Ares Management Corp
NYSE:ARES
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Ares Management Corp
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Hello, and welcome to Ares Management Corporation's Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded on Thursday, 28th of July, 2022.
I will now turn the call over to Carl Drake, Head of Public Market Investor Relations to begin. Carl, over to you.
Good afternoon and thank you for joining us today for our second quarter conference call. I'm joined today by Michael Arougheti, our Chief Executive Officer; and Jarrod Phillips, our Chief Financial Officer. We also have a number of executives with us today, who will be available during Q&A.
Before we begin, I want to remind you that comments made during this call contain forward-looking statements, and are subject to risks and uncertainties, including those identified in our risk factors in our SEC filings. Our actual results could differ materially, and we undertake no obligation to update any such forward-looking statements. Please also note that, past performance is not a guarantee of future results.
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.
Please note that, nothing on this call constitutes an offer to sell, or a solicitation of an offer to purchase an interest in any Ares fund. This morning, we announced that we declared our third quarter common dividend of $0.61 per share of our Class A, and non-voting common stock, representing an increase of 30% over our dividend for the same quarter a year ago. The dividend will be paid on September 30 to holders of record on September 16.
Now, I'll turn the call over to Michael Arougheti, who will start with some quarterly financial and business highlights.
Thank you, Carl, and good afternoon. I hope everyone is doing well. Despite prevailing market volatility and economic uncertainty, our second quarter results demonstrate the resiliency and durability of our business, highlighted by strong growth across our AUM and fee-related earnings, as well as our ability to generate attractive fund performance for our investors.
We raised $16.4 billion of new gross commitments, driving our AUM to $334 billion, up 35% year-over-year, and our fee-paying AUM was up 37% year-over-year. Our management fees continued their steady growth, up 41% year-over-year and our fee-related earnings growth was even better increasing almost 50% as we continue to gain operating efficiencies from our strong top line momentum.
Our continued growth was driven primarily by our opportunistic and diverse investing activities, often taking advantage of the retrenchment of the banks, and the public markets to provide solutions to high-quality companies and asset owners.
Our firm is structured to navigate volatile markets as we build large direct sourcing networks, coupled with flexible strategies that are able to invest across asset classes, geographies and markets.
As we mentioned on previous calls, 2022 is the year, where we're investing in our front and back office platforms in advance of our expected growth in the years to come. Yet despite adding 200 professionals in the first half of 2022, and continuing to invest in systems and infrastructure to support future growth, our FRE margins expanded to a record 40.1% in the quarter.
We recognize that investors and analysts have been concerned about the impact on alternative managers, from the more challenging market, and economic conditions, marked by high inflation, rising interest rates, and a possible recession.
We believe that, our business and portfolios are well positioned to navigate these types of risks. In fact, we have a track record of accelerated growth during past periods of economic recession and market volatility.
For example, we increased both our AUM and management fees at a compound annual growth rate of more than 25%, during both the global financial crisis of 2007 to 2009, and the volatility introduced by the COVID pandemic from 2019 to 2021.
Our goal at Ares is to perform for our investors throughout market cycles and to be able to invest opportunistically and flexibly when other market participants won't or can't. To accomplish this, we've built our business to withstand market volatility across our AUM, our revenue mix, and the composition of our balance sheet.
Approximately 64% of our invested assets are in credit investments, which provide protection from losses or declines in valuation multiples during economic downturns by generally being in the top half of the capital structures of our portfolio investments.
While every cycle is different, I would note that the direct lending asset class outperformed other credit investments such as high-yield bonds, syndicated bank loans and investment-grade bonds during the past two full cycles, encompassing the Fed tightening, recession and recovery.
Our credit portfolio also provides meaningful benefits to both our fund investors and Ares during rising interest rate environments as roughly 90% of our credit group debt assets are in floating-rate instruments. We would expect this to drive higher ARCC Part one and other credit-based incentive fees in the second half of this year.
In fact, ARCC reported on Tuesday that, a full run rate earnings impact from the recent increase in base interest rates through the end of the second quarter, could have increased its second quarter core earnings by about 11%, and add an additional 100 basis point increase in base rates from June 30, could add a 17% increase from second quarter core earnings all else being equal. As you know Ares Management would see a corresponding increase in its ARCC Part I fees.
Across the rest of our asset mix, we believe that our growing AUM and real assets, such as real estate and infrastructure will also provide meaningful inflation protection due to the built-in inflation escalators generally incorporated in these assets. Our private equity business is also differentiated with its focus on resilient industries, and flexible capital deployment across debt equity and even distressed assets which may protect our downside through dislocated markets.
I would also note that the structure of our AUM and long-dated and perpetual vehicles also provides insulation. About 88% of our AUM and 95% of our management fees are from either long-dated funds or perpetual capital vehicles.
Due to the long-term nature of this capital, we have not experienced significant redemption issues during volatile periods. This has enabled us to be patient investors and utilize the capabilities of our experienced teams to support portfolio companies during challenging times.
Having significant dry powder and access to capital is also critical to success. At quarter end, we're well-positioned with over $90 billion of available capital of which $52.7 billion is not yet generating management fees, and available to support further FRE growth when deployed.
Combining our significant dry powder with the flexible investment mandates of many of our funds, we expect to take further advantage of increasingly attractive opportunities that we believe will arise in the coming quarters as the competitive landscape potentially improves.
We believe that our management fee-centric model also provides greater stability to our realized income compared to more performance fee-based and balance sheet-heavy business models. In the first half of 2022, 91% of our RI is derived from our fee-related earnings, and this stability in our earnings has been steadily increasing over the past three years. We have also consistently generated 83% or more of total fee revenues from our management fees.
The final component of our model is our asset-light balance sheet where investments represent less than 0.5% of our total AUM. This means that we're less susceptible to changes in market values for risk assets.
Putting this all together, we believe that Ares is well-positioned to continue its strong growth with our fee-related earnings and our common stock dividend increasing at least 20% per annum through 2025.
