Ares Management Corp (ARES) 2014 Q2 法說會逐字稿

Good day, and welcome to the Ares Management LP second-quarter 2014 earnings call and webcast.

(Operator Instructions)

Please note, this event is being recorded. I would like to turn the conference call over to Mister Carl Drake, Managing Director, Head of Ares Management, Investor, and Corporate Relations. Please go ahead, Sir.

Good afternoon, and thank you for joining us today for our second-quarter earnings conference call.

I am joined today by Tony Ressler, our Chairman and Chief Executive Officer, Michael Arougheti, our President, and Dan Nguyen, our Chief Financial Officer. In addition, Greg Margolies, our Head of Tradable Credit will also be on the call today and available for questions.

Before we begin, I want to remind you that comments made during the course of this conference call and webcast contain forward-looking statements and are subject to risks and uncertainties. Our actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in our SEC filings.

We assume no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results. Moreover, investors should note that an investment in any of our funds is discrete from an investment at Ares Management LP.

During this conference call, we will refer to certain non-GAAP financial measures including assets under management, fee- earning assets under management, economic net income, and distributable earnings. We use these as measures of operating performance, not as measures of liquidity. These measures should not be considered in isolation from or a substitute for measures prepared in accordance with generally accepted accounting principles.

In addition, these measures may not be comparable to similarly titled measures used by other companies. Please refer to our earnings release and Form 10-Q for definitions and reconciliations of these measures to the most directly comparable GAAP measures. I'd like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase an interest in any Ares fund.

We have also posted a new second-quarter earnings presentation under the Investor Resources section of our website at www.Aresmgmt.com which we will refer to during our call today.

I will now turn the call over to Mr. Tony Ressler, Ares' Chairman and Chief Executive Officer.

Thanks, Carl.

On our last call, we highlighted our investment thesis and growth strategy as a new public Company following the IPO in early May. Today, I'd like to start by expressing our views on the current market environment and the opportunities to raise and invest capital before I turn the call over to Michael and Dan for details about our second-quarter results and additional comments.

In short, we feel the marketplace has enjoyed very, very low interest rates for quite a while, which we believe has led to very full valuations in both the United States and Europe. We view all of our investment activities through this perspective, or as the co-heads of our private equity business say to their fund investors, quote, we see the investment universe with blinking yellow lights move slowly and carefully, end quote.

On the capital raising side of our business, there is robust demand for the strategies of each of our direct lending, tradable credit, private equity, and real estate groups. Investors of all types across various geographies are increasingly in need of compelling, risk-adjusted returns and increasingly and more frequently looking to firms like Ares with our deep expertise in alternative assets. Our investment capabilities are stronger today than they have ever been, and when we overlay investor trends such as the growing appetite for alternative investment strategies and the consolidation of relationships with proven-scaled managers, we are very excited about our ongoing fundraising prospects.

Pension funds, both corporate and public, sovereign wealth funds, high net worth clients, insurance companies, and retail investors are all consistent in their objectives, drive additional yield without excessive risk, and all four of our businesses are well positioned to continue to raise AUM from these investors. Particular growth in our mandates in the direct lending and illiquid credit markets, real estate private equity in both the United States and Europe, and tradable credits recent success in loan mandates and special situations funds are just a few recent highlights.

On the capital deployment side of our Business, finding attractive risk reward opportunities across the market cycle is why investors choose Ares. In today's world, investment returns in our alternative credit products, while they have absolutely come down as compared to our prior five years. However, please understand they remain significantly above traditional fixed income products such as high grade corporates, agency mortgages, and treasuries.

We believe our expertise up and down the credit spectrum in both tradable credit and self-originated direct lending will continue to generate attractive risk reward opportunities for our investors and partners. We view illiquid credit instruments and illiquid credit investments overall as particularly interesting given the constraints in the banking system and competitive dynamics relative to our significant boots on the ground and market leadership in both the United States and Europe.

In tradable credit, we believe our flexible credit opportunity strategy, which allows us to go anywhere across various credit strategies or categories, or as we like to say, how to earn 8% in a 2.5% 10-year treasury environment is another strategy well positioned for meaningful growth. This product is in high demand from pension funds and insurance companies seeking high single-digit returns with limited interest rate or credit risk.

In the private equity markets, values are stretched, but corporate fundamentals are strong. As of today, we have committed approximately $2 billion out of our $4.7 billion ACOF IV fund and continue to move, as we mentioned earlier, slowly and prudently. Our most recent investment in the fund is the largest veterinary hospital group in America, Private Veterinary Hospital, a defensive business with solid cash flows and significant growth opportunities. We're excited about the performance and positioning of our overall portfolio and continue to evaluate realization opportunities across the portfolio.

In US real estate, we have an experienced team focused on repositioning underappreciated cash flowing assets with an active exit environment to core buyers. We also have an excellent pan-European real estate franchise which originates a diverse set of interesting development and distressed investment opportunities. Our clients are validating these strategies and performance by investing in our latest US value-add fund and latest European opportunity fund, which Mike will discuss in more detail a bit later.

In addition to organic growth in all four of our businesses, we continue to evaluate the potential for consolidation in the asset management industry, particularly for asset managers with a single product or industry focus that would benefit from the strength of a larger, more diverse platform. Of course, there is no assurance, but we do believe acquisitions of complementary and accretive asset managers represent real opportunity for us going forward.

We have a diversified and balanced platform with four quality businesses. We also believe that we are well-positioned to continue our growth in AUM, in management fees, and of course, in annual distributions. I will now turn the call over to our President, Mike Arougheti to provide some highlights on our recent results and performance.

Great. Thanks, Tony. Good afternoon, everyone.

As Karl mentioned, I will refer to our second-quarter earnings presentation as I discuss a few key highlights of our performance. As shown on slide 3, during the second quarter, we continued to make progress on a number of areas, but most importantly, we achieved strong growth in several key metrics. Our AUM, our fee-earning AUM, fee revenue, and fee-related earnings.

At the end of the second quarter, our AUM had increased to $79.2 billion, a more than 30% increase year-over-year driven primarily by capital inflows. We had yet another solid quarter in this area with $4.4 billion of new capital flows in a range of our strategies across long-only leverage loans, including two new CLOs in the US and Europe, inflows into our high-yield and global credit op strategies, and new accounts in US and European direct lending.

We also held additional closings in our US value-add and European opportunity real estate equity funds currently in the market. Our fee-earning AUM also increased at a healthy 21% pace over the last 12 months. When we take the new capital raised against our net capital deployment and other reductions, our dry powder increased from $18.2 billion at the end of the first quarter to a record $19 billion at the end of the second quarter.

As a reminder, a significant portion of our dry powder is eligible for fees once we actually deploy this capital. For example, our total AUM not yet earning fees increased to $10.2 billion representing approximately $86 million in potential management fees that could be generated from these assets. Our assets are also growing through our investment performance which continues to be strong across all of our strategies.

In our credit funds, we have achieved solid performance in our long-only loan and high yield funds within our respective composites, generating about 6% gross returns in loans and more than 10% in high yield for the past 12 months. Our credit opportunities and special situations funds have enjoyed stronger appreciation from credit selection and improving asset prices over the past 12 months and have delivered gross returns of approximately 10.5% for credit opportunities on average to over 40% for our flagship special situations fund.

We continue to generate solid returns for our fund investors within direct lending, both in the US and Europe. For example, our public business development Company, Ares Capital Corporation, the largest in the market today, has generated a total return to its shareholders of over 13% over the last 12 months through June 30. In real estate, our US flagship value-add fund seven had a gross return of nearly 25% in the last 12 months.

Our largest private equity fund, ACOF IV, is still ramping, but it experienced net appreciation during the second quarter of approximately 5%. Long-term performance in our 2008 vintage ACOF III private equity fund remains very strong with a gross IRR since inception of over 30%. Our credit and private equity portfolios remain well positioned, generally enjoying strong EBITDA growth and very low defaults.

Our fee revenue, which is comprised of management fees and net performance fees, increased 53% year-over-year through the second quarter. Our management fees, which are derived from over 150 funds and include ARCC part one fees, increased nearly 27% on a year-over-year basis. The increase in management fees was partially offset by our incurrence of additional front-end expenses to continue to build out our infrastructure and marketing leading to slower growth in our fee-related earnings of 15% on a year-over-year basis. And, our management fees accounted for 88.5% of our total fee revenue for the second quarter.

From an earnings standpoint, we generated economic net income, or ENI, of $75.1 million, and while this was much higher than last year, it was modestly below our expectations as the timing of new fund raises, lower net capital deployment and direct lending and illiquid credit mandates, and modestly lower performance-related earnings in our tradable credit group weighed and pushed out future earnings.

Now maybe for a more detailed review of our earnings and financial position, I'll turn the call over to Dan Nguyen, our CFO.

Thanks.

Although we were not a public Company for the full quarter ending June 30, we provided pro forma information in our earnings release as if we had completed our IPO on January 1 of 2014 to make our information more useful for our unit holders and analysts. Let me start off with a discussion of the component of our economic net income.

As Mike stated, we continue to enjoy strong management fee and total fee growth from a balanced and diverse source of strategies. We have also invested heavily in new technology, new front and back office personnel, and new office location to support future growth. Although our top line has grown nearly 30% during the second quarter and year-to-date periods, our fee-related earnings have increased as a slower rate due to the infrastructure expenses, about 15% this quarter and about 1% for the year-to-date period.

The quarter-over-quarter growth in our fee-related earnings for the second quarter of about $4.1 million highlights the higher margin opportunity as we invest and raise new capital. We expect that our fee-related earnings will continue to grow from a combination of new capital raises and the deployment of our significant capital, both current and new and from a slower growth rate in expenses as the year progresses.

Our performance-related earnings have also improved compared to the year-ago period both on a quarterly basis and a year-to-date basis, but they were down slightly from the first-quarter level. Performance-related earnings were $40 million in Q2 2014 versus a negative $4.4 million a year ago. The variance was attributable to high net performance fees in our private equity group in Q2 2014 versus Q2 2013 as valuation last year were generally impacted across the P/E sector by greater volatility. While there will always be variability, we believe our performance fees can be more stable over longer periods due to our lower dependence on large private equity funds for appreciation.

As Mike stated, our second-quarter economic net income of $75.1 million was much higher compared to the same period a year ago, but it was more in line with our first-quarter level of $77.4 million due to the lower performing-related earnings. On a per unit basis, our economic net income, net of tax, was $0.33 compared to $0.34 for the first quarter. Moving to our distributable earnings, we reported $48.5 million on a pretax basis compared to $54.5 million in the first quarter and $67.8 million a year ago.

In the second quarter, we did not have any material exits from our P/E-oriented funds, and exit activity were also modest within our CLOs and alternative credit funds compared to a year ago, resulting in lower-than-average realized performance fees and investment income. Over the longer term, the realized component of our performance-related earnings has averaged about 70% or more for the past three years. However, in the second quarter, our realization components was only 50% of our performance-related earnings. Although this metric is difficult to predict, we do have good visibility on an improved realization pipeline based upon quarter-to-date exits, and we expect new fundraising and deployment to continue to improve our fee-related earnings.

Now, let me move you to distributions. Second-quarter distributable earnings, allocable to 38% attributable to common unit holders, was $0.18 per common unit, net of tax. This morning, we announced an $0.18 per common unit distribution for the second quarter. While this amount was above our stated 80% to 90% range of distributable earnings, we are comfortable with the full payout, given our lower second-quarter distributable learnings and our solid visibility for third-quarter realizations.

Lastly, our balance sheet is a great source of our strength, and we believe it provides us with optionality to make potentially accretive acquisitions and investments. As of June 30, we had about $87 million in cash, $848 million in available capacity under our five-year $1 billion revolver.

In addition, we have over $585 million in investments and in our own funds, many of which are in generally higher returning strategies. In fact, the return on our portfolio investment have been quite strong at over 10% year-to-date through the second quarter. We believe these investments will provide another attractive source of income for our unit holders over time. Finally, we are pleased that we received an A minus rating from Standard & Poor's following our IPO giving us additional potential options for raising attractive, long-term capital to support our strategic growth initiatives.

Now, I will turn it back to Mike for some additional thought on recent fundraising activities and closing remarks.

Great. Thanks, Dan.

Looking out to the third quarter, we're continuing to have strong success on the fundraising side. Our BDC, Ares Capital Corporation, completed an equity offering in July raising $258 million. In early August, we priced a $1.26 billion CLO, the largest in our Firm's history, and we believe the second-largest CLO since the financial crisis and clearly one of the largest-ever transactions. We are also experiencing strong interest in our fourth flagship special situations fund on the heels of strong performance for our third special situations fund, which was up over 40%, as I mentioned before. In fact, last week, we held our first closing of over $700 million in our fourth special sitz fund as we work towards our target of $1 billion.

Our two most recent real estate equity funds, US value-add and European opportunity, have received about $500 million and $650 million in commitments respectively relative to their targets of $750 million and $1 billion with final closings all expected by year-end. We are also in active discussions with investors for European real estate debt opportunities, long-only loans and high yield, credit opportunities, and European direct lending. Within private equity, we expect to be fully invested in our first Asian private equity fund shortly, and we are planning to launch our second Asian private equity fund by the end of the year.

Needless to say, we are excited about our position as a global alternative asset manager with market-leading, highly collaborative, and integrated investment groups. We believe that we are well positioned in the fastest growing segments of the alternative sector, have a terrific and long-tenured investment team in place, and possess a loyal and growing base of diverse investors.

Our investment strategies give us the ability to be flexible and balanced so that we can take advantage of investment opportunities regardless of the interest rate or market environment. We are experienced distressed investors, and we're well positioned across most of our strategies to take advantage of investment opportunities arising from volatility or a serious market downturn. This balanced and flexible strategy has served us very well in the past and should hopefully do so going forward.

Hopefully, one can see from our top line growth that our underlying earnings power is very strong. Our fundamental strengths of raising and investing capital have never been better over our 17-year history, and we've scaled our infrastructure, geographic presence, and investment platform. We have $19 billion of dry powder, a large portion of which will drive new fees, and our balance sheet gives us great flexibility to pursue exciting opportunities to expand our Business into complementary strategies and to make potentially very accretive investments. As Tony mentioned, our goal is to continue to provide a stable and growing profit and dividend stream over time for our common unit holders, and we believe that we've built the foundation for higher margin growth in the future. With that, I'd like to thank you for your time and support, and thanks to our dedicated employees around the globe for all of their continued hard work and effort. And, we would now like to open up the line for Q&A.

(Operator Instructions)

Michael Carrier, Bank of America Merrill Lynch.

Maybe first on the DE distribution outlet, just given some of your color on the third quarter looking more promising than the second quarter? You gave some incremental color on the fundraising in terms of what has happened in the third quarter.

I don't know if you can provide any granularity on the distribution outlook? Either things that have happened or things that are in the pipeline so we can get some sense of why the more favorable Outlook?

Sure. Obviously, as we've talked about in the past, distributable earnings can be somewhat lumpy quarter to quarter. We do encourage people to look at long-term trend lines in terms of the distributable earnings. In terms of visibility into Q3 and some of the activity that we've had post-quarter date, as we've mentioned, we've had a number of funds in our tradable credit group that are giving us very good visibility into the third-quarter distributable earnings.

It is currently our expectation that the DE should return to our historical average level starting in Q3. As you highlighted, given the assets under management trajectory that we have given our fundraising momentum, I'd expect that growth rate to continue into Q4 as well.

On the incentive income or the performance fees, it looked like the comp ratio is a bit on the higher end, and I know the mix can fluctuate that around. In terms of Outlook, is there any range of where that can fluctuate from quarter to quarter depending on if the performance fees are coming from the private equity or real estate business versus direct lending or tradable credit?

I think you highlight mix. Generally speaking, we're formulaic and consistent in the way that we have our payout ratios and comp structured around incentive-generating funds. Some of our funds, i.e., our private equity funds will have higher payout ratios than some of our tradable credit and direct lending funds.

So mix will generally impact it. But, generally speaking, we should see ourselves somewhere in the 60% to 80%-type payout range depending on the fund structure.

Last one, on two components. But, on the fee AUM and in the incentive AUM. I think for both of those buckets you have some future potential. I think you mentioned a $10 billion of capital that's not earning fees yet, and then on the incentive AUM, you report the eligible universe is what's earning, I think it's about a 55%, 56% ratio currently.

On both of those, is there any way to give some granularity, some color on the timing of increases? Or, what can be the potential catalyst for the fees to start to kick in, obviously, as you deploy? Or, on the incentive AUM if there's new funds that will eventually be incentive-generating? Or, if it's performance and so once the funds cross a hurdle -- just to get some insight on where those numbers could go?

I don't know if people have the slide show, but it may be helpful to look at page 5 of the slide deck if people have it just to get a sense for some of the numbers that you just rattled off. Clearly, as I mentioned, we have significant momentum in fundraising, both in our SSF, special situations funds, the soon-to-be-launched Asian private equity fund, and a lot of momentum in our P/E and incentive-generating real estate funds.

If you look at the growth in incentive-generating AUM, obviously we're showing good sequential quarter-over-quarter growth and good year-over-year growth. But to your specific point, if you look at the incentive-generating AUM as one example, our fourth private equity fund ACOF IV, which is a $4.7 billion fund -- given where is in its life cycle is actually just at the hurdle. As I mentioned, it is performing very, very well from an IRR standpoint.

It is just at the hurdle so you'll start to see some of the P/E-style funds roll into the incentive-generating category as they mature so I'd expect to see that percentage go from that to mid-50% range obviously to continue to increase as those funds develop.

Ken Worthington, JPMorgan.

Maybe to hit the other topic, investing the capital. About $19 billion of dry powder at work. I think in your prepared remarks you talked about the low rate environment and the credit environment that we've heard in many places is quite frothy right now.

So, how do see the pace of putting that $19 billion to work? And then, would love to hear your Outlook for the credit environment, say over the next 12 months, and how that will factor into how you deploy the capital?

I guess maybe I will take a crack, and maybe Greg, you'll help out. I think from a pace, we're finding assets certainly to invest in -- what we tried to highlight on the call -- clearly in both tradable credit and self-originated, direct lending, spreads have come in a bit, but we're still seeing our tradable credit business, and direct lending business. Greg, I'm not sure if you'd agree.

I would, and just as a follow up to that, I think what we are seeing on the tradable credit side, we continue to see what would be selective in how we are investing in both leverage loans and bonds. Obviously, we take a specific duration view given the potential for rising rates, and we're managing through that well for our clients.

Our view for the next 12 months or so is to continue to find high-quality franchise credit that we can invest in that are more defensive in nature, but setting ourselves up for over time, a potential credit cycle and having the liquidity and available capital to take advantage of that over time, as the market will eventually bifurcate into a more traditional credit cycle of both performing assets that are available and attractive, and potential stressed or distressed assets that are available as well.

Just as tradable credit has, if you will, widened its fairway in special situations to include US and European assets to include certainly, European non-performing loans, as well as traditional distressed and post-reorg equities. So, widening the fairway is part of the process.

One, maybe two on ARCC. You made some management changes within ARCC. Maybe talk about the catalyst there? And then, investment income was down for ARCC in the quarter. Maybe talk about the dynamics there and the positioning -- well, you talked about positioning. But, the dynamics for the quarter in ARCC?

For those of you who don't know, the management changes that are being referred to, is that on our most recent earnings call, we made an announcement that I moved from being the CEO of the BDC to become Co-Chairman. Obviously, I'm still very actively involved in that business given that, that's where my roots are, and my very long-time partners and friends, Kipp deVeer, Mike Smith, and Mitch Goldstein were all elevated to the roles of CEO and Co-Presidents, respectively.

The catalyst really is the natural evolution of leadership in any business. I had been running that Company for 10 years. Obviously, I'm spending a significant amount of my time now at Ares Management. But, to make sure people understand, Kipp, Mike, and Mitch as well as the [DE] team of 125 people below them have been presiding over the growth and success at ARCC since its inception as a public Company in 2004.

Really just a continuation of how the business is being managed today, and I couldn't be happier for them and for the Company. I think it's in great hands.

With regard to the investment income, as we mentioned, this is the kind of environment where you have to be selective. When you look at deployment, whether it's in tradable credit, private equity, or ARCC, what we do think we bring is not only flexible capital to find the best risk-adjusted return in the market, but real competitive advantages in terms of our unique origination and size.

When you look at ARCC, as we communicated on the call, the deal pipeline is very strong. The forward calendar is very strong. We expect Q3 and Q4 to be strong, and as we highlighted on that call, a lot of the softness that we saw in Q2 frankly was a factor of timing.

We had a number of refinancings that showed up in the portfolio early in Q2, and we had a very backend-loaded deployment pace in ARCC, specifically in Q2 as well. When we look at the run rate for Q3, we're pretty excited about what's in store for ARCC.

Chris Harris, Wells Fargo.

I appreciate your comments on M&A activity that you might want to be looking at. I'm sure you can't talk about potential candidates, but maybe you can talk to us a little bit about some of the capabilities or strategies at Ares Management that you'd potentially like to build out or grow through inorganic opportunities.

Maybe just to take a step back and frame the consolidation discussion, and then we could dive you give you a sense as to what's on the strategic roadmap without getting into details. The consolidation trend in our industry we think is very real. It's being driven by a number of different factors.

First and foremost, as we just talked about there are meaningful economies of scale in our business. Not just in terms of how the profitability of the business develops, but in terms of how you're driving investment advantages as you grow the balance sheet and really drive synergies across the platform. There are increasing regulatory and infrastructure demands being placed on asset managers of all different sizes, and we're seeing a growing investor appetite -- particularly among the larger global institutional investors -- to invest more dollars with fewer managers I think recognizing the benefits of scale.

We're also seeing meaningful trends and changes in distribution of alternatives, I think augers well for the larger platforms to take disproportionate share. What we're seeing now, and Ares is really a perfect example of this is, there are a number of partnerships and smaller but very successful asset managers that are going through generational transfers, or finding that they are disadvantaged as the market continues to consolidate and are looking to platforms like Ares where they can attach, diversify their product offering, enhance their distributions, provide more incentives, and frankly, more investment advantages to their people. This is a trend that we think we are on the front-end of and is very exciting.

In terms of how we think about M&A and the filters, clearly anything we do from an M&A standpoint needs to be accretive, and it needs to be accretive not just from a financial standpoint but from a cultural and human capital standpoint. As we think about acquisitions, we want to make sure that they are complementary to our existing competencies, and if they are not, obviously it's not something that we're interested in pursuing.

We do think that we have the opportunity to enhance the strategic positioning of our business by acquiring new distribution, new product capabilities, and new industries. And then, obviously, leveraging the investments we've made in our platform to drive revenue synergies there.

As we look at the four businesses that we're in today, and the geographies that we're in, we actually think that there is M&A opportunities in each of our four businesses. Areas that we are particularly excited about are expanding geographically. We are excited about continuing to expand our already strong franchise in energy and infrastructure, both private equity and direct lending.

Then, to Tony's point about widening the fairway, we think that there are a whole host of opportunities to acquire very discrete and complementary skill sets within our tradable credit group as well to grow the business. I will tell you that the pipeline of opportunities is something that we are quite pleased with just in terms of the amount of potential M&A activity that is out there for us.

Just to pile on a little bit with Mike. Obviously, accretive and complementary is the focus we have in any acquisition, but the ability to create flow for our direct lending businesses, or widen the fairway of what our tradable credit business can do through these type of what we define complementary-type acquisitions. That's the benefit -- that's the revenue enhancement that we see and have experienced in prior acquisitions.

Just a quick follow-up on fundraising. It's a numbers question. If you had to aggregate everything you have in the pipeline right now, could you help us out, maybe giving us a ballpark figure of what you'd anticipate raising over the next couple of years?

It's hard for us to do that simply because again it's lumpy depending on how the cycle develops will affect timing and what products we are actually in the market with. I would just simply say as we talk about our strategic goals of the business, our hope is that we can continue to grow each of our businesses. Our hope is that we can raise at least $10 billion a year in assets across the platform, and to frame that then, it would also be our hope that we could double the size of our business over the next five or six years.

It has been our experience, frankly, if you look at the historical growth rates, that we've grown our assets under management 31% CAGR over the last 15 years, and we've actually seen accelerated growth through market downturns. So, if you look at the 2007 to 2009 timeframe, we actually grew our AUM closer to 40%.

How this cycle develops, frankly, is going to have a little bit of an impact as to what funds we're raising and when and the magnitude of those funds. But generally speaking, that $10 billion a year and doubling over the next five or six years are good ways to think about the growth opportunity.

(Operator Instructions)

Marc Irizarry, Goldman Sachs.

Mike, can you give us some perspective on tradable credit, the distributions this quarter? And, I guess what you see so far in the first half?

How far along are you? I guess you have 71 active funds in tradable credit. But, any perspective on which funds have been in distribution mode, and how far along are you in terms of distributions from those funds?

Why don't Dan and I kick that off, and then I will turn it to Greg just to talk about generally the lifecycle on some of those funds. When you look at the number of active funds within tradable credit. Clearly, there's a lot of refinancing, repayment, extension into new funds, et cetera. It's probably our most active business just given the diversity of fund structures.

When you look at what has been going on there both Q2 and Q3, we are seeing a fair amount of activity within our existing CLO book, repositioning it into new CLOs. We're seeing a fair amount of activity within some of our leveraged loan mandates. On the cusp of building out our fourth special situations fund.

Clearly, we're starting to see some liquidity within our third special situations fund. The good news is that within the tradable credit group, we have such a diversity of funds and investment strategies that the distribution and the liquidity are actually coming from each of those products and each of those fund structures.

I don't know Greg if you want to tack onto that?

I completely agree. The word I would use is organic, and diverse -- it is going across all of our funds. As you can tell, we've had quite a bit of success raising new CLOs, refinancing old CLOs, and also adding new capital to CLOs. So, we're seeing realizations within the loan-only side as we refinance, reposition.

We are also seeing it across our alternative businesses. We are both successfully unwinding alternative funds profitably, but also raising substantial new alternative funds as people are asking us to raise the kind of dynamic capital that's required for this market. It is across all of our product base.

Broadly in terms of the markets, obviously there's concern about high-yield outflows. I'm curious what you are telling your LPs in terms of the opportunities for high-yield bond investing and just broadly across credit. As rates rise, do you expect to see more opportunities in the 15% to 18% category rear their head? Or, maybe you can give us some sense in terms of what you've seen recently with some of the dynamics in high yield.

Clearly, we've seen a substantive outflow in the high-yield market. Last week was at slightly over $7 billion outflow, which was the largest outflow on record. The prior record was $4.6 billion, and for the last four weeks, it's $12.6 billion of outflow. Clearly, there has been a retail outflow in the high-yield marketplace and that's backed up, spreads between 75 and 100 basis points in the market.

What's interesting, however, that's all happened with the 10-year being flat to slightly higher at 2.4%, 2.435%. It has not been rate-driven. It has been more liquidity- and headline-driven. Not specific credit-driven either.

Our view is that there are two trends that are important for investors to keep in mind. One is, and we said this many times in the past, which is the ability to be dynamic as you allocate across capital. Whether it be loans or bonds, up and down capital structures, across geographies.

Given the volatility in our market today, as they will be going forward, having that dynamic capital is extremely important to manage both credit and duration risk. And, that is a message that is clearly resonating with our investors, and the ability to do that with lower volatility in a 2.4% 10-year, to be able to earn a 6% to 8% rate of return by dynamically allocating capital. That's the message to our investors. It is working, and we are raising substantial capital. In that matter.

The second portion of it is positioning ourselves for a potential downturn -- credit cycle downturn. We don't see a tremendous [mass] systemic risk, but we definitely see potential credit risk in the markets. And therefore, we are out raising more credit opportunity capital as well as special situations capital to take advantage of that potential credit cycle, and we will be able to invest in some of those parts of the market that do turn stressed or distressed.

I think we could also add, Greg, in our tradable credit business and our direct lending business, something in the neighborhood of 75% or 80% of our assets in tradable credit are in fact floating rate. I think it is North of 90% in our direct lending business floating rate. So, please understand, the difficulties in the long-duration, fixed-rate market actually does not hurt our business but does create some buying opportunities from our perspective.

Bulent Ozcan, RBC.

Quick question on the opportunities at, here in the US for direct lending? Could you touch upon regulatory changes that you are anticipating? And also, accounting changes that might serve as a catalyst for the business in the US?

Just a quick clarification. When you talk about the regulatory changes, are you talking about the BDC-specific changes? Or, you're just talking about bank regulatory changes more generally?

BDC as well as bank regulatory. There was some news out that there's going to be some changes in terms of how banks recognize future losses on their loans, and my thinking would be that it might serve as a catalyst for business. But, I'd like to get your perspective on that?

Without going into excruciating detail, I'd say generally and it's not just limited to the United States but our direct lending business in Europe, as well is a big beneficiary of regulatory headwinds in the banking system. Starting with Dodd-Frank and Volcker. Moving towards the implementation of Basel III. Moving then towards the OCC leveraged lending guidelines.

There's just a lot of challenges within the bank community today to hold SME and below investment grade cash flow credit. We're also seeing parts of the direct lending space open up to us that we are attacking with our growing commercial finance business and the specialty asset-based lending markets, as well as the asset-oriented lending markets. We see that as a big growth opportunity.

When you look at those headwinds, we don't think that this is a short-term phenomenon. We think there has been a fairly long-term secular shift for the types of assets that we're underwriting and originating outside of the banking community.

In terms of a specific catalyst, we've talked about this before, and there can really be no assurances that it will happen, but there's a fair amount of momentum on new proposed legislation within the House of Representatives to increase the regulatory leverage limit within the BDC structure from 1 to 1 to 2 to 1. Clearly, if that were to happen, it would create a very significant growth opportunity for our flagship BDC areas capital Corporation. The regulatory opportunity, if you will, is very significant for us.

Patrick Davitt, Autonomous

As an extension of the direct lending question, more specifically on Europe, which is a more nascent business, I guess, in the direct lending world. Could you talk about maybe how the deal flow has evolved post-AQR? If you're starting to see a pickup in deal flow, and maybe give us an idea of what inning you think you're in, in terms of the scaling of Europe relative to the US?

Maybe let me frame what we have in Europe, how we think about it. And then, maybe Greg can fill in a little bit on some of the specifics of what we're seeing in the more liquid markets.

Europe -- I wouldn't use the term nascent. We've meaningfully been in Europe since 2006. We have over 100 people on the ground there. We have assets under management. Now, we're approaching $15 billion across each of our strategies.

What I would say generally, what we think we've done well in Europe, is we brought the same integrated platform that we have in the US across our four businesses into Europe to drive sourcing and investment advantages, and we've positioned ourselves to be active in the primary and the secondary markets -- self-originating direct lending flow, self-originating real estate private equity flow. But also, using our capabilities in tradable credit to take advantage of assets as they are coming out of the banking system.

We are in the early innings in terms of the resolution of the economic and banking challenges that exist in Europe. We talked about this on the last call though, the one thing there that think most people have been a little bit surprised at -- it hasn't necessarily affected our business from the same extent that it has affected others, is the pace with which certain types of assets are leaving the banking system has probably been slower than some people would have imagined, as they continue to raise capital behind that opportunity starting a couple of years ago.

Again, I think the good news for us is we have very significant front-end primary market origination capabilities, so to the extent that the assets aren't actually coming out in the secondary market, we're taking advantage of the bank illiquidity and the bank de-risking by self-originating the product across the platform. I don't know, Greg, if you want to tack on a little bit?

One tack-on there is -- agree, and the biggest change we've seen in the course of the last six months is finally seeing, to what Mike's point was on the performing or nonperforming asset side, coming off mostly non-corporate -- coming off the banks' balance sheets in Europe. It has been well talked about for the last five years with much ado about not much. But, we have seen a substantial increase in our pipeline on the nonperforming side, coming off the banks' balance sheet with [the most] diversity we've seen in terms of assets, strategies, geographies, and types of banks that are finally letting those assets go.

We're very excited about that opportunity and having the kind of broad-based, global fund that we have to take advantage of, the best risk-adjusted returns across geographies. We're really liking what we see there today.

On the fundraising side, particularly in direct lending, which I believe the majority of your AUM is in separate accounts in Europe. Could you talk a little bit about incoming demand for that product? I imagine in the separate account structure you have a little bit more visibility on mandates there? Or, maybe I'm wrong, and you can correct me if I am.

Just to clarify, the AUM in European direct lending is a very balanced combination between co-mingled funds and separately managed accounts. We raised our second meaningfully-sized, co-mingled direct lending fund last year and surrounded it with a number of SMAs. Deployment -- back to the question earlier -- deployment there has actually been quite good, so our expectation is that both the SMA and co-mingled fund business and direct lending in Europe will continue to be a meaningful area of growth.

In terms of investor demands, we have seen a meaningful uptick in investor appetite for European direct lending and self- originated credit. I think the good news for us is, we do have a market-leading position both in the US and in Europe with very developed origination teams. When you look at the European direct lending landscape in particular, that is a fairly nascent market.

It is much earlier in its development when you compare it to the non-bank lending opportunity in the US. We have a very long dated track record there and a real, we think, first mover advantage. Long-winded way of saying both co-mingled and SMA appetite for direct lending in Europe is very strong right now.

Good pipeline.

This will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Michael Arougheti for any closing remarks. Sir?

Thank you, Operator. We really appreciate everybody spending so much time with us today. Needless to say, we're very excited about the fundamentals in the business.

AUM growth of 30%-plus with a real meaningful fundraising pipeline. Fee growth of 27% with a meaningful opportunity to continue to grow that. We're just feeling really good about where the business is today. We're feeling really good about the market opportunity that lies ahead of us, and look forward to updating everybody next quarter.

We thank you, sir, and to the rest of management team for your time today. The conference call is now concluded. Again, we thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you, and take care, everyone.