12%-15% short-duration floating rate return, I'm going to take allocations away from my equity bucket and move it into credit." What we've now seen develop over the last 20-plus years is there's durability to the allocation, and whatever's leaving the market, you're seeing at least the same amount come in to capture the excess return, because it's always about relative to what?
Yep, makes sense. Let's move on to secondaries. I think this is one part of your business that maybe hasn't grown as much as we had hoped. As some background, you purchased Landmark to gain a foothold in that business. It seems like there should be a big opportunity emerging as LPs seek liquidity. Do you think there could be a bigger pickup in fundraising for that business? Maybe walk through the broader growth strategy.
Sure. Yeah, we acquired Landmark, 2 years ago, almost to the day, probably. The reason we made that acquisition was we had a view that there was going to be transformational change in secondaries. That was already underway, and it was a combination of growth in the primary market for private equity, real estate, and increasingly infrastructure and credit. We had a view that we would be able to grow the secondaries business away from private equity and into other parts of the market. Two, there was a change underway, to move away from LP-led secondaries, which was institutional LPs looking to sell portfolios of fund investments to manage portfolio construction, and a shift to GP-led, which was this whole world of GPs looking for liquidity solutions in their own portfolios.
Then three, we had a view that it would globalize just based on where the capital was and the increased appetite for alternative exposures. That was a big secular view that we had. Fast-forward two years later, we have this massive cyclical accelerant, which I think you're referring to, which is in a world where people are feeling unable to raise as much equity capital as they want, both on the LP and GP side. Secondaries, in addition to structured equity, structured credit, private credit, is going to be a big part of how we resolve-
Right
-the installed base of all. I think you will see, you know, meaningful growth coming out of this moment in time, as the GPs are trying to extend duration, get to a better valuation environment, get to a lower rate environment, preserve their carry opportunity. You're gonna start to see LPs, and we're already seeing it, more actively use the secondary market to rotate into the current vintage.
Right.
What's interesting, we're seeing this in secondaries, but we're also seeing it coming out of banks. The things that are getting sold first tend to be the highest quality assets, because part of the game right now is minimize the discount and minimize realized loss. In the continuation fund side of the business, we're seeing some of the best performing, highest quality assets come to market.
Okay
... which is a unique opportunity. On the secondary side, we're seeing a meaningful increase in the amount of credit secondaries, because the discount on a credit book is somewhere in the, in the nineties, and discounts on equity books somewhere in the eighties, and discounts on venture books is probably somewhere in the seventies. If you're a CIO that's looking to generate liquidity, easier to sell something in the nineties right now than the eighties, and redeploy it into a high coupon-
Mm-hmm
-part of the market. I think the investment thesis for secondaries is intact. In terms of it being disappointing, and that's not. Again, I don't want to sound defensive, not how we, you know, we think about it. We went in and bought a business with a 30-year track record, that was a great cultural fit for us, had deep institutional relationships, but maybe didn't bring to the table some of the things that we brought, and I think that was reflected in what we paid for the business. You can go back and look, they were doing about $97 million in FRE when we bought them, and we paid about $1 billion for it. I think roughly a 10 times purchase price.
Mm
for a business with real presence and scale, with a view that we could transform the business by extending the product set. What have we done? We've launched a credit secondaries business, not surprisingly, given our credit leadership position. We announced a billion-dollar joint venture with Mubadala to get that business off the ground, and we've now launched a commingled fund into this current market opportunity, which we think, you know, is really exciting. Two, we leveraged our wealth management platform to launch a private market fund, i.e., secondaries and private equity-oriented strategy for the non-traded market. That's already up to $300 million and scaling, and is opening up a whole new investor base for secondaries. Three, we're actively raising for the real estate and infra strategies, where I think we still have a meaningful leadership position.
If there's any, quote, unquote, "disappointment," I think it would only be reflected in the fact that our last private equity fund was.
Yeah
... smaller than maybe some would have expected it to be or would have hoped it to be. There's a whole host of reasons for that, not the least of which is private equity fundraising is hard right now-
Yeah
as everybody knows. Two, that fund got launched well before our transaction was announced and ultimately closed, and had been in the market for a very long time.