From a fundraising perspective there's been a lot of discussion about the more difficult institutional fundraising environment caused by the denominator effect as the value of public equity and fixed income portfolios have traded off substantially. We have not seen this impact in our fundraising to-date and we feel very good about our future fundraising pipeline.
During the second quarter, we continued to see strong demand across our investment groups raising $16.4 billion of gross commitments across more than 15 different funds and numerous SMAs, including more than $5 billion of capital raised in our perpetual capital vehicles.
As we look forward in addition to our ongoing fundraising activities, we expect to begin another commingled flagship fundraising cycle with four of our largest fund complexes launching successor funds in the second half of this year targeting first closings in 2023. This includes our seventh corporate private equity fund, our sixth European direct lending fund, our second flagship closed-end alternative credit fund and our third U.S. junior capital direct lending fund. We also expect to follow up with our third US senior direct lending fund next year.
We continued our momentum with retail investors in the second quarter raising over $1.6 billion in the retail channel. Our retail channel AUM now stands at $57 billion at June 30. With respect to Ares Wealth Management Solutions, we continue to expand in a variety of ways as we see a significant opportunity to gain share in what we believe is a multi-trillion dollar market opportunity just in the next several years.
As a global leader in credit and real assets, we believe that we're uniquely positioned to gain share with high net worth investors through our growing suite of income-generating, less volatile non-traded alternative investment products. We've added a senior leader in Asia Pacific and we will be adding a senior leader in Europe shortly both of whom are focused on helping us expand our retail distribution globally.
We're also adding additional resources to our 108 professionals globally expanding new products and increasing our distribution channels. We continue to make progress with our distribution here in the US market and we expect to add one or more new wirehouses for our non-traded REIT distribution in the second half of the year.
And on the new product front, we launched a new secondary private markets fund with more than $250 million of capital during the second quarter and we remain on file with a new non-traded BDC.
Our deployment activity in the second quarter highlights the power of the size, diversity and scale of the platform that we've built over the past several decades. Although private credit and private equity market volumes were generally slower in the second quarter, we had our second largest deployment quarter to-date as we stepped in to gain share in these large addressable markets.
We invested $24.1 billion in the quarter, well ahead of the $16.3 billion that we deployed in the first quarter of the year. We saw strong deployment across our US and European direct lending businesses, totaling $7.7 billion and $3.8 billion respectively, as we focus on the expansion needs of our incumbent relationships and larger higher-quality companies, which saw access to private capital while banks retrenched and the capital markets were largely closed.
We believe that this compelling environment could continue for some time as many banks and traditional capital providers are generally risk-averse during dislocated markets. In private equity, our special opportunity strategy was very active, deploying $1.7 billion in the quarter as the market environment opened up new opportunities.
Of note, our ASOF team has one of the largest investment pipelines that they've seen to date, finding new opportunities in the liquid secondary market as well as a large pipeline of private opportunities in companies seeking creative capital solutions. Our alternative credit business, which also invest opportunistically in diversified portfolios of cash flowing assets also deployed $1.7 billion taking advantage of increased demand for private capital across their target sectors due to a pullback from traditional capital providers.
Our real assets group deployed over $5 billion of capital including over $2 billion across our non-traded REITs and $2 billion in our other real estate funds largely maintaining our focus on industrial and multifamily assets. Our newly acquired infrastructure debt business was also active investing nearly $750 million of capital in the quarter. We invested over $800 million through our secondary solution strategy.
Interestingly, some of the denominator effect issues I referenced earlier are creating an increased need for portfolio management among private asset owners, which we expect to contribute to an acceleration of secondary transactions. In terms of fund performance, results remained generally strong in the second quarter as cash flow growth trends continued and we didn't see meaningful signs of fundamental weakness in our portfolios.
The standout performers for us in the quarter were our US real estate equity strategy, which generated gross returns in the second quarter and last 12 months of 5.1% and 54.9% and our European real estate equity strategy, which generated gross returns in the second quarter and last 12 months of 5.3% and 20.3%.
Our non-traded REITs also continued to generate strong income and returns with second quarter net returns for AI-REIT of 6.3% and 3.1% for AREIT. Our US and European real estate portfolios continue to benefit from the overweighting of the best performing industrial and multifamily sectors with significant underweight in office, retail and hospitality.
Of note, our $7.6 billion Ares Industrial REIT, which is a good proxy for our US industrial assets saw rent gains on new and renewal leases, up 42% on average in the second quarter and the portfolio was 99.5% leased at quarter end, illustrating the strong demand in the industrial real estate market.
In AREIT, our multifamily portfolio generated rent increases on new leases of 21% and on renewing leases 18% during the second quarter. We are seeing cap rates moving higher albeit unevenly across real estate property types but portfolio cash flow growth remains a strong offset in our target markets.
Within our significant funds in credit, our direct lending credit strategies continue to outperform liquid market alternatives. Ares Capital Corporation generated a net return of 1.2% in the second quarter and 13.4% for the last 12 months. Similarly, our two largest direct lending strategy composites in the US and Europe also had steady returns. Our US senior direct lending strategy had a gross return of 2.3% for the second quarter and 15.5% for the last 12 months and our European direct lending strategy generated gross returns of 2.6% for the quarter and 11.3% for the last 12 months.
Our performance benefited from our floating rate portfolios, strong EBITDA growth and our credit selection in larger companies with a focus on defensive industries. Our private equity returns were also steady, driven by strong EBITDA growth in the second quarter, partially offset by lower equity multiples.
Our corporate private equity composite generated gross returns of positive 1.5% in the second quarter and 14% for the last 12 months, while Ares Special Opportunities Fund I generated gross returns of minus 1.5% in the second quarter and 16.8% for the last 12 months. Our ACOF portfolio, particularly benefited from strong growth in healthcare services and our energy investments.
Let me now turn the call over to Jarrod to walk through our second quarter financial results in detail and to provide an updated outlook. Jarrod?
Thank you, Mike. Hello, everyone and thank you for joining us. As Mike mentioned, our second quarter results highlight the resilient nature of our business model, our diverse deployment capability, the breadth of our product offering and our excellent long-term relationships with our investors.
In the face of market volatility and ongoing economic uncertainty, we delivered robust growth in management fees, fee-related earnings and fee-paying AUM. Our fundraising also continues to be strong, with year-to-date gross inflows of $30 billion. In a softer environment for realizations, our management fee-centric business model continues to drive stability in our financial results.
Our quarterly management fees increased 41% year-over-year to $525 million, driven by continued deployment and growth in our fee-paying AUM. As Mike highlighted, 95% of our management fees are derived from long-dated or perpetual capital funds.
Our other fee income has also been growing reaching approximately $22 million in the second quarter slightly above the first quarter and more than triple a year ago. This increase was driven predominantly by property-related fees from our non-traded REITs in addition to our typical capital structuring and origination fees in certain of our direct lending perpetual funds.
In the second quarter, we generated $219.8 million of FRE, an increase of 49% over the second quarter of 2021. As expected, we had virtually no fee-related performance revenues during the second quarter. We continue to expect 90% or more of our annual FRPR to occur in the fourth quarter.
As of 6/30, the non-traded REITs had an accrual totaling $140.8 million of gross performance participation for Ares. As these funds pay on an annual basis this value is not included in our accrued net performance income or our fee-related performance revenues, since it remains subject to the fund's future returns.
However, the first half of the year for these two funds was strong and sets us up well as we enter the back half of 2022. Our FRE as a percentage of realized income was 89% in the second quarter and over 90% year-to-date.
Our FRE margin for the second quarter was a record 40.1% up slightly over the first quarter and up 150 basis points versus the second quarter of 2021. We continue to be on track to achieve our 45%-plus target run rate FRE margin by the end of 2025.
Despite slowing transaction volumes as valuations recalibrated in the private markets we still generated over $26 million in realized net performance income in the second quarter, largely from credit and real estate.
During the second quarter European waterfall style funds comprised 95% of our total realizations. Realized income for the second quarter totaled $247.2 million, up 19% from the second quarter of 2021 and up 37% when comparing year-to-date 2022 versus the prior year comparable period. After-tax realized income per share of Class A common stock was $0.74 for the second quarter, up from $0.64 in the second quarter of 2021 and well ahead of our declared dividend of $0.61.
Our accrued net performance income declined 1% in the quarter to $839.5 million due to market value adjustments and realized distributions in the quarter, but was up more than 37% over the last 12 months. Given the largely floating rate nature of our assets and our credit funds as interest rates rise, we expect to see higher rates of return over our fixed hurdle rates in these funds.
As we highlighted at our Investor Day last year we have a growing number of European waterfall funds that are seasoning. And we expect to ramp up in their contribution to realized net performance income in the years ahead with continued growth thereafter.
Looking at the realized performance income potential in our European waterfall funds over the next couple of years, we currently have $13 billion in AUM primarily from our 2017 and prior vintage funds that are generally out of their reinvestment period and are expected to have only a few years remaining on their fund life.
In these funds we currently have approximately $250 million of accrued net performance income and we would expect to ramp up the realizations of this accrued amount with the vast majority realized over the next 24 months. Of course we continue to have significant value in American style waterfall funds that are eligible for realizations as well, but the ramp in European style funds will be new for us.
Turning to our AUM and related metrics, our assets under management totaled $334.3 billion, an increase of nearly 3% quarter-over-quarter and up 35% from $247.9 billion in the second quarter of 2021. Our AUM growth was driven by strong fundraising across the platform.
Several notable fundraising highlights during the second quarter include $1.6 billion in new CLOs an additional $1.5 billion in debt and equity commitments to our inaugural sports, media and entertainment fund, $1.3 billion in inflows through alternative credit funds.
Nearly $900 million across our secondary fund and nearly $800 million in our sixth European real estate equity fund and related vehicles another $700 million in our tenth U.S. value-add real estate fund and nearly $300 million for our sixth Asian special situations fund.
Importantly, we generated these inflows without closes from any of our top five largest fund series during the first half of the year as the expansion of both our product set and distribution channels continues to increase our fundraising capability.
In addition, in light of the recent market volatility, strong client demand and improving market opportunity our second special opportunities fund has increased its hard cap from $6.1 billion to $7.1 billion. And we have a strong line of sight to achieving the new hard cap and expect to close on an incremental $1.4 billion in the third quarter.
Going forward our fundraising pipeline is very strong. And as Mike mentioned, we expect to launch four of our largest commingled fund series in the second half of this year, with first closes anticipated in 2023. I would note that the four predecessor funds raised approximately $30 billion of gross commitments. And we hope to build upon that amount.
Our fee-paying AUM totaled $211.3 billion at quarter end, an increase of more than 6% from the first quarter and up over 37% from the second quarter 2021. Our growth in fee-paying AUM was primarily driven by meaningful deployment in our direct lending, alternative credit, real estate debt and special opportunity strategies which are paid as we invest.
With market volatility likely to be a constant theme throughout 2022 and 2023, we're well prepared to invest in this market dislocation. Our available capital totaled $91 billion and we ended the quarter with $52.7 billion of AUM, not yet paying fees available for future deployment. If deployed, this corresponds to potential annual management fees totaling $505 million, which represents over 25% of our last 12 months total management fees.
Our incentive eligible AUM increased by 2% quarter-over-quarter and nearly 30% year-over-year to $195.1 billion. Of this amount, $69 billion was uninvested at quarter end which represents a meaningful amount of potential future value creation opportunities for us.
We believe our firm is well prepared for the likelihood of continued market uncertainty into the back half of the year. Our management fee-driven FRE-centric business model provides stability which is further supported by the expanding balance of perpetual capital and the long-dated nature of our funds protecting us from redemption pressures.
Our dry powder of $91 billion provides a significant opportunity to deploy in an increasingly attractive investing environment. Given our available capital position a growing balance of credit-focused European waterfall-style funds to help mitigate an uncertain realization environment and significant earnings benefits from rising interest rates, we believe we are well positioned to continue to generate strong results.
I'll now turn the call back over to Mike for his concluding remarks.
Thanks Jarrod. I believe our results reinforce the attractiveness of Ares' business model and the important role that private capital plays during times of volatility and uncertainty. As banks retrench and as the capital markets become less reliable, private capital providers like Ares step up, filling the gaps and regain market share.
In our view this countercyclicality is an attractive attribute of our business model. So, while there are clearly challenges that lie ahead, we have long tenured teams with a demonstrated track record of growth through volatile markets and while every business cycle is different and this high inflationary environment is certainly new to our economy over the last four decades.
Our experience sizable platform, portfolio positioning long-dated capital base and ample dry powder provide us with the tools that we need to generate successful investment outcomes for our clients which in turn we believe will drive impressive results for Ares' shareholders. Through these reasons that we remain confident in our growth trajectory including our longer-term AUM forecast of $500 billion or more by year-end 2025.
I want to end by expressing my appreciation for the hard work and the dedication of our employees around the globe. I'm also deeply thankful to our investors for their continued support for our company. Thanks for your time today. And operator could you please open the line for questions.
[Operator Instructions] And our first question today is from Craig Siegenthaler of Bank of America. Craig, your line is now open.
Good afternoon, Mike. Hope you and the team are doing well.
Thank you.
We wanted to start with investing. It was nice to see two back-to-back quarters of stronger deployments in credit. But can you talk about how spreads and yields on new originations today are comparing to last year across our US and European direct lending franchise?
Sure. It's hard to say exactly Craig because obviously as we're price discovering and structure discovery in the private markets a lot of it is where we attach and detach and generally where we're comfortable pricing risk. So -- but order of magnitude, if you were to look at the market today factoring in OID and credit spread adjustment and the new SOFR environment, first lien loans in the middle market are probably somewhere in the 500 to 550 range with 90 to 95 OID. So kind of pricing 7% to 875 [ph] all-in for first lien piece of paper. That's significantly wider than we saw coming into the beginning of the year.
And just as my follow-up on credit quality. How have you seen credit quality migrate across your US direct lending portfolios year-to-date? And any color in terms of nonaccruals, delinquencies, restructurings? And then a mini follow-up here but just as in the event of a covenant trip, if you've had any, what type of solutions have you been seeking year-to-date?
Yes. Kipp's on the line. I'll answer that and Kipp if you have any color chime in because I thought that Kipp did a great job addressing this on the ARCC earnings call earlier in the week. But interestingly a lot of the anxiety that people are feeling right now is forward looking into the back half of the year because if you look at our private credit portfolio the same would be true as we said in our prepared remarks for our real estate and PE portfolios.
The reality is, there's still a lot of good fundamental performance and strength. So with regard to private credit and US direct lending in particular, we talked about on the call a 16% year-over-year growth in EBITDA. So still pretty strong. Revenues are up. EBITDAs are up. And if you look at nonaccruals, nonaccruals at cost in the ARCC portfolio at the end of the quarter were 1.6% and significantly lower than that at fair value that's measured against, what would be a 10-year average of 2.5%. Now the same would be true, if you were to look at the liquid markets with the high-yield market at or near historical lows in terms of default rate. So obviously, we have to be measured as we think about credit performance going forward. But at least, as the book sits today still demonstrating a fair amount of credit strike.
Thank you. And our next question is from the line of Alex Blostein of Goldman Sachs. Alez your line is now open.
Yes, everybody. Good morning. Good afternoon. Mike, maybe just building on some of the credit discussion. I was surprised to see US direct lending and European direct lending performance being up over 2% in the quarter, relative to obviously the syndicated market being down but also some of your public peers in direct lending, some were challenging results. So maybe kind of help us bridge the gap of what drove the absolute positive returns, in a world with obviously wider credit spreads for the broader market.
And as you think about deployment, in what sounds like is still a pretty robust backdrop with you doing larger deals in this environment, how are the terms changing? So I heard you on the yield and the spreads, but what kind of protections are you guys starting to build in more to make sure that the credits you're extending will protect you in case the environment deteriorates from here?
Yes. Thanks, Alex. That's a good question. So a couple of things. One, and this is true for the credit book. It's also true for PE and for real estate, where we've talked about the fundamental performance outpacing multiple declines or mark-to-market impacts from spread widening and that's an important thing to keep in mind. So again, if you have a book that's growing 16% deleveraging in high-quality companies that are outperforming, even as spreads widen the effect of base rate increases and spreads widening mitigates a little bit. Spreads blew out a little bit more post quarter end. So some of that may be timing.
But if you were to look at the middle market index generally, for the quarter, the middle market index broadly was only down about 1%. So, I think it's important to keep in mind, when you see rapid valuation changes happening in the public markets debt or equity, some of that is attributable to a change in the discount rate. A lot of it is attributable to technical funds flow. And the reality is in the private markets. Multiples are holding up much better. And the market is just much more stable in terms of, flows and performance.
In terms of credit protection, obviously, we're going from what was a very active deployment environment coming out of the pandemic in 2021 into 2022, moving from an issuer-friendly backdrop to a lender-friendly backdrop. So that shows up in spread and in structure. And so you'll see tightening happening Alex, in every part of the credit dock from number of covenants available nature of those covenants baskets, et cetera. And I would say generally, the more prolonged the potential for stress, the tighter the docs will get.
Great. Thanks for that. And then the my second question, maybe just a follow-up around some of the comments you made around retail which sounds like the Wealth Management segment as a whole continues to be pretty strong. I think you highlighted $1.6 billion of retail flows in the quarter. Can you help unpack that a little bit in terms of, which products specifically comprise this $1.6 billion? And just what are some of the latest thoughts you're hearing on the ground from the wires and your distribution partners, given the retail channel has gotten a little bit softer overall from what obviously, was a very robust environment last year?
Yes. So, the majority of that was from our two non-traded REITs so about -- of that was from our non-traded REITs. We had close to $100 million through ATM equity issuance at ARCC and then we had about another $400 million, coming in through our diversified credit interval funds and some of the other funds that we're raising through the retail channel on the co-mingled side.
What we're seeing on the ground, it's interesting and it really depends on the product. We're not seeing a meaningful slowdown in growth right now month-over-month, which is we're happy to see that. We're also not seeing significant redemption. So if you look, at that $818 million of inflows an example into our non-traded REITs, I think we had redemptions to match that of about $38 million.
I think that's a commentary on the positioning of some of those funds. In terms of the performance, the full cycle investment strategy the lower leverage and the yield. But I think the appetite in that channel continues to be really strong across the board, for some of this alternative product. The other advantage we have, is we continued to invest as frankly despite the growth that we're experiencing we're underpenetrated, with some of these products across the wires. And so as I said in my prepared remarks, we would expect to add one or two new wires in the back half of the year, for the non-traded product, which is generally going to give us a little bit more organic growth opportunity just as we broaden out that distribution. So at least from our perspective what we're seeing on the ground is the demand is there. I think the secular trend is intact. And the redemptions are lower than I think some of our peers have seen.
Great. Thanks so much again.
Sure.
Thank you. And our next question comes from Gerry O'Hara of Jefferies. Gerry, your line is now open. Gerry O'Hara of Jefferies, your line is now open. Your question.
Great. Thanks. Sorry about that. I appreciate the color on the floor. Flagship is expected to enter the market here in the back half of 2022 and I guess early 2023 become fee-paying. Jarrod, perhaps you could give us a little sense of how we should think about kind of the trajectory on the FRE margins that would be associated with this onboarding of fee-paying AUM given that we're still quite a bit of ways away from your longer term 2025 target? Thank you.
Sure. Thanks. Good to hear from you. And I think taking a look at those coming online, obviously, as we've talked about it's not just those that give us tailwinds in terms of our margin expansion but it's also the undeployed AUM that models out to about a little bit over $500 million of management fees that will come on as we deploy that AUM. Both of those things working in conjunction, help us to reaffirm that target that we laid out there of 45%-plus by 2025.
So I think we continue to be well on pace for that this quarter. We have seen a little bit of expansion in our G&A expenses as we saw return to more normal travel behavior. And I expect that we'll see a little bit of that as we go here over the quarters. And as Mike mentioned in the prepared remarks and we've talked about before, we really view 2022 as a year where we're hiring and building up the platform for that $500 billion plus AUM business that we expect to have in the future that we laid out at our Investor Day.
So it's certainly a tailwind to it. It's -- as you know it comes on at deployment not at committed. So that will help the margin, but it will expand over time and kind of reaffirm what we've laid out in the past.
Okay. That's helpful. And then I guess Mike maybe one for you as well. I think we're all grappling with how to evaluate ESG as it kind of is an overlay or getting built into the investment process. But maybe you could give us a little bit of a reminder as to what the targets if any are for Ares as a whole, or just maybe how you're thinking about the evolution into the investment process? Thank you.
Sure. Happy to Gerry. Just to clarify when you mean targets, can you just expand on what exactly you'd like me to comment on? I'm happy to.
Well, if there's any targets that have been put forth either at a company level or within your portfolio of companies that would be helpful. And if they are not specific targets just sort of an overall approach. Anything from a color perspective would be I think helpful?
Sure. I'll try to cover a very wide-ranging topic in a fairly concise answer here. We are very committed to best-in-class execution across all of our ESG activities. And the way that we think about positioning of ESG, number one we have an ESG group that reports directly into me. I think it's a demonstration of the strategic importance of that function as we continue to develop it over time. And that team at corporate is supported by, gosh, probably close to 100 what we would call ESG champions in the field that represent each of the investment and non-investment functions as they think about embedding ESG best practices into their business.
The way we think about it in a simplistic framework is corporate sustainability is one pillar of our ESG framework and that's where we basically are looking at all things Ares as it relates to ESG. So what's our carbon footprint? What can we do to improve? And so on and so forth.
With regard to targets there, we have not made any kind of net-zero commitment. But I think over time we likely will. We just put out our first TCFD report about a month ago in our second corporate sustainability report. So if you want to dig in, you can see some of the goals that we're setting for ourselves there and that will give people a general sense for the road we're on.
We marry corporate sustainability initiatives with what we broadly call our responsible investment initiatives and that's where we're embedding ESG practices into our due diligence portfolio management and investing activities that is quite robust and is becoming more developed. Obviously, there's a significant amount of investor demand to see progress along that framework. So I would expect to see a number of our funds in the market and coming to market to designate articulate in Europe and I think you'll begin to see other products coming online in the near future, not the least of which is for example our climate infrastructure fund, which just by its very nature is right in the heart of the energy transition and all things ESG.
We have been leading in our private credit business as a very significant provider of sustainability-linked loans into the private market across the franchise. And as a borrower, we've also been a pretty significant user of SLLs in our own borrowing. And so, we're trying to lead by example in the private credit markets as well. So, this is a long multiyear journey, Gerry, but we've got it very well resourced. We've got a significant operating plan in place and I think we're executing well against it.
Appreciate the color, and apologies for the broad-based question. But, thank you.
No, no worries. I’m glad you brought that out. Thank you.
Our next question today comes from the line of Patrick Davitt of Autonomous Research. Patrick, your line is now open.
Good afternoon, everyone. So there's some press reports the last couple of weeks suggesting that some of the large private credit managers are dialing back on deal financing risk on direct lending. You obviously reported a pretty meaningful uptick there in 2Q. So through that lens, could you speak to how you're balancing the increased credit risk versus deployment opportunity dynamics, and how you see that flowing through to continued deployment here in the second half?
Sure. I think we have to differentiate between dialing back when we talk about deployment and dollars invested versus dialing back in terms of credit selectivity, structuring and pricing discipline, et cetera. So, we are absolutely dialing back as well in terms of our expected return for the risk that we're taking and the structure of that risk.
It's not showing up in the deployment numbers, because we are the largest player in the market with a broad global footprint and the ability to play up and down the capital structure in different geographies and industries. So, what you don't see in those numbers, is actually more selectivity, more structuring and pricing discipline and more price discovery as we work through the available pipeline.
The other thing keep in mind, and I referenced this in the prepared remarks is, the banks are obviously retrenching. They're dealing with a fairly sizable I wouldn't say catastrophic in any way, but fairly sizable inventory of unsyndicated exposure. That's obviously having them reduce risk appetite. The capital markets are challenged right now.
So, when we get into that type of environment, we tend to see larger higher quality borrowers that otherwise would have gone into those markets come direct to the private credit market and effectively expand the addressable market opportunity. So, that's part of, I think, what is driving the numbers in the quarter and should into the back of the year.
One thing I would highlight, when you look at our deployment numbers, we did make a meaningful acquisition of a middle market portfolio from annually in the quarter about $2.4 billion. So that skews the numbers slightly in terms of the deployment when you're just thinking about new issue volumes versus secondary.
So, I would say we are being more selective. We're being more demanding. Dialing back, I'll leave it to you as to kind of how you want to define that. But I absolutely think you're supposed to be more measured in the market that's transitioning the way that this one is.
Very helpful. Thanks. That’s all for me.
Thank you.
Thank you. And our next question comes from Finian O'Shea of Wells Fargo. Finian, your line is now open. Please proceed.
Hi, everyone. Good afternoon. Question on the fundraising headwinds. We're not seeing that in the large alternative managers as you noted. But are you seeing any fundraising challenges within middle market private equity through your lens of the direct lending business franchise? And if so, how do you see that impact playing out?
Yeah, Hi, Fin. It's a good question. I think the simple answer is yes. And we talked about it in the prepared remarks, which is everyone refers to denominator effect. But it's really a combination of numerator effect in 2021 and denominator effect in 2022. So, if you just look at it, generally speaking, over the last three years, we had very significant deployment -- probably accelerated deployment coming out of the heart of COVID, which had a lot of private equity GPs coming back to market earlier than they otherwise expected on the heels of significant performance, 40% 50% 60% type rates of returns last year. So, going into 2022, I think a lot of institutional investors were at or near their full allocation for regular way private equity. And then, the denominator effect kicks in, which makes that full allocation start to feel like an over-allocation.
Again, as I said in the script, I think it's largely for the time being a private equity phenomenon and what winds up happening in markets like that is fundraisings get drawn out, as people resolve their allocations and available capital. And then, I think other solutions for liquidity kick-in. So secondary, as an example should actually see an acceleration in demand both from LPs and GPs as people are trying to manage through the current liquidity environment. And I think creative private credit solutions the likes of which we provide through our special ops teams, our alternative credit teams, and our direct lending teams will also become a bigger factor as people are owning companies longer.
So, you referenced the larger platforms. We've been talking about this for years. If you think about the secular growth trends and also growing across the broad spectrum but the larger platforms are growing at a minimum 2x the market growth and just capturing more share of wallet and I think that will continue to accelerate, particularly in a market like this where I think LPs that are potentially over-allocated or at allocation will likely lean in on some of the more strategic GP relationships.
So, the interesting thing about our business is positioned on either side of that, right? So, if you see a modest slowdown in primary LBO activity in the middle market, you're going to see a pickup in structured debt and equity investing to resolve the in-place book of business as well as likely a ramp in secondaries.
But again, I don't think that there's anything problematic about it. We've seen it before and I think it will resolve itself. But it's definitely leading to slower fundraising for regular way PE at least in the early part of this year.
Thanks. That's helpful. And just a follow-up on real estate continuing to do very well there's very strong pricing as you outlined. Can you talk about how much as you see it how much this phenomenon has played out in terms of pricing gains as leases roll over? How will it go for the rest of the portfolio and perhaps in the future?
I think Bill Benjamin; our Global Head of Real Estate is on. I'll let him if he is -- give you his views and I can chime in with some color to the extent I have anything to add. Bill are you on?
I'm on. Thanks Mike. Across our industrial portfolio, we believe and this is about an 80 million square feet or more that our leases in place are 20% below market. And it might even be more so on the Tier 1 coastal markets. So, there has been yield expansion, prices are softening, but there's a lot of inbuilt rental growth in our existing portfolio.
And in addition in multifamily, our second largest holdings, we are seeing new leases again at double-digit increases to outgoing leases whether it's an incumbent tenant or a replacement tenant for vacancy. So, we feel the rental story in our two major asset allocations is very much intact which will support values even as cap rates rise. There will be a moderating.
We hit 2021 was a 20% year 20% growth in asset values in the major markets. We don't see that being sustained by any sense. But rents will support the values we have. And we continue to be underweight the very challenged sector of office. We're seeing some come back in retail, but we only have small holdings there.
And one thing I would also maybe just to add -- one quick addition which I think is just important for people to keep in mind. If you think about past real estate cycles and where we've seen distress, they've largely occurred in markets and situations where the market was oversupplied. We are in exactly the opposite situation. So, even before we got into supply chain constraint we were in an appropriately if not undersupplied market.
When you factor in supply chain constraints and inflation on raw material inputs the time to deliver new product into some of these undersupplied markets and the cost to deliver product into these undersupplied markets obviously makes the value of the in-force real estate just that much more attractive.
So, it is a slightly different dynamic that exists today in most of the markets that we play in that I think people are used to seeing through the lens of historical cycle. So it's also less leverage. We're seeing less for selling. So there's just a lot more stability in the market than we would have seen in prior cycles.
Thank you. And our next question of the day comes from Robert Lee at KBW. Robert, your line is now open, would you like to proceed?
Great. Thanks. Good afternoon everyone. Thanks for taking the questions and answers. I know it's still a small business and really just getting off the ground. But can you maybe update us a little bit on the speed? I believe it was this year it was going to -- you had mentioned it was talked about starting to actually originate and underwrite business and it's certainly a pretty strong environment for fixed annuities given the rate environment.
So, you maybe just update us on progress there maybe how we should think about that maybe starting to contribute to asset growth?
Yes, sure. Thanks for the question, Rob. So we obviously showed folks a high-level view of growth expectations at our Investor Day. And I would say we are still on that trajectory. You do have a good memory, we said that we would expect that we would begin the organic distribution of our annuity product this quarter and we did in fact doing that. So that machine turned on about a month ago and now we're starting to ramp that..
Importantly too, our reinsurance business is growing. I think at our Investor Day we talked about roughly $1 billion of reinsurance flows. That number is now $2 billion. So we're seeing good growth with the existing scenic relationships as well as the addition of new relationships, and we continue to have success on raising behind that growth largely with third-party capital. So we have hit a couple of those important milestones that you referenced in terms of turning on the organic growth engine and the capital raising and are absolutely on plan with the path that we laid out at the Investor Day.
Great. And then maybe just a follow-up. You've talked about this in the past. I mean, obviously, the last couple of years, you've significantly expanded the business through acquisitions. I know you've talked about there being a higher hurdle to future acquisitions. But just given the environment maybe some managers having a little bit more issue raising capital with -- they had some good products. I mean, do you see anything that may create opportunities over the next 18 months or so if this environment unfortunately continues, or how are you thinking about that potential use of capital?
Yes, it's a good point to make, because when we were talking about acquisitions prior to this bad market volatility, it was obviously largely about identifying large addressable markets, where we felt like we could bring some kind of strategic advantage to. And just as a quick aside, the acquisition integration and growth strategy, it's been going exactly as we hoped it would. And so the combination of the Black Creek acquisition Landmark and the AMP debt are all, I think, we're pleased to have them on the platform going into this environment.
We have seen in the past just, as a reminder, if you look at the GFC we acquired Allied Capital in 2010 and the reverberations of the GFC, we acquired ACAS, we had a number of tuck-in CLO manager acquisition. So our historical experience would tell us that when you see distress in the market in smaller less well-capitalized managers that are either having balance sheet issues or personnel issues, we'll look to transact. And so I would expect that that would happen again if this market persisted. It's still too early Rob to see that flow.
It usually first shows up frankly as portfolio acquisition opportunities or portfolio acquisitions with small team lift outs as opposed to platform trades. But if it persists and is prolonged I would expect to see some things get catalyzed and I would expect that we would get calls on those, but I think that's still a ways away.
Great. That's all I had. Thanks for taking my questions today.
Thanks, Rob.
Thanks. And our next question is from Adam Beatty of UBS. Adam, your line is now open.
Thank you and good afternoon. I wanted to ask about competition in terms of deploying capital in two areas: direct lending and real estate. On the direct lending side, it sounds like banks kind of pulling back has given you an opportunity, maybe for some new issuer or borrower relationships. I'm just wondering, how much competition you're seeing there obviously not from banks, but maybe from other alternative managers or what have you? And also in real estate the themes of kind of multi-family, industrial logistics are pretty familiar. So just wondering as you go out for those assets the competition, you're encountering in that area and how you're dealing with it? Thank you.
Sure. I'll give a general overview for both, because I think the answer is the same. And I apologize for kind of grossly oversimplifying. But we just finished talking about the consolidation of dollars with fewer managers. The reality is as that continues to play out large players like us have come to realize that scale is a huge benefit and driver of positive investment outcomes and growth.
And the reason is, we just frankly have more people against more markets with a better toolkit that's more relevant to more people in the market. And so we're capturing disproportionate share. And so the origination engine is a huge advantage. The capital scale and flexibility is a huge advantage. The portfolio management investment is a huge advantage. The information that we're able to pull across all these different markets.
So the simple answer is, while there's always competition, the larger we get, the more entrenched our relationships become, the more we're able to outcompete people for higher-quality assets. And that's true in direct lending and it's true in real estate, in a market that is consolidating, whether you're talking about brokers, banks, sell-side advisers, they're consolidating as well. And I think that means that, while there is continued flows into the market, I would expect we'll see just a disproportionate share of that flow and disproportionate share of the investment opportunity.
Direct lending is a little bit unique relative to real estate in the sense that, as a lender, versus an equity investor, we're able to monetize incumbent relationships within the portfolio much more actively.
So if you look at our private credit books, 50% to 60% of our deal flow is typically coming from incumbent borrowers. As we continue to build specialty lending verticals like technology, software, sports media and entertainment, life sciences, they start to grow the non-sponsored side of the business, which is also a way to mitigate any marginal competition that we feel. So we're seeing over half of our flow in largely noncompeting situations just monetizing the existing relationships we have.
On the equity side, when we talk about real estate, we don't have those incumbent lender relationships. We have those incumbent broker, operating partner, bank relationships that also drive disproportionate flow. And I think we're not alone in that. I think the other large-scaled alt managers would tell you that they're having a similar experience.
Got it. Makes sense. Thank you, Mike. And then just one quick follow-up on -- you talked a little bit about the potential increased opportunity for secondaries, given need to rebalance, reallocate, manage portfolios and what have you. And not to be hopefully too picky, but the way you phrased it with a little more future tense than I might have expected, like, sort of expect to contribute.
And I might have thought that it would already sort of be quite active. So maybe I'm just picking on your words, or is it that there's demand, but the deals haven't come together yet? Just, how are you seeing that? Thanks.
Yes. No, I appreciate it. I don't think you're picking on my words. It's actually, it's both, right? So when we talked about the opportunity in secondaries leading up to this year, we were talking about a broad secular growth theme, which was being driven by a move from LP-led deals to GP-led deals, globalization of the business and move away from private equity transactions into real assets and credit. So there's this broad overarching secular growth trend which is still intact.
What I was really referring to now is, there should be an accelerated cyclical growth opportunity because of this issue of overallocation in certain pockets of the market. And so, both for LPs looking to free up liquidity to invest into this vintage, or GPs who need to extend the life of their existing portfolios, I think, you'll see secondaries both on the LP side and the GP side benefit.
So I think, for me, it's not picking the words. It's really secular versus cyclical. I think, now we have a cyclical opportunity that we'll just amplify the secular trend that we've been talking about for the last couple of years.
Got it. So a couple layers there. Thank you. Mike. Appreciate it.
Sure. You got it.
Thank you. And our next question of the day is from Michael Cyprys of Morgan Stanley. Michael, your line is now open, if you’d like to proceed with your question.
Great. Thanks for squeezing me in. Just a quick question on the AMP and infrastructure debt platform. I'm just hoping you could update us on the progress of the integration, how that's progressing and what sort of initiatives are underway to meaningfully scale that business. Thank you.
Sure. We can't comment on any specific fund raise, but what I will say qualitatively is, the integration could not be going any better. As we talked about when that acquisition was made, what we loved about it was, we had a market-leading team that was already scaled with an institutional quality track record and investor base.
And the opportunity to come here was to accelerate fundraising, continue to invest in growth of the platform in new parts of the capital structure and new geographies and then, to begin to leverage some of the synergies that exist with other parts of the Ares Infrastructure business. And all of that is happening and the integration collaboration has been fantastic.
So we've got really good fundraising momentum. We are adding people in new geographies, making increased investments in the European market, continuing to scale our presence in APAC and just going to be happier with the way that's going. And we'll be in a position I think to update people on the fundraising progress that we're making there next quarter.
Great. Thank you.
Thank you. And our next question comes from Kenneth Lee of RBC. Kenneth, your line is now open.
Hi. Thanks for taking my question. Just one on the fundraising for the four commingled funds in the second half. I think in the past, you've mentioned that, typically you would see anywhere from 20% to 40% in terms of upsizing for successor funds. Just wondering, if you would expect similar ranges for these four? Thanks.
Yes, Ken. I mean, that would be our hope. But I just want to highlight, these four funds, obviously, they're very meaningful flagship credit funds. And if you look at the sequential growth of the prior vintages, it's been within that range, if not better. I'm less focused on fund size and fund growth here because all of those fund products actually pay on deployment. So I think the reality is whether we grow 20%, 40% or 50%, the value contribution is going to come from bringing that liquidity on and deploying it. So yeah, we hope to see them grow consistent with our past experience, but we don't need them to grow in order to continue to deliver the types of growth rates that we've articulated to all of you.
Got you. Very helpful. And just one follow-up if I may, just back on direct lending. I wonder if you could talk a little bit more about what trends you're seeing within Europe and Asia and whether there are any differences than what you're seeing in the US on the direct lending side? Thanks.
Yeah. I mean, Europe I would say we're seeing similar trends to what we're seeing here in terms of bank retrenchment and challenges in the capital markets. Our competitive position in Europe, frankly is probably stronger, not to say that we don't have a leading US franchise as well, but we just have much less consistent scaled competition in that market. So I would say while the trends in terms of the ecosystem around us and the investment opportunity I would say that from a competitive dynamic standpoint, there's just less competition there and I think we've been demonstrating that market leadership is pretty valuable.
On the Asia side, I think you have to think about it by region in our what I would call more regular way acquisition finance business in developed Asia, largely focused on Australia and New Zealand. That continues on a good growth trajectory and is seeing similar trends to what we're seeing in other parts of the developed world. When you start to talk about what we're seeing coming out of developing Asia slightly different. Those capital markets are pretty volatile right now, you're dealing with challenges in the China bank and bond market. You've got some regional economic issues with a slow recovery from COVID.
And so that set up is different here. And obviously the direct lending market in Asia Pacific generally is just much less developed much less evolved and much less scale than this year. That's what we're excited about. But at the same time, the way that the market is developing there, it's probably a little bit more challenging from a pure direct lending standpoint than the US and Europe is.
Got you. Very helpful. Thanks again.
Thank you.
Thank you. Our next question is from Chris Kotowski of Oppenheimer. Chris, your line is now open.
Yeah. Good afternoon. Thanks. In your recent developments on Page three of the deck, you noted the launch of Ares Private Markets Fund. And I wonder can you just flesh that out a little bit in the target audience for that fund and how you're marketing it and to the extent that you can the fee structure and ultimate potential target size?
Yeah. So that is a -- we referenced it in the prepared remarks. That's actually a retail-oriented fund that we launched this quarter with $250 million of seed capital from Ares and two of our strategic investors. Similar to our other retail-oriented product, we would expect that it will get raised through a combination of distribution through the RIA and wirehouse channel. It is focused on the private equity side of the market. So if you think about our broad product offering on the retail side, we have our non-traded REIT product to deliver a broad exposure to our real estate capabilities.
We have our diversified credit tangible fund to give people access to our broad-based credit expertise and this is really an opportunity for people to get access to the private equity capabilities that exist here. The fund as it ramps will largely be focused on leveraging our secondary solutions business. But as it scales, the fund also has the ability to do direct private equity investing. And as the fund diversifies that's exactly what we would plan to do. So there's no real target per se seeing as it's a perpetual open-ended vehicle and we'll continue to ramp it the way that we've ramped our other non-traded product.
So it's evergreen? And is there an incentive or carry component to it? And does that rely on marks, or is it kind of like some of the other retail closed-end vehicles that we see where it's three-year...
Yeah, it has both management fee and incentives. I don't have the terms of that fund in front of me. I don't know if Jarrod or anybody else does that they want to chime in if not we can get you that information off-line.
And Mike, I can give the numbers. That's a standard management fee of 1.4% generally across the share type and the incentive fee is based on profits, which includes your unrealized and you can find that in the entry document that's filed with the SEC.
Okay. And we'll get those numbers quarter-by-quarter as that ramps up, right?
Yes, it will be -- it's excellent. Just like our non-traded REITs and our interval fund that will always have quarterly filings, public quarterly filings.
Okay. Great. Thank you.
Thank you.
Thank you. And we have no more questions for today. So it's my pleasure to hand back to Mike Arougheti for any closing remarks.
Great. Thank you. Thanks for all the time today. Sorry, if we ran a little long, but we appreciate everybody's support and attention and hope that everybody gets a little bit of downtime this summer and look forward to talking to everybody next quarter.
Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available through August 25, 2022 by dialing 866-813-9403 and to international callers by dialing +44 204-525-0658. For all replays, please reference access code 124972. An archived replay will also be available on a webcast link located on the home page of the Investor Resources section of our website. This concludes the call and you may now disconnect your lines.