Mm-hmm.
That's just a tough thing to, you know, re-accelerate. As I sit here today, we're thrilled with the acquisition, we're thrilled where and how we acquired it, we're thrilled with the product diversification. We've been adding talent, opening up new geographies. Now we've caught this really interesting moment where, to your point, secondaries is gonna really accelerate, and I hope we capture a fair bit of that.
Sure. I think that's a good parlay into retail, 'cause I imagine that's an asset class that might package better for retail. You're a little bit earlier in that process versus some of the other firms. Maybe update on the products you have in the market there. Do you think, you know, the high-profile fund gatings that have been much reported, have, you know, shifted the discussions you're having with distributors?
Sure. Let's see, where to start? We have a number of products that are already in market. We have two non-traded REITs that have, you know, good, long-standing track record and performance. Total AUM there is about thirteen and a half billion. We have a credit-diversified credit interval fund, which is about $4 billion. We have this private markets fund that I referenced, which is about $300 million, and we recently launched our non-traded BDC, with initial capitalization of one and a half billion. Call it, give or take, $20 billion in a diversified portfolio of strategies, you know, with good performance and growth prospects. You know, that's pretty meaningful, given where the retail market opportunity sits today relative to the TAM.
We have a pretty unique platform, and I've said this publicly before: the market opportunity is quite significant, but it is not available to everybody. You need the combination of people-
Mm
... wholesalers, client service folks, et cetera, that can actually service the large platforms and the RIA channel. To put that in perspective, we have probably 120 people in our wealth management business around the globe that are building product and relationships in that channel. Only the largest managers will be able to make that investment and support it through different market environments. Two, the platforms are going to require not just great service, but they're gonna require a broad product set, because the pitch to the advisor, and ultimately to the client, is invest behind brands that were, up until this point, available only to the institutional client, but you need to be able to choose where you want to invest: real estate, real assets, private equity, private credit. Then I think brand is gonna become increasingly important.
I think the good news is, we have been managing BDC, ARCC, and putting a lot of our institutional product into this channel for 20 years. You know, given all the investments we've made in people and product, we're doing it already with a lot of brand awareness in the channel. The gating, I would rephrase it, because the, the funds that you're talking about have not really been gated.
Yeah.
Right? They are structurally designed to allow for 5% liquidity per quarter for a reason. I think that the investment managers, the allocators, and the clients all recognize that if you're going to put less liquid product in a semi-liquid wrapper, that you need some mechanism for orderly liquidity, where you're not fire-selling assets to the detriment of those investors that want to stay in the fund. I think we should all be careful that we're not talking about this as gates going up, because that has a implication of underperformance that we're not necessarily seeing in the channel, and implies that somehow the funds aren't doing what they're supposed to do.
Right.
They're actually doing exactly what they're supposed to do.
Totally.
Orderly liquidity, in an illiquid asset class. Yeah, there was some disruption in the market at the end of last year into early this year because of that phenomenon. It's hard to know exactly how much of that was investor dependent. You know, there were certain geographies where investors were owning these products with leverage. They got margin called, so there's a technical-.
Right
... thing at play here that we don't quite know how to, you know, how much to attribute. Two, the funds that are seeing that occur are largely real estate-oriented, and, you know, you can't turn on the television or open up the newspaper and not see an article about all the pending, you know, challenges in the real estate market. There's also part of this that is probably just a commentary on people's appetite for CRE exposure. When we look at the experience that we're seeing in the BDC, as an example, I don't think that this is an indictment in the opportunity in the channel. I think you're gonna see rotation away from certain brands to other brands, away from certain asset classes to other asset classes, and we'll keep growing through this.
No, that makes sense. On the non-traded BDC launch, you know, I think it's launching... You obviously have a great brand name, but it's launching in a fairly crowded market of, at least on the surface, what look like similar products. How do you think that can differentiate itself from all the other non-traded REIT products, you know, being sold to retail investors right now?
Well, we're gonna find out.
Yeah.
It's always hard, because I'm totally immodest. We are by far, in my opinion, the best BDC manager in the market.
Right. Yeah.
We have a 20-year track record of outperformance at ARCC. We've, you know, grown that business through various cycles, and I think we've earned a lot of credibility, not just in the private credit markets, but in the BDC structure. While we've been slow, again, back to some of the ways we think about business building, to bring the non-traded BDC into the market, I would say that people have been hoping that we would, for those that wanted to access our capability, in that form versus the traded form. It's still early. Obviously, we'll keep you all posted, I think our brand and track record are pretty unique.
Yeah.
Again, while the market will seem crowded, and I don't want to sound disparaging, putting a fund in the channel and scaling it with good performance is different than registering a fund. We're in this moment in time now where, I get this question a lot about private credit, "There's all these people raising private credit. How are you gonna compete? There's all these BDCs." The reality is, you have a lot of people, rightfully so, given how attractive the asset class is, are raising their hand to, you know, try to be in the business, but that doesn't necessarily translate into $ raised and sustainable growth, and you have to kind of look at it through that lens, as opposed to the number of people who are raising their hands.
I think there are a lot of funds that are either in the market or registering, but I'm not quite sure that they are going to scale.
Yeah.
Time will tell.
That makes sense. I have one from the audience on the pad here. Kind of goes back to what we were talking about at the beginning, but in terms of underwriting, are you still seeing a lot of cov-lite loans out there? I guess, more broadly, you know, do you feel like the market is still pretty aggressive in terms of underwriting terms, and how has that evolved?
It's a great question. The pendulum always swings from borrower-friendly to lender-friendly. We're coming off of a, you know, decade-plus, borrower-friendly market, and it has very quickly swung aggressively to a lender-friendly market. Not only are new underwritings coming in at lower leverage with higher fees and higher coupon, but the documents are significantly tighter across the board, covenant levels, baskets, et cetera. You're not really seeing a lot of that bad behavior in today's market. It's not to say that it's gone forever, because the pendulum always does swing. At least in terms of the underwritings, again, why are people so excited about this vintage? Is because you're attaching, given the debt service constraints, on the owners, you're attaching at a very low leverage level, with very high rates of return and very tight documents.
That tends to last a while, right? It will eventually swing back. The other thing I do wanna highlight, again, I've said this before, Covenant-lite has not demonstrably underperformed covenanted loans. It, it's not something people wanna hear, because it sounds like it's just bad underwriting and bad risk-taking. You know, if you look at how Covenant-lite loans performed in prior down markets, they've actually done as well, and in certain cases, better. The reason is, number one, only the best borrowers and the best owners tend to be able to access Covenant-lite loans. There's a, you know, a positive selection bias.
Right
in terms of who gets those structures. Two, a lot of value destruction within the credit markets generally happens when you have a syndicate of borrowers with different structures, different agendas, and therefore, a different path to value creation. When you have covenant-lite loans, what it actually forces people to do is to freeze in place, and it allows the owner of the business, the management team, to actually maximize the value of the enterprise for the collective good of the equity and the lender. Sadly, I, you know, I don't want to say this is true for a lot, but sometimes lenders don't act in their self-interest.
Right.
You know, a lot of times, the covenant-lite loans are actually getting resolved, you know, to the benefit of the lenders, even though the equity is driving the outcomes. It'll be interesting to see how that plays out in this cycle, because a lot of these loans are owned in CLO structures.
Yeah
... that can't own downgraded securities and can't reinvest into new capital structures. If we are going through a world where new money needs to come in to resolve some of these, you know, covenant-lite situations, there could be some, you know, some knock-on effect in terms of how that impacts performance of certain CLO.
Right
... managers. You know, long-winded answer, but no, the underwriting is about as good as we've seen now.
Right.
It's tightened up considerably.
Yeah, I'm hearing that from a lot of people. Let's move to capital. You've been one of the more acquisitive alternative managers over the years. Are there any major verticals or geographies that you think are still a priority, or is it really about pivoting to organic growth now?
I think all the acquisitions we made have brought some really unique capabilities to the table, and using the secondaries example that we just talked about, we're opening up new markets with the acquired-.
Yeah
... platforms. We do have a bias towards investing in organic growth right now. It's easier, it's a higher ROE. You know, we have greater control over outcomes. I feel like we've got a really good set of capabilities and a really broad set of markets that we can continue to drive. That being said, when you go into markets like the one we're in now, it tends to catalyze a lot of interesting conversations.
Mm-hmm.
you know, managers who are poorly capitalized, or their balance sheet's not quite right, or they're challenged on the fundraising. you know, I think we're gonna be opportunistic if the market shows us things that are interesting and if they underwrite well, but definitely a bias towards organic right now.
Got it. Makes sense. A new one from the audience: "Is there a sustainable long-term illiquidity premium for private credit versus public liquid credit, or is competition and narrowing spreads going to eliminate that?
My own personal view is there will be a durable illiquidity premium. The premium that makes its way into these loans is illiquidity premium, but there's also what I would generally call complexity premium and service premium. Without going down a rabbit hole, when people are borrowing in the private market at, let's say, even 150 basis points over where they would execute in the loan market. You know, we've seen historically, it's been more than that, but even if it's 150 basis points, when you look at how they drive value.
Mm-hmm
in those investments, the top of the list is earnings, cash flow, NOI growth, multiple expansion because of that growth, amount of leverage, and cost of leverage is actually significantly lower. It's not to say that sophisticated institutional borrowers aren't price-sensitive. If they can get better execution and pay for the flexibility to execute the business plan,
Right
... they're gonna generate higher returns. That's, I think, why you see so many people borrowing in the private market and paying that premium over time, because it's actually value creative.
Mm-hmm.
There's another nuance that a lot of people don't talk about is, as a lot of these markets now converge into unitranche and stretch senior type loans, the borrowers get to pay down over time their blended cost of capital. Which is, in the old days, if you were doing bank bond executions or bank mezz, you were always paying down your lowest cost of capital. When you ran your model, your cost of capital was increasing over time as you were executing on your business plan. There's actually just some arithmetic that makes the private credit-
Okay
... instrument more, more accretive to the IRR in a leveraged structure.
Makes sense. Perhaps to conclude, I think a lot of people have the view that we're heading towards a recession, and in particular, through the lens of a lot of the questions we had tonight, are worried about leveraged credit. Through that lens, why do you think we should be buying your stock now? Particularly after such a good run of outperformance?
I always hate answering that because my job, and I'm a large shareholder, my job is to run the business.
Yeah, I know.
and deliver growth. I'll tell you why I think we're differentiated. I am an investor by trade. You know, there are very few businesses that I know of, and we invest in thousands of businesses, that have strong, durable, secular tailwinds of growth, right? Our market generally is growing, and we are capturing a disproportionate share of that growth. We're a growing company in a growing market. There are very few businesses that I know that generate 40% EBITDA margins with 20%-30%+ growth. That's a very unique animal, particularly when you're in a market where you are seeing secular growth tailwinds and, you know, burgeoning leadership. I think the stock has been differentiating itself, right? If you look, we've been the best performing alt.
I think we are actually the best performing financial stock.
Yeah
over the last five years.
I think, yeah.
in terms of total stock return. I think that's a reflection of really good execution against this growth model. I think right now, in this moment in time, I would just say all of that is intact, as expressed through our guidance on FRE growth, dividend growth, et cetera. Now you have this real moment where private credit and alts are in higher demand, which should drive, you know, more predictable fundraising and more predictable deployment. Again, we always think about the world through the secular and the cyclical. I think we've demonstrated now, hopefully over 25 years, that we can deliver pretty consistent, predictable, high growth. We're about to go through another transformational cyclical shift, which is gonna, you know, highlight some of the value of the strategies that we've, you know, rightfully so, over indexed to. That's, you know.
That would be my pitch.
It's a good one.
Thanks.
Thank you. Thanks.
Thanks, everybody.
Yeah.
Appreciate it. Thanks, bye